10-Q 1 e10-q.txt ANDOVER BANCORP INC. 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------------------- FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended June 30, 2000 or ------------- [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from ____________ to ____________ Commission File Number 0-16358 ------- ANDOVER BANCORP, INC. ---------------------------------------------------- (Exact name of Registrant as specified in its charter) DELAWARE 04-2952665 ------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 61 MAIN STREET, ANDOVER, MASSACHUSETTS 01810 -------------------------------------- ---------------------- (Address of principal executive office) (Zip Code) (978) 749-2000 ---------------------------------------------------- (Registrant's telephone number, including area code) Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- The number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date is: Class: Common Stock, par value $0.10 per share Outstanding as of August 7, 2000: 6,654,639 shares 2 ANDOVER BANCORP, INC. AND SUBSIDIARIES INDEX PART I - FINANCIAL INFORMATION

3 ANDOVER BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS --------------------------- (Unaudited)

The accompanying notes are an integral part of the consolidated financial statements. 1 4 ANDOVER BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- (Unaudited)

The accompanying notes are an integral part of the consolidated financial statements. 2 5 ANDOVER BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEAR ENDED DECEMBER 31, 1999 AND SIX MONTHS ENDED JUNE 30, 2000 (UNAUDITED)

The accompanying notes are an integral part of the consolidated financial statements. 3 6 ANDOVER BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (Unaudited)

Statement continued on next page. 4 7 ANDOVER BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) ------------------------------------------------- (Unaudited)

The accompanying notes are an integral part of the consolidated financial statements. 5 8 ANDOVER BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1) BASIS OF PRESENTATION The unaudited consolidated financial statements of Andover Bancorp, Inc. (the "Company") and its principal subsidiary, Andover Bank (the "Bank"), presented herein, should be read in conjunction with the consolidated financial statements of the Company as of and for the year ended December 31, 1999. Andover Bank is a state chartered savings bank with its headquarters located in Andover, Massachusetts. In the opinion of management, the unaudited consolidated financial statements presented herein reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation. Interim results are not necessarily indicative of results to be expected for the entire year. 2) SUBSEQUENT EVENT On July 1, 2000, the Company completed its acquisition of GBT Bancorp ("GBT") and its wholly-owned subsidiary, Gloucester Bank and Trust Company. Gloucester Bank and Trust Company is a Massachusetts-chartered trust company with two banking offices located in Gloucester, Massachusetts. The transaction will be accounted for as a purchase. Under the terms of the merger agreement, Andover will issue approximately 300,000 new shares of its common stock and $8.1 million in cash to the GBT shareholders. As of June 30, 2000, GBT had $132.6 million in assets, primarily commercial real estate loans and investment securities, and deposits of $107.8 million. The goodwill attributed to this transaction is not expected to exceed $11.0 million. 6 9 ANDOVER BANCORP, INC. AND SUBSIDIARIES ANALYSIS OF NET YIELD ON EARNING ASSETS --------------------------------------- (Unaudited)

(1) Included in the average balance amounts are the corresponding components of the assets held for sale, available for sale and held to maturity. The yield has been calculated using interest income divided by the average balance of the amortized historical cost. (2) Included in the average balance and interest earned amounts is the stock in FHLB of Boston. (3) Interest on nonaccruing loans has been included only to the extent reflected in the statement of operations. However, the loan balances are included in the average balance outstanding. (4) The "Average Yield/Rate" calculation is based on an annualized basis reflecting 91 days in the second quarter of both years and 182 days in the year-to-date period of 2000 versus 181 days in the year to date period of 1999. 7 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2000 PRELIMINARY NOTE IN REGARD TO FORWARD-LOOKING STATEMENTS. This quarterly report on Form 10-Q contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes", "anticipates", "plans", "expects", "intends" and similar expressions are intended to identify forward-looking statements. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Company. These expressed or implied important risks, uncertainties and other factors may cause the Company's actual results, performance or achievements to differ materially from those expressed or implied by such forward-looking statements. These factors include, without limitation, those set forth below under the caption "Certain Factors That May Affect Future Results". CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS. The following important factors, among others, could cause actual results, performance or achievements of the Company to differ materially from those expressed or implied by forward-looking statements made in this quarterly report on Form 10-Q or presented elsewhere by management from time to time. Defined terms used elsewhere in this quarterly report have the same meanings herein as therein. A number of uncertainties exist that could affect the Company's future operating results, performance or achievements including, without limitation, the Company's ability to integrate systems and other back-office operations of GBT and Gloucester Bank and Trust Company following the acquisition of GBT, unanticipated costs in connection with the proposed acquisition, the Bank's continued ability to originate quality loans, fluctuations of interest rates, real estate market conditions in the Bank's lending area, general and local economic conditions, the Bank's continued ability to attract and retain deposits, the Company's ability to control costs, new accounting pronouncements, and changing regulatory requirements. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this report and the Company does not promise to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes. RESULTS OF OPERATIONS GENERAL. Net income amounted to $4.8 million, or $0.73 per diluted share, for the quarter ended June 30, 2000 as compared to net income of $4.7 million, or $0.71 per diluted share, for the second quarter of 1999. The Company's results through June 30, 2000, do not reflect the operations of Gloucester Bank and Trust Company which was acquired by the Company on July 1, 2000. Andover's annualized return on average assets totaled 1.22% for the second quarter of 2000 compared to 1.33% in the second quarter of 1999. The annualized return on average stockholders' equity decreased to 14.60% in the second quarter of 2000 from 15.45% in the second quarter of 1999. NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income totaled $12.8 million for the second quarter of 2000 as compared to $11.8 million for the same period in 1999. This increase resulted primarily from a 10.4% increase in average earning assets. The 5 basis point decrease in the net yield on earning assets to 3.36% for the second quarter of 2000, as compared to 3.41% in the corresponding quarter of 1999, was due primarily to a 44 basis point increase in the rate on interest bearing liabilities, partially offset by a 36 basis point rise in the yields earned on the interest-earning assets. PROVISION FOR LOAN LOSSES. The allowance for loan losses is established through a provision for loan losses charged to the statement of operations. The allowance 8 11 is reduced by a credit for loan losses as well as loan charge-offs. Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management's evaluation of the amount required to meet possible loan losses after weighing various factors. Among the factors that management may consider are the quality of specific loans, risk characteristics of the loan portfolio generally, the level of nonaccruing loans, current economic conditions, trends in delinquencies, actual charge-off experience, and collateral values of the underlying security. Because the allowance for loan losses is based on various estimates, and includes a high degree of judgment by management, subsequent changes in the general economic prospects of the borrowers may require changes in those estimates. In addition, regulatory agencies, as an integral part of the examination process, review the Bank's allowance and may require the Bank to provide additions to the allowance based on their assessment, which may differ from management's assessment. There was a provision for loan losses of $400,000 for the second quarter of 2000 and no provision taken in the comparative quarter in 1999. In addition to the factors mentioned above, management considered several other factors in determining that a provision was needed in the second quarter of 2000. These factors include, without limitation, the level and mix of loan growth, the ratio of the allowance to total loans as well as charge-offs and recoveries. Net recoveries totaled $114,000 for the second quarter of 2000 as compared to $120,000 in 1999. Based on this analysis, management believes that the allowance for loan losses is adequate as of June 30, 2000. NON-INTEREST INCOME. Net gains from sales of loans, investments and mortgage-backed securities held for sale and available for sale totaled $17,000 in the second quarter of 2000 as compared to net losses of $7,000 in the second quarter of 1999. Mortgage banking income totaled $418,000 in the second quarter of 2000 versus $302,000 in the comparable quarter in 1999. In both years, there was a credit taken to reduce the mortgage servicing asset valuation allowance, thereby increasing mortgage banking income. This credit to the valuation allowance totaled $250,000 and $175,000, respectively for the second quarter of 2000 and 1999. The mortgage servicing assets are assessed for impairment on a quarterly basis. During the second quarter of 2000, mortgage interest rates continued to rise, thereby increasing the value of the servicing rights and reducing the need for the same level of valuation allowance. Amortization expense totaled $628,000 and $623,000, respectively, for the quarters ended June 30, 2000 and 1999. While there were no mortgage servicing asset charge-offs in the second quarter of 2000, charge-offs totaled $100,000 for the second quarter of 1999. It should be noted, however, that if mortgage interest rates decline from their current levels, it is possible that future provisions to the valuation allowance or servicing asset charge-offs may be necessary due to the mortgage prepayment risk inherent in the servicing portfolio. This mortgage prepayment risk is the result of loans repaying faster than expected, causing the fair value of the mortgage servicing asset to decline. Loans serviced for investors totaled $954.2 million and $813.8 million, respectively, at June 30, 2000 and 1999. The following table summarizes the activity in the valuation allowance for mortgage servicing assets for the three months and quarters ended June 30, 2000 and 1999:

9 12 Other income totaled $962,000 in the second quarter of 2000 as compared to $864,000 in the second quarter of 1999 primarily due to a rise in deposit fee and miscellaneous income, partially offset by lower loan fees due to a lower level of delinquent loans. NON-INTEREST EXPENSE. Non-interest expenses increased by $798,000, or 14.7%, to $6.2 million in the second quarter of 2000 from $5.4 million in the second quarter of 1999. The efficiency ratio (a ratio that measures operating expenses as a percentage of operating income) increased from 42.1% in the second quarter of 1999 to 44.1% in the comparable period of 2000 primarily due to higher general and administrative costs. The increase in non-interest expense during the second quarter of 2000 was attributable to a rise in both salaries and employee benefits and data processing expenses, partially offset by a decrease in mortgage banking expenses. Salaries and employee benefits, the largest component of non-interest expense, increased $318,000, or 10.8%, in the second quarter of 2000 to $3.3 million primarily due to the introduction of a money purchase plan and an increase in the corporate match to the existing 401(k) plan. These enhanced benefits added approximately $130,000 in benefit costs during the second quarter of 2000. In addition, a higher level of employees contributed to the increased salaries and benefits expense in 2000. Office occupancy and equipment expenses remained flat from the second quarter of 1999 to $810,000 for the three months ended June 30, 2000. This trend is not anticipated to continue as the Bank opened its 13th branch location in the latter part of the second quarter of 2000. Data processing expenses increased from the second quarter of 1999 to the corresponding quarter in 2000 by 19.5% or $112,000. This was primarily due to an increase in the number of loans serviced by the Company as well as increased costs associated with alternative delivery systems such as the internet, debit cards and automated services. In addition, as the size and complexity of the Company increases, information systems needed to support the decisions and the costs related thereto will increase. Professional fees increased $97,000 to $322,000 in the second quarter of 2000 from $225,000 in the second quarter of 1999 due to corporate legal expenses and consulting fees unrelated to the merger of GBT. Marketing expenses increased 32.1% to $280,000 for the second quarter of 2000 compared to 1999's second quarter due to increased advertising for the Bank's deposit products in light of the large bank divestitures occurring in the Company's market area. Mortgage banking expenses decreased 57.6% or $34,000 in the second quarter of 2000 versus 1999's second quarter due to reduced costs incurred in conjunction with the serviced loan portfolio as well as a significant reduction in the costs incurred by the Bank resulting from higher refinancing activity experienced in 1999. Other operating expenses increased 39.3% from the second quarter of 1999 to $843,000 in the corresponding quarter in 2000 due to a rise in miscellaneous loan charges, postage, office supplies and telephone costs along with various other sundry costs. INCOME TAX EXPENSE. The Company recorded an income tax expense of $2.8 million and $2.7 million on its financial statement earnings for the second quarters of 2000 and 1999, respectively. The effective tax rate for the second quarters of both 2000 and 1999 was 36.5%. FINANCIAL CONDITION Total assets increased from $1,491.1 million at December 31, 1999 to $1,637.1 million at June 30, 2000. Increases in the investment and loan portfolios were funded primarily by the significant increase in the total deposits during the first half of 2000. 10 13 LOANS. The following table shows the composition of the Company's loan portfolio at June 30, 2000 and December 31, 1999. The balances shown in the table are net of unadvanced funds and deferred loan origination fees and costs.

Total loans increased $86.0 million during the first half of 2000 to $1,219.1 million at June 30, 2000, primarily due to an increase in the residential real estate and construction and land portfolios as a result of continued demand for new housing. However, each loan category experienced growth in the first six months of 2000. Originations of all loan types are sensitive to the interest rate environment, the capacity for borrowing and real estate values, current and anticipated economic conditions as well as the competitive landscape. Due to the favorable interest rates experienced in the first six months of 1999, mortgage refinancing volume was very heavy and resulted in residential loan originations totaling $125.7 million. Conversely in 2000, residential loan originations totaled only $59.2 million due to a decrease in refinancing activity caused by a rise in interest rates. Residential loan balances increased only $28.2 million during the first six months of 2000 primarily due to the securitization of certain fixed-rate loans as well as regular amortization and loan prepayments. Outstanding corporate loans, comprised of commercial real estate, commercial, construction and land loans and leases, increased $50.3 million during the first half of 2000. The volume of corporate loan originations reflects the Company's increased interest for this type of loan, however, real estate values, current and anticipated economic conditions and a customer's capacity for borrowing have a more critical role. Corporate loan originations totaled $119.3 million and $92.1 million, respectively, for the six months ended June 30, 2000 and 1999. The loan balances do not reflect the full impact of the total originations due to loan prepayments and certain amounts that remain unadvanced as of June 30, 2000. Consumer loan balances increased by approximately 12.1% on an annualized basis, to $69.3 million at June 30, 2000, primarily due to an increase in the second mortgage portfolio. RISK ELEMENTS. The following table shows the composition of non-performing assets at June 30, 2000 and December 31, 1999:

11 14 At June 30, 2000, total impaired loans were $1.9 million, of which $553,000 had related allowances of $28,000 and $1.3 million which did not require a related allowance. All of the $1.9 million in impaired loans have been measured using the fair value of the collateral method. During the six months ended June 30, 2000, the average recorded value of impaired loans was $2.2 million. NONACCRUING LOANS. Management places loans on nonaccrual status when loan payments are past due 90 days or more, regardless of collateral values. All previously accrued but uncollected interest is reversed against current period interest income when a loan is placed on nonaccrual status. Loans for which payments are less than 90 days past due are placed on nonaccrual status when concern exists as to the ultimate collectibility of the loan. Nonaccrual loans are generally not returned to performing status until the obligation is brought current and when concern no longer exists as to the collectibility of principal or interest. The following table shows the composition of nonaccruing loans at June 30, 2000, and December 31, 1999:

12 15 ALLOWANCE FOR LOAN LOSSES. The following table summarizes the activity in the Company's allowance for loan losses for the three months and six months ended June 30, 2000 and 1999:

Management analyzes the adequacy of the allowance for loan losses on a quarterly basis. See "Results of Operations - Provision for Loan Losses". INVESTMENTS. As of June 30, 2000, the Company's total investment portfolio amounted to $317.3 million, an increase of $30.5 million from December 31, 1999. The increase in the first half of 2000 was primarily due to purchases of various investments available for sale, including mortgage-backed securities, corporate bonds, U.S. government and federal agency obligations. However, these purchases were partially offset by principal repayments in the mortgage-backed portfolio. Management continually evaluates its investment alternatives in order to properly manage the overall balance sheet mix. The timing of purchases, sales and reinvestment, if any, will be based on various factors including expectation of movements in market interest rates and loan demand. Notwithstanding these events, it is the intent of management to grow the earning asset base through loan originations, loan purchases or investment acquisitions while funding this growth through a mix of retail deposits, FHLB advances and other borrowings. 13 16 The following table presents the composition and carrying values of the investment portfolio at June 30, 2000 and December 31, 1999:

The following table shows the gross unrealized gains and losses by major categories of securities as of June 30, 2000:

At June 30, 2000, the Company's net unrealized loss on investments available for sale amounted to $5.7 million, a fair value decline of $690,000 from $5.0 million at December 14 17 31, 1999. At June 30, 2000, the Company's net unrealized loss on investments held to maturity totaled $1.3 million, for a fair value decline of $72,000 from $1.2 million at December 31, 1999. The changes in the net unrealized loss on the total investment portfolio from year-end 1999 were primarily due to an increase in market interest rates during the first six months of 2000. DEPOSITS AND BORROWED FUNDS. Total deposits increased $103.4 million to $1,072.0 million at June 30, 2000 from $968.5 million at December 31, 1999. This increase was most pronounced in certificates of deposit accounts which increased by $41.1 million during the first six months of 2000. In addition, NOW accounts rose by $29.0 million, demand deposits increased $20.9 million and savings deposits rose $15.4 million during this period. Partially offsetting this increase, however, was a modest decline of $2.9 million in money market deposit accounts during the first half of 2000. Included in the certificate of deposits shown below were $30 million of brokered certificates opened in the second quarter of 2000. The following table shows the composition of the Company's deposits at June 30, 2000 and December 31, 1999:

To help fund the growth in total assets experienced during the first six months of 2000, the Bank increased its borrowed funds position. Federal Home Loan Bank advances increased $41.5 million from December 31, 1999 to $347.2 million at June 30 2000. Other borrowings increased $1.1 million to $74.8 million at June 30, 2000. These increases fueled the rise in total assets for the first half of 2000. LIQUIDITY. The goal of the Company's liquidity management process is to assess its funding requirements so as to efficiently meet the cash needs of borrowers and depositors, while also providing funds for attractive investment opportunities. Liquidity involves the Company's ability to raise or gain access to funds in order to fulfill its existing and anticipated financial obligations. The Company's primary source of funds is dividends from its bank subsidiary. Dividends from the Bank to the Company totaled $10.0 million in the second quarter of 2000. The Company made payments of dividends to stockholders in the amount of $1.5 million in the second quarter of 2000. In July, 2000, the Company declared a dividend in the amount of $1.6 million, payable in the third quarter of 2000. The Bank has a diverse base of funding. Sources of liquidity include increasing customer deposits, borrowed funds, repayments, prepayments and amortization of the investment and loan portfolios as well as sales of securities in the investments available for sale portfolio. Sources of borrowed funds include funds purchased from other banks, customer repurchase agreements, the sale of securities under repurchase agreements and borrowings from the FHLB, of which the Bank is a voluntary member. The Bank may also obtain funds from the discount window of the Federal Reserve Bank of Boston by pledging certain assets. Cash flows used by operations decreased $16.9 million to $985,000 in the first six months of 2000, as compared to cash flows provided of $15.9 million in the corresponding period of 1999 primarily due to an increase in other assets and assets held for sale. Cash flows used by investing activities increased by $37.0 million to $124.6 million for 15 18 the six months ended June 30, 2000, as compared to $87.6 million during the equivalent period last year. This increase was mainly attributable to an increase in the loan portfolio as well as a higher level of purchases of whole loans. Cash flows provided by financing activities increased $81.4 million for the six months ended June 30, 2000 to $138.3 million, as compared to $56.9 million in the equivalent period in 1999. The financing activity increase was due to a change in the mix of financing sources, with a significant rise in deposits and FHLB advances offset by a decrease in other borrowings. During the first quarter of 2000, the Company repurchased 177,900 common shares in connection with its previously announced stock repurchase plan. No shares were repurchased during the second quarter of 2000. Approximately 146,000 shares remain eligible for repurchase under the 5% program limitation. At June 30, 2000, the Company had home equity, reserve credit and commercial unadvanced lines of credit totaling $105.0 million. Outstanding commitments to originate loans totaled $116.9 million. Unadvanced portions of construction and land loans amounted to $49.6 million. Standby letters of credit were $4.3 million. Loans sold with recourse totaled $918,000. Management believes that its sources of liquidity are sufficient to meet these commitments if and as called upon. CAPITAL RESOURCES. The following table presents regulatory capital ratios under current regulatory and risk-based capital requirements as of June 30, 2000:

As of June 30, 2000, the most recent notification from the FDIC categorized the Bank as well capitalized under the prompt corrective action provisions. Therefore, the Bank is entitled to pay the lowest deposit premium possible. ASSET AND LIABILITY MANAGEMENT AND MARKET RISK. The Bank's primary source of revenue is net interest income, which is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. The Company seeks to manage its exposure to interest rate risk or market risk, through active monitoring and management of its interest rate risk exposure, which is inherent in its lending and deposit taking activities. The policies and procedures for managing both on and off balance sheet activities are established by Andover's Asset/Liability Management Committee (ALCO), who reports its findings to the Board of Directors on a regular basis. The main objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Company's net interest income and to preserve capital, while adjusting the Company's asset/liability structure to obtain the maximum yield-cost spread on that structure. However, a sudden and substantial increase in interest rates may adversely impact earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. For further information regarding quantitative and qualitative disclosures about market risk, please refer to the Company's Form 10-K as of and for the year ended December 31, 1999. 16 19 RECENT ACCOUNTING DEVELOPMENTS. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), which establishes new accounting and reporting standards for derivative instruments. SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities and measure those instruments at fair value. This statement, as amended by SFAS 137, is effective for financial statements issued for all fiscal quarters of fiscal years beginning after June 15, 2000. Early application is encouraged but restatement of prior periods is prohibited. SFAS 133 is not expected to have a material impact on the consolidated financial statements of the Company. 17 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2000 RESULTS OF OPERATIONS GENERAL. Net income amounted to $9.3 million, $1.42 per diluted share, for the six months ended June 30, 2000, compared to net income of $9.5 million, $1.42 per diluted share, in the corresponding period of 1999. The financial performance in the first six months of 2000 was positively impacted by an increase in net interest and dividend income, offset by an increase in non-interest expenses. The first six months results for 1999 were positively impacted by a $1.1 pre-tax gain due to the curtailment of the defined benefit pension plan. The annualized return on average assets was 1.22% for the first six months of 2000 as compared to 1.36% in the comparable period of 1999. The annualized return on average stockholders' equity was 14.30% in the first six months of 2000, for a decline from 15.82% in the comparable period of 1999. NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income was $25.3 million for the six months of 2000, as compared to $23.2 million for the same period in 1999, an increase of 9.0%. The net yield on earning assets remained constant for the first six months of 2000 and 1999 at 3.40%. This was in spite of an increase of 25 basis points in the rates paid on interest-bearing liabilities, offset by a 25 basis point rise in the rate earned on interest-earning assets. Total earning assets increased $122.3 million for the first six months of 2000 over 1999's level. PROVISION FOR LOAN LOSSES. There was a provision for loan losses of $600,000 in the first six months of 2000 and no provision in the comparable period of 1999. Several factors were used to determine that a provision was necessary in 2000. Among them were the level of charge-offs and recoveries and the mix and level of loan growth. Nonaccruing loans decreased by 19.7% during the first six months of 2000 while overdue loans remained stable. In addition, net loan charge-offs totaled $67,000 in the first half of 2000 compared to net recoveries totaling $788,000 in the first six months of 1999. In addition, the loan growth of $86.0 million, primarily experienced in the corporate lending areas during the first six months of 2000, contributed to the need for a loan loss provision. NON-INTEREST INCOME. Andover recorded gains from non-interest sources of $2.7 million for the first six months of 2000, as compared to $2.4 million in the corresponding period of 1999. Net gains from sales of assets held for sale and investments available for sale totaled $24,000 in 2000 as compared to $86,000 in the same period of 1999. Mortgage banking income totaled $842,000 during the first six months of 2000 as compared to income of $519,000 in the corresponding period of 1999 due to partial reversals of the valuation allowance on mortgage servicing assets totaling $500,000 in 2000 and $175,000 in 1999's first half. Total amortization amounted to $1.3 million for the first six months of both 2000 and 1999. There were no charge-offs on mortgage servicing assets in the first half of 2000 versus charge-offs totaling $390,000 for the six month period ending June 30, 1999. Other income remained relatively stable at $1.8 million in the first six months of 2000 and 1999. NON-INTEREST EXPENSE. Non-interest expenses increased 18.8% to $12.7 million in the first six months of 2000 primarily due to an increase in salaries and employee benefits and data processing costs. 18 21 Salaries and benefits increased $1.7 million or 31.9% to $7.0 million as of June 30, 2000. The increase resulted primarily from the curtailment of the defined benefit pension plan in the first half of 1999 resulting in a pre-tax gain of $1.1 million. In addition, increased costs incurred from the enhanced benefit plans in 2000 totaled another $300,000. Office occupancy and equipment increased 6.5% to $1.7 million in 2000 primarily resulting from the addition of two new branches becoming operational in the first half of 2000 and the related costs for operating them. Data processing expenses increased 21.3% to $1.3 million resulting from the Company's loan and deposit growth as well as expenses relating to the newer delivery channels. Professional fees decreased 28.1% to $509,000 in 2000 from $708,000 in 1999 due to increased legal and corporate consulting fees incurred in the early part of 1999 in curtailing the pension plan and consolidating Andover Bank NH into Andover. Marketing expenses increased 23.6% to $524,000 primarily due to increased advertising for discretionary promotions and direct mail solicitations. Mortgage banking expenses decreased 74.1% due to a lower level of residential mortgage loan originations and refinances experienced in the first six months of 2000 over 1999's levels. Other operating expenses increased 15.4% to $1.6 million primarily due to increased deposit insurance, telephone costs, printing expenses and other miscellaneous costs in running a larger, more geographically diverse company. INCOME TAX EXPENSE. The Company recorded an income tax expense of $5.4 million and $5.3 million on its financial statement earnings for the first six months of 2000 and 1999, respectively. This corresponds to an effective tax rate of 36.5% and 35.9%, respectively, for the first six months of 2000 and 1999. 19 22 PART II - OTHER INFORMATION

20 23 EXHIBITS TO FORM 10-Q ANDOVER BANCORP, INC. EXHIBIT INDEX

ANDOVER BANCORP INC 10-Q