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New Hampshire Thrift Bancshares 10-K 2006
Form 10-K for the fiscal year ended December 31, 2005
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

   23

Notes to Financial Statements

   29

Form 10-K

   51

Board of Directors

   81

Officers and Managers

   81

Board of Advisors

   82

Shareholder Information

   82

Information on Common Stock

   82


Table of Contents

Selected Financial Highlights

 

For the Years Ended December 31,

   2005     2004     2003     2002     2001  
     (In thousands, except per share data)  

Net Income

   $ 5,524     $ 5,098     $ 5,771     $ 4,300     $ 3,100  

Per Share Data:

          

Basic Earnings (1) (2)

     1.31       1.23       1.46       1.10       0.80  

Diluted Earnings (2)

     1.29       1.20       1.42       1.09       0.80  

Dividends Paid (2)

     0.50       0.45       0.36       0.32       0.32  

Dividend Payout Ratio

     38.17       36.59       24.66       29.09       40.00  

Return on Average Assets

     0.89 %     0.87 %     1.15 %     0.88 %     0.65 %

Return on Average Equity

     13.10 %     12.17 %     15.83 %     13.94 %     11.07 %
As of December 31,    2005     2004     2003     2002     2001  
     (In thousands, except per share data)  

Total Assets

   $ 650,179     $ 595,514     $ 526,246     $ 496,645     $ 493,937  

Total Deposits

     464,637       433,072       428,477       429,328       422,737  

Total Securities (3)

     119,303       123,421       126,179       85,828       56,784  

Loans, Net

     463,151       413,808       344,573       317,144       337,183  

Federal Home Loan Bank Advances

     100,000       75,000       22,000       —         —    

Shareholders’ Equity

     46,727       43,835       39,125       33,766       28,966  

Book Value per Share

   $ 11.07     $ 10.52     $ 9.74     $ 8.62     $ 7.48  

Average Common Equity to Average Assets

     6.80 %     7.15 %     7.28 %     6.35 %     5.87 %

Shares Outstanding

     4,219,980       4,167,180       4,017,380       3,917,848       3,873,948  

Number of Branch Locations

     17       15       14       14       14  

 

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

 

(2) 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.

 

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


Table of Contents

Letter to Shareholders

… the primary operating theme for 2006… will focus more on the deepening of relationships within our existing customer base…

As the top producer of purchase-money mortgage loans in the Dartmouth-Lake Sunapee-Kearsarge Region, the Company hit all of its established benchmarks for 2005 despite the significant market pressures of rising interest rates and the demise of the multi-year mortgage loan refinance boom. While not a record year for mortgage activity, the market clearly exceeded earlier expectations and served to advance the Company to the point of solid performance returns. Continued growth in all segments of operations helped the Company to overcome certain embedded costs associated with the opening of three new branches during the year and to advance the strategic positioning of our financial services franchise into more geographically-diversified economic communities.

Increases in assets, loans, deposits, net income and book value all combined to support the long-term goals and objectives of the Company as it continues to build and expand upon core business relationships, while at the same time, broadening its marketplace presence into selected segments of the New Hampshire economy where consistently growing economic strengths are clearly evident.

Within an ever-increasingly competitive environment, the Company must endeavor to strike a reasonable balance between the forces of margin compression, credit quality, regulatory expense, technological advancements and funding costs in an effort to deliver consistent growth in core earnings and shareholder value. It is, therefore, the incremental and successful execution of the strategic plan that is more important than the plan itself. One is just a guide to where one wants to go, while the other is the deliberate act of making choices on how best to get there. The Company, which operates on the basis of three-year business plans, accomplished all of its primary goals for 2005 and, while being flexible enough to make certain mid-course corrections for 2006, remains confident that the longer-term goals and objectives can be achieved.

The primary operating theme for 2006, then, will focus more on the deepening of relationships within our existing customer base rather than the expense-driven advance of the Company into a variety of new markets through de novo branching. It is currently anticipated that only one new branch will be opening later in the year in Milford, New Hampshire that will both complement and build upon the market positioning of our new Peterborough, New Hampshire office that opened in January of 2005.

COMPANY EARNINGS

Earnings for 2005 increased by just over 8.00% over the previous year, with consolidated net income for the year-ended December 31, 2005 of $5,524,288, or $1.29 per share of common stock (diluted). This compares to net income of $5,098,093, or $1.20 per share of common stock (diluted) that the Company reported for 2004. As with almost all traditional financial institutions, the consistent rise in interest rates throughout the year brought on margin compression in the form of higher funding costs that narrowed the Company’s net interest margin as a percentage of income over expense. The Federal Reserve Board continued to maintain their hawkish economic position throughout the year by incrementally raising interest rates at every meeting and signaling that their posture going forward would remain substantially unchanged until they were convinced that any and all inflationary trends had been successfully constrained by their own policies. Rising interest rates, however, are not friendly to the vast majority of financial institutions across the country when the cost of funds, deposits and advances, increases at a more rapid pace than the periodic adjustments on the loan portfolio can keep up with in the short run. Sustainable and recurring sources of noninterest income are more critical now than ever before to the longer-term stability of net earnings over time. Complete financial details for the year ending December 31, 2005 can be found in the Management’s Discussion and Analysis section that immediately follows this letter.

SHAREHOLDER VALUE

For community banks like ours, the concept of developing greater shareholder value embraces more than just bottom-line numbers or point-in-time stock prices. Beyond net income, the smaller regional institutions that dot the landscape of many of our Northeastern states also look for a blend of customer loyalty, franchise positioning, marketplace demographics, portfolio diversification and asset quality. In this regard, the Company has sought, and continues to focus on, the broadening of both

 

2


Table of Contents

Letter to Shareholders (continued)

 

our individual customers relationships and the expansion of our branching network in an effort to better insulate the institution from the economic ups-and-downs of just one or two primary-market communities.

Adjusted for the two-for-one stock split that occurred in the first quarter of 2005, the Company’s stock price closed the year 2005 at $14.74 per share, with closing prices having ranged from a high of $18.45 immediately after the stock split to a low of $12.50 in the fall of 2005. Shareholders’ equity stood at $46,726,549 as compared to $43,835,017 at the end of 2004, representing a 6.60% increase, or $2,891,532, over the course of the year. The number of common shares outstanding at the end of 2005 totaled 4,219,980 and the book value per share stood at $11.07, an increase of $0.55 or 5.23% over December 31, 2004.

During calendar year 2005, in addition to the previously mentioned stock split, the Company authorized an increase in the annualized split-adjusted stock dividend from $0.45 per share to $0.50 per share, representing an 11.11% increase and announced the reinstatement of a previously unfinished stock buy-back program. All of these decisions were based in the belief that the Company’s strong financial position and sustainable earnings record provided a baseline for continued growth that would benefit both current and future shareholders alike.

The Company has always viewed itself as a long-term investment and manages the daily operations on the premise and concept of stewardship. This is the Company’s twentieth year as a publicly-traded financial institution and it is, perhaps, both appropriate and timely to note that over just the last five years (based on stock price alone) $100.00 invested in the stock of the Company on January 1, 2001 had grown to $220.00 as of December 31, 2005. It should also be noted that this rate of growth, over the same period of time, exceeds that of the Dow Jones Industrials, the S&P 500 Index, the Nasdaq Composite Index or the Amex Composite Index.

BANKING IN NEW HAMPSHIRE

New Hampshire’s strong economic base and recent national designation as the ‘most livable state’ in the country exemplify and support the Company’s continuing interest in expanding upon our established patterns of institutional growth. We are not, of course, alone in this thinking and competition for deposits and loans remains of constant concern as we strategize for the future. In addition, the changing demographic characteristics of our customer base require that we maintain a vigilant eye on who our customers are, what they expect of us and how do we ensure their continued relationship with the Company going forward.

To this end, the Company recognizes the need to be technologically advanced enough to meet the emerging needs of the growing ‘self-service’ segment of the population that is less interested in the ‘nine-to-five’ operations of a branch, while at the same time serving the currently-larger segment that continues to value, appreciate and rely upon the delivery of banking products in the more traditional setting. While a costlier approach, branching remains the bedrock of community banking and the Company’s strategy continues to focus on expanding the current branch office network over the next few years.

Considerable effort is also being placed on the need to deepen relationships within our existing customer base. Our strategies include combining a systems enhancement that will integrate all current customer relationships with a personal contact effort to be sure that products or services that would be beneficial to a customer are, in fact, being utilized. As the Company approaches its 140th year in business, we are seeking ways to better identify, quantify and articulate the attributes of our historical growth and success in a manner that will help both existing and prospective customers envision what the benefits are of choosing to do business with us. The goal, quite simply, is to more clearly differentiate the Company from the competition by expecting more of ourselves than the customer does.

BALANCE SHEET FUNDAMENTALS

Total assets of the Company stood at $650,178,681 at year-end December 31, 2005 as compared to $595,514,082 at year-end 2004. This is a net increase of just over 9.00% and nearly $55 million in real growth over the course of the year. All primary asset and liability areas were up for the year, including loans, deposits and advances. As noted previously, the increasing cost of funds remains of serious concern to the Company as it attempts to offset the affects of margin

… the Company recognizes the need to be technologically advanced enough to meet the emerging needs of the growing ‘self-service’ segment of the population… while at the same time serving the currently-larger segment that continues to value, appreciate and rely upon the delivery of banking products in the more traditional setting…

 

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Table of Contents

\Letter to Shareholders (continued)

 

…the role and positioning of a financial services intermediary such as ours remains culturally intertwined with our communities and our customers…

compression with corresponding growth in other service-sector areas of our banking operations.

With the mortgage loan refinance boom now well behind us and many of our existing borrowers now comfortably locked into longer-term fixed-rate mortgages that we service for the secondary market, the Company has focused more attention once again on the purchase-money and construction-loan market. In this regard, 2005 was a very good year for the Company, with net portfolio loan growth of just under $50 million or nearly 12.00%. At December 31, 2005 the loan portfolio stood at $467,172,877 as compared to $417,827,740 at year-end 2004. In addition, the sold loan portfolio has now crossed the $300,000,000 mark and the Company services more than 2,700 loans for the secondary market. When these numbers are combined with those of the Company’s own loan portfolio, it is becomes clear that, from an operational basis, we are conducting the day-to-day business of a company much larger than our asset size would indicate.

The two underlying and fundamental strengths of any financial institution are capital adequacy and asset quality. To this end, the Company has continued to maintain its well-capitalized position and to further reduce the already record-low levels of non-performing assets from 0.05% of total assets at year-end 2004 to 0.04% on December 31, 2005. The Company believes that good asset quality is most important to the longer-term stability of the franchise and that yielding on loan policy guidelines and extending credit risk limits can in no way be offset by the attraction of the associated higher interest rates. With the annual Safety and Soundness Examination and Compliance Examination having been conducted by the Office of Thrift Supervision just prior to the close of the year, it is reassuring to note that the Company received a high quality rating in all categories of the examinations.

LOOKING TO THE FUTURE

The Company’s strategic planning process looks for continued growth over the next several years. Focusing on both existing and emerging markets, the goal is to develop a clear vision and enabling environment for our employees that encourages them to become active participants in the success of the institution by recognizing new opportunities for expanding customer relationships. People will always be the foundation of our business.

While it is universally acknowledged that the financial services industry is currently facing a number of daunting hurdles…higher funding costs, slower deposit and loan growth, credit quality concerns, cost controls and risk mitigation…it is also true that the core business of banking remains unchanged. The role and positioning of a financial services intermediary such as ours remains culturally intertwined with our communities and our customers. We must, then, strive to deliver more than the customer expects by becoming a more and more important part of their lives.

We are committed to growing the Company, enhancing the revenue stream and managing risk at all operational levels. The Company operates within a ‘best practices’ environment and acknowledges its historic role to advance economic stability across its base of relationships…individuals, families, businesses and municipalities. The overall value of the banking franchise is directly tied to the markets it serves, the capacity of its capital position and its vision for future growth.

CLOSING COMMENT

On behalf of all those involved in working toward the long-term success and advancement of the Company…the Board, the Management and the Staff…I would like to take this opportunity to express our appreciation for the continued support and confidence that has been shown by both our customers and our shareholders. We pledge to continue operating the Company in the best interests of all concerned and look forward to expanding our core business relationships in the years ahead.

 

/s/ Stephen W. Ensign

 

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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 $650,178,681 at December 31, 2005, an increase of $54,664,599, or 9.18%, from December 31, 2004.

 

    Net loans increased $49,342,246, or 11.92%, to $463,150,536 at December 31, 2005 from $413,808,290 at December 31, 2004.

 

    In 2005, the Bank originated over $248.4 million in loans, compared to over $282.1 million in 2004. The slow-down in refinancings accounted for the decrease.

 

    The Bank’s loan servicing portfolio increased to $304,267,740 at December 31, 2005 from $293,569,964 at December 31, 2004, an increase of $10,697,776, or 3.64%.

 

    The Company earned $5,524,288, or $1.29 per common share, assuming dilution, for the year ended December 31, 2005, compared to $5,098,093, or $1.20 per common share, assuming dilution, for the year ended December 31, 2004.

 

    Net interest and dividend income for the year ended December 31, 2005, increased by $947,336, or 5.05%, to $19,714,670. The increase was due to an increase in loans outstanding which helped to offset compressing spread margins.

 

    The Bank’s interest rate spread decreased to 3.40% as of December 31, 2005 from 3.48% at December 31, 2004, due to continuing margin compression resulting from a flattening yield curve.

 

    During 2005, the Bank sold $59.3 million in loans to the secondary market, realizing gains on those sales of $546,730, as compared to 2004, when the Bank sold $67.5 million in loans to the secondary market, realizing gains on those sales of $595,231. A slow-down in mortgage loan refinancings contributed to the decrease.

 

    On December 12, 2005, the Company reactivated a previously existing, but uncompleted stock repurchase program, originally adopted on February 22, 2001. Up to 248,000 shares of the Company’s common stock will be repurchased from time to time at the discretion of management.

 

    The Bank opened three branch offices during 2005, located in Peterborough, Claremont, and Enfield, New Hampshire.

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: losses resulting from higher risk loans; a need to increase the allowance for loan losses; changes in interest rates; changes in general and local economic conditions; loss of the services of executive officers or key personnel; changes in the laws or regulations to which the Company is subject; changes in competition; failure by the Company to maintain an effective system of internal control over financial reporting; changes in deposit flows; changes in real estate values; changes in accounting principles, policies or guidelines; 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.

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

Provisions are made to reserve for estimated losses in outstanding loan balances. The allowance for loan losses is a significant estimate and is regularly reviewed by the Company for adequacy by assessing such factors as changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency and charge-off rates; and current economic conditions that may affect a borrower’s ability to repay. The Company’s methodology with respect to the assessment of the adequacy of the allowance for loan losses is more fully discussed on pages 14-17 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, 2005, 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 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. 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. 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.

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

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, 2005 and December 31, 2004, the Bank recorded $103,348 and $155,278, 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, 2005 and December 31, 2004, the Bank generated commissions in the amount of $263,705 and $192,617, respectively.

Comparison of Years Ended December 31, 2005 and 2004

Financial Condition

Total assets increased by $54,664,599, or 9.18%, from $595,514,082 at December 31, 2004 to $650,178,681 at December 31, 2005. Cash and Federal Home Loan Bank overnight deposit increased $4,801,809. Net loans receivable and loans held-for-sale increased by $50,310,546, or 12.12%, to $465,413,836 at December 31, 2005 from $415,103,290 at December 31, 2004.

Total gross loans, excluding loans held-for-sale, increased $49,303,403, or 11.85%, to $465,383,129 at December 31, 2005 from $416,079,726 at December 31, 2004. The increase was attributed to increases of $30,537,359, or 8.93%, in real estate mortgage loans (including conventional and commercial). In particular, the Bank’s commercial real estate portfolio increased $13,603,542, or 15.70%, to $100,264,007. Consumer loans increased $6,943,235, or 12.09%, to $64,392,818, due to a demand for the Bank’s Home Equity Line of Credit product. The continued favorable interest rate environment made the above loan offerings very attractive. Sold loans totaled $304,267,740 at year-end 2005, compared to $293,569,964, at year-end 2004. Sold loans are loans originated by the Bank and sold to Freddie Mac with the Bank retaining the servicing of these loans. 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.

The amortized cost of investment securities available-for-sale decreased $3,058,536, or 2.58%, from $118,767,782 at December 31, 2004, to $115,709,246 at December 31, 2005. 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 $50,328 during 2005, as compared to $392,813 in 2004. At December 31, 2005, the Bank’s investment portfolio had a net unrealized holding loss of $2,114,113, as compared to a net unrealized holding loss of $226,471 at December 31, 2004. As interest rates increased during 2005, 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. In addition, all securities are rated as investment grade by the leading rating agencies.

Real estate owned and property acquired in settlement of loans remained at $0 at December 31, 2005 and 2004.

Investments in real estate increased $1,596,729 from $357,119 at December 31, 2004 to $1,953,848 at December 31, 2005. In August of 2005, the Bank purchased commercial real estate property located in Hillsborough, NH, which houses one of the Bank’s branch offices.

Total deposits increased by $31,565,324, or 7.29%, to $464,636,904 as of December 31, 2005, from $433,071,580 as of December 31, 2004. The increase in deposits was helped in part by the opening of three new branch offices during 2005.

Advances from the Federal Home Loan Bank (FHLB) increased by $25,000,000, or 33.33%, to

 

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Management’s Discussion and Analysis (continued)

 

$100,000,000 at December 31, 2005 from $75,000,000 at December 31, 2004. The Bank used the proceeds from the advances to fund loan demand. The weighted average interest rate for the outstanding FHLB advances was 4.11% as of December 31, 2005, as compared to the average 2.53% as of December 31, 2004.

Liquidity and Capital Resources

The Bank is required to maintain sufficient liquidity for safe and sound operations. At year-end 2005 the Bank’s liquidity was sufficient to cover the Bank’s anticipated needs for funding loan commitments of approximately $10 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, 2005 the Bank had approximately $85,000,000 in additional borrowing capacity from the FHLB.

At December 31, 2005, the Company’s shareholders’ equity totaled $46,726,549, as compared to $43,835,017 at year-end 2004. The increase of $2,891,532 reflects net income of $5,524,288, the payment of $2,097,465 in common stock dividends, the exercise of 60,800 stock options in the amount of $593,345, a tax benefit on the exercise of stock options of $124,277, an increase in accumulated other comprehensive loss $1,139,947, and the repurchase of 8,000 shares in the amount of $112,966.

On December 12, 2005, the Company reactivated a previously existing but uncompleted 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 248,000 shares are repurchased. As of December 31, 2005, 127,000 shares of common stock had been repurchased. During 2005, 8,000 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, 2005, the Company had funds in the amount of $5,589,951 available, which it plans to use for stockholder dividend payments, to pay interest on the Company’s capital securities, and to repurchase the Company’s shares of common stock. The Company increased the quarterly dividend on its common stock by $.0125 per share, or 11.11%, to $0.125 per share effective with the January 30, 2005 dividend payment. The common stock dividend and capital securities interest payments are approximately $3.5 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, it is anticipated that funds will be available to cover the Company’s future dividend, interest, and stock repurchase needs.

Net cash provided by operating activities decreased by $5,767,659 to $3,496,317 in 2005 from $9,263,976 in 2004. A decrease in the amount of $3,579,436 in accrued expenses and other liabilities caused by the timing of customer mortgage loan payments on sold loans primarily accounted for the change in other liabilities.

Net cash flows used in investing activities totaled $51,867,494 in 2005 compared to $68,563,105 in 2004, a change of $16,695,611. During 2005, the Bank’s decrease in the amount of $23,589,031 in loan originations and principal collections, net, primarily accounted for the decrease in cash flows used in investing activities.

In 2005, net cash flows provided from financing activities totaled $53,172,986 compared to $62,316,739 in 2004, a change of $9,143,753. Net proceeds from advances provided by the FHLB in the amount of $25,000,000 accounted for 47% of net cash provided from financing activities in 2005, as compared to 85% in 2004. Net increases in deposits in the amount $31,565,324, or 59%, of the total financing activities, accounted for the balance.

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, 2005, approximately $10,000,000 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.

 

8


Table of Contents

Management’s Discussion and Analysis (continued)

 

The following table represents the Company’s contractual obligations at December 31, 2005:

 

     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

   $ 75,000    $ 20,000    $ 35,000    $ —      $ 20,000

Operating Lease Obligation

     864      279      393      161      31
                                  

Total

   $ 75,864    $ 20,279    $ 35,393    $ 161    $ 20,031
                                  

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, 2005, the Bank’s ratios were 7.80%, 7.80%, and 11.31%, respectively, well in excess of the OTS requirements.

Book value per share was $11.07 at December 31, 2005 versus $10.52 per share at December 31, 2004.

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 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, 2005, was negative 8.31%, as compared to the December 31, 2004 gap of negative 6.10%. If short-term interest rates were to rise, the Bank’s net interest income would be reduced because the cost to re-finance the FHLB advances and re-pricing deposits 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.

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 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

 

9


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Management’s Discussion and Analysis (continued)

 

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.

The following table shows the Bank’s interest rate sensitivity (gap) table at December 31, 2005:

 

    

0-3

Months

   

3-6

Months

   

6 Months-

1 Year

   

1-3

Years

   

Beyond

3 Years

    Total
     ($ in thousands)

Interest-earning assets:

            

Loans

   $ 95,892     $ 30,619     $ 51,645     $ 144,163     $ 143,064     465,383

Investments and FHLB overnight deposit

     22,738       2,958       11,943       45,575       45,575     125,709
                                            

Total

     118,630       33,577       63,588       189,738       185,559     591,092
                                            

Interest-bearing liabilities:

            

Deposits

     76,756       20,700       50,262       52,467       218,188     418,373

Repurchase agreements

     11,873       —         —         —         —       11,873

Borrowings

     85,310       20,000       —         5,000       10,310     120,620
                                            

Total

     173,939       40,700       50,262       57,467       228,498     550,866
                                            

Period sensitivity gap

     (55,309 )     (7,123 )     13,326       132,271       (42,939 )   40,226

Cumulative sensitivity gap

   $ (55,309 )   $ (62,432 )   $ (49,106 )   $ 83,165     $ 40,226    

Cumulative sensitivity gap as a percentage of interest-earning assets

     -9.36 %     -10.56 %     -8.31 %     14.07 %     6.81    

The following table sets forth the Bank’s NPV as of December 31, 2005, as calculated by the OTS for the December 31, 2005 reporting cycle:

 

Change

in Rates

   Net Portfolio Value     NPV as % of PV Assets
     $ Amount    $ Change    % Change     NPV Ratio     Change
+300 bp    63,180    -16,067    -20 %   9.78 %   - 213bp
+200 bp    69,618    -9,630    -12 %   10.62 %   - 125bp
+100 bp    75,125    -4,123    -5 %   11.38 %   - 53bp
0 bp    79,248    —      —       11.90 %   —  
- 100 bp    80,284    1,594    +2 %   12.09 %   + 18bp

 

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Management’s Discussion and Analysis (continued)

 

Results of Operations 2005 versus 2004

Net Interest and Dividend Income

Net interest and dividend income for the year ended December 31, 2005 increased by $947,336, or 5.05%, to $19,714,670. The increase was due to the continuing favorable interest rate environment and the increase in loans outstanding.

Total interest and dividend income increased by $3,346,442, or 13.24%. Interest and fees on loans increased by $3,684,633, or 18.34%, to $23,772,395 in 2004, due to the increase in loans outstanding.

Interest on taxable investments decreased by $512,005, or 10.23%, as the Bank redeployed the proceeds of maturing securities to fund loan demand. Dividends increased by $124,789, or 89.91%, to $263,586. Interest on other investments increased by $49,025, or 95.94%, to $100,125.

Total interest expense increased $2,399,106, or 36.81%, for the year ended December 31, 2005. Interest on deposits increased by $1,135,965, or 35.55%, because the Bank’s certificates of deposit (CD) matured and re-priced into higher yielding term deposits. In addition, the Bank was unable to lag deposit re-pricing due to competitive pressures. Interest on FHLB advances increased by $1,801,639, or 150.08%, to $3,002,106 for the year ended December 31, 2005 from $1,200,467 for the year ended December 31, 2004. FHLB advances outstanding increased to $100,000,000 at December 31, 2005 from $75,000,000 at December 31, 2004 as the Bank used the increased proceeds from the advances to fund loan growth.

The Bank’s overall cost of funds increased to 1.66% in 2005 from 1.29% in 2004. The cost of deposits, including repurchase agreements, increased 27 basis points to 1.09% in 2005 from 0.82% in 2004. The Bank’s time deposits, in particular, rolled into term deposits with higher rates as short-term interest rates increased during 2005.

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, decreased to 3.40% at December 31, 2005 from 3.48% at December 31, 2004. The Bank’s net interest margin, representing net interest income as a percentage of average interest-earning assets, decreased to 3.49% from 3.54%. Both decreases are indicative of the increase in short-term interest rates as the yield curve flattened during 2005. Since the Bank is liability sensitive, as interest rates increase, the Bank’s interest rate spread and margin will decrease.

 


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:

 

       For the Years Ended December 31,  
       2005     2004     2003     2002     2001  

Yield on loans

     5.37 %   5.13 %   5.33 %   6.27 %   7.25 %

Yield on investment securities

     3.95 %   3.76 %   3.20 %   4.22 %   6.82 %

Combined yield on loans and investments

     5.06 %   4.77 %   4.78 %   5.80 %   7.18 %

Cost of deposits, including repurchase agreements

     1.09 %   0.82 %   1.02 %   2.18 %   3.63 %

Cost of other borrowed funds

     3.95 %   3.37 %   7.64 %   9.43 %   9.12 %

Combined cost of deposits and borrowings

     1.66 %   1.29 %   1.35 %   2.46 %   3.89 %

Interest rate spread

     3.40 %   3.48 %   3.43 %   3.34 %   3.29 %

Net interest margin

     3.49 %   3.54 %   3.50 %   3.42 %   3.33 %

 

11


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,

   2005     2004     2003  
   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),

   $ 442,335    $ 23,772    5.37 %   $ 391,541    $ 20,088    5.13 %   $ 334,041    $ 17,795    5.33 %

Investment securities and other

     123,143      4,859    3.95 %     138,156      5,197    3.76 %     115,608      3,699    3.20 %
                                                

Total interest-earning assets

     565,478      28,631    5.06 %     529,697      25,285    4.77 %     449,649      21,494    4.78 %
                                                

Noninterest-earning assets:

                        

Cash

     18,978           16,024           13,553      

Other noninterest-earning assets (3)

     35,583           40,317           37,502      
                                    

Total noninterest-earning assets

     54,561           56,341           51,055      
                                    

Total

   $ 620,039         $ 586,038         $ 500,704      
                                    

Liabilities and Shareholders’ Equity:

                        

Interest-bearing liabilities:

                        

Savings, NOW and MMAs

   $ 294,073    $ 1,510    0.51 %   $ 292,351    $ 1,183    0.40 %   $ 277,968    $ 1,370    0.49 %

Time deposits

     123,224      2,820    2.29 %     106,027      2,013    1.90 %     116,354      2,669    2.29 %

Repurchase agreements

     11,325      344    3.04 %     11,492      154    1.34 %     9,165      96    1.05 %

Capital securities and other borrowed funds

     107,505      4,242    3.95 %     94,100      3,168    3.37 %     20,942      1,601    7.64 %
                                                

Total interest-bearing liabilities

     536,127      8,916    1.66 %     503,970      6,518    1.29 %     424,429      5,736    1.35 %
                                                

Noninterest-bearing liabilities:

                        

Demand deposits

     32,403           28,161           30,170      

Other

     9,331           12,001           9,647      
                                    

Total noninterest-bearing liabilities

     41,734           40,162           39,817      
                                    

Shareholders’ equity

     42,178           41,906           36,458      
                                    

Total

   $ 620,039         $ 586,038         $ 500,704      
                                    

Net interest income/Net interest rate spread

      $ 19,715    3.40 %      $ 18,767    3.48 %      $ 15,758    3.43 %
                                                

Net interest margin

         3.49 %         3.54 %         3.50 %
                                    

Percentage of interest-earning assets to interest-bearing liabilities

         105.47 %         105.10 %         105.94 %
                                    

 

(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.

 

12


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, 2005 vs. 2004

Increase (Decrease)

due to

 
     Volume     Rate     Total  
     ($ in thousands)  

Interest income on loans

   $ 2,752     $ 932     $ 3,684  

Interest income on investments

     (604 )     266       (338 )
                        

Total interest income

     2,148       1,198       3,346  
                        

Interest expense on savings, NOW and MMAs

     8       319       327  

Interest expense on time deposits

     1,052       (245 )     807  

Interest expense on repurchase agreements

     (2 )     192       190  

Interest expense on capital securities and other borrowings

     460       614       1,074  
                        

Total interest expense

     1,518       880       2,398  
                        

Net interest income

   $ 630     $ 318     $ 948  
                        
    

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  
                        

 

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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 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. In accordance with regulatory examiners recommendations, the Bank enhanced the procedures for testing the adequacy of the loan loss allowances through further stratification of the loan portfolio.

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, 2005 the allowance for loan losses was $4,022,341 compared to $4,019,450 at year- end 2004. The increase is due to the introduction of a fee for service overdraft privilege program in 2005 and the establishment of a valuation allowance for losses associated with overdraft charge-offs. At December 31, 2005 the allowance for the overdraft privilege program was $31,838, an amount equal to 105% of the aggregate negative balance of accounts that had remained negative for 30 days or more. The allowance for the overdrafts is combined with the allowance for loan losses for financial reporting. In the absence of that combination, the allowance would have declined to $3,990,503 due to net loan charge-offs (excluding overdrafts) of $28,947 in 2005. That compares to net recoveries of $45,803 in 2004. Excluding the overdrafts, the Bank charged-off $36,766 in 2005 compared to $14,737 in 2004. The $88,500 provision made in 2005 was entirely for the overdraft program. It compares to a $74,997 provision made in 2004. On an aggregate basis, including overdrafts, the allowance represented 0.86% of total loans at year-end 2005 compared to 0.97% at the end of 2004. The decline is due to the $49 million increase in the loan portfolio. The provision for the overdraft program is driven by a policy to maintain that allowance at a level sufficient to cover 100% of the aggregate balance of accounts remaining negative for 30 days or more. There were no other provisions for loan losses made in 2005 because the results of the adequacy test, based on current conditions, showed the allowance remained at a sufficient level, 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 loans, excluding special mention loans, as of December 31, 2005 and 2004 were $612,223 and $5,196,123, respectively. The decline is primarily due to the payoff of some classified loans, and also to the upgrade of about $850,000 of performing loans remaining in the portfolio. Special mention loans were $2,700,000 million at year-end 2005 compared to $240,000 at year-end 2004. That increase is attributable to one commercial real estate loan.

Loans 30 to 89 days past due were $2,278,612 and $2,705,154 at December 31, 2005 and 2004, respectively. Total non-performing loans amounted to $278,422 and $293,203 at December 31, 2005 and 2004, respectively. At the end of 2005, non-performing loans consisted entirely of loans over 90 days past due. At year-end 2004 non-performing loans included $243,809 of loans over 90 days past due and $49,394 of non-accrual impaired loans. Non-accrual impaired loans were liquidated in 2005. Loans over 90 days past due increased $34,613 to $278,422 as of December 31, 2005. As a percent of assets, non-performing loans dropped from 0.05% to 0.04% at year-end 2005. Non-performing loans as a percent of total loans fell from 0.07% to 0.06%

 

14


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Management’s Discussion and Analysis (continued)

 

at the end of 2005. The bank had no other real estate owned or repossessed assets at year-end 2005 or 2004. If all non-accruing loans had been current in accordance with their terms during the years ended December 31, 2005 and 2004 interest income on such loans would have amounted to approximately $6,800 and $7,000, respectively.

As of December 31, 2005 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.

As of December 31, 2005, the Bank’s portfolio did not include any “troubled debt restructurings” as defined in Statement of Accounting Standards No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings.”

The following table sets forth the breakdown of non-performing assets at December 31:

 

     2005    2004    2003    2002    2001

Nonaccrual loans (1)

   $ 278,422    $ 293,203    $ 1,157,957    $ 664,092    $ 2,521,424

Real estate owned

     —        —        —        20,668      100,000
                                  

Total nonperforming assets

   $ 278,422    $ 293,203    $ 1,157,957    $ 684,760    $ 2,621,424
                                  

 

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

The following table sets forth nonaccrual (1) loans by category at December 31:

 

     2005    2004    2003    2002    2001

Real estate loans -

              

Conventional

   $ 254,982    $ 243,809    $ 1,074,096    $ 499,053    $ 1,048,780

Construction

     —        —        —        59,000      101,606

Consumer loans

     7,977      —        1,891      —        68,474

Commercial and municipal loans

     15,463      —        31,036      685      35,527

Nonaccrual impaired loans (2)

     —        49,394      50,934      105,354      1,267,037
                                  

Total

   $ 278,422    $ 293,203    $ 1,157,957    $ 664,092    $ 2,521,424
                                  

 

(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.

 

15


Table of Contents

Management’s Discussion and Analysis (continued)

 

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

 

     2005     2004     2003     2002     2001  

Balance, beginning of year

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

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

     —         —         —         604,686       —    
                                        

Charge-offs:

          

Residential real estate

     —         —         —         15,964       43,358  

Commercial real estate

     —         —         —         —         88,822  

Construction

     —         —         —         —         24,642  

Consumer loans (1)

     123,885       14,737       28,862       48,120       18,866  

Commercial loans

     —         —         57,780       19,129       25,768  
                                        

Total charged-off loans

     123,885       14,737       86,642       83,213       201,456  

Recoveries (2)

          

Residential real estate

     2,403       —         —         9,856       —    

Commercial real estate

     —         35,000       —         —         —    

Construction

     —         —         —         22,000       —    

Consumer loans (1)

     35,873       25,540       9,588       6,366       125  

Commercial loans

     —         —         —         —         83,862  
                                        

Total recoveries

     38,276       60,540       9,588       38,222       83,987  

Net charge-offs (recoveries)

     85,609       (45,803 )     77,054       44,991       117,469  

Provision charged to income (3)

     88,500       74,997       99,996       120,000       90,000  
                                        

Balance, end of year (4)

   $ 4,022,341     $ 4,019,450     $ 3,898,650     $ 3,875,708     $ 4,405,385  
                                        

Ratio of net charge-offs (recoveries) to average loans

     0.02 %     (0.01 )%     0.02 %     0.01 %     0.03 %
                                        

 

(1) 2005 Consumer loan charge-offs include $87,119 of overdraft privilege charge-offs.

 

(2) 2005 Recoveries include $30,457 of overdraft charge-offs recovered.

 

(3) 2005 Provision includes $88,500 provision for overdraft privilege valuation allowance.

 

(4) 2005 Balance at end of year includes $31,838 allowance for overdraft privilege losses.

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):

 

     2005     2004     2003  

Real estate loans -

                  

Conventional

   $ 2,544     63 %   77 %   $ 2,445     61 %   77 %   $ 2,405     62 %   78 %

Construction

     291     7 %   3 %     265     7 %   5 %     251     6 %   4 %

Collateral and consumer loans

     224     6 %   14 %     109     3 %   14 %     114     3 %   13 %

Commercial and municipal loans

     963     24 %   6 %     1,058     26 %   4 %     1,012     26 %   5 %

Impaired loans

     —       —           142     3 %       117     3 %  

Unallocated

     —       —           —       —           —       —      
                                                            

Allowance

   $ 4,022     100 %   100 %   $ 4,019     100 %   100 %   $ 3,899     100 %   100 %
                                                            

Allowance as a percentage of total loans

     0.86 %         0.97 %         1.12 %    
                                    

 

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Management’s Discussion and Analysis (continued)

 

     2002     2001  

Real estate loans -

            

Conventional

   $ 2,763     71 %   80 %   $ 2,421     55 %   82 %

Construction

     207     5 %   5 %     176     4 %   5 %

Collateral and consumer loans

     155     4 %   10 %     132     3 %   7 %

Commercial and municipal loans

     723     19 %   5 %     1,273     29 %   6 %

Impaired loans

     28     1 %       293     7 %  

Unallocated

     —       —           110     2 %  
                                        

Allowance

   $ 3,876     100 %   100 %   $ 4,405     100 %   100 %
                                        

Allowance as a percentage of total loans

     1.21 %         1.29 %    
                        

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 increased $33,818, or 0.83%, to $4,108,385 for 2005. Customer service fees increased $519,479, or 25.10%, due to the introduction of an overdraft protection program. Net gain on sales and calls of securities decreased in the amount of $342,485, or 87.19%, due to the absence of an arbitrage transaction completed during 2004 which contributed most of the realized gain in 2004. Net gain on sale of loans decreased by $48,501, or 8.15%, due to a decrease in sold loans. The Bank sold $59.3 million of loans in 2005 as compared to $67.5 million of sold loans during 2004. The decrease was due in part to a slow down in mortgage refinancings attributable to rising interest rates. In addition, the Realized gain in Charter Holding Corp. decreased by $51,930, or 33.44%, to $103,348 from $155,278. Brokerage service income increased in the amount of $71,088, or 36.91%, to $263,705 for the year ended December 31, 2005 as compared to $192,617 for the year ended December 31, 2004, due to new fees generated from the opening of three branch offices.

Total noninterest expenses increased $446,619, or 3.08%, to $14,951,920 for 2005, from $14,505,301 for 2004.

 

    Salaries and employee benefits increased by $1,176,614, or 17.33%, to $7,966,348 for 2005, from $6,789,734 for 2004. Gross salaries and benefits paid increased by $672,208, or 8.06%, to $9,013,612 for 2005, compared to $8,341,404 for 2004. In addition to normal salary and benefit increases, twenty new staff positions were added to the Bank as a result of the opening of three new branch offices. The deferral of expenses in conjunction with the origination of loans decreased by $504,406, or 32.51%, to $1,047,264 for 2005, from $1,551,670 for 2004. This change was due to the lower volume of loan originations in 2005 as compared to 2004, which results in a lower amount of deferred expenses associated with origination costs.

 

    Occupancy expenses increased by $84,838, or 3.67%, to $ 2,396,402, primarily due to the opening of three new branches.

 

    Advertising and promotion increased in the amount of $114,253, or 37.02%, to $422,896, as the Bank heavily promoted the opening of the three new branch offices during 2005.

 

    Professional fees increased $34,663, or 6.59%, due in part to the hiring of an employee recruitment agency.

 

    Data processing and outside services fees decreased by $7,392, or 1.26%, to $581,380, due to the absence of certain non-recurring expenses incurred during 2004 for payroll data processing and a conversion to a new brokerage clearing-house provider.

 

    ATM processing fees decreased by $79,171, or 17.30%, to $378,529 due to conversion of the Bank’s processing of ATM transactions to an in-house system.

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

    Amortization of mortgage servicing rights (MSR) in excess of mortgage servicing income decreased in the amount of $162,290, or 77.88%, to $46,086 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 prepayments occurred during 2004 due to a higher volume of refinancings, the unamortized portion of the MSRs was required to be expensed during 2004 as compared to 2005.

 

    Write-off of issuance cost due to prepayment of debentures amounted to $758,408 in 2004 compared to $0 in 2005. In September 2004, 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 recognized during 2004 represented the remaining amortization of those expenses, which was offset in part by the savings in interest expense on the new debentures.

 

    Other expenses increased in the amount of $33,900, or 1.52%, to $2,271,428 for 2005, from $2,237,528 for 2004, due in part to normal increases in postage and telephone usage.

Impact of New Accounting Standards

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

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

For additional information on the above-referenced new accounting standards, refer to Note 1 of the Consolidated Financial Statements beginning on page 29 of this report.

Accounting for Income Taxes

The provision for income taxes for the years ended December 31, 2005, 2004, and 2003, includes net deferred income tax expense of $91,565, $378,216, and $1,046,854, respectively. These amounts were determined by the asset and liability 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, 2004 and 2003

In 2004, the Company earned $5,098,093, or $1.20 per common share, assuming dilution, compared to $5,771,453 or $1.42 per common share, assuming dilution, in 2003. The decrease in earnings in 2004 was due to a one-time, non-recurring, pre-tax expense in the amount of $758,408 incurred during 2004 resulting from the redemption of the Company’ $16,400,000 of Trust Preferred Securities. The Bank’s servicing portfolio on sold loans increased to $293,569,964 as of December 31, 2004, from $289,825,192 as of December 31, 2003. During 2004, the Bank originated $282,120,942 in total loans, as compared to $379,532,051 in total loans during 2003. Rising interest rates during 2004 tempered the refinance boom of 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 funds sold 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 fixed rate, ten year amortizing and seven-year hybrid loan products 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

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

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. Typically, the Bank holds adjustable rate loans in portfolio. Adjustable rate mortgages comprised approximately 79% of the Bank’s real estate mortgage loan portfolio, which is consistent with prior years.

The amortized cost of investment securities available-for-sale 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 an unrealized holding loss of $226,471, compared to a net unrealized holding 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 was less than five years and the liquidity of the bank remained strong, the bank did 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 December 31, 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. 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 (noninterest-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 form 57.68% at December 31, 2003 to 63.69% at December 31, 2004.

Advances from the 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%.

Net Interest and Dividend Income

Net interest and dividend 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 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 and dividends on taxable investments increased by $1,462,875, or 41.28%. Dividends increased by $58,884, or 73.69%, to $138,797. Interest and dividends on other investments decreased $24,016, or 31.97%, to $51,100, as the Bank deployed these funds in 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 2004 from $53,115 for 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% for 2004 from 3.43% for 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 falling interest rates.

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

Allowance and Provision for Loan Losses

The allowance for loan losses at December 31, 2004 was $4,019,450, compared to $3,898,650 at year-end 2003. During 2004, the Bank had net recoveries of $45,803 compared to net charge-offs of $77,054 in 2003. The improvement in 2004 came from both a reduction in charge-offs and an increase in recoveries. The provision for loan losses was $74,997 in 2004 compared to $99,996 in 2003. The allowance represented 0.97% of loans at year-end 2004 versus 1.12% at year-end 2003. The decline in the percentage resulted from the $69 million increase in the loan portfolio.

Total classified loans, excluding special mention loans, as of December 31, 2004 and 2003 were $5,196,123 and $4,046,955, respectively. Total non-performing loans amounted to $ 293,203 and $1,157,957 for the respective years. Non-performing loans include loans 90 days or more past due, which were $243,809 at December 31, 2004 and $1,107,023 at the end of 2003. The decrease in non-performing loans was largely due to the liquidation of one residential mortgage loan that was over 90 days past due at year-end 2003. At December 31, 2004 and 2003 the respective amount of impaired loans was $902,458 and $777,632, respectively. At December 31, 2004 and 2003 the impaired loan amount included $853,064 and $726,698, respectively, of performing loans that remained on accrual status. Loans 30 to 89 days delinquent were $2,705,154 at December 31, 2004 compared to $3,397,736 at year-end 2003.

Noninterest Income and Expense

Total noninterest income decreased $2,256,010, or 35.64%, to $4,074,567 for 2004. Net gain on sale 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 income in the amount of $3,009,299 offset the decrease in the net gain on the sale 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 Holding Corp.

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 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 the lower volume of loan originations in 2004 as compared to 2003.

 

    Occupancy and equipment expenses increased slightly by $63,672, or 2.83%, to $ 2,311,564.

 

    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.

 

    Data Processing and 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 represented the remaining amortization expense of Trust I. The Company expects to save approximately $500,000 in annual, pre-tax interest expense due to the refinance.

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

    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 processing fees 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 $103,577, or 4.85%, to $2,237,528 during 2004, from $2,133,951 during 2003, due to normal increases in supplies, postage, and telephone usage.

Off-Balance Sheet Arrangements

The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to originate loans, standby letters of credit and unadvanced funds on loans. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. Further detail on the financial instruments with off-balance sheet risk to which the Company is party is contained in Note 18 to the Consolidated Financial Statements.

 

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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, 2005 and 2004 and the related consolidated statements of income, changes in shareholders’ equity, comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2005. 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. 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, 2005 and 2004 and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.

LOGO

SHATSWELL, MacLEOD & COMPANY, P.C.

West Peabody, Massachusetts

January 9, 2006

LOGO

 

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Table of Contents

New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

 

As of December 31,

   2005     2004  

ASSETS

    

Cash and due from banks

   $ 16,345,434     $ 13,243,625  

Federal Home Loan Bank overnight deposit

     10,000,000       8,300,000  
                

Total cash and cash equivalents

     26,345,434       21,543,625  

Securities available-for-sale

     113,595,133       118,541,311  

Federal Home Loan Bank stock

     5,707,500       4,879,200  

Loans held-for-sale

     2,263,300       1,295,000  

Loans receivable, net of the allowance for loan losses of $4,022,341 as of December 31, 2005 and $4,019,450 as of December 31, 2004

     463,150,536       413,808,290  

Accrued interest receivable

     2,282,737       1,938,421  

Premises and equipment, net

     11,332,960       9,700,477  

Investments in real estate

     1,953,848       357,119  

Goodwill

     12,140,016       12,140,016  

Investment in partially owned Charter Holding Corp., at equity

     3,139,971       3,135,834  

Other assets

     8,267,246       8,174,789  
                

Total assets

   $ 650,178,681     $ 595,514,082  
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

LIABILITIES

    

Deposits:

    

Noninterest-bearing

   $ 46,263,562     $ 34,131,596  

Interest-bearing

     418,373,342       398,939,984  
                

Total deposits

     464,636,904       433,071,580  

Federal Home Loan Bank advances

     100,000,000       75,000,000  

Securities sold under agreements to repurchase

     11,872,717       13,647,969  

Subordinated debentures

     20,620,000       20,620,000  

Accrued expenses and other liabilities

     6,322,511       9,339,516  
                

Total liabilities

     603,452,132       551,679,065  
                

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: 10,000,000 shares authorized, 4,227,980 shares issued and 4,219,980 shares outstanding as of December 31, 2005 and 5,000,000 shares authorized, 4,167,180 shares issued and outstanding as of December 31, 2004

     42,280       41,672  

Paid-in capital

     17,025,045       16,308,031  

Retained earnings

     31,048,903       27,622,080  

Accumulated other comprehensive loss

     (1,276,713 )     (136,766 )

Treasury stock, 8,000 shares as of December 31, 2005 and no shares as of December 31, 2004

     (112,966 )     —    
                

Total shareholders’ equity

     46,726,549       43,835,017  
                

Total liabilities and shareholders’ equity

   $ 650,178,681     $ 595,514,082  
                

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

 

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New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

 

For the years ended December 31,

   2005    2004    2003

INTEREST AND DIVIDEND INCOME

        

Interest and fees on loans

   $ 23,772,395    $ 20,087,762    $ 17,794,613

Interest on debt investments

        

Taxable

     4,494,920      5,006,925      3,544,050

Dividends

     263,586      138,797      79,913

Other

     100,125      51,100      75,116
                    

Total interest and dividend income

     28,631,026      25,284,584      21,493,692
                    

INTEREST EXPENSE

        

Interest on deposits

     4,331,043      3,195,078      4,039,149

Interest on advances and other borrowed money

     3,002,106      1,200,467      53,115

Interest on debentures

     1,239,625      1,967,354      1,547,136

Interest on securities sold under agreements to repurchase

     343,582      154,351      96,257
                    

Total interest expense

     8,916,356      6,517,250      5,735,657
                    

Net interest and dividend income

     19,714,670      18,767,334      15,758,035

PROVISION FOR LOAN LOSSES

     88,500      74,997      99,996
                    

Net interest and dividend income after provision for loan losses

     19,626,170      18,692,337      15,658,039
                    

NONINTEREST INCOME

        

Customer service fees

     2,589,077      2,069,598      1,866,250

Net gain on sales and calls of securities

     50,328      392,813      227,687

Net gain on sale of loans

     546,730      595,231      3,420,714

Rental income

     471,384      495,319      494,950

Realized gain in Charter Holding Corp.

     103,348      155,278      81,489

Brokerage service income

     263,705      192,617      108,818

Other income

     83,813      173,711      130,669
                    

Total noninterest income

     4,108,385      4,074,567      6,330,577
                    

NONINTEREST EXPENSES

        

Salaries and employee benefits

     7,966,348      6,789,734      5,814,729

Occupancy and equipment expenses

     2,396,402      2,311,564      2,247,892

Advertising and promotion

     422,896      308,643      244,886

Professional services

     560,718      526,055      503,542

Data processing and outside services fees

     581,380      588,772      450,436

ATM processing fees

     378,529      457,700      335,270

Amortization of mortgage servicing rights in excess of mortgage servicing income

     46,086      208,376      598,287

Write-off of issuance cost due to prepayment of debentures

     —        758,408      —  

Supplies

     328,133      318,521      381,648

Other expenses

     2,271,428      2,237,528      2,133,951
                    

Total noninterest expenses

     14,951,920      14,505,301      12,710,641
                    

INCOME BEFORE PROVISION FOR INCOME TAXES

     8,782,635      8,261,603      9,277,975

PROVISION FOR INCOME TAXES

     3,258,347      3,163,510      3,506,522
                    

NET INCOME

   $ 5,524,288    $ 5,098,093    $ 5,771,453
                    

Earnings per common share

   $ 1.31    $ 1.23    $ 1.46
                    

Earnings per common share, assuming dilution

   $ 1.29    $ 1.20    $ 1.42
                    

Dividends declared per common share

   $ .50    $ .45    $ .36
                    

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

 

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New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

 

For the years ended December 31,

   2005     2004     2003  

COMMON STOCK

      

Balance, beginning of year

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

Exercise of stock options (60,800 shares in 2005, 149,800 shares in 2004 and 105,900 shares in 2003)

     608       749       530  

Retirement of treasury stock

     —         (5,342 )     —    

Stock split in form of stock dividend

     —         20,836       —    
                        

Balance, end of year

   $ 42,280     $ 41,672     $ 25,429  
                        

PAID-IN CAPITAL

      

Balance, beginning of year

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

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

     592,737       1,397,249       968,148  

Tax benefit for stock options

     124,277       284,403       139,921  

Retirement of treasury stock

     —         (4,884,267 )     —    
                        

Balance, end of year

   $ 17,025,045     $ 16,308,031     $ 19,510,646  
                        

RETAINED EARNINGS

      

Balance, beginning of year

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

Net income

     5,524,288       5,098,093       5,771,453  

Cash dividends paid

     (2,097,465 )     (1,859,333 )     (1,419,736 )

Stock split in form of stock dividend

     —         (20,836 )     —    
                        

Balance, end of year

   $ 31,048,903     $ 27,622,080     $ 24,404,156  
                        

ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME

      

Balance, beginning of year

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

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

     (1,139,947 )     (210,740 )     (28,221 )
                        

Balance, end of year

   $ (1,276,713 )   $ (136,766 )   $ 73,974  
                        

TREASURY STOCK

      

Balance, beginning of year

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

Shares repurchased, (8,000 shares in 2005, 0 shares in 2004 and 6,368 shares in 2003)

     (112,966 )     —         (73,495 )

Shares retired, (0 shares in 2005, 534,218 shares in 2004 and 0 shares in 2003)

     —         4,889,609       —    
                        

Balance, end of year

   $ (112,966 )   $ —       $ (4,889,609 )
                        

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

 

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New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

 

For the years ended December 31,

   2005     2004     2003  

Net income

   $ 5,524,288     $ 5,098,093     $ 5,771,453  

Other comprehensive loss

      

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

     (1,139,947 )     (210,740 )     (28,221 )
                        

Comprehensive income

   $ 4,384,341     $ 4,887,353     $ 5,743,232  
                        

Reclassification disclosure for the years ended December 31:

 

     2005     2004     2003  

Net unrealized holding (losses) gains on available-for-sale securities

   $ (1,837,314 )   $ 43,848     $ 116,850  

Reclassification adjustment for realized gains in net income

     (50,328 )     (392,813 )     (227,687 )
                        

Other comprehensive loss before income tax effect

     (1,887,642 )     (348,965 )     (110,837 )

Income tax benefit

     747,695       138,225       82,616  
                        

Other comprehensive loss, net of tax

   $ (1,139,947 )   $ (210,740 )   $ (28,221 )
                        

Accumulated other comprehensive (loss) income as of December 31, 2005, 2004 and 2003 consists of net unrealized holding (losses) gains on available-for-sale securities, net of tax effect.

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

 

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New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 

For the years ended December 31,

   2005     2004     2003  

Cash flows from operating activities:

      

Net income

   $ 5,524,288     $ 5,098,093     $ 5,771,453  

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

      

Depreciation and amortization

     1,258,117       1,219,145       1,360,447  

Net decrease (increase) in mortgage servicing rights

     145,035       53,164       (660,982 )

Amortization of securities, net

     541,705       700,566       688,220  

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

     10,693       27,948       30,136  

Write-off of issuance cost due to prepayment of debentures

     —         758,408       —    

Amortization of fair value adjustments, net

     12,074       12,073       12,073  

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

     (968,300 )     (425,460 )     4,686,879  

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

     (2,500 )     44,104       618  

Net gain on sales and calls of debt securities

     (50,328 )     (392,813 )     (227,687 )

Increase in investment in Charter Holding Corp., at equity

     (4,137 )     (10,879 )     (81,489 )

Provision for loan losses

     88,500       74,997       99,996  

Deferred tax expense

     91,565       378,216       1,046,854  

(Increase) decrease in accrued interest receivable and other assets

     (747,786 )     871,120       (897,335 )

Change in deferred loan origination costs, net

     (41,734 )     (363,267 )     (231,339 )

(Decrease) increase in accrued expenses and other liabilities

     (2,360,875 )     1,218,561       (1,641,683 )
                        

Net cash provided by operating activities

     3,496,317       9,263,976       9,956,161  
                        

Cash flows from investing activities:

      

Proceeds from sales of other real estate owned

     —         —         17,050  

Proceeds from sale of equipment

     2,500       23,000       3,000  

Proceeds from sale of investment in real estate

     —         377,734       —    

Capital expenditures - investment in real estate

     (1,617,496 )     (48,985 )     —    

Capital expenditures - software

     (96,298 )     —         (71,500 )

Capital expenditures - premises and equipment

     (2,493,973 )     (1,436,944 )     (929,547 )

Investment in unconsolidated subsidiaries

     —         (620,000 )     —    

Proceeds from maturities of securities held-to-maturity

     —         3,000,000       —    

Proceeds from sales of securities available-for-sale

     —         28,635,547       36,241,623  

Purchases of securities available-for-sale

     (35,104,977 )     (73,050,663 )     (202,664,999 )

Proceeds from maturities of securities available-for-sale

     37,672,136       46,227,984       125,297,605  

Purchases of Federal Home Loan Bank stock

     (828,300 )     (2,711,400 )     —    

Redemption of Federal Home Loan Bank stock

     —         —         203,600  

Loan originations and principal collections, net

     (42,442,901 )     (66,031,932 )     (26,879,732 )

Purchases of loans

     (6,996,461 )     (2,987,986 )     (439,629 )

Recoveries of loans previously charged off

     38,276       60,540       9,588  
                        

Net cash used in investing activities

     (51,867,494 )     (68,563,105 )     (69,212,941 )
                        

 

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New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Continued)

 

For the years ended December 31,

   2005     2004     2003  

Cash flows from financing activities:

      

Net (decrease) increase in demand deposits, savings and NOW accounts

     (7,788,484 )     14,388,246       4,217,767  

Net increase (decrease) in time deposits

     39,353,808       (9,793,213 )     (5,069,640 )

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

     (5,000,000 )     (19,000,000 )     9,000,000  

Principal advances from Federal Home Loan Bank

     95,000,000       75,000,000       13,000,000  

Repayment of advances from Federal Home Loan Bank

     (65,000,000 )     (3,000,000 )     —    

Net (decrease) increase in repurchase agreements

     (1,775,252 )     1,283,845       3,772,026  

Repurchase of treasury stock

     (112,966 )     —         (73,495 )

Dividends paid

     (2,097,465 )     (1,859,333 )     (1,419,736 )

Proceeds from exercise of stock options

     593,345       1,397,998       968,678  
                        

Net cash provided by financing activities

     53,172,986       62,316,739       24,395,600  
                        

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     4,801,809       3,017,610       (34,861,180 )

CASH AND CASH EQUIVALENTS, beginning of year

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

CASH AND CASH EQUIVALENTS, end of year

   $ 26,345,434     $ 21,543,625     $ 18,526,015  
                        

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

      

Interest paid

   $ 8,566,691     $ 6,450,630     $ 5,729,557  
                        

Income taxes paid

   $ 3,461,426     $ 2,140,386     $ 2,620,972  
                        

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES

      

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.

 

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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 seventeen 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 Financial Accounting Standards Board (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, 2005 and 2004 includes $6,224,000 and $4,738,000, 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 in the fair value of individual available-for-sale securities below their cost that are deemed to be other than temporary result in write-downs of the individual securities to their fair value. There were no write-downs for the years ended 2005, 2004 and 2003.

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.

Securities held for trading - Trading securities are carried at fair value on the consolidated balance sheets. Unrealized holding gains and losses for trading securities are included in earnings.

 

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Table of Contents
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, 2005 and 2004 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.

 

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Table of Contents
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.

Mortgage servicing rights are 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.

 

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Table of Contents
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 securities - Fair values for available-for-sale 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.

Subordinated debentures - 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.

 

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

 

Stock based compensation - At December 31, 2005, the Company has five fixed stock-based employee compensation plans which are described more fully in Note 11. 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), Share-Based Payment, to stock-based employee compensation.

 

For the years ended December 31,

   2005    2004    2003

Net income, as reported

   $ 5,524,288    $ 5,098,093    $ 5,771,453

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

     635,490      —        652,078
                    

Pro forma net income

   $ 4,888,798    $ 5,098,093    $ 5,119,375
                    

Earnings per share:

        

Basic - as reported

   $ 1.31    $ 1.23    $ 1.46

Basic - pro forma

   $ 1.16    $ 1.23    $ 1.29

Diluted - as reported

   $ 1.29    $ 1.20    $ 1.42

Diluted - pro forma

   $ 1.14    $ 1.20    $ 1.26

Recent Accounting Pronouncements - 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 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 adoption of SOP 03-3 did not have a material impact on the Company’s financial position or results of operations.

 

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

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“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 annual reporting period that begins after December 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.

Reclassifications - Certain amounts in the 2004 and 2003 consolidated financial statements have been reclassified to conform to the current year’s presentation.

 

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 capital securities 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.

 

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NOTE 2. Issuance of Capital Securities: (continued)

 

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.

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, 2005:

           

Bonds and notes -

           

U. S. Government, including agencies

   $ 29,492,908    $ —      $ 591,814    $ 28,901,094

Mortgage-backed securities

     58,207,406      —        1,554,749      56,652,657

Other bonds and debentures

     27,524,546      52,101      162,265      27,414,382

Equity securities

     484,386      142,614      —        627,000
                           

Total available-for-sale

   $ 115,709,246    $ 194,715    $ 2,308,828    $ 113,595,133
                           

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
                           

There were no sales of available-for-sale debt securities during 2005. For the years ended December 31, 2004 and 2003, proceeds from sales of debt securities available-for-sale amounted to $28,635,547 and $36,241,623, respectively. Gross gains of $369,494 and $265,794, and gross losses of $8,757 and $55, were realized during 2004 and 2003, respectively, on sales of available-for-sale debt securities. The tax provision applicable to these net realized gains amounted to $142,888 and $105,259, respectively. There were no sales of available-for-sale equity securities during 2005, 2004 and 2003.

 

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NOTE 3. Securities: (continued)

 

Maturities of debt securities, excluding mortgage-backed securities, classified as available-for-sale are as follows as of December 31, 2005:

 

    

Fair

Value

U.S. Government, including agencies

   $ 5,989,688

Other bonds and debentures

     6,030,849
      

Total due in less than one year

   $ 12,020,537
      

U.S. Government, including agencies

   $ 22,911,406

Other bonds and debentures

     13,120,431
      

Total due after one year through five years

   $ 36,031,837
      

Other bonds and debentures

   $ 1,940,102
      

Total due after five years through ten years

   $ 1,940,102
      

Other bonds and debentures

   $ 6,323,000
      

Total due after ten years

   $ 6,323,000
      

There were no securities of issuers which exceeded 10% of shareholders’ equity as of December 31, 2005.

Securities, carried at $83,059,829 and $99,226,273 were pledged to secure public deposits, the treasury, tax and loan account and securities sold under agreements to repurchase as of December 31, 2005 and 2004, 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, 2005:

 

     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

   $ 4,898,438    $ 68,361    $ 24,002,656    $ 523,453    $ 28,901,094    $ 591,814

Mortgage-backed securities

     32,411,315      631,407      24,241,342      923,342      56,652,657      1,554,749

Other bonds and debentures

     5,082,988      45,894      9,044,292      116,371      14,127,280      162,265
                                         

Total temporarily impaired securities

   $ 42,392,741    $ 745,662    $ 57,288,290    $ 1,563,166    $ 99,681,031    $ 2,308,828
                                         

The investments in the Company’s investment portfolio that are temporarily impaired as of December 31, 2005 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. As company management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available-for-sale, no declines are deemed to be other than temporary.

 

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Table of Contents
NOTE 4. Loans receivable:

Loans receivable consisted of the following as of December 31:

 

     2005     2004  

Real estate loans

    

Conventional

   $ 259,040,247     $ 233,429,745  

Construction

     13,080,027       21,756,712  

Commercial

     100,264,007       86,660,465  
                
     372,384,281       341,846,922  

Consumer loans

     64,392,818       57,449,583  

Commercial and municipal loans

     28,557,736       16,722,853  

Unamortized adjustment to fair value

     48,294       60,368  
                

Total loans

     465,383,129       416,079,726  

Allowance for loan losses

     (4,022,341 )     (4,019,450 )

Deferred loan origination costs, net

     1,789,748       1,748,014  
                

Loans receivable, net

   $ 463,150,536     $ 413,808,290  
                

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

 

     2005     2004     2003  

BALANCE, beginning of year

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

Charged-off loans

     (123,885 )     (14,737 )     (86,642 )

Recoveries of loans previously charged-off

     38,276       60,540       9,588  

Provision for loan losses charged to income

     88,500       74,997       99,996  
                        

BALANCE, end of year

   $ 4,022,341     $ 4,019,450     $ 3,898,650  
                        

Certain directors and executive officers of the Company and companies in which they have significant ownership interest were customers of the Bank during 2005. Total loans to such persons and their companies amounted to $2,949,530 as of December 31, 2005. During 2005 principal advances of $4,461,851 were made and principal payments totaled $3,132,749.

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

 

     December 31,
     2005    2004

Total nonaccrual loans

   $ 278,422    $ 293,203
             

Accruing loans which are 90 days or more overdue

   $ —      $ —  
             

 

Impaired loans as of December 31,

   2005    2004

Recorded investment in impaired loans at December 31

   $ —      $ 902,458

Portion of allowance for loan losses allocated to impaired loans

   $ —      $ 141,666

Net balance of impaired loans

   $ —      $ 760,792

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

   $ —      $ 902,458

 

Years Ended December 31,

   2005    2004    2003

Average recorded investment in impaired loans

   $ 335,434    $ 479,096    $ 425,009

Interest income recognized on impaired loans

   $ 22,285    $ 50,701    $ 22,770

Interest income on impaired loans on a cash basis

   $ 22,285    $ 2,748    $ 8,945

 

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Table of Contents
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:

 

     2005    2004

Sold loans

   $ 304,267,740    $ 293,569,964
             

Participation loans

   $ 15,987,416    $ 12,782,673
             

The balance of capitalized servicing rights, net of valuation allowances, included in other assets at December 31, 2005 and 2004 was $2,136,274 and $2,281,309, respectively.

Servicing rights of $617,167, $859,564 and $1,837,297 were capitalized in 2005, 2004 and 2003, respectively. Amortization of capitalized servicing rights was $781,975 in 2005, $944,959 in 2004 and $1,293,748 in 2003.

The fair value of capitalized servicing rights was $3,306,858 and $3,021,319 as of December 31, 2005 and 2004, respectively. Following is an analysis of the aggregate changes in the valuation allowances for capitalized servicing rights:

 

     2005     2004  

Balance, beginning of year

   $ 28,884     $ 61,115  

Decrease

     (19,773 )     (32,231 )
                

Balance, end of year

   $ 9,111     $ 28,884  
                

 

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:

 

     2005    2004

Land

   $ 1,269,548    $ 1,128,768

Buildings and premises

     11,742,199      10,329,871

Furniture, fixtures and equipment

     6,223,161      5,334,432
             
     19,234,908      16,793,071

Less - Accumulated depreciation

     7,901,948      7,092,594
             
   $ 11,332,960    $ 9,700,477
             

Depreciation expense amounted to $861,490, $797,630 and $949,931 for the years ending December 31, 2005, 2004 and 2003, respectively.

 

NOTE 6. Investment in real estate:

The balance in investment in real estate consisted of the following as of December 31:

 

     2005    2004

Land

   $ 430,017    $ 219,743

Building

     1,718,584      311,362
             
     2,148,601      531,105

Less - Accumulated depreciation

     194,753      173,986
             
   $ 1,953,848    $ 357,119
             

Rental income from investment in real estate amounted to $48,066, $31,497 and $53,419 for the years ended December 31, 2005, 2004 and 2003, respectively. Depreciation expense amounted to $20,767, $15,648 and $8,203 for the years ending December 31, 2005, 2004 and 2003, respectively.

 

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Table of Contents
NOTE 7. Deposits:

The following is a summary of maturities of time deposits as of December 31, 2005:

 

2006

   $ 117,453,242

2007

     21,217,709

2008

     1,278,436

2009

     948,236

2010

     40,899
      
   $ 140,938,522
      

Deposits from related parties held by the Bank as of December 31, 2005 and 2004 amounted to $3,996,070 and $5,495,567, respectively.

As of December 31, 2005 and 2004, time deposits include $38,829,203 and $28,654,490, respectively of certificates of deposit with a minimum balance of $100,000.

 

NOTE 8. Federal Home Loan Bank Advances:

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

Maturities of advances from the FHLB for the three years ending after December 31, 2005 are summarized as follows:

 

2006

   $ 65,000,000

2007

     5,000,000

2008

     30,000,000
      
     $100,000,000
      

At December 31, 2005, the interest rates on FHLB advances ranged from 3.09% to 4.94%. The weighted average interest rate at December 31, 2005 is 4.11%.

A $30,000,000 advance maturing in 2008 has a capped interest rate of 4.48% for the life of the advance. As of December 31, 2005, the advance has reached the maximum interest rate of 4.48%.

Borrowings from the FHLB are secured by a blanket lien on qualified collateral, consisting primarily of loans with first mortgages secured by one to four family properties, certain unencumbered investment securities and other qualified assets.

 

NOTE 9. Securities sold under agreements to repurchase:

The securities sold under agreements to repurchase as of December 31, 2005 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 10. Income taxes:

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

 

     2005    2004    2003

Current tax expense

   $ 3,166,782    $ 2,785,294    $ 2,459,668

Deferred tax expense

     91,565      378,216      1,046,854
                    

Total income tax expense

   $ 3,258,347    $ 3,163,510    $ 3,506,522
                    

 

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Table of Contents
NOTE 10. Income taxes: (continued)

 

The reasons for the differences 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:

 

     2005     2004     2003  

Federal income tax at statutory rate

   34.0 %   34.0 %   34.0 %

Increase (decrease) in tax resulting from:

      

Tax-exempt income

   (.6 )   (.3 )   (.1 )

Dividends received deduction

   (.7 )   (1.2 )   (.9 )

Other, net

   4.4     5.7     4.8  
                  

Effective tax rates

   37.1 %   38.2 %   37.8 %
                  

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

 

     2005     2004  

Deferred tax assets:

    

Interest on non-performing loans

   $ 2,141     $ 2,052  

Allowance for loan losses

     1,279,908       1,238,003  

Deferred compensation

     130,322       115,128  

Deferred retirement expense

     189,811       167,660  

Accrued directors fees

     48,113       56,175  

Net unrealized holding loss on securities available-for-sale

     837,400       89,705  

Other

     16,154       13,128  
                

Gross deferred tax assets

     2,503,849       1,681,851  
                

Deferred tax liabilities:

    

Deferred loan costs, net of fees

     (708,919 )     (692,011 )

Prepaid pension

     (1,008,665 )     (954,206 )

Accelerated depreciation

     (675,196 )     (819,319 )

Purchased goodwill

     (1,184,288 )     (888,216 )

Mortgage servicing rights

     (846,178 )     (903,626 )
                

Gross deferred tax liabilities

     (4,423,246 )     (4,257,378 )
                

Net deferred tax liability

   $ (1,919,397 )   $ (2,575,527 )
                

As of December 31, 2005, the Company had no operating loss and tax credit carryovers for tax purposes.

 

NOTE 11. Stock compensation plans:

At December 31, 2005, the Company has three fixed stock-based employee compensation plans under which options are outstanding. As of December 31, 2005, 216,500 options are available to be 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 199,500 options granted in 2005 and 218,000 options granted in 2003. The fair value of each option granted in 2005 and 2003 was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

 

     2005    

2004

   2003  

Weighted risk-free interest rate

   4.60 %   —      4.36 %

Weighted expected life

   10 years     —      10 years  

Weighted expected volatility

   26.55 %   —      22.3 %

Weighted expected dividend yield

   3.39% per year     —      2.78% per year  

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

 

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Table of Contents
NOTE 11. Stock compensation plans: (continued)

 

A summary of the status of the Company’s fixed stock option plans as of December 31, 2005, 2004 and 2003 and changes during the years ending on those dates is presented below:

 

     2005    2004    2003
     Shares     Weighted
Average
Exercise
Price
   Shares     Weighted
Average
Exercise
Price
   Shares     Weighted
Average
Exercise
Price

Outstanding at beginning of year

     373,000     $ 10.90    522,800     $ 10.45      410,700     $ 8.74

Granted

     199,500       13.25    —         —        218,000       13.05

Exercised

     (60,800 )     9.76    (149,800 )     9.33      (105,900 )     9.15
                                          

Outstanding at end of year

     511,700     $ 11.95    373,000     $ 10.90      522,800     $ 10.45
                                          

Options exercisable at year-end

     511,700        373,000          522,800    

Weighted-average fair value of options granted during the year

   $ 3.45        N/A        $ 3.29    

The following table summarizes information about fixed stock options outstanding as of December 31, 2005:

 

Options Outstanding and Exercisable
Exercise Prices   

Number

Outstanding

as of 12/31/05

  

Remaining

Contractual Life

$ 6.25    4,000    1 year
  7.375    30,600    3.5 years
  9.125    66,000    6.5 years
  10.50    56,000    2 years
  13.05    155,600    7.75 years
  13.25    199,500    9.83 years
         
   511,700    7.46 years
         

 

NOTE 12. Employee benefit plans:

Defined benefit pension plan - The Company has a defined benefit pension plan covering substantially all full-time employees who have attained age 21 and have completed one year of service. Annual contributions to the plan are based on actuarial estimates.

 

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NOTE 12. Employee benefit plans: (continued)

 

The following tables set forth information about the plan, using a measurement date of November 30, for 2005 and 2004 and December 31 for 2003:

 

     Years Ended December 31,  
     2005     2004     2003  

Change in projected benefit obligation:

      

Benefit obligation at beginning of year

   $ 5,282,443     $ 4,357,510     $ 3,998,524  

Service cost

     450,044       442,543       314,033  

Interest cost

     304,380       305,205       244,762  

Actuarial (gain) loss

     (33,030 )     601,796       (87,600 )

Benefits paid

     (449,056 )     (272,556 )     (112,209 )

Plan amendments

     —         (152,055 )     —    
                        

Benefit obligation at end of year

     5,554,781       5,282,443       4,357,510  
                        

Change in plan assets:

      

Plan assets at estimated fair value at beginning of year

     5,412,640       5,056,841       2,953,827  

Actual return on plan assets

     259,557       272,029       770,102  

Employer contribution

     529,288       356,326       1,445,121  

Benefits paid

     (449,056 )     (272,556 )     (112,209 )
                        

Fair value of plan assets at end of year

     5,752,429       5,412,640       5,056,841  
                        

Funded status

     197,648       130,197       699,331  

Unrecognized net loss

     2,325,999       2,256,178       1,617,519  

Unrecognized prior service cost

     22,836       22,629       174,477  
                        

Prepaid pension cost

   $ 2,546,483     $ 2,409,004     $ 2,491,327  
                        

The discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 6.25% and 3.5%, respectively at December 31, 2005 and 2004 and 6.5% and 3.5% at December 31, 2003, respectively.

The accumulated benefit obligation for the defined benefit pension plan was $4,067,218 and $3,962,941 at December 31, 2005 and 2004, respectively.

Components of net periodic cost:

 

     Years Ended December 31,  
     2005     2004     2003  

Service cost

   $ 450,044     $ 442,543     $ 314,033  

Interest cost on benefit obligation

     304,380       305,205       244,762  

Expected return on assets

     (449,401 )     (413,929 )     (289,033 )

Amortization of unrecognized prior service cost

     (207 )     (207 )     9,398  

Amortization of unrecognized net loss

     86,993       105,037       94,037  
                        

Net periodic cost

   $ 391,809     $ 438,649     $ 373,197  
                        

For the years ended December 31, 2005, 2004 and 2003, the assumptions used to determine the net period pension cost are as follows:

 

     Years Ended December 31,  
     2005     2004     2003  

Discount rate

   6.25 %   6.25 %   6.50 %

Increase in future compensation levels

   3.50 %   3.50 %   3.50 %

Expected long-term rate of return on plan assets

   8.00 %   8.00 %   8.00 %

 

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NOTE 12. Employee benefit plans: (continued)

 

Lake Sunapee Bank has examined the historical benchmarks for returns in each asset class in its portfolio, and based on the target asset mix has developed a weighted-average expected return for the portfolio as a whole, partly taking into consideration forecasts of long-term expected inflation rates of 2.0% to 3.5%. The long-term rate of return used by Lake Sunapee Bank is 8.00%. This rate was determined by adding the expected inflation rates to the weighted sum of the expected long-term return on each asset allocation.

Plan Assets

The Company’s pension plan weighted-average asset allocations by asset category are as follows:

 

     Plan Assets at December 31,  

Asset Category

   2005    Percent     2004    Percent  

Equity securities

   $ 3,454,494    60.0 %   $ 3,418,992    63.2 %

Corporate debt securities

     814,776    14.2       684,872    12.6  

U.S. Government and agency securities

     1,246,519    21.7       1,267,607    23.4  

Money Market

     236,640    4.1       41,169    0.8  
                          

Total

   $ 5,752,429    100.0 %   $ 5,412,640    100.0 %
                          

Equity securities include 30,000 and 30,000 shares of the Company’s common stock as of December 31, 2005 and 2004, respectively. The fair value of the shares on those dates was $420,000 (7.3% of total plan assets) and $442,800 (8.2% of total plan assets), respectively.

The investment policy for the defined benefit pension plan sponsored by Lake Sunapee Bank is based on ERISA standards for prudent investing. The Bank seeks maximum return while limiting risk, through a balanced portfolio of equity and fixed income investments, as well as alternative asset classes. Within each asset class, a diversified mix of individual securities and bonds is selected. Equity allocations are targeted between 40% and 65% of the portfolio, with the remainder in fixed income investments and a small portion in alternative asset classes such as real estate. Asset manager performance is reviewed at least once every six months and benchmarked against the peer universe for the given investment style. The target allocation for the 2006 plan year and for the prior two years follows.

 

       Target Percentage of Plan Assets
Years Ended December 31,
 

Asset Category

     2006     2005     2004  

Equity securities

     40-65 %   40-65 %   40-65 %

Corporate debt securities

     10-35 %   10-35 %   10-35 %

U.S. Government and agency securities

     15-25 %   15-25 %   15-25 %

Other

     0-10 %   0-10 %   0-10 %

The Bank expects to contribute $500,000 to the defined benefit pension plan in 2006.

Estimated future benefit payments, which reflect expected future service, as appropriate, are as follows:

 

2006

   $ 123,533

2007

     123,955

2008

     143,682

2009

     146,059

2010

     160,650

Years 2011-2015

     1,481,157

 

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NOTE 12. Employee benefit plans: (continued)

 

Profit Sharing - Stock Ownership Plan

The Bank sponsors a Profit Sharing - Stock Ownership Plan. The Bank may elect, but is not required, to make discretionary and/or matching contributions to the Plan.

For 2005, 2004 and 2003, participating employees’ contributions totaled $358,181, $336,034 and $295,090, respectively. The Bank made a matching contribution of $40,377 for 2005, $30,000 for 2004 and $40,000 for 2003. A participant’s retirement benefit will depend on the amount of the contributions to the Plan together with the gains or losses on the investments.

The Company and the Bank entered into parallel employment agreements (the “Agreements”) with the President and Chief Executive Officer of the Company and with the Executive Vice President and Chief Financial Officer of the Company. The Agreements are for a period of five years and extend automatically each day unless either the Company or the Executive give contrary written notice in advance. The Agreements provide for a salary and certain benefits.

The Agreements also provide for severance benefits upon termination without cause or following a change in control as defined in the agreements in an amount equal to the present value of the cash compensation and fringe benefits that the Executive(s) would have received if the Executive(s) would have continued working for an additional five years.

 

NOTE 13. Commitments and contingencies:

In the normal course of business, the Company has outstanding various commitments and contingent liabilities, such as legal claims, which are not reflected in the consolidated financial statements. Management does not anticipate any material loss as a result of these transactions.

As of December 31, 2005, the Company was obligated under non-cancelable operating leases for bank premises and equipment expiring between July 31, 2006 and September 30, 2012. The total minimum rent commitments due in future periods under these existing agreements is as follows as of December 31, 2005:

 

2006

   $ 278,746

2007

     226,500

2008

     166,028

2009

     145,016

2010

     17,474

Years thereafter

     30,580
      

Total minimum lease payments

   $ 864,344
      

Certain leases contain provisions for escalation of minimum lease payments contingent upon increases in real estate taxes and percentage increases in the consumer price index. The total rental expense amounted to $283,374, $260,078 and $222,094 for the years ended December 31, 2005, 2004 and 2003, respectively.

 

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NOTE 14. Shareholders’ equity:

Liquidation account - On May 22, 1986, Lake Sunapee Bank, fsb received approval from the Federal Home Loan Bank Board and converted from a federally-chartered mutual savings bank to a federally-chartered stock savings bank. At the time of conversion, the Bank established a liquidation account in an amount of $4,292,510 (equal to the Bank’s net worth as of the date of the latest financial statement included in the final offering circular used in connection with the conversion). The liquidation account will be maintained for the benefit of eligible account holders who maintain their deposit accounts in the Bank after conversion. In the event of a complete liquidation of the Bank subsequent to conversion (and only in such event), each eligible account holder will be entitled to receive a liquidation distribution from the liquidation account before any liquidation distribution may be made with respect to capital stock. The amount of the liquidation account is reduced to the extent that the balances of eligible deposit accounts are reduced on any year-end closing date subsequent to the conversion. Company management believes the balance in the liquidation account would be immaterial to the consolidated financial statements as of December 31, 2005.

Dividends - The Bank may not declare or pay a cash dividend on or purchase any of its stock if the effect would be to reduce the net worth of the Bank below either the amount of the liquidation account or the net worth requirements of the banking regulators.

Special bad debts deduction - In prior years, the Bank, a wholly-owned subsidiary of the Company, was allowed a special tax-basis under certain provisions of the Internal Revenue Code. As a result, retained income of the Bank, as of December 31, 2005 includes $2,069,878 for which federal and state income taxes have not been provided. If the Bank no longer qualifies as a bank as defined in certain provisions of the Internal Revenue Code, this amount will be subject to recapture in taxable income ratably over four (4) years, subject to a combined federal and state tax rate of approximately 39.6%.

 

NOTE 15. Earnings per share (EPS):

Reconciliation of the numerators and the denominators of the basic and diluted per share computations for net income are as follows:

 

     Income
(Numerator)
   Shares
(Denominator)
   Per-Share
Amount

Year ended December 31, 2005

        

Basic EPS

        

Net income and income available to common shareholders

   $ 5,524,288      4,202,833    $ 1.31

Effect of dilutive securities, options

        94,045   
                

Diluted EPS

        

Income available to common shareholders and assumed conversions

   $ 5,524,288    $ 4,296,878    $ 1.29
                

Year ended December 31, 2004

        

Basic EPS

        

Net income and income available to common shareholders

   $ 5,098,093      4,140,828    $ 1.23

Effect of dilutive securities, options

        115,702   
                

Diluted EPS

        

Income available to common shareholders and assumed conversions

   $ 5,098,093      4,256,530