ITEM 1 BUSINESS
Chittenden Corporation (the “Company” or “Chittenden”), a Vermont corporation organized in 1971, is a registered bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 2006, the Company had total consolidated assets of approximately $6.4 billion. The Company is the holding company parent and owns 100% of the outstanding common stock of Chittenden Trust Company (“CTC”), Flagship Bank and Trust Company (“FBT”), The Bank of Western Massachusetts (“BWM”), Maine Bank & Trust (“MBT”), and Ocean National Bank (“ONB”) (collectively the “Banks”).
The following table summarizes Chittenden’s acquisition history since 1994. The acquisitions of Vermont Financial Services Corp. and Granite State Bancshares, Inc. are also included as they were significant transactions that were merged into the Company’s existing franchise banks:
(1) These acquisitions have been accounted for as purchases and accordingly, the results of operations of the acquired companies are included in the financial statements from their dates of acquisition.
(2) These acquisitions were accounted for as poolings of interests and accordingly, all financial data was restated to reflect the combined financial condition and results of operations as if these acquisitions were in effect for all periods presented.
(3) United Bank merged into The Bank of Western Massachusetts in the third quarter of 1999. Vermont National Bank merged into Chittenden Trust Company in the first quarter of 2000.
(4) Granite Bank merged into Ocean National Bank in the second quarter of 2004.
(5) On January 19, 2007 Chittenden announced the acquisition of Merrill Merchants Bancshares, Inc, and its subsidiary Merrill Merchants Bank, for approximately $111.4 million in cash and stock. The acquisition is expected to close in the second quarter of 2007.
The Company engages in one line of business, that of providing financial services through its banking subsidiaries. Through its subsidiaries, the Company offers a variety of lending services, with loans totaling approximately $4.7 billion at December 31, 2006. The largest loan categories are commercial loans and residential real estate loans. Commercial loans include the following loan categories: commercial & industrial, municipal, multi-family, commercial real estate and construction. Commercial loans amounted to approximately 72% of the total loans outstanding at December 31, 2006.
Residential real estate loans include those collateralized by 1-4 family units and home equity lines of credit, comprised 23% of total loans outstanding at December 31, 2006. The Company underwrites its residential mortgages based upon secondary market standards and sells substantially all of its fixed-rate residential mortgage loans on a servicing-retained basis. Private banking residential mortgage loans are made primarily to commercial and wealth management customers and are typically held in portfolio. These loans generally do not meet secondary market underwriting standards. Consumer loans at December 31, 2006 were 5% of total loans outstanding. Approximately 86% of these loans were indirect installment loans while the remaining loans consisted of direct installment and revolving credit.
The Company’s lending activities are conducted primarily in Vermont, Massachusetts, New Hampshire and Maine, with additional activity related to nearby market areas in New York, Connecticut, and Quebec. In addition to the portfolio diversification described above, the loans are diversified by borrowers and industry groups. In making commercial loans, the Company occasionally solicits the participation of other banks. The Company also occasionally participates in loans originated by other banks. Certain of the Company’s commercial loans are made under programs administered by the U.S. Small Business Administration, U.S. Department of Agriculture Rural Development or other local government agencies within the Company’s markets. Loan terms generally include repayment guarantees by the agency involved in varying amounts up to 90% of the original loan amount.
The Banks offer a wide range of banking services, including the acceptance of demand, savings, NOW, money market, cash management and time deposits. As of December 31, 2006, the Banks had total interest-bearing deposits of approximately $4.5 billion and noninterest-bearing demand deposits of approximately $967 million. The Banks also provide personal trust services, including services as executor, trustee, administrator, custodian and guardian. Corporate trust services are also provided, including services as trustee for pension and profit sharing plans. Asset management services are also provided for both personal and corporate clients. Wealth management assets under administration totaled $9.0 billion at December 31, 2006, which included $2.1 billion under full discretionary management.
The Company also provides various business services including payroll processing, business credit cards, merchant credit card processing, and cash management. Financial and investment counseling is provided to municipalities and school districts within the Company’s service area, as well as central depository, lending, and other banking services. The Banks offer a variety of other services including safe deposit facilities, certain non-deposit investment products through the brokerage services of Chittenden Securities, LLC, and various insurance related products through Chittenden Insurance Group, LLC. Chittenden Securities and Chittenden Insurance Group are subsidiaries of Chittenden Trust Company.
The Company’s principal executive offices are located at Two Burlington Square, Burlington, Vermont 05401; telephone number: 802-658-4000.
CHITTENDEN TRUST COMPANY
CTC was chartered by the Vermont Legislature as a commercial bank in 1904. It is the largest bank headquartered in Vermont, based on total assets of approximately $3.3 billion, total loans of approximately $2.3 billion and total deposits of approximately $2.9 billion at December 31, 2006. CTC’s principal offices are located in Burlington, Vermont and it has fifty additional locations in Vermont. The trade name “Chittenden Bank” is used at all locations. The Company operates its mortgage banking and servicing operations under the “Chittenden Mortgage Services” trade name.
CTC has a registered broker/dealer subsidiary, Chittenden Securities, LLC. (“CSC”). A full service broker-dealer registered with the Securities and Exchange Commission (SEC), CSC is a member of the National Association of Securities Dealers, Inc. (NASD) and the Securities Investor Protection Corporation (SIPC). CSC operates throughout the locations of the CTC franchise as well as at locations of the other Banks.
CTC, through its subsidiary Chittenden Insurance Group, LLC (“CIG”), offers various insurance related products including commercial, personal and life/health policies, as well as specialized coverages and risk management services. CTC, through its subsidiary Chittenden Commercial Finance based in Montreal, Quebec, offers commercial finance lending services in Canada. CTC also provides these services directly throughout Northern New England and Massachusetts.
THE BANK OF WESTERN MASSACHUSETTS
BWM was chartered by the Commonwealth of Massachusetts as a commercial bank in 1986. At December 31, 2006, BWM had total assets of $765 million, total loans of $692 million and total deposits of $636 million. BWM’s principal offices are located in Springfield, Massachusetts and it has thirteen additional locations in western Massachusetts and Connecticut.
FLAGSHIP BANK AND TRUST COMPANY
FBT was chartered by the Commonwealth of Massachusetts as a commercial bank in 1986. At December 31, 2006, FBT had total assets of $525 million, total loans of $357 million and total deposits of $475 million. FBT’s principal offices are located in Worcester, Massachusetts and it has seven additional locations in the greater Worcester, Massachusetts area.
MAINE BANK & TRUST
MBT was chartered by the State of Maine as a commercial bank in 1991. At December 31, 2006, MBT had total assets of $383 million, total loans of $288 million and total deposits of $318 million. MBT’s principal offices are located in Portland, Maine and it has eleven additional locations in southern Maine.
OCEAN NATIONAL BANK
ONB is a federally chartered commercial bank founded in 1854. At December 31, 2006, ONB had total assets of $1.6 billion, total loans of $1.0 billion and total deposits of $1.2 billion. ONB’s principal offices are located in Portsmouth, New Hampshire and it has thirty-seven additional locations in southern Maine and New Hampshire.
ECONOMY
The Northern New England economy continues to expand at a modest pace. Commercial businesses are generally performing well, and experiencing moderate growth. Meanwhile, retail sales sagged from a year ago due to a disappointing holiday season and by the housing slowdown. The residential real estate market slowed during 2006, reflecting the changing economic conditions. The slower sales pace has translated into comparatively higher amounts of inventory across the region. The ability and willingness of the Company’s borrowers to honor their repayment commitments are impacted by many factors, including the prevailing market interest rates and the level of overall economic activity within the borrowers’ geographic area. See “Risk Factors” in Part I, Item 1A
ITEM 1A RISK FACTORS
The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us and our business. If any of these risks were to occur, our business, financial condition or results of operations could be materially and adversely affected.
We face significant competition for banking services in New England, our primary market, and in the local markets in which we operate. Competition in the local banking industries may limit our ability to attract and retain customers. We may face competition now and in the future from the following: other banking institutions, including larger New England and other commercial banking organizations; savings banks; credit unions; other financial institutions; and non-bank financial services companies serving New England and adjoining areas.
In particular, our competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with higher capitalization and financial intermediaries not subject to bank regulatory restrictions have bigger lending limits,
which enable them to serve the credit needs of larger customers. We also face competition from out-of-state financial intermediaries that have opened low-end production offices or that solicit deposits in our respective market areas. If we are unable to attract and retain banking customers we may be unable to continue our loan growth and level of deposits and our results of operations and financial condition may otherwise be negatively affected.
In the past, we have expanded our operations into non-banking activities such as asset management and wealth advisory services, insurance-related products, credit cards, payroll processing and brokerage services. We may have difficulty competing with more established providers of these products and services due to the intense competition in many of these industries, especially in the New England region. In addition, we may be unable to attract and retain non-banking customers due to a lack of market and product knowledge or other industry specific matters or an inability to attract and retain qualified, experienced employees. Our failure to attract and retain customers with respect to these non-banking activities could negatively impact our future earnings.
Our main source of income from operations is net interest income, which is equal to the difference between the interest income received on loans, investment securities and other interest-bearing assets and the interest expense incurred in connection with deposits, borrowings and other interest-bearing liabilities. As a result, our net interest income can be affected by changes in market interest rates. These rates are highly sensitive to many factors beyond our control, including general economic conditions, both domestic and foreign, and the monetary and fiscal policies of various governmental and regulatory authorities. We have adopted asset and liability management policies to try to minimize the potential adverse effects of changes in interest rates on our net interest income, primarily by altering the mix and maturity of loans, investments and funding sources. However, even with these policies in place, we cannot provide assurance that changes in interest rates will not negatively impact our operating results.
An increase in interest rates also could have a negative impact on our business by reducing the ability of borrowers to repay their current loan obligations, which could not only result in increased loan defaults, foreclosures and write-offs, but also necessitate further increases to our allowance for loan losses. Increases in interest rates also may reduce the demand for loans and, as a result, the amount of loan and commitment fees. In addition, fluctuations in interest rates may result in disintermediation, which is the flow of funds away from depository institutions into direct investments that pay higher rates of return, and may affect the value of our investment securities and other interest-earning assets.
If our customers default on the repayment of their loans, our profitability could be adversely affected. A borrower’s default on its obligations under one or more of our loans may result in lost principal and interest income and increased operating expenses as a result of the allocation of management time and resources to the collection and work-out of the loans. If collection efforts are unsuccessful or acceptable workout arrangements cannot be reached, we may have to write-off the loans in whole or in part. Although we may acquire any real estate or other assets that secure the defaulted loans through foreclosure or other similar remedies, the amount owed under the defaulted loans may exceed the value of the assets acquired.
Our management periodically makes a determination of our allowance for loan losses based on available information, including the quality of our loan portfolio, economic conditions, the value of the underlying collateral and the level of our non-accruing loans. If our assumptions prove to be incorrect, our allowance may not be sufficient. Increases in this allowance will result in an expense for the period. If, as a result of general economic conditions or an increase in non-performing loans, management determines that an increase in our allowance for loan losses is necessary, we may incur additional expenses.
In addition, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses and the value we attribute to real estate acquired through foreclosure or other similar remedies. These regulatory agencies may require us to adjust our determination of the value for these items. These adjustments could negatively impact our results of operations or financial condition.
Because we serve primarily individuals and smaller businesses located in New England and adjoining areas, the ability of our customers to repay their loans is impacted by the economic conditions in these areas. As of December 31, 2006, approximately 72% of our loan portfolio consisted of commercial loans, defined as commercial and industrial, municipal, multi-family, commercial real estate and construction loans. Thus, our results of operations, both in terms of the origination of new loans and the potential default of existing loans, is heavily dependent upon the strength of local businesses.
In addition, a substantial portion of our loans are secured by real estate located primarily in Vermont, Massachusetts, New Hampshire and Maine. Consequently, our ability to continue to originate real estate loans may be impaired by adverse changes in local and regional economic conditions in these real estate markets or by acts of nature. These events also could have an adverse effect on the value of our collateral and, due to the concentration of our collateral in real estate, on our financial condition.
We have traditionally obtained funds principally through deposits and borrowings. As a general matter, deposits are a cheaper source of funds than borrowings, because interest rates paid for deposits are typically less than interest rates charged for borrowings. If, as a result of competitive pressures, market interest rates, general economic conditions or other events, the balance of our deposits decreases relative to our overall banking operations, we may have to rely more heavily on borrowings as a source of funds in the future. Such an increased reliance on borrowings could have a negative impact on our results of operations or financial condition.
In the course of our business, we may acquire, through foreclosure, properties securing loans that are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, we might be required to remove these substances from the affected properties at our sole cost and expense. The cost of this removal could substantially exceed the value of the affected properties. We may not have adequate remedies against the prior owners or other responsible parties and could find it difficult or impossible to sell the affected properties. The occurrence of one or more of these events could adversely affect our financial condition or operating results.
Bank holding companies and state and federally chartered banks operate in a highly regulated environment and are subject to supervision and examination by federal and state regulatory agencies. We are subject to the Bank Holding Company Act of 1956, as amended, and to regulation and supervision by the Federal Reserve Board, or FRB. Our state chartered banks are subject to regulation and supervision by the Federal Deposit Insurance Corporation, or FDIC, and the applicable state banking authorities, including the Vermont Commissioner of Banking, Insurance, Securities and Health Care Administration, the Maine Superintendent of the Bureau of Banking and the Massachusetts Commissioner of Banks. Our national bank subsidiary is subject to regulation by the Office of the Comptroller of the Currency, or the OCC. The cost of compliance with regulatory requirements may adversely affect our results of operations or financial condition. Federal and state laws and regulations govern numerous matters including: changes in the ownership or control of banks and bank holding companies; maintenance of adequate capital and the financial condition of a financial institution; permissible types, amounts and terms of extensions of credit and investments; permissible non-banking activities; the level of reserves against deposits; and restrictions on dividend payments.
The FDIC, the OCC and state banking authorities possess cease and desist powers to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the FRB possesses similar powers with respect to bank holding companies. These and other restrictions limit the manner in which we may conduct our business and obtain financing.
Furthermore, our banking business is affected not only by general economic conditions, but also by the monetary policies of the FRB. Changes in monetary or legislative policies may affect the interest rates we must offer to attract deposits and the interest rates we can charge on our loans, as well as the manner in which we offer deposits and make loans. These monetary policies have had, and are expected to continue to have, significant effects on the operating results of depository institutions, including our banks.
We will continue to consider the acquisition of other businesses. However, we may not have the opportunity to make suitable acquisitions on favorable terms in the future, which could negatively impact the growth of our business. We expect that other banking and financial companies will compete with us to acquire compatible businesses. This competition could increase prices for acquisitions that we would likely pursue, and our competitors may have greater resources than us. Also, acquisitions of regulated businesses such as banks are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to complete an acquisition that we believe is in our best interests.
We have in the past acquired, and will in the future consider the acquisition of, other banking and related businesses. If we acquire other companies in the future, our business may be negatively impacted by risks related to those acquisitions. These risks include the following: the risk that the acquired business will not perform in accordance with management’s expectations; the risk that difficulties will arise in connection with the integration of the operations of the acquired business with our operations; the risk that management will divert its attention from other aspects of our business; the risk that we may lose key employees of the acquired business; the risks associated with entering into geographic and product markets in which we have limited or no direct prior experience; and the risks of the acquired company that we may assume in connection with an acquisition.
As a result of these risks, any given acquisition, if and when consummated, may adversely affect our results of operations or financial condition. In addition, because the consideration for an acquisition may involve cash, debt or the issuance of shares of our common stock and may involve the payment of a premium over book and market values, existing holders of our common stock could experience dilution in connection with the acquisition.
We rely heavily on communications and information systems to conduct our business. Any failure or interruptions or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposits, servicing or loan origination systems. The occurrence of any failures or interruptions could result in a loss of customer business and have a material adverse effect on our results of operations and financial condition.
Under regulatory capital adequacy guidelines and other regulatory requirements, we and our Banks must meet guidelines that include quantitative measures of assets, liabilities, and certain off-balance sheet items, subject to qualitative judgments by regulators about components, risk weightings and other factors. If we fail to meet these minimum capital guidelines and other regulatory requirements, our financial condition would be materially and adversely affected. Our failure to maintain the status of “well capitalized” under our regulatory framework could affect the confidence of our customers in us, thus compromising our competitive position. In addition, failure to maintain the status of “well capitalized” under our regulatory framework or “well managed” under regulatory examination procedures could compromise our status as a bank holding company and related eligibility for a streamlined review process for acquisition proposals.
ITEM 1B
ITEM 1B UNRESOLVED STAFF COMMENTS
None
ITEM 2
ITEM 2 PROPERTIES
The offices of the Company are located in a facility owned by CTC at Two Burlington Square in Burlington, Vermont. CTC’s principal offices are also located in Burlington, Vermont and it has fifty additional locations in Vermont and one commercial finance lending office in Montreal, Quebec. BWM’s principal offices are located in Springfield, Massachusetts and it has thirteen additional locations in western Massachusetts and Connecticut. FBT’s principal offices are located in Worcester, Massachusetts and it has seven additional locations in the greater Worcester, Massachusetts area. MBT’s principal offices are located in Portland, Maine and it has eleven additional locations in southern Maine. ONB’s principal offices are located in Portsmouth, New Hampshire and it
has thirty-seven additional locations in southern Maine and New Hampshire. The offices of all subsidiaries are in good physical condition with modern equipment and facilities considered by management to be adequate to meet the banking needs of customers in the communities served.
ITEM 3
ITEM 3 LEGAL PROCEEDINGS
A number of legal claims against the Company arising in the normal course of business were outstanding at December 31, 2006. Management, after reviewing these claims with legal counsel, is of the opinion that these matters, when resolved, will not have a material effect on the Company’s consolidated financial statements.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5
ITEM 5 MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
The $1 par value common stock of Chittenden Corporation has been publicly traded since 1974. As of January 31, 2007, there were 4,282 holders of record of the Company’s common stock.
The Company’s common stock trades on the NYSE under the symbol “CHZ”. The following table sets forth the range of the high and low sales prices for the Company’s common stock, and the dividends declared, for each quarterly period within the past two years.
For a discussion of dividend restrictions on the Company’s common stock, see “Dividends” under the caption “Business-Supervision and Regulation” in this report.
Share Repurchases. The following table sets forth information with respect to any purchase made by or on behalf of Chittenden or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) under the Exchange Act, of shares of Chittenden common stock during the indicated periods.
(1) On July 19, 2006, the Board of Directors authorized the repurchase of 1,000,000 shares of the Company’s common stock. The repurchase of the common stock may be done in negotiated transactions or open market purchases for two years from the date the repurchase plan was adopted.
(2) On January 18, 2007, the Board of Directors authorized an additional repurchase of 1,000,000 shares of the Company’s common stock. The repurchase of the common stock may be done in negotiated transactions or open market purchases over the next two years.
Stock Performance Graph. The following table provides a comparison, from December 31, 2001 through December 31, 2006, of the cumulative total stockholder return (assuming reinvestment of dividends) for Chittenden; the Standard & Poor’s 600 Small Cap Index; and the SNL $5B-$10B Bank Index. The historical information set forth below is not necessarily indicative of future performance.
Chittenden Corporation
The Company has used the S&P Small Cap 600 (of which the Corporation is a member) as its broad based market index. The Corporation presents the SNL $5B-$10B Bank Index as an industry specific index that is consistent with the Corporation’s current asset size. The Corporation’s total assets ranged from $4.2 billion at December 31, 2001 to $6.4 billion at December 31, 2006.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
(3) Common stock cash dividends declared divided by net income.
(4) Efficiency Ratio is computed by dividing total noninterest expense (less oreo expense, amortization expense, franchise tax and any nonrecurring items) by the sum of net interest income on a tax equivalent basis and total noninterest income (exclusive of gains and losses from bank investment securities, and nonrecurring items). The Company uses this non-GAAP measure, which is used widely in the banking industry, to provide important information regarding its operational efficiency.
(5) The sum of nonperforming assets (nonaccrual loans, restructured loans, and other real estate owned) divided by the sum of total loans and other real estate owned.
While the Company’s management uses non-GAAP measures for operational and investment decisions and believes that these measures are among several useful measures for understanding its operating results and financial condition, these measures should not be construed as a substitute for GAAP measures. Non-GAAP measures should be read and used in conjunction with the Company’s reported GAAP operating results and financial information.
ITEM 7
ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Years Ended December 31, 2006, 2005, and 2004
The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and accompanying notes and selected statistical information included in this report.
Application of Critical Accounting Policies
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included in Item 8 of this Form 10-K. The Company considers the following accounting policies and related estimates to be the most critical in their potential effect on its financial position or results of operations:
Allowance for Credit Losses. The allowance for credit losses consists of two components: (1) the allowance for loan losses and (2) the reserve for unfunded commitments. The allowance for loan losses is established through a charge against current earnings to the provision for credit losses. The allowance for loan losses is based on management’s estimate of the amount required to reflect the probable inherent losses in the loan portfolio, based on circumstances and conditions known at each reporting date in accordance with Generally Accepted Accounting Principles (“GAAP”). There are three components of the allowance for loan losses: 1) specific reserves for loans considered to be impaired or for other loans for which management considers a specific reserve to be necessary; 2) allocated reserves based upon management’s formula-based process for assessing the adequacy of the allowance for loan losses; and 3) a non-specific environmentally-driven allowance considered necessary by management based on its assessment of other qualitative factors. The allowance for loan losses is a significant estimate and is regularly reviewed by the Company for adequacy using a consistent, systematic methodology which assesses such factors as changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency and charge-off rates; and current economic conditions that may affect a borrower’s ability to repay. Adverse changes in management’s assessment of these factors could lead to additional provisions for credit losses. The Company’s methodology with respect to the assessment of the adequacy of the allowance for loan losses is more fully discussed in later sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).
The reserve for unfunded commitments is based on management’s estimate of the amount required to reflect the probable inherent losses on outstanding letters of credit, merchant processing activity and unused loan credit lines. Adequacy of the reserve is determined using a consistent, systematic methodology, similar to the one which analyzes the allowance for loan losses. Management must also estimate the likelihood that these commitments would be funded and become loans. This is done by evaluating the historical utilization of each type of unfunded commitment and estimating the likelihood that the current utilization rates on lines available at the balance sheet date could increase in the future.
Income Taxes. The Company estimates its income taxes for each of the jurisdictions in which it operates to determine an appropriate expense against current pre-tax earnings. This involves estimating the Company’s actual current income tax expense as well as assessing temporary differences resulting from differing treatment of items, such as timing of the deduction of expenses, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2006, there were no valuation allowances set aside against any deferred tax assets.
Interest Income Recognition. Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due unless they are adequately secured and
in the process of collection or on other loans when management believes collection is doubtful. All loans considered impaired are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all unpaid interest previously accrued is reversed against current-period interest income; therefore, an increase in loans on nonaccrual status could have an adverse impact on interest income recognized in future periods.
Stock Compensation Plans. The Company has two stock compensation plans: The Stock Incentive Plan and the Directors’ Omnibus Long-term Incentive Plan. In January 2006, the Company adopted FASB Statement No. 123R (revised 2004), “Share-Based Payment” (SFAS 123R) which amends SFAS 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS 123R requires new, modified and unvested share-based payment transactions with employees to be measured at fair value and recognized as compensation expense over the vesting period. The fair value of each option award is estimated using a Black-Scholes option valuation model that requires the Company to develop estimates for assumptions used in the model. The Black-Scholes valuation model uses the following assumptions: expected volatility, expected term of option, risk-free interest rate and dividend yield. Expected volatility estimates are developed by the Company based on historical volatility of the Company’s stock. The Company uses historical data to estimate the expected term of the options. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury yield in effect at the grant date. The dividend yield represents the expected dividends on the Company stock.
Executive Overview
Chittenden posted 2006 net income of $85.5 million, compared with $82.0 million in 2005. Diluted earnings per share were $1.83, an increase of 5% from 2005. Specific highlights included:
•
Average loans increased $328 million, or 8% during 2006. The increase was attributable to continued growth throughout all of its markets, particularly in the commercial real estate, and construction portfolios.
•
Average deposits for 2006 increased $209 million from 2005 due to higher levels of CMA/money market deposits and CDs.
•
Average borrowings were $306 million at December 31, 2006, compared with $318 million at December 31, 2005. The decline from last year was due to lower Federal Home Loan Bank (“FHLB”) advances.
•
The Company repurchased 1,800,000 common shares in 2006 and the tangible capital ratio remained over 7.00% at year end.
•
Tax-equivalent net interest income for the year end was $252 million, compared to $246 million for 2005. The increase in net interest income from the same period a year ago was due to higher average earning assets, which was partially offset by a lower net interest margin.
•
The Company’s net interest margin for 2006 was 4.24%, a decline of 7 basis points from 2005. The decline in the net interest margin from 2005 was due to an increase in funding costs, which was partially offset by an increase in the yield on interest earning assets. The increase in funding costs was driven by strong competition for commercial and consumer deposits as well as increases in the federal funds rate in 2005 and 2006.
•
Noninterest income increased to $70.2 million at December 31, 2006. Investment management and trust fees ($1.3 million), credit card income ($571,000), and other noninterest income ($769,000) increased while declines were recorded in gains on sales of loans ($2.7 million), and insurance commissions ($560,000). These fluctuations are more fully explained on page 41.
•
Noninterest expenses increased only $2.5 million, or 1.4% from 2005. Salary expense increased $3.7 million or 4% which was driven primarily by higher share based payment compensation of $1.1 million and salary expense related to the opening of new branches. Other noninterest expense decreased $975,000 primarily due to lower education and training expense, examination fees and armored car costs.
•
The Company’s efficiency ratio improved to 55.98% for 2006 compared with 56.67% in 2005.
•
The provision for credit losses of $6.9 million was $1.8 million higher than in 2005 due to higher net charge-offs and nonperforming loans; however, 42% of net charge-offs primarily related to one commercial finance loan that was placed on non-accrual status in the first quarter of 2006.
•
Return on average equity (ROE) was 12.80% for the year-ended December 31, 2006, compared with 12.72% and 12.13% in 2005 and 2004. Return on average assets (ROA) was 1.33% for 2006, an increase from 1.32% in 2005 and 1.23% in 2004. These increases were primarily due to higher levels of net income.
Lending Activity
Loan Portfolio
The Company offers a range of banking services, including residential real estate, consumer and commercial loans. The following table shows the composition of the loan portfolio (based on underlying collateral utilizing bank regulatory definitions) for the five years ended:
Commercial Loans. The Company offers a wide range of banking services to businesses with revenues up to approximately $100 million. The Company’s lending activities are conducted primarily in Vermont, New Hampshire, Massachusetts and Maine, with additional activity relating to nearby market areas in New York, Connecticut, and Quebec. The total commercial loan portfolio, defined as commercial & industrial (“C&I)”), municipal, multi-family, commercial real estate (“CRE”) and construction loans, constituted $3.386 billion, or 72% of Chittenden’s loan portfolio at December 31, 2006.
The Company’s commercial loans increased 7% from 2005 with growth primarily coming from the CRE portfolio (up 9%), multi-family portfolio (up 10%) and the construction portfolio (up 21%). Municipal loans declined $19 million or 12% from the prior year-end, with the decrease came from the Vermont and Massachusetts markets.
The primary emphasis in the construction portfolio is the financing of projects for the Company’s commercial customers, as well as individual consumer loans. At December 31, 2006, the construction portfolio was comprised of approximately 30% to residential developers, 26% in individual consumer construction loans, 23% for commercial customers for investor properties, and 21% in loans to commercial customers for owner-occupied properties. The continued growth came primarily from the Company’s Vermont, Maine and New Hampshire markets and was not specifically concentrated in any one industry.
The following graph shows the industry diversification, which are based on NAICS sector codes, of the commercial loan portfolios at December 31, 2006:
Residential Real Estate Loans. Residential real estate loans, comprised of 1-4 family and home equity lines of credit, totaled $1.074 billion at December 31, 2006, an increase of $20 million from 2005. The increase is primarily attributable to higher 1-4 family loans of $14 million due to the increased production of private banking loans in our Vermont, Massachusetts and Maine markets. Approximately 3% or $25 million of the residential real estate loans are nontraditional interest only loans. Home equity lines of credit totaled $322.1 million at December 31, 2006 compared with $316.5 million at the end of 2005.
Consumer Loans. Consumer loans were $237.5 million at December 31, 2006, a decline of $20 million from 2005. Approximately 86% of these loans were indirect installment loans, which continued to experience prepayments in excess of origination volume, while the remaining loans consisted of direct installment and revolving credit. All of the Company’s indirect installment loans were originated from dealers within the Banks’ primary operating areas and the average FICO score in the indirect portfolio was 720.
Mortgage Banking Operations
Residential mortgage sales during 2006 totaled $307 million, compared to $427 million during 2005. This decline was primarily due to the origination of lower volumes of fixed rate residential loans caused by increasing market rates during 2006 and lower volumes of refinancing activity. The Company underwrites its residential mortgages to secondary market standards and sells substantially all of its fixed-rate residential mortgage production on a servicing-retained non-recourse basis.
The portfolio of residential mortgages serviced for investors totaled $2.037 billion at December 31, 2006, compared to $2.098 billion at year-end 2005. These assets are owned by investors other than Chittenden and therefore are not included in the Company’s consolidated balance sheets. The net assets relating to this servicing
portfolio recorded on the Company’s books at December 31, 2006 and 2005 were $14.2 million and $13.7 million, respectively. At December 31, 2006, the mortgage servicing right’s amortized cost of $14.8 million was reduced by an impairment reserve of $622,000, as compared to an impairment reserve of $639,000 at the end of 2005.
Nonperforming Assets
Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Management classifies loans as nonaccrual when they become 90 days past due as to principal or interest, unless they are adequately secured and in the process of collection. In addition, loans that have not met this delinquency test may be placed on nonaccrual at management’s discretion. To the extent that certain loans classified as nonaccrual have an associated governmental agency guarantee, a separate assessment of the classification of the guaranteed portion is made. Generally, as long as interest and principal are less than 90 days past due, the guaranteed amounts are collectible from the guarantor and therefore are not classified as nonaccrual. In these situations, only the non-guaranteed portion of the loan would be classified as nonaccrual. (In the event that a guaranteed loan were to exceed 90 days past due, no further interest would be accrued on the guaranteed portion, as it generally would not be reimbursed by the guarantor.) Consumer and residential loans are included when management considers it to be appropriate, based upon evidence of collectibility, the value of any underlying collateral and other general criteria. Generally, a loan remains on nonaccrual status until the factors which indicated doubtful collectibility no longer exist or the loan is determined to be uncollectible and is charged off against the allowance for loan losses.
A loan is classified as a restructured loan when its interest rate is reduced and/or other terms are modified because of the inability of the borrower to service debt at current market rates and terms. Other real estate owned (“OREO”) is real estate that has been acquired through foreclosure and is recorded at the lower of the carrying amount of the loan or the fair value of the property, less estimated costs to sell, at the time of acquisition.
The following table shows the composition of nonperforming assets and loans past due 90 days or more and still accruing interest as of the end of each of the five years ended:
The following graph compares the Company’s percentage of nonperforming assets to total loans and other real estate owned with the composite of banks included in the SNL Securities $5-$10 billion bank index.
Nonaccrual loans at December 31, 2006 consisted of approximately 168 loans, which were diversified across a range of industries, sectors and geography. Approximately 52% of the total nonaccrual loans, or $10.5 million, represent relationships of $1.0 million or greater, 3% or $528,000 represent relationships between $500,000 to $1.0 million, and 45% of the nonaccrual loan relationships are under $100,000. Nonaccrual loans with payments less than 30 days past due represent 60% of total loans on nonaccrual at December 31, 2006.
Allowance for credit losses
The allowance for credit losses consists of two components: 1) the allowance for loan losses which is presented as a contra to total gross loans in the assets section of the balance sheet, and 2) the reserve for unfunded commitments included in other liabilities on the balance sheet.
Adequacy of the allowance for loan losses is determined using a consistent, systematic methodology, which analyzes the risk inherent in the loan portfolio. In addition to evaluating the collectibility of specific loans when determining the adequacy of the allowance for loan losses, management also takes into consideration other factors such as changes in the mix and size of the loan portfolio, historic loss experience, the amount of delinquencies and loans adversely classified, and economic trends. The adequacy of the allowance for loan losses is assessed by an allocation process whereby specific loss allocations are made against certain adversely classified loans, and general loss allocations are made against segments of the loan portfolio which have similar attributes.
The allowance for loan losses is increased by provisions charged against current earnings. Loan losses are charged against the allowance when management believes that the collectibility of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance. While management uses available information to assess possible losses on loans, future additions to the allowance may be necessary based on increases in non-accrual loans, changes in economic conditions, growth in loan portfolios, or for other reasons. Any future additions to the allowance would be recognized in the period in which they were determined to be necessary. In addition, various regulatory agencies periodically review the Company’s allowance for loan losses as an integral part of their examinations. Such agencies may require the Company to record additions to the allowance based on judgments different from those of management.
Credit quality of the commercial portfolios is quantified by a corporate credit rating system designed to parallel regulatory criteria and categories of loan risk. Individual loan officers monitor their loans to ensure appropriate rating assignments are made on a timely basis. Risk ratings and quality of commercial and consumer
credit portfolios are also assessed on a regular basis by an independent Credit Review Department. Credit Review personnel conduct ongoing portfolio trend analyses and individual credit reviews to evaluate loan risk and compliance with corporate lending policies. The level of allowance allocable to each group of risk-rated loans is then determined by applying a loss factor that estimates the amount of probable loss in each category. The assigned loss factor for each risk rating is based upon management’s assessment of historical loss data, portfolio characteristics, economic trends, overall market conditions and past experience.
Consumer and residential real estate loan quality is evaluated on the basis of delinquency data and other credit data available due to the large number of such loans and the relatively small size of individual credits. Allocations for these loan categories are principally determined by applying loss factors that represent management’s estimate of inherent losses. In each category, inherent losses are estimated based upon management’s assessment of historical loss data, portfolio characteristics, economic trends, overall market conditions and past experience. In addition, certain loans in these categories may be individually risk-rated if considered necessary by management.
The other method used to allocate the allowance for loan losses entails the assignment of reserve amounts to individual loans on the basis of loan impairment. Certain loans are evaluated individually and are judged to be impaired when management believes it is probable that the Company will not collect all of the contractual interest and principal payments as scheduled in the loan agreement. Under this method, loans are selected for evaluation based on internal risk ratings or non-accrual status. A specific reserve amount is allocated to an individual loan when that loan has been deemed impaired and when the amount of a probable loss is estimable on the basis of its collateral value, the present value of anticipated future cash flows, or its net realizable value. At December 31, 2006, impaired loans with specific reserves totaled $1,088,850 (all of these loans were on nonaccrual status) and the amount of such reserves was $231,175.
The adequacy of the reserve for unfunded commitments is determined similarly to the allowance for loan losses, with the exception that management must also estimate the likelihood of these commitments being funded and becoming loans. This is done by evaluating the historical utilization of each type of unfunded commitment and estimating the likelihood that the current utilization rates could increase in the future.
Results and recommendations from these processes provide senior management and our Board of Directors with independent information on the loan portfolio and unfunded commitments credit risk. The following table summarizes the activity in the Company’s allowance for credit losses for the five years ended:
Management strives for directional consistency between its provision for credit losses and the quantitative and qualitative indicators of its asset quality. In 2003, the provision was reduced by $1.2 million, primarily due to improved credit quality evidenced by much lower net charge-offs, which declined $2.5 million. This trend continued in 2004 when the provision declined $2.8 million to $4.4 million, primarily due to significantly lower net charge-offs, which declined $3.0 million from 2003. In 2005, the provision increased $777,000 primarily due to continued strong commercial loan growth. In 2006, the provision increased $1.8 million, primarily due to higher net charges-offs and nonperforming loans. Approximately $2.3 million or 42% of net charge-offs primarily relates to one commercial finance loan that was placed on non-accrual status in the first quarter of 2006. Excluding this one loan, net charge-offs for 2006 would have approximated 7 basis points. The allowance
for credit losses as a percentage of loans has declined from 1.62% at December 31, 2002 to 1.35% at December 31, 2006, as a result of the sustained period of lower net charge-offs and the relative stability in the ratio of nonperforming assets to loans plus OREO.
The allowance for loan losses is allocated to various loan categories for analytical purposes as part of the Company’s process of evaluating the adequacy of the allowance for loan losses. The following table summarizes the allocation of the allowance for loan losses at:
During 2006, the allowance for loan losses allocated to commercial & industrial loans increased by $159,000, the allocation to commercial real estate loans increased by $1.0 million and the allocation to construction loans increased $580,000. The increased allocations to these categories reflected growth in the portfolios.
The other category is the allowance considered necessary by management based on its assessment of historical loss experience, industry trends, and the impact of the local and regional economy on the Company’s borrowers that have not been captured in the specific risk classifications. Due to the imprecise nature of the loan loss estimation process and the effects of changing environmental conditions, these risk attributes may not be adequately captured in the data related to the formula-based loan loss components used to determine allocations in the Company’s analysis of the adequacy of the allowance for loan losses.
Prior to the Company’s recognition in 2005 of a separate reserve for unfunded commitments, a portion of the other category was reserved for inherent losses in the off-balance sheet exposures, which are now recognized in the separate liability.
Investment Securities
The investment portfolio is used to meet liquidity demands, invest excess liquidity, generate interest income and mitigate interest rate sensitivity. At December 31, 2006, net unrealized losses were $27.3 million compared with net unrealized losses of $29.3 million at December 31, 2005. The decline is primarily attributable to lower investment securities at December 31, 2006. There was no “other than temporary” impairment in the available for sale portfolio at December 31, 2006 (see note 3 to the Company’s consolidated financial statements in Item 8 of this Form 10-K for further discussion).
The following table shows the composition of the Company’s investment portfolio, at:
The following table shows the maturity distribution of the amortized cost of the Company’s investment securities and weighted average yields of such securities on a fully taxable equivalent basis at December 31, 2006, with comparative totals for 2005. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay certain investments:
(1) Maturities of mortgage-backed securities are based on contractual payments and estimated mortgage loan prepayments.
(2) Tax-equivalent yield computed using a 35% effective tax rate and historical cost balances and does not give effect to changes in fair value.
The Company evaluates and monitors the credit risk of its investments utilizing a variety of resources including external credit rating agencies (predominantly Moody’s and S&P). The following table shows the rating distribution of the investment portfolio on December 31, 2006 with comparative totals for 2005 (in thousands):
Deposits
During 2006, total deposits averaged $5.4 billion, up from $5.2 billion in 2005. The increase from the prior year end was primarily attributable to higher levels of demand, CMA/money market, and CDs. The growth in CDs was generated by our customers’ desire for higher interest rates as well as their willingness to invest money for longer time periods. Approximately 42% of the Company’s deposit base is comprised of demand deposits, savings and NOW accounts, which had an overall weighted average cost of 43 basis points in 2006. In addition, approximately 30% of the Company’s total deposits are held in CMA/money market accounts that are primarily from its commercial customers with a weighted average cost of 2.67%. The remaining deposits consist of CDs of less than $100,000 and CDs of $100,000 and greater with a weighted average cost of 3.30% and 4.16%, respectively, for 2006. The average term at year-end 2006 of the Company’s CDs of less than $100,000 is 8.5 months and greater than $100,000 is 6.2 months. The overall cost of deposits, including demand deposits at 0%, in 2006 was 2.01%, compared to 1.23% in 2005, and the all in cost of funds was 2.20% compared to 1.38% in 2005.
The following table shows average balances of the Company’s deposits for the periods indicated:
The Company’s ending balances of outstanding certificates of deposit and other time deposits in denominations of $100,000 and greater had maturities as follows:
Borrowings
Borrowings and customer repurchase agreements were $210.0 million at December 31, 2006, a decrease of $17.3 million from the end of 2005. During 2006, borrowings averaged $306.0 million, down slightly from $317.8 million in 2005. This funding consists of proceeds from securities sold under agreements to repurchase, FHLB borrowings, federal funds purchased and the trust-preferred securities described below. Repurchase agreements averaged $86.0 million for 2006, up from $86.7 million in 2005. FHLB borrowings averaged $13.2 million for 2006, down from $52.4 million in 2005.
On May 21, 2002, a wholly-owned subsidiary of the Company, Chittenden Capital Trust I (the “Trust”), issued $125 million of 8% trust preferred securities (“TPS”) to the public and invested the proceeds from this offering in an equivalent amount of junior subordinated debentures issued by the Company. The TPS pay interest quarterly, are mandatorily redeemable on July 1, 2032 and may be redeemed by the Trust at par any time on or after July 1, 2007. The Company has fully and unconditionally guaranteed the securities issued by the Trust. Concurrent with the issuance of these securities, the Company entered into interest rate swap agreements with two counterparties, in which the Company receives 8% fixed on the notional amount of $125 million, while paying the counterparties a variable rate based on the three month LIBOR (London Interbank Offered Rate), plus approximately 122 basis points. In August 2006, the Company terminated the interest rate swap agreements with both counterparties and settled with a final payment of interest and termination fees of $372,000. Transaction costs associated with the issuance were amortized on an effective yield basis over five years to the call date. The amortization of these costs added approximately 92 basis points to the overall cost of these borrowings.
Capital Resources
The Company’s capital is the foundation for developing programs for growth and new activities. Total capital at December 31, 2006 was $671 million, which was effectively equivalent to total capital at December 31, 2005. Net income of $85.5 million increased the Company’s capital position in 2006, while dividend payments of $36.2 million, and the repurchase of $51.1 million of the Company’s common stock reduced it. In addition, accumulated other comprehensive income declined approximately $5.0 million due primarily to the fourth quarter adoption of Financial Accounting Standard No. 158 on employers accounting for defined benefit pension and other post retirement plans. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. Accordingly, the Company decreased other assets and increased accumulated other comprehensive income by $7.1 million in the connection with the adoption of SFAS 158.
The FRB, FDIC and OCC have defined leverage capital requirements, which measure Tier 1 capital (as defined below) against average total assets without regard to risk weighting. Additionally, these regulators have a risk-based capital standard. Under this measure of capital, banks are required to hold more capital against certain assets perceived as higher risk, such as commercial loans, than against other assets perceived as lower risk, such
as residential mortgage loans and U.S. Treasury securities. Further, certain off-balance sheet items such as unfunded loan commitments and standby letters of credit are included for purposes of determining risk-weighted assets. Commercial banking organizations are required to have total capital equal to 8% of risk-weighted assets, and Tier 1 capital-consisting of common stock and certain types of preferred stock, including the TPS, equal to at least 4% of risk-weighted assets. Tier 2 capital, included in total capital, includes the allowance for possible loan losses up to a maximum of 1.25% of risk-weighted assets.
FDIC and OCC regulations pertaining to capital adequacy, which apply to the Banks, require a minimum 3% leverage capital ratio for those institutions with the most favorable composite regulatory examination rating. In addition, a 4% Tier 1 risk-based capital ratio, and an 8% total risk-based capital ratio are required for a bank to be considered adequately capitalized. Leverage, Tier 1 risk-based, and total risk-based capital ratios exceeding 5%, 6%, and 10%, respectively, qualify a bank for the “well-capitalized” designation.
The following table presents the regulatory capital ratios for each subsidiary bank and the Company at December 31, 2006:
These ratios placed the Banks in the FDIC’s highest capital category of “well capitalized”. Capital ratios in excess of minimum requirements indicate capacity to take advantage of profitable and credit-worthy opportunities as well as the potential to respond to unforeseen adverse conditions.
In June 2004, the central bank governors of the member countries of the Basel Committee approved a revised capital adequacy framework generally known as the “Basel II Framework.” The Basel II Framework is a three-pillar capital adequacy approach versus the flat 8% of risk-weighted assets (as defined) currently used. The Basel II Framework also permits qualifying bank institutions to use more advanced approaches for measuring operational risk and credit risk. In order to address competitive equity issues for community and regional banking organizations that could arise under the bifurcated regulatory capital framework following the implementation of the Basel II Framework, the United States bank regulatory agencies issued an advance notice of proposed rulemaking in October 2005, known as Basel IA, which would make some aspects of the Basel II Framework applicable in modified form to smaller banks. After receiving extensive comment, the agencies proposed a notice of proposed rulemaking in December 2006. It remains uncertain whether the rules will be adopted and, even if adopted, how closely the final Basel IA rules will resemble the rules described in the notice of proposed rulemaking and the effective date of such rules.
On July 19, 2006, the Company announced that the Board of Directors authorized the repurchase of up to 1,000,000 shares of the Company’s common stock in negotiated transactions or open market purchases. Chittenden, depending on market conditions, may repurchase its common stock without further Board authorization over the next two years.
The following table presents regulatory capital components and ratios of the Company at:
(1) Total average assets for the fourth quarter of the respective year.
(2) Includes allowable portion of allowance for credit losses.
The components of stockholders’ equity under GAAP that are not considered in capital for regulatory purposes include goodwill, accumulated other comprehensive income and directors deferred compensation to be settled in stock.
Liquidity
The measure of an institution’s liquidity is its ability to meet its cash commitments at all times with available cash or by conversion of other assets to cash at a reasonable price. The Asset and Liability Committee, based upon policies approved by our Board of Directors, monitors the Company’s liquidity and rate sensitivity.
The primary source of funding for the parent company is dividends received from the Banks. For the Banks, primary sources of funding include customer deposits, and wholesale funding. The Banks generate significant amounts of low cost funds through their deposit gathering operations. For the year ended December 31, 2006, the Company’s ratio of average loans to average deposits was approximately 86%. At December 31, 2006, the Company maintained cash and cash equivalents of approximately $199 million, compared with $180.7 million at December 31, 2005. In addition, the Company’s securities available for sale were $1.1 billion at December 31, 2006 with expected cash flow of $312 million in 2007 from maturities and normal MBS prepayments.
The Company’s borrowing costs and its ability to raise wholesale funds can be impacted by its credit ratings and changes thereto. Chittenden Corporation’s credit ratings at December 31, 2006 were Moody’s A3, DBRS A, Fitch A-, and S&P of BBB+. S&P’s rating was increased to BBB+ on February 10, 2006. An adverse change in one or more of Chittenden’s credit ratings could inhibit the Company’s ability to raise additional wholesale funds or increase costs related to the Company’s capital raising activities.
The Company has available borrowing capacity under certain programs including the FHLB, U.S. Treasury, repurchase agreement lines, and advised Fed Funds lines totaling more than $957 million as of December 31, 2006. Chittenden also has an effective shelf registration statement under which an additional $100 million in debt securities, common stock, preferred stock, or warrants may be offered from time to time ($225 million at December 31, 2006 prior to Chittenden’s issuance of $125 million of notes in February 2007).
Aggregate Contractual Obligations
Due to recent contributions made in excess of the minimum required amounts, the Company does not anticipate a required pension contribution during 2007. However, it is possible that the Company could make a voluntary contribution during 2007 to respond to changes in pension funding legislation and/or to further improve the plan’s funded status. No pension contributions are reflected beyond 12 months because these depend on a variety of factors that cannot be easily predicted.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, to meet customers’ financing needs and to reduce their own exposure to fluctuations in interest rates, the Banks are parties to financial instruments with off-balance sheet risk, held for purposes other than trading. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Banks’ exposure to credit loss in the event of nonperformance by the other party for loan commitments and standby letters of credit is represented by the contractual amount of those instruments, assuming that the amounts are fully advanced and that collateral or other security is of no value. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, plant and equipment, and real estate.
Commitments to originate loans, unused lines of credit, and unadvanced portions of commercial real estate and construction 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. Many of the commitments are expected to expire without being drawn upon. Therefore, the amounts presented below do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance by a customer to a third party. These guarantees are issued primarily to support public and private borrowing arrangements, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.
Other commitments refer to the Company’s equity investments in limited partnerships for CRA related low income housing projects.
Financial instruments whose contractual amounts represent off-balance sheet risk at December 31, 2006 and 2005 are as follows:
Results of Operations
Comparison of Years Ended December 31, 2006 and 2005
Net Interest Income
Net interest income is the amount by which interest income on interest earning assets exceeds interest paid on interest bearing liabilities. Fluctuations in interest rates, as well as changes in the amount and type of interest earning assets and interest bearing liabilities, combine to affect net interest income.
For 2006, net interest income was $249 million, up $4.7 million from the 2005 level. On a fully tax equivalent basis, net interest income increased $5.6 million from 2005, to $252 million in 2006. The net yield on earnings assets was 4.24%, a decline of 7 basis points from 2005. The decline in the net yield on earning assets from 2005 was due to an increase in funding costs, which was partially offset by an increase in the yield on interest earning assets. The increase in funding costs was driven by strong competition for both commercial and consumer deposits as well as increases in the federal funds rate in 2006 and 2005.
The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the years indicated:
(1) On a fully taxable equivalent basis using a Federal income tax rate of 35%. Loan income includes fees.
(2) Residential real estate includes 1-4 family, multi-family, home equity credit lines, and loans held for sale.
(3) Interest rate spread is the average rate earned on total interest-earning assets less the average rate paid on interest-bearing liabilities.
(4) Net yield on earning assets is net interest income divided by total interest-earning assets.
The following table attributes changes in the Company’s net interest income (on a fully taxable equivalent basis) to changes in either average balances or average rates. Changes due to both interest rate and volume have been allocated to change due to balance and change due to rate in proportion to the relationship of the absolute dollar amounts of the change in each.
Noninterest Income and Noninterest Expense
Noninterest income for the year ended December 31, 2006, was $70.2 million, an increase of $225,000 from the prior year. The increase was a result of higher investment management and trust fees and other noninterest income which was mostly offset by lower gains on sales of mortgage loans. Investment management and trust income increased approximately $1.3 million from 2005 primarily due to higher retail investment and retirement plan services income. Other noninterest income increased $769,000 from 2005 due to $1.1 million recognized in relation to the Company’s interest in a mortgage insurance captive, which was partially offset by higher amortization on investments in low income housing limited partnerships. Gains on sales of mortgage loans declined from 2005 primarily due to increases in market interest rates during 2006, which slowed mortgage originations and resulted in lower volumes of mortgage loans sold.
In 2006, noninterest expenses were $186.4 million an increase of $2.5 million from 2005. The increase was primarily attributable to higher salary costs that were partially offset by lower other noninterest expenses. The increase in salary expense was driven by higher share based payment compensation of $1.1 million and salary expense related to the opening of new branches. Other noninterest expenses declined $975,000 from 2005 due to lower legal and accounting ($1,075 million) education and trainings ($262,000), examination fees ($149,000) and armored car costs ($114,000), which was primarily offset by higher marketing expense ($1,224 million).
The components of other noninterest expense for the years presented are as follows:
Income Tax Provision
The Company and the Banks are taxed on income by the IRS at the Federal level and by various states in which they do business. For the years ended December 31, 2006 and 2005, Federal and state income tax provisions amounted to $40.4 million and $43.2 million, respectively. The effective tax rates for the respective periods were 32.1% and 34.5%. The lower effective income tax rate was attributable to higher low-income housing and historic rehabilitation tax credits. During both periods, the Company’s statutory Federal corporate tax rate was 35%. The Company’s effective tax rates differed from the statutory rates primarily because of state income taxes, net of benefit on Federal taxes, interest income from state and municipal securities and loans, which are partially exempt from Federal taxation, and historic rehabilitation tax credits and investments in qualified low income housing projects. The Company invests in these partnerships primarily for CRA purposes.
Tax returns filed by the Company are subject to periodic examinations by various federal and state governmental tax authorities. During 2005, two such examinations were completed. The impact of the examinations on income tax expense in 2005 was not material.
Results of Operations
Comparison of Years Ended December 31, 2005 and 2004
Net Interest Income
For 2005, net interest income was $244.3 million, up $18.8 million from the 2004 level. On a fully tax equivalent basis, net interest income increased $19.5 million from 2004, to $246.4 million in 2005. The net yield on earnings assets was 4.31%, an increase of 10 basis points from 2004. The increase in the net yield on earning assets from 2004 was primarily attributable to higher yields on loans driven by increases in the prime rate, as well as continued improvement in the Company’s asset mix which was partially offset by higher funding costs.
Noninterest Income and Noninterest Expense
Noninterest income for the year ended December 31, 2005 was $69.9 million, a decline of $3.4 million from the prior year. The decline was a result of lower investment management and trust income, lower service charges on deposits and lower levels of gains on sales of securities, net of losses on prepayments of borrowings. Partially offsetting these declines were higher mortgage servicing and other income. Investment management and trust income declined $1.6 million from 2004 primarily due to lower annuity sales. Service charges on deposits declined $1.8 million due to lower overdraft fee income from our customers. Mortgage servicing income was $1.7 million higher in 2005 than in 2004, driven primarily by lower amortization of $3.1 million.
In 2005, noninterest expenses were $183.8 million, up $651,000 from 2004. Higher salary expenses, net occupancy expenses, and other expenses were offset by lower data processing and conversion and restructuring charges. Salary expense increased due to higher incentive accruals of $3.3 million. Net occupancy expense increased from 2004 due to higher utility and property expenses as well as the opening of new branches in Westborough, Massachusetts and Manchester, New Hampshire. Increases in other noninterest expense were related to higher legal and accounting, and education & training. Data processing expenses declined $2.7 million from 2004 due to efficiencies gained from the conversion of the Company’s core data processing platform in mid-2004.
Income Taxes
For the years ended December 31, 2005 and 2004, Federal and state income tax provisions amounted to $43.2 million and $38.7 million, respectively. The effective tax rates for the respective periods were 34.5% and 34.7%. During both periods, the Company’s statutory Federal corporate tax rate was 35%. The Company’s effective tax rates differed from the statutory rates primarily because of state income taxes, net of benefit on Federal taxes, interest income from state and municipal securities and loans which are partially exempt from Federal taxation, and tax credits on investments in qualified low income housing projects. The Company invests in these partnerships primarily for CRA purposes.
Tax returns filed by the Company are subject to periodic examinations by various federal and state governmental tax authorities. During 2005, two such examinations were completed. The impact of the examinations on income tax expense in 2005 was not material.
ITEM 7A.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the sensitivity of income to changes in interest rates, foreign exchange rates, commodity prices, equity prices, and other market-driven rates or prices. Since the Company has no trading operations, risks associated with foreign exchange rates, commodity prices, and equity prices are not significant. Interest rate risk, including mortgage prepayment risk, is the single most significant non-credit risk to which the Company is exposed.
To measure the sensitivity of its income to changes in interest rates, the Company uses a variety of methods, including simulation, and gap analyses. Interest rate risk is the sensitivity of income to variations in interest rates over both short-term and long-term horizons. The primary goal of interest-rate risk management is to control this risk within limits approved by our Board of Directors, which reflect the Company’s tolerance for interest-rate risk. The Company attempts to control interest-rate risk by identifying exposures, quantifying them and taking appropriate actions.
The Company uses simulation analyses to measure the exposure of net interest income to changes in interest rates over a relatively short (i.e., within one year) time horizon. Simulation analysis incorporates what management believes to be the most appropriate assumptions about customer and competitor behavior in the specified interest rate scenario. These assumptions are the basis for projecting future interest income and expense from the Company’s assets and liabilities under various scenarios. Simulation analysis may have certain
limitations caused by market conditions varying from those assumed in a model. Actual results can often differ due to the effects of prepayments and refinancings of loans and investments, as well as the repricing or runoff of deposits, which may be different from that which has been assumed.
The Company’s limits on interest-rate risk specify that if interest rates were to shift immediately, up or down 200 basis points, estimated net interest income for the next twelve months should not be impacted by greater than 10%. An additional analysis is performed to review results if interest rates were to shift quarterly, (ramped) up or down 100 and 200 basis points over a twelve-month period. The results of these simulations are shown below:
Interest Rate Sensitivity Analysis
As of December 31, 2006
($ in thousands)
As noted above, one of the tools used to measure rate sensitivity is gap analysis. The gap is defined as the amount by which a bank’s rate sensitive assets exceed its rate sensitive liabilities. A positive gap exists when rate sensitive assets exceed rate sensitive liabilities. This indicates that a greater volume of assets than liabilities will reprice during a given period. This mismatch will improve earnings in a rising rate environment and inhibit earnings when rates decline. Conversely, when rate sensitive liabilities exceed rate sensitive assets, the gap is referred to as negative. In this case, a rising rate environment will inhibit earnings and declining rates will improve earnings. Notwithstanding this general description of the effect on net interest income of the gap position, it may not be an accurate predictor of changes in net interest income. The Company’s limits on interest-rate risk specify that the cumulative one-year gap should be less than 10% of total assets.
The following table shows the amounts of interest-earning assets and interest-bearing liabilities at December 31, 2006 that reprice and/or mature during the periods indicated:
(1) Loans include loans held for sale.
(2) Amounts are based on amortized cost balances. Total includes securities available for sale and FRB / FHLB stock.
The following table shows scheduled maturities of selected loans at December 31, 2006:
(1) Includes commercial, municipal and multi-family.
ITEM 8
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CHITTENDEN CORPORATION
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
CHITTENDEN CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these consolidated financial statements.
CHITTENDEN CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
Years ended December 31, 2006, 2005 and 2004
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CHITTENDEN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Chittenden Corporation (the “Company”) and its subsidiaries: Chittenden Trust Company (CTC), and its subsidiaries Chittenden Insurance Group, LLC (CIG), Chittenden Securities, LLC (CSC) and Chittenden Commercial Finance (CCF); The Bank of Western Massachusetts (BWM); Flagship Bank and Trust Company (FBT); Maine Bank & Trust (MBT); and Ocean National Bank (ONB). (CTC, BWM, FBT, MBT, and ONB are collectively referred to as the “Banks.”) All material intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year balances to conform to the current year presentation.
Nature of Operations
The Banks’ primary business is providing loans, deposits, and other banking services to commercial, individual, and public sector customers. Chittenden Mortgage Services is a mortgage banking operation with offices in Brattleboro, Vermont. CIG is an independent insurance agency with offices in Vermont, Massachusetts and New Hampshire. CSC is a registered broker/dealer providing brokerage services to its customers through banking locations in Vermont, Massachusetts, New Hampshire, and Maine. CCF’s commercial finance operations are based in Montreal, Quebec.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for credit losses, income tax expense, recognition of interest income on loans, and the recognition of restructuring charges.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand, amounts due from banks, interest-bearing deposits and certain money market fund investments. Cash equivalents are accounted for at cost, which approximates fair value.
Investments
Investments in debt securities may be classified as held for investment and measured at amortized cost only if the Company has the positive intent and ability to hold such securities to maturity. Investments in debt securities that are not classified as held for investment and equity securities that have readily determinable fair values are classified as either trading securities or securities available for sale. Trading securities are investments purchased and held principally for the purpose of selling in the near term; securities available for sale are investments not classified as trading or held for investment. All of the Company’s securities are classified as available for sale.
Securities transferred between categories are accounted for at market value. Unrealized holding gains and losses on trading securities are included in earnings; unrealized holding gains and losses on securities available for sale or on securities transferred into the available for sale category from the held for investment category are
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
reported as a separate component of stockholders’ equity, net of applicable income taxes. Unrealized losses that are considered other than temporary in nature are recognized in earnings. The Company uses the specific identification method to determine the cost basis in the recognition of gains and losses on the sales of securities as well as the calculation of unrealized gains and losses.
Loans
Loans are stated at the amount of unpaid principal, net of unearned discounts and unearned loan origination fees. Such fees and discounts are accreted using the effective-interest method. Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due unless they are adequately secured and in the process of collection or on other loans when management believes collection is doubtful. All loans considered impaired (except troubled debt restructurings), as defined in the following paragraph, are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all unpaid interest previously accrued is reversed against current-period interest income.
A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate. In the case of collateral dependent loans, impairment may be measured based on the fair value of the collateral. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance.
Allowance for Loan Losses
The allowance for loan losses is based on management’s estimate of the amount required to reflect the probable inherent losses in the loan portfolio, based on circumstances and conditions known at each reporting date. There are inherent uncertainties with respect to the collectibility of the Banks’ loans. Because of these inherent uncertainties, it is reasonably possible that actual losses experienced in the near term may differ from the amounts reflected in these consolidated financial statements.
Adequacy of the allowance is determined using a consistent, systematic methodology, which analyzes the size and risk of the loan portfolio. In addition to evaluating the collectibility of specific loans when determining the adequacy of the allowance for loan losses, management also takes into consideration other factors such as changes in the mix and volume of the loan portfolio, historic loss experience, the amount of delinquencies and loans adversely classified, and economic trends. An allocation process whereby specific loss allocations are made against certain adversely classified loans, and general loss allocations are made against segments of the loan portfolio, which have similar attributes together, assesses the adequacy of the allowance for loan losses.
Provisions charged against current earnings increase the allowance for loan losses. Loan losses are charged against the allowance when management believes that the collectibility of the loan principal is doubtful. Recoveries on loans previously charged off are credited to the allowance. While management uses available information to assess probable losses on loans, future additions to the allowance may be necessary. In addition, various regulatory agencies periodically review the Company’s allowance for loan losses as an integral part of their examination process. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.
Credit quality of the commercial portfolios is quantified by a corporate credit rating system designed to parallel regulatory criteria and categories of loan risk. Individual loan officers monitor their loans to ensure appropriate rating assignments are made on a timely basis. Risk ratings and quality of both commercial and
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
consumer credit portfolios are also assessed on a regular basis by an independent Credit Review Department. Credit Review personnel conduct ongoing portfolio trend analyses and individual credit reviews to evaluate loan risk and compliance with corporate lending policies. Results and recommendations from this process provide senior management and the Board of Directors with independent information on the loan portfolio condition. Consumer and residential real estate loan quality is evaluated on the basis of delinquency data and other credit data available due to the large number of such loans and the relatively small size of individual credits.
Key elements of the above estimates, including assumptions used in developing independent appraisals, are dependent on the economic conditions prevailing at the time such estimates are made. Accordingly, uncertainty exists as to the final outcome of certain valuation judgments as a result of changes in economic conditions in the Banks’ lending areas.
Loan Origination and Commitment Fees
Loan origination and commitment fees, and certain loan origination costs, are deferred and amortized over the contractual term of the related loans as yield adjustments using primarily the level-yield method. When loans are sold or paid off, the unamortized net fees and costs are recognized in income. Net deferred loan fees amounted to $6,849,000 and $6,720,000 at December 31, 2006 and 2005, respectively.
Loans Held for Sale / Gains and Losses on Sales of Mortgage Loans
Loans held for sale are carried at the lower of aggregate cost or market value. Gains and losses on sales of mortgage loans are recognized at the time of the sale and are generally comprised of 1) an amount representing a mortgage servicing right (see below) and 2) a cash gain or loss based on the sale of the loan to a third party. The price paid by a willing third party is influenced by the contractual interest rate charged to the borrower and the prevailing market rate for similar loans. The Company enters into forward sale contracts on substantially all loan commitments at the time that the customer locks their contractual interest rate, so that the exposure due to interest rate changes on the cash gain / loss recognized by the Company is minimal.
Mortgage Servicing Rights
Servicing assets are recognized when rights are acquired through purchase or sale of residential mortgage loans. Capitalized servicing rights are amortized against mortgage servicing income in proportion to, and over the period of, the estimated future net servicing income of the underlying mortgage loans. Servicing assets are evaluated regularly for impairment based upon the fair value of the servicing rights as compared to their amortized cost. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the premises and equipment. Leasehold improvements are amortized over the shorter of the terms of the respective leases or the estimated useful lives of the improvements. Expenditures for maintenance, repairs, and renewals of minor items are charged to expense as incurred.
Other Real Estate Owned
Collateral acquired through foreclosure (“Other Real Estate Owned” or “OREO”) is recorded at the lower of the carrying amount of the loan or the fair value of the property, less estimated costs to sell, at the time of acquisition. Net operating income or expense related to OREO is included in noninterest expense in the accompanying consolidated statements of income.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Identified Intangible Assets & Goodwill
Intangible assets include the excess of the purchase price over the fair value of net assets acquired (goodwill) in various acquisitions as well as core deposit intangibles (CDI) and customer list intangibles. Core deposit intangibles are amortized on a straight-line basis over 10 years. The straight-line basis is used because the Company has not experienced significant run off of core deposits in its past acquisitions. The customer list intangibles are also amortized straight-line over 10 years. The Company periodically evaluates intangible assets for impairment on the basis of whether these assets are fully recoverable from projected, undiscounted net cash flows of the related acquired segment or customer base.
Income Taxes
The Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of the Company’s assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is based on management’s estimate of the amount required to reflect the probable inherent losses on outstanding letters of credit, merchant processing activity and unused loan credit lines. Adequacy of the reserve is determined using a consistent, systematic methodology, similar to the one, which analyzes the allowance for loan losses. Additionally, management must also estimate the likelihood that these commitments would be funded and become loans. This is done by evaluating the historical utilization of each type of unfunded commitment and estimating the likelihood that the current utilization rates on lines available at the balance sheet date could increase in the future.
Earnings Per Share
The calculation of basic earnings per share is based on the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is based on the weighted average number of shares of common stock outstanding adjusted for the incremental shares attributed to outstanding common stock equivalents, using the treasury stock method. Common stock equivalents include options granted under the Company’s stock plans and shares to be issued under the Company’s Directors’ Deferred Compensation Plan.
Investment Management and Trust
Assets under administration of approximately $9.0 billion and $9.1 billion at December 31, 2006 and 2005, respectively, held by the Banks in a fiduciary or agency capacity for customers, are not included in the accompanying consolidated balance sheets. Investment management and trust income is recorded on the cash basis (which approximates the accrual method) in accordance with industry practice.
Credit Card Income
Credit card income includes interchange income from business credit cards issued by the Company, and merchant discount income. Merchant discount income consists of the fees charged on credit card receipts submitted by the Company’s commercial customers. Credit card income is presented net of credit card expense, which includes fees paid by the Company to credit card issuers and third-party processors. Such amounts are recognized on the accrual basis, and are presented in noninterest income in the consolidated statements of income.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Insurance Commissions
Insurance commission income is recognized when billed to the customer, net of commissions paid to the producing agent. In addition, CIG may receive additional performance commissions based on achieving specific sales goals and loss experience targets.
Stock-Based Compensation
Effective January 1, 2006, the Company adopted Financial Accounting Standards Board Statement No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R) which amends SFAS 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. The Company adopted SFAS 123R using the modified retrospective method. The modified retrospective method requires that compensation cost be recognized beginning with the effective date 1) based on the requirements of SFAS 123R for all share-based payments granted after the effective date and 2) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123R. The modified retrospective method also requires companies to adjust prior year financials based on the amounts previously reported under the SFAS 123 pro forma disclosures for all prior periods in which SFAS 123 was effective.
Accounting for Derivatives
The Company accounts and reports for derivative instruments in accordance with Statement of Financial Accounting 149, Amendment of Statement of 133 on Derivative Instruments and Hedging Activities (“SFAS 149”). SFAS 149 amends Statement 133 for decisions made (1) as part of the Derivatives Implementation Group, (2) in connection with other Board projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the application of the definition of a derivative. Statements 133 and 149 require companies to recognize all derivatives as either assets or liabilities in the statement of financial position and to measure those instruments at fair value.
Changes in the fair value of a derivative that is highly effective, and that is designated and qualifies, as a fair value hedge, along with changes in fair value of the hedged asset or liability that is attributable to the hedged risk (including losses or gains on firm commitments), are recorded in noninterest income. If a derivative has ceased to be highly effective, hedge accounting is discontinued prospectively.
On May 21, 2002, a wholly-owned subsidiary of the Company, Chittenden Capital Trust I (the “Trust”), issued $125 million of 8% trust preferred securities (“TPS”) to the public and invested the proceeds from this offering in an equivalent amount of junior subordinated debentures issued by the Company. The TPS pay interest quarterly, are mandatorily redeemable on July 1, 2032 and may be redeemed by the Trust at par any time on or after July 1, 2007. Concurrent with the issuance of these securities, the Company entered into interest rate swap agreements with two counterparties, in which the Company receives 8% fixed on the notional amount of $125 million, while paying the counterparties a variable rate based on the three month LIBOR (London Interbank Offered Rate), plus approximately 122 basis points. The Company’s risk management objective for undertaking the hedge is to hedge its exposure to changes in the risk free (or benchmark) rate, specifically LIBOR. The Company designated the swap transactions as hedging the exposure in changes in the fair value of its obligation to pay 8% fixed; therefore the hedge is considered a fair value hedge. The Company assesses effectiveness of the hedge on an ongoing basis utilizing the dollar offset method effectiveness test. In August 2006, the Company terminated the interest rate swap agreements with both counterparties and settled with a final payment of interest and termination fees of $372,000.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Restructuring Charges
The Company has adopted Statement of Financial Accounting Standard No. 146 Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”), which contains specific guidance regarding the types of, and circumstances under which, certain expenses related to restructuring activities can be accrued. In general, SFAS 146 requires that the Company have a detailed plan in place, which has been communicated to employees affected. Significant management judgment is required in estimating the amount of expense that is appropriate to recognize in relation to these plans.
Accounting Policies Adopted in the Current Period
Effective January 1, 2006, the Company adopted Financial Accounting Standards Board Statement No. 123 (revised 2004), Share-Based Payment (SFAS 123R) which amends SFAS 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. The Company adopted SFAS 123R using the modified retrospective method. The modified retrospective method requires that compensation cost be recognized beginning with the effective date 1) based on the requirements of SFAS 123R for all share-based payments granted after the effective date and 2) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123R. The modified retrospective method also requires companies to adjust prior year financials based on the amounts previously reported under the SFAS 123 pro forma disclosures for all prior periods in which SFAS 123 was effective. See Note 9 for a more detailed description of the Company’s adoption of SFAS 123R.
Effective November 15, 2006, the Company adopted Staff Accounting Bulletin No. 108 (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial-statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatements present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The adoption of SAB 108 had no impact on the reported results of operations or financial conditions.
Effective December 15, 2006, the Company adopted Financial Accounting Standards Board Statement No. 158 Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS 158”), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date-the date at which the benefit obligation and plan assets are measured-is required to be the company’s fiscal year end. SFAS 158 was effective for publicly held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. See Note 10 for a more detailed description of the Company’s adoption of SFAS 158.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 2 INTANGIBLE ASSETS AND GOODWILL
Identified Intangible Assets
There were no changes in the carrying amount of goodwill for the year ended December 31, 2006.
Note 3 INVESTMENTS
Investment securities at December 31, 2006 and 2005 are as follows:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table presents information related to sales of debt securities in each of the years ended December 31:
The market value of securities pledged to secure U.S. Treasury borrowings, public deposits, securities sold under agreements to repurchase, and for other purposes required by law, amounted to $645 million and $519 million at December 31, 2006 and 2005, respectively.
The following table shows the maturity distribution of the amortized cost of the Company’s investment securities at December 31, 2006, with comparative totals for 2005. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations:
(1) Maturities of mortgage-backed securities are based on contractual payments and estimated mortgage loan prepayments.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table shows the maturity distribution of the fair value of the Company’s investment securities at December 31, 2006, with comparative totals for 2005. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations:
(1) Maturities of mortgage-backed securities are based on contractual repayments and estimated mortgage loan prepayments.
The following table is a summary of those investment securities that had been in a continuous unrealized loss position for less than and greater than twelve months as of December 31, 2006 and 2005, respectively:
December 31, 2006 (in thousands):
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2005 (in thousands):
U.S. Treasury securities and U.S. government agency obligations. The unrealized losses on the Company’s investments in U.S. Treasury securities and direct obligations of U.S. government agencies were caused by interest rate increases. The Company has the ability and intent to hold these investments until a recovery of their amortized cost, which may be at maturity, and does not consider these investments to be other-than-temporarily impaired at December 31, 2006.
Mortgage-backed securities. The unrealized losses on the Company’s investment in federal agency mortgage-backed securities were caused by interest rate increases. The decline in market value is attributable to changes in interest rates and not credit quality. The Company has the ability and intent to hold these investments until a recovery of their amortized cost, which may be at maturity, and does not consider these investments to be other-than-temporarily impaired at December 31, 2006.
Corporate bonds and notes. The Company’s unrealized loss on investments in corporate bonds and notes was caused by a general increase in market interest rates. Included are 31 issuers with a carrying value of $286 million and a fair value of $281 million. These bonds have at least an S&P rating of A- and a Moody’s rating of A3. The Company has the ability and intent to hold these investments until a recovery of their amortized cost, which may be at maturity, and does not consider these investments to be other-than-temporarily impaired at December 31, 2006.
Note 4 LOANS
The Company’s lending activities are conducted primarily in Vermont, New Hampshire, Massachusetts and Maine, with additional activity relating to nearby market areas in New York, Connecticut and Quebec. The Banks make single-family and multi-family residential loans, commercial real estate loans, commercial & industrial loans, and a variety of consumer loans and municipal loans. In addition, the Banks make loans for the construction of residential homes, multi-family and commercial properties, and for land development.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Major classifications of loans at December 31, 2006 and 2005 are as follows:
Changes in the allowance for loan losses are summarized as follows:
The principal amount of loans on nonaccrual status was $20,093,800 and $15,819,400 at December 31, 2006 and 2005, respectively. At the end of 2006 and 2005, the Company had no loans whose terms had been substantially modified in troubled debt restructurings.
The amount of interest which was not earned but which would have been earned had nonaccrual loans performed in accordance with their original terms and conditions were as follows:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Information regarding loans that were considered to be impaired under SFAS 114 is as follows:
Residential mortgage loans serviced for others, which are not reflected in the consolidated balance sheets, totaled approximately $2.037 billion and $2.098 billion at December 31, 2006 and 2005, respectively. No recourse provisions exist in connection with such servicing.
The following table is a summary of activity for mortgage servicing rights purchased and originated for the three years ended December 31, 2006:
SFAS 140 requires enterprises to measure the impairment of servicing assets based on the difference between the carrying amount of the servicing rights and their current fair value. Fair value is measured as the discounted cash flow of future servicing income expected to be received based upon market conditions at the time the estimate is made. Significant assumptions made by management at December 31, 2006 include the weighted average discount rate (9.8%), weighted average prepayment speed (226 PSA/13.56 CPR), weighted average servicing fee (25.60 basis points) and net cost to service loans ($17/loan). Based upon these assumptions, the Company calculated the fair value of its servicing rights to be $19.382 million at December 31, 2006.
The Company stratifies its servicing portfolio based upon interest rate (in increments of 50 basis points) and original loan term (primarily 15 and 30 year). The estimated market value of capitalized servicing rights may vary significantly in subsequent periods primarily due to changing market interest rates, and their effect on prepayment speeds, and discount rates. At December 31, 2006 and 2005, the impairment valuation allowance was $622,000 and $639,000, respectively.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The estimated sensitivity of the current fair value of the mortgage servicing rights portfolio to changes in interest rates at December 31, 2006, was as follows:
The sensitivities in the table above are hypothetical and should be used with caution. The effect of a variation in a particular assumption on the fair value of the mortgage servicing right is calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Because the amount recognized on the Company’s balance sheet is at the lower of cost or market (fair value), changes in the calculated fair value of mortgage servicing rights will not necessarily translate to a corresponding change in the amount shown on the balance sheet.
Note 5 PREMISES AND EQUIPMENT
Premises and equipment at December 31, 2006 and 2005 are summarized as follows:
Total depreciation expense amounted to approximately $7,427,000, $8,066,000 and $7,977,000 in 2006, 2005 and 2004.
The Company is obligated under various noncancelable operating leases for premises and equipment expiring in various years through 2021. Total lease expense, net of income from subleases, amounted to approximately $4,480,000, $4,518,000 and $4,560,000 in 2006, 2005, and 2004, respectively.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Future minimum rental commitments for noncancelable operating leases on premises and equipment with initial or remaining terms of one year or more at December 31, 2006 are as follows:
Note 6 BORROWINGS
Borrowings at December 31, 2006 and 2005 consisted of the following:
Securities sold under agreements to repurchase are collateralized by U.S. Treasury and agency securities, mortgage-backed securities and corporate notes or bonds. These assets had a carrying value and a market value of $82,254,000 and $78,369,000, respectively, at December 31, 2006, and $63,802,000 and $61,418,000, respectively, at December 31, 2005. The borrowings from the Federal Home Loan Bank of Boston are secured by residential mortgage loans held in the Company’s loan portfolio.
The following information relates to securities sold under agreements to repurchase:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following information relates to FHLB borrowings:
On May 21, 2002, a wholly-owned subsidiary of the Company, Chittenden Capital Trust I (the “Trust”), issued $125 million of 8% trust preferred securities (“TPS”) to the public and invested the proceeds from this offering in an equivalent amount of junior subordinated debentures issued by the Company. These debentures are the sole asset of the trust subsidiary. The proceeds from the offering, which was net of $4.5 million of issuance costs, were used as the cash consideration in the Granite Bank acquisition. The TPS pay interest quarterly, are mandatorily redeemable on July 1, 2032 and may be redeemed by the Trust at par any time on or after July 1, 2007. The Company has fully and unconditionally guaranteed the TPS issued by the Trust.
Concurrent with the issuance of these securities, the Company entered into interest rate swap agreements with two counterparties, in which the Company received 8% fixed on the notional amount of $125 million, while paying the counterparties a variable rate based on the three month LIBOR (London Interbank Offered Rate), plus approximately 122 basis points. In August 2006, the Company terminated the interest rate swap agreements with both counterparties and settled with a final payment of interest and termination fees of $372,000.
The following information relates to TPS borrowings:
Note 7 INCOME TAXES
Income tax expense consists of the following:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Current income taxes payable, included in other liabilities, was $3,813,000 at December 31, 2006, compared to a current income taxes receivable, included in other assets of $2,285,000 at December 31, 2005.
The following is a reconciliation of the provision for Federal income taxes, calculated at the statutory rate, to the recorded income tax expense:
The components of the net deferred tax asset at December 31, 2006 and 2005 are as follows:
Note 8 STOCKHOLDERS’ EQUITY
Treasury Stock
During 2006, the Company repurchased a total of 1.8 million shares of common stock. On October 20, 2005, the Company announced that the Board of Directors authorized the repurchase of up to 1,000,000 shares of the Company’s common stock in negotiated transactions or open market purchases. Chittenden repurchased all of those shares by June 30, 2006. On July 19, 2006 the Board of Directors authorized the repurchase of an additional 1,000,000 shares of the Company’s common stock. The Company repurchased 800,000 of this second authorization during 2006.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Dividends
Dividends paid by the Banks are the primary source of funds available to the Company for payment of dividends to its stockholders and for other corporate needs. Applicable federal and state statutes, regulations, and guidelines impose restrictions on the amount of dividends that may be declared by the Banks. The Company paid dividends to stockholders’ of $36.2 million, $33.4 million and $31.9 million, which represented $0.78, $0.72, and $0.70 per share during 2006, 2005, and 2004, respectively.
Earnings Per Share
The following table summarizes the calculation of basic and diluted earnings per share:
The following table summarizes options that could potentially dilute earnings per share in the future which were not included in the computation of the common stock equivalents because to do so would have been antidilutive:
Accumulated Other Comprehensive Income
Comprehensive income is the total of net income and all other non-owner changes in equity. The Company has chosen to display comprehensive income in the Consolidated Statements of Changes in Stockholders’ Equity. The following table summarizes reclassification detail for other comprehensive income for the years ended December 31:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 9 STOCK PLANS
The Company has two stock option plans: The Stock Incentive Plan, and the Directors’ Omnibus Long-term Incentive Plan. Effective January 1, 2006, the Company adopted SFAS 123R using the modified retrospective method to account for share-based payments to employees and the Company’s Board of Directors. In accordance with the modified retrospective method, the Company has adjusted previously reported results to reflect the effect of expensing stock options granted during those periods. The cumulative adjustment associated with the adoption of SFAS 123R increased the Company’s deferred tax asset $4.2 million, surplus $19.8 million and decreased retained earnings $15.6 million as of the quarter ended March 31, 2006.
Under the plans there are various types of stock incentives, including, but not limited to options; restricted stock which vests after a specified period of time; unrestricted stock awards; and performance awards. The primary type of share-based payment utilized by the Company is stock options. Stock options are awards which allow the employee to purchase shares of the Company’s stock at a fixed price. In accordance with Chittenden’s Stock Incentive Plan, stock options are granted at an exercise price equal to the Company stock price at the date of grant. Prior to 2006, the stock options issued by the Company generally vested immediately at the time of issuance. In 2006, the Company’s Board of Directors changed this practice and vested the new option grants over one year. There were a total of 7,688,324 shares at December 31, 2006 and 2005 available to be issued under the plans and 6,163,698 and 5,636,131 had been issued at each of these dates.
The Company has a Performance Share Program that governs Performance Share Awards under the Stock Incentive Plan. Performance awards consist of shares of the Company’s common stock to be issued at the conclusion of the three-year performance cycle provided that performance goals are met as measured by one or more of the following: corporate profitability, EPS, ROE and/or other measures as deemed relevant by the Executive Committee. In 2006 and 2005, targets of 45,500 and 41,460 Performance Shares were set that could be earned at the end of the three-year performance cycle if the performance measures are attained. The plan is a leveraged plan meaning that if the Company is ranked in the 100th percentile versus its comparison group, up to 150% of the targeted amount of shares could be earned. In order to earn the full target award of 45,500, the Company would need to be ranked in the 75th percentile. If the Company is not ranked in at least the 25th percentile, no shares will be awarded. Notwithstanding these guidelines, the Board of Directors has the authority to reduce, but not increase, these awards if they deem it to be appropriate in the circumstances. Salary expenses related to the performance shares were $855,000 in 2006.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following tables summarize information regarding the Company’s stock option plans:
OPTIONS OUTSTANDING AND EXERCISABLE
December 31, 2006
The Company estimates the fair value of stock option grants using the Black-Scholes valuation model and the key input assumptions are: expected volatility, expected term of option, risk-free interest rate and dividend yield. Expected volatility estimates are developed by the Company based on historical volatility of the Company’s stock. The Company uses historical data to estimate the expected term of the options. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury yield in effect at the grant date. The dividend yield represents the expected dividends on the Company stock. The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are consistent with SFAS 123R. Estimates of fair value are not intended to predict the actual future value ultimately realized by employees who receive share-based awards, and subsequent events are not indicative of the reasonableness of original estimates of fair value made by the Company under SFAS 123R.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table presents the key input assumptions for the Black-Scholes valuation model for grants in 2006, 2005 and 2004:
The total intrinsic value (market value on date of exercise less grant price) of options exercised during the twelve months ended December 31, 2006, 2005 and 2004, was $1.9 million, $3.1 million, and $4.6 million, respectively. The total cash received from employees as a result of employee stock option exercises for the years ended December 31, 2006, 2005, and 2004 was approximately $6.8 million, $9.3 million and $9.7 million, respectively. The tax benefit realized as a result of the stock option exercises was $619,000 in 2006 compared with $1.1 million in 2005 and $1.6 million in 2004.
The total compensation costs related to options were $3.2 million, $2.1 million and $3.8 million during 2006, 2005, and 2004, respectively. These amounts are included in salary expense in the accompanying consolidated Statements of Income.
Note 10 EMPLOYEE BENEFITS
Pension Plan
The Company sponsors a qualified defined benefit pension plan that covers substantially all of its employees who meet minimum age and service requirements.
In 2005, the Board of Directors approved changes to the Company’s retirement program. As a result, on December 31, 2005, benefits accrued under the defined benefit Pension Account Plan were frozen based on participants’ current service and pay levels. Effective January 1, 2006, the Company’s annual contribution to the Incentive Savings and Profit Sharing Plan (401(k) Plan) was enhanced for all eligible employees.
The changes in the benefit obligation for the years ended December 31, 2006 and 2005 are as follows:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Weighted-average assumptions used in determining pension obligations for the years ended December 31:
The changes in the plan assets for the years ended December 31, 2006 and 2005 are as follows:
The asset allocation for the Company’s pension plan at December 31, 2005 and 2006, and the target asset allocation for 2007, by asset category are as follows:
Chittenden uses a measurement date of September 30 for its pension plan.
The Company’s investment policy seeks to achieve long-term capital growth to enable the plan to meet its future benefit obligations to participants and to maintain liquidity sufficient to cover plan distributions without exposing the Company to undue investment risk. The Retirement Plan Committee is responsible for overseeing the investment performance of the plan, including evaluating the performance of the investment managers. The Committee is also responsible for periodically reviewing the plan’s investment objectives and guidelines to ensure they remain appropriate.
Funded status, end of year:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Amounts recognized in the statement of financial position:
Amounts recognized in accumulated other comprehensive income (pretax):
At the end of 2006 and 2005, the projected benefit obligation, the accumulated benefit obligation and the fair value of plan assets for the pension plan with a projected benefit obligation in excess of plan assets and for the pension plan with an accumulated benefit obligation in excess of plan assets were as follows:
Benefit disbursements and employer contributions for the years ended December 31, 2005 and 2006, and expected benefit disbursements and contributions for 2007 are as follows:
Expected Cash Flows
Due to recent contributions made in excess of the minimum required amounts, the Company does not anticipate a required contribution during 2007.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Net pension expense components included in employee benefits in the consolidated statements of income are as follows:
Weighted-average assumptions used to determine net cost:
* 5.75% was used to determine cost for the first eight months of 2005. As of May 31, 2005, the plan was remeasured due to the Company’s decision to change the delivery mechanism, effective January 1, 2006, for its employees’ pension benefit by redirecting it through the Company’s 401(k) plan. 5.25% was used to determine cost for the last four months of 2005.
The estimated amounts that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2007 are as follows:
Based on a representative allocation within the target asset allocation described above, management expects an annual long-term return for its portfolio of 7.25%. In formulating this assumed long-term rate of return, the Company considered historical returns by asset category and expectations for future returns by asset category based, in part, on simulated capital market performance over the next 15 years. Resulting expected returns by asset category have been weighted based on the target asset allocation to produce the weighted average assumption of 7.25%.
Amounts resulting from changes in actuarial assumptions used to measure the Company’s benefit obligations are not recognized as they occur, but are amortized systematically over subsequent periods.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CTC has supplemental pension arrangements with certain retired employees. The liability, included in accrued expenses and other liabilities, related to such arrangements was $1,149,000 and $1,297,000 at December 31, 2006 and 2005, respectively.
The Company has established a supplemental executive retirement plan (SERP) for members of the executive management group. This unfunded plan is intended to cover only those benefits excluded from coverage under the Company’s qualified defined benefit pension plan as a result of IRS regulations. The design elements of this SERP mirror those of the Company’s qualified plan. In addition to the SERP, the Company has a separate arrangement with its Chief Executive Officer under which contributions are accrued based upon the Company’s return on equity (ROE). A ROE of 10% is the minimum threshold at which any contribution will be made. Benefits are payable upon attaining the age of 55, except in the event of death or disability. The liability related to the CEOs SERP, included in accrued expenses and other liabilities was $3,675,000 and $3,258,000 at December 31, 2006 and 2005, respectively. Expenses related to this plan were $417,385, $265,000 and $377,000 in 2006, 2005 and 2004, respectively.
Other Benefit Plans
The Company has an incentive savings and profit sharing plan to provide eligible employees with a means to invest a portion of their earnings for retirement. Eligible employees of the Company may contribute, by salary reductions, up to 6% of their compensation as a basic employee contribution and may contribute up to an additional 20% of their compensation as a supplemental employee contribution. Investment in the Company’s common stock is one of the investment options available to employees; however, there are no restrictions on transfers or required holding periods.
During the three year period ended December 31, 2006, the Company made incentive savings contributions in amounts equal to 35% of each employee’s basic contribution, which was charged to benefits expense.
The Company may also make an additional matching contribution (profit-sharing) to the incentive savings and profit sharing plan based on the extent to which the annual corporate profitability goals established by the Board of Directors are met. Benefits expense related to the additional matching contribution totaled:
The following table reflects the shares of the Company’s common stock that were purchased through the incentive savings and profit sharing plan, during each of the last three years:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company has established a supplemental executive savings plan. This plan is intended to cover only those benefits excluded from coverage under the Corporation’s qualified incentive savings and profit sharing plan as a result of IRS regulations. Any contributions under this supplemental plan, when combined with the regular pre-tax contributions shall not exceed 16% of the individual’s earnings. Benefit expense related to this plan was $87,000, $110,000 and $12,000 in 2006, 2005 and 2004, respectively.
The Company also has an Executive Management Incentive Compensation Plan. Executives at defined levels of responsibility are eligible to participate in the plan. Incentive award payments are determined on the basis of corporate and group profitability, relative performance within a defined peer group and individual performance. Awards may range from zero to 100% of annual compensation. Expenses for this plan totaled $2,058,000, $2,235,000 and $715,000 in 2006, 2005, and 2004, respectively.
The Company has a Directors’ Deferred Compensation Plan. Under the plan, Directors may defer fees and retainers that would otherwise be payable currently. Deferrals may be made to an uninsured interest bearing account or to an account recorded in equivalents of the Company’s common stock. Directors are required to defer 50% of their compensation (and may defer as much as 100%) in the equivalent of the Company’s common stock. Expenses for this plan totaled $1,365,000, $1,256,000, and $1,189,000 for 2006, 2005, and 2004, respectively. Based on these elections, shares that could be issued under the plan totaled 417,299 at December 31, 2006.
Note 11 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, to meet customers’ financing needs and to reduce their own exposure to fluctuations in interest rates, the Banks are parties to financial instruments with off-balance sheet risk, held for purposes other than trading. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Banks’ exposure to credit loss in the event of nonperformance by the other party for loan commitments and standby letters of credit is represented by the contractual amount of those instruments, assuming that the amounts are fully advanced and that collateral or other security is of no value. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, plant and equipment, and real estate.
Commitments to originate loans, unused lines of credit, and unadvanced portions of commercial real estate and construction 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. Many of the commitments are expected to expire without being drawn upon. Therefore, the amounts presented below do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance by a customer to a third party. These guarantees are issued primarily to support public and private borrowing arrangements, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Financial instruments whose contractual amounts represent off-balance sheet risk at December 31, 2006 and 2005 are as follows:
Note 12 COMMITMENTS AND CONTINGENCIES
The Federal Reserve System requires nonmember banks to maintain certain reserve requirements of vault cash and/or deposits with the Federal Reserve Bank of Boston. The amount of this reserve requirement, included in cash and cash equivalents, was $31,802,000 and $29,483,000 at December 31, 2006 and 2005, respectively.
The Company has entered into severance agreements with the Chief Executive Officer and several members of senior management. These agreements are triggered by a change of control under certain circumstances. Payments are equal to two times (2.99 times for the CEO) the amount of the highest base salary and target bonus in effect at or following a change in control; two times (2.99 times for the CEO) the amount of the Core Contribution that would have been contributed on the officer’s behalf under the Chittenden Corporation Incentive Savings and Profit Sharing Plan in the event the officer had continued employment until the end of the then current year; two times (2.99 times for the CEO) the amount of the 401(k) match, the profit sharing portion of the 401(k) contribution and the amount of the 401(k) restoration payment, if any, that would have been contributed on behalf of the officer in the event the officer had continued employment until the end of the then current year; and two times (2.99 times for the CEO) the amount that would have been contributed on behalf of the officer under the supplemental executive retirement plan for members of the executive management group in the event the officer had continued employment until the end of the then current year.
Various legal claims against the Company arising in the normal course of business were outstanding at December 31, 2006. Management, after reviewing these claims with legal counsel, is of the opinion that the resolution of these claims will not have a material effect on the financial condition or results of operations of the Company.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 13 OTHER NONINTEREST EXPENSE
The components of other noninterest expense for the years presented are as follows:
Note 14 FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and Cash Equivalents
The carrying amounts for cash and cash equivalents approximate fair value because they mature in 90 days or less and do not present unanticipated valuation risk.
Securities
The fair value of investment securities, other than Federal Home Loan Bank (FHLB) stock and Federal Reserve Bank (FRB) stock, is based on quoted market prices. The carrying value of FHLB and FRB stock represents its redemption value.
Loans
Fair values are estimated for portfolios of loans with similar financial and credit characteristics. The loan portfolio was evaluated in the following segments: 1) commercial loans which include commercial & industrial, municipal, multi-family, commercial real estate and construction and 2) residential real estate loans including home equity credit lines.
The fair value of performing commercial loans is estimated by discounting cash flows through the estimated maturity using discount rates that reflect the expected maturity, credit and interest rate risk inherent in such loans. The fair value of nonperforming commercial loans is estimated using historical net charge-off experience applied to the nonperforming balances. For performing residential real estate loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources. The fair value of municipal loans is estimated to be equal to amortized cost since most of these loans mature within nine months. The fair value of consumer loans is estimated based on secondary market prices for asset-backed securities with similar characteristics.
Mortgage Servicing Rights
The fair value is estimated by discounting the future cash flows through the estimated maturity of the underlying mortgage loans.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Deposits
The fair value of deposits with no stated maturity is equal to the amount payable on demand, that is, the carrying amount. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate used is based on the estimated rates currently offered for deposits of similar remaining maturities.
Borrowings
The fair value of long-term debt is based upon the discounted value of contractual cash flows using a discount rate consistent with currently offered rates of similar duration.
Commitments to Extend Credit and Standby Letters of Credit
The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of financial standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties.
Assumptions
Fair value estimates are made at a specific point in time, based on relevant market information and information about specific financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Banks’ entire holdings of a particular financial instrument. Because no active observable market exists for a significant portion of the Banks’ financial instruments, fair value estimates are 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.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The estimated fair values of the Company’s financial instruments are as follows:
Note 15 PARENT COMPANY FINANCIAL STATEMENTS
Chittenden Corporation (Parent Company Only)
BALANCE SHEETS
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
STATEMENTS OF INCOME
STATEMENTS OF CASH FLOWS
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 16 REGULATORY MATTERS
The Company and the Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Each entity’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios (set forth in the tables below) of total and Tier I capital (as defined in the regulation) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2006, that the Company and the Banks meet all capital adequacy requirements.
As of December 31, 2006, the Company and the Banks were “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as adequately or well capitalized, the Company and the Banks must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the tables below.
The Company’s and the Banks’ actual capital amounts (dollars in thousands) and ratios are presented in the following tables:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
NOTE 17 BUSINESS SEGMENTS
Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and Related Information has established standards for public companies relating to the reporting of financial and descriptive information about their operating segments in financial statements. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the President and Chief Executive Officer of the Company.
The Company has identified Commercial Banking as its reportable operating business segment based on the fact that the results of operations are viewed as a single strategic unit by the chief operating decision-maker. The Commercial Banking segment is comprised of the five Commercial Banking subsidiaries, which provide similar products and services, have similar distribution methods, types of customers and regulatory responsibilities. Commercial Banking derives its revenue from a wide range of banking services, including lending activities, acceptance of demand, savings and time deposits, business services, trust and investment management, brokerage services, mortgage banking, and loan servicing for investor portfolios.
Immaterial operating segments of the Company’s operations, which do not have similar characteristics to the commercial banking operations and do not meet the quantitative thresholds requiring disclosure, are included in the Other category in the disclosure of business segments below. Revenue derived from these segments includes insurance commissions from insurance products and services, as well as other operations associated with the parent holding company. The accounting policies used in the disclosure of business segments are the same as those described in the summary of significant accounting policies.
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following tables present the results of the Company’s reportable operating business segments:
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(1) The Commercial Banking segment derives a majority of its revenue from net interest income. In addition, management primarily relies on net interest income, not the gross revenue and expense amounts, in managing that segment. Therefore, only the net amount has been disclosed.
(2) Revenue derived from these non-reportable segments includes insurance commissions from various insurance related products and services, as well as other operations associated with the parent holding company.
Note 18 RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 “Fair Value Measurements” (Statement 157). Statement 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. Statement 157 does not require any new fair value measurements, but clarifies and standardizes some divergent practices that have emerged since prior guidance was issued. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact.
In June, 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies
CHITTENDEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order to be recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 31, 2006. Accordingly, the Company will adopt FIN 48 on January 1, 2007. The cumulative effect of applying the provisions of FIN 48 will be reported as an adjustment of the Company’s opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position). The Company has assessed the impact of this Interpretation and estimates that the adoption of this standard will not result in a material effect. The Company will implement FIN 48 in the first quarter of 2007.
In March 2006, the FASB also issued Statement of Financial Accounting Standards No. 156 (“SFAS 156”), “Accounting for Servicing of Financial Assets”. This statement amends Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS 156 requires companies to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. The statement permits a company to choose either the amortized cost method or fair value measurement method for each class of separately recognized servicing assets. This statement is effective as of the beginning of a company’s first fiscal year after September 15, 2006. The Company has analyzed SFAS 156 and determined that upon adoption it will have no material impact on the reported results of operations or financial conditions. The Company will implement SFAS 156 in the first quarter of 2007.
Note 19 SUBSEQUENT EVENTS
On January 19, 2007, the Company announced that it had signed a definitive merger agreement whereby Chittenden will acquire Merrill Merchants Bancshares, Inc. and its subsidiary, Merrill Merchants Bank, for approximately $111.4 million in cash and stock. The transaction, which is subject to regulatory approval, the approval of Merrill’s Shareholders, and other customary closing conditions, is expected to close in the second quarter of 2007. The acquisition will be accounted for as a purchase. Merrill and its subsidiary, Merrill Merchants Bank, are headquartered in Bangor, Maine. Merrill had total assets of $449 million, $339 million in loans, deposits of $360 million, and $39 million of stockholders’ equity at December 31, 2006 and presently operates 11 banking offices in central and eastern Maine.
On February 14, 2007, the Company issued $125 million of Subordinated Notes due 2017. The notes will bear interest at 5.80% per year from the date of issuance to but excluding February 14, 2012. The notes will mature on February 14, 2017. Beginning February 14, 2012, we may, at our option and subject to prior regulatory approval, redeem some or all of the notes. The Company will use the net proceeds from the sale of the notes for general corporate purposes. Initially the net proceeds may be used to make short-term investments and repay short-term borrowings.
Report of Independent Registered Public Accounting Firm
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF CHITTENDEN CORPORATION:
We have completed integrated audits of Chittenden Corporation’s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Chittenden Corporation (the “Company”) and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements 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 of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Annual Report on Internal Control over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the COSO. The Company’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 opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting 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. An audit of internal control over financial reporting includes 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 consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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.
PricewaterhouseCoopers LLP
Montpelier, VT
February 26, 2007
MANAGEMENT’S STATEMENT OF RESPONSIBILITY
The consolidated financial statements contained in this annual report on Form 10-K have been prepared in accordance with generally accepted accounting principles and, where appropriate, include amounts based upon management’s best estimates and judgments. Management is responsible for the integrity and the fair presentation of the consolidated financial statements and related information.
Management maintains a system of internal controls to provide reasonable assurance that the Company’s assets are safeguarded against loss and that transactions are executed in accordance with management’s authorization and recorded properly to permit the preparation of consolidated financial statements in accordance with generally accepted accounting principles in the United States of America. These internal controls include the establishment and communication of policies and procedures, the selection and training of qualified personnel and an internal auditing program that evaluates the adequacy and effectiveness of such internal controls, policies and procedures. Management recognizes that even a highly effective internal control system has inherent risks, including the possibility of human error and the circumvention or overriding of controls, and that the effectiveness of an internal control system can change with circumstances. However, management believes that the internal control system provides reasonable assurance that errors or irregularities that could be material to the consolidated financial statements are prevented or would be detected on a timely basis and corrected through the normal course of business. As of December 31, 2006, management believes the internal controls were in place and operating effectively.
The Board of Directors discharges its responsibility for the consolidated financial statements through its Audit Committee, which is comprised entirely of non-employee directors. The Audit Committee meets periodically with management, internal auditors and the independent public accountants. The internal auditors and the independent public accountants have direct full and free access to the Audit Committee and meet with it, with and without management being present, to discuss the scope and results of their audits and any recommendations regarding the system of internal controls.
The independent accountants were engaged to perform an independent audit of the consolidated financial statements. They have conducted their audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) as stated in their report which appears on page 86 and 87.
Paul A. Perrault
Kirk W. Walters
President, Chief Executive Officer and
Chair of Board of Directors
Executive Vice President and
Chief Financial Officer
QUARTERLY FINANCIAL DATA (Unaudited)
A summary of quarterly financial data for 2006 and 2005 is presented below:
ITEM 9
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A
ITEM 9A CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of December 31, 2006, the end of the period covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and the Company’s management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. The Company reviews its disclosure controls and procedures, which may include its internal control over financial reporting on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.
There was no change in the Company’s internal control over financial reporting that occurred during the fiscal quarter ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Chittenden Corporation is responsible for establishing and maintaining adequate internal control over financial reporting and for identifying the framework used to evaluate its effectiveness. Chittenden’s system of internal control over financial reporting was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of financial statements in accordance with Generally Accepted Accounting Principles.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Chittenden’s management including the Company’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2006. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on that assessment, management concluded that, as of December 31, 2006, the Company’s internal control over financial reporting was effective based on those criteria.
Chittenden’s independent auditors, PricewaterhouseCoopers, LLP, an independent registered public accounting firm, have issued an attestation report on our management’s assessment of the Company’s internal control over financial reporting, as referenced below.
ATTESTATION REPORT OF THE REGISTERED PUBLIC ACCOUNTING FIRM
See Report of Independent Registered Public Accounting Firm on pages 86 and 87.
ITEM 9B
ITEM 9B OTHER INFORMATION
none
PART III
ITEM 10
ITEM 10 DIRECTORS, EXECUTIVE OFFICERS and CORPORATE GOVERNANCE
Information with respect to directors and executive officers of the Company required by Item 10 shall be included in the Proxy Statement for the Annual Meeting of Stockholders to be held on April 18, 2007 and is incorporated herein by reference.
The Company’s Policy on Ethics and Professional Standards was approved by the Chittenden Board of Directors on September 17, 2003 and is available on the Company’s website at www.chittendencorp.com. A copy of the Code of Ethics will be provided to any person without charge upon request to the Secretary of the Company.
ITEM 11
ITEM 11 EXECUTIVE COMPENSATION
Information with respect to executive compensation required by Item 11 shall be included in the Proxy Statement for the Annual Meeting of Stockholders to be held on April 18, 2007 and is incorporated herein by reference.
ITEM 12
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Equity Compensation Plan Information. The following table sets forth the aggregate information regarding securities authorized for issuance under the Company’s equity compensation plans as of December 31, 2006:
Equity Compensation Plan Information
ITEM 13
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information with respect to certain relationships and related transactions required by Item 13 shall be included in the Proxy Statement for the Annual Meeting of Stockholders to be held on April 18, 2007 and is incorporated herein by reference.
ITEM 14
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
Information with respect to principal accounting fees and services required by Item 14 shall be included in the Proxy Statement for the Annual Meeting of Stockholders to be held on April 18, 2007 and is incorporated herein by reference.
PART IV
ITEM 15
ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
(1) FINANCIAL STATEMENTS
The financial statements of the Company and its subsidiaries are included in Part II, Item 8 hereof and are incorporated herein by reference.
(2) FINANCIAL STATEMENT SCHEDULES
There are no financial statement schedules required to be included in this report.
(3) EXHIBITS
(a) The following are included as exhibits to this report:
* Filed / furnished herewith
EXHIBIT 21 LIST OF SUBSIDIARIES OF CHITTENDEN CORPORATION
Chittenden Trust Company, Vermont, d/b/a Chittenden Bank, and Chittenden Mortgage Services, Chittenden Trust Company’s subsidiaries Chittenden Securities, LLC, Chittenden Insurance, LLC, and Chittenden Commercial Finance
The Bank of Western Massachusetts, Massachusetts
Flagship Bank and Trust Company, Massachusetts
Maine Bank & Trust, Maine
Ocean National Bank, New Hampshire and Maine
EXHIBIT 23 CONSENT OF PRICEWATERHOUSECOOPERS HAS BEEN FILED AS AN EXHIBIT
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, thereto duly authorized.
SIGNATURES
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.
CHITTENDEN CORPORATION
SKU-#002CS-13457