10-Q 1 b39220abe10-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 March 31, 2001 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 May 1, 2001: 6,701,244 shares 2 ANDOVER BANCORP, INC. AND SUBSIDIARIES ---------------- INDEX PART I - FINANCIAL INFORMATION ITEM 1 Financial Statements Page Consolidated Balance Sheets 1 Consolidated Statements of Operations 2 Consolidated Statements of Changes in Stockholders' Equity 3 Consolidated Statements of Cash Flows 4-5 Note to Consolidated Financial Statements 6 Analysis of Net Yield on Earning Assets 7 ITEM 2 Management's Discussion and Analysis of 8-16 Financial Condition and Results of Operations For the Three Months Ended March 31, 2001 ITEM 3 Quantitative and Qualitative Disclosures About Market Risk 16 PART II - OTHER INFORMATION ITEM 1 Legal Proceedings 18 ITEM 2 Changes in Securities 18 ITEM 3 Defaults upon Senior Securities 18 ITEM 4 Submission of Matters to a Vote of Security Holders 18 ITEM 5 Other Information 18 ITEM 6 Exhibits and Reports on Form 8-K 18 Signatures 19 Exhibit Index 20 3 ANDOVER BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS --------------------------- (Unaudited)

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

The accompanying note is 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, 2000 and Three Months Ended March 31, 2001 (Unaudited)

The accompanying note is 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 note is an integral part of the consolidated financial statements. 5 8 ANDOVER BANCORP, INC. AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENTS ----------------------------------------- 1) BASIS OF PRESENTATION Andover Bancorp, Inc.(the "Company" or "Andover") is the multi-bank holding company parent of Andover Bank (the "Bank") and Gloucester Bank & Trust Company ("Gloucester" or "GBT"). The unaudited consolidated financial statements of Andover Bancorp, Inc. and its subsidiaries presented herein, should be read in conjunction with the consolidated financial statements of the Company as of and for the year ended December 31, 2000. Andover Bank is a state chartered savings bank with its headquarters located in Andover, Massachusetts. Gloucester Bank & Trust Company is a Massachusetts-chartered trust company with two banking offices located in Gloucester, 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. 6 9 ANDOVER BANCORP, INC. AND SUBSIDIARIES 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 amounts outstanding. (4) The "Average Yield/Rate" calculation is based on an annualized basis reflecting 90 days in the first quarter of 2001 and 91 days in the first quarter of 2000. 7 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2001 ----------------------------------------- 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. We may also make written or oral forward-looking statements in other documents we file with the Securities and Exchange Commission ("SEC"), in our annual report to stockholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. Without limiting the foregoing, the words "believe", "estimate", "assume", "outlook", "should", "anticipate", "plan", "expect", "intend" and similar expressions which predict or indicate future events and which do not relate to historical matters 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, including future SEC filings. 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 Banks' continued ability to originate quality loans, fluctuation of interest rates, real estate market conditions in the Banks' lending areas, general and local economic conditions, the Banks' 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 $5.1 million, or $0.75 per diluted share, for the quarter ended March 31, 2001 as compared to net income of $4.6 million, or $0.69 per diluted share, for the first quarter of 2000. The results for 2001 were positively impacted by the acquisition of Gloucester which was consummated on July 1, 2000. The Company recorded a charge to earnings of $207,000 which is reflected as a reduction of mortgage banking income during the first quarter of 2001. This charge resulted from declining mortgage interest rates causing a reduction in the estimated fair value of the mortgage servicing rights. In the first quarter of 2000, a credit to the valuation account of $250,000 was recorded. Andover's annualized return on average assets totaled 1.17% for the first quarter of 2001 compared to 1.21% in the first quarter of 2000. The annualized return on average stockholders' equity decreased to 13.43% in the first quarter of 2001 from 14.00% in the first quarter of 2000. 8 11 NET INTEREST AND DIVIDEND INCOME. Net interest and dividend income totaled $15.1 million for the first quarter of 2001 as compared to $12.5 million for the same period in 2000. The 20.6% increase resulted primarily from a 17.1% increase in average earning assets as well as a higher net interest margin which was 3.56% in the first quarter of 2001 versus 3.43% last year. Growth in net interest and dividend income was enhanced in the first quarter of 2001 by the acquisition of Gloucester. 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 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 any of the factors considered or 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 Banks' allowance and may require the Banks to provide additions to the allowance based on their assessment, which may differ from management's assessment. There was a provision for loan losses totaling $275,000 in the first quarter of 2001 and $200,000 in the comparable quarter in 2000. Management considered several factors in determining that a provision was needed in the first quarters of both 2001 and 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. The slight increase in nonaccruing loans during the first quarter of 2001, particularly in commercial real estate loans, combined with the troubled debt restructuring of a loan totaling $2.4 million, contributed to the need for a loan loss provision in the current quarter. Taking all of the factors into consideration, management believes that the allowance for loan losses is adequate as of March 31, 2001. NON-INTEREST INCOME. Net gains from sales of loans, investments and mortgage-backed securities held for sale and available for sale totaled $173,000 in the first quarter of 2001 as compared to $7,000 in the first quarter of 2000. Mortgage banking losses totaled $112,000 in the first quarter of 2001 versus mortgage banking income of $424,000 in the comparable quarter in 2000. The mortgage servicing assets are assessed for impairment on a quarterly basis. During the first quarter of 2001, mortgage interest rates declined, thereby decreasing the value of the servicing rights and resulting in the need for a valuation allowance which amounted to $207,000 in the first quarter of 2001. The first quarter of 2000 marked a rise in mortgage interest rates, thereby increasing the value of servicing rights resulting in a credit to valuation allowance of $250,000. 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. Amortization expense totaled $677,000 and $626,000, respectively, for the quarters ended March 31, 2001 and 2000. Mortgage servicing asset charge-offs in the first quarter of 2001 were $55,000. There were no mortgage servicing asset charge-offs in the first quarter of 2000. Loans serviced for investors totaled $910.6 million and $938.8 million, respectively, at March 31, 2001 and 2000. 9 12 The following table summarizes the activity in the valuation allowance for mortgage servicing assets for the three months ended March 31, 2001 and 2000: Three Months Ended March 31 ------------------ 2001 2000 ---- ---- (In thousands) Balance at beginning of period $ -- $ 500 Provision (credit) for valuation allowance 207 (250) Charge-offs (55) -- ----- ----- Balance at end of period $ 152 $ 250 ===== ====== Other income totaled $1.1 million in the first quarter of 2001 as compared to $858,000 in the first quarter of 2000 primarily due to a rise in deposit and loan fee income. The first quarter of 2001 also includes a net loss of $79,000 from the sale of various equipment made obsolete in the consolidation of the data processing functions of the two banks. NON-INTEREST EXPENSE. Non-interest expenses increased by $1.4 million, or 22.1%, to $7.8 million in the first quarter of 2001 from $6.4 million in the first quarter of 2000. The efficiency ratio (a ratio that measures operating expenses as a percentage of operating income) increased from 46.5% in the first quarter of 2000 to 48.6% in the comparable period of 2001 primarily due to higher general and administrative costs associated with the acquisition of GBT. The total operating expenses associated with GBT were approximately $950,000 in the first quarter of 2001. Salaries and employee benefits, the largest component of non-interest expense, increased $560,000, or 15.2%, in the first quarter of 2001 to $4.3 million. This rise in expenses is due mainly to an increase in the number of employees from the GBT acquisition, staffing a new branch in Derry, New Hampshire and company-wide merit increases awarded in the quarter. Office occupancy and equipment expenses rose from $850,000 in the first quarter of 2000 to $1.0 million for the three months ended March 31, 2001 due to the addition of Gloucester's two branches and remote ATM's and their related operating costs. Data processing expenses increased from the first quarter of 2000 to the corresponding quarter in 2001 by 31.3% or $203,000, and totaled $851,000. This was primarily due to an increase in the number of loans and deposits serviced by the Banks as well as increased costs associated with alternative delivery systems such as the internet, debit cards and automated services. As the size and complexity of the Company continues to increase, the information systems needed to support the Company will likely increase. Professional fees increased $68,000 to $255,000 in the first quarter of 2001 from $187,000 in the first quarter of 2000 due to increased legal expenses and consulting fees. Marketing expenses increased 8.2% to $264,000 for the first quarter of 2001 compared to 2000's first quarter due to increased advertising for the Banks' deposit products over a larger geographically diverse area. Amortization of goodwill amounted to $150,000 in the first quarter of 2001 resulting from the acquisition of Gloucester in 2000. This charge to earnings will continue until a proposed accounting change on business combinations is finalized and adopted. The proposal, if adopted in its current version, would result in the cessation of the goodwill amortization. The carrying amount of goodwill would be reduced only if found to be impaired or associated with assets to be sold or otherwise disposed of. Goodwill 10 13 would also be subject to new impairment test rules. For further information, please refer to the section entitled "Recent Accounting Developments", in this Form 10-Q. Other operating expenses increased $226,000 or 28.5% from the first quarter of 2000 to $1.0 million in the corresponding quarter in 2001 due to the continued growth of the Company which impacts office supplies, printing expense and other general administrative costs. Gloucester's operations represented $110,000 of the other operating expenses. INCOME TAX EXPENSE. The Company recorded an income tax expense of $3.0 million for the first quarter of 2001. By comparison, income tax expense for the first quarter of 2000 totaled $2.6 million. The net effective tax rates for the first quarters of 2001 and 2000 were 37.1% and 36.5%, respectively. The higher tax rate in 2001 was partly due to the nondeductability of the goodwill amortization. FINANCIAL CONDITION Total assets at March 31, 2001 amounted to $1,799.0 million, for a modest decline of $24.2 million or 1.3% from $1,823.2 million at December 31, 2000. The decrease from December 31, 2000 was mainly attributable to the decline in the investment portfolio resulting from maturities and redemptions of callable securities, which in turn, allowed the company to reduce its borrowed funds. LOANS. The following table shows the composition of the Company's loan portfolio at March 31, 2001 and December 31, 2000. The balances shown in the table are net of unadvanced funds and deferred loan origination fees and costs. 3/31/01 12/31/00 ---------- ----------- (In thousands) Real estate loans: Residential $ 817,575 $ 811,214 Commercial 289,623 284,419 Construction and land 84,691 89,922 ---------- ---------- Total real estate loans 1,191,889 1,185,555 ---------- ---------- Consumer loans 88,406 87,322 ---------- ---------- Commercial loans: Commercial and lease loans 48,752 47,828 Lease financing 33,874 35,476 ---------- ---------- Total commercial loans 82,626 83,304 ---------- ---------- Total loans $1,362,921 $1,356,181 ========== ========== Total loans increased $6.7 million to $1,362.9 million at March 31, 2001. The modest loan growth experienced by the Company in the first three months of 2001 does not fully reflect the higher level of originations since the refinance volume was also high for the first quarter. Originations of all loan types are sensitive to a variety of factors including, without limitation, the interest rate environment, the capacity for borrowing, real estate values, current and anticipated economic conditions, and the competitive landscape. Due to the favorable interest rate environment in the first three months of 2001, residential loan originations totaled $46.1 million. Conversely in 2000, residential loan originations totaled only $21.1 million due to the higher interest rate environment experienced during the first quarter of 2000. Residential loan balances increased only $6.4 million during the first three months of 2001 primarily due to securitization and sale of 15 year and 30 year fixed rate loans; regular amortization and loan prepayments. Outstanding corporate loans, comprised of commercial real estate, commercial, construction and land loans and leases, totaled $456.9 million at March 31, 2001 versus $457.6 million at December 31, 2000. The balance of the corporate loan portfolio reflects the Company's efforts with respect to originations in this type of loan. However, the level of the corporate loan originations is impacted more by the current 11 14 real estate values, current and anticipated economic conditions and a customer's capacity for borrowing than the Company's desire to grow this portfolio. Corporate loan originations totaled $30.2 million and $39.6 million, respectively, for the three months ended March 31, 2001 and 2000. The reduction over the prior year is primarily due to reduced demand. The loan balances outstanding do not reflect the full impact of the total originations due to loan prepayments and certain amounts that remain unadvanced as of March 31, 2001. Consumer loan balances remained relatively stable at $88.4 million and $87.3 million at March 31, 2001 and 2000, respectively. Strong levels of second mortgage loan activity accounted for the modest growth in the first quarter of 2001. RISK ELEMENTS. The following table shows the composition of non-performing assets at March 31, 2001 and December 31, 2000: 3/31/01 12/31/00 ------- -------- (Dollars in thousands) Nonaccruing loans $2,007 $ 1,676 Other real estate owned 30 30 ------ ------ Total non-performing assets $2,037 $1,706 ====== ====== Total non-performing assets as a percentage of total assets 0.11% 0.09% At March 31, 2001, total impaired loans were $3.8 million. These loans did not require a related allowance at March 31, 2001. All of the $3.8 million in impaired loans have been measured using the fair value of the collateral method. During the three months ended March 31, 2001, the average recorded value of impaired loans was $2.7 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 March 31, 2001 and December 31, 2000: 3/31/01 12/31/00 ------- ------- (Dollars in thousands) Residential real estate $ 510 $ 342 Commercial real estate 1,019 799 Construction and land -- -- Commercial and lease loans 361 382 Lease financing 64 100 Consumer 53 53 ------- ------- Total nonaccrual loans outstanding $ 2,007 $ 1,676 ======= ======= Allowance for loan losses $15,080 $14,640 ======= ======= Allowance for loan losses as a percentage of total loans 1.1% 1.1% RESTRUCTURED LOANS. A restructured loan is a loan in which management has modified the terms to provide a temporary reduction in the rate of interest below the prevailing market interest rates at the time of modification and, in most instances, an extension of payments of principal or interest or both due to the deterioration in the financial 12 15 position of the borrower. Restructured loans are not returned to performing status until the obligation has performed for a reasonable period of time, its ultimate collectibility is no longer in doubt and is at a market rate of interest. Restructured loans totaled $2.4 million at March 31, 2001. There were no restructured loans at December 31, 2000. ALLOWANCE FOR LOAN LOSSES. The following table summarizes the activity in the Company's allowance for loan losses for the three months ended March 31, 2001 and 2000: THREE MONTHS ENDED MARCH 31, ------------------------- 2001 2000 -------- -------- (Dollars in thousands) Balance at beginning of period $ 14,640 $ 11,384 Provision for loan losses 275 200 Charge-offs: Residential real estate -- -- Commercial real estate -- -- Construction and land -- -- Commercial and lease loans (9) (75) Lease financings -- (166) Consumer (1) (1) -------- -------- Total charge-offs (10) (242) -------- -------- Recoveries: Residential real estate 6 4 Commercial real estate 118 34 Construction and land -- -- Commercial and lease loans 49 19 Lease financings 1 -- Consumer 1 4 -------- -------- Total recoveries 175 61 -------- -------- Net (charge-offs) recoveries 165 (181) -------- -------- Balance at end of period $ 15,080 $ 11,403 ======== ======== Ratio of annualized net (charge-offs) recoveries to average loans outstanding 0.05% (0.06)% Management analyzes the adequacy of the allowance for loan losses on a quarterly basis. See "Results of Operations - Provision for Loan Losses". INVESTMENTS. At March 31, 2001, the Company's total investment portfolio amounted to $332.3 million, a decrease of $34.7 million from December 31, 2000. The decrease in the first three months of 2001 was due to a reduction in the balances held in federal funds, maturities and redemptions of investments both held for and available for sale totaling $18.8 million as well as a sale of an investment available for sale in the amount of $4.1 million. 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 March 31, 2001 and December 31, 2000: 3/31/01 12/31/00 -------- -------- (In thousands) SHORT-TERM INVESTMENTS $ 19,000 $ 29,300 ======== ======== INVESTMENTS AVAILABLE FOR SALE (AT MARKET): Common stocks $ 3,780 $ 3,494 -------- -------- U.S. government and federal agency obligations 65,691 73,691 Other bonds and obligations 142,337 140,457 -------- -------- Total bonds and obligations 208,028 214,148 -------- -------- GNMA mortgage-backed securities 28,689 29,387 FHLMC participation certificates 17,712 18,366 FNMA pass-through certificates 11,838 11,986 Collateralized mortgage obligations 7,378 11,774 -------- -------- Total mortgage-backed securities 65,617 71,513 -------- -------- Total investments available for sale $277,425 $289,155 ======== ======== INVESTMENTS HELD TO MATURITY (AT AMORTIZED COST): U.S. government and federal agency obligations $ -- $ 8,500 Other bonds and obligations 1,003 1,005 -------- -------- Total bonds and obligations 1,003 9,505 -------- -------- FNMA pass-through certificates 15,079 17,917 FHLMC participation certificates 11,419 12,207 GNMA mortgage-backed securities 1,410 1,573 Collateralized mortgage obligations 6,655 7,042 Other asset-backed securities 275 289 -------- -------- Total mortgage-backed securities 34,838 39,028 -------- -------- Total investments held to maturity $ 35,841 $ 48,533 ======== ======== Total investments $332,266 $366,988 ======== ======== The following table shows the gross unrealized gains and losses by major categories of securities as of March 31, 2001: Unrealized Unrealized Gains Losses --------- ---------- (In thousands) INVESTMENTS AVAILABLE FOR SALE: Common stocks $ 1,150 $ -- U.S. government and federal agency obligations 2,590 (33) Other bonds and obligations 4,728 (115) Mortgage-backed securities 1,887 (72) ------- ------- Total investments available for sale $10,355 $ (220) ======= ======= INVESTMENTS HELD TO MATURITY: Other bonds and obligations $ 20 $ -- Mortgage-backed securities 722 (10) ------- ------- Total investments held to maturity $ 742 $ (10) ======= ======= Total unrealized gains and losses $11,097 $ (230) ======= ======= At March 31, 2001, the Company's net unrealized gain on investments available for sale amounted to $10.1 million, a fair value rise of $4.9 million from a $5.3 million net unrealized gain at December 31, 2000. At March 31, 2001, the Company's net unrealized 14 17 gain on investments held to maturity totaled $732,000, for a fair value rise of $251,000 from a $481,000 net unrealized gain at December 31, 2000. The changes in the net unrealized gain on the total investment portfolio from year-end 2000 were primarily due to a decline in market interest rates during the first three months of 2001. DEPOSITS AND BORROWED FUNDS. Total deposits increased $33.1 million to $1,254.3 million at March 31, 2001 from $1,221.2 million at December 31, 2000. Aided by the disruption caused by large bank acquisitions and divestitures, the Company has been successful in attracting new deposit relationships. Included in the certificates of deposit shown below were $45.0 million of brokered certificates of deposit at both March 31, 2001 and December 31, 2000. The following table shows the composition of the Company's deposits at March 31, 2001 and December 31, 2000: 3/31/01 12/31/00 ----------- ----------- (In thousands) Demand deposit accounts $ 147,556 $ 145,660 NOW accounts 163,994 151,168 Money market accounts 110,924 107,814 Savings accounts 261,272 246,812 Certificates of deposit 570,576 569,735 ---------- ---------- Total deposits $1,254,322 $1,221,189 ========== ========== During the first three months of 2001, the Company decreased its borrowed funds position. Federal Home Loan Bank advances decreased $66.5 million from December 31, 2000 to $350.8 million at March 31, 2001. Other borrowings decreased $1.7 million to $17.2 million at March 31, 2001. This net decline of $68.2 million was partially offset by the growth in total deposits reflected above. The change in the liability mix was a significant factor in the increased net interest margin for the first quarter of 2001. The following table shows the composition of the Company's borrowed funds at March 31, 2001 and December 31, 2000: 3/31/01 12/31/00 ------- -------- (In thousands) Cash management accounts $ 17,203 $ 17,460 Federal funds purchased 2 1,481 FHLB advances 350,755 417,277 -------- -------- $367,960 $436,218 ======== ======== 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 subsidiaries. The Banks paid no dividends to the Company in the first three months of 2001. The Company made payments of dividends to stockholders in the amount of $1.8 million in the first three months of 2001. In April, 2001, the Company declared a dividend in the amount of $1.8 million, payable in the second quarter of 2001. The Banks have 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 15 18 agreements and borrowings from the FHLB, of which both Banks are voluntary members. The Banks may also obtain funds from the discount window of the Federal Reserve Bank of Boston by pledging certain assets. Cash flows provided by operations decreased $1.8 million to $2.9 million in the first three months of 2001, as compared to cash flows provided of $4.7 million in the corresponding period of 2000 primarily due to an increase in assets held for sale. Cash flows provided by investing activities increased by $77.5 million to $22.7 million for the three months ended March 31, 2001, as compared to cash flows used of $54.8 million during the equivalent period last year. This increase was mainly attributable to a decrease in purchases of investments available for sale and maturities and redemptions of investments both held for and available for sale, as well as, a higher level of purchases of whole loans. Cash flows provided by financing activities decreased $97.8 million for the three months ended March 31, 2001 to cash flows used of $36.6 million. This compares to cash flows provided of $61.2 million in the equivalent period in 2000. The financing activity decline was primarily due to a reduction in FHLB advances combined with a smaller 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 at a cost of $4.7 million. No shares were repurchased during the first quarter of 2001. Approximately 146,000 shares remain eligible for repurchase under the 5% program limitation. At March 31, 2001, the Company had home equity, reserve credit and commercial unadvanced lines of credit totaling $136.1 million. Outstanding commitments to originate loans totaled $70.6 million. Unadvanced portions of construction and land loans amounted to $39.0 million. Standby letters of credit were $3.4 million. Loans sold with recourse totaled $789,000. 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 March 31, 2001: Regulatory Andover Andover Gloucester Bank Minimum Bancorp, Inc. Bank & Trust Company ---------- ------------- ------- --------------- Tier 1 Leverage Capital Ratio 4.00% 8.20% 7.77% 7.94% Risk Based Capital Ratio: Tier 1 4.00 12.10 11.60 10.34 Total 8.00 13.36 12.79 11.59 As of March 31, 2001, the most recent notification from the FDIC categorized the Banks as well capitalized under the prompt corrective action provisions. Therefore, the Banks are entitled to pay the lowest deposit premium possible. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Banks' 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 quarterly 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 16 19 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 Annual Report on Form 10-K as of and for the year ended December 31, 2000 (the "2000 Annual Report"). There have been no material changes in the quantitative disclosures about market risk from those presented in the Company's 2000 Annual Report. RECENT ACCOUNTING DEVELOPMENTS. The Financial Accounting Standards Board ("FASB") has issued a revised exposure draft, "Business Combinations and Intangible Assets - Accounting for Goodwill", which, if adopted, would establish new accounting standards for goodwill acquired in a business combination. Amortization of goodwill would not be allowed in any circumstance. The carrying amount of goodwill would be reduced only if found to be impaired or associated with assets to be sold or otherwise disposed of. Goodwill would also be subject to new impairment test rules. An impairment loss would be recognized if the implied fair value of the goodwill was deemed to be less than its carrying amount. This proposed statement is expected to be effective for the first fiscal quarter following its final issuance. Earlier application would not be permitted, nor would retroactive application to financial statements of prior periods. 17 20 PART II - OTHER INFORMATION PAGE NO. -------- ITEM 1 Legal Proceedings Not Applicable -- ITEM 2 Changes in Securities and Use of Proceeds Not Applicable -- ITEM 3 Defaults Upon Senior Securities Not Applicable -- ITEM 4 Submission of Matters to a Vote of Security Holders The 2001 Annual Meeting of Shareholders of the Andover Bancorp, Inc. was held on April 26, 2001. Three nominees of the Board of Directors of the registrant were re-elected, each for a three-year term. In addition, the following individuals continued to remain members of the Board of Directors following the meeting: John P. Bachini, Thomas F. Caffrey, Clifford E. Elias, Frank D. Goldstein, Cornelius J. McCarthy, Gerald T. Mulligan, and Fred P. Shaheen. Other matters voted on at the meeting included approval of the Andover Bancorp, Inc. 2001 Stock Incentive Plan and ratification of the appointment of KPMG LLP as Andover's independent auditors. Votes were cast as follows: I. Election of three Class II Directors NOMINEE FOR WITHHELD ------- --- -------- Paul J. Donahue, Sr. 5,507,661 47,104 Naomi A. Gardner 5,506,308 48,457 Irving E. Rogers, III 5,501,435 53,330 -- II. Approval of The Andover Bancorp, Inc. 2001 Stock Incentive Plan. FOR AGAINST ABSTAIN BROKER NON-VOTE -- --- ------- ------- --------------- 5,197,690 324,000 33,074 1 III. Ratification of KPMG LLP as Independent Auditors FOR AGAINST ABSTAIN --- ------- ------- 5,509,383 24,304 21,078 -- ITEM 5 Other Information None -- ITEM 6 Exhibits and Reports on Form 8-K (a) Exhibits Exhibit Index 19 (b) Reports on Form 8-K None -- 18 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ANDOVER BANCORP, INC. May 7, 2001 /s/ Gerald T. Mulligan ----------------------------------------- Gerald T. Mulligan President and Chief Executive Officer May 7, 2001 /s/ Joseph F. Casey ----------------------------------------- Joseph F. Casey Chief Financial Officer and Treasurer 19 22 EXHIBITS TO FORM 10-Q ANDOVER BANCORP, INC. --------------------- EXHIBIT INDEX Form 10-Q EXHIBIT NO. DESCRIPTION OF EXHIBIT PAGE NO. ----------- ---------------------- -------- 3(ii).1 Amendment dated January 26, 1999 to By-laws of the Company 20 3(ii).2 By-laws of the Company, as amended January 26, 1999 22 20

ANDOVER BANCORP INC 10-Q