Item 1. Business
THE COMPANY
General
Enterprise Bancorp, Inc. (the “company”) is a Massachusetts corporation, which was organized on February 29, 1996, at the direction of Enterprise Bank and Trust Company (the “bank”) for the purpose of becoming the holding company for the bank. On July 26, 1996, the bank became the wholly owned subsidiary of the company and the former shareholders of the bank became shareholders of the company. The business and operations of the company are subject to the regulatory oversight of the Board of Governors of the Federal Reserve System.
Substantially all of the company’s operations are conducted through the bank. The bank is a Massachusetts trust company with two wholly owned subsidiaries, Enterprise Investment Services, LLC and Enterprise Insurance Services, LLC. The bank’s deposit accounts are insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (the “FDIC”), up to the maximum amount provided by law. The FDIC and the Massachusetts Commissioner of Banks (the “Commissioner”) have regulatory authority over the bank.
The company’s headquarters and the bank’s main office are located at 222 Merrimack Street in Lowell, Massachusetts. The company’s primary market area is northeastern Massachusetts and southern New Hampshire. The company has twelve additional full service branch banking offices located in the Massachusetts cities and towns of Andover, Billerica, Chelmsford, Dracut, Fitchburg, Leominster, Lowell, Tewksbury, and Westford; and in Salem, New Hampshire which serve those cities and towns as well as the surrounding communities. The company anticipates opening a second Tewksbury location in mid-2005.
The company is principally engaged in the business of attracting deposits from the general public and investing in commercial loans and investment securities. Through the bank and its subsidiaries, the company offers a range of commercial and consumer loan and deposit products, and investment management, trust and insurance services. Management seeks to hire, develop and retain highly motivated top professionals who understand the communities in which the bank operates as well as the local banking environment. The company endeavors to expand market share in existing markets and to pursue strategic growth through expansion into neighboring markets. The company places an emphasis on providing highly responsive, knowledgeable, personal service to its customers and on developing innovative products to serve the financial requirements of growing businesses, professionals, non-profit organizations, and individuals.
Lending
General
The company specializes in lending to growing businesses, corporations, partnerships, non-profits, professionals and individuals. Loans made by the company to businesses include commercial mortgage loans, construction loans, secured and unsecured commercial loans and lines, and standby letters of credit. The company also originates equipment lease financing for businesses. Loans made to individuals include residential mortgage loans, home equity loans, residential construction loans, secured and unsecured personal loans and lines of credit and mortgage loans on investment and vacation properties.
The company has an internal loan review function that assesses the compliance of loan originations with the company’s internal policies and underwriting guidelines and monitors the ongoing quality of the loan portfolio. The company also contracts with an external loan review company to review loans in the loan portfolio on a pre-determined schedule, based on the type, size, rating, and overall risk of the loan.
In addition, a management loan review committee, consisting of senior lending officers and loan review personnel, meets monthly to discuss loan policy and procedures, as well as loans on the company’s internal “watch asset list” and classified loan report. A loan committee, consisting of nine outside members of the board of directors, and two senior managers who are also members of the board of directors, also meets six times per year to review current portfolio statistics, new credits, construction loan reviews, loan delinquencies, allowance for loan losses and watched assets, as well as current market conditions and issues relating to the construction and real estate development industry.
The company has also established an internal credit review committee, consisting of senior lending officers and loan review personnel. The committee meets on an as needed basis to review loan requests related to borrowing relationships of certain levels, as well as other borrower relationships recommended for discussion by committee members. The company’s executive committee of the board of directors also approves loan relationships exceeding certain prescribed limits.
At December 31, 2004, the bank’s statutory lending limit, based on 20% of capital, to any individual borrower was approximately $12.9 million, subject to certain exceptions provided under applicable law. At December 31, 2004, the bank had no outstanding lending relationships or commitments in excess of the legal lending limit. Total loans amounted to $570.5 million and represented 67% of total assets at December 31, 2004.
Commercial Real Estate, Commercial and Construction Loans
The company’s primary lending focus is on the development of high quality commercial real estate, construction and commercial industrial lending relationships achieved through active business development efforts, strong community involvement and focused marketing strategies. The company employs a seasoned commercial lending staff, with commercial lenders supporting each branch location.
Commercial real estate loans include loans secured by commercial and industrial properties, apartment buildings, office and mixed use facilities, strip shopping malls, or other commercial property. Commercial real estate loans generally have repayment periods of approximately fifteen to twenty years. Variable rate loans comprise approximately 90% of the commercial real estate portfolio. Variable interest rate loans are generally fixed for the first one to five years before periodic rate adjustment begins. Adjustable rates are generally set at a margin above the Federal Home Loan Bank of Boston’s Regular Classic Advance rate or a monthly average of the prime lending rate as published in The Wall Street Journal (“Prime”), with a variety of periodic adjustment terms. At December 31, 2004, commercial real estate loans totaled $257.7 million, an increase of 15% over the prior year, and represented 45% of gross loans outstanding at December 31, 2004.
Commercial and industrial loans include seasonal revolving lines of credit, working capital loans, equipment financing and leases, loans partially guaranteed by the Small Business Administration (SBA), and loans under various programs issued in conjunction with the Massachusetts Development and Finance Agency and other agencies, as well as unsecured loans and lines to financially strong borrowers. Commercial loans may be secured in whole or in part by real estate unrelated to the principal purpose of the loan or secured by inventories, equipment, or receivables, and are generally guaranteed by the principals of the borrower. Approximately 80% of loans in this portfolio have interest rates that are periodically adjusted, generally with fixed initial periods of one to three years. The interest rates on adjustable commercial loans vary at a margin above a key index, generally the Prime rate, however other indices are also utilized from time to time. Commercial and industrial loans have average repayment periods of one to seven years. At December 31, 2004, commercial and industrial loans totaled $142.9 million, an increase of 8% over the prior year, and represented 25% of gross loans. Unadvanced portions of commercial and industrial loans and lines amounted to $80.2 million at December 31, 2004.
Construction loans include the development of residential housing and condominium projects, the development of commercial and industrial use property, loans for the purchase and improvement of raw land and loans for the construction of owner-occupied single-family residences. The company’s seasoned construction lenders work to cultivate long term relationships with experienced developers. The company limits the amount of financing provided for the construction of properties built on a speculation basis. Funds for construction projects are disbursed as pre-specified stages of construction are completed and regular site inspections are performed, either by experienced construction lenders on staff or by independent outside inspection companies, at each construction phase, prior to advancing additional funds. Construction loans generally have terms of one to three years. Adjustable rate construction loans generally have interest rates set at a margin above Prime and subject to periodic adjustments. Approximately 90% of the construction portfolio is composed of adjustable rate loans. Construction loans amounted to $83.4 million, or 15% of gross loans outstanding, at December 31, 2004. At that date, amounts committed but unadvanced in connection with such loans amounted to $62.5 million. Construction loans outstanding increased by 54% over the prior year due to the company’s market expansion and the results of management’s strategic planning to grow this segment of the portfolio.
From time to time the company participates in the financing of certain large commercial real estate or construction projects with other banks. In some cases the company may act
as the lead lender, originating and servicing the loans, but participating out a portion of the funding to other local community banks. In other cases the company may participate in loans originated by other institutions. In each case the participating bank funds a percentage of the loan commitment and takes on the related risk.
Commercial real estate lending may entail significant additional risks compared to residential mortgage lending. Loan size is typically larger and payment expectations on such loans can be more easily influenced by adverse conditions in the real estate market or in the economy in general. Construction financing involves a higher degree of risk than long term financing on existing occupied real estate. Property values at completion of construction or development can be influenced by underestimation of the actual costs expended to complete the project. Thus, the company may be required to advance funds beyond the original commitment in order to finish the development. If projected cash flows to be derived from the loan collateral or the values of the collateral prove to be inaccurate, for example because of unprojected additional costs or slow unit sales, the collateral may have a value that is insufficient to ensure full repayment.
Residential Loans
The company makes conventional mortgage loans on single family residential properties with original loan-to-value ratios generally up to 97% (with private mortgage insurance) of the appraised value of the property securing the loan. These residential properties serve as the primary homes of the borrowers. The company also originates loans on second homes, vacation properties and two-to-four family owner occupied dwellings with original loan-to-value ratios generally up to 80% of the property’s appraised value. At December 31, 2004, residential loans totaled $40.7 million, or 7% of gross loans outstanding, and represented 3% growth over the prior year.
Residential mortgage loans made by the company have traditionally been long-term loans made for periods of up to 30 years at either fixed or adjustable rates of interest. Depending on the current interest rate environment, management projections of future interest rates and the overall asset-liability management program of the company, management may elect to sell or hold residential loan production for the company’s portfolio. Long-term fixed rate residential mortgage loans are generally originated using underwriting standards and standard documentation allowing their sale in the secondary market. The company generally sells fixed rate residential mortgage loans and puts variable rate loans into the company’s portfolio. The company may retain or sell the servicing when selling the loans. All loans sold are currently sold without recourse.
Home Equity Lines of Credit
Home equity lines are originated for the company’s portfolio for single family residential properties with maximum original loan-to-value ratios generally up to 80% of the appraised value of the property securing the loan. Home equity lines generally have interest rates that adjust monthly based on changes in the Prime rate. The payment schedule for home equity lines for the first 10 years of the loans are interest only payments. At the end of ten years the line is frozen to future advances and principal and interest payments are collected over a fifteen-year amortization schedule. Home equity lines amounted to $42.8 million at December 31, 2004, representing 8% of gross loans outstanding, and 22% growth over the prior year. Amounts committed but unadvanced related to home equity lines amounted to $41.7 million at December 31, 2004.
Consumer Loans
Consumer loans primarily consist of secured or unsecured personal loans and overdraft protection lines on checking accounts extended to individual customers. Consumer loans amounted to $4.1 million, or 0.7% of gross loans outstanding at December 31, 2004, which constituted a 9% decrease since December 31, 2003.
Risk Elements
Non-performing assets consist of non-performing loans and other real estate owned (“OREO”). Non-performing loans include non-accrual loans, impaired loans, and loans past due 90 days or more but still accruing. Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Accrual of interest on loans is discontinued when a loan becomes contractually past due, with respect to interest or principal, by 90 days for real estate loans and generally 60 days for all other loans, or when reasonable doubt exists as to the full and timely collection of interest or principal. In certain instances, loans that have become 90 days past due may remain on
accrual status if the value of the collateral securing the loan is sufficient to cover principal and interest and the loan is in the process of collection or if the principal and interest is guaranteed by the federal government or an agency thereof.
Loans for which management considers it probable that not all contractual principal and interest will be collected in accordance with the original loan terms are designated as impaired loans. Loans where interest rates and/or principal payments have been deferred or reduced as a result of financial difficulties of the borrower are also classified as restructured. Not all loans on non-accrual status are designated as impaired. OREO consists of real estate acquired through foreclosure proceedings and real estate acquired through acceptance of a deed in lieu of foreclosure.
The classification of a loan or other asset as non-performing does not necessarily indicate that loan principal and interest will be ultimately uncollectable. However, management recognizes the greater risk characteristics of these assets and therefore considers the potential risk of loss on assets included in this category in evaluating the adequacy of the allowance for loan losses.
Non-performing assets amounted to $2.1 million, or 0.38% of total loans at December 31, 2004.
Additional information regarding these risk elements is contained in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Asset Quality”, contained in this report.
Allowance for Loan Losses
Inherent in the lending process is the risk of loss. While the company endeavors to minimize this risk, management recognizes that loan losses will occur and that the amount of these losses will fluctuate depending on the risk characteristics of the loan portfolio. The credit risk of the portfolio depends on a wide variety of factors.
The allowance for loan losses is an estimate of credit losses inherent in the loan portfolio. The allowance for loan losses is established through a provision for loan losses charged to operations. Loan losses are charged against the allowance when management believes that the collectability of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance. The company maintains the allowance at a level that it deems adequate to absorb all reasonably anticipated losses from specifically known and other credit risks associated with the portfolio.
The allowance for loan losses was $10.9 million, or 1.91% of total loans, at December 31, 2004. The company provided $1.7 million to the allowance for loan losses, and net charge-offs amounted to $0.7 million during 2004.
Additional information regarding the allowance for loan losses is contained in Item 7 of this report, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Allowance for Loan Losses”, which is contained in both the “Critical Accounting Estimates” section and the “Financial Condition” section of Item 7.
Investment Activities
The company’s investment activity is an integral part of the overall asset-liability management program of the company. The investment function provides readily available funds to support loan growth as well as to meet withdrawals and maturities of deposits and attempts to provide maximum return consistent with liquidity constraints and general prudence, including diversification and safety of investments. The securities in which the company may invest are subject to regulation. In addition, the company has an internal investment policy which restricts investments to the following categories: U.S. treasury securities, federal agency obligations (obligations issued by government sponsored enterprises that are not backed by the full faith and credit of the United State government), mortgage-backed securities (“MBSs”), including collateralized mortgage obligations (“CMOs”), and state, county and municipal securities (“Municipals”), all of which must be considered investment grade by a recognized rating service. The company also invests in Federal Home Loan Bank of Boston (“FHLB”) stock, certificates of deposit, and on a limited basis in equity securities. The short-term investments classified as cash equivalents may be comprised of short-term U.S. Agency Discount Notes, money market mutual funds and overnight and short-term federal funds sold. Other short-term investments may consist of auction rate preferred securities, which typically have redemption (auction) dates of up to 49 days, but cannot readily be converted to cash at
par value until the next successful auction. The investment policy also limits the categories within the investment portfolio to particular percentages of the total portfolio and to certain percentages of total assets and/or capital. The effect of changes in interest rates, principal payments and market values are considered when purchasing securities.
Investment transactions, portfolio allocations and projected cash flows are prepared monthly and presented to the company’s Asset-Liability Committee of the Board of Directors (“ALCO”) on a periodic basis. ALCO is comprised of six outside directors and three senior managers of the company who are also directors, with various management liaisons. ALCO also meets at least quarterly to perform an in-depth review of the company’s asset-liability strategy. The credit rating of each security or obligation in the portfolio is closely monitored by management and presented, at least annually, to the ALCO, along with a detailed evaluation of the company’s municipal securities portfolio.
The fair market value of the investment portfolio was $187.6 million at December 31, 2004, and total short-term investments amounted to $40.3 million at that date.
At December 31, 2004, 2003, and 2002, all investment securities were classified as available for sale and were carried at fair market value.
Source of Funds
Deposits
Deposits have traditionally been the principal source of the company’s funds. The company offers a broad selection of deposit products to the general public, including personal interest checking accounts (“PIC”), savings accounts, money market accounts, individual retirement accounts (“IRA”) and certificates of deposit. The company also offers commercial checking, business and municipal savings accounts, money markets and business sweep accounts, escrow management accounts, as well as checking and Simplified Employee Pension (“SEP”) accounts to employees of our business customers. Terms on certificates of deposit range from overnight to thirty months. The company does not currently use brokered deposits. The company has offered premium rates on specially designated products from time to time in order to promote new branches and to attract customers.
Management determines the interest rates offered on deposit accounts based on current and expected economic conditions, competition, liquidity needs, the volatility of the existing deposits, the asset-liability position of the company and the overall objectives of the company regarding the growth and retention of relationships.
The company utilizes money market mutual funds managed by Federated Investors, Inc. (“Federated”) for the investment portion of the company’s commercial sweep accounts. Management believes that commercial customers benefit from enhanced interest rate options on sweep accounts, while retaining a conservative investment option of the highest quality and safety. The balances transferred to Federated do not represent obligations of the company.
Total deposits were $768.6 million at December 31, 2004, representing 91% of total assets.
Borrowings
The bank is a member of the FHLB. This membership enables the bank to borrow funds from the FHLB. The company utilizes borrowings from the FHLB to fund short term liquidity needs. This facility is an integral component of the company’s asset-liability management program. At December 31, 2004, the company had outstanding FHLB advances of $1.9 million.
The company also borrows funds from customers (generally commercial and municipal customers) by entering into agreements to sell and repurchase investment securities from the company’s portfolio with terms typically ranging from overnight to six months. These repurchase agreements represent a cost competitive funding source for the company. Interest rates paid by the company on the repurchase agreements are based on market conditions and the company’s need for additional funds at the time of the transaction. Repurchase agreements amounted to $1.7 million at December 31, 2004.
Junior Subordinated Debentures
In March 2000 the company organized Enterprise (MA) Capital Trust I (the “Trust”), a statutory business trust created under the laws of Delaware, in order to issue $10.5 million of 10.875% trust preferred securities that mature in 2030 and are callable beginning in 2010. The proceeds from the sale of the trust preferred securities were used
by the Trust, along with the company’s $0.3 million capital contribution, to acquire $10.8 million in aggregate principal amount of the company’s 10.875% Junior Subordinated Debt Securities that mature in 2030 and are callable beginning in 2010.
Pursuant to Financial Interpretation No. 46R, issued by the Financial Accounting Standards Board in December 2003, the company has excluded the Trust from current period financial statements beginning in 2003, and has elected to voluntarily restate prior period financial statements for comparability purposes. This “deconsolidation” has caused the company to carry its $10.8 million of Junior Subordinated Debt Securities, which were issued by the company to the Trust, on the company’s financial statements as borrowings, with related interest expense, and to exclude the $10.5 million of trust preferred securities issued by the Trust, and the related non-interest expense, from its financial statements. This deconsolidation did not have a material impact on the company’s financial statements.
Investment Management and Trust Division
The company provides a range of investment management services to individuals, family groups, businesses, trusts, foundations and retirement plans. These services include: securities brokerage services through Enterprise Investment Services LLC, which provides these services through a third party service arrangement with Commonwealth Financial Network, a licensed securities brokerage firm; management of equity, fixed income, balanced and strategic cash management portfolios through the company’s investment management and trust division; and commercial sweep accounts through Federated for the company’s commercial deposit customers. Portfolios are managed based on the individual investment objectives of each client.
The company’s investment management and trust division utilizes an open-architecture, “manager of managers” approach to client investment management. Our philosophy is to identify and hire highly competitive outside investment management firms on behalf of our clients. The company performs in house searches and related due diligence in identifying and hiring outside investment managers, as well as all of the ongoing oversight and monitoring of each outside investment manager retained by the company.
Enterprise Insurance Services
Enterprise Insurance Services LLC engages in insurance sales activities through a third party arrangement with HUB International New England, LLC (“HUB”), formerly known as C.J. McCarthy Insurance Agency, Inc., a full service insurance agency, with nine offices in Massachusetts and New Hampshire. Enterprise Insurance Services provides, through HUB, a full array of insurance products including property and casualty, employee benefits and risk-management solutions tailored to serve the specific insurance needs of businesses in a range of industries operating in the company’s market area.
eCommerce Banking
The company uses an in-house turn-key solution from its core banking system vendor for internet banking services for retail and commercial customers. Major internet banking capabilities include the following: balance inquiry; internal transfers; loan payments; ACH origination; federal tax payments; placement of stop payments; and initiation of request for wire transfers. In addition to the services described above the in-house solutions also give customers access to images of checks paid as well as previous account statements.
Company Website
The company currently uses an outside vendor to design, support and host its website. The site provides information on the company and its services, as well as providing the access point to various specified banking services and to various financial management tools. In addition, the site includes the following major capabilities: career opportunities; loan and deposit rates; calculators; an ATM/Branch Locator/Map; and shareholder and investor information, which includes a corporate governance page containing board of directors’ committees, charters, corporate governance guidelines and the company’s code of business conduct and ethics, among other items, and a link to the company’s SEC filings. The company makes available free of charge through a link to its SEC filings, its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments to these reports. Access to these reports is essentially simultaneous with the SEC’s posting of these reports on its EDGAR system through the SEC website (www.SEC.gov). The underlying structure of the site provides for dynamic
maintenance of the information by company personnel. The company’s internet web address is: www.ebtc.com.
Competition
The company faces strong competition to attract deposits and to generate loans. National and larger regional commercial banks have a local presence in the Merrimack Valley and in the Leominster/Fitchburg, Massachusetts area. Numerous local savings banks, cooperative banks, credit unions and savings and loan associations have one or more offices in the company’s market area. Larger banks have certain competitive advantages over the company, including the ability to make larger loans to a single borrower than is possible for the company. The greater financial resources of larger banks also allow them to offer a broad range of automated banking services, to maintain numerous branch offices and to mount extensive advertising and promotional campaigns. Competition for loans and deposits also comes from other businesses that provide financial services, including consumer finance companies, mortgage brokers, insurance companies, securities brokerage firms, institutional mutual funds and private lenders. Advances in, and the increased use of, technology, such as Internet banking and electronic item processing, are expected to have a significant impact on the future competitive landscape confronting financial institutions.
Management believes that the company’s market position has been enhanced by the acquisition of peer independent banks by the larger regional and national banking organizations, and the resultant consolidation of competitors’ banking operations and services within the company’s market area. This consolidation is expected to continue as national banks seek entrance into the New England market area and local regional banks continue their growth by acquisition strategy. Management actively seeks to strengthen its position by capitalizing on the market disruption of these activities by pursuing growth opportunities in neighboring markets, as evidenced by the company’s 2004 expansion into the Andover, Massachusetts and Salem, New Hampshire markets. The company also continues to examine new products and technologies in order to maintain a competitive mix of offerings and services that can be delivered through multiple distribution channels at competitive prices.
Notwithstanding the substantial competition with which the company is faced, management believes that the company has established a solid reputation in the Merrimack Valley and the Leominster/Fitchburg area. The company believes that it has differentiated itself from competitors by providing customers, composed principally of growing and privately held businesses, professionals, and consumers, with highly responsive and personal service based on management’s familiarity and understanding of such customers’ banking needs. The company’s officers and directors have substantial business and personal ties in the cities and towns in which the company operates. The company’s past and continuing emphasis is to target product lines to customer needs, and to seek out and hire top professionals who understand the community and local banking environment.
To the extent that changes in the regulation of financial services may further increase competition, these changes could result in the company paying increased interest rates to obtain deposits while receiving lower interest rates on its loans. Under such circumstances, the company’s net interest margin would decline.
See also “Supervision and Regulation” below, for further discussion on how new laws and regulations may effect the company’s competitive position.
Supervision and Regulation
General
Bank holding companies and banks are subject to extensive government regulation through federal and state statutes and related regulations, which are subject to changes that can significantly affect the way in which financial service organizations conduct business.
As a general matter, regulation of the banking and financial services industries continues to undergo significant changes, some of which are intended to ease legal and regulatory restrictions while others have increased regulatory requirements. For example, the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) eased regulatory restrictions by removing the legal barriers that formerly served to separate the banking, insurance and securities industries. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, which reduced geographic restrictions on banking organizations by enhancing their ability to operate on a nationwide basis, is another example of federal legislation that has reduced the legal and regulatory burdens on banks and their holding companies.
Changes in law and regulation that have increased banks’ and financial organizations’ regulatory requirements include the United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”). The USA Patriot Act added new provisions to the Bank Secrecy Act that are intended to facilitate the prevention, detection and prosecution of international money laundering and the financing of terrorism. Among other requirements under the USA Patriot Act, in 2003 the company implemented a comprehensive risk-based customer identification program that is applied to all new account openings.
The passage of the Sarbanes-Oxley Act of 2002 (“SOX”) has also added new financial reporting and corporate governance requirements to the company’s ongoing regulatory compliance obligations. Pursuant to SOX requirements, the company took several steps in 2003 and 2004 to formalize the corporate governance policies, procedures and guidelines that are followed by the management and directors of the company. These included: developing an independent Corporate Governance/Nominating Committee, determining the independence of each of the company’s directors, restructuring board committees, identifying an audit committee financial expert, providing internal control and disclosure certifications, enhancing our code of ethics and developing board committee charters. In 2004, the company became an accelerated filer, as defined by the SEC, and as such, fell under the SEC’s rules implementing Section 404 of SOX. As required by Section 404, management undertook a complete evaluation and documentation of the company-wide systems of internal controls and procedures over financial reporting and fraud. Management must present a report on its assessment of the effectiveness of the company’s internal control over financial reporting, which must be attested to, and reported on, by the company’s independent registered public accounting firm and included in the company’s annual report on Form 10-K. See “Management’s Report on Internal Control Over Financial Reporting” in Item 9A, “Controls and Procedures” and also the Report of Independent Registered Public Accounting Firm on Internal Controls Over Financial Reporting on page 79.
The Check Clearing for the 21st Century Act (“Check 21”) became effective on October 28, 2004. Check 21 is designed to facilitate the automation of the nation’s check-processing system away from physical transportation of paper checks via couriers over land and through air. The law allows banks to process check information electronically, and to deliver digital images of the check to banks that choose to continue to receive paper checks. The digital image is converted to a substitute check, which replaces and becomes the legal equivalent of the original check.
On December 4, 2003, the President signed into law the Fair and Accurate Credit Transaction Act (“FACT Act”), which amends the Fair Credit Reporting Act. The FACT Act establishes uniform national standards in key areas of regulation regarding consumer credit report information. In general, the FACT Act enhances the ability of consumers to combat identity theft, increases the accuracy of consumer reports, allows consumers to exercise greater control regarding the type and amount of marketing solicitations they receive, restricts the use and disclosure of sensitive medical information, and establishes a commission to improve federal financial education programs and financial literacy among consumers.
Any future increase in the extent of regulation imposed upon the banking or financial services industries generally could result in the company incurring additional operating and compliance costs, which in turn could impede profitability.
To the extent that the information in this report under the heading “Supervision and Regulation” describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provision so described. Any changes in applicable laws or regulations may have a material effect on the business and prospects of the company.
Regulation of the Holding Company
The company is a registered bank holding company under the federal Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). It is subject to the supervision and examination of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and files reports with the Federal Reserve Board as required under the Bank Holding Company Act. Under applicable Massachusetts’s law, the company is also subject to the supervisory jurisdiction of the Commissioner.
The Bank Holding Company Act requires prior approval by the Federal Reserve Board of the acquisition by the company of substantially all the assets or more than five percent of the voting stock of any bank. The Bank Holding Company Act also authorizes the Federal
Reserve Board to determine (by order or by regulation) what activities are so closely related to banking as to be a proper incident of banking, and thus, whether the company, either directly or indirectly through non-bank subsidiaries, can engage in such activities. The Bank Holding Company Act prohibits the company and the bank from engaging in certain tie-in arrangements in connection with any extension of credit, sale of property or furnishing of services. There are also restrictions on extensions of credit and other transactions between the bank, on the one hand, and the company, or other affiliates of the bank, on the other hand.
The GLB Act enhanced the authority of banks and their holding companies to engage in non-banking activities. By electing to become a “financial holding company”, a qualified parent company of a banking institution may engage, directly or through its non-bank subsidiaries, in any activity that is financial in nature or incidental to such financial activity or in any other activity that is complimentary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
A bank holding company will be able to successfully elect to be regulated as a financial holding company if all of its depository institution subsidiaries meet certain prescribed standards pertaining to management, capital adequacy and compliance with the federal Community Reinvestment Act. Financial holding companies remain subject to regulation and oversight by the Federal Reserve Board. The company believes that the bank, which is the company’s sole depository institution subsidiary, presently satisfies all of the requirements that must be met to enable the company to successfully elect to become a financial holding company. However, the company has no current intention of seeking to become a financial holding company. Such a course of action may become necessary or appropriate at some time in the future depending upon the company’s strategic plan.
Regulation of the Bank
As a trust company organized under Chapter 172 of the Massachusetts General Laws, the deposits of which are insured by the FDIC, the bank is subject to regulation, supervision and examination by the Commissioner and the FDIC. The bank is also subject to certain requirements of the Federal Reserve Board.
The regulations of these agencies govern many aspects of the bank’s business, including permitted investments, the opening and closing of branches, the amount of loans which can be made to a single borrower, mergers, appointment and conduct of officers and directors, capital levels and terms of deposits. The Federal Reserve Board also requires the bank to maintain minimum reserves on its deposits. Federal and state regulators can impose sanctions on the bank and its management if the bank engages in unsafe or unsound practices or otherwise fails to comply with regulatory standards. Various other federal and state laws and regulations, such as truth-in-lending and truth-in-savings statutes, the Equal Credit Opportunity Act, the Bank Secrecy Act, the Real Estate Settlement Procedures Act, the Community Reinvestment Act, Check 21 and the FACT Act, also govern the bank’s activities and operations.
Pursuant to the GLB Act, the bank may also form, subject to the approvals of the Commissioner and the FDIC, “financial subsidiaries” to engage in any activity that is financial in nature or incidental to a financial activity. In order to qualify for the authority to form a financial subsidiary, the bank would be required to satisfy certain conditions, some of which are substantially similar to those that the company would be required to satisfy in order to elect to become a financial holding company. The company believes that the bank would be able to satisfy all of the conditions that would be required to form a financial subsidiary, although the company has no current intention of doing so. Such a course of action may become necessary or appropriate at some time in the future depending upon the company’s strategic plan.
Dividends
Under Massachusetts law, the company’s board of directors is generally empowered to pay dividends on the company’s capital stock out of its net profits to the extent that the board of directors considers such payment advisable. Massachusetts banking law also imposes substantially similar standards upon the payment of dividends by the bank to the company. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) also prohibits a bank from paying any dividends on its capital stock in the event that the bank is in default on the payment of any assessment to the FDIC or if the payment of any such dividend would otherwise cause the bank to become undercapitalized.
Capital Resources
Capital planning by the company and the bank considers current needs and anticipated future growth. The primary sources of capital have been the sale of common stock in 1988 and 1989, the issuance of $10.5 million of trust preferred securities in 2000 by the Trust, and retention of earnings less dividends paid since the bank commenced operations.
The Company
The Federal Reserve Board has adopted capital adequacy guidelines that generally require bank holding companies to maintain total capital equal to 8% of total risk-weighted assets, with at least one-half of that amount (or 4% of total risk-weighted asset) consisting of core or Tier 1 capital. Total capital for the company consists of Tier 1 capital and supplementary or Tier 2 capital. Tier 1 capital for the company begins with common stockholders’ equity and is reduced by certain intangible assets. In addition, trust preferred securities may compose up to 25% of the company’s Tier 1 capital (with any excess allocable to Tier 2 capital). Supplementary capital for the company is comprised solely of a portion of the allowance for loan losses. Assets are adjusted under the risk-based capital guidelines to take into account different levels of credit risk, for example, cash and government securities are placed in a 0% risk category (requiring no additional capital), most home mortgage loans are placed in a 50% risk category, and the bulk of assets that, by their nature in the ordinary course of business, pose a direct credit risk to a bank holding company, including commercial real estate loans, commercial business loans and consumer loans are placed in a 100% risk category.
In addition to the risk-based capital requirements, the Federal Reserve Board requires bank holding companies to maintain a minimum “leverage” ratio of Tier 1 capital to quarterly average total assets of 3%, with most bank holding companies required to maintain at least a 4% ratio.
The Bank
The bank is subject to separate capital adequacy requirements of the FDIC, which are substantially similar to the requirements of the Federal Reserve Board applicable to the company. However, trust preferred proceeds contributed to the bank from the company are included in Tier 1 capital of the bank without limitation. The company contributed $10.3 million of proceeds from the sale of these securities to the bank. Under the FDIC requirements, the minimum total capital requirement is 8% of total assets and certain off-balance sheet items, weighted by risk. At least 4% of the total 8% ratio must consist of Tier 1 capital (primarily common equity including retained earnings) and the remainder may consist of subordinated debt, cumulative preferred stock and a limited amount of loan loss reserves. At the bank level, as at the company level on a consolidated basis, certain intangible assets are deducted from Tier 1 capital in calculating regulatory capital ratios.
Under the applicable FDIC capital requirements, the bank is also required to maintain a minimum leverage ratio. The ratio is determined by dividing Tier 1 capital by quarterly average total assets, less intangible assets and other adjustments. FDIC rules require a minimum of 3% for the highest rated banks. Banks experiencing high growth rates are expected to maintain capital positions well above minimum levels.
Depository institutions, such as the bank, are also subject to the prompt corrective action framework for capital adequacy established by FDICIA. Under FDICIA, the federal banking regulators are required to take prompt supervisory and regulatory actions against undercapitalized depository institutions. FDICIA establishes five capital categories: “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, and “critically capitalized”. A “well capitalized” institution has a total capital to total risk-weighted assets ratio of at least 10%, a Tier 1 capital to total risk-weighted assets ratio of at least 6%, a leverage ratio of at least 5% and is not subject to any written order, agreement or directive; an “adequately capitalized” institution has a total capital to total risk-weighted assets ratio of at least 8%, a Tier 1 capital to total risk-weighted assets ratio of at least 4%, and a leverage ratio of at least 5% (3% percent if given the highest regulatory rating and not experiencing significant growth), but does not qualify as “well capitalized”. An “undercapitalized” institution fails to meet one of the three minimum capital requirements. A “significantly undercapitalized” institution has a total capital to total risk-weighted assets ratio of less than 6%, a Tier 1 capital to total risk-weighted assets ratio of less than 3%, and a leverage ratio of less than 3%. A “critically capitalized” institution has a ratio of tangible equity to assets of 2%, or less. Under certain circumstances, a “well
capitalized”, “adequately capitalized” or “undercapitalized” institution may be required to comply with supervisory actions as if the institution were in the next lowest category.
Failure to meet applicable minimum capital requirements, including a depository institution being classified as less than “adequately capitalized” within FDICIA’s prompt corrective action framework, may subject a bank holding company or its subsidiary depository institution(s) to various enforcement actions, including substantial restrictions on operations and activities, dividend limitations, issuance of a directive to increase capital and, for a depository institution, termination of deposit insurance and the appointment of a conservator or receiver.
Patents, Trademarks, etc.
The company holds no patents, registered trademarks, licenses (other than licenses required to be obtained from appropriate banking regulatory agencies), franchises or concessions which are material to its business.
Employees
At December 31, 2004, the company employed 249 full-time equivalent employees, including 90 officers. None of the company’s employees are presently represented by a union or covered by a collective bargaining agreement. Management believes its employee relations to be excellent.
Item 2.
Item 2. Properties
The company conducts its business from its main office located at 222 Merrimack Street, and operational support and lending offices at 21-27 Palmer Street and 170 Merrimack Street, Lowell, Massachusetts. The company currently has twelve additional full service branch banking offices in Massachusetts and New Hampshire, and anticipates opening its thirteenth branch office in mid-2005, in Tewksbury Massachusetts. The company is currently renovating a facility in Andover and anticipates relocating its current “temporary” Andover branch (63 Park Street) into this expanded location in late 2005. The company is obligated under various non-cancelable operating leases, some of which provide for periodic adjustments. The company believes that all its facilities are well maintained and suitable for the purpose for which they are used.
The following table sets forth general information related to facilities owned or used by the company.
(1) Relocation of the Park St. office expected to open in late 2005
(2) The company has the option to purchase this facility on the last day of the basic term or at any time during any extended term at the price of $550,000 as adjusted for increases in the producer’s price index.
(3) Anticipated to open in mid-2005
See note 4, “Premises and Equipment”, to the consolidated financial statements in Item 8 for further information regarding the company’s lease obligations.
Item 3.
Item 3. Legal Proceedings
The company is involved in various legal proceedings incidental to its business. Management does not believe resolution of any present litigation will have a material adverse effect on the financial condition of the company.
See “Massachusetts Department of Revenue Tax Dispute” contained in Item 7, and also in note 14 to the consolidated financial statements contained in Item 8, for further details regarding 2003 tax legislation and the company’s dispute and settlement of prior year assessments, and a description of the adverse effect that this new legislation will have on the company’s earnings in future periods.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during the quarter ended December 31, 2004.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market for Common Stock
On February 14, 2005 the company’s common stock began trading on the NASDAQ® Stock Market, under the symbol “EBTC.” Prior to this date there had been no established public trading market for the company’s common stock. Although periodically there have been private trades of the company’s common stock, prior to its trading on the NASDAQ Stock Market, the company cannot state with certainty the sales price at which such transactions occurred. The following table sets forth sales volume and price information, to the best of management’s knowledge, for the common stock of the company for the periods indicated.
The number of shares outstanding of the company’s common stock and number of shareholders of record as of March 1, 2005, were 3,691,210 and 770 respectively.
Dividends
The company declared and paid annual cash dividends of $0.43 per share and $0.38 per share in 2004 and 2003, respectively. Although the company expects to continue to pay an annual dividend, the amount and timing of any declaration and payment of dividends by the board of directors will depend on a number of factors, including capital requirements, the tax effect on individual stockholders, regulatory limitations, the company’s operating results and financial condition, anticipated growth of the company and general economic conditions. As the principal asset of the company, the bank currently provides the only source of cash for the payment of dividends by the company. Under Massachusetts law, trust companies such as the bank may pay dividends only out of “net profits” and only to the extent that such payments will not impair the bank’s capital stock. Any dividend payment that would exceed the total of the bank’s net profits for the current year plus its retained net profits of the preceding two years would require the Commissioner’s approval. FDICIA also prohibits a bank from paying any dividends on its capital stock if the bank is in default on the payment of any assessment to the FDIC or if the payment of dividends would otherwise cause the bank to become undercapitalized. These restrictions on the ability of the bank to pay dividends to the company may restrict the ability of the company to pay dividends to the holders of its common stock.
The statutory term “net profits” essentially equates with the accounting term “net income” and is defined under the Massachusetts banking statutes to mean the remainder of all earnings from current operations plus actual recoveries on loans and investments and other assets after deducting from such total all current operating expenses, actual losses, accrued dividends on any preferred stock and all federal and state taxes.
Sales of Unregistered Securities and Repurchases of Shares
The company has not sold any equity securities that were not registered under the Securities Exchange Act of 1934 during the year ended December 31, 2004. Neither the company nor any “affiliated purchaser” (as defined in the SEC’s Rule 10b-18(a)(3)) has repurchased any of the company’s outstanding shares, nor caused any such shares to be repurchased on its behalf, during the fiscal quarter ended December 31, 2004.
Item 6.
Item 6. Selected Consolidated Financial Data
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis should be read in conjunction with the company’s consolidated financial statements and notes thereto contained in Item 8, the information contained in the description of the company’s business in Item 1 and other financial and statistical information contained in this annual report.
Special Note Regarding Forward-Looking Statements
This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements concerning plans, objectives, future events or performance and assumptions and other statements that are other than statements of historical fact. Forward-looking statements may be identified by reference to a future period or periods or by use of forward-looking terminology such as “anticipates”, “believes”, “expects”, “intends”, “may”, “plans”, “pursue”, “views” and similar terms or expressions. Various statements contained in Item 1 - “Business”, Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 7A
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Margin Sensitivity Analysis
The company’s primary market risk is interest rate risk, specifically, changes in the interest rate environment. The company’s asset-liability committee (“the committee”) is responsible for establishing policy guidelines on acceptable exposure to interest rate risk and liquidity. The committee is comprised of six outside directors of the company and three senior managers of the company, who are also members of the Board of Directors with various management liaisons. In addition, several directors who are not on the committee rotate in on a regular basis. The primary objectives of the company’s asset-liability policy is to monitor, evaluate and control interest rate risk, as a whole, within certain tolerance levels while ensuring adequate liquidity and adequate capital. The committee establishes and monitors guidelines for the company’s net interest margin sensitivity, equity to capital ratios, liquidity and FHLB borrowing capacity. The asset-liability strategies are reviewed on a periodic basis by management and presented and discussed with the committee on at least a quarterly basis. The asset-liability strategies and guidelines are revised accordingly based on changes in interest rate levels, general economic conditions, competition in the marketplace, the current position of the company, anticipated growth of the company and other factors.
One of the principal factors in maintaining planned levels of net interest income is the ability to design effective strategies to cope with the impact on future net interest income of changes in interest rates. The balancing of the changes in interest income from interest earning assets and the interest expense of interest bearing liabilities is done through the asset-liability management program. On a quarterly basis, management completes a simulation analysis of the company’s net interest margin under various rate scenarios and presents it to the committee. Variations in the interest rate environment affect numerous factors, including prepayment speeds, reinvestment rates, maturities of investments (due to call provisions), and interest rates on various assets and liability accounts.
It should be noted that the interest rate scenarios used do not necessarily reflect management’s view of the “most likely” change in interest rates over the next 24 months. Furthermore, since a static balance sheet is assumed, the results do not reflect the anticipated future net interest income of the company.
The table below summarizes the projected cumulative net interest income for a 24-month period as of December 31, 2004, simulated under three rate scenarios: (i) an instantaneous 200 basis point upward shift in all interest rates, (ii) no change in interest rates, and (iii) an instantaneous 200 basis point downward shift in all interest rates. Rates on the company’s interest sensitive assets and liabilities (i.e., rates on investments, loans, deposits and borrowings) have been changed accordingly.
Management estimates that over a 24-month period net interest income will increase in a rising rate environment and decrease in a declining rate environment due to the company being more asset than liability sensitive.
The results and conclusions reached from the December 31, 2004 simulation are not significantly different from the December 31, 2003 simulation set forth below.
(1) The low rate environment in effect at December 31, 2003 precluded modeling a large downward shift in rates, therefore a 100 basis point shift, rather than a 200 basis point downward shift was simulated in the model.
Maturity and composition information of the company’s loan portfolio, investment portfolio, certificates of deposit, and other borrowings are contained in Part I, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the captions “Loans,” “Short-Term Investments,” “Investment Securities,” “Deposits” and “Borrowings.” Management uses this information in the simulation model along with other information about the company’s assets and liabilities. Management makes certain prepayment assumptions based on an analysis of market consensus and management projections, regarding how the factors discussed above will affect the assets and liabilities of the company as rates change. One of the more significant changes in the anticipated maturity of assets occurs in the investment portfolio, specifically the reaction of mortgage backed securities (including collateralized mortgage obligations) and callable securities as rates change.
Management also periodically assesses the sensitivity of the change in the net value of assets and liabilities (Economic Value of Equity or “EVE”) under different scenarios. As interest rates rise, the value of interest earning assets generally declines while the value of interest bearing liabilities increases. Management monitors the EVE on at least an annual basis. Although management considers the effect on the EVE when making asset-liability strategy decisions, the primary focus is on managing the effect on the net interest margin under changing rate environments.
Item 8.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Income for the years ended December 31, 2004, 2003 and
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and
Notes to the Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
ENTERPRISE BANCORP, INC.
Consolidated Balance Sheets
December 31, 2004 and 2003
See accompanying notes to consolidated financial statements.
ENTERPRISE BANCORP, INC.
Consolidated Statements of Income
Years Ended December 31, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
ENTERPRISE BANCORP, INC.
Consolidated Statements of Changes in Stockholders’ Equity
Years Ended December 31, 2004, 2003 and 2002
(1) Common stock is issued to shareholders under the dividend reinvestment plan and to members of the Board of Directors in lieu of cash compensation for attendance at Board and Board committee meetings.
See accompanying notes to consolidated financial statements.
ENTERPRISE BANCORP, INC.
Consolidated Statements of Cash Flows
Years Ended December 31, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
ENTERPRISE BANCORP, INC.
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
(a) Basis of Presentation
The consolidated financial statements of Enterprise Bancorp, Inc. (the “company”) include the accounts of the company and its wholly owned subsidiary Enterprise Bank and Trust Company (the “bank”). Enterprise Bank and Trust Company is a Massachusetts trust company organized in 1989.
The bank has two wholly owned subsidiaries, Enterprise Insurance Services LLC and Enterprise Investment Services LLC, organized for the purpose of engaging in insurance sales activities and offering non-deposit investment products and related securities brokerage services to its customers.
The company’s main office is located at 222 Merrimack Street in Lowell, Massachusetts. The company currently has twelve additional full service branch banking offices, and anticipates opening an additional branch in Tewksbury in mid 2005. The company’s deposit gathering and lending activities are conducted primarily in Lowell and the surrounding Massachusetts cities and towns of Andover, Billerica, Chelmsford, Dracut, Tewksbury, Tyngsboro, Westford, Leominster and Fitchburg, and most recently in Salem, NH. The company offers a range of commercial and consumer loan and deposit products, and investment management, trust and insurance services with a goal of satisfying the needs of individuals, professionals and growing businesses.
The company’s deposit accounts are insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum amount provided by law. The FDIC and the Massachusetts Commissioner of Banks (the “Commissioner”) have regulatory authority over the bank.
The business and operations of the company are subject to the regulatory oversight of the Board of Governors of the Federal Reserve System. The Massachusetts Commissioner of Banks also retains supervisory jurisdiction over the company.
In preparing the financial statements, management is required to make estimates and assumptions that affect the reported values of assets and liabilities at the balance sheet date and income and expenses for the years then ended. Actual results, particularly regarding the estimate of the allowance for loan losses and impairment valuation of goodwill and other intangible assets may differ from these estimates.
All significant intercompany balances and transactions have been eliminated in the accompanying consolidated financial statements.
(b) Reclassification
Certain amounts in previous years’ financial statements have been reclassified to conform to the current year’s presentation.
(c) Short-term Investment Securities
The company utilizes short-term investment vehicles to earn returns on short-term excess liquidity. The company’s short-term investments consist of investments carried as both cash equivalents and non-cash equivalents. Cash equivalents are defined as short-term highly liquid investments that are both readily convertible to known amounts of cash and are so near their maturity date that they present insignificant risk of changes in value due to changes in interest rates. Cash equivalent short-term investments are comprised of overnight and term federal funds sold, money market mutual funds and discount U.S. agency notes maturing in less than ninety days. Other short-term investments not classified as cash equivalents consist of auction rate preferred securities which cannot readily be
converted to cash at par value until the next successful auction date, typically every 49 days.
(d) Investment Securities
Investment securities that are intended to be held for indefinite periods of time but which may not be held to maturity or on a long-term basis are considered to be “available for sale” and are carried at fair value. Net unrealized appreciation and depreciation on investments available for sale, net of applicable income taxes, are reflected as a component of accumulated comprehensive income. Included as available for sale are securities that are purchased in connection with the company’s asset-liability risk management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk and other related factors. In instances where the company has the positive intent to hold to maturity, investment securities will be classified as held to maturity and carried at amortized cost. At December 31, 2004 and 2003 all of the company’s investment securities were classified as available for sale and carried at fair value. If a decline in market value of a security is considered other than temporary, the cost basis of the individual security is written down to market value and the loss is charged to net gains on sales of investment securities.
Investment securities’ discounts are accreted and premiums are amortized over the period of estimated principal repayment using methods that approximate the interest method.
Gains or losses on the sale of investment securities are recognized on the trade date on a specific identification basis.
(e) Loans
The company grants single family and multi-family residential loans, commercial real estate loans, secured and unsecured commercial loans and a variety of consumer loans. In addition, the company grants loans for the construction of residential homes, multi-family properties, and commercial real estate properties and for land development. Most loans granted by the company are collateralized by real estate or equipment and/or are guaranteed by the borrower. The ability and willingness of the single family residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity and real estate values within the borrowers’ geographic areas. The ability and willingness of commercial real estate, commercial and construction loan borrowers to honor their repayment commitments is generally dependent on the health of the real estate sector in the borrowers’ geographic areas and the general economy.
Loans are reported at the principal amount outstanding, net of deferred origination fees and costs. Loan origination fees received, offset by direct loan origination costs, are deferred and amortized using the straight line method over three to five years for lines of credit and demand notes or over the life of the related loans using the level-yield method for all other types of loans. When loans are sold or paid off, the unamortized fees and costs are recognized as interest income.
Loans held for sale are carried at the lower of aggregate amortized cost or market value, giving consideration to commitments to originate additional loans and commitments to sell loans. When loans are sold a gain or loss is recognized to the extent that the sales proceeds exceed or are less than the carrying value of the loans. Gains and losses are determined using the specific identification method.
Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Accrual of interest on loans is discontinued when a loan becomes contractually past due, with respect to interest or principal, by 90 days for real estate loans and generally 60 days for all other loans, or when reasonable doubt exists as to the full and timely collection of interest or principal. When a loan
is placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest accruals are resumed on such loans only when payments are brought current and when, in the judgment of management, the collectability of both principal and interest is reasonably assured. Payments received on loans in a non-accrual status are generally applied to principal.
Impaired loans are individually significant commercial and commercial real estate loans for which it is probable that the company will not be able to collect all amounts due in accordance with original contractual terms. Impaired loans are accounted for, except those loans that are accounted for at the lower of cost or fair value, at the present value of the expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, in the case of collateralized loans, the lower of the fair value of the collateral or the recorded amount of the loans. Impaired loans exclude large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, loans that are measured at fair value and leases as defined in SFAS No. 115. Management considers the payment status, net worth and earnings potential of the borrower, and the value and cash flow of the collateral as factors to determine if a loan will be paid in accordance with its contractual terms. Management does not set any minimum delay of payments as a factor in reviewing for impaired classification. Impaired loans are charged off when management believes that the collectability of the loan’s principal is remote.
(f) Allowance for Loan Losses
The allowance for loan losses is an estimate of credit losses inherent in the loan portfolio. The company’s allowance is accounted for in accordance with SFAS No. 114, as amended by SFAS No. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures”, and SFAS No. 5, “Accounting for Contingencies”. The allowance for loan losses is established through a provision for loan losses charged to operations. Loan losses are charged against the allowance when management believes that the collectability of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance. The company maintains the allowance at a level that it deems adequate to absorb all reasonably anticipated losses from specifically known and other credit risks associated with the portfolio.
The company uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: identification of specific loan losses, general loss allocations for certain loan types based on credit grade and loss experience factors, and general loss allocations for other economic or market factors. The methodology includes analysis of individual loans deemed to be impaired in accordance with the terms of SFAS 114. Other individual commercial, commercial mortgage and construction loans are evaluated using an internal rating system and the application of loss allocation factors. The loan rating system and the related loss allocation factors take into consideration the borrower’s financial condition, the borrower’s performance with respect to loan terms and the adequacy of collateral. Portfolios of more homogenous populations of loans, including residential mortgages and consumer loans, are analyzed as groups taking into account delinquency ratios and other indicators, the company’s historical loss experience and comparison to industry standards of loss allocation factors for each type of credit product. Finally, an additional allowance is maintained, if necessary, based on a subjective process whereby management considers qualitative and quantitative assessments of other factors, including industry concentrations, results of regulatory examinations, historical charge-off and recovery experience, character and size of the loan portfolio, trends in loan volume, delinquencies and non-performing loans, the strength of the local and national economy, interest rates and other changes in the portfolio. The allowance for loan losses is management’s estimate of the probable loan losses incurred as of the balance sheet date.
Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the company’s allowance for loan losses. Such agencies may require the company to recognize additions to the allowance based on judgments different from those of management.
See “Allowance for Loan Losses” under the heading, “Financial Condition”, contained in Item 7 above for further information regarding the allowance for loan losses.
(g) Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation and amortization. Fully depreciated assets have been removed from the premises and equipment inventory. Depreciation or amortization is computed on a straight-line basis over the lesser of the estimated useful lives of the asset or the respective lease term (with renewal options) for leasehold improvements as follows:
(h) Impairment of Long-Lived Assets Other than Goodwill
The company reviews long-lived assets, including premises and equipment, for impairment on an ongoing basis or whenever events or changes in business circumstances indicate that the remaining useful life may warrant revision or that the carrying amount of the long-lived asset may not be fully recoverable. If impairment is determined to exist, any related impairment loss is recognized through a charge to earnings. Impairment losses on assets disposed of, if any, are based on the estimated proceeds to be received, less cost of disposal.
(i) Goodwill and Core Deposit Intangible Assets
Goodwill and core deposit intangibles carried on the company’s consolidated financial statements were $5.7 million and $0.7 million, respectively, at December 31, 2004. Both of these assets are related to the company’s acquisition of two branch offices in July 2000.
In accordance with generally accepted accounting standards, the company does not amortize goodwill and instead, at least annually, evaluates whether the carrying value of goodwill has become impaired. Impairment of the goodwill occurs when the estimated fair value of the company is less than its recorded value. A determination that goodwill has become impaired results in immediate write-down of goodwill to its determined value with a resulting charge to operations.
The annual impairment test is a two-step process used to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized, if any. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of the reporting unit with its carrying amount, or the book value of the reporting unit, including goodwill. If the fair value of the reporting unit equals or exceeds its book value, goodwill is considered not impaired, and the second step of the impairment test is unnecessary. The second step, if necessary, measures the amount of goodwill impairment loss to be recognized. The reporting unit must determine fair values for all assets and liabilities, excluding goodwill. The net of the assigned fair value of assets and liabilities is then compared to the book value of the
reporting unit, and any excess book value becomes the implied fair value of goodwill. If the carrying amount of the goodwill exceeds the newly calculated implied fair value of that goodwill, an impairment loss is recognized in the amount required to write down the goodwill to the implied fair value.
The company’s consolidated financial statements also include intangible assets (core deposit intangibles), which are amortized to expense over their estimated useful life of ten years and reviewed for impairment on an ongoing basis or whenever events or changes in business circumstances warrant a review of the carrying value. If impairment is determined to exist, the related write-down of the intangible asset’s carrying value is charge to operations.
Based on these impairment reviews the company determined that goodwill and core deposit intangible assets were not impaired at December 31, 2004.
(j) Income Taxes
The company uses the asset and liability method of accounting for income taxes. Under this method deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities will be adjusted accordingly through the provision for income taxes.
(k) Stock Options
The company measures compensation cost for stock-based compensation plans using the intrinsic value method, under which no compensation cost is recorded if, at the grant date, the exercise price of the options is equal or greater than the fair market value of the company’s common stock.
Had the company determined compensation expense based on the fair value at the grant date for its stock options under SFAS 123, the company’s net income would have been reduced to the pro forma amounts indicated below:
The company granted 107,940 options in 2004, there were no options granted in 2003, and 81,500 options were granted in 2002.
The per share weighted average fair value of stock options was determined to be $3.09 and $4.78 for options granted in 2004 and 2002, respectively. The fair value of the options was determined to be 11% and 24% of the market value of the stock at the date of grant in 2004 and 2002, respectively. The value was determined by using a binomial distribution model. The average assumptions used in the model for the 2004 grant for the risk-free interest rate, expected volatility, dividend yield and expected life in years were 3.59%, 15%, 1.53% and 6, respectively. The assumptions used in the model for the 2002 grant for the risk-free interest rate, expected volatility, dividend yield and expected life in years were 4.58%, 12.5%, 1.65% and 6, respectively.
See note 9, “Stock Option Plans”, for further information regarding the company’s stock option plans and grants.
(l) Investment Management and Trust Services
Securities and other property held in a fiduciary or agency capacity are not included in the consolidated balance sheets because they are not assets of the company. Investment assets under management, consisting of assets managed by the trust division, investment services division, and the Federated sweep product, totaled $363.3 million and $375.3 million at December 31, 2004 and 2003, respectively. Fee income is reported on an accrual basis.
(m) Earnings Per Share
Basic earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding during the year. Diluted earnings per share reflects the effect on weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method.
The table below presents the increase in average shares outstanding, using the treasury stock method, for the diluted earnings per share calculation for the years ended December 31st and the effect of those shares on earnings:
At December 31, 2004 3,000 stock options were outstanding but excluded from the calculations of diluted earnings per share above due to the exercise price exceeding the average market price. These options, which are not currently dilutive, may potentially dilute earnings per share in the future.
(n) Reporting Comprehensive Income
Comprehensive Income is defined as all changes to equity except investments by and distributions to stockholders. Net income is one component of comprehensive income, with other components referred to in the aggregate as other comprehensive income. The company’s only other comprehensive income component is the net unrealized holding gains on investments available for sale, net of deferred income taxes.
(o) Derivatives
The company recognizes all derivatives as either assets or liabilities in its balance sheet and measures those instruments at fair market value. The company establishes at the inception of a hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The company generally originates fixed rate residential mortgage loans with the anticipation of selling such loans. The company generally does not pool mortgage loans for sale but instead sells the loans on an individual basis and generally does not retain the servicing of these loans. Interest rate lock commitments related to the origination of mortgage loans that will be sold are considered derivative instruments. The company estimates the fair value of these derivatives using the difference between the
guaranteed interest rate in the commitment and the current market interest rate. To reduce the net interest rate exposure arising from its loan sale activity, the company enters into the commitment to sell these loans at essentially the same time that the interest rate lock commitment is quoted on the origination of the loan. The commitments to sell loans are also considered derivative instruments, with estimated fair values based on changes in current market rates. At December 31, 2004 the estimated fair value of the company’s derivative instruments were considered to be immaterial.
(p) Other Accounting Rule Changes
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities - An Interpretation of Accounting Research Bulletin No. 51.” FIN 46 establishes accounting guidance for the consolidation of Variable Interest Entities (VIEs) that function to support the activities of the primary beneficiary, as defined. Prior to the implementation of FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of the voting interest in the entity. In October 2003, the FASB announced that it had deferred the implementation date for FIN 46 to the fourth quarter of 2003 for VIEs in existence prior to February 1, 2003.
Enterprise (MA) Capital Trust I (the “Trust”) constitutes the only entity in which the company holds a variable interest. The company fully and unconditionally guarantees on a subordinated basis all of the Trust’s obligations with respect to distributions and amounts payable upon liquidation, redemption or repayment with respect to the trust preferred securities issued by the Trust. At December 31, 2004 the company’s investment in the Trust was $671 thousand and the Trust had outstanding trust preferred securities totaling $10.5 million.
In December 2003, the FASB issued FIN 46R, a revision of FIN 46, which in part specifically addressed limited purpose trusts formed to issue trust preferred securities. The guidance required companies to deconsolidate their investments in these limited purpose trusts. Transition guidance for public companies issued by the FASB, required the application of either FIN 46 or FIN 46R to all special purpose entities (such as the Trust) in which the company holds a variable interest no later than the end of the first reporting period ending after December 15, 2003 (i.e. December 31, 2003 for entities with calendar fiscal years). Accordingly, calendar year end public entities may choose to apply either FIN 46 or FIN 46R to their trust preferred structures at December 31, 2003.
Pursuant to FIN 46R, beginning with December 31, 2003 financial statements, the company has excluded the Trust from the current periods and has elected to voluntarily restate prior period financial statements for comparability purposes. This “deconsolidation” has caused the company to carry its $10.8 million of Junior Subordinated Debt Securities, which were issued by the company to the Trust, on the company’s financial statements as borrowings, with related interest expense, and to exclude the $10.5 million of trust preferred securities issued by the Trust, and the related non-interest expense, from its financial statements. This deconsolidation did not have a material impact on the company’s financial statements.
In May 2004, due to accounting changes by the FASB related to trust preferred securities, the Federal Reserve Board published proposed changes to capital rules for bank holding companies, which were finalized on March 1, 2005. These changes continue to allow the inclusion of trust preferred securities as a component of Tier 1 capital within prescribed limits, while imposing tighter requirements on the calculation of Tier 1 capital. Under the new calculation method, the company’s Tier 1 regulatory capital ratios as of December 31, 2004, would continue to exceed the minimum required regulatory levels to be considered “Well Capitalized.”
In March 2004, the FASB issued Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,” to determine the meaning of other-than-temporary impairment and its application to debt and equity securities within the scope of FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The task force concluded that an investment is impaired if the fair value of the investment is less than cost. If impaired, the investor must make an evidence-based judgment to determine if the impairment is recoverable within a reasonable period of time considering the severity and duration of the impairment in relation to the forecasted recovery of fair value. The impairment should be considered other than temporary if the investor does not have the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the cost of the investment. For those investments for which impairment is considered other than temporary, the company would recognize in earnings an impairment loss equal to the difference between the investment’s cost and its fair value. EITF No. 03-1 other-than-temporary impairment evaluations are effective for reporting periods beginning after June 15, 2004.
In September 2004, the FASB issued FSP (FASB Staff Position) EITF Issue 03-1-1, “Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1” due to industry responses to EITF No. 03-1. The FSP provides guidance for the application of EITF No. 03-1 as it relates to debt securities that are impaired because of interest rate and/or sector spread increases. It also delayed the effective date of EITF No. 03-1 for debt securities that are impaired because of interest rate and/or sector spread increases until a final consensus could be reached.
In December 2004, the FASB announced that it will reconsider in its entirety the EITF’s and all other guidance on disclosing, measuring, and recognizing other-than-temporary impairments of debt and equity securities. Until the new guidance is issued, companies must continue to comply with the disclosure requirements of EITF 03-1 and all relevant measurement and recognition requirements in other accounting literature.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” (“SFAS 123(R)”). The standard, an amendment of FASB Nos. 123 and 95, eliminates the ability of companies to account for stock-based compensation transactions using the intrinsic value method and requires instead that such transactions be accounted for using a fair-value based method. Under the intrinsic value method, no compensation cost is recorded if, at the grant date, the exercise price of the options is equal to or greater than the fair market value of the company’s common stock; however, pro forma net income and earnings per share information is supplementally disclosed as if the fair-value based method of accounting had been used. The fair value method requires companies to recognize compensation expense over the service period (usually the vesting period), equal to the fair value at the grant date for stock options issued in exchange for employee services. The statement is applicable to public companies prospectively for any interim or annual period beginning after June 15, 2005. As of the effective date, all public entities that used the fair-value-based method for either recognition or disclosure under Statement 123 will apply this Statement using a modified version of prospective application method. Under this transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for either recognition or pro forma disclosures.
For periods before the required effective date entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by Statement 123. The company currently uses the intrinsic value method to measure compensation cost with footnote disclosure of the fair value method under SFAS 123. As of December 31, 2004, the estimated impact of adopting
SFAS 123(R) in 2005 will be recognition of additional compensation expense of $87 thousand for the six months of 2005 for which SFAS 123(R) will be effective. This estimate excludes any forfeitures or additional grants in 2005. The company is still analyzing the full effect of the adoption of SFAS 123(R).
See Item (k) “Stock Options”, in this Note 1, for pro forma information regarding compensation expense using the fair value method under SFAS 123.
(2) Investment Securities
The amortized cost and estimated fair values of investment securities at December 31, are summarized as follows:
(1) Federal agency obligations include securities issued by government sponsored enterprises such as Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. These securities do not represent obligation of the US government and are not backed by the full faith and credit of the United States Treasury.
The following table summarizes investments having temporary impairment, due to the fair market values having declined below the amortized costs of the individual securities, and the period that the investments have been impaired.
The mortgage backed securities with unrealized losses were comprised of collateralized mortgage obligations issued by GNMA, FHLMC or FNMA, with contractual cash flows guaranteed by the issuing agency. The federal agency and municipal obligations with unrealized losses carried credit ratings of AAA. Impairment on these securities has occurred primarily within the preceding nine months due to recent increases in the overall market rates. Because the decline in fair value is attributed to changes in interest rates and not credit quality, and because the company has the intent and ability to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.
The contractual maturity distribution of total fixed income securities at December 31, 2004 is as follows:
Mortgage-backed securities are shown at their final maturity but are expected to have shorter average lives due to principal prepayments. Included in municipal securities and federal agency obligations are investments that can be called prior to final maturity with fair values of $39.6 million at December 31, 2004.
At December 31, 2004, securities with a fair value of $15.1 million were pledged as collateral for various municipal deposit accounts and short-term borrowings (note 7) and securities with a fair value of $2.0 million were pledged as collateral for treasury, tax and loan deposits. At December 31, 2003, securities with a fair value of $5.7 million and $1.1 million were pledged as collateral for municipal deposit accounts and short-term borrowings and treasury tax and loan deposits, respectively.
Sales, calls and principal paydowns of investment securities for the years ended December 31, 2004, 2003, and 2002 are summarized as follows:
Tax exempt interest earned on the municipal securities portfolio was $2.0 million, $1.8 million and $1.9 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(3) Loans and Loans Held for Sale
Major classifications of loans and loans held for sale at December 31, are as follows:
Directors, officers, principal stockholders and their associates are credit customers of the company in the normal course of business. All loans and commitments included in such transactions are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and do not involve more than a normal risk of collectability or present other unfavorable features. As of December 31, 2004 and 2003, the outstanding loan balances to directors and officers of the company and their associates was $11.0 million and $10.2 million, respectively. Unadvanced portions of lines of credit available to directors and officers were $2.9 million and $3.0 million, as of December 31, 2004 and 2003, respectively. During 2004, new loans and net increases in loan balances or lines of credit under existing commitments of $2.2 million were made and principal paydowns of $1.3 million were received. All loans to these related parties are current.
Non-performing assets at December 31, are summarized as follows:
There were no commitments to lend additional funds to those borrowers whose loans were classified as non-accrual at December 31, 2004, 2003, and 2002. The reduction or increase in interest income for the years ended December 31, associated with non-accruing loans is summarized as follows:
The increase in interest income in 2004 resulted primarily from the settlement of three loan relationships that had been carried as non-performing and/or impaired for a number of years.
At December 31, 2004 and 2003, total impaired loans were $2.0 million and $4.3 million, respectively. In the opinion of management, there were no impaired loans requiring an allocated reserve at December 31, 2004 and 2003, respectively. All of the impaired loans have been measured using the fair value of the collateral method. During the years ended December 31, 2004, 2003 and 2002, the average recorded value of impaired loans was $3.8million, $3.8 million and $1.7 million, respectively. Included in the reduction in interest income in the table above is $209,000, $172,000 and $99,000 of interest income that was not recognized on loans that were deemed impaired as of December 31, 2004, 2003 and 2002, respectively. All payments received on impaired loans in non-accrual status are applied to principal. The company is not committed to lend additional funds on any loans that are considered impaired.
Changes in the allowance for loan losses for the years ended December 31, are summarized as follows:
At December 31, 2004, 2003 and 2002, the company was servicing mortgage loans sold to investors amounting to $15.1 million, $15.1 million, and $16.9 million, respectively.
(4) Premises and Equipment
Premises and equipment at December 31, are summarized as follows:
The company is obligated under various non-cancelable operating leases, some of which provide for periodic adjustments. At December 31, 2004 minimum lease payments for these operating leases were as follows:
Total rent expense for the years ended December 31, 2004, 2003 and 2002 amounted to $787,000, $709,000, and $662,000, respectively.
(5) Accrued Interest Receivable
Accrued interest receivable consists of the following at December 31:
(6) Deposits
Deposits at December 31, are summarized as follows:
The aggregate amount of overdrawn deposits that have been reclassified as loan balances were $0.6 million at both December 31, 2004 and 2003.
The following table shows the scheduled maturities of time deposits with balances less than $100,000 and greater than $100,000 at December 31, 2004:
Interest expense on time deposits with balances of $100,000 or more amounted to $0.9 million, $1.1 million, and $1.6 million, in 2004, 2003 and 2002, respectively.
(7) Other Borrowings
Borrowed funds at December 31, are summarized as follows:
Securities sold under agreements to repurchase at December 31, 2004 had maturities ranging generally from one week to six months, with a weighted average term of 42 days. Maximum amounts outstanding at any month end during 2004, 2003, and 2002 were $14.5 million, $1.0 million, and $48.1 million, respectively. Securities sold under agreement to repurchase averaged $2.9 million, $1.0 million, and $16.0 million during 2004, 2003, and 2002, respectively. The average cost of repurchase agreements was 1.62%, 1.19%, and 1.77% during 2004, 2003, and 2002, respectively. The reductions in balances reflect the company’s transition of the investment portion of commercial sweep accounts from overnight repurchase agreements secured by municipal securities held by the company to money market mutual funds managed by Federated Investors, Inc. The transition began in 2002 and was completed in May 2003.
The bank became a member of the Federal Home Loan Bank of Boston (“FHLB”) in March 1994. Federal Home Loan Bank borrowings at December 31, 2004 consisted of $1.4 million in short-term borrowings and $0.5 million in a fifteen year term advance maturing in 2013. Maximum amounts outstanding at any month end during 2004, 2003, and 2002 were $20.7 million, $20.5 million, and $16.5 million, respectively. FHLB borrowings averaged $5.0 million, $4.4 million, and $1.2 million during 2004, 2003, and 2002, respectively. The average cost of FHLB borrowings was 1.71%, 1.83%, and 3.47% during 2004, 2003, and 2002, respectively. Borrowings from the FHLB are secured by the company’s investment portfolio not otherwise pledged, FHLB stock and 1-4 family owner occupied residential loans.
As a member of the FHLB, the bank has access to a pre-approved overnight line of credit for up to 5% of its total assets and the capacity to borrow an amount up to the value of its qualified collateral, as defined by the FHLB. At December 31, 2004, based on qualifying collateral less outstanding advances, the bank had the capacity to borrow additional funds up to approximately $148.2 million from the FHLB, which includes a pre-approved overnight line of credit in the amount of $11.0 million.
On March 10, 2000 the company organized Enterprise (MA) Capital Trust I (the “Trust”), a statutory business trust created under the laws of Delaware. The Trust issued $10.5 million of 10.875% trust preferred securities. The proceeds from the sale of the trust preferred securities were used by the Trust, along with the company’s $0.3 million capital contribution, to acquire $10.8 million in aggregate principal amount of the company’s 10.875% Junior Subordinated Debt Securities due 2030.
See paragraph (p), “Other Accounting Rule Changes”, in note 1 above to these consolidated financial statements for further information on the Trust.
(8) Stockholders’ Equity
The company’s authorized capital is divided into common stock and preferred stock. The company is authorized to issue 10,000,000 shares of common stock and 1,000,000 shares of preferred stock.
Holders of common stock are entitled to one vote per share, and are entitled to receive dividends if and when declared by the board of directors. Dividend and liquidation rights of the common stock may be subject to the rights of any outstanding preferred stock.
The company maintains a dividend reinvestment plan pursuant to which shareholders may elect to reinvest some or all of any cash dividends they may receive in shares of the company’s common stock at a purchase price equal to fair market value. Shares issued under the plan may be newly issued or treasury shares. In 2004 the company issued 30,834 shares under the plan at a per share purchase price of $31.39. In 2003 the company issued 38,063 shares under the plan at a per share purchase price of $24.70.
The company maintains a shareholders rights plan pursuant to which each share of common stock includes a right to purchase under certain circumstances one-two hundredth of a share of the company’s Series A Junior Participating Preferred Stock, par value $0.01 per share, at a purchase price of $37.50 per one-two hundredth of a preferred share, subject to adjustment, or, in certain circumstances, to receive cash, property, shares of common stock or other securities of the company. The rights are not presently exercisable and remain attached to the shares of common stock until the occurrence of certain triggering events that would ordinarily be associated with an unsolicited acquisition or attempted acquisition of 10% or more of the company’s outstanding shares of common stock. The rights will expire, unless earlier redeemed or exchanged by the company, on January 13, 2008. The rights have no voting or dividend privileges, and unless and until they become exercisable have no dilutive effect on the earnings of the company.
Applicable regulatory requirements require the company to maintain total capital equal to 8.00% of risk-weighted assets (total capital ratio), Tier 1 capital equal to 4.00% of risk-weighted assets (Tier 1 capital ratio) and Tier 1 capital equal to 4.00% of average assets (leverage capital ratio). Tier 1 capital, in the case of the company, is composed of common equity and trust preferred securities, reduced by certain intangible assets. Total capital includes Tier 1 capital plus Tier 2 capital (which in the case of the company is composed of the allowance for loan losses up to 1.25% of risk-weighted assets).
The company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate or result in certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a material adverse effect on the company’s financial statements. Under applicable capital adequacy requirements and the regulatory framework for prompt corrective action applicable to the bank, the company must meet specific capital guidelines that involve quantitative measures of the company’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The company’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the company to maintain the minimum capital amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined). Management believes, as of December 31, 2004, that the company meets all capital adequacy requirements to which it is subject.
As of December 31, 2004 and 2003, both the company and the bank qualified as “well capitalized” under applicable Federal Reserve Board and FDIC regulations. To be categorized as well capitalized, the company and the bank must maintain minimum total, Tier 1 and, in the case of the bank, leverage capital ratios as set forth in the table below.
The company’s and the bank’s actual capital amounts and ratios are presented in the following tables.
* For the bank to qualify as “well capitalized”, it must maintain a leverage capital ratio (Tier 1 capital to average assets) of at least 5%. This requirement does not apply to the company.
Neither the company nor the bank may declare or pay dividends on its stock if the effect thereof would cause stockholders’ equity to be reduced below applicable regulatory capital requirements or if such declaration and payment would otherwise violate regulatory requirements.
(9) Stock Option Plans
The board of directors of the bank adopted a 1988 Stock Option Plan (the “1988 plan”), which was approved by the shareholders of the bank in 1989. The 1988 plan permitted the board of directors to grant both incentive and non-qualified stock options to officers and full-time employees for the purchase of up to 307,804 shares of common stock. The 1988 plan was assumed by the company upon the completion of the bank’s reorganization into a holding company structure in 1996. While no further grants of options may be made under the 1988 plan, all currently outstanding and unexercised options previously granted under the 1988 plan remain outstanding in accordance with their terms.
The board of directors of the company adopted a 1998 stock incentive plan (the “1998 plan”), which was approved by the shareholders of the company in 1998. In 2001, both the board of directors and the shareholders of the company approved an amendment and restatement of the 1998 plan to increase the number of shares that may be issued thereunder. The 1998 plan, as so amended and restated, permits the board of directors to grant incentive and non-qualified options (as well as shares of stock, with or without restrictions, and stock appreciation rights) to officers and other employees, directors and consultants for the purchase of up to 328,023 shares of common stock.
In 2003, the board of directors of the company adopted and the shareholders approved, a 2003 stock incentive plan (the “2003 plan”). The 2003 plan permits the board of directors to grant both incentive and non-qualified stock options (as well as shares of stock subject to restriction, stock appreciation rights, and other rights) to officers and other employees, directors and consultants for the purchase of up to 176,546 shares of common stock.
There were no options granted in 2003. On January 2, 2004, the company granted 103,690 options, comprised of 74,690 options under the 1998 plan, as amended, and 29,000 options under the 2003 plan. The company granted an additional 4,250 options during 2004 under both the 2003 and 1998 plans. All options that have been granted under the plans generally become exercisable at the rate of 25% a year. All options granted prior to 1998 expire 10 years from the date of the grant. All options granted since 1998 expire 7 years from the date of grant.
Under the terms of the plans, incentive stock options may not be granted at less than 100% of the fair market value of the shares on the date of grant and may not have a term of more than ten years. Any shares of common stock reserved for issuance pursuant to options granted under the plans which are returned to the company unexercised shall remain available for issuance under the plans. For participants owning 10% or more of the company’s outstanding common stock, incentive stock options may not be granted at less than 110% of the fair market value of the shares on the date of grant.
In the absence of an active trading market for the company’s common stock, prior to February 14, 2005, the per share exercise price on all stock options granted had been determined on the basis of a fair market valuation provided to the company by an outside financial advisor, which does not necessarily reflect the actual prices at which shares of the common stock had been purchased and sold in privately negotiated transactions. (On February 14, 2005 the company’s common stock began trading on the NASDAQ® Stock Market, under the symbol “EBTC.”)
Stock option transactions are summarized as follows:
A summary of options outstanding and exercisable by exercise price as of December 31, 2004 follows:
During 2004 and 2003, 5,933 and 6,382, respectively, shares of stock were issued to members of the Board of Directors in lieu of cash compensation for attendance at Board and Board Committee meetings. These shares were issued at a fair market value price of $30.68 and $20.20 for 2004 and 2003, respectively, and were issued from the shares reserved for future grants under the 1998 plan. Expense recognized in association with the issuance of these shares was $182,000 and $129,000 in 2004 and 2003, respectively.
See paragraph (j), “Stock Options”, in note 1 above to these consolidated financial statements for further information related to equity compensation plans.
(10) Employee Benefit Plans
401(k) Defined Contribution Plan
The company has a 401(k) defined contribution employee benefit plan. The 401(k) plan allows eligible employees to contribute a base percentage, plus a supplemental percentage, of their pre-tax earnings to the plan. A portion of the base percentage, as determined by the board of directors, is matched by the company. No company contributions are made for supplemental contributions made by participants. The percentage matched was 50% in 2004 and 75% for 2003 and 2002, up to the first 6% contributed by the employee.
All employees, at least 21 years of age, are immediately eligible to participate. Vesting for the company’s 401(k) plan contribution is based on years of service with participants becoming 20% vested after 2 years of service, increasing pro-rata to 100% vesting after 6 years of service. Amounts not distributable to an employee following termination of employment are returned to the company.
Employee Bonus Program
The company bonus program includes all employees. Bonuses are paid to the employees based on the accomplishment of certain goals and objectives that are determined at the beginning of the fiscal year and approved by the compensation committee of the board of directors. The company also pays incentive awards based on the achievement of certain growth objectives. All employees are eligible for the incentive awards. From time to time the company may also make an annual discretionary employer contribution to the 401(k) plan of an additional percentage of employee contributions. Payout under the programs will vary depending on the level of achievement attained. In 2004, 2003 and 2002 amounts charged to salaries and benefits under these programs were $225,000, $796,000 and $2,078,000, respectively.
The company maintains a supplemental cash bonus plan for its top six executive officers. The goals, objectives and payout schedule of this plan are set by the compensation committee. The plan provides for payment of cash bonuses based on the achievement of a bonus payout to all employees in the employee bonus program discussed in the previous paragraph and the achievement of certain earnings per share goals. In 2004, 2003 and 2002, $0, $172,000 and $366,000, respectively, were charged to salaries and benefits under this plan.
Supplemental Retirement Plan
The bank has in effect a supplemental retirement plan for the chief executive officer, the president and an executive vice president. The plan provides for a supplemental retirement benefit, the amount subject to vesting requirements, to be provided for a period of 20 years after reaching a defined “retirement age”. The amount charged to expense for these benefits was $510,000, $295,000 and $4,000, in 2004, 2003 and 2002, respectively.
(11) Income Taxes
The components of income tax expense for the years ended December 31 were calculated using the asset and liability method as follows:
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate (34%) as follows:
At December 31 the tax effects of each type of income and expense item that give rise to deferred taxes are:
Management believes that it is more likely than not that current recoverable income taxes and the results of future operations will generate sufficient taxable income to realize the deferred tax asset existing at December 31, 2004.
(12) Related Party Transactions
Certain of the company’s offices in Lowell, Massachusetts, are leased from realty trusts, the beneficiaries of which included during the years ended December 31, 2004, 2003 and 2002 various bank officers and directors. The maximum remaining term of the leases including options is for 20 years.
Total amounts paid to the realty trusts for the years ended December 31, 2004, 2003, and 2002, were $527,000, $495,000, and $513,000, respectively.
(13) Commitments, Contingencies and Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk
The company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to originate loans, standby letters of credit and unadvanced lines of credit.
The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The contract amounts of these instruments reflect the extent of involvement the company has in the particular classes of financial instruments.
The company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amounts of those instruments. The company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Financial instruments with off-balance sheet credit risk at December 31, 2004 and 2003, are as follows:
Commitments to originate loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include security interests in mortgages, accounts receivable, inventory, property, plant and equipment and income-producing properties.
Standby letters of credit are conditional commitments issued by the company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. If the letter of credit is drawn upon the company creates a loan for the customer with the same criteria associated with similar loans. The fair value of these commitments were estimated to be the fees charged to enter into similar agreements. The estimated fair value of these
commitments carried on the balance sheet was $41,000 and $23,000 at December 31, 2004 and 2003, respectively. These amounts are amortized to income over the life of the letters of credit, typically one year.
The company originates residential mortgage loans under agreements to sell such loans, generally with servicing released. At December 31, 2004 and 2003, the company had commitments to sell loans totaling $0.7 million and $2.8 million respectively.
The company manages its loan portfolio to avoid concentration by industry or loan size to minimize its credit risk exposure. Commercial loans may be collateralized by the assets underlying the borrower’s business such as accounts receivable, equipment, inventory and real property. Residential mortgage and home equity loans are secured by the real property financed. Consumer loans such as installment loans are generally secured by the personal property financed. Credit card loans are generally unsecured. Commercial real estate loans are generally secured by the underlying real property and rental agreements.
The bank is required to maintain in reserve certain amounts of vault cash and/or deposits with the Federal Reserve Bank of Boston. The amount of this reserve requirement, included in “Cash and Due from Banks”, was approximately $7.7 million and $4.8 million at December 31, 2004, and 2003.
The company is involved in various legal proceedings incidental to its business. After review with legal counsel, management does not believe resolution of any present litigation will have a material adverse effect on the financial condition or results of operations of the company.
(14) Massachusetts Department of Revenue Tax Dispute
The bank previously organized and controlled a real estate investment trust, Enterprise Realty Trust, Inc. (“ERT”), through which the bank held mortgages and mortgage-related securities. This ownership structure enabled the company to receive favorable Massachusetts state income tax treatment on the income earned on the assets held by ERT. This favorable tax treatment was initially disputed by the Massachusetts Department of Revenue (the “DOR”) in 2002 and subsequently eliminated on a retroactive basis back to 1999 by the Massachusetts legislature in March 2003.
As a result of the enactment of the legislation, in the first quarter of 2003 the company recorded income tax expense of $1.9 million, net of federal income tax benefit and deferred tax asset, for the tax years ended December 31, 1999 through 2002.
In June 2003 the DOR and the bank settled their dispute as to the tax amount owed for the tax years 1999 through 2002. Under the terms of the settlement the net income tax charge to the bank was approximately $1.1 million and, consequently, in June the bank recorded a credit to tax expense of approximately $0.8 million to reverse the excess reserve taken in March.
In addition, beginning with the first quarter of 2003 and continuing through September 30, 2003, the company recorded state income tax liability on the income earned on the assets held by ERT. On September 30, 2003 the company dissolved ERT and all ERT assets were transferred in liquidation to the bank. The company will continue to record state income tax liability on the income earned on these additional assets held by the bank.
(15) Fair Values of Financial Instruments
The following methods and assumptions were used by the company in estimating fair values of its financial instruments:
The respective carrying values of certain financial instruments approximated their fair value, as they were short-term in nature or payable on demand. These include cash and due from banks, total short-term investments, accrued interest receivable, repurchase agreements, accrued interest payable and non-certificate deposit accounts.
Investments: Fair values for investments were based on quoted market prices, where available. If quoted market prices were not available, fair values were based on quoted market prices of comparable instruments. The carrying amount of FHLB stock reported approximates fair value. If the FHLB stock is redeemed, the company will receive an amount equal to the par value of the stock.
Loans: The fair values of loans, was determined using discounted cash flow analysis, using interest rates currently being offered by the company. The incremental credit risk for non-accrual loans was considered in the determination of the fair value of the loans.
Commitments: The fair values of the unused portion of lines of credit and letters of credit were estimated to be the fees currently charged to enter into similar agreements. Commitments to originate non-mortgage loans were short-term and were at current market rates and estimated to have no significant change in fair value.
Financial liabilities: The fair values of time deposits and FHLB borrowings were estimated using discounted cash flow analysis using rates offered by the bank, or advance rates offered by the FHLB on December 31, 2004 for similar instruments. The fair value of junior subordinated debentures was estimated using discounted cash flow analysis using a market rate of interest at December 31, 2004.
Limitations: The estimates of fair value of financial instruments were based on information available at December 31, 2004 and 2003 and are not indicative of the fair market value of those instruments at the date this report is published. These estimates do not reflect any premium or discount that could result from offering for sale at one time the company’s entire holdings of a particular financial instrument. Because no active market exists for a portion of the company’s financial instruments, fair value estimates were based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates were based on existing on- and off-balance sheet financial instruments without an attempt to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments, including premises and equipment and foreclosed real estate.
In addition, the tax ramifications related to the realization of the unrealized appreciation and depreciation can have a significant effect on fair value estimates and have not been considered in any of the estimates. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the company.
(16) Parent Company Only Financial Statements
Balance Sheets
Statements of Income
Statements of Cash Flows
Cash and cash equivalents include cash and due from subsidiary.
(17) Quarterly Results of Operations (Unaudited)
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
The Board of Directors and Stockholders
Enterprise Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Enterprise Bancorp, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 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 financial position of Enterprise Bancorp, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Enterprise Bancorp, Inc. and subsidiaries internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 11, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Stockholders
Enterprise Bancorp, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Enterprise Bancorp, Inc. and subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Enterprise Bancorp, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Enterprise Bancorp, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Enterprise Bancorp, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)”.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Enterprise Bancorp, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 11, 2005 expressed an unqualified opinion on those consolidated financial statements.
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The company maintains a set of disclosure controls and procedures designed to ensure that the information required to be disclosed in reports that it files or submits to the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
The company carried out an evaluation as of the end of the period covered by this report, under the supervision and with the participation of the company’s management, including its chief executive officer and chief financial officer, of the effectiveness of the design and operation of the company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon that evaluation, the company’s chief executive officer and chief financial officer concluded that the company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the company (including its consolidated subsidiaries) required to be included in the company’s periodic SEC filings.
Management’s Report on Internal Control Over Financial Reporting
The company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. The company’s internal control system was designed to provide reasonable assurance to the company’s management and board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, however, no matter how well designed, have inherent limitations and may not prevent or detect misstatement. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The company’s management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2004. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control-Integrated Framework.” Based on management’s assessment, the company believes that, as of December 31, 2004, the company’s internal control over financial reporting is effective based on those criteria.
The company’s independent registered public accounting firm has issued an audit report on management’s assessment of the company’s internal control over financial reporting, which appears on page 79 of this report.
Changes in Internal Controls Over Financial Reporting
There has been no change in the company’s internal controls over financial reporting that has occurred during the company’s most recent fiscal quarter (i.e., the three months ended December 31, 2004) that has materially affected, or is reasonably likely to materially affect, such internal controls.
Item 9B.
Item 9B. Other Information
None
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Certain information regarding directors, executive officers and significant employees of the company and compliance with Section 16(a) of the Securities Exchange Act of 1934, in response to this item, is incorporated herein by reference from the definitive proxy statement for the company’s annual meeting of stockholders to be held May 3, 2005, which it expects to file with the Securities and Exchange Commission within 120 days of the end of the fiscal year covered by this report.
The company maintains a code of business conduct and ethics. This code applies to every director, officer (including the chief executive officer, chief financial officer and chief accounting officer) and employee of the company and its subsidiaries. The code is available on the company’s website: www.ebtc.com
Directors of the Company
George L. Duncan
Chairman and Chief Executive Officer of the Company and the Bank
Richard W. Main
President of the Company and President and Chief Lending Officer of the Bank
John P. Clancy, Jr.
Executive Vice President and Chief Operating Officer of the Company and the Bank and Chief
Investment Officer of the Bank
Walter L. Armstrong
Retired; former Executive Vice President of the Bank
Kenneth S. Ansin
President, Norwood Cabinet Company
Gerald G. Bousquet, M.D.
Physician; director and partner in several health care entities
Kathleen M. Bradley (audit committee)
Retired; former owner, Westford Sports Center, Inc.
John R. Clementi
President, Plastican, Inc., a plastic shipping container manufacturer, and President,
Holiday Housewares, Inc., a consumer storage products manufacturer
James F. Conway, III
Chairman, Chief Executive Officer and President
Courier Corporation, a commercial printing company
Dr. Carole A. Cowan (audit committee)
President, Middlesex Community College
Nancy L. Donahue
Chair of the Board of Trustees, Merrimack Repertory Theatre
Lucy A. Flynn (audit committee)
Marketing and Communications Executive, Raytheon Company
Eric W. Hanson
Chairman and President, D.J. Reardon Company, Inc., a beer distributorship
John P. Harrington (audit committee)
Energy Consultant for Tennessee Gas Pipeline Company
Arnold S. Lerner
Vice Chairman of the Company and the Bank
Director, Courier Corporation, a commercial printing company
Charles P. Sarantos
Assistant Clerk of the Company and the Bank
Michael A. Spinelli
Clerk of the Company and the Bank
Owner, Merrimack Travel Service
International Tourism Consultant for Mike Spinelli International
and Chairman Emeritus of Vacation.com
Nickolas Stavropoulos (audit committee chairman and audit committee financial expert)
Executive Vice President of KeySpan Corporation
President of KeySpan Energy Delivery
Additional Executive Officers of the Company
Items 11, 12, 13 and 14.
Other than the information provided below, with respect to Item 12, the information required in Items 11, 12, 13 and 14 of this part is incorporated herein by reference to the company’s definitive proxy statement for its annual meeting of stockholders to be held May 3, 2005, which it expects to file with the Securities and Exchange Commission within 120 days of the end of the fiscal year covered by this report.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2004 with respect to the Company’s 1988 Stock Option Plan, Amended and Restated 1998 Stock Incentive Plan and 2003 Stock Incentive Plan, which together constitute all of the Company’s existing equity compensation plans that have been previously approved by the Company’s stockholders. The Company does not have any existing equity compensation plans, including any existing individual equity compensation arrangements, which have not been previously approved by the Company’s stockholders.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this annual report:
Financial Statements
See Index to Consolidated Financial Statements contained in Item 8 above.
Financial Statement Schedules
None (information included in financial statements)
Exhibits
Exhibit No. and Description
2.1
Purchase and Assumption Agreement dated as of September 22, 1999 by and among Fleet Financial Group, Inc., Fleet National Bank, Enterprise Bancorp, Inc. and Enterprise Bank and Trust Company (exclusive of disclosure schedules), incorporated by reference to Exhibit 2.1 to the company’s Form 10-Q for the quarter ended September 30, 1999.
3.1
Restated Articles of Organization of the Company, as amended through May 10, 1999, incorporated by reference to Exhibit 3.1 to the company’s Form 10-Q for the quarter ended March 31, 1999.
3.2
Amended and Restated Bylaws of the company, incorporated by reference to Exhibit 3.1 to the company’s Form 10-QSB for the quarter ended June 30, 1997.
4.1
Rights Agreement dated as of January 13, 1998 between Enterprise Bancorp, Inc. and Enterprise Bank and Trust Company, as Rights Agent, incorporated by reference to Exhibit 4.1 to the company’s Registration Statement on Form 8-A filed on January 14, 1998.
4.2
Terms of Series A Junior Participating Preferred Stock, incorporated by reference to Exhibit 4.2 to the company’s Registration Statement on Form 8-A filed on January 14, 1998.
4.3
Summary of Rights to Purchase Shares of Series A Junior Participating Preferred Stock, incorporated by reference to Exhibit 4.3 to the company’s Registration Statement on Form 8-A filed on January 14, 1998.
4.4
Form of Rights Certificate, incorporated by reference to Exhibit 4.4 to the company’s Registration Statement on Form 8-A filed on January 14, 1998.
10.1
Lease agreement dated July 22, 1988, between the bank and First Holding Trust relating to the premises at 222 Merrimack Street, Lowell, Massachusetts, incorporated by reference to Exhibit 10.1 to the company’s Form 10-QSB for the quarter ended June 30, 1996.
10.2
Amendment to lease dated December 28, 1990, between the bank and First Holding Trust for and relating to the premises at 222 Merrimack Street, Lowell, Massachusetts, incorporated by reference to Exhibit 10.2 to the company’s Form 10-QSB for the quarter ended June 30, 1996.
10.3
Amendment to lease dated August 15, 1991, between the bank and First Holding Trust for 851 square feet relating to the premises at 222 Merrimack Street, Lowell, Massachusetts, incorporated by reference to Exhibit 10.3 to the company’s Form 10-QSB for the quarter ended June 30, 1996.
10.4
Lease agreement dated May 26, 1992, between the bank and Shawmut Bank, N.A., for 1,458 square feet relating to the premises at 170 Merrimack Street,
Lowell, Massachusetts, incorporated by reference to Exhibit 10.4 to the company’s Form 10-QSB for the quarter ended June 30, 1996.
10.5
Lease agreement dated March 14, 1995, between the bank and North Central Investment Limited Partnership for 3,960 square feet related to the premises at 2-6 Central Street, Leominster, Massachusetts, incorporated by reference to Exhibit 10.5 to the company’s Form 10-QSB for the quarter ended June 30, 1996.
10.6
Employment Agreement dated as of June 1, 2001 by and among the company, the bank and George L. Duncan, incorporated by reference to Exhibit 10.41 to the company’s Form 10-Q for the quarter ended June 30, 2001.
10.7
Employment Agreement dated as of June 1, 2001 by and among the company, the bank and Richard W. Main, incorporated by reference to Exhibit 10.42 to the company’s Form 10-Q for the quarter ended June 30, 2001.
10.8
Lease agreement dated June 20, 1996, between the bank and Kevin C. Sullivan and Margaret A. Sullivan for 4,800 square feet related to the premises at 910 Andover Street, Tewksbury, Massachusetts, incorporated by reference to Exhibit 10.10 to the company’s Form 10-KSB for the year ended December 31, 1996.
10.9
Split Dollar Agreement for George L. Duncan, incorporated by reference to Exhibit 10.13 to the company’s Form 10-KSB for the year ended December 31, 1996.
10.10
Lease agreement dated April 7, 1993 between the bank and Merrimack Realty Trust for 4,375 square feet relating to premises at 21-27 Palmer Street, Lowell, Massachusetts, incorporated by reference to Exhibit 10.12 to the company’s Form 10-KSB for the year ended December 31, 1997.
10.11
Lease agreement dated September 1, 1997, between the bank and Merrimack Realty Trust to premises at 129 Middle Street, Lowell, Massachusetts, incorporated by reference to Exhibit 10.13 to the company’s Form 10-KSB for the year ended December 31, 1997.
10.12
Lease agreement dated May 2, 1997 between the bank and First Lakeview Avenue Limited Partnership to premises at 1168 Lakeview Avenue, Dracut, Massachusetts, incorporated by reference to Exhibit 10.14 to the company’s Form 10-KSB for the year ended December 31, 1997.
10.13
Enterprise Bancorp, Inc. 1988 Stock Option Plan, incorporated by reference to Exhibit 10.15 to the company’s Form 10-KSB for the year ended December 31, 1997.
10.14
Enterprise Bancorp, Inc. Amended and Restated 1998 Stock Incentive Plan, incorporated by reference to Exhibit 4.1 to the company’s Registration Statement on Form S-8 (Reg. No. 333-60036), filed May 2, 2001.
10.15
Enterprise Bancorp, Inc. automatic dividend reinvestment plan, incorporated by reference to the section of the company’s Registration Statement on Form S-3 (Reg. No. 333-79135), filed May 24, 1999, appearing under the heading “The Plan”.
10.16
Split Dollar Agreement for Richard W. Main, incorporated by reference to Exhibit 10.17 to the company’s Form 10-Q for the quarter ended March 31, 1999.
10.17
Split Dollar Agreement for Robert R. Gilman, incorporated by reference to Exhibit 10.18 to the company’s Form 10-Q for the quarter ended March 31, 1999.
10.18
Additional Split Dollar Agreement for George L. Duncan, incorporated by reference to Exhibit 10.40 to the company’s Form 10-K for the year ended December 31, 1999.
10.19
Change in Control/Noncompetition Agreement dated as of July 17, 2001 by and among the company, the bank and Diane J. Silva, incorporated by reference to Exhibit 10.43 to the company’s Form 10-Q for the quarter ended September 30, 2001.
10.20
Change in Control/Noncompetition Agreement dated as of July 17, 2001 by and among the company, the bank and Brian H. Bullock, incorporated by reference to Exhibit 10.44 to the company’s Form 10-Q for the quarter ended September 30, 2001.
10.21
Change in Control/Noncompetition Agreement dated as of August 1, 2001 by and among the company, the bank and Robert R. Gilman, incorporated by reference to Exhibit 10.45 to the company’s Form 10-Q for the quarter ended September 30, 2001.
10.22
Change in Control/Noncompetition Agreement dated as of August 7, 2001 by and among the company, the bank and Chester J. Szablak Jr., incorporated by reference to Exhibit 10.46 to the company’s Form 10-Q for the quarter ended September 30, 2001.
10.23
Change in Control/Noncompetition Agreement dated as of April 3, 2002 by and among the company, the bank and Stephen J. Irish, incorporated by reference to Exhibit 10.23 to the company’s Form 10-Q for the quarter ended March 31, 2002.
10.24
Change in Control/Noncompetition Agreement dated as of April 20, 2003 by and among the company, the bank and Christopher W. McCarthy incorporated by reference to Exhibit 10.24 to the company’s Form 10-Q for the quarter ended March 31, 2003.
10.25
Enterprise Bancorp, Inc. 2003 Stock Incentive Plan, incorporated by reference to Exhibit 4 to the company’s Registration Statement on Form S-8 (Reg. No. 333-105079) filed May 8, 2003.
10.26
Lease agreement dated November 24, 2003, between the bank and Park Street Village Realty Trust for 1,678 square feet related to the premises at Park Street Village, Andover, Massachusetts, incorporated by reference to Exhibit 10.26 to the company’s Form 10-K for the year ended December 31, 2003.
10.27
Change in Control/Noncompetition Agreement dated as of December 15, 2003 by and among the company, the bank and Paul M. O’Connell, Jr., incorporated by reference to Exhibit 10.27 to the company’s Form 10-K for the year ended December 31, 2003.
10.28
Amended and Restated Employment Agreement dated as of January 1, 2004 made by and among the company, the bank and George L. Duncan, incorporated by reference to Exhibit 10.28 to the company’s Form 10-K for the year ended December 31, 2003.
10.29
Amended and Restated Employment Agreement dated as of January 1, 2004 made by and among the company, the bank and Richard W. Main, incorporated by reference to Exhibit 10.29 to the company’s Form 10-K for the year ended December 31, 2003.
10.30
Lease agreement dated January 20, 2004, between the bank and M K Realty Trust for 3,745 square feet of space related to the premises located at 1120 Main Street, Tewksbury, Massachusetts, incorporated by reference to Exhibit 10.30 to the company’s Form 10-K for the year ended December 31, 2003.
10.31
Lease agreement dated January 28, 2004, between the bank and Lally II Realty Trust related to premises located at 8 and 8R High Street, Andover, Massachusetts, incorporated by reference to Exhibit 10.31 to the company’s Form 10-Q for the quarter ended March 31, 2004.
10.32
Employment Agreement dated April 1, 2004 by and among the company, the bank and John P. Clancy, Jr., incorporated by reference to Exhibit 10.32 to the company’s Form 10-Q for the quarter ended March 31, 2004.
10.33
Lease agreement dated September 15, 2004, between the bank and E-Point, LLC related to premises located at 130 Main Street, Salem, New Hampshire, incorporated by reference to Exhibit 10.33 to the company’s Form 10-Q for the quarter ended June 30, 2004.
10.34
Amendment No.1 dated as of December 31, 2004 to Amend and Restate Employment Agreement dated January 1, 2004 by and among the company, the bank and Richard W. Main, incorporated by reference to Exhibit 10.34 to the company’s Form 8-K filed on January 3, 2005.
10.35
Amendment No.1 dated as of December 31, 2004 to Employment Agreement dated April 1, 2004 by and among the company, the bank and John P. Clancy, Jr., incorporated by reference to Exhibit 10.35 to the company’s Form 8-K filed on January 3, 2005.
10.36
Enterprise Bancorp, Inc. Executive Officer Supplemental Bonus Plan, incorporated by reference to Exhibit 10.36 to the company’s Form 8-K filed on January 27, 2005.
10.37
Description of directors’ compensation (as of December 31, 2004).
10.38.1
Specimen Incentive Stock Option Agreement for executive officers under Enterprise Bancorp, Inc. Amended and Restated 1998 Stock Incentive Plan and 2003 Stock Incentive Plan.
10.38.2
Specimen Nonqualified Stock Option Agreement for executive officers under Enterprise Bancorp, Inc. Amended and Restated 1998 Stock Incentive Plan and 2003 Stock Incentive Plan.
21.0
Subsidiaries of the Registrant.
23.0
Consent of KPMG LLP.
31.1
Certification of principal executive officer under Securities and Exchange Act Rule 13a-14(a)
31.2
Certification of principal financial officer under Securities and Exchange Act Rule 13a-14(a)
32.0
Certification of principal executive officer and principal financial officer under 18 U.S.C § 1350 furnished pursuant to Securities and Exchange Act Rule 13a-14(b)
(b) Reports on Form 8-K
Current Report on Form 8-K filed on October 27, 2004 providing disclosure under Item 2.02 (Results of Operation and Financial Condition) and Item 7.01 (Regulation FD Disclosure), including the company’s statements of income for the three and nine months ended September 30, 2004 and 2003 and balance sheets at September 30, 2004, December 31, 2003 and September 30, 2003.
Current Report on Form 8-K filed on January 3, 2005 providing disclosure under Item 1.01 (Entry into a Material Definitive Agreement), Item 5.02 (Departure of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers) and Item 8.01 (Other Events) regarding certain changes in title with respect to two of the registrant’s executive officers, effective December 31, 2004, including amendments to the two executive officers’ employment agreements.
Current Report on Form 8-K filed on January 27, 2005 providing disclosure under Item 1.01 (Entry into a Material Definitive Agreement), regarding adoption by the Compensation and Personnel Committee of the company’s Board of Directors of an Executive Officer Supplemental Bonus Plan, including a copy of such plan.
Current Report on Form 8-K filed on February 4, 2005 providing disclosure under Item 2.02 (Results of Operations and Financial Condition), and Item 7.01 (Regulation FD Disclosure),including the company’s statements of income for the three and twelve months ended December 31, 2004 and 2003 and balance sheets at December 31, 2004 and December 31, 2003 and regarding the company’s intention to list its shares of common stock for trading on the NASDAQ National Market.
(c) Exhibits required by Item 601 of Regulation S-K
The exhibits listed above either have been previously filed and are incorporated herein by reference to the applicable prior filing or are filed herewith.
(d) Additional Financial Statement Schedules
None
ENTERPRISE BANCORP, INC.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ George L. Duncan
Chairman, Chief Executive Officer
March 14, 2005
George L. Duncan
and Director
/s/ James A. Marcotte
Executive Vice President, Chief
March 14, 2005
James A. Marcotte
Financial Officer and Treasurer
/s/ Joseph R. Lussier
(Principal Accounting Officer of the Bank)
March 14, 2005
Joseph R. Lussier
/s/ Kenneth S. Ansin
Director
March 14, 2005
Kenneth S. Ansin
/s/ Walter L. Armstrong
Director
March 14, 2005
Walter L. Armstrong
/s/ Gerald G. Bousquet, M.D.
Director
March 14, 2005
Gerald G. Bousquet, M.D.
/s/ Kathleen M. Bradley
Director
March 14, 2005
Kathleen M. Bradley
/s/ John P. Clancy, Jr.
Director, Executive Vice President
March 14, 2005
John P. Clancy Jr.
/s/ John R. Clementi
Director
March 14, 2005
John R. Clementi
/s/ James F. Conway, III
Director
March 14, 2005
James F. Conway, III
/s/ Carole A. Cowan
Director
March 14, 2005
Carole A. Cowan
/s/ Nancy L. Donahue
Director
March 14, 2005
Nancy L. Donahue
/s/ Lucy A. Flynn
Director
March 14, 2005
Lucy A. Flynn
/s/ Eric W. Hanson
Director
March 14, 2005
Eric W. Hanson
/s/ John P. Harrington
Director
March 14, 2005
John P. Harrington
/s/ Arnold S. Lerner
Director, Vice Chairman
March 14, 2005
Arnold S. Lerner
/s/ Richard W. Main
Director, President
March 14, 2005
Richard W. Main
/s/ Charles P. Sarantos
Director, Assistant Clerk
March 14, 2005
Charles P. Sarantos
/s/ Michael A. Spinelli
Director, Clerk
March 14, 2005
Michael A. Spinelli
/s/ Nickolas Stavropoulos
Director
March 14, 2005
Nickolas Stavropoulos