-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HdDPiBatgBQUIP68t6+4IfVIThQDSXqWrHsoGayPWkC00h7/qf1SDgCBUbKoBH4H LHdtd4zeiiRCqAZ4Ll23UA== 0000950109-98-002338.txt : 19980401 0000950109-98-002338.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950109-98-002338 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST INTERNATIONAL BANCORP INC CENTRAL INDEX KEY: 0001040339 STANDARD INDUSTRIAL CLASSIFICATION: BLANK CHECKS [6770] IRS NUMBER: 061151731 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22861 FILM NUMBER: 98580525 BUSINESS ADDRESS: STREET 1: ONE COMMERCIAL PLZ CITY: HARTFORD STATE: CT ZIP: 06103 BUSINESS PHONE: 8607270700 MAIL ADDRESS: STREET 1: ONE COMMERCIAL PLZ CITY: HARTFORD STATE: CT ZIP: 06103 10-K 1 FORM 10K FOR 1ST INTERNATIONAL BANCORP ________________________________________________________________________________ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ____________ For the fiscal year ended December 31, 1997 Commission file no. 0-22861 ____________ FIRST INTERNATIONAL BANCORP, INC. (Exact name of registrant as specified in its charter) Delaware 06-1151731 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Commercial Plaza Hartford, CT 06103 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (860) 727-0700 ____________ Securities Registered Pursuant to Section 12(b) of the Act: (Title of each class) Common Stock, par value $.10 per share Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No__ --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 or Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ____ As of March 5, 1998, the aggregate market value of the voting stock held by non- affiliates of the Registrant, based on the closing price of the common stock as reported by the Nasdaq Stock Market of $15.375, was approximately $52,828,838. As of March 5, 1998, the Registrant had 7,876,208 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE: Part II, items 5, 6, 7, 7A and 8 are incorporated by reference to First International Bancorp's, Inc. 1997 Annual Report to Shareholders which is included as an exhibit hereto. Part III, items 10, 11, 12 and 13 are incorporated by reference to First International Bancorp, Inc.'s definitive proxy statement to stockholders which will be filed with the Securities and Exchange Commission no later than 120 days after December 31, 1997. ________________________________________________________________________________ TABLE OF CONTENTS
PART 1 Page No. ITEM 1. BUSINESS 1 ITEM 2. PROPERTIES 24 ITEM 3. LEGAL PROCEEDINGS 24 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 24 PART II ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS 25 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA 25 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 25 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES 25 ABOUT MARKET RISK ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 25 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 25 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 25 ITEM 11. EXECUTIVE COMPENSATION 25 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 25 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 25 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K 26
PART 1 ITEM 1: BUSINESS GENERAL Overview First International Bancorp, Inc., a Delaware corporation, is a one bank holding company incorporated in 1985 and regulated by the Board of Governors of the Federal Reserve System. Its principal asset and subsidiary is First National Bank of New England, a national banking association established in 1955 and regulated by the Office of the Comptroller of the Currency (the "OCC"). The Company specializes in providing credit, trade and depository services to small and medium size manufacturing companies located in the United States and in international emerging markets. The Company serves its target market by offering flexible and attractive terms to borrowers and manages its credit risk through the combined utilization of commercial loan guarantee programs made available by three U.S. federal agencies: the U.S. Small Business Administration (the "SBA"), the U.S. Department of Agriculture (the "USDA"), and the Export-Import Bank of the U.S. ("Ex-Im Bank"). For the federal fiscal year ending September 30, 1997, the Company was the country's fourteenth largest SBA 7(a) lender, and the largest SBA lender in New England, measured by dollar volume; the country's largest USDA Business and Industry lender measured by dollar volume; and the country's largest Ex-Im Bank lender measured by number of transactions. The Company maintains preferred status with the federal agencies for several jurisdictions and programs. In recognition of the Company's efforts in promoting small business exports and its high volume of loan originations, the Company received Ex-Im Bank's annual "Small Business Bank of the Year Award" in May 1997. Loan Originations Management believes that the specialized market knowledge and experience of the Company's lending officers, combined with a broad range of commercial and international financing products, enable the Company to satisfy the needs of its small and medium size manufacturing clients. Brand recognition for the Company is maintained by incorporating the servicemark Financing Manufacturers Worldwide(R) in its logos. The Company's domestic and international lending relationships generally range from $150,000 to $2.5 million. The Company's Commercial business units underwrite lines of credit, term loans, industrial mortgages and trade financing for businesses located primarily in the Northeast and Midatlantic regions of the United States. Commercial lenders operate from the Company's Hartford, 1 Connecticut headquarters, as well as from regional representative offices located in Boston and Springfield, Massachusetts; Providence, Rhode Island; Morristown, New Jersey; Pittsburgh and Philadelphia, Pennsylvania; Rochester, New York and Washington D.C. The Company is considering the opening of additional offices in the Midwest U.S. in 1998. The Company's domestic loan officers are trained to understand the specific financial needs of small and medium size manufacturers, and to use government guaranteed and other commercial loan products to respond to those needs. Domestic loan officers participate in industrial trade organizations representing the Company's target market and conduct other marketing activities to reach potential borrowers. The Company's International business units underwrite Ex-Im Bank guaranteed and insured loans to small and medium size manufacturers located throughout the United States and in eleven international emerging markets. In 1998, the Company's International business units also began offering loans to U.S. importers of foreign-made goods. See "International Banking Services and Products." International lending activities support trade flows between the United States and emerging markets which have grown at a rate of 12% annually since 1990. The Company's International business units operate from its Hartford, Connecticut headquarters and are assisted in their efforts by contractual international marketing representatives, or "master agents", who are actively involved in providing financial, accounting, consulting and/or engineering services to manufacturers in their home countries. Contractual marketing arrangements have been established with professionals in Argentina, Brazil, Central America, India, Indonesia, Korea, Mexico, Philippines, Poland, South Africa and Turkey. The Company began lending internationally in 1994 and has increased its medium term loan originations from $397,000 in 1994 to $1.8 million in 1995, $13.6 million in 1996 and $60.9 million in 1997. Underwriting The Company's underwriting activities are initiated from each of its lending offices and supported and approved at the Hartford, Connecticut headquarters. Commercial lending officers analyze the creditworthiness of proposed borrowers and evaluate each borrower's financial statements, credit reports, business plans and other data to determine if the credit and proposed collateral satisfy the Company's specific lending standards and policies. All credit memoranda are reviewed by an independent credit officer and may require additional approval depending on the particular circumstances of the financing package. Domestic and international loans undergo a substantially identical approval process. Loan Sales The Company seeks to achieve high returns while meeting the growing credit needs of its target market by selling a portion of its commercial and international loans on a non-recourse, servicing-retained basis. A separate Capital Markets business unit was established in 1996 to sell loans, including commercial and international loans without federal guarantees. The Capital Markets business unit directs its resources toward identifying non-government guaranteed secondary loan markets as a further means of mitigating credit risk, leveraging capital and replenishing liquidity. As of December 31, 1997, $87.7 million, or 20%, of the loan portfolio 2 serviced for investors did not have government guarantees or credit enhancements compared to $48.9 million, or 18%, of such servicing portfolio as of December 31, 1996. Funding Sources The Company's lending and investing activities are funded primarily by interest- bearing deposits from commercial borrowers, their principals and other private banking clients. The Private Banking business units provide stable, low-cost funding to the Company by managing the deposit base while offering a full array of financial products to serve the personal needs of, and facilitate relationships with, the Company's client base. Private bankers continually seek to expand the Company's deposit base by soliciting deposits from individuals who seek highly personalized service and to strengthen existing deposit relationships by offering new financial products and services to both existing and prospective clients. In addition to deposits, alternative funding sources are being developed to support the Company's business strategy. BUSINESS STRATEGY The Company's strategy is to serve small and medium size manufacturers through the following key activities: Domestic Loan Origination Activities. Commercial business units currently operate from the Hartford, Connecticut headquarters, as well as from eight regional loan production or "representative" offices located in Boston and Springfield, Massachusetts; Providence, Rhode Island; Pittsburgh and Philadelphia, Pennsylvania; Morristown, New Jersey; Rochester, New York and the Washington D.C. area. The Company intends to continue to expand in its established geographic markets by adding additional staff during the next two years. In addition, the Company will continue to enter new markets by opening representative offices as marketing diligence is completed, most likely in the Midwest U.S. Financing Trade with International Emerging Markets. The International business units operating from the Hartford, Connecticut headquarters are assisted in their efforts abroad by its contractual relationships with international master agents in Argentina, Brazil, Central America, India, Indonesia, Korea, Mexico, Philippines, Poland, South Africa and Turkey. The master agents are actively involved in providing professional financial services to small and medium size manufacturers in their home countries. The Company also provides working capital to U.S. manufacturers who export to, and in 1998 the Company began financing U.S. imports from, international emerging markets. Loan Sales Activities. The Capital Markets business unit was established in July 1996 to sell the non-recourse, servicing-retained portions of government guaranteed and non-government guaranteed loans. Sales of the unguaranteed portions of SBA and USDA loans and unguaranteed commercial loans have increased as the Capital Markets business unit has developed a network of purchasers. The Company plans to continue developing this network of 3 purchasers as loan origination activities increase and secondary markets, evolve for all categories of loans. LENDING ACTIVITIES AND POLICIES The Company's distribution of domestic and international commercial loan originations are detailed below:
FOR THE YEARS ENDED ----------------------------------------------------------------------- DECEMBER 31, 1997 DECEMBER 31, 1996 ------------------------------- --------------------------------- LOAN ORIGINATIONS BY DEPARTMENT PRINCIPAL PERCENTAGE PRINCIPAL PERCENTAGE --------------- -------------- --------------- -------------- (Dollars in thousands) Domestic: SBA loans....................................... $100,382 33% 85,303 50% USDA loans...................................... 30,404 10% 12,700 7% Other commercial loans.......................... 84,975 28% 37,824 22% -------------- ------------ ----------- ---------- Total domestic banking........................ 215,761 71% 135,827 79% International: Ex-Im working capital lines..................... 30,347 10% 23,300 13% Ex-Im medium term loans......................... 59,852 19% 13,617 8% Inventory buyer credit.......................... 1,000 - - - -------------- ------------ ----------- ---------- Total international banking.................... 91,199 29% 36,917 21% -------------- ------------ ----------- ---------- Total commercial loan originations............. $306,960 100.00% $172,744 100.00% ============== ============ =========== ==========
MARKETING Domestic Banking The Company originates domestic loans through its network of 31 commercial loan officers in nine offices who seek to establish long-term relationships with their clients. The Company believes it is uniquely positioned to serve its domestic market through an ability to provide clients with a flexible combination of lines of credit, term loans and mortgages for industrial property and trade financing. The Company generally utilizes the SBA, USDA and/or Ex-Im Bank loan guarantee and insurance programs as a part of a financing package in light of an applicant's particular situation. The Company's participation in three government guaranteed loan programs enables it to provide clients with longer loan terms than are typically available to small and medium size manufacturers. Commercial loan officers are responsible for marketing, underwriting, servicing, monitoring and collecting their portfolio of loans. The Company believes that this broad range of responsibilities enables the commercial loan officers to establish strong working relationships with both existing and prospective clients and promotes strong client service and prudent loan portfolio management. Commercial loan officers are encouraged to keep apprised of market conditions 4 through frequent contact with clients and potential borrowers, to develop specific knowledge of their clients' businesses, and to offer flexible structuring of loan products. In consultation with the borrower, a commercial loan officer will evaluate the financing needs of the business and then recommend the best way to structure the lending transaction to fit the client's unique needs. The marketing efforts by commercial loan officers include participation in trade associations serving the needs of small and medium size manufacturers; contacting accountants, attorneys and other professionals known by the Company to have contact with businesses in need of financing; personal visits; direct mail solicitations; and referrals from existing clients. Since the target client of both domestic and international loan officers is often the same, there is an active cross-selling effort between these two functions. International Banking The Company has four international loan officers who target U.S. exporters eligible for trade financing programs, including those supported by Ex-Im Bank. These loan officers market pre-export working capital lines of credit. As with the domestic banking relationships, the Trade Finance business unit is responsible for marketing, underwriting, servicing, monitoring and collecting its portfolio of loans. If a borrower has both domestic and international banking loan facilities, the relationship is evaluated and monitored on an aggregate basis and each loan officer is responsible for his loan and further responsible for close coordination with his lending counterpart to ensure proper maintenance of the entire relationship. Internationally, the Company has established contractual marketing relationships with professional firms in eleven emerging markets who, in the course of conducting their primary business, have frequent contact with local manufacturers who require financing to purchase U.S. goods. Prior to entering into relationships with these "Master Agents," the Company conducts due diligence, including visiting the prospective representative and conducting local diligence concerning their business reputation and legal status. The Company also requires that each Master Agent be trained on the Company's products and services at the Hartford, Connecticut headquarters. Each Master Agent markets, on behalf of the Company, medium terms loans guaranteed by Ex-Im Bank in its respective foreign market. Once the Master Agent develops a lead with a potential borrower, it directs the prospect to a U.S.-based loan officer who completes the application process. The Master Agent receives a negotiated fee when a loan referral made to the Company has been underwritten and closed. The Master Agent assists the loan officer in obtaining certain information from the applicant and in responding to inquiries of the applicant, but does not have any direct underwriting responsibilities. All decisions with respect to referrals of Master Agents are made by the Company, which retains full control over international loan originations. Although the Company has contractual marketing relationships with firms in eleven markets, 90% of the $60.8 in million medium term loan originations during 1997 were loans to borrowers in Brazil, Turkey and Mexico. This concentration of originations reflects the length of time which the Company has been marketing in these countries. Loan origination activity does not begin until some months after the date a Master Agent is established, the Company's in-country 5 representatives are trained, marketing plans have been developed and initial calling efforts are undertaken. Marketing efforts include visits to and direct mail solicitation of, U.S.-based exporters of capital goods, direct mail solicitation of foreign-based manufacturers and industrial trade organizations and in-country marketing by the Company's network of Master Agents. DOMESTIC BANKING SERVICES AND PRODUCTS Loan Products and the Origination Process The commercial loans originated by the Company include industrial mortgage loans (i.e., loans to businesses collateralized by industrial real property), equipment term loans and revolving lines of credit to manufacturers, wholesalers and distributors, many of which are exporters. The typical commercial borrower is a privately owned and operated company with annual sales of $2 million to $25 million, employing 10-175 workers, which has been in business for at least three years. A number of the Company's borrowers have a proprietary product line, export their products and/or have a geographically diverse client base. The Company is typically the borrower's primary lender and provides loans which are collateralized by assets of the borrower. The Company's Private Banking business units also provide a variety of business and personal financial services to borrowers and their principals. The Company believes it has a competitive advantage in the marketplace because it is able to provide a wide range of lending options, deposit accounts and related services. The Company originates loans to a variety of industries; however, based upon its loss experience and economic forecasts, the Company may decide to de-emphasize industries from time to time. The interest rates accruing on the Company's commercial loans are typically Prime-based, changing monthly or quarterly when the Prime Rate changes. The Company also makes fixed rate loans from time to time. The Company originates certain loans for sale through loan purchase programs pre-established with investors. The term of a loan depends upon whether the loan is guaranteed or is underwritten for a loan purchase program. Government guarantee programs give clients access to longer term financing and slower amortization than otherwise available. A government guaranteed mortgage loan has a maximum term and amortization of up to 30 years, while the term and amortization of an unguaranteed mortgage loan typically does not exceed 15 years. Equipment loans are underwritten to correspond to the useful life of the equipment and generally range from 5-15 years. SBA guaranteed working capital term loans range from 7- 10 years, while unguaranteed working capital revolving lines of credit have one- year terms. Medium term loans are generally fully amortizing. The primary collateral sought by the Company for commercial loans consists of liens which are generally first liens, on owner-occupied industrial real estate, equipment, inventory and/or accounts receivable, although additional collateral may include junior liens on residential properties. The Company generally requests the personal guarantee of the principals of a 6 business because the Company believes this induces the guarantor to facilitate repayment of the loan. In striving to meet the credit needs of its clients, the Company utilizes government guarantee loan programs which allow it to offer longer-term loans while mitigating the credit risk to the Company through the government guarantee. The two government guarantee loan programs utilized by the Company's Commercial business units to provide financing to its niche market are discussed below. SBA Guaranteed Loan Originations The Company utilizes the SBA's 7(a) loan program for eligible borrowers. Eight of the Company's nine offices have Preferred Lender status. Preferred Lender status allows the Bank to approve loans on behalf of the SBA, with the national SBA processing center's concurrence that the applicant meets the SBA eligibility requirements. The SBA generally completes its eligibility review within 24 hours of submission. Eight of the Company's offices also have Certified Lender status. Certified Lender status entitles the Bank to 72-hour turnaround from local SBA district offices for approval of loan applications. The SBA's 7(a) loan program provides for a guarantee equal to 75% of the principal balance, up to a maximum guarantee of $750,000 per borrower. The Company makes SBA loans to businesses which qualify under agency regulations as a "small business." The primary operative SBA eligibility criterion privately-owned manufacturers employing fewer than 500 workers. Loans may generally be used for the acquisition or refinancing of plant and equipment, working capital and debt consolidation. In the event of default, the SBA and Company share in any collections or collateral on a pari passu basis. For example, if a loan carries a 75% guarantee, the SBA receives 75% of all collections while the Company receives 25% of such amounts, beginning with the initial recovery. The SBA also reimburses the Company's collection costs on a similar basis. If the SBA establishes that any resulting loss is attributable to a failure by the Company to comply with SBA policies and procedures in connection with the origination, documentation or funding of a loan, the SBA may decline to pay the guaranteed amount, or if the guaranty has already been paid, may seek recovery of funds from the Company. With respect to guaranteed SBA loan participations which have been sold, the SBA will first honor its guarantee and then seek compensation from the Company in the event that a loss is deemed to be attributable to such failure to comply with SBA policies and procedures. USDA Guaranteed Loan Originations The Company utilizes the Business and Industry Program ("B&I Program") of the USDA when applicable based on an applicant's geographical location and other characteristics. The B&I Program provides for 80% guarantees on loans with principal balances up to $5 million and 70% 7 guarantees on loans with principal balances up to $10 million and, therefore, enables the Company to provide financing to borrowers with greater needs than those eligible for SBA loans and non-guaranteed commercial loans from the Company, due to legal lending limit constraints. The stated purpose of this program is to support industry, employment and general economic and environmental conditions in rural communities, which are defined as towns with fewer than 50,000 inhabitants. Such loans may be utilized for acquisition, improvement or refinancing of plant, equipment, working capital and debt consolidation. Loans to be guaranteed under the B&I Program are submitted to the USDA district office and, depending on that office's loan authority, may be required to be forwarded to the national USDA for approval. The USDA approved the Company as a Certified Lender in six states in 1997, making it one of the first USDA Certified Lenders nationally. As a Certified Lender, the Company is recognized as a "Subject Matter Expert" and is able to reserve funds, which facilitates the processing of USDA loans. The guarantee of the USDA also provides for pari passu recovery of collection proceeds, and for recourse to the Company similar to that discussed above for SBA loans in the event the Company is found to have been negligent in the origination, documentation or funding of USDA loans. DOMESTIC UNDERWRITING For the Company's domestic underwriting process, the Company's staff seeks to: (i) analyze borrowers' credit profiles; (ii) assess the collateral underlying a loan; (iii) assure compliance with eligibility requirements for inclusion under the guarantee programs; and (iv) obtain or provide documentation. Commercial lending officers receive and assemble initial applications, analyze the creditworthiness of proposed borrowers, prepare credit memoranda, and aided by staff prepare any required government guarantee loan application forms and conduct credit and trade reference checks. In the course of analyzing the creditworthiness of prospective borrowers, commercial lending officers evaluate each applicant's and any guarantors' financial statements, credit reports, appraisals and other information regarding the value of collateral the experience, strength and continuity of the borrower's management business plans and other data to determine if the credit and collateral satisfy the Company's standards and compliance with any applicable government guaranteed loan program requirements. Such standards may include debt service coverage ratios, or other financial ratios, reasonableness of the borrower's projections (when submitted), the experience, strength and continuity of the borrower's management, the financial condition of individual guarantors, the value of collateral, and compliance with government guarantee loan program requirements. An originating officer and, generally, another senior officer perform on-site inspections to determine the condition of a borrower's facility, the manner in which business is being conducted, the condition and maintenance of assets, the existence of environmental issues, and other market conditions. 8 Originating lending officers have no authority to approve a loan on their own. Subject to compliance with credit policies and program parameters, the business manager of each commercial business unit has limited lending authority in accordance with his experience, and loans above his lending authority must be approved by the Chief Operating Officer ("COO") and the Loan Committee of the Bank's Board of Directors. All loans to a borrower and its affiliates are aggregated to determine whether they are within a loan officer's lending authority. Upon initial approval by a business manager, the credit memorandum must be approved by the Credit Policy Officer, who reports to the Chief Credit Officer. The Credit Policy Officer reviews the memorandum and supporting file for compliance with internal Company policy as well as applicable government guarantee requirements. If additional approvals are required, the credit memorandum is forwarded to the appropriate parties as noted above. If the financing package includes a government guaranteed loan, the application is forwarded to the applicable government agency. The Company performs a credit analysis on all applications, considering the type and value of the assets collateralizing a loan, the characteristics of the borrower, the borrower's industry, and the anticipated debt service ratio. The Company generally requires that a borrower's most recently completed fiscal year financial statements demonstrate historical debt service coverage ratio of at least 1.25 to 1. If requested funding is for plant or line of business expansions, consideration may also be given to projected results and, therefore, certain loans may be granted when historical debt service coverage is less than 1.25 to 1. Real property taken as primary collateral for a loan is valued by an independent appraiser in accordance with federal banking regulations, and the appraisal is then subject to an internal review in accordance with such regulations. Equipment serving as primary collateral for a loan is generally valued by an independent equipment appraiser. The Company will generally obtain a Phase I environmental report completed in accordance with the standards of the American Society for Testing and Materials on any commercial real property to be mortgaged. Additional environmental reporting and remediation are required prior to closing if environmental issues either exist or are suspected. INTERNATIONAL BANKING SERVICES AND PRODUCTS The Company's International Banking business units offer Ex-Im Bank guaranteed revolving lines of credit to U.S. manufacturers, medium term loans to foreign buyers of U.S. goods, and letters of credit issued in connection with such facilities. 9 The International banking business units include the following:
TERRITORY EX-IM PRODUCT USED DESCRIPTION --------- ------------------ ----------- United States (principally Working capital line of credit; One year revolving line of the Northeast and 90% guaranteed; indexed to U.S. credit to U.S. manufacturers Mid-atlantic) Prime, variable daily; U.S. collateralized by export dollar denomination accounts receivable and inventory Americas (principally Medium term loan; 100% guaranteed 1- to 5-year term loans to Argentina, Brazil, Central or insured; indexed to 6-month foreign purchasers of America, Mexico) and LIBOR, variable semi-annually; qualified U.S. made inventory Asia/Africa/Europe U.S. dollar denominated and equipment (principally India, Indonesia, Korea, Philippines, Poland, South Africa and Turkey)
Ex-Im Bank is an independent agency of the U.S. whose mission is to facilitate export financing of U.S. goods and services by neutralizing the effect of export credit subsidies from other governments and absorbing credit risks that the private sector will not accept. The Company utilizes the Ex-Im Bank's loan guarantee and insurance programs designed to support small and medium size U.S. exporters. In 1997 the Company received Ex-Im Bank's annual "Small Business Bank of the Year" award. International Banking - United States Working Capital Loan Products and the Origination Process The typical U.S. client for the Company's international products is a U.S.-based manufacturer with sales of $2 million to $25 million and export financing needs. The Trade Finance business unit handles these clients, which comprise the same target profile as for the Company's domestic loan officers. The one-year revolving Ex-Im Bank working capital lines of credit are indexed to WSJ Prime and adjust daily. The primary collateral for these loans includes export-related accounts receivable and inventory. The accounts receivable are generally insured under an Ex-Im Bank insurance policy, private export credit insurance or an acceptable letter of credit. Open accounts receivable may qualify as collateral if approved in advance by the Company and Ex-Im Bank. Borrowers must submit borrowing base certificates to the Company to evidence the availability of acceptable collateral when an advance is requested, and monthly thereafter. The Company is one of ten lenders in the U.S. with "AA Level Delegated Authority" status with respect to Ex-Im Bank's working capital loan guarantee program and, therefore, has authority to 10 approve working capital lines up to $5 million per borrower, up to an aggregate portfolio of $75 million without prior Ex-Im Bank approval. In the event of a loan default, the Company and Ex-Im Bank share in all loan recovery proceeds on a pari passu basis in accordance with the 90% guaranteed/10% unguaranteed ratio. The Company also has the responsibility to ensure that loans are underwritten, documented and funded in accordance with Ex- Im Bank polices and procedures in order to avoid loss of the guarantee. International Banking - Emerging Markets Short and Medium Term Loan Products and Origination Process Emerging market-based clients of the Company's Americas and Asia/Africa/Europe business units are typically small and medium size manufacturers requiring financing to purchase equipment, components and raw materials from the U.S. Medium term loans are 100% Ex-Im Bank guaranteed or insured, typically 3-5 years in term, and finance the acquisition of qualified U.S.-made capital goods. Ex- Im Bank program allows the financing of up to the lower of 85% of purchase price or 100% of U.S. content. Certain other U.S. content and product requirements must also be met. The loans range in size from $150,000 to $10 million and are U.S. dollar-denominated. Although the purchase of the equipment is being financed, the loans are unsecured; the Company relies on the borrower's cash flow and the 100% Ex-Im Bank guarantee or insurance. International lending officers are responsible for marketing, underwriting, servicing, monitoring and collecting their portfolios of loans. Because the loans are medium term and fully amortizing with semi-annual payments, there is less post-closing analysis required for performing loans than for other types of loans made by the Company. In the event of default, Ex-Im Bank handles the liquidation of medium term loans and pays the Company 100% of the principal balance, plus accrued interest. See "Delinquency and Collection Activities." INTERNATIONAL BANKING UNDERWRITING International lending officers receive and assemble initial applications, analyze the creditworthiness of proposed borrowers, prepare memoranda, and aided by staff prepare the required Ex-Im Bank loan application forms and conduct credit and trade reference checks. For medium term loans, in-country Master Agents, where applicable, aid in the transaction by obtaining required financial or operational data from borrowers and generally assist in the loan origination and closing process. The Company's international lending officers will often visit the prospective U.S. borrower's place of business and perform on-site inspections. The Company will generally instruct its in- 11 country Master Agents to make such inspections of foreign borrowers. Although inventory serves as collateral for working capital lines of credit to U.S. exporters, other tangible assets are generally not taken as collateral under the Ex-Im Bank loan programs. However, site inspections in most cases are conducted because such information is helpful in assessing a borrower's operations. The approval process is substantially similar to that followed by the commercial lending officers. The Credit Policy Officer reviews the memorandum and supporting file for compliance with internal Company policies as well as applicable Ex-Im Bank guarantee program parameters. As with the domestic lending, exceptions to the Company's and Ex-Im Bank's loan policies are entertained on a case-by-case basis by the approving loan officers, and acceptance of exceptions depends upon the overall creditworthiness of the applicant. Working capital lines of credit are collateralized by export-related inventory and accounts receivable less than 90 days old; such collateral has maximum prescribed collateral values of 75% and 90%, respectively. As is the case with respect to domestic loans, the collateral value required to support a loan is based on the borrower's individual circumstances, and applications exceeding the Company's general standards may receive special consideration. Medium term loans are unsecured, although debt service coverage and operating history are reviewed in the underwriting process. The lending officer also considers the availability to the borrower of U.S. dollars and other "hard" currency revenue sources from sales to the U.S. and other stable currency markets. While most working capital lines of credit are within the Company's "AA Delegated Authority", applications which do not comply with and/or are above the Company's authority, and all medium term loans, require Ex-Im Bank approval. CAPITAL MARKETS AND LOAN SERVICING Capital Markets Activities The Capital Markets business unit was established in July 1996 to assume responsibility for the non-recourse, servicing-retained sale of SBA, USDA and Ex-Im Bank government guaranteed loans and to identify markets for the sale of non-guaranteed mortgage, term and revolving loans on a non-recourse, servicing- retained basis. Capital Markets activities allow the Company to leverage capital, replenish liquidity, mitigate the risk of balance sheet exposure to any single borrower, and reduce reliance on government guaranteed loan programs for revenue. The guaranteed portions of SBA and USDA loans are generally sold during the quarter of origination on a single loan basis to established brokers. Brokers generally pool the SBA guaranteed portions. USDA loans are individually sold. The guaranteed portions of the Ex-Im Bank loans and lines of credit are sold to various parties, including Private Funding Export Funding Corporation ("PEFCO"). PEFCO is a private corporation established with the support 12 of the United States Treasury and Ex-Im Bank to assist in financing exports of U.S. goods and services by making direct loans to foreign importers of U.S. made goods, and to provide liquidity support for private sector lending utilizing Ex- Im Bank programs. The Company is a 1% shareholder and one of among approximately 50 PEFCO shareholders, with a common stock investment of $599,000 at December 31, 1997. SBA and USDA regulations permit the Company to sell a portion of the unguaranteed amount of loans originated under their respective programs. SBA regulations require a bank lender to retain an unguaranteed interest equal to 10% of each SBA loan, although in 1997 the Company received permission to reduce its retained interest in its SBA loans to 5%. The SBA has proposed regulations which would allow banks to securitize or sell the unguaranteed portions of SBA loans subject to certain criteria designed to ensure that originators retain a continuing economic interest in the loans. The regulations would also reduce the required unguaranteed retention to 5% of the total SBA loan. USDA regulations permit the Company to sell unguaranteed portions equal to all but 5% of the total USDA loan. Upon the sale of such unguaranteed portions, the Company shares in the payment stream and collateral on a pari passu basis with all (guaranteed and unguaranteed) investors, beginning with the initial recovery. Sales of unguaranteed portions of SBA Loans and USDA loans totaled approximately $29.2 million and $33.1 million for the years ended December 31, 1997 and 1996, respectively. Approximately $7.8 million of the 1997 sales represented the additional 5% unguaranteed SBA portions held in the Company's portfolio for which the Company received permission to sell. A significant portion of the 1996 loans sold had been originated in 1994 and 1995. Due to these unique circumstances, there can be no assurance that this volume of unguaranteed portion loan sales will be representative of future sales activity. The Capital Markets business unit has developed a list of potential buyers of non-guaranteed mortgage loans, term loans and revolving lines of credit and devotes substantial resources to the identification of such buyers. A primary objective in the negotiation and sale of such loans is the Company's retention of sole responsibility for borrower contact. Investors meet with borrowers only in rare circumstances, and generally rely on the Company to prudently service and monitor lending relationships. The Company believes that this is important to maintain client relationships and also reflects investor confidence in its servicing ability and reputation. 13 Loan Servicing Activities At December 31, 1997, the total loan portfolio serviced by the Company was comprised of the following:
SERVICED FOR COMPANY TOTAL BALANCE OTHERS BALANCE SERVICED ------------------- --------------------- ------------------- (dollars in thousands) Commercial banking portfolio: SBA loans....................................... $247,127 $ 29,913 $277,040 USDA loans...................................... 51,132 6,541 57,673 Business loans.................................. 5,059 28,791 33,850 Revolving lines of credit....................... 2,550 30,414 32,964 Commercial mortgages............................ 19,033 19,918 38,951 Investor property mortgages..................... 593 5,497 6,090 Private loans................................... - 1,353 1,353 ------------------- --------------------- --------------------- Total commercial banking.................. 325,494 122,427 447,921 International banking portfolio: Ex-Im medium term loans......................... 69,631 723 70,354 Ex-Im working capital lines..................... 12,183 3,858 16,041 Inventory buyer credit loans.................... 980 20 1,000 ------------------- --------------------- --------------------- Total international banking............... 82,794 4,601 87,395 Private banking portfolio: Residential mortgages........................... 17,305 6,515 23,820 Other consumer loans............................ 3,484 1,855 5,339 ------------------- --------------------- --------------------- Total private banking..................... 20,789 8,370 29,159 Loans held for sale................................ - - 9,070 ------------------- --------------------- --------------------- Totals......................................... $429,077 $135,398 $573,545 =================== ===================== =====================
The Company services substantially all of the loans it originates, whether sold to investors or held in portfolio. Servicing includes collecting payments from borrowers and remitting applicable payments and required reports to any investors; accounting for principal, interest and any real estate taxes or other escrow receipts and payments; contacting delinquent borrowers; supervising foreclosures; and liquidating collateral when required. Other than tasks performed by the assigned lending officers, loan servicing functions are centralized in the Hartford, Connecticut headquarters. The Company receives servicing fees on loans serviced for others in varying amounts, as determined under the particular terms of the sale. Management believes that servicing most loans originated enhances the Company's relationship with borrowers. This contact allows the Company to continue to offer its loan and deposit products to clients who may need additional financing or retail services. Further, such arrangements provide an additional and profitable revenue stream that is less cyclical than the business of originating and selling loans. 14 DELINQUENCY AND COLLECTION ACTIVITIES The assigned lending officer retains responsibility for routine collection of his portfolio. The Company attempts to collect all loans on a 30-day basis, leaving very few loans past due 30 days or more at any month end. An officer's initial collection efforts generally begin when an account is 15 days past due. At 20 days past due, a reminder notice is sent to the borrower and the officer again attempts to contact the borrower to determine the reason for the delinquency and if the account will be brought current. If a borrower is unable to make a payment within 30 days of the due date as of month-end, and has not made acceptable alternative arrangements with the Company, the account is transferred to the Company's Loan Workout business unit for consideration of additional collection procedures, including issuance of a demand letter and possible liquidation of collateral. The Loan Workout business unit is responsible for contacting the borrower and analyzing its current and projected financial condition, the reasons leading to the delinquency and the value of the collateral available to the Company. The Loan Workout Officer then proposes a workout plan to the Chief Credit Officer and other involved members of Senior Management. The Loan Workout business unit will also provide any required notices and generally seek to comply with applicable government guarantee program or investor requirements. If a modification of loan terms or other acceptable workout cannot be achieved within a reasonable time frame, the Company will liquidate the collateral securing the loan.. The Company prefers not to take title to real property or equipment unless required to facilitate the collection process. The Company solicits assistance from the principals of the delinquent borrower to effect the liquidation of any property, with title remaining in the borrower's name, thereby avoiding a lengthy foreclosure or repossession process and exposure to the Company regarding environmental or other liability issues. The Company has generally found principals of borrowers to be cooperative in assisting the Company to liquidate collateral efficiently. The Company follows the same general workout procedures for substantially all of the loans serviced. If a loan carries an SBA guarantee, the responsible SBA District Office will be notified of the delinquency and will be presented with a liquidation plan within 60-90 days of such delinquency. Unless the SBA objects, the Company will carry out the terms of the liquidation plan. As a Preferred Lender, the Bank has responsibility and authority over liquidation procedures on all SBA guaranteed loans serviced. Any loss after liquidation of collateral is allocated pro rata between the guaranteed and unguaranteed portions of an SBA Loan. After an SBA loan becomes 60-90 days past due, the SBA at the Company's request will repurchase the guaranteed portion of the principal balance of the loan at par from the secondary market investor, together with accrued interest covering a period of up to 120 days. USDA procedures require that the Company file a liquidation plan when it is believed action should be taken on a delinquent loan, which is generally when the loan is 60-90 days delinquent. The USDA has 30 days to review the plan. The Company will then execute the approved plan or work with the USDA to arrive at a mutually acceptable plan. Any loss after liquidation of 15 collateral is allocated pro rata between the guaranteed and unguaranteed portions of the USDA loan. The holder of the guaranteed portion may request that the USDA repurchase the guaranteed portion at any time, or the Company will request repayment on such holder's behalf when liquidation is complete. The USDA does not impose any restrictions on the number of days for which interest will be paid on the guaranteed portions. The liquidation of delinquent working capital and medium term Ex-Im Bank loans is handled by Ex-Im Bank. The Company may submit a claim for repurchase at any time between 30 and 120 days after a delinquency occurs, but at no time may such claim be made more than 150 days after the delinquency. Ex-Im Bank will make payment under its guarantee 30 days after acceptance of the Company's request. The Company retains responsibility for the proper documentation and servicing of all loans serviced for others, and may incur losses related to such loans if it is found to be negligent by a guaranteeing agency or investor in carrying out these duties. Unguaranteed loans or unguaranteed portions of loans held by investors are subject to negotiated servicing agreements, which generally provide investors with the option of assuming responsibility for all collection efforts after a loan becomes 60-90 days delinquent. If the Company is contractually responsible for collection efforts, the servicing agreements generally require that the investor pre-approve liquidation actions. CREDIT RISK MANAGEMENT The Chief Credit Officer has primary responsibility for credit risk management, ensuring the appropriateness of underwriting criteria and application thereof, the implementation of RISCOPE/sm/, (the Company's proprietary commercial risk assessment model), and the independent analyses of loans by the Loan Review business unit. The Credit Policy Officer, who reports to the Chief Credit Officer, reviews all credit memoranda for compliance with the requirements of government guarantee programs and Company credit policies. If, based on particular facts and circumstances, policy exceptions are proposed by lending officers, the Credit Policy Officer will ensure that all appropriate policy exceptions are documented and approved by the authorized party. The Chief Credit Officer periodically evaluates the nature and trends of such exceptions, reporting them quarterly to the Board of Directors' Audit Committee. As a nationally-chartered bank, the Bank is required to "risk rate" its loan portfolio by monitoring changes in the financial condition of borrowers, assessing overall economic trends, and assigning numerical ratings to individual loans. The Company applies regulatory risk rating definitions and has developed additional ratings for the "Pass" or uncriticized loan category. Such a rating system, in conjunction with other available quantitative and qualitative data, is 16 utilized to assist management in its quarterly evaluation of the Adequacy of the Allowance for Loan Losses. The assigned lending officer has primary responsibility for risk ratings, and such officer's decisions are periodically reviewed by the Loan Review business unit. Risk ratings are based on the borrower's operating cash flow, industry, product line, earnings, assets, liability, management experience, debt capacity, and prior credit history with the Company. The Company has developed a proprietary risk analysis model, RISCOPE/sm/, used in the initial underwriting, post-closing loan monitoring and rating process by lending officers and the Loan Review business unit. RISCOPE/sm/ assists the Company in quantifying the credit risk of commercial clients. The model takes into account quantitative and qualitative factors and was designed to analyze the Company's primary client base: small and medium size manufacturers. RISCOPE/sm/ is intended to quantify credit risk with respect to the probability of default and, therefore, assists management in risk rating loans and providing an Appropriate Allowance for Loan Losses. Additionally, the model helps management identify weaknessess in credits earlier than might otherwise be done if payment default were their only manifestation. The Loan Review business unit reviews the loan portfolio to evaluate the appropriateness of officer risk ratings and overall trends in the portfolio. Loan Review results are reported to the Audit Committee of the Board quarterly. PRIVATE BANKING The Private Banking business unit seeks to provide stable, low-cost funding for the Company by managing its deposit base, which consists of demand deposits, money market savings accounts and time certificates of deposits. The Company completed its transition from a retail to wholesale financial institution by selling its last suburban retail branch facility and deposits totaling $24 million in September 1996. The Company operates one depository branch located on the first floor of its Hartford, Connecticut headquarters. Many of the Company's commercial clients transact business through electronic funds transfer, telephone and the mail. The Private Banking business units target the commercial depository accounts of small and medium size manufacturers, as well as the personal accounts of their principals, by offering a full array of financial products. These products include automatic sweep accounts, merchant and corporate credit cards, payroll processing, business and individual retirement accounts, international funds transfer and foreign exchange conversion. The Private Banking business units seek to expand the Company's deposit base by strengthening existing relationships and soliciting new ones. Private bankers are trained to focus on, and respond to, the needs of commercial borrowers which management believes are often not served effectively by other depository institutions. Private bankers based in Hartford, Connecticut market the Company's services through direct mail and telephone in order to reach businesses, 17 institutions and individuals in the areas where the Company has domestic offices and international Master Agents. The Company maintains an interactive voice response and personal computer-based system, First Access/SM/, which enable clients to obtain information about their loan or deposit accounts. Business lock box and expanded its foreign exchange services have recently been introduced to clients as well. The following table sets forth the Company's deposit structure as noted:
December 31, --------------------------------------------------------------------- 1997 1996 1995 ------------------- ------------------- ------------------- (dollars in thousands) BUSINESS ACCOUNTS: Non-interest bearing checking..................... $ 37,718 $ 27,485 $ 19,337 Interest bearing checking......................... 4,670 4,567 5,897 Savings........................................... 58,800 46,660 31,453 ------------------- ------------------- ------------------- Total business................................ 101,188 78,712 56,687 CONSUMER ACCOUNTS: Non-interest bearing checking..................... 518 403 3,284 Interest bearing checking......................... 3,197 3,681 4,835 Savings........................................... 33,203 22,618 39,573 ------------------- ------------------- ------------------- Total consumer................................ 36,918 26,702 47,692 TIME DEPOSITS ACCOUNTS: Non-IRA time deposits............................. 25,110 32,372 17,904 IRA time deposits................................. 9,105 6,530 6,078 ------------------- ------------------- ------------------- Total time deposits............................ 34,215 38,902 23,982 ------------------- ------------------- ------------------- Total deposits........................... $172,321 $144,316 $128,361 =================== =================== =================== Externally indexed savings accounts included above...................................... $ 88,539 $ 65,779 $ 57,310 =================== =================== ===================
The average balances held in checking and savings accounts are higher than industry norms, which the Company believes is attributable to the Company's focus of attracting primarily commercial business deposits. Management believes that such deposits are at least as stable as those obtained from consumers. The Company does not generally compete with retail branches of other depository institutions, but rather with mutual and money market funds, yet it retains the advantage of FDIC insurance. The Company's basic business cash management and private banking savings accounts are variable rate money market accounts tied to an external index published daily in The Wall Street Journal and are designed to ----------------------- compete with non-insured alternatives. Additional funding for the Company's operations is also available from the on- going sale of guaranteed and non-guaranteed loans, advances from the Federal Home Loan Bank of Boston and other sources. COMPETITION The Company competes for clients with other commercial and savings banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking firms and certain other nonfinancial institutions, many of whom are able 18 to devote far greater resources than the Company to market, underwrite and service loans to the same client base. The Company competes by emphasizing its expertise and knowledge of its clients' businesses, commitment to service, flexibility in structuring financial transactions, and strong relationships. Through the combined utilization of government guaranteed loan programs, the Company is able to provide flexible longer-term financing than would otherwise be available to borrowers, and through its Private Banking business units it is able to offer depository and related products. REGULATION AND SUPERVISION Holding Company Regulation The Company is registered as a bank holding company and regulated and subject to periodic examination by the Federal Reserve Bank ("FRB") under the Bank Holding Company Act ("BHCA"). Pursuant to FRB regulations, the Company is limited to the business of owning, managing or controlling banks and engaging in certain other bank-related activities, including those activities that the FRB determines from time to time to be closely related to banking. The BHCA requires, among other things, the prior approval of the FRB if a bank holding company proposes to (i) acquire all or substantially all of the assets of a bank, (ii) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank (unless it already owns a majority of such bank's voting shares) or (iii) merge or consolidate with any other bank holding company. As a bank holding company, the Company is required by the FRB to act as a source of financial strength and to take measures to preserve and protect the Bank. As a result, the Company may be required to inject capital in the Bank if such a need arises. The FRB may charge a bank holding company such as the Company with unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. The Company expects to downstream approximately $11 million of capital to the Bank in the first quarter of 1998 in support of the Bank's ongoing activities. Such amount represents the balance of the Company's available funds. To be considered regulatory capital, loans from the Company to the Bank must be on terms subordinate in right of payment to deposits and to most other indebtedness of the Bank. The FRB, OCC and Federal Deposit Insurance Corporation (the "FDIC") collectively have extensive enforcement authority over bank holding companies and national banks in the United States. This enforcement authority, initiated generally for violations of law and unsafe and unsound practices, includes, among other things, the ability to assess civil money penalties, to initiate injunctive actions and to terminate deposit insurance in extreme cases. 19 The bank regulatory agencies' enforcement authority was substantially enhanced by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). FIRREA significantly increased the amount of civil money penalties and expanded the grounds for imposing such penalties. Also, under FIRREA, should a Bank failure result in a loss to the FDIC, any other FDIC-insured subsidiaries of the Company could be required to compensate the FDIC for the estimated amount of the loss. Additionally, pursuant to FDICIA, the Company in the future could have the potential obligation to guarantee the capital restoration plans of any undercapitalized FDIC-insured subsidiaries it may control. INTERSTATE BANKING As of September 29, 1995, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "RNA") permitted adequately capitalized and managed bank holding companies to acquire control of banks in any state. Additionally, beginning on June 1, 1997, the RNA enabled banks to branch across state lines, although individual states are authorized to permit interstate branches earlier or to elect to opt out entirely. REGULATION OF THE BANK General The Bank, as an FDIC-insured national bank, is subject to regulation primarily by the OCC, and secondarily by the FDIC. As a national bank, the Bank is a member of the Federal Reserve System and its operations are subject to certain FRB regulations. Various other federal and state consumer laws and regulations also affect the operations of the Bank. As a national bank, the Bank may be able to engage in certain activities approved by the OCC which the FRB would not necessarily approve for the Company. The OCC has been particularly aggressive in recent years in allowing national banks to undertake an ever-increasing range of securities and insurance activities. Along these lines, pursuant to certain revisions of the OCC's regulations pertaining to banking activities effective on December 31, 1996, national banks are permitted on a case-by-case basis to operate subsidiaries engaging in activities not permissible for the Bank itself. Although the revised regulations do not authorize any specific new activities, it is expected that national banks, if eligible and if they obtain the approval of the OCC, will use these regulations to expand further into the insurance and securities businesses. The revised OCC regulations contain "fire walls" intended to protect a national bank from the risks taken by a subsidiary, including imposing a 10% cap on the amount of bank capital that may be invested in a new subsidiary, as well as requirements that extensions of credit to an operating subsidiary be fully- collateralized and that transactions between the bank and subsidiary be conducted at arm's-length. The parent national bank's exposure to any losses the 20 subsidiary may incur are limited to the bank's equity investment in the subsidiary. Parent national banks are required to be well-capitalized both before and after an investment is made. Since OCC approval is required on a case-by-case basis for an eligible bank to engage in activities not permissible for the bank to conduct directly, the effect of these revised regulations on the operations of national banks is unclear. Further, it is expected that Congress will consider new banking legislation in the near future addressing these revisions. As a national bank, the Bank may ordinarily lend up to 15% of its capital on an unsecured basis to any one borrower, and may lend up to an additional 10% of its capital to that same borrower on a fully secured basis involving readily liquid collateral having an established market value as determined by reliable and continuously available price quotations, and equal at least to the amount borrowed. In addition, there are various other circumstances in which the Bank may lend in excess of such limits, including authority to lend up to 35% of capital and surplus when the loan is secured by documents of title to readily marketable staples, unlimited authority if loans are guaranteed by a U.S. government agency, and certain other exceptions relevant to international trade finance. Federal law also imposes additional restrictions on the Bank with respect to loans and credit to certain related parties and transactions with the Company's principal stockholders, officers, directors and affiliates. Extensions of credit to such persons (i) must be made on substantially the same terms (including interest rates and collateral) as, and follow credit underwriting procedures not less stringent than, those prevailing for comparable transactions with members of the general public, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. Capital Adequacy The federal bank regulatory authorities have adopted risk-based capital guidelines to which the Bank is subject. The guidelines establish a systematic framework that makes regulatory capital requirements more sensitive to differences in risk profile among banking organizations, takes off-balance sheet exposures into explicit account in assessing capital adequacy, and minimizes disincentives to holding liquid, low-risk assets. These risk-based capital ratios are determined by allocating assets and specified off-balance sheet financial instruments into four weighting categories, with higher levels of capital required for the categories perceived as representing greater risk. Under these guidelines, a banking organization's capital is divided into two tiers. The first tier ("Tier 1") includes common equity, perpetual preferred stock (excluding auction rate, money market or remarketable issues) and minority interests held by others in a consolidated subsidiary, less goodwill and any disallowed intangibles. Supplementary ("Tier 2") capital includes, among other items, cumulative and limited-life preferred stock, mandatory convertible securities, subordinated debt and the allowance for loan and lease losses, subject to certain limitations and less required deductions as provided by regulation. 21 Banking organizations are required to maintain a risk-based capital ratio of total capital (Tier 1 plus Tier 2) to risk-weighted assets of 8%, of which at least 4% must be Tier 1 capital. Federal bank regulatory authorities may, however, set higher capital requirements when a banking organization's particular circumstances warrant. As a general matter, banking organizations are expected to maintain capital ratios well above the regulatory minimums. In addition, federal bank regulatory authorities have established guidelines for a minimum leverage ratio (Tier 1 capital to average total assets). These guidelines provide for a minimum leverage ratio of 3% for banking organizations that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating. Banking organizations not meeting these criteria or which are experiencing or anticipating significant growth are required to maintain a leverage ratio which exceeds the 3% minimum by a least 100 to 200 basis points. The risk based capital and leverage ratios of the Bank as of December 31, 1997 and December 31, 1996 are set forth in Note 7 to the Company's Consolidated Financial Statements. Failure to meet applicable capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies available to the federal bank regulatory authorities, including limitation on the ability to pay dividends, the issuance of a capital directive to increase capital and, in the case of a bank, the termination of deposit insurance by the FDIC or (in severe cases) the appointment of a conservator or receiver. Dividends The Bank is subject to legal limitations on the frequency and amount of dividends that can be paid to the Company. The OCC, in general, also has the power to prohibit the payment of dividends by the Bank which would otherwise be permitted under applicable regulations if the OCC determines that such dividends would constitute an unsafe or unsound practice. OCC approval is required for the payment of dividends by the Bank in any calendar year if the total of all dividends declared by the Bank in that year exceeds the current year's net income combined with the retained net income of the two preceding years. "Retained net income" means the net income of a specified period less any common or preferred stock dividends declared for that period. Moreover, no dividends may be paid by a national bank in excess of its undivided profits account. In addition, the FRB and the FDIC have issued policy statements which provide that, as a general matter, insured banks and bank holding companies may pay dividends only out of current operating earnings. There are also statutory limits on other transfers of funds to the Company and any other future non-banking subsidiaries of the Company by the Bank, whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by the Bank generally are limited in amount to 10% of the Bank's capital and surplus to the Company and any such future subsidiary of the Company, or 20% in the aggregate to the Company and all such subsidiaries. Furthermore, such loans and extensions of credit are required to be fully collateralized in specified amounts depending on the nature of the collateral involved. 22 FDICIA FDICIA was enacted on December 19, 1991. It substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to other federal banking statutes. A central feature of FDICIA is the requirement that the federal banking agencies take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Based on the Bank's current regulatory capital position, management believes that the Bank is "well capitalized." FDICIA generally prohibits the Bank from making any capital distribution (including payment of a cash dividend) or paying any management fees to the Company if the Bank would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit a capital restoration plan acceptable to federal banking agencies. If a depository institution fails to submit an acceptable plan, it is treated as if it is "significantly undercapitalized." Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, reduce total assets, and stop accepting deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator, generally within 90 days of the date of such institution is determined to be critically undercapitalized. COMMUNITY REINVESTMENT ACT The Federal Community Reinvestment Act (the "CRA") requires the OCC to evaluate the Bank's performance in helping to meet the credit needs of the community. The Bank defines its CRA marketplace as Hartford County. This definition is not intended to restrict the availability of credit services throughout the Bank's general service area, but represents a special commitment the Bank has made to provide lending and depository services to the community. As a part of the CRA program, the Bank is subject to periodic examinations by the OCC and maintains comprehensive records of its CRA activities for this purpose. Following its most recent examination in November 1995, the Bank received a rating of "Outstanding." The Bank is specifically interested in making financing available to small and medium size manufacturers in its defined lending area. The Bank evaluates credit applications without regard to race, color, religion, national origin, gender, marital status or age, and does not discriminate 23 against any loan applicant whose income may come entirely or in part from any public assistance program, or against any applicant who has exercised in good faith any right under the Consumer Protection Act. The Company maintains preferred status with the SBA, USDA and Ex-Im Bank which enables it to provide access to credit products that might otherwise be unavailable. ITEM 2. PROPERTIES The Company leases approximately 38,000 square feet in Hartford, Connecticut to house its headquarters, lending and support staff, and its only full-service branch. The Company maintains leased space for representative offices in Boston and Springfield, Massachusetts; Providence, Rhode Island; Morristown, New Jersey; Rochester, New York; Philadelphia and Pittsburgh, Pennsylvania; and Washington, D.C. The Company's leases generally provide for two five-year renewal options and options on additional space. Management believes that its existing facilities are adequate for their present and proposed uses and that suitable facilities will be available on reasonable terms for any additional space required. ITEM 3. LEGAL PROCEEDINGS Neither the Company nor the Bank is involved in any legal proceedings except for routine litigation incidental to the business of banking, none of which is expected to have a material adverse effect on the Company's financial position, results of operations or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of 1997 to a vote of security holders through solicitation of proxies or otherwise. 24 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information required by this item may be found on the inside back cover of the Company's 1997 Annual Report to Shareholders, which is incorporated by reference and is filed as Exhibit 13.1 hereto. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA Information required by this item may be found on page 4 of the Company's 1997 Annual Report to Shareholders, which is incorporated by reference and is filed as Exhibit 13.1 hereto. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item may be found on pages 5 through 16 of the Company's 1997 Annual Report to Shareholders, which is incorporated by reference and is filed as Exhibit 13.1 hereto. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this item may be found on pages 14 and 15 of the Company's 1997 Annual Report to Shareholders, which is incorporated by reference and is filed as Exhibit 13.1 hereto. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item may be found on pages 17 through 35 of the Company's 1997 Annual Report to Shareholders, which is incorporated by reference and is filed as Exhibit 13.1 hereto. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEMS 10 - 13 Information required by these items may be found in the Company's Proxy Statement which is incorporated by reference. 25 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K A. The following documents are filed as a part of this report: 1. Financial Statements set forth on pages 17 through 35 of the 1997 Annual Report to Shareholders which is filed herewith as Exhibit 13.1. (i) Report of Independent Accountants (ii) Consolidated Balance Sheets as of December 31, 1997 and 1996 (iii) Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 (iv) Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 (v) Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 2. Financial Schedules: None required. 3. Exhibits: Exhibit Number Description ------ ----------- 3.1 Amended and Restated Certificate of Incorporation of the Registrant.* 3.2 Amended and Restated By-laws of the Registrant.* 10.1 Employment Agreement among Registrant, First National Bank of New England (the "Bank") and Brett N. Silvers as amended by Letter Agreement, dated July 3, 1997.* 10.2 Promissory Note of Brett N. Silvers, payable to the Registrant, dated June 30, 1994, as amended.* 10.3 Stock Pledge Agreement, dated June 30, 1994, between the Registrant and Brett N. Silvers, as amended.* 10.4 Amended and Restated 1996 Stock Option Plan.* 10.5 1994 Incentive Stock Option Plan, as amended.* 10.6 401(k) Plan.* 10.7 Lease between Cambridge One Commercial Plaza, LLC and the Bank.* 10.8 Employment Agreement between the Bank and Brian J. Charlebois dated August 25, 1997.* 10.9 Employment Agreement between the Bank and Leslie A. Galbraith dated August 25, 1997.* 13.1 1997 Annual Report to Shareholders. 21.1 Subsidiaries of Registrant.* 23.1 Consent of Coopers & Lybrand L.L.P. 26 27.1 Financial Data Schedule for the Year Ended December 31, 1997. * Denotes an exhibit which has previously been filed as an exhibit to the Company's Registration Statement on Form S-1, Commission File No. 333-31339. B. Reports on Form 8-K. The Company has not filed any Current Reports on Form 8-K since the filing of its Registration Statement dated September 22, 1997. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 26, 1998 First International Bancorp, Inc. By: /s/ Brett N. Silvers ------------------------ Brett N. Silvers Chairman of the Board and President Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
Signature Title Date --------- ----- ---- /s/ Brett N. Silvers - --------------------------- Brett N. Silvers Chairman of the Board March 26, 1998 and President /s/ Michael R. Carter - --------------------------- Michael R. Carter Director March 26, 1998 /s/ Arnold L. Chase - --------------------------- Arnold L. Chase Director March 26, 1998 /s/ Cheryl A. Chase - --------------------------- Cheryl A. Chase Director March 26, 1998 /s/ Frank P. Longobardi - --------------------------- Frank P. Longobardi Director March 26, 1998 /s/ Bernard M. Waldman - --------------------------- Bernard M. Waldman Director March 26, 1998 /s/ Leslie A. Galbraith - --------------------------- Leslie A. Galbraith Executive Vice President, March 26, 1998 Secretary and Treasurer
28 EX-13.1 2 EXHIBIT 13.1 ANNUAL REPORT 1 First National Bank of New England Financing Manufacturers Worldwide(R) Corporate Headquarters Hartford One Commercial Plaza Hartford, CT 06103 (860) 727-0700 (860) 525-2083 (fax) www.fnbne.com Representative Offices Boston 175 Federal Street Boston, MA 02110-2205 (617) 357-0500 (617) 357-0502 (fax) Providence 55 Dorrance Street Providence, RI 02903 (401) 553-2400 (401) 553-2402 (fax) Springfield One Monarch Place Springfield, MA 01144 (413) 827-4980 (413) 827-4982 (fax) Morristown 1776 On The Green 67 Park Place Morristown, NJ 07960 (201) 682-9900 (201) 682-9944 (fax) Pittsburgh 301 Grant Street One Oxford Centre Suite 1500 Pittsburgh, PA 15219 (412) 255-3744 (412) 255-3745 (fax) Washington 10202 Sunrise Valley Drive Suite 270 Reston Place 2 Reston, VA 20191 (703) 391-8020 (703) 301-8480 (fax) Philadelphia 1 Commerce Square 2005 Market Street Philadelphia, PA 19103 (215) 587-6486 (215) 587-6497 (fax) Rochester 710 Bausch & Lomb Place Rochester, NY 14604 (716) 246-0430 (716) 246-0439 (fax) International Representatives Argentina Brazil Central America India Indonesia Korea Mexico Philippines Poland South Africa Turkey - -------------------------------------------------------------------------------- First International Bancorp, Inc. First National Bank of New England [GRAPHIC APPEARS HERE] 1997 Annual Report - -------------------------------------------------------------------------------- [GRAPHIC APPEARS HERE] [GRAPHIC APPEARS HERE] [GRAPHIC APPEARS HERE] [GRAPHIC APPEARS HERE] Financing Manufacturers Worldwide(R) Member FDIC, Equal Housing Lender First International Bancorp, Inc. Index to Consolidated Financial Statements 2 Letter to Shareholders and Clients 4 Summary Financial Highlights 5 Management's Discussion and Analysis of Financial Conditions and Results of Operations 17 Report of Independent Accountants 18 Consolidated Balance Sheets as of December 31, 1997 and 1996 19 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995 20 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995 21 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 22 Notes to Consolidated Financial Statements 36 Directors and Officers and General Information 1 To Our Shareholders and Clients I am pleased to address you at the close of our first year as a public company. First International Bancorp, Inc. completed a successful public offering in September 1997, raising more than $23.8 million in capital, and is now trading on NASDAQ under the symbol FNCE. This was one of last year's many significant accomplishments. For the year ended December 31, 1997, consolidated net income for First International Bancorp, Inc. and its wholly owned subsidiary, First National Bank of New England, was $4.4 million or $.67 per share on a diluted basis. This represented an increase of 37% from 1996's consolidated net income of $3.2 million or $.56 per share. Returns on average equity and assets in 1997 were 20.5% and 2.5%, respectively. We pursued our corporate mission, Financing Manufacturers Worldwide(R), by expanding both domestic and international locations last year and now have more than 600 profile clients in 19 states and 10 countries. New representative offices were opened outside the New England region in Pittsburgh, Philadelphia, Morristown, Rochester and Washington, D.C., and these offices contributed 30% of total gains on domestic loan sales in their first year of operation. Our U.S. expansion will continue in 1998 with the opening of four additional representative offices in the industrial Midwest. New financing programs for small and medium size manufacturers are currently being developed with national and regional strategic partners in the areas of production equipment financing, power contract financing and energy efficiency financing. Master Agency Agreements are in place with international representatives in 11 foreign countries, providing a strong marketing effort for our financial services throughout Argentina, Brazil, Central America, India, Indonesia, Korea, Mexico, Philippines, Poland, South Africa and Turkey. The original products offered by our International Business Units, equipment and inventory financing for foreign buyers of U.S. made products, have been supplemented by a new financing program for U.S. importers of products manufactured in these emerging markets. Our company is now well-positioned to take advantage of two-way international trade flows. [PICTURE APPEARS HERE] Representatives Throughout The World. 2 [BAR GRAPH APPEARS HERE] Loan Originations
Category 1997 1996 - -------- ---- ---- Domestic 216 136 International 91 37 ---- ---- Total Loan Originations $307 $173 million ==== ====
First National Bank of New England continues to be a leader in the use of federal loan guarantee programs. In 1997 we were named by Ex-Im Bank as their "Small Business Bank of the Year," we became Ex-Im Bank's first "Medium Term Priority Lender" and we were the nation's largest user of this agency's programs measured by number of transactions. In addition, the Bank remained the largest SBA 7(a) lender in New England and was the fourteenth largest in the nation in terms of dollar volume. We also finished first in the nation for dollars lent under the Department of Agriculture's Business & Industry program. Capital Markets, which is our Business Unit specializing in the non-recourse, servicing-retained sale of commercial and international loans to investors, enjoyed a successful year in 1997, with a 71% increase in loan sales volume to $222 million, bringing the serviced loan portfolio to $574 million. Especially noteworthy is the fact that $55 million of the 1997 sales were of loans without credit enhancements, owing to our underwriting expertise, reputation and niche, as well as to Capital Markets' continuing development of secondary market relationships. Our two Private Banking Business Units continue to be the organization's primary funding source for lending activities. Core deposits represented 80% of total deposits by December 31, 1997, a significant achievement given the Bank's limited branch strategy. A business lock box service was introduced for commercial clients during 1997 and our new PC banking service, First Access/SM/, was brought on-line this month. These advances will improve the delivery of financial services to our clients worldwide. Serviced Loan Portfolio at December 31, 1997 [PIE CHART APPEARS HERE] Category Percentage - -------- ---------- Ex-Im Bank 17 SBA/USDA Loans Guaranteed 42 Consumer 5 Other Commercial 20 SBA/USDA Loans Unguaranteed 16 Total $574 Million I would like to thank our old and new shareholders, clients and friends for their continued support of First International Bancorp, Inc.'s pioneering efforts on behalf of small and medium size manufacturers, both in the United States and abroad. [SIGNATURE APPEARS HERE] Brett N. Silvers Chairman and President March 1998 [PICTURE OF BRETT N. SILVERS APPEARS HERE] 3 Summary Financial Highlights (Dollars in Thousands)
- ------------------------------------------------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------ Total Loans Serviced $573,544 $380,431 $260,842 $193,369 $128,968 Non-Interest Income to Net Revenues 64.7% 50.6% 38.2% 42.7% 49.4% Return on Average Equity 20.5% 25.5% 19.3% 11.7% 3.6% Return on Average Assets 2.5% 2.1% 1.5% .9% .3% Interest Income $14,625 $13,305 $11,601 $7,997 $6,559 Interest Expense $6,371 $5,741 $4,869 $3,150 $2,891 Net Interest Income $8,254 $7,564 $6,732 $4,847 $3,668 Gain on Loan Sales $11,810 $5,844 $2,859 $2,730 $2,411 Loan Servicing Income and Other Fees $3,300 $1,899 $1,294 $878 $1,164 Total Net Revenues $23,364 $17,509 $10,885 $8,455 $7,243 Operating Expenses $13,801 $8,425 $6,128 $5,129 $4,576 Provision for Possible Loan Losses $2,239 $3,487 $1,237 $1,683 $2,225 Net Income $4,429 $3,244 $2,026 $1,060 $305 Basic Earnings Per Share $0.70 $0.56 $0.35 $0.18 $0.06 Diluted Earnings Per Share $0.67 $0.56 $0.35 $0.18 $0.06 Dividend Payout Ratio 16.5% 20.3% 8.1% --- --- Total Assets $218,851 $161,642 $141,223 $125,609 $109,735 Total Loans $135,398 $114,627 $106,992 $95,118 $71,413 Core Deposits $138,106 $105,414 $104,379 $76,662 $63,719 Total Deposits $172,321 $144,316 $128,361 $111,849 $95,787 Core Deposits to Total Deposits 80.1% 73.0% 81.3% 68.5% 66.5% Total Capital to Risk Weighted Assets 17.6% 11.6% 10.7% 9.3% 10.8% - ------------------------------------------------------------------------------------------------------------------------
[BAR CHART APPEARS HERE] Net Income Year Net Income (Millions) ---- --------------------- 1993 $ 0.3 1994 1.1 1995 2.0 1996 3.2 1997 4.4 [BAR CHART APPEARS HERE] Total Loans Serviced Year Total Loans Serviced (Millions) ---- ------------------------------- 1993 $ 129 1994 193 1995 261 1996 380 1997 574 4 Management's Discussion and Analysis of Financial Conditions and Results of Operations The following discussion and analysis of the consolidated financial condition and results of operations of First International Bancorp, Inc. (the "Company") should be read in conjunction with the Company's consolidated financial statements, including the related notes thereto, and other information. General First International Bancorp, Inc., a Delaware corporation, is a one bank holding company incorporated in 1985 and regulated by the Board of Governors of the Federal Reserve System. Its principal asset and subsidiary is First National Bank of New England, a national banking association established in 1955 and regulated by the Office of the Comptroller of the Currency (the "OCC"). The Company completed an underwritten public offering in September 1997 whereby 1,955,000 shares of common stock were issued for net proceeds of $23.8 million. The Company specializes in providing credit, trade and depository services to small and medium size manufacturing companies located in the United States and in international emerging markets. The Company serves its target market by offering flexible and attractive terms to borrowers and manages its credit risk through the combined utilization of commercial loan guarantee programs made available by three U.S. federal agencies: the U.S. Small Business Administration (the "SBA"), the U.S. Department of Agriculture (the "USDA"), and the Export-Import Bank of the U.S. ("Ex-Im Bank"). For the federal fiscal year ending September 30, 1997, the Company was the country's largest Ex-Im Bank lender measured by number of transactions; the largest USDA Business and Industry lender measured by dollar volume; and the fourteenth largest SBA 7(a) lender measured by dollar volume (and the largest in New England). The Company maintains preferred status for several jurisdictions and government guaranteed lending programs. In recognition of the Company's efforts in promoting small business exports and its high volume of loan originations, the Company received Ex-Im Bank's annual "Small Business Bank of the Year" award in May 1997 and was designated Ex-Im Bank's first "Medium Term Priority Lender." Except for historical information contained herein, certain matters discussed in this annual report are "forward looking statements" as defined in the Private Securities Litigation Reform Act (PSLRA) of 1995, which involve risk and uncertainties that exist in the Company's operations and business environment, and are subject to change based in various important factors. The Company wished to take advantage of the "safe harbor" provisions of the PSLRA by cautioning readers that numerous important factors discussed below, among others, in some cases have caused, and in the future could cause the Company's actual results to differ materially form those expressed in any forward-looking statements made by, or on behalf of , the Company. The following include some, but not all, of the factors or uncertainties that could cause actual results to differ from projections: . A general economic slowdown. . Inability of the Company to continue its growth strategy either domestically or internationally. . Unpredictable delays or difficulties in the development and introduction of new products and programs. . Risks associated with government guarantee loan programs since a substantial portion of the Company's business still depends upon the continuation of the various government guarantee loan programs as discussed below . The Company believes that it has the product offerings, facilities, personnel and competitive and financial resources for continued business success. However, future revenues, costs, margins and profits are all influenced by a number of factors, as discussed above. Recent Growth In contrast to many of its banking competitors, the Company derives a majority of its revenues from non-interest income, principally gains on the sale of commercial and international loans and related loan servicing income. During the past three years of operations, the Company has achieved significant earnings growth primarily as a result of increases in the sale of government guaranteed and other commercial loans, net interest income, which is the difference between interest earned on interest-earning assets (principally loans) and interest paid on interest-bearing liabilities (principally deposits), and fee income on loans serviced for others. The Company has expanded its domestic loan origination activities into the Northeast and Mid-atlantic regions of the United States and its international presence in emerging markets. The Company plans to continue this expansion in 1998 by opening four offices in the industrial Midwest. - --------------------------------------------------------------- December 31, 1997 1996 1995 - --------------------------------------------------------------- (net income in thousands) Net income ................ $4,429 $3,244 $2,026 Diluted earnings per share $.67 $.56 $.35 5 The following discussions make reference to average balances of certain assets and liabilities as well as volume and rate changes. For further information with respect to these matters see the tables set forth on pages 10 and 11. Accounting for Loan Sales Gains from loan sales and servicing income represented approximately 62% of the total net interest income and non-interest income for the year ended December 31, 1997 and, although the Company does carry a servicing asset as required under generally accepted accounting principles, approximately 90% of the 1997 gains are comprised of cash received in excess of the carrying value of the loans sold. Detailed below is a discussion of the relevant accounting principles governing loan sales and servicing activities. SBA and USDA Loan Sales The majority of the Company's SBA and USDA guaranteed loans are variable rate, indexed to the Prime Rate as quoted in The Wall Street Journal ("Prime"). The Company generally sells, for a premium, the guaranteed portions of these loans at origination. For example, if the Company sells a 20-year SBA or USDA guaranteed mortgage loan with an interest rate of Prime plus 1.50%, the Company generally receives a premium because the market demands a yield of less than Prime plus 1.50%. Investors of the guaranteed portions demand rates between U.S. Treasury bills and commercial loans due to prepayment risks and other factors inherent in the guaranteed loans. After the loan sale, an investor will receive the pro rata principal and pro rata interest at the note rate less any ongoing guarantee and Company servicing fees. Sales of the unguaranteed portions of SBA and USDA loans are generally at or above the carrying value. The Company continues to retain an unguaranteed participation equal to at least 5% of the original loan. Statement of Financial Accounting Standards No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No. 125) governs accounting for sales by the Company of a part of a loan and, as discussed in Note 1 to the consolidated financial statements, requires that the gain on the sale of a portion of a loan be based on the relative fair market value of the loan sold, the portion of the loan retained and any other assets created in the transaction. The Company creates a servicing asset when it sells loans on a servicing-retained basis with a servicing fee in excess of what accounting literature defines as "adequate compensation." This servicing asset is equal to the net present value of the estimated cash flows in excess of such compensation. The original principal basis of a loan must be allocated between the guaranteed portion sold, the unguaranteed portion retained and the servicing asset, resulting in a discount being recognized on the unguaranteed retained portion of the loan. In connection with calculating gain on sale, the Company must make certain assumptions which include (i) the amount of "adequate compensation" used to determine the amount of the servicing asset that the Company will recognize at the date of the sale, (ii) the estimated life of the underlying loan used in projecting the time period over which the Company will receive the servicing fee and (iii) the discount rate used in the present value calculation of the servicing asset. Management has defined adequate compensation as 40 basis points. The constant prepayment rates utilized by the Company in estimating the lives of the loans depend on the original term of the loan, industry and Company historical data. Such constant prepayment rates range from 6% to 12% per annum. The discount rate utilized in the net present value calculation is equal to 200 basis points above the stated note rate, which for 1997 was approximately 10-12%. Actual prepayment rates may be affected by a variety of economic and other factors, including prevailing interest rates and the availability of alternative financing. The effect of these factors varies depending on the types of loans. Estimated prepayment rates are based on management's expectations of future prepayments, and while management believes that the term of amortization and market interest rate on the variable rate loans somewhat reduce the prepayment risk, there can be no assurance that management's prepayment estimates are accurate. If the actual prepayment rate of loans sold is higher than projected at the time such loans were sold, the carrying value of the servicing asset would be reduced by a charge to earnings. Because the Company also recognizes a discount on the retained loan, an adjustment to the discount would be made which would partially offset the effect of the negative servicing adjustment. If the actual prepayment rate for loans sold is lower than estimated, the carrying value is not increased, although the total income would exceed previously estimated amounts. The servicing asset is amortized against the servicing fee income received monthly, on an effective interest method, and the discount on the retained loan is accreted to interest income on an effective interest method. The servicing asset is carried at the lower of amortized cost or net realizable value. Ex-Im Bank and Other Commercial Loan Sales Sales of 100% of Ex-Im Bank guaranteed medium term loans are generally made at the carrying value although the Company receives a servicing fee above the amount defined as "adequate compensation," which ranges from 20-40 basis points, resulting in the recognition of a gain at the time of the sale equal to the calculated servicing asset and any net loan origination fees. The Company uses a discount factor on the estimated cash flows equal to 200 basis points above the note rate. The Company adjusts for prepayments on these 3-5 year term loans as they occur, although prepayments are minimal due to the lack of alternative U.S. dollar financing in the international markets served and the fact that such Ex-Im Bank financing is unsecured. The Company also sells 100% of certain other unguaranteed commercial loans and certain residential and other consumer loans where no portion of the loan is retained on the Company's balance sheet. 6 Results of Operations Comparison of the Years Ended December 31, 1997, 1996 and 1995 Net Income. Net income totaled $4.4 million in 1997, an increase of $1.2 million, or 37%, from 1996 net income of $3.2 million, which had increased $1.2 million or 60% from 1995 net income of $2.0 million. The increase in 1997 reflects a $6.0 million increase in gain on loan sales due to an increase in the sales of all types of loans, and a more significant contribution from Ex-Im Bank medium term guaranteed loans and the unguaranteed portions of SBA and USDA loans and other non-guaranteed commercial loans. The results for fiscal 1996 also included a $2.2 million gain on the sale of the Company's last retail branch facility and related deposits. Operating expenses in 1997 increased by $5.4 million due to additions to lending and support personnel. The increase in 1996 net income from 1995 reflects the geographic expansion of the Company's U.S. commercial loan origination activities and the initial stages of the international expansion. Geographic expansion contributed to a $3.5 million, or 92%, increase in lending-related non-interest income in 1996 from 1995. The loan loss provision increased $2.3 million in 1996 from 1995 due to a $1.2 million increase in charge-offs attributable to continued poor performance of the remaining investor mortgage portfolio, a line of business abandoned in 1990, and a $1 million increase in the allowance for loan losses to reflect the mix and continued growth of the Company's loan portfolio. See "Allowance for Loan Losses." The impact on net income for the increase in the allowance for loan losses was offset by a $2.2 million gain realized on the branch sale in September 1996. Net Interest Income. Net interest income increased $690,000, or 9%, to $8.3 million in 1997 from 1996 due to a $16 million or 12% increase in average interest-bearing assets offset by a 14 basis point decrease in the margin as a more significant portion of assets were held in investment securities and the Company's higher rate premier money market savings accounts represented a greater portion of the interest-bearing liabilities. Average interest-bearing liabilities increased $6.4 million or 6%. Net interest income increased $832,000, or 12%, to $7.6 million in 1996 from $6.7 million in 1995 as growth more than offset the net interest margin decrease of 8 basis points. Average interest-earning assets increased $17.0 million, or 14%, while average interest-bearing liabilities increased $16.1 million, or 16%, in 1996 from 1995. The higher asset growth, however, was offset by a greater increase in the cost of deposits over the yield on assets as deposits shifted into the premier money market savings and certificates of deposit which were used to replace the sold retail deposits. Interest Income. Interest income increased $1.3 million, or 10%, to $14.6 million in 1997 from $13.3 million in 1996 due to a $6.8 million or 6% increase in average loans out standing and a $8.6 million or 82% increase in average investments. The yield on loans remained essentially level for both years, while the yield on investments decreased by 10 basis points due to the shorter term investments made in 1997. Interest income increased by $1.7 million in 1996, or 15%, from $11.6 million in 1995 due primarily to a $19.6 million increase in the average balance of commercial loans. This increase was partially offset in 1996 by a lower yield on commercial loans due to a 25 basis point decrease in the Prime Rate in February 1996. The annual average Prime Rate decreased 50 basis points from 1995 to 1996. The yield on loans also decreased in the fourth quarter of 1996 due to a bulk-sale of unguaranteed portions of SBA loans. Interest earned on federal funds sold increased 8% to $632,000 due to a $2.0 million average balance increase maintained to fund loan demand partially offset by a 25 basis point decrease in short-term interest rates in February 1996. Interest Expense. Interest expense increased $630,000, or 11%, to $6.4 million in 1997 from $5.7 million in 1996 due to a 14 basis point increase in the average rate paid on the Company's premier money market accounts, as the underlying external index increased during 1997 and greater reliance was placed on these accounts to fund the balance sheet growth. Total average deposits increased 5% while the average balance of the money market savings accounts increased 18% in 1997. An increase in the rates offered for time deposits due to competitive demands resulted in a 25 basis point increase in the cost of interest bearing liabilities, although a $4.2 million, or 17%, increase in non-interest bearing demand deposits held the overall cost of liabilities to 4.14% for 1997 or a total 13 basis point increase for 1997. Interest expense increased $872,000, or 18%, in 1996 from 1995, due principally to a $19.7 million increase in the average balance of the money market accounts to $61.5 million in 1996 from $41.8 million in 1995. The impact of the increase in these account balances was partially offset by a 25 basis point reduction in October 1995 of the margin added to the Company's external index. The reduction in the margin was made after consideration of prevailing market rates; this action had no discernible effect on the Company's ability to attract such deposits because the Company was able to maintain competitive rates. Provision for Possible Loan Losses. The provision for possible loan losses totaled $2.2 million in 1997, $3.5 million in 1996 and $1.2 million in 1995. The provision is affected by net loan charge-offs, changes in the level and mix of loans, changes in asset quality and general economic conditions. Approximately 69% of the charge-offs for the period from January 1, 1995 to December 31, 1997 are attributable to the Company's investor mortgage portfolio. See "Allowance for Loan Losses." 7 Non-Interest Income. The components of non-interest income are detailed below: - ------------------------------------------------------------------------------ Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------ (dollars in thousands) Non-interest income: Gain on loan sales: SBA sales ......................... $ 5,056 $ 3,558 $ 1,570 USDA sales ........................ 1,901 805 822 Ex-Im working capital sales ....... 251 201 104 Ex-Im medium term sales ........... 2,299 340 248 Inventory buyer credit sales ...... 5 -- -- Unguaranteed portions of SBA and USDA sales .............. 1,522 842 -- Other commercial sales ............ 705 91 97 Residential sales ................. 71 7 18 ------- ------- ------- Gain on loan sales .............. 11,810 5,844 2,859 Loan servicing income and fees ...... 2,618 1,475 896 Other non-interest income ........... 438 424 398 Income on stockholder note receivable ........................ 244 -- -- Gain on branch sale ................. -- 2,202 -- ------- ------- ------- Total non-interest income ....... $15,110 $ 9,945 $ 4,153 ------- ------- ------- Non-interest income increased $5.2 million, or 52%, to $15.1 million in 1997 from $9.9 million in 1996 due to a $6.0 million increase in gain on loan sales and a $1.1 million increase in the loan servicing income, offset by the $2.2 million non-recurring gain on branch sale in 1996. The increase in gains on SBA and USDA loan sales reflects increased loan originations from the Company's four mature New England locations as well as a contribution equal to 30% of total domestic gains from the five representative offices opened in 1997. The gain on Ex-Im Bank medium term loans reflects an increase in the volume of these loans originated as the Company's international Master Agent relationships continue to result in more significant referrals to the Hartford-based International Business Units. U.S. dollar loans to companies in Brazil, Mexico and Turkey represented approximately 90% of the total medium term loan originations in 1997. The $680,000, or 81%, increase in gains on the sale of the unguaranteed portions of SBA and USDA loans ("Unguaranteed Portions") to $1.5 million in 1997 also contributed to the overall increase in gains on loan sales. The Company began selling the Unguaranteed Portions in 1996 on a non-recourse, servicing-retained basis and has been able to do so above the carrying value, thus realizing gains upon the sale. Through 1997 SBA regulations required that a bank originator retain an Unguaranteed Portion equal to 10% of the SBA outstanding loan. In 1997, however, the Company received permission from the SBA to reduce the retained Unguaranteed Portion to 5% of the total loan, thus providing additional liquidity to meet loan demand. In 1997 a total of $29.2 million in Unguaranteed Portions were sold, including approximately $7.8 million of loans representing 5% of the Unguaranteed Portions of loans previously sold by the Company. In 1996, gains from the sale of the Unguaranteed Portions totaled $842,000 on sales of loans totaling $33.1 million. The Company is required to retain 5% of all USDA loans originated. Many of the unguaranteed portions of SBA and USDA loans sold were originated prior to 1996. The Company can give no assurance that it will have a similar volume of loans available to sell and therefore that it will attain similar gains in the future. Gain on the sale of other commercial loans increased to $705,000 realized on the sale of commercial loans totaling $25.9 million in 1997 from $91,000 realized on the sale of $9.3 million in 1996. All such sales were completed on a non-recourse, servicing retained basis. This increase reflects the success of the Company's Capital Markets Business Unit in the development of secondary markets for unguaranteed commercial loans. The Company plans to continue to originate such commercial loans to small and medium size manufacturers for sale in the secondary markets. The non-interest income increase of $5.8 million in 1996 from 1995 reflects the non-recurring $2.2 million gain realized on the sale of the Company's suburban branch facility and its deposits as well as increasing gains on the sale of the guaranteed and unguaranteed portions of SBA and USDA loans. The increased loan sales activity reflected the contribution from the representative offices in Providence, Rhode Island and Springfield, Massachusetts which were opened in the second half of 1995, and the hiring of nine additional commercial loan officers. Loan servicing income comprises the servicing fees received on loans sold on a servicing retained basis, net of amortization of the servicing asset. - ------------------------------------------------------------------------------- Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------- (dollars in thousands) Loan Servicing Income and Fees Loan servicing income: SBA guaranteed loans .................. $ 1,203 $ 921 $ 766 USDA guaranteed loans ................. 278 151 43 Ex-Im working capital loans ........... 186 56 7 Ex-Im medium term loans ............... 264 43 -- Other commercial loans ................ 123 65 16 Residential and consumer loans ........ 64 59 48 -------- -------- -------- Total loan servicing income ......... 2,118 1,295 880 Other loan fees ......................... 500 180 16 -------- -------- -------- Total loan servicing income and fees. $ 2,618 $ 1,475 $ 896 ======== ======== ======== Loans serviced for others (at period end) Outstanding balance ................. $429,077 $265,805 $153,850 ======== ======== ======== The increases in total loan servicing income reflect the growth of the servicing portfolios. The $823,000 or 64% increase in loan servicing income to $2.1 million in 1997 reflects the $115.1 million or 62% increase in the average balance of commercial loans serviced for others to $300.8 million in 1997 from $185.7 million in 1996 while the 47% increase in loan servicing income in 1996 to $1.3 million from $880,000 in 1995 reflects the 69% increase in the average balance of loans serviced for others over the period. Other loan fees are comprised primarily of fees earned on letters of credit, which have increased $320,000, or 177%, to $500,000 in 1997 from $180,000 in 1996 as more of the Company's clientele conduct business overseas and have the need for letters of credit to support their trade activities. 8 Data with respect to the retained portions of loans of SBA and USDA loan sales and related accounts are detailed below: - ------------------------------------------------------------------------- At December 31, 1997 1996 1995 - ------------------------------------------------------------------------- (dollars in thousands) Portfolio Loans Unguaranteed portions of: SBA loans ................ $29,912 $31,691 $37,873 USDA loans ............... 6,541 3,211 3,265 ------- ------- ------- Total SBA and USDA loans 36,453 34,902 41,138 Less: Discount ................. 1,775 2,232 2,300 ------- ------- ------- Net carrying value ..... $34,678 $32,670 $38,838 ======= ======= ======= - --------------------------------------------------------------------------- Years Ended December 31, 1997 1996 1995 - --------------------------------------------------------------------------- (dollars in thousands) Discount on Retained SBA and USDA Loans Balance at beginning of year $ 2,232 $ 2,300 $ 1,792 Current period sales ..... 2,131 1,510 839 Deletions due to sales ... (1,620) (1,113) -- Accretion ................ (968) (465) (331) ------- ------- ------- Balance at end of year ..... $ 1,775 $ 2,232 $ 2,300 ======= ======= ======= The servicing asset for all loans sold is as follows: - -------------------------------------------------------------------------------- At December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- (dollars in thousands) Servicing Asset Servicing on other loan sales: Ex-Im medium term ................. $2,025 $ 374 $ 161 Other commercial .................. 122 173 140 Other consumer .................... 2 8 16 ------ ------ ------ Total other servicing ........... 2,149 555 317 Servicing on SBA and USDA loan sales: SBA ............................. 3,155 3,100 2,290 USDA ............................ 375 483 202 ------ ------ ------ Total SBA and USDA servicing .. 3,530 3,583 2,492 ------ ------ ------ Total servicing asset ......... $5,679 $4,138 $2,809 ====== ====== ====== The activity in the servicing asset is detailed below: - ------------------------------------------------------------------------------- Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------- (dollars in thousands) Servicing Asset Activity Balance at beginning of period. $ 4,138 $ 2,809 $ 2,084 Current period sales ........ 3,172 1,979 1,127 Amortization ................ (1,631) (650) (402) ------- ------- ------- Balance at end of period ...... $ 5,679 $ 4,138 $ 2,809 ======= ======= ======= Non-Interest Expense. Increases in non-interest expense reflect the Company's growth over the periods as indicated below: - ------------------------------------------------------------------------------ Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------ (dollars in thousands) Non-interest expense: Salaries and benefits ....... $ 9,302 $ 4,963 $ 3,399 Occupancy ................... 985 774 573 Office expenses ............. 901 702 538 Marketing ................... 840 621 288 Furniture and equipment ..... 692 462 407 Outside services ............ 425 231 210 Loan collection ............. 148 360 311 Other ....................... 508 312 402 -------- -------- -------- Total non-interest expense $ 13,801 $ 8,425 $ 6,128 -------- -------- -------- Selected Data Total servicing portfolio ... $573,544 $380,432 $260,842 -------- -------- -------- Number of loans serviced .... 1,938 1,519 1,308 -------- -------- -------- Number of total personnel ... 131 92 67 -------- -------- -------- Number of loan officers ..... 46 26 11 -------- -------- -------- Non-interest expenses increased $5.4 million, or 64%, in 1997 from 1996 due to a 42% increase in personnel. Approximately half of the 1997 personnel additions were lending officers, as the Company opened five new representative offices and increased the number of Hartford loan officers in both the domestic and international business units during the year. The other additions to staff were primarily in the loan servicing and credit business units. Geographic expansion and personnel additions resulted in an increase in occupancy and related expenses, as new offices were leased and the leased headquarters offices were expanded. Salary and benefits expense for 1997 also included approximately $636,000 associated with bonuses paid to officers in connection with the successful completion of the September 1997 public offering. The $219,000, or 35%, increase in marketing expense primarily reflects increases associated with international activities. Travel expenses increased as Company officers visited the majority of the targeted international countries to finalize Master Agency agreements and remain in contact with Agents and borrowers abroad, and an increase in the expense reimbursements provided to Master Agents in accordance with the increase in their referrals to the Company. The $194,000, or 84%, increase in outside services reflects an increase in legal fees associated with new product development, international Master Agency agreements and diligence on state banking laws in each of the new states where domestic representative offices were opened in 1997. Loan collection costs decreased $212,000, or 59%, in 1997 from 1996 due to the ability of the Company to more quickly resolve and/or liquidate the non-performing loans in 1997, as compared to 1996 when the non-performing loans were primarily investor mortgages requiring a more protracted workout period. The $196,000, or 63%, increase in other non-interest expense in 1997 from 1996 reflects an increase in directors and officers insurance obtained in conjunction with the Company becoming an SEC registrant, as well as increases in service bureau fees paid for credit reports due to an increase in the volume of loans underwritten, a greater percentage of which were for foreign companies which are more expensive. 9 Non-interest expense increased $2.3 million, or 38%, in 1996 from 1995 reflecting the personnel increases and related occupancy increases as the Company leased space at its headquarters facility to accommodate additional lending staff and the support staff hired in 1996. The occupancy, furniture and equipment expense increase reflects the cost of additional leased space acquired for three New England representative offices, each of which had twelve months rental expense in 1996 compared to a partial year's expense in 1995. The increases in office and marketing expenses in 1996 from 1995 reflect costs to support the growth of personnel over the periods and the Company's geographically wider and more formalized marketing efforts. The $164,000, or 30%, increase in office expense in 1996 from 1995 includes increase in telephone and postage expenses as international loan officers responded to inquiries from potential borrowers and domestic commercial loan officers expanded their marketing efforts. The $333,000, or 116%, increase in marketing expense in 1996 from 1995 reflects an investment in the development of international marketing relationships and marketing literature. The Company also engaged a public relations firm to create various marketing pieces for use in mass mailing solicitations and other expanded and regionalized calling efforts. International development efforts included legal expenses, visits by Company officers to the locations of prospective international Master Agents and related due diligence, as well as training in Connecticut of the international agents. The Company's domestic and international loan officers also incurred greater travel and other business development costs as they expanded their marketing efforts, and the number of officers increased to 26 from 11. Other non-interest expense decreased $90,000, or 22%, due to a $135,000 decrease in FDIC deposit premiums following a decrease in the rate charged for such deposit insurance. This was partially offset by increases in credit report fees as loan volume increased. The Company's efficiency ratios, calculated as the ratio of non-interest expenses to the sum of net interest income and non-interest income, excluding the 1996 gain on the branch sale, were 59%, 55% and 56% for the years ended December 31, 1997, 1996 and 1995, respectively. Income Taxes. The effective income tax rates for the years ended December 31, 1997, 1996 and 1995 were 39.5%, 42.0% and 42.4%, respectively. The 1997 tax provision reflects a benefit from the dividend received deduction on certain investments. The following table sets forth the components of the Company's net interest income and yield on average interest earning assets and rate on interest bearing liabilities:
- ------------------------------------------------------------------------------------------------------------------------------------ For the Years Ended December 31, 1997 December 31, 1996 December 31, 1995 - ------------------------------------------------------------------------------------------------------------------------------------ Interest Average Interest Average Interest Average Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/ Balance Paid Rate Balance Paid Rate Balance Paid Rate --------------------------- ------------------------ --------------------------- (dollars in thousands) Total earning assets: Loans (1) Commercial and commercial real estate . $ 112,386 $ 12,002 10.68% $ 101,656 $10,882 10.70% $ 82,040 $ 8,976 10.94% Residential ............................ 8,129 595 7.32% 12,848 1,059 8.24% 14,472 1,152 7.96% Other consumer ......................... 1,668 156 9.35% 874 86 9.84% 1,388 138 9.94% --------- -------- ------ --------- ------- ------ -------- --------- ------ Total Loans .......................... 122,183 12,753 10.44% 115,378 12,027 10.42% 97,900 10,266 10.49% Investment securities (2) ................ 19,085 1,156 6.06% 10,495 646 6.16% 12,921 750 5.80% Federal funds sold ....................... 13,139 716 5.45% 12,153 632 5.20% 10,179 585 5.75% --------- -------- ------ --------- ------- ------ -------- --------- ------ Total investment securities and federal funds sold .................. 32,224 1,872 5.81% 22,648 1,278 5.64% 23,100 1,335 5.78% --------- -------- ------ --------- ------- ------ -------- --------- ------ Total earning assets ................ 154,407 $ 14,625 9.47% 138,026 $13,305 9.64% 121,000 $ 11,601 9.59% --------- ------ ------- ------ --------- ------ Total non-earning assets ............ 23,484 19,466 12,924 --------- --------- -------- Total assets ........................ $ 177,891 $ 157,492 $133,924 --------- --------- -------- Interest bearing liabilities: Deposits Interest bearing demand deposits ....... $ 7,406 $ 183 2.47% $ 8,705 $ 241 2.77% $ 9,970 $ 229 2.30% Premier money market ................... 72,965 3,869 5.30% 61,519 3,176 5.16% 41,822 2,417 5.78% Other savings .......................... 6,268 135 2.15% 12,607 386 3.06% 16,462 425 2.58% Certificates of deposit ................ 30,825 1,786 5.79% 28,384 1,564 5.51% 25,626 1,356 5.29% IRA certificates of deposit ............ 6,552 364 5.56% 6,436 347 5.39% 6,262 344 5.49% --------- -------- ------ --------- ------- ------ -------- --------- ------ Total deposits ....................... 124,016 6,337 5.11% 117,651 5,714 4.86% 100,142 4,771 4.76% Other borrowings ......................... 702 34 4.84% 623 27 4.33% 1,999 98 4.90% --------- -------- ------ --------- ------- ------ -------- --------- ------ Total interest bearing liabilities ... 124,718 6,371 5.11% 118,274 5,741 4.85% 102,141 4,869 4.77% --------- -------- ------ --------- ------- ------ -------- --------- ------ Non-interest bearing liabilities Demand deposits ........................ 29,066 24,862 20,220 Other liabilities ...................... 2,458 1,630 1,068 --------- --------- -------- Total non-interest bearing liabilities 31,524 26,492 21,288 Stockholders' equity ..................... 21,649 12,726 10,495 --------- --------- -------- Total liabilities and stockholders' equity $ 177,891 $ 157,492 $133,924 --------- --------- -------- Net interest income/net interest spread .. $ 8,254 4.36% $ 7,564 4.79% $ 6,732 4.82% -------- ------ ------- ------ --------- ------ Net interest margin ...................... 5.34% 5.48% 5.56% ------ ------ ------ - ------------------------------------------------------------------------------------------------------------------------------------
(1) For purposes of these computations, non-accruing loans are included in the average balances. (2) The yield does not give effect to changes in fair value that are reflected as a component of stockholders' equity. 10 The following rate/volume analysis shows the portions of the net change in net interest income due to changes in volume or rate. The changes in interest due to both volume and rate have been allocated proportionally to changes due to volume and changes due to rate.
================================================================================================================================== Year Ended December 31, Year Ended December 31, 1997 Compared to 1996 1996 Compared to 1995 Changes due to: Changes due to: ------------------------------- -------------------------------- Volume Rate Total Volume Rate Total ------------------------------- -------------------------------- (dollars in thousands) Increase (decrease) in net interest income due to: Loans Commercial loans ..................................... $ 1,147 $ (27) $ 1,120 $ 2,100 $ (194) $ 1,906 Residential loans .................................... (346) (118) (464) (134) 41 (93) Other consumer loans ................................. 74 (4) 70 (51) (1) (52) ------- ------- ------- ------- ------- ------- Total loans ..................................... 875 (149) 726 1,915 (154) 1,761 Investment securities .................................. 520 (10) 510 (149) 45 (104) Federal funds sold ..................................... 54 30 84 103 (56) 47 ------- ------- ------- ------- ------- ------- Total investments and federal funds sold......... 574 20 594 (46) (11) (57) ------- ------- ------- ------- ------- ------- Total interest earning assets ................... 1,449 (129) 1,320 1,869 (165) 1,704 ------- ------- ------- ------- ------- ------- Deposits Interest-bearing demand deposits ..................... (32) (26) (58) (35) 47 12 Premier money market savings ......................... 607 86 693 1,017 (258) 759 Other savings ........................................ (136) (115) (251) (118) 79 (39) Time deposits ........................................ 141 81 222 152 56 208 IRA time deposits .................................... 6 11 17 9 (6) 3 ------- ------- ------- ------- ------- ------- Total deposits .................................. 586 37 623 1,025 (82) 943 FHLB advances .......................................... 4 3 7 (60) (11) (71) ------- ------- ------- ------- ------- ------- Total interest-bearing liabilities .............. 590 40 630 965 (93) 872 ------- ------- ------- ------- ------- ------- Change in net interest income ................... $ 859 $ (169) $ 690 $ 904 $ (72) $ 832 ======= ======= ======= ======= ======= =======
Financial Condition General. Total assets increased $57.3 million, or 36%, to $218.9 million at December 31, 1997 from $161.6 million at December 31, 1996, and $20.4 million, or 14%, from the December 31, 1995 balance of $141.2 million. These increases reflect the increasing loan portfolio and related accounts, such as loans held for sale and receivables from loans sold which were funded by an increase in deposits and the September 1997 underwritten public stock offering which raised $23.8 million for the Company. Cash and Cash Equivalents. Cash and cash equivalents remained fairly flat at $17.4 million at December 31, 1997 from $18.9 million at December 31, 1996 but increased at December 31, 1996 by $8.8 million from the December 31, 1995 balance of $10.0 million as the Company maintained greater funds on hand as Federal Funds Sold, providing overnight liquidity for the Company's increased volume of loan originations. Investment Securities. The investment securities portfolio increased $6.4 million, or 40%, to $22.3 million at December 31, 1997 from $15.9 million at December 31, 1996 and increased $4.3 million, or 37%, in 1996 from the December 31, 1995 balance of $11.6 million. The portfolios are managed for liquidity and security and are comprised primarily of U.S. Treasury and other U.S. government mortgage-backed securities and collateralized mortgage obligations with average lives of less than five years. The portfolios are also utilized to collateralize lines of credit with correspondent banks, providing letter of credit facilities to supplement the Company's own product offerings. Refer to Note 2 of the Company's consolidated financial statements for additional information. Loans. Loans increased $21.2 million, or 19%, to $130.6 million at December 31, 1997 from $109.5 million at December 31, 1996 and increased $6.7 million, or 7%, from $102.7 million at December 31, 1995. The growth in the portfolios resulted primarily from increases in unguaranteed commercial loans, comprised of revolving lines of credit and term equipment loans, offset by decreases due to the sale of loans from portfolio. The 1997 growth in the unguaranteed commercial loan portfolios totaled $28.3 million while such portfolios increased by $6.4 million in 1996, consistent with the Company's desire to originate and sell a greater amount of unguaranteed loans as the secondary market for such loans is developing. 11 Allowance for Loan Losses. The Company reviews the adequacy of the allowance for loan losses quarterly. The allowance totaled $3.1 million at December 31, 1997, a slight increase from the $3.0 million balance at December 31, 1996. The allowance for loan losses was increased by $1.0 million during 1996 from the December 31, 1995 balance of $2.0 million to reflect a specific allocation for certain investor property mortgage loans and increases in the commercial loan portfolios.
Activity in the Allowance for Loan Losses - --------------------------------------------------------------------------------------------------------------------------------- At December 31, 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Balance of allowance for loan losses at the beginning of the period............. $ 3,000 $ 2,000 $ 2,000 Charge-offs: Investor mortgage ........................................................... 1,395 1,730 1,086 SBA ......................................................................... 262 478 18 USDA ........................................................................ 68 -- -- Commercial .................................................................. 279 168 173 Private ..................................................................... 46 27 8 Ex-Im working capital ....................................................... -- -- -- Ex-Im medium term ........................................................... -- -- -- Construction ................................................................ -- -- 4 Residential and other consumer .............................................. 195 124 32 -------- -------- -------- Total charge-offs ......................................................... 2,245 2,527 1,321 Recoveries: Investor mortgage ........................................................... 6 13 13 SBA ......................................................................... 13 -- -- Commercial .................................................................. 77 16 6 Private ..................................................................... -- 10 63 Residential and other consumer .............................................. 10 1 2 -------- -------- -------- Total recoveries .......................................................... 106 40 84 -------- -------- -------- Net charge-offs ....................................................... 2,139 2,487 1,237 Provision for loan losses ...................................................... 2,239 3,487 1,237 -------- -------- -------- Balance of allowance for loan losses at end of period .......................... $ 3,100 $ 3,000 $ 2,000 ======== ======== ======== Total loans .................................................................... $135,398 $114,627 $106,992 ======== ======== ======== Allowance to total loans ....................................................... 2.3% 2.6% 1.9% ======== ======== ========
Net charge-offs from the investor mortgage portfolio represented 62%, 69% and 82% of the total charge-offs for the years ended December 31, 1997, 1996 and 1995, respectively. The Company's portfolio of investor mortgages is collateralized by multi-family urban residential units located in various Connecticut inner cities. Following the recession in 1990, management determined that no new loans collateralized by and/or supporting the purchase of urban residential units would be made as the Company's focus turned toward its current target market of small and medium size manufacturers. In the early 1990's the Company worked to resolve investor mortgages related to certain urban residential loans by facilitating sales of the troubled properties to experienced property managers who had an interest in acquiring and rehabilitating them. Due to deteriorating economic conditions in Hartford and New Haven, Connecticut, many of these properties experienced cash flow difficulties again in 1995 and 1996. The Company increased the allocated allowance for loan losses for such properties in 1996. The Company continues to monitor this portfolio and, based on current information, believes that it maintains appropriate reserves. The outstanding balance of this portfolio at December 31, 1997 totaled $5.5 million. The SBA loan charge-offs for the years ended 1997 and 1996 represented losses realized on the unguaranteed portions of SBA loans after liquidation of the collateral, and represent annual loss ratios of 61 and 100 basis points, respectively, of the average balances of the unguaranteed portion of SBA loans which were retained in the Company's portfolio. The provision for loan losses reflects the charge to earnings deemed appropriate by management to maintain an adequate allowance for loan losses. The provision totaled $2.2 million in 1997, a decrease of $1.3 million or 37% from $3.5 million for the year ended December 31, 1996. The 1996 provision had increased $2.3 million or 192% from 1.2 million for the year ended December 31, 1995. The $2.3 million increase in the provision for loan losses in 1996 was necessitated by the continued deterioration of the investor mortgage portfolio which became evident in the third and fourth quarters of 1996. It was at that time that management determined that the cash flow difficulties of the underlying properties were other than temporary. Management also determined that the unallocated portion of 12 the allowance should be increased to reflect a broader geographic base of originations to areas where the Company had no previous experience. The Company manages charge-offs by relationships and has noted no appreciable increase in the number of relationships charged-off. For the years ended December 31, 1997, 1996 and 1995, the charge-offs were comprised of 16, 21 and 19 lending relationships respectively. The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated. Management believes that the allowance can be allocated by category only on an approximate basis, and therefore allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict use of the allowance to absorb losses in any category. The unallocated portion of the allowance represents an amount that is not specifically allocable to one of the loan portfolios. All of the loans included in the Company's portfolio are to domestic companies. Loans to foreign entities are 100% Ex-Im Bank guaranteed and generally sold at origination.
- -------------------------------------------------------------------------------------------------------------------------- December 31, 1997 1996 1995 1994 1993 - -------------------------------------------------------------------------------------------------------------------------- Allocation of the allowance by category of loans Unguaranteed portions of: SBA and USDA loans ...................................... $ 853 $ 491 $ 563 $ 338 $ 147 Ex-Im Bank working capital loans ........................ 145 44 2 -- -- Commercial mortgage loans .................................. 250 271 483 237 416 Other commercial loans ..................................... 1,052 475 316 353 346 Investor mortgage loans .................................... 269 1,061 399 581 223 Residential and other consumer loans ....................... 67 113 72 106 99 Unallocated ................................................ 464 545 165 385 194 -------- -------- -------- -------- -------- Total allowance for loan losses ....................... $ 3,100 $ 3,000 $ 2,000 $ 2,000 $ 1,425 ======== ======== ======== ======== ======== Percent of loans in each category to total loans Unguaranteed portions of: SBA and USDA loans ...................................... 26.9% 30.5% 38.5% 32.0% 15.9% Ex-Im Bank working capital loans ........................ 2.8 3.0 0.2 -- -- Ex-Im Bank medium term loans ............................... 0.5 1.8 0.1 0.2 -- Commercial mortgage loans .................................. 14.7 16.4 14.5 17.1 19.5 Other commercial loans ..................................... 44.8 29.4 26.9 21.6 28.1 Investor mortgage loans .................................... 4.1 6.6 7.2 9.9 13.5 Residential and other consumer loans ....................... 6.2 12.3 12.6 19.2 23.0 -------- -------- -------- -------- -------- Total ................................................. 100.0% 100.0% 100.0% 100.0% 100.0% ======== ======== ======== ======== ========
The following table sets forth information regarding the Company's non-performing loans at the dates indicated:
- ------------------------------------------------------------------------------------------------------------------------- December 31, 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Non-Performing Loans Commercial: Unguaranteed portions: SBA and USDA loans .................................... $1,226 $ 188 $ 419 $ -- $ -- Ex-Im Bank working capital loans ...................... -- -- -- -- -- Commercial mortgage loans ............................... 39 -- -- 703 -- Other commercial loans .................................. 535 132 -- 106 -- Investor mortgages loans ................................ 415 1,853 839 1,437 755 Consumer ................................................... 149 79 -- -- -- -------- -------- -------- -------- -------- Total non-performing loans ................................. $2,364 $2,252 $1,258 $2,246 $ 755 ======== ======== ======== ======== ======== Total non-performing loans to total loans................... 1.75% 1.96% 1.18% 2.36% 1.06% ======== ======== ======== ======== ======== Total non-performing loans to total assets.................. 1.08% 1.39% 0.89% 1.79% 0.69% ======== ======== ======== ======== ======== Allowance to total non-performing loans .................... 131% 133% 159% 89% 189% ======== ======== ======== ======== ========
Although the balance of non-performing SBA/USDA loans has increased in 1997, the Company believes that this reflects a seasoning of the portfolio. The Company had no loans past due 90 days and accruing interest at any period end as presented in the above table. Other Real Estate Owned. It is the Company's policy, whenever possible, not to take title to real property collateralizing loans, thereby avoiding management time and any environmental liabilities associated with holding such properties. From the end of the 1995 to 1997 reporting periods discussed herein, the highest balance of other real estate owned totaled $300,000. 13 Receivable From Loans Sold. Receivable from loans sold represents the balance of loans sold for which funding has not yet been received. Government guaranteed loans are generally sold within a day of origination and settled within 30 days of the trade date. During this thirty day period, the Company reviews and delivers closing documents to the investor. The receivable balance fluctuates with the month's loan sale activity and tends to be higher at any quarter end due to increased loan closing activity. The average balance of this receivable was $8.5 million, $8.0 million and $3.5 million for the fiscal years ended December 31, 1997, 1996 and 1995, respectively. The Company actively monitors the settlement of loans to ensure that this source of liquidity is properly managed. Prepaid Expenses and Other Assets. Prepaid Expenses and Other Assets is comprised principally of servicing assets as discussed in "-Accounting for Loan Sales." - -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Other assets Servicing assets .................... $5,679 $4,138 $2,809 Prepaid expenses and other assets.... 1,143 631 280 ------ ------ ------ Total other assets ............. $6,822 $4,769 $3,089 ====== ====== ====== Deposits. Deposits are the Company's primary funding source and have increased to sustain the Company's balance sheet growth. Federal Home Loan Bank of Boston Advances. Federal Home Loan Bank ("FHLB") advances were utilized in 1994 to "match fund" certain community reinvestment initiatives and were repaid in 1995 when alternative, less expensive deposits became available. Since 1995, these advances have been utilized to provide short-term liquidity. As of December 31, 1997, the Bank had a $2.9 million unused line of credit from the FHLB and had the ability to borrow approximately $3.8 million from the FHLB under various term advance programs. Stockholders' Equity. Stockholders' equity increased $27.9 million to $42.1 million at December 31, 1997 from $14.2 million at December 31, 1996 due to the issuance of 1,955,000 shares of common stock in an underwritten public offering completed in September 1997, resulting in net proceeds to the Company of $23.8 million and the retention of earnings. In 1996, stockholders' equity increased $2.6 million from $11.6 million at December 31, 1997 due principally to the retention of earnings. The Company has paid quarterly dividends of $.03 per share since the fourth quarter of 1995. As explained in Note 7 to the Company's consolidated financial statements, the Company holds a note receivable from the Company's Chairman of the Board and President related to the issuance of 614,600 shares of common stock in June 1994, the repayment of which would result in an increase in stockholders' equity. Liquidity and Capital Resources The Company's primary sources of liquidity and funding are its diverse deposit base and loan sales and participations. Secondary sources of liquidity include FHLB advances, federal funds purchased under correspondent bank lines of credit and the sale of investments. As an FDIC-insured institution, the Bank may make available traditional business and consumer depository products, including checking, savings and time deposit accounts. Management considers scheduled cash flows from existing clients and borrowers, projected deposit levels as well as estimated liquidity needs from maturing and disintermediating deposits, and approved extensions of credit and unadvanced commitments to existing borrowers in determining the level and maturity of deposits necessary to support operations. Historically, the Company has increased the level of deposits to support its planned loan growth. Marketing efforts are focused on externally indexed "core accounts" of checking and savings deposits, which have proven to be generally less interest rate sensitive than time deposits. In addition to its primary deposit solicitation efforts, the Company may occasionally undertake time deposit campaigns to the general public in conjunction with anticipated liquidity needs in order to better allow an appropriate matching of its funding sources to its funding needs. Average balances of deposits accounts increased $10.6 million to $153.1 million in 1997 from $142.5 million in 1996 which was an increase of $22.1 million from $120.4 million in 1995 with the majority of the increases in savings account balances. The Company's liquidity position is monitored daily by management to maintain a level of liquidity conducive to efficient operations and is continuously evaluated as part of the asset/liability management process. The Company believes that its liquidity sources will continue to provide funding sufficient to support operating activities, loan originations and commitments, and deposit withdrawals. The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial condition. The regulations require that the Bank meet specific capital adequacy guidelines as calculated under regulatory accounting practices. The Bank's capital classification is also subject to qualitative judgments by the regulators about interest rate risk, concentration of credit risk and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Tier I capital to total average assets (as defined), and minimum ratios of Tier I and total capital to risk weighted assets. The Bank's capital ratios are well in excess of regulatory minimum requirements. As the Company is a small bank holding company, it is not subject to any additional capital ratio requirements. See Note 7 to the consolidated financial statements for a table of minimum required and actual capital ratios. Quantitative and Qualitative Disclosures About Market Risk and Asset/Liability Management An earnings at risk model is one tool utilized by the Company to measure interest rate risk. Such a model computes the estimated effect on net income from changes in interest earned on assets and expenses paid on liabilities, as well as the impact of off-balance sheet items in the event of a range of assumed changes in market interest rates. This analysis estimates the risk of loss in market risk sensitive instruments in the event of a sudden and sustained one hundred to three hundred basis point increase or decrease in the market interest rates. The Company's Board of Directors has adopted an interest rate risk policy which establishes maximum decreases in net income and capital in the event of a sudden and sustained change in market interest rates. 14 In the event that the Prime Rate, as quoted in The Wall Street Journal, decreases by 100, 200 or 300 basis points as of December 31, 1997, the Company estimates that net income will decrease by $520,000, $745,000 and $730,000, respectively. If the Prime Rate increases by 100, 200 or 300 basis points, the Company estimates that net income will increase by $520,000, $745,000 and $315,000, respectively. All of the Company's market risk sensitive instruments are classified as held to maturity or available for sale. The Company has no trading securities. At December 31, 1997 the estimated changes in the Company's net income based on the hypothetical changes in interest rates were within the limits established by the Board of Directors. Such earnings at risk calculation is based on the estimated change in interest income and interest expense utilizing numerous assumptions, including historical relationships between various indices utilized by the Company in setting interest rates and management's judgment as to the expected relationship of such rates in the current environment. This calculation utilizes such relative levels of market interest rates as well as assumptions regarding loan prepayments and deposit decays and should not be relied upon as indicative of actual results. Importantly, the computations do not contemplate any actions the Company could undertake in response to changes in interest rates. Certain shortcomings are inherent in the method of analysis presented in the computation of earnings at risk. Actual results may differ from those presented should market conditions vary from assumptions used in the calculation. In the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in the earnings at risk calculation. Finally, the ability of many borrowers to repay their adjustable rate loans and the value of the underlying collateral may decrease in the event of interest rate decreases. The Company does seek to manage its assets and liabilities to reduce the potential adverse impact on net interest income that might result from changes in interest rates. Control of interest rate risk is conducted through systematic monitoring of maturity mismatches. The Company's investment decision-making takes into account not only the rates of return and their underlying degree of risk, but also liquidity requirements, including minimum cash reserves, withdrawal and maturity of deposits and additional demand for funds. For any given period, the pricing structure is matched when an equal amount of assets and liabilities reprice. An excess of assets or liabilities over these matched items results in a gap or mismatch, as shown on the following table. A negative gap denotes liability sensitivity and normally means that a decline in interest rates would have a positive effect on net interest income, while an increase in interest rates would have a negative effect on net interest income. However, significant variations may exist in the degree of interest rate sensitivity between individual asset and liability types within the repricing periods presented due to differences in their repricing elasticity relative to the change in the general level of interest rates. All of the Company's assets and liabilities are U.S. dollar-denominated and, therefore, the Company bears no foreign exchange risk. The majority of the Company's assets reprice according to contractual arrangements although the Company has fairly broad discretion over the frequency and magnitude of interest rate changes on its liabilities which has enabled the Company to minimize the impact of any general changes in the interest rate environment. The Company utilizes the analysis detailed below to generally monitor the composition of assets and liabilities and focuses on the one-year mismatch. The Company believes the negative one year cumulative gap $8.1 million, or 5%, reflects a relatively balanced position. For purposes of the following analysis, checking and savings accounts are presented 20% in the 0-90 day period, 20% in the 91-180 day period, and 30% in the 181-365 day period and 30% in the 1-5 year period. Although the elasticity of such deposits cannot be tied to any one time period, these are the assumptions which have been developed by the Company based on historical experience and are utilized for internal and regulatory reporting purposes.
- ----------------------------------------------------------------------------------------------------------------------------------- December 31, 1997 0 to 90 91 to 180 181 to 365 1 to 5 Over 5 Days Days Days Years Years Total - ----------------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Commercial loans ............................. $ 100,800 $ 1,933 $ 4,486 $ 8,684 $ 11,125 $ 127,028 Residential loans ............................ 574 1,038 1,194 1,975 1,734 6,515 Other consumer loans ......................... 1,389 1 13 401 51 1,855 Investments .................................. 2,335 1,013 5,173 8,133 1,511 18,165 Federal funds sold ........................... 6,450 -- -- -- -- 6,450 --------- --------- --------- --------- --------- --------- Total interest earning assets ......... $ 111,548 $ 3,985 $ 10,866 $ 19,193 $ 14,421 $ 160,013 ========= ========= ========= ========= ========= ========= Checking ..................................... $ 10,687 $ 10,687 $ 16,031 $ 16,031 -- $ 53,436 Money market savings ......................... 16,679 16,679 25,018 25,018 -- 83,394 Other savings ................................ 1,722 1,722 2,583 2,582 -- 8,609 Time deposits ................................ 13,870 7,648 10,075 2,622 -- 34,215 Treasury, tax and loan ....................... 1,085 -- -- -- -- 1,085 --------- --------- --------- --------- --------- --------- Total interest bearing liabilities..... $ 44,043 $ 36,736 $ 53,707 $ 46,253 -- $ 180,739 ========= ========= ========= ========= ========= ========= Interest sensitivity gap ..................... $ 67,505 $ (32,751) $ (42,841) $ (27,060) $ 14,421 $ (20,726) ========= ========= ========= ========= ========= ========= Cumulative gap ............................... $ 67,505 $ 34,754 $ (8,087) $ (35,147) $ (20,726) ========= ========= ========= ========= ========= Cumulative gap as a percentage of total interest earning assets ............ 42% 22% (5)% (22)% (13)% ========= ========= ========= ========= =========
15 Seasonality The Company's business is somewhat seasonal as the level of domestic loan originations tend to be lower during the first quarter when many U.S. companies have not yet produced their fiscal financial statements and during the third quarter when many U.S. manufacturers shut down for a limited time for summer vacation. Impact of Inflation The consolidated financial statements and related data presented elsewhere have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the operations of the Company is reflected in increased operating costs. Interest rates have a significant impact on the Company's performance. Increases in interest rates affect the ability of the Company's borrowers to service their variable rate debt. Furthermore, inflation can directly affect the value of loan collateral in general, and real estate collateral in particular. These factors are taken into account in the initial underwriting process and over the life of the loans. The Company believes that it has the systems in place to continue to manage the rates, liquidity and interest rate sensitivity of the Company's assets and liabilities. Year 2000 Compliance As the year 2000 approaches, a critical business issue has emerged regarding how existing application software programs and operating systems can accommodate this date value. In brief, many existing application software products in the marketplace were designed to only accommodate a two digit date position which represents the year (e.g., '95 is stored on the system and represents the year 1995). As a result, the year 1999 (i.e., '99) could be the maximum date value these systems will be able to accurately process. The Company has determined that its deposit item processing system could not be readily made to be year 2000 compliant and outsourced this function in the first quarter of 1998. All other major systems are supported by third party vendors. The Company has developed a plan to address the issues raised by the year 2000 in accordance with the guidance issued by the Federal Financial Institutions Examination Council and is in the process of working with all its service providers and software vendors to assure that the Company is prepared for the year 2000. Management does not anticipate that the Company will incur significant operating expenses or be required to invest heavily in computer system improvements to be year 2000 compliant. Recent Accounting Pronouncements SFAS No. 130 In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income" which established standards for reporting and display of comprehensive income, defined as the change in equity of a business enterprise during a period from nonowner sources. SFAS No. 130 is effective for years beginning after December 15, 1997 and requires reclassification of financial statements for all years presented. The adoption of SFAS No. 130 will require the Company to expand the financial statements to present the impact of any changes in the valuation allowance for the available-for-sale investment portfolio, any tax benefits associated with Company's stock option plans or other components of comprehensive income. SFAS No. 131 In June 1997, the FASB also issued SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires public companies to report financial and descriptive information about operating segments in annual financial statements and requires selected information about operating segments to be reported in interim financial reports issued to shareholders. Operating segment financial information is required to be reported on the basis that it is used internally for evaluating segment performance and allocation of resources. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997 and requires presentation of comparative information for prior periods presented. The Company is currently reviewing this pronouncement, and the adoption of SFAS No. 131 is expected to impact the way the Company reports information about its operations. Specific determination has not yet been made as to how this Statement will be implemented. 16 Report of Independent Accountants The Board of Directors and Stockholders of First International Bancorp, Inc. We have audited the consolidated balance sheets of First International Bancorp, Inc. and Subsidiary (the "Company") as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First International Bancorp, Inc. and Subsidiary as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand L.L.P. Hartford, Connecticut January 23, 1998 17 First International Bancorp, Inc. and Subsidiary Consolidated Balance Sheets December 31, 1997 and 1996 (dollars in thousands)
- ---------------------------------------------------------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------------------------------------------------------- Assets Cash and due from banks .................................................. $ 10,944 $ 5,867 Federal funds sold ....................................................... 6,450 13,000 --------- --------- Cash and cash equivalents ........................................ 17,394 18,867 Investment securities (Note 2): Available for sale at fair value .................................... 12,767 11,524 Held to maturity at amortized cost (fair value $7,429 and $3,056) ................................... 7,435 3,063 U.S. Agency stocks at cost ............................................... 2,069 1,287 Loans, net (Note 3) ...................................................... 130,625 109,453 Loans held for sale ...................................................... 9,070 -- Receivable from loans sold (Note 1) ...................................... 28,775 10,341 Accrued interest receivable .............................................. 1,200 823 Premises and equipment, net (Note 4) ..................................... 2,694 1,515 Prepaid expenses and other assets (Note 3) ............................... 6,822 4,769 --------- --------- Total assets ..................................................... $ 218,851 $ 161,642 ========= ========= Liabilities and Stockholders' Equity Deposits (Note 5) ........................................................ $ 172,321 $ 144,316 U.S. Treasury demand note ................................................ 1,085 1,061 Accrued interest payable ................................................. 745 622 Other liabilities ........................................................ 2,552 1,427 --------- --------- Total liabilities ................................................ 176,703 147,426 Commitments and Contingencies (Notes 3 and 4) Stockholders' equity (Notes 1, 7, 8, and 9): Common stock, $.10 par value, 12,000,000 shares authorized; 7,866,735 and 5,766,352 shares issued and outstanding ............... 787 577 Preferred stock, $.10 par value, 2,000,000 shares authorized; no shares issued and outstanding ................................. -- -- Paid-in capital in excess of par value .............................. 32,083 8,222 Stockholder note receivable ......................................... (877) (954) Unrealized holding gain/(loss) on investments available-for-sale, net .............................................................. 12 (74) Retained earnings ................................................... 10,143 6,445 --------- --------- Total stockholders' equity ....................................... 42,148 14,216 --------- --------- Total liabilities and stockholders' equity ....................... $ 218,851 $ 161,642 ========= =========
- -------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements 18 First International Bancorp, Inc. and Subsidiary Consolidated Statements of Income December 31, 1997, 1996 and 1995 (dollars in thousands, except per share amounts)
- ---------------------------------------------------------------------------------------------- 1997 1996 1995 - ---------------------------------------------------------------------------------------------- Interest income: Loans, including net fees .................. $12,753 $12,027 $10,266 Investment securities ...................... 1,156 646 750 Federal funds sold ......................... 716 632 585 ------- ------- ------- Total interest income ................... 14,625 13,305 11,601 ------- ------- ------- Interest expense: Deposits ................................... 6,337 5,714 4,771 Other ...................................... 34 27 98 ------- ------- ------- Total interest expense .................. 6,371 5,741 4,869 ------- ------- ------- Net interest income ..................... 8,254 7,564 6,732 Provision for possible loan losses .............. 2,239 3,487 1,237 ------- ------- ------- Net interest income after provision for possible loan losses... 6,015 4,077 5,495 Non-interest income: Service charges and other deposit fees ..... 438 424 398 Loan servicing income and fees ............. 2,618 1,475 896 Income on stockholder note receivable ...... 244 -- -- Gain on sale of guaranteed commercial loans 9,513 4,904 2,744 Gain on sale of commercial loans ........... 2,227 933 97 Gain on residential loan sales ............. 70 7 18 Gain on branch sale ........................ -- 2,202 -- ------- ------- ------- Total non-interest income ............... 15,110 9,945 4,153 ------- ------- ------- Total operating income .................. 21,125 14,022 9,648 ------- ------- ------- Non-interest expense: Salaries and benefits ...................... 9,302 4,963 3,399 Occupancy .................................. 985 774 573 Furniture and equipment .................... 692 462 407 Outside services ........................... 425 231 210 Office expenses ............................ 901 702 538 Marketing .................................. 840 621 288 Other ...................................... 656 672 713 ------- ------- ------- Total non-interest expense .............. 13,801 8,425 6,128 ------- ------- ------- Income before income taxes .............. 7,324 5,597 3,520 Provision for income taxes (Note 9) ............. 2,895 2,353 1,494 ------- ------- ------- Net income .............................. $ 4,429 $ 3,244 $ 2,026 ------- ------- ------- Basic earnings per share (Notes 1 and 7) ....... $ .70 $ .56 $ .35 ------- ------- ------- Diluted earnings per share (Notes 1 and 7) ...... $ .67 $ .56 $ .35 ------- ------- -------
- -------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements 19 First International Bancorp, Inc. and Subsidiary Consolidated Statements of Changes in Stockholders' Equity December 31, 1997, 1996 and 1995 (dollars in thousands, except per share amounts)
- --------------------------------------------------------------------------------------------------------------------------------- Paid-in Unrealized Capital in Stockholder Holding Gain (Loss) Common Excess of Note on Investments Retained Stock Par Value Receivable Available-for-Sale Earnings - --------------------------------------------------------------------------------------------------------------------------------- Balance at January 1, 1995 ...................... $ 582 $ 8,299 $ (1,021) $ (182) $ 1,997 Repurchase and retirement of 62,132 shares of common stock (Note 7) .............................. (6) (103) -- -- -- Issuance of 3,500 shares of common stock under option plan (Note 8) ............................... -- 6 -- -- -- Dividend on common stock ($.03/share) ................... -- -- -- -- (164) Principal payment on stockholder note receivable (Note 7) ................................ -- -- 14 -- -- Reduction in unrealized holding loss, net of income taxes -- -- -- 154 -- Net income .............................................. -- -- -- -- 2,026 -------- -------- -------- -------- -------- Balance at December 31, 1995 .................... 576 8,202 (1,007) (28) 3,859 Repurchase and retirement of 7,875 shares of common stock (Note 7) .............................. (1) (21) -- -- -- Issuance of 21,000 shares of common stock under option plan (Note 8) ............................... 2 41 -- -- -- Dividends on common stock ($.11/share) .................. -- -- -- -- (658) Principal payment on stockholder note receivable (Note 7) ................................ -- -- 53 -- -- Increase in unrealized holding loss, net of income taxes. -- -- -- (46) -- Net income .............................................. -- -- -- -- 3,244 -------- -------- -------- -------- -------- Balance at December 31, 1996 .................... 577 8,222 (954) (74) 6,445 Issuance of 145,350 shares of common stock under option plan (Note 8) ............................... 14 249 -- -- -- Issuance of 1,955,000 shares of common stock at public offering (Note 1) .................................. 196 23,612 -- -- -- Dividends on common stock ($.12/share) .................. -- -- -- -- (731) Discount on stockholder note receivable (Note 7) ........ -- -- 92 -- -- Accretion on stockholder note receivable (Note 7) ....... -- -- (15) -- -- Reduction in unrealized holding loss, net of income taxes .............................................. -- -- -- 86 -- Net income .............................................. -- -- -- -- 4,429 -------- -------- -------- -------- -------- Balance at December 31, 1997 ....................... $ 787 $ 32,083 $ (877) $ 12 $ 10,143 ======== ======== ======== ======== ========
- -------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements 20 First International Bancorp, Inc. and Subsidiary Consolidated Statements of Cash Flows December 31, 1997, 1996 and 1995 (dollars in thousands, except per share amounts)
- ----------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income ..................................................... $ 4,429 $ 3,244 $ 2,026 --------- --------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .................................. 644 374 315 Amortization of investment premiums, net ....................... 7 55 93 Accretion of loan discount, net ................................ 1,161 1,042 485 Provision for possible loan losses ............................. 2,239 3,487 1,237 Provision for loss on other real estate owned .................. -- 200 280 Increase in other liabilities .................................. 1,004 686 122 (Increase) decrease in deferred loan costs ..................... (42) (15) 35 (Increase) decrease in accrued interest receivable ............. (377) 54 (194) Increase (decrease) in accrued interest payable ................ 123 324 (1) Deferred income tax provision (benefit) ........................ 121 (249) (52) Gain on sale of loans .......................................... 1,070 (1,018) (353) (Increase) decrease in receivable from loans sold .............. (18,434) 932 (2,813) Increase in prepaid expenses and other assets .................. (2,113) (1,395) (1,438) Discount on stockholder note receivable ........................ 92 -- -- Accretion on stockholder note receivable ....................... (15) -- -- Loans originated for sale ........................................... (232,900) (132,839) (55,686) Proceeds from sale of loans originated for sale ..................... 231,636 136,742 58,193 --------- --------- --------- Total adjustments ........................................... (15,784) 8,380 223 --------- --------- --------- Net cash provided by (used in) operating activities ......... (11,355) 11,624 2,249 Cash flows from investing activities: Net increase in loans .......................................... (33,406) (14,119) (15,265) Purchase of investment securities available for sale ........... (13,587) (10,514) (1,498) Purchase of investment securities held to maturity ............. (8,496) (500) (75) Purchase of equity securities .................................. (782) (415) (5) Proceeds from maturities and principal repayments of investment securities available for sale .................... 11,998 1,500 1,500 Proceeds from maturities of mortgage-backed securities available for sale ............................................ 486 4,023 1,606 Proceeds from maturities and principal repayments of investment securities held to maturity ...................... 4,000 -- -- Proceeds from maturities of mortgage-backed securities held to maturity ............................................. 123 1,526 961 Proceeds from sale of branch premises .......................... -- 275 -- Proceeds from sale of other real estate owned .................. -- 100 -- Capital expenditures, net ...................................... (1,823) (894) (372) --------- --------- --------- Net cash used in investing activities ....................... (41,487) (19,018) (13,148) Cash flows from financing activities: Net increase in deposits ....................................... 28,005 15,954 16,512 Net increase (decrease) in other borrowings .................... 24 841 (106) Repayments of FHLBB Advances ................................... -- -- (2,788) Proceeds from sale of common stock at public offering, net ..... 23,808 -- -- Proceeds from issuance of common stock under option plan ....... 263 43 6 Repurchase of common stock ..................................... -- (22) (109) Dividends paid ................................................. (731) (658) (164) Principal payment on stockholder note receivable ............... -- 53 14 --------- --------- --------- Net cash provided by financing activities ................... 51,369 16,211 13,365 --------- --------- --------- Net increase (decrease) in cash and equivalents ............. (1,473) 8,817 2,466 Cash and cash equivalents at beginning of year ...................... 18,867 10,050 7,584 --------- --------- --------- Cash and cash equivalents at end of year ............................ $ 17,394 $ 18,867 $ 10,050 --------- --------- --------- Supplemental disclosures of cash flow information: Cash paid during the year for: Interest ....................................................... $ 6,248 $ 5,418 $ 4,869 Income taxes ................................................... $ 2,791 $ 2,664 $ 1,694 Non-cash items: Real estate acquired in settlement of loans .................... -- -- $ 580
- -------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements 21 First International Bancorp, Inc. and Subsidiary Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies: Basis of Presentation The consolidated financial statements include the accounts of First International Bancorp, Inc. (the Company) and its wholly-owned subsidiary, First National Bank of New England (the Bank). Intercompany accounts and transactions have been eliminated in consolidation. The Bank operates a full service branch at its headquarters in Hartford, Connecticut and representative offices, which are responsible for regional loan origination efforts, in Boston and Springfield, Massachusetts; Providence, Rhode Island; Rochester, New York; Morristown, New Jersey; Philadelphia and Pittsburgh, Pennsylvania; and Washington D.C. The Bank sold its last retail branch facility and certain deposits in 1996. The Company completed an underwritten public stock offering of 1,700,000 shares in September 1997 and issued an additional 255,000 shares in October when the underwriters exercised their option to purchase such shares. The offering resulted in net proceeds to the Company of $23.8 million. The Company's primary revenues are derived from net interest income and the origination and sale, on a servicing retained basis, of commercial loans. The Bank is a national leader in the use of loan guarantee programs offered by the U.S. Small Business Administration (SBA), the U.S. Department of Agriculture (USDA) and the Export-Import Bank of the United States (Ex-Im Bank). Continued availability of such loan guarantees are dependent upon timely and adequate federal budget appropriations. Each of these federal programs is funded through September 1998, but there can be no assurance of sufficient budgetary allocations to allow a continuation of such programs in substantially their current form. In preparing the consolidated financial statements, management makes estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and the results of operations for the period. Material estimates in these consolidated financial statements relate to the allowance and provision for possible loan losses, the valuation of other real estate owned and the estimated lives of loans sold where servicing has been retained. Market conditions are evaluated and independent appraisals of significant properties are obtained by management as needed in the process of setting the estimates. Notwithstanding this, such estimates are particularly sensitive to the economic environment and can be significantly affected by changing economic conditions affecting the value of the collateral, interest rates, borrowers' financial position and other factors. Accordingly, actual results could differ significantly from the estimates. Investment Securities Securities that may be sold as part of the Company's asset/liability or liquidity management, or in response to or in anticipation of changes in interest rates and resulting prepayment risk, or for other similar factors, are classified as available for sale and carried at fair market value. Unrealized holding gains and losses on such securities are reported net of related taxes as a separate component of stockholders' equity. Debt securities that the Company has the ability and positive intent to hold to maturity are classified as held to maturity and carried at amortized cost. Realized gains and losses on the sales of all investment securities are reported in earnings and computed using the specific identification cost basis. Declines in the market value of investment securities that are deemed to be other than temporary are charged to income. Loans Loans are stated at their principal amount outstanding. Interest income on loans is recognized on the simple interest method based upon the principal amount outstanding. In May 1995, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights," - an amendment of FASB Statement No. 65 (SFAS No. 122), which the Company adopted on January 1, 1996. SFAS No. 122 amends FASB Statement No. 65, "Accounting for Certain Mortgage Banking Activities," to provide that a mortgage banking enterprise recognize as separate assets rights to service mortgage loans for others, however those servicing rights are acquired. It also requires the Company to assess its capitalized mortgage servicing rights for impairment based on the fair value of those rights. The adoption of this statement did not have a material impact on the Company's financial condition or its results of operations. In June 1996, FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. These standards are based on consistent application of a financial-components approach that focuses on control. 22 Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS No. 125 also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. The adoption of this statement as of January 1, 1997 did not have a material impact on the Company's financial condition or its results of operations. This statement generally applies SFAS No. 122 concepts to a variety of assets sold and the resultant retained servicing. SFAS No. 125 also changed terminology used to describe the methods and assumptions used to calculate the servicing assets. The discussion below reflects the concepts and terminology included in SFAS No. 125. Receivable from loans sold and gain on commercial loan sales are primarily attributable to the sale of commercial loans which have been at least partially guaranteed by the SBA, the USDA and Ex-Im Bank. The Company is required to retain at least 5% of the unguaranteed portions of SBA and USDA loans. Transactions are generally settled within 30 days of the sale. The gains on the sale of a portion of a loan are based on the relative fair market values of the loan sold and the loan retained. A portion of the gain on commercial loan sales is due to a servicing asset which represents the present value of the differential between the servicing fee received by the Company and adequate compensation, defined as the sum of the Company's costs and a normal profit, after considering the estimated effects of prepayments. The discount rate utilized in calculating the servicing asset approximates the market rate an investor would demand on a risk-adjusted basis. The servicing asset is amortized as a charge to non-interest income over the estimated lives of the underlying loans on an effective interest method. The servicing asset is analyzed periodically for impairment based on the term of the serviced loan, the perceived alternatives for refinancing, the current interest rate environment and historical default and prepayment patterns and is carried at the lower of amortized cost or net realizable value. Unearned interest reflected as a reduction of loans in the consolidated balance sheet relates primarily to the discount recognized on the retained portion of the commercial loans sold. The discount is recorded in interest income over the estimated life of the retained loan on an effective interest method. Loans Held for Sale The Company classifies loans for which it does not have a positive intent to hold to maturity as loans held for sale and carries them at the lower of cost or market based on the aggregate value of the portfolio. Loan Origination Fees (Costs) Fees for loan originations and commitments, and related origination costs, are deferred and recognized as a yield adjustment utilizing the interest method over the contractual life of the related loan, adjusted for prepayment and sales. Provision/Allowance For Possible Loan Losses The Company evaluates the collectibility of impaired loans, as defined below, based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for collectibility of contractual principal and interest based on the estimated fair value of the collateral. Smaller-balance homogeneous loans consisting of residential mortgages and consumer loans are evaluated for collectibility by the Company based on historical loss experience rather than on an individual loan-by-loan basis. The Company evaluates all impaired loans, other than small balance loans, on an individual loan-by-loan basis; it does not aggregate impaired loans into major risk classifications. The Company considers a loan to be impaired when, based on current information and events, it is probable that it will be unable to collect all amounts of contractual interest and principal as scheduled in the loan agreement. An insignificant delay of under 60 days or a 10% shortfall in the amount of the payment is not an event that, when considered in isolation, would automatically cause the Company to consider a loan to be impaired. The Company places a loan on nonaccrual status when it is 90 days or more past due or when, in management's assessment, the full collectibility of principal and interest is uncertain. Except for certain restructured loans, impaired loans are loans that are on nonaccrual status. When an impaired loan or a portion of an impaired loan is deemed uncollectible, the portion deemed uncollectible is charged against the allowance for loan losses and subsequent recoveries, if any, are credited to the allowance. The Company recognizes interest income on impaired loans on a cash basis and reverses any accrued interest income at the date of determination. Management determines the adequacy of its allowance for possible loan losses primarily through periodic reviews of the loan portfolio, loan delinquencies, collateral on loans and past payment history adjusted for such factors as known changes in the character of the loan portfolio and current economic conditions. Consideration is also given to anticipated economic conditions, as well as other relevant factors in establishing the allowance. The allowance is increased by provisions for loan losses charged to income and decreased by charge offs, net of recoveries. Other Real Estate Owned Other real estate owned (OREO), representing property acquired by foreclosure or acceptance of a deed in lieu of foreclosure is carried at the lower of the unpaid loan balance at the date of acquisition or fair value less estimated disposal costs. Improvements are capitalized to the extent realizable. Holding and selling costs are expensed as incurred. 23 Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the period of the related lease. Costs of maintenance and repairs are expensed, while major improvements are capitalized. Income Taxes Income taxes are provided based on the asset/liability method of accounting. Deferred income taxes and tax benefits are recognized for the future income tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is established when it is more likely than not that some portion of the deferred tax asset will not be realized. Earnings Per Share Earnings per share for all periods presented have been calculated in accordance with SFAS No. 128, "Earnings Per Share" which requires the presentation of basic and diluted earnings per share. Basic earnings per share is determined based on the weighted average shares outstanding, while diluted earnings per share reflects the potential dilution that could occur if options to issue common stock were exercised. (See Note 7.) Stock Option Plans SFAS No. 123, "Accounting for Stock Based Compensation" (SFAS No. 123) issued in October 1995 gives companies the option of employing intrinsic value accounting under the guidelines of Accounting Principles Board (APB) No. 25 or fair value accounting for stock based compensation. While SFAS No. 123 does not require the adoption of fair value accounting, it does require certain disclosures in the financial statements as if fair value accounting had been adopted, including pro forma net income and earnings per share. The Company adopted this accounting standard effective January 1, 1996 for disclosure purposes only and will continue to apply APB 25 in accounting for stock based compensation. Common Stock Split On June 26, 1997, the Company's stockholders approved a 3.5-for-1 stock split to stockholders of record on July 14, 1997, effective August 7, 1997. Stockholders' equity has been restated to give retroactive recognition to the stock split in prior periods by reclassifying from paid-in capital in excess of par value to common stock an amount equal to the par value of the additional shares arising from the split. In addition, all references to the number of shares, per share amounts and stock option data have been restated. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are sold for one day periods or terms of less than 30 days. The Company is required to maintain certain levels of cash reserves at the Federal Reserve Bank of Boston based on its deposit accounts. Such required reserves totaled $1,700,000 at December 31, 1997. Reclassifications Certain amounts from 1996 and 1995 have been reclassified to conform to the 1997 presentation. Recent Accounting Pronouncements SFAS No. 130 In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income" which established standards for reporting and display of comprehensive income, defined as the change in equity of a business enterprise during a period from nonowner sources. SFAS No. 130 is effective for years beginning after December 15, 1997 and requires reclassification of financial statements for all years presented. The adoption of SFAS No. 130 will require the Company to expand the financial statements to present the impact of any change in the valuation allowance for the available for sale investment portfolio and the tax benefit associated with the Company's stock option plans or other components of comprehensive income. SFAS No. 131 In June 1997, the FASB also issued SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires public companies to report financial and descriptive information about operating segments in annual financial statements and requires selected information about operating segments to be reported in interim financial reports issued to shareholders. Operating segment financial information is required to be reported on the basis that it is used internally for evaluating segment performance and allocation of resources. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997 and requires presentation of comparative information for prior periods presented. The Company is currently reviewing this pronouncement, and the adoption of SFAS No. 131 is expected to impact the way the Company reports information about its operations. Specific determination has not yet been made as to how this statement will be implemented. 24 ================================================================================ 2. Investment Securities: Securities classified as available for sale (carried at fair value) and as held to maturity (carried at amortized cost) as of December 31, 1997 and 1996 are as follows:
- --------------------------------------------------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value - --------------------------------------------------------------------------------------------------------------- (dollars in thousands) December 31, 1997 Available for Sale U.S. Treasury obligations .................. $ 12,013 $ 15 $ (3) $ 12,025 U.S. Government mortgage-backed securities.. 648 9 -- 657 Mutual funds ............................... 85 -- -- 85 -------- -------- -------- -------- $ 12,746 $ 24 $ (3) $ 12,767 ======== ======== ======== ======== Held to Maturity U.S. Government mortgage-backed securities.. $ 2,285 $ 4 $ (10) $ 2,279 Debt securities of foreign governments ..... 1,150 -- -- 1,150 Variable rate preferred stock .............. 4,000 -- -- 4,000 -------- -------- -------- -------- $ 7,435 $ 4 $ (10) $ 7,429 ======== ======== ======== ======== December 31, 1996 Available for sale U.S. Treasury obligations .................. $ 10,516 $ 2 $ (63) $ 10,455 U.S. Government mortgage-backed securities.. 1,134 8 (73) 1,069 -------- -------- -------- -------- $ 11,650 $ 10 $ (136) $ 11,524 ======== ======== ======== ======== Held to maturity U.S. Government mortgage-backed securities.. $ 1,913 $ 14 $ (21) $ 1,906 Debt securities of foreign governments ..... 1,150 -- -- 1,150 -------- -------- -------- -------- $ 3,063 $ 14 $ (21) $ 3,056 ======== ======== ========= ========
Stock securities are carried at cost and are comprised of the following: - -------------------------------------------------------------------------------- December 31, - -------------------------------------------------------------------------------- 1997 1996 -------------------------------- (dollars in thousands) Federal Reserve Bank ......................... $224 $224 Federal Home Loan Bank of Boston (FHLBB)...... 1,246 648 Private Export Funding Corporation ........... 599 415 ------ ------ $2,069 $1,287 ====== ====== The Company is required to hold common stock investments in the Federal Reserve Bank based on First National Bank of New England's capital and in the FHLBB based on borrowings from the FHLBB (Note 6). At December 31, 1997 investments with a carrying value of $14,422,000 were pledged to collateralize public and government deposits, as required by law, and certain of the Bank's lines of credit. There were no sales of debt securities in the three year period ended December 31, 1997. 25 The contractual maturities of debt securities at December 31, 1997 and 1996 are as follows: - -------------------------------------------------------------------------------- Weighted Amortized Fair Average Cost Value Yield - -------------------------------------------------------------------------------- (dollars in thousands) December 31, 1997 Available for sale Due in one year or less ....... $ 5,588 $ 5,588 5.65% Due after one year through five years ....... 6,510 6,522 5.82% Mortgage-backed securities..... 648 657 6.22% ------- ------- ------- $12,746 $12,767 5.77% ======= ======= ======= Held to maturity Due after one year through five years ....... $ 4,545 $ 4,545 4.43% Due after five years through ten years ........ 1,100 1,100 7.88% Mortgage-backed securities 1,790 1,784 6.09% ------- ------- ------- $ 7,435 $ 7,429 5.34% ======= ======= ======= December 31, 1996 Available for sale Due in one year or less ....... $ 998 $ 1,001 5.93% Due after one year through five years ....... 9,518 9,454 5.70% Mortgage-backed securities..... 1,134 1,069 6.32% ------- ------- ------- $11,650 $11,524 5.78% ======= ======= ======= Held to maturity Due after one year through five years ....... $ 350 $ 350 7.88% Due after five years through ten years ........ 800 800 7.59% Mortgage-backed securities..... 1,913 1,906 5.35% ------- ------- ------- $ 3,063 $ 3,056 6.22% ======= ======= ======= ================================================================================ 3. Loans: The outstanding balances of loans originated and held by the Company are as follows: - -------------------------------------------------------------------------------- December 31, 1997 1996 - -------------------------------------------------------------------------------- (dollars in thousands) Commercial and industrial ............... $ 71,836 $ 61,435 Commercial real estate .................. 55,192 39,095 Residential real estate ................. 6,515 12,843 Consumer loans and lines of credit ...... 1,855 1,254 --------- --------- Total loans ..................... 135,398 114,627 ========= ========= Less: Allowance for possible loan losses 3,100 3,000 Discount on retained loans ........ 1,782 2,241 Net deferred loan origination costs (109) (67) --------- --------- Loans, net ...................... $ 130,625 $ 109,453 ========= ========= At December 31, 1997, the Company had fixed and variable rate loans with maturities greater than one year totaling $11,486,000 and $89,759,000 respectively. The scheduled maturities of the Company loan portfolio as of December 31, 1997 are as follows: - -------------------------------------------------------------------------------- After one Within One Year Through After Five Year Five Years Years Total - -------------------------------------------------------------------------------- Commercial and industrial ............ $ 32,331 $ 7,324 $ 32,181 $ 71,836 Commercial real estate 1,280 4,063 49,849 55,192 Residential loans ........ 2,806 1,975 1,734 6,515 Consumer loans and lines of credit ....... 1,403 401 51 1,855 -------- -------- -------- -------- $ 37,820 $ 13,763 $ 83,815 $135,398 ======== ======== ======== ======== ================================================================================ The outstanding balances of loans originated by the Company and sold to others on a servicing retained basis are as follows: - -------------------------------------------------------------------------------- December 31, 1997 1996 - -------------------------------------------------------------------------------- (dollars in thousands) Guaranteed Loans: SBA ........................... $195,454 $145,620 USDA .......................... 45,806 26,901 Ex-Im Bank .................... 82,794 26,670 FHLMC ......................... 17,305 17,731 -------- -------- 341,359 216,922 ======== ======== Unguaranteed Portions and Unguaranteed Loans: SBA ........................... 51,673 28,814 USDA .......................... 5,326 3,191 Other commercial .............. 27,235 12,896 Home equity lines ............. 3,484 3,982 -------- -------- 87,718 48,883 ======== ======== Total loans serviced for others $429,077 $265,805 ======== ======== The following amounts are included in Loans, net: - -------------------------------------------------------------------------------- December 31, Discount on Retained Loans 1997 1996 1995 - -------------------------------------------------------------------------------- (dollars in thousands) Balance at beginning of period ....... $ 2,241 $ 2,312 $ 1,792 Discount on current period sales .. 2,131 1,510 852 Deletions due to sales ............ (1,620) (1,113) -- Accretion ......................... (970) (468) (332) -------- -------- -------- Balance at end of period ....... $ 1,782 $ 2,241 $ 2,312 ======== ======== ======== 26 The following amounts are included in Prepaid expenses and other assets: - -------------------------------------------------------------------------------- December 31, Servicing Assets 1997 1996 1995 - -------------------------------------------------------------------------------- (dollars in thousands) Balance at beginning of period ......... $ 4,138 $ 2,809 $ 2,084 Net servicing on current period sales .. 3,172 1,979 1,127 Amortization ........................... (1,631) (650) (402) -------- -------- -------- Balance at end of period .......... $ 5,679 $ 4,138 $ 2,809 ======== ======== ======== Changes in the Allowance for possible loan losses were as follows: - -------------------------------------------------------------------------------- December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- (dollars in thousands) Balance at beginning of period ........... $ 3,000 $ 2,000 $ 2,000 Provision charged to income .............. 2,239 3,487 1,237 Recoveries on loans previously charged off ..................................... 106 40 85 Loans charged off ........................ (2,245) (2,527) (1,322) -------- -------- -------- Balance at end of period ......... $ 3,100 $ 3,000 $ 2,000 ======== ======== ======== Certain information with regard to impaired loans is detailed below: - -------------------------------------------------------------------------------- December 31, 1997 1996 - -------------------------------------------------------------------------------- (dollars in thousands) Impaired loans ............... $2,215 $2,173 Allocated allowance .......... 644 543 Average recorded investment .. 2,194 1,670 Interest income recognized ... 131 125 The carrying value of the impaired loans has been calculated based on the estimated fair value of the underlying collateral. Nonaccrual loans totaled $2,364,000 and $2,252,000 at December 31, 1997 and 1996, respectively. The gross interest income that would have been recorded if the non-accrual loans had been current in accordance with their original terms would have been $231,000 for the period ended December 31, 1997. The actual amount of interest income recognized on those loans was $134,000 for the period ended December 31, 1997. There were no loans over 90 days and still accruing interest at each period end presented. Loans to principal stockholders, directors, companies of which directors are principal owners, individuals directly related to or affiliated with directors, and executive officers aggregated $602,000 and $2,570,000 at December 31, 1997 and 1996, respectively. During 1997, repayments and sales amounted to $1,978,000 while advances under new or existing loans totaled $10,000. In the normal course of business, the Bank enters into agreements to extend credit which are not reflected in the accompanying consolidated financial statements. Outstanding credit commitments are detailed below: - -------------------------------------------------------------------------------- December 31, 1997 1996 - -------------------------------------------------------------------------------- (dollars in thousands) Commercial lines of credit ....... $47,987 $38,922 Consumer lines of credit ......... 530 229 Performance letters of credit .... 18,975 8,204 Financial letters of credit ...... 1,415 1,392 Commercial letters of credit ..... 1,542 -- ------- ------- Total credit commitments .... $70,449 $48,747 ======= ======= At December 31, 1997 and December 31, 1996, letters of credit totaling $17,548,000 and $8,161,000, respectively, carry the guarantee of Ex-Im Bank. Commitments to extend such credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since some of the agreements may expire without being drawn upon or may be terminated by the Bank, these amounts do not necessarily represent a future cash requirement of the Bank. Prior to entering into any agreement to extend credit, the Bank evaluates the client's creditworthiness in accordance with loan underwriting standards as approved by the Board of Directors. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the client. Collateral for commercial loan commitments varies but may include accounts receivable, inventory, property, plant and equipment and commercial real estate. Although the Bank's maximum exposure to credit loss is the total contract amount of the commitments and letters of credit noted above, management does not anticipate any material losses as a result of these agreements and does not consider them to represent an undue level of credit, interest or liquidity risk for the Bank. The Bank specializes in lending to small privately owned commercial enterprises and professional firms throughout southern New England and the Mid-atlantic U.S., although the majority of the loans outstanding are made to borrowers located in Connecticut. Such loans and loan commitments are generally collateralized by real estate or other assets. The Bank also lends to companies in various international emerging markets. Such U. S. dollar loans are fully guaranteed by Ex-Im Bank and are generally sold at origination to various investors on a non-recourse, servicing retained basis. Gains from the sale of such international loans totaled $2,299,000 for the year ended December 31, 1997. The majority of these international loans were made to borrowers in Brazil. Gains from the sale of Brazilian loans totalled $1,326,000 for 1997 and loan servicing income related to Ex-Im guaranteed loans to Brazilian companies totaled approximately $95,000 while servicing income from all other foreign loans was $169,000. No other individual country accounts for a significant amount of foreign revenue. 27 ================================================================================ 4. Premises, Equipment and Leases: - ------------------------------------------------------------------------------- December 31, 1997 1996 - ------------------------------------------------------------------------------- (dollars in thousands) Buildings and leasehold improvements.............. $1,590 $1,001 Furniture, fixtures, and equipment................ 3,408 2,174 ------ ------ 4,998 3,175 Less: Accumulated depreciation and amortization... 2,304 1,660 ------ ------ Premises and equipment, net.................. $2,694 $1,515 ====== ====== The Company leases its corporate offices in Hartford, Connecticut and other facilities for its representative offices in the Northeast and Mid-atlantic United States. Each of the leases provide for minimum and contingent rentals and include renewal options. Total rental expense for the years ended December 31, 1997, 1996 and 1995 was $833,000, $636,000 and $456,000, respectively. Minimum future obligations for premises under noncancelable leases are as follows: - -------------------------------------------------------------------------------- Year End Operating Leases - -------------------------------------------------------------------------------- (dollars in thousands) 1998 $1,137 1999 1,117 2000 1,077 2001 992 2002 955 Thereafter 8 ------ $5,286 ====== ================================================================================ 5. Deposits:
- --------------------------------------------------------------------------------------------------- December 31, 1997 1996 ------------------------ ---------------------------- Weighted Weighted Average Average Amount Rate Amount Rate --------------------------------------------------------- (dollars in thousands) Transaction Accounts: Non-interest bearing checking... $ 38,236 - % $ 27,888 - % Interest bearing checking ...... 7,867 2.51 8,248 2.52 -------- ------ -------- ------ Total checking accounts...... 46,103 0.43 36,136 0.58 Savings accounts .................... 92,003 5.25 69,278 5.09 Time deposits under $100,000 ........ 26,542 5.88 37,085 5.57 Time deposits $100,000 or more ...... 7,673 5.26 1,817 5.06 -------- ------ -------- ------ Total deposits .............. $172,321 4.06% $144,316 4.08% ======== ====== ======== ======
- -------------------------------------------------------------------------------- December 31, Time Deposit Maturities 1997 1996 - -------------------------------------------------------------------------------- (dollars in thousands) Time deposits maturing within: 1 year .................................. $31,593 $35,712 2 years ................................. 1,984 2,350 3 years ................................. 245 290 4 years ................................. 219 259 5 years ................................. 174 206 More than 5 years ....................... -- 85 ------- ------- Total time deposits $34,215 $38,902 ======= ======= - -------------------------------------------------------------------------------- Maturity Period of Time December 31, Deposits Over $100,000 1997 - -------------------------------------------------------------------------------- (dollars in thousands) Three months or less .................... $3,009 Over three through six months ........... 940 Over six through twelve months .......... 3,009 Over one year ........................... 715 ------ Total time deposits over $100,000........ $7,673 ====== 28 ================================================================================ 6. Borrowings: Federal Home Loan Bank of Boston Advances: The Bank has a $2,870,000 unused line of credit from the Federal Home Loan Bank of Boston (FHLBB) and currently has the ability to borrow approximately $3,800,000 from the FHLBB under various term advance programs. Any outstanding advances from the FHLBB are collateralized mortgage loans on residential properties and certain U.S. Treasury and Agency-issued securities. Other Borrowings: The Bank also maintains lines of credit at various correspondent banks which are primarily used for the issuance of letters of credit. At December 31, 1997, these lines aggregated $42,500,000 of which $20,000,000 is required to be collateralized upon usage. Letters of credit totaling $19,414,000 were outstanding for the Bank's clients at December 31, 1997 under such lines. ================================================================================ 7. Stockholders' Equity: Stockholder Note Receivable: In June 1994 the Board of Directors approved the issuance of 614,600 shares (as adjusted for the common stock split) of the Company's common stock to the Company's President at a price of $1.69 per share. The terms of the transaction provided for a cash down payment of $17,560 and a promissory note in the amount of $1,020,000 for the balance. The note is collateralized by the stock issued. Principal is due at maturity on December 31, 2000. Interest was to accrue at the rate of 7% and was due at maturity; however, upon completion of the public offering, the accrued interest was forgiven and it was converted to a non-interest bearing note (See Note 1). The note was then discounted to yield a market rate of interest. The President is legally entitled to any cash dividends declared, although the promissory note provided that 75% of such cash dividends must be retained by the Company and applied to the note as a repayment of principal. This repayment provision was eliminated effective January 1, 1997. Although the stock is legally outstanding, since a note was accepted in exchange for a portion of the issue price, the note receivable is presented as a separate component of stockholders' equity, and only as repayments of principal are received does this sale of stock serve to increase stockholders' equity. Because these shares are legally outstanding, they are included in the earnings per share calculations as of the date of issuance. Repurchase and Retirement of Common Stock: The Board of Directors authorized the repurchase and retirement of 8,000 and 62,000 shares of the Company's common stock for average purchase prices of $2.78 and $1.75 per share in 1996, and 1995, respectively. Earnings Per Share Calculation: The table detailed below reconciles the number of shares used in the basic earnings per share ("EPS") calculation to the number of shares used with diluted EPS calculation in accordance with SFAS No. 128 (See Note 1). There were no changes to net income available to common stockholders between the basic and diluted EPS calculations. - -------------------------------------------------------------------------------- December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- (shares in thousands) Common shares outstanding for basic EPS ..... 6,330 5,763 5,753 Dilutive securities from stock option plans 237 72 15 ------ ------ ------ Common shares outstanding for diluted EPS ... 6,567 5,835 5,768 ====== ====== ====== Options to purchase 222,560 shares of common stock at $8.50 and options to purchase 15,000 shares of common stock at $13.50 per share were outstanding at the end of 1997, but were not included in the computation of diluted EPS because the options' exercise price exceeded the average market price of the common shares. Preferred Stock: The Company has established a class of 2,000,000 shares of preferred stock. The Board of Directors was granted the power to establish and designate the different series and voting powers, designations, preferences and other rights, qualifications, limitations or restrictions to be placed upon any shares of preferred stock to be issued by the Company. Dividends: Dividends payable by First International Bancorp, Inc. are generally unrestricted (see below), although the ability of the Company to pay dividends may from time to time be dependent upon the dividends paid to it by the Bank. A national bank must obtain the approval of the Office of the Comptroller of the Currency (OCC) if the total of all dividends declared in any calendar year exceeds the bank's net profits, as defined, for that year combined with its retained net profits for the preceding two calendar years. Regulatory Capital Requirements: Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets (as defined in the regulations). 29 Management believes, as of December 31, 1997 and 1996, that the Bank meets all capital adequacy requirements to which it is subject and that, under the current regulations, the Bank will continue to meet its minimum capital requirements in the foreseeable future. As of December 31, 1997 and 1996, the most recent notifications from the Office of the Comptroller of the Currency categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total, Tier I risk-based and Tier I leverage ratios as set forth in the table below. There are no conditions or events since the notification that management believes have changed the Bank's category.
- -------------------------------------------------------------------------------------------------------------------------- Amounts Amounts To be Well Capitalized For Capital Under Prompt Corrective Actual Amounts Adequacy Purposes Action Provisions Capital Ratio Capital Ratio Amount Ratio - -------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) As of December 31, 1997: Total Capital/Risk Weighted Assets...... $31,415 17.57% $14,348 8.00% $17,935 10.00% Tier I Capital/Risk Weighted Assets..... 29,170 16.32% 7,174 4.00% 10,761 6.00% Tier I Capital/Average Assets .......... 29,170 14.74% 8,258 4.00% 10,322 5.00% As of December 31, 1996: Total Capital/Risk Weighted Assets...... $14,253 11.62% $ 9,811 8.00% $12,264 10.00% Tier I Capital/Risk Weighted Assets..... 12,702 10.36% 4,906 4.00% 7,358 6.00% Tier I Capital/Average Assets .......... 12,702 8.44% 6,017 4.00% 7,522 5.00%
================================================================================ 8. Stock Option Plans: The Company's 1994 Incentive Stock Option plan allows for the award of options to officers which vest immediately. As of December 31, 1997, all reserved shares were subject to option agreements. The Company adopted an Amended and Restated 1996 Stock Option Plan which reserved 701,106 shares of common stock for the issuance of options that may be granted to officers and directors. These options would generally vest ratably over a four year period beginning one year after the grant date. Both plans provide that the options may be granted to purchase common stock at a price not less than the fair market price of the Company's stock at the date for the granting of such options, and unless otherwise provided, the options have a ten year term. The plans also provide that options granted and the related option price are adjusted to reflect changes in the shares outstanding due to stock splits and dividends, or other adjustments. The following tables detail the activity of the 1994 Incentive Stock Option Plan and 1996 Stock Option Plan: - -------------------------------------------------------------------------------- Average Option Option 1994 Incentive Stock Option Plan Shares Price - -------------------------------------------------------------------------------- Outstanding at January 1, 1995 .... 178,500 $ 1.689 Granted ...................... 131,250 1.840 Exercised .................... (3,500) 1.764 Canceled ..................... (1,750) 1.840 ------- ------- Outstanding at December 31, 1995 304,500 1.752 Granted ...................... 83,653 2.191 Exercised .................... (21,000) 2.045 Canceled ..................... (37,538) 1.866 -------- ------- Outstanding at December 31, 1996 329,615 1.832 Exercised .................... (144,325) 1.765 Canceled ..................... (5,513) 2.191 -------- ------- Outstanding at December 31, 1997... 179,777 $ 1.875 ======== ======= 30 - -------------------------------------------------------------------------------- Average Option Option 1996 Stock Option Plan Shares Price - -------------------------------------------------------------------------------- Outstanding at January 1, 1996 ............ -- $ -- Granted .............................. 46,663 2.191 Canceled ............................. (1,568) 2.191 ------- ------- Outstanding at December 31, 1996........... 45,095 2.191 Granted .............................. 453,025 5.356 Exercised............................. (1,025) 2.191 Canceled ............................. (44,240) 2.642 ------- ------- Outstanding at December 31, 1997........... 452,855 $5.313 ======= ======= In July 1997, the Company's Board of Directors approved the grant of options to purchase 5,000 shares of common stock to each non-employee director in recognition of their prior service at the price of $8.50 per share. A total of 40,000 options, which vest 180 days from the date of grant were awarded at that date. Such options have a remaining contractual life of 9.56 years at December 31, 1997. Certain information with regard to options outstanding at December 31, 1997 is detailed below:
- ----------------------------------------------------------------------------------------------------------------------------- Weighted- Number of Average Weighted- Options Remaining Average Number Range of Outstanding at Contractual Life Exercise Exercisable at Exercise Price December 31, 1997 (years) Price December 31, 1997 - ----------------------------------------------------------------------------------------------------------------------------- 1994 Incentive Stock Option Plan: $1.689 to 2.191 179,777 7.17 $1.875 179,777 1996 Stock Option Plan: $2.191 to 2.631 255,665 9.03 $2.560 10,051 $8.50 182,190 9.56 $8.500 -- $13.50 15,000 9.89 $13.500 -- ----------- ---------- ----------- 632,632 $4.336 189,828 =========== ========== ===========
The weighted average grant date fair value of the options awarded in 1997 was $1.485. There is no compensation expense for any options granted prior to July 15, 1997, the date of the Company's initial filing with the Securities and Exchange Commission indicating its intent to complete a public stock offering (Note 1), based on the minimum value methodology of SFAS No. 123, assuming a four year expected life and annual dividends ranging from 6.2% to 7.7% of the exercise prices. In estimating the compensation which would be attributable to each option grant since July 15, 1997 under SFAS No. 123, the Company has used the Black Scholes option pricing model with the following weighted average assumptions: dividend yield of 1.4%; expected volatility of 30%; risk free interest rate of 6.14%, and; an expected life of 5 years. Had compensation been determined in accordance with SFAS No. 123, the Company's net income, basic earnings per share and diluted earnings per share would have been $4,336,000, $.69 and $.66, respectively, as compared to the actual amounts of $4,429,000, $.70 and $.67, respectively. 31 ================================================================================ 9. Income Taxes: The components of the income tax provision (benefit) for the years ended December 31 are as follows:
- ---------------------------------------------------------------------------------------------------- 1997 1996 1995 - ---------------------------------------------------------------------------------------------------- (dollars in thousands) Current Provision: Federal ..................................... $ 2,047 $ 1,883 $ 1,155 State ....................................... 727 719 392 ------- ------- ------- 2,774 2,602 1,547 ------- ------- ------- Deferred Provision (Benefit): Federal ..................................... 87 (184) (60) State ....................................... 34 (65) 36 Benefit from state net operating loss carryforward ............................... -- -- (29) ------- ------- ------- 121 (249) (53) ------- ------- ------- Total provision for income taxes ......... $ 2,895 $ 2,353 $ 1,494 ======= ======= =======
The effective tax rates differ from the federal statutory rate due to state taxes, net of the federal benefit and a dividend received deduction. The components of the net deferred tax asset and liability at December 31 are as follows:
- -------------------------------------------------------------------------------------------------- 1997 1996 Federal State Federal State - -------------------------------------------------------------------------------------------------- (dollars in thousands) Deferred tax assets: Allowance for possible loan losses $123 $ 38 $152 $ 53 Investments mark-to-market ....... -- -- 38 13 Other ............................ 74 23 93 32 ------- ------- ------- ------- Total deferred tax assets ..... 197 61 283 98 ------- ------- ------- ------- Deferred tax liabilities: Investments mark-to-market ....... 7 2 -- -- Depreciation ..................... 88 27 56 19 Deferred loan costs .............. 32 10 20 7 Other ............................ 2 1 6 1 ------- ------- ------- ------- Total deferred tax liabilities 129 40 82 27 ------- ------- ------- ------- Net deferred tax assets ....... $ 68 $ 21 $201 $ 71 ------- ------- ------- -------
The allocation of the deferred tax provision (benefit) involving items charged to current year income and items charged directly to stockholders' equity for the year ended December 31, are as follows:
- ----------------------------------------------------------------------------------------------------------------------------- 1997 1996 Federal State Federal State - ----------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Deferred tax provision (benefit) allocated to shareholders' equity $ 46 $ 16 $ (27) $ (10) Deferred tax provision (benefit) allocated to income ............. 87 34 (184) (65) -------- -------- -------- -------- Total deferred tax provision (benefit) ...................... $ 133 $ 50 $(211) $ (75) ======== ======== ======== ========
32 ================================================================================ 10. Employee Benefit Plan: The Company maintains a contributory savings plan which qualifies under Section 401(k) of the Internal Revenue Code for employees meeting certain service requirements. Eligible employees may make contributions to the Plan based on specified percentages of their compensation. Beginning January 1, 1996, the Company matched 75% of employees' contribution up to 6% of compensation. The matching contribution was 50% in prior years. The Company's matching contributions were $139,000, $96,000 and $56,000 for the years ended December 31, 1997, 1996 and 1995, respectively. ================================================================================ 11. Estimated Fair Values of Financial Instruments: Statement of Financial Accounting Standards No. 107 "Disclosures About Fair Value of Financial Instruments" (SFAS No. 107) requires the Company to disclose fair value information for certain of its financial instruments, including loans, securities, deposits, borrowings and other such instruments. Quoted market prices are not available for a significant portion of the Company's financial instruments and, as a result, the fair values presented may not be indicative of net realizable or liquidation values. Fair values are estimates derived using present value or other valuation techniques and are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics and other factors. In addition, fair value estimates are based on market conditions and information about the financial instrument at a specific point in time. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Such items include loan servicing, core deposit intangibles and other customer relationships, premises and equipment, foreclosed real estate and income taxes. In addition, the tax ramifications relating to the realization of the unrealized gains and losses may have a significant effect on fair value estimates, and have not been considered in the estimates. The following is a summary of the methodologies and assumptions used to estimate the fair value of the Company's financial instruments pursuant to SFAS No. 107: Cash, cash equivalents and other: The fair value of cash and due from banks, federal funds sold, accrued interest receivable and accrued interest payable, is considered to approximate the book value due to their short-term nature and negligible credit losses. Securities: Securities classified as available for sale are carried at fair value. Fair value for securities available for sale and held to maturity was determined by secondary market and independent broker quotations. Loans: The fair values for loans are estimated using discounted cash flow analyses, and interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loans held for sale: The fair values for loans held for sale are based on estimated sales prices derived from the current market conditions. Deposits: The fair value for demand and savings deposits is equal to the amount payable on demand at the balance sheet date which is equal to the carrying value. The fair value of certificates of deposit was estimated by discounting cash flows using rates currently offered by the Bank for deposits of similar remaining maturities. The fair value information of the Company's financial instruments required to be valued by SFAS No. 107 are as follows:
========================================================================================================= December 31, 1997 December 31, 1996 - --------------------------------------------------------------------------------------------------------- Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value ------------------------------------------------------------ (dollars in thousands) Financial Assets Cash and due from banks ................. $ 10,944 $ 10,944 $ 5,867 $ 5,867 Federal funds sold ...................... 6,450 6,450 13,000 13,000 Securities available for sale............ 12,767 12,767 11,524 11,524 Securities held to maturity ............. 7,435 7,429 3,063 3,056 Loans ................................... 130,625 130,567 109,453 108,910 Loans held for sale ..................... 9,070 9,207 -- -- Accrued interest receivable ............. 1,200 1,200 823 823 Financial Liabilities Deposits Checking ........................... $ 46,103 $ 46,103 $ 36,136 $ 36,136 Savings ............................ 92,003 92,003 69,278 69,278 Time deposits ...................... 34,215 34,402 38,902 39,079 U.S. Treasury demand note ............... 1,085 1,085 1,061 1,061 Accrued interest payable ................ 745 745 622 622
33 ================================================================================ 12. Parent Company Financial Information: First International Bancorp, Inc. is the parent company of First National Bank of New England. There have been no loans extended from the Bank to First International Bancorp, Inc. since inception of the holding company.
Condensed Balance Sheets - ------------------------------------------------------------------------------------------------------ December 31, 1997 1996 - ------------------------------------------------------------------------------------------------------ (dollars in thousands) Assets Cash on deposit with Bank subsidiary .................................... $ 7,334 $ 21 Investment securities: Available for sale, at fair value .................................. 85 -- Held to maturity, at amortized cost (fair value $4,000) ............ 4,000 -- Investment in the Bank .................................................. 30,622 14,195 Other assets ............................................................ 107 -- ------- ------- Total assets ....................................................... $42,148 $14,216 ======= ======= Liabilities and Stockholders' Equity Stockholders' equity .................................................... $42,148 $14,216 ------- ------- Total liabilities and stockholders' equity ......................... $42,148 $14,216 ======= =======
Condensed Statements of Operations - --------------------------------------------------------------------------------------------------------- For the Years Ended December 31, 1997 1996 1995 - --------------------------------------------------------------------------------------------------------- (dollars in thousands) Dividends from Bank subsidiary ............................. $ 731 $ 415 $ 430 Net interest income from investments ....................... 102 -- -- Equity in undistributed net income of the Bank ............. 3,796 2,829 1,596 Non-interest expenses, net ................................. (284) -- -- ------- ------- ------- Income before income taxes ............................ 4,345 3,244 2,026 Benefit for income taxes ........................... (84) -- -- ------- ------- ------- Net income ............................................ $ 4,429 $ 3,244 $ 2,026 ======= ======= =======
Condensed Statements of Cash Flows - ------------------------------------------------------------------------------------------------------------------------------------ For the Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Net income ..................................................................... $ 4,429 $ 3,244 $ 2,026 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiary .......................... (3,796) (2,829) (1,596) Increase in other assets .................................................. (107) -- -- Stockholder note receivable discount ...................................... 92 -- -- Stockholder note receivable accretion ..................................... (15) -- -- -------- -------- -------- Net cash provided by operations ........................................ 603 415 430 -------- -------- -------- Cash flows from investing activities: Purchase of investment securities available for sale, net ................. (4,085) -- -- Additional investment in Bank subsidiary .................................. (12,545) -- -- -------- -------- -------- Net cash used in investing activities .................................. (16,630) -- -- ======== ======== ======== Cash flows from financing activities: Proceeds from sale of common stock under option plan ...................... 263 43 6 Proceeds from sale of common stock at public offering, net ................ 23,808 -- -- Repurchase of common stock ................................................ -- (22) (109) Dividends paid ............................................................ (731) (658) (164) Principal payment on stockholder note receivable .......................... -- 53 14 -------- -------- -------- Net cash provided by (used in) financing activities .................... 23,340 (584) (253) -------- -------- -------- Net increase (decrease) in cash and cash equivalents ................... 7,313 (169) 177 Cash and cash equivalents beginning of year .................................... 21 190 13 -------- -------- -------- Cash and cash equivalents end of year .......................................... $ 7,334 $ 21 $ 190 ======== ======== ========
34 ================================================================================ 13. Selected Quarterly Consolidated Financial Information (unaudited)
- -------------------------------------------------------------------------------------------------------------------------------- 1997 Quarter Ended March 31 June 30 September 30 December 31 - -------------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Net interest income ................................................... $1,799 $1,812 $2,119 $2,523 Provision for possible loan losses .................................... 368 591 157 1,123 ------ ------ ------ ------ Net interest income after provision for possible loan losses...... 1,431 1,221 1,962 1,400 Gain on sale of loans ................................................. 2,222 3,256 1,739 4,593 Other non-interest income ............................................. 618 707 1,064 912 ------ ------ ------ ------ Total operating income ........................................... 4,271 5,184 4,765 6,905 Non-interest expense ............................................. 2,496 3,414 3,472 4,419 ------ ------ ------ ------ Income before income taxes ....................................... 1,775 1,770 1,293 2,486 Provision for income taxes ............................................ 763 729 542 861 ------ ------ ------ ------ Net income ....................................................... $1,012 $1,041 $ 751 $1,625 ====== ====== ====== ====== Basic earnings per share .............................................. $ 0.17 $ 0.18 $ 0.13 $ 0.22 ====== ====== ====== ====== Diluted earnings per share ............................................ $ 0.17 $ 0.18 $ 0.12 $ 0.20 ====== ====== ====== ======
- ---------------------------------------------------------------------------------------------------------------------------------- 1996 Quarter Ended March 31 June 30 September 30 December 31 - ---------------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Net interest income ................................................... $1,840 $1,888 $1,969 $1,868 Provision for possible loan losses .................................... 349 205 1,511 1,423 ------ ------ ------ ------ Net interest income after provision for possible loan losses...... 1,491 1,683 458 445 Gain on sale of loans ................................................. 1,261 1,435 1,625 1,524 Other non-interest income ............................................. 392 442 2,372 894 ------ ------ ------ ------ Total operating income ........................................... 3,144 3,560 4,455 2,863 Non-interest expense .................................................. 1,809 2,091 2,158 2,368 ------ ------ ------ ------ Income before income taxes ....................................... 1,335 1,469 2,297 495 Provision for income taxes ............................................ 561 618 965 208 ------ ------ ------ ------ Net income ....................................................... $ 774 $ 851 $1,332 $ 287 ====== ====== ====== ====== Basic earnings per share .............................................. $ 0.13 $ 0.15 $ 0.23 $ 0.05 ====== ====== ====== ====== Diluted earnings per share ............................................ $ 0.13 $ 0.15 $ 0.23 $ 0.05 ====== ====== ====== ======
35 Directors and Officers - ----------------------------------- First National Bank of New England Board of Directors William J. Anderson * Michael R. Carter Carter Morse & Company Brian Charlebois Executive Vice President Chief Operating Officer * Arnold Chase Chase Enterprises * Cheryl Chase Chase Enterprises Craig M. Cooper Fairbank Mortgage Company Leslie A. Galbraith Executive Vice President Chief Financial Officer * Frank P. Longobardi, CPA Haggett, Longobardi & Company David G. Sandberg The Cornerstone Companies * Brett N. Silvers Chairman and President Kenneth R. Sonenclar Classics Interactive, Inc. * Bernard Waldman Windsor Investors Corp. * Member of First International Bancorp, Inc. Board of Directors - ------------------------------------------- First International Bancorp, Inc. Officers Brett N. Silvers Chairman and President Leslie A. Galbraith Executive Vice President Secretary and Treasurer - ----------------------------------- First National Bank of New England Officers Chairman and President Brett N. Silvers Executive Vice Presidents Brian J. Charlebois Chief Operating Officer David J. Etter Chief Credit Officer Leslie A. Galbraith Chief Financial Officer Richard W. Bradshaw Division Executive Paul J. Falvey Division Executive James G. Fortsch Division Executive Senior Vice Presidents Alex Adashev David M. Baroody Cynthia D. Bradley David B. Cook Tyler T. Foster Ira J. Gottlieb Stephen M. Greene Thomas G. Hollinger Theodore J. Horan Timothy Jones Keith D. Kelly Michael D. Leonard Frank MacHugh Gerald O'Loughlin Constance E. Perrine Charles E. Poehnert Richard M. Rabideau Leona M. Rapelye Matthew J. Roach Gerald R. Tavernier, Jr. Shaun P. Williams 36 Corporate Profile First International Bancorp. Inc. and First National Bank of New England, both headquartered in Hartford, Connecticut, specialize in providing credit, trade and depository services to small and medium size manufacturing companies located in the United States and in international emerging markets. The Company offers flexible and attractive terms to borrowers and is a national leader in the use of commercial loan guarantee programs make available by the U.S. Small Business Administration, the U.S. Department of Agriculture and the Export Import Bank of the U.S. The Company maintains preferred status in several jurisdictions and received Ex-Im Bank's "Small Business Bank of the Year" award for 1997. [LOGO APPEARS HERE] [LOGO APPEARS HERE] General Information - -------------------------------------------------------------------------------- Corporate Headquarters One Commercial Plaza Hartford, CT 06103 (860) 727-0700 www.fnbne.com NASDAQ: FNCE Transactions Counsel Updike, Kelly & Spellacy One State Street Hartford, CT 06123-1277 General Corporate Counsel Bingham Dana LLP 100 Pearl Street Hartford, CT 06103-4507 Independent Accountants Coopers & Lybrand L.L.P. 100 Pearl Street Hartford, CT 06103 Transfer Agent Requests for changes in the registration of stock certificates, replacement of lost or destroyed certificates, or undeliverable dividend checks should be referred to the Company's Transfer Agent: ChaseMellon Shareholder Services Securities Transfer Services 111 Founders Plaza, Suite 1100 East Hartford, CT 06108 1-800-288-9541 www.chasemellon.com Annual Meeting Tuesday, April 28, 1998, 4:00 p.m. The Sheraton Hotel 315 Trumbull Street Hartford, CT 06103 Form 10-K A copy of First International Bancorp, Inc.'s annual report and Form 10-K as filed with the Securities and Exchange Commission is available upon request to Leslie Galbraith, Chief Financial Officer at the corporate address or 860-241-2529 or galbraithl@fnbne.com. Media representatives, analysts and investors seeking information are invited to contact Leslie Galbraith. Investor Relations Leslie Galbraith Chief Financial Officer First International Bancorp, Inc. One Commercial Plaza Hartford, CT 06103 - -------------------------------------------------------------------------------- Market for the Company's Common Stock and Related Stockholder Matters The Company's common stock was listed on The Nasdaq Stock Market/SM/ under the symbol FNCE on September 23, 1997. The Company's initial public offering was paid at $13.50 per share. The following table sets forth the range of the high and low closing sales prices for the Company's common stock on the Nasdaq: 1997 High Low - -------------------------------------------------------- Third Quarter (from 9/23/97) $18 1/2 $15 1/2 Fourth Quarter $18 1/2 $11 1/4 On March 5, 1998, the Company had approximately 194 stockholders of record. This number does not include beneficial owners holding shares through nominee or "street" names. The Company believes the number of beneficial stockholders is in excess of 1,400. Holders of the common stock are entitled to receive dividends when, as, and if declared by the Board of Directors, out of funds legally available for such purpose. The Company has paid quarterly cash dividends to its stockholders since October 1995 equal to $.03 per share. The Company currently plans to continue to declare and pay quarterly cash dividends on approximately the same basis to the holders of the common stock. However, there can be no assurance that dividends will be declared and paid in the future. In determining whether, and to what extent, the Company should declare and pay dividends, the Company's Board of Directors will consider, among other factors, the Company's consolidated financial condition and results of operations, tax considerations, general economic conditions and capital requirements. Additionally, the Company's ability to declare and pay dividends may depend upon the receipt of dividends from its wholly owned subsidiary, First National Bank of New England which is restricted by the requirements of federal banking law. See Note 7 of the Consolidated Financial Statements. EX-23.1 3 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS ---------------------------------- We consent to the incorporation by reference in the registration statements of First International Bancorp, Inc. on Form S-8 (File Nos. 333-46149 and 333- 46151) of our report dated January 23, 1998, on our audits of the consolidated financial statements of First International Bancorp, Inc. as of December 31, 1997 and 1996, and for the years ended December 31, 1997, 1996 and 1995, which report is incorporated by reference in this Annual Report on Form 10-K. COOPERS & LYBRAND L.L.P. Hartford, Connecticut March 25, 1998 EX-27.1 4 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 1997 ANNUAL REPORT TO SHAREHOLDERS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS 12-MOS DEC-31-1997 DEC-31-1996 JAN-01-1997 JAN-01-1996 DEC-31-1997 DEC-31-1996 10,882 5,643 62 224 6,450 13,000 0 0 14,836 12,811 7,435 3,063 7,429 3,056 135,398 114,627 3,100 3,000 218,851 161,642 172,321 144,316 1,085 1,061 3,297 2,049 0 0 0 0 0 0 787 577 41,361 13,639 218,851 161,642 12,753 12,027 1,156 646 716 632 14,625 13,305 6,337 5,714 6,371 5,741 8,254 7,564 2,239 3,487 0 0 13,801 8,425 7,324 5,597 7,324 5,597 0 0 0 0 4,429 3,244 0.70 0.56 0.67 0.56 5.34 5.48 2,364 2,252 0 0 0 0 0 0 3,000 2,000 2,245 2,527 106 40 3,100 3,000 2,636 2,455 0 0 464 545
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