As you will see from the enclosed financial statements and the senior officer summaries, the Bank had another successful year in 2012. It will go down as a year of considerable change, from a switch at the helm and introducing new products to meet customer demands, to preparing the Bank to weather the impending regulatory storm.
Our focus has and will continue to be on providing the best banking experience for our customers. Customers appreciate being able to speak to staff who are knowledgeable and accessible. They enjoy local and quick decisions that come from being in one office. This business practice will continue to be important going forward even as customer banking preferences change. Just four years ago the preferred banking method for customers was to conduct business in the office or branch (30%), according to an American Bankers Association survey. In 2012 the preferred banking method was internet banking at 39% with branches declining to 18%. This shift was even more pronounced in the 18 to 34 year olds surveyed with 45% preferring internet banking, 15% preferring mobile banking and those preferring branches representing only 11%. With a number of internet services already implemented during the past year our staff will be working to introduce mobile banking and researching a service called remote deposit capture that allows customers to deposit checks using their cellular phone. The challenge will be to introduce new products with an emphasis on bridging technology with great customer service.
One of the keys to providing great customer service is making sure we have exceptional employees. Over the next one to five years there will be a number of key employees who will be retiring creating the need for succession planning throughout the organization. Management has already taken steps to support key areas of the Bank, such as Information Technology, Finance, and Trust. Succession planning will continue to be developed in 2013 and beyond to assure smooth transitions.
There are many challenges in the banking industry, but none greater than the regulatory burden presented by the Dodd-Frank Act. Although enacted in 2010 many of the regulations that are being implemented have not yet come to fruition. This Act is larger than any other Acts previously imposed on the banking industry. It has 848 pages of regulation for 398 rulemaking requirements with an estimated 30,000 pages of final rulemaking documentation. This is a staggering amount of regulation especially for an institution with 40 employees. To give you a reference point, when the Gramm-Leach-Bliley Act was passed in 1999 it consisted of 145 pages of regulation and the Sarbanes-Oxley Act of 2002 consisted of only 66 pages of regulation. In preparation for a meeting with the New Hampshire delegates in Washington, DC during the American Bankers Association Government Relations Summit in April, I asked staff to prepare an estimate of the cost of regulation compliance for 2012. This estimate consists of actual hard costs for compliance support, training and man-hours needed to implement and monitor regulations. The total cost of compliance for 2012 was estimated at $638,000. Also, a total of 14,971 man-hours were devoted to regulation compliance which represented 7.2 full-time equivalent employees out of a total 36.55 full-time equivalent employees. Management is planning to allocate even more resources in 2013 as more final rules of Dodd-Frank Act need to be implemented. Although the cost of compliance is high, it would cost the Bank even more in increased regulatory oversight and possible fines for non-compliance.
With the ever spiraling cost of compliance it will be increasingly important to find ways to reduce or stabilize operational costs of the Bank. Cost control measures will be explored through increased use of technology, improved delivery of services and controlling overhead. During 2012, the Benefits and Compensation Committee and management conducted a seven month retirement plan design review. Through that process the Board approved changes to the retirement plan that will reduce benefit cost volatility, making benefit costs more predictable in the future.
For those of you who have not yet seen the video that describes what makes Piscataqua Savings Bank “Different”, I encourage you to go to our website, piscataqua.com, to see how history and mutuality make the Bank unique.
Richard M. Wallis, Executive Vice President
David H. Bryan, Treasurer/Financial Officer
The year ending 2012 was another strong year with respect to the Bank’s financial performance. Modest growth on the Balance Sheet was realized with the Bank’s community deposit base holding firm. Low interest rates have forced some consumers in need of more income to redeem maturing certificates of deposit and seek higher returns in the financial markets and/or through specials at other institutions. However, many folks are also simply parking money waiting for rates to rise. Consequently, deposit composition has shifted being more heavily weighted in transaction and savings accounts. Finding solid returns without taking undue credit risk or extending too far with maturity has been no easier for management at the Bank. A large cash position maintained with correspondents at the beginning of the year was redeployed into Investments. The Bank took on a more substantial position in high quality municipal and corporate bonds. Portfolio lending at the Bank is accomplished through adjustable-rate products. It has been very difficult to maintain loan volume on the Balance Sheet with the consumer generally looking to purchase or refinance with a fixed-rate product. The current environment provides a serious challenge in managing the asset/liability mix that can support a strong enough margin while being prudent. Dynamic simulation relative to the Bank’s Balance Sheet in varying interest rate scenarios can help, and modeling software is being employed to manage the risk and return potential.
Notwithstanding very low yields on earning assets and a shrinking Net Interest Margin, Earnings from operations came in quite solid for 2012-only $46 thousand less than what was generated the year prior. An overall Return on Assets of .54% was a noteworthy accomplishment given interest rates, competition, and an increasing regulatory burden. Non-interest income in the form of fees for services has become a more critical component in the generation of revenue. The Bank is fortunate to be in a good strategic position in the local area with regard to a well-established Trust Department.
Relationship banking is better cultivated with the services the Trust Department offers, and the fiduciary fee revenue generated strongly augments the Bank’s bottom line. It was mentioned above that maintaining balances for the Bank’s loan portfolio has been a struggle; however, the Loan Department originates and services fixed-rate mortgage products that are sold to a correspondent. The Loan Department was extremely busy this past year in generating fee income associated with this service. Fee income associated with trust and loan services offset some higher operating expenses that resulted from the Bank celebrating its 135th anniversary.
Control of overhead has always been a hallmark in managing operations. Efficiency is monitored closely. It is the measure by which we can quantify the percentage of a dollar needed to support the generation of that dollar. In our case, it is taking approximately 78 cents in operating expenses to realize a dollar in revenue (refer to Net Income chart). This number increased during the Bank’s anniversary year. Through capitalizing on a vast array of products and services offered without a costly branch network, the Bank continues to generate strong returns internally and for the community at large.
Another strong earnings year combined with controlled growth has enabled the Bank to maintain a Capital ratio in excess of 16%. Most financial institutions operate with more leverage, or a lower Capital ratio, for the benefit of shareholder returns. At Piscataqua Savings Bank, the Capital accounts are viewed as the foundation of the financial base that enables the Bank to continue being a vibrant and productive force in the community. As you continue reading on in this Annual Report, please take note of the positive position depicted in the financial charts regarding the Bank’s Balance Sheet and Earnings.
Debra S. Perry, Vice President/Senior Loan Officer
We recently had an email from a current customer who wrote: “I know things have changed and why, so I’m not objecting to scrutiny about my employment and credit rating. But I can’t help but remember when my dad was buying a house in New Castle in 1970; an acquaintance of his took him to visit Bob McLaughlin who was mowing his lawn. Bob said OK and told dad to go to the Bank and fill out the paperwork. A different era.” How true that statement is!
We have never strayed from our prudent underwriting standards and the attention that we give to our customers despite mandated regulatory changes throughout the years. Unfortunately, since the housing market meltdown in 2007, laws and regulations have continually changed and underwriting guidelines have tightened even further. This means we are required to collect and verify even more supporting documentation from our borrowers than ever before. We are bracing for more changes as two new lending regulations will be taking effect this year along with three other proposed rules that could take effect by the end of the year. Additionally, there are seven more proposed lending rules for 2014. Compliance has become a high priority consuming many hours of our time. In order to remain compliant and stay on top of the regulatory changes, the Loan Department purchased and installed a new Loan Origination System. This new web- based system constantly monitors and updates any new regulatory changes. This ensures us that all loan origination documents provided to our borrowers are up to date and compliant.
Although compliance is a high priority, our top priority in the Loan Department is originating loans. In 2012 the Loan Department originated $61.4 million in new mortgage loans, an increase from 2011 when we originated $56.2 million. Rates continued to remain historically low resulting in more refinance and new home purchase activity. Once again, this small department of seven showed their remarkable capability of originating and processing a huge volume of loans. Of the $61.4 million, $49.3 million were portfolio mortgage loans and $12.1 million were fixed rate mortgage loans. Despite the new portfolio originations of $49.3 million, the portfolio ended the year down by $7.2 million. This was a direct result of borrowers seeking low fixed rate mortgages which do not remain on our books.
Piscataqua Saving Bank’s loan volume compared favorably to that of other lenders. According to Real Data Corporation, Piscataqua Savings Bank was the eighth highest mortgage volume lender (out of approximately 250 lenders) in a market area made up of eight surrounding communities (Greenland, Hampton, North Hampton, New Castle, Newington, Portsmouth, Rye and Stratham). This volume represented a 2.4% share of the market which was slightly below 2011 when the Bank’s market share was 2.56%.
The purchase activity in the local real estate market has increased. According to Northern New England Real Estate Network, Rockingham County experienced higher residential real estate sales with 4,571 sales in 2012 up from 3,771 in 2011, or a 21% increase. In addition to the higher sales volume the median sales price of a residential home increased from $225,000 in 2011 to $230,000 in 2012. These are all good signs of a modest improvement in the economy.
Other signs of a modest improvement in the economy include the decline in the number of foreclosure deeds and delinquency rates. The number of foreclosures throughout the state decreased in 2012 by 5% from 2011 and 7% below the total for 2010 according to data provided by New Hampshire Housing Finance Authority.
The national residential mortgage delinquency rate for banks (those mortgages thirty days or more past due) declined from 10.34% in 2011 to 10.07% in 2012. Piscataqua Savings Bank’s delinquency rate also declined from 1.13% to 1.05% during the same time period. This continued low delinquency rate is a reflection of sound underwriting practices that the Bank has maintained during both good times and bad. Borrowers have come to value and appreciate the experience and advice that our Loan Department staff provides.
Deposit Operations and Compliance Results
Joan W. Gile, Executive Vice President/Operations
The last line of the Piscataqua Savings Bank value statement reads “We are Different.” That difference is what makes banking at Piscataqua Savings Bank a valuable experience. When you call during banking hours you do not end up in an endless maze of menu options. You do not have to fit your reason for calling into a cookie cutter list of options. You will speak to a person who will help you. When you come into the Bank, you are greeted by a staff member who has been with the Bank for many years and most likely will know your name. The average tenure for the Customer Service, Deposit Operations and Teller Departments is over 12 years. They are friendly, knowledgeable and eager to help. The employees’ commitment to Piscataqua Savings Bank and its customers is one example of how “We are Different.”
Today’s economic and political environment creates a significant set of challenges for community banks like Piscataqua Savings. Staying abreast of and implementing the required regulatory changes into our daily procedures is very challenging. This year we implemented a major release to our core banking, teller, and online banking systems. These upgrades were not only necessary to meet regulatory requirements but also to enable us to continue to deliver high quality banking products and services to our customers.
Our online banking bill payment system was upgraded with a new Person to Person payment system. This system, called Popmoney®, allows you to pay another individual electronically, regardless of where they bank. An email or text message is sent with a code and a message that you have sent them money. They can then have the money sent electronically to their account at any bank. Person to Person payments are very popular in European countries and are becoming more popular in the U.S.
Last year we began offering eStatements to our online banking customers for their checking and savings statements. We have over 900 statements being delivered electronically, saving paper, postage and time. Eventually, we will be able to send all statements and notices electronically.
In an effort to offer products and services that will meet the changes in the preferred banking methods of our customers, we began offering the eAccess Account. This account is geared toward the customer who prefers to bank all electronically using a debit card, online banking and online bill pay. There are no monthly maintenance fees as long as there are no checks written. Foreign ATM fees can be totally avoided by using SUM® ATM machines or getting cash back with Point of Sale purchases.
With the changes in the payments industry and increase in number of electronic banking solutions comes an increase in the need for safe and secure delivery. Piscataqua is committed to the security of our customers’ information and you can be assured we have taken all precautions to meet or exceed regulatory and industry standards before offering a new product and service.
Traditional and innovative banking products and services delivered by attentive, experienced and dedicated staff is how banking at Piscataqua Savings Bank is “Different.”
Trust/Investment Management Results
Richard G. Kaiser, Vice President/Senior Trust Officer
The Trust and Investment Department had a successful year and as of December 31, 2012 reached an all-time high with respect to assets under management of $201.52 million. This was due in part to strong new business development and the global bull market that continued throughout 2012. To the surprise of many investors, 2012 was a year in which risk taking was rewarded, the more risk taken the bigger the reward. Global Central Banks have actively promoted risk taking by suppressing interest rates over the last several years, in effect transferring wealth from savers to borrowers – in an attempt to boost housing, equities and eventually economic growth. The Federal Reserve (the Fed) maintained a very accommodative stance as its easy monetary policy continued to keep interest rates at “rock bottom lows” with Operation Twist being extended along with launching Quantitative Easing III and IV (QE3 & QE4). Markets exhibited less volatility than in previous years and while there was heightened investor concern, from time to time during the year, about slowing global growth (specifically in China), European sovereign debt crisis, geopolitical concerns in the Middle East and North Korea and Congress’ continued inability to resolve the “fiscal cliff” and debt ceiling issues, the bull market continued in its third year. Investors’ hopes were buoyed by positive economic data most notably with the housing market strengthening (new home sales rising by double-digits year-over-year and the median price of new homes shooting up 23% from April 2010 lows) as well as increased industrial production, durable goods orders, auto sales and decreasing unemployment (8.7% down to 7.8%). Domestic and international markets posted positive returns and investors continued to embrace a “risk on” posture to garner higher returns in a very low interest rate environment. U.S. stock markets managed to post respectable returns in 2012 although they lagged their foreign and emerging counterparts for the year. Domestically, the Dow Jones Industrial Average (DJIA), which represents the largest of the blue chips, returned 10.2% for the year vs. the S & P 500 Index gaining 16% and the Russell 2000, made up of small capitalized companies, returned 16.35% with the NASDAQ composite returning 17.5%. Internationally, foreign stocks outperformed U.S. stocks with the MSCI EAFE Index, which measures performance for Europe and Asia, returning 17.32% followed by the MSCI Emerging Markets ND Index for markets such as Brazil, Russia, India and China (BRIC) at 18.22%. In the fixed income markets higher risk bonds and those with longer maturities outperformed long term U.S. Treasury Bonds. For the year, high yield “junk” bonds yielded 15.81% and longer term corporate bonds returned 12.73% with U.S. Treasuries returning only 2% for the year.
Both the stock and bond markets positive performance for the year, in concert with the strong net new business development, propelled the Trust Department’s total market value for assets under management to a new high of $201.52 million, an increase of $12.85 million or 6.81% from the beginning of the year. Of this increase, market value appreciation attributed $4.65 million or 36% and net new business development of $8.20 million or 64% comprised the balance. This year, as in the previous two years, our New Business effort focused on increasing the amount of assets under management while reducing the number of actively managed accounts. At year-end, the total number of Trust Department managed accounts was 372, down from 374 a year ago with the average account size increasing to $541,700 from $504,500. Total new business development in 2012 reverted back to trend line with $18.9 million developed vs. $32.4 million in the previous year (the second strongest year since the development of the Department). Net new business after distributions and terminating accounts was $8.2 million compared with $21.9 last year and $9 million for 2010. We continue to see good new business growth as a result of our excellent referral program which comes from existing clients, Bank Trustees and Corporators, Bank Officers and staff as well as other referrals from local professionals, i.e. attorneys, CPAs, CLUs and financial planners. During this past year several large bank wealth management firms in the Seacoast area changed their Trust/Investment/Administrative models which resulted in high employee turnover and client dissatisfaction. Some of their clients are now with us. In 2013 the Bank will be heavily promoting the Trust Department and advertising our fiduciary and investment management services through local newspapers, billboards, various senior magazine publications and a “Money Minute” on a local radio program.
The composition of the Department’s accounts continues to be consistent with 2011 with personal trusts and estates comprising 39% of our account base, IRA’s at 15%, investment management accounts for individuals and charitable organizations at 42% and custodial relationships at 4%.
The increase in the Trust Department’s assets under management positively impacted revenue for the year. Total trust revenue received was $1.457 million, $107.8 thousand or 8% over 2011. Trust Department expenses increased by $115.1 thousand to $1.215 million, a 10. 4% increase over last year due in part to increased overhead expenses associated with the renovated second floor and new third floor Trust Department office space and expenses related to adding a new Trust Investment Officer to our staff. Net profit for the department before taxes was $241.8 versus $249.1 thousand in 2011 and net after profit taxes for 2012 was $140.8 thousand, down from 2011 by $19,003.
Since 2006, the State of New Hampshire has passed landmark trust legislation with additional trust related bills enacted in 2008 through 2012 which has made New Hampshire one of the most progressive states with respect to its trust laws and one of the best states in which to conduct trust business. At the end of July 2012, New Hampshire enacted SB Bill 326 which completely eliminated the application of the 5% Interest & Dividends tax (the I & D Tax) to “non-grantor” trusts. (A non-grantor trust is an irrevocable trust that is treated as a taxpayer separate from its grantor for federal and New Hampshire tax purposes). New Hampshire does not tax capital gains within trusts, and has historically only taxed interest and dividends on trusts with New Hampshire resident beneficiaries, and then only on that portion of the trust’s interest and dividend income attributable to that resident beneficiary. Beginning in 2013, regardless of the residence of the beneficiaries, non-grantor trusts will not be subject to any New Hampshire taxes. Instead, New Hampshire resident beneficiaries of these trusts will pay I & D taxes only on the taxable interest and dividends actually distributed to them. Non-resident beneficiaries of New Hampshire trusts will pay no New Hampshire I & D tax on distributions they receive from these trusts.
The passage of this bill is important as it continues to posture New Hampshire as a one of the premier states for establishing and administering trusts. This should provide new opportunities for us to grow and work closely with new clients in developing, managing and administering their trusts and estate plans.
Also, on January 1, 2013 federal tax law was changed as Congress passed the American Tax Payer Relief Act for 2012. The passage of this act prevented the automatic sun-setting of Bush-era tax cuts for many individuals while allowing taxes to rise for those with higher incomes. One of the key changes was in the exemption for estate and gift taxes. Every individual is entitled to a unified credit that offsets gift and estate tax on a certain amount of lifetime gifts and transfers at death. A $5.12 million exemption was allowed for 2012 and the exemption will stay at $5 million adjusted annually for inflation. In 2013 the inflation adjusted amount will be approximately $5.25 million per person. Additionally, the annual gift tax exclusion has been increased to $14,000. Anyone can make annual gifts of up to $14,000 per recipient and can make as many gifts as they want without triggering any gift tax or using their unified credit. Married couples can give $28,000 per recipient.
During 2013, Kathleen N. Donovan, CTFA (Certified Trust & Financial Advisor) will be working to obtain the Accredited Estate Planner (AEP) designation. An AEP designee provides quality, professional advice and meets the highest standards of knowledge, skill, ethical conduct and experience in estate planning. The AEP designation is the only graduate level multi-disciplinary accreditation that focuses specifically on estate planning. It emphasizes the disciplines of law, accounting, insurance, financial planning and trust services.
Lastly, I am very pleased to announce that in early January 2013, John P. Fredette, CFA (Chartered Financial Analyst) joined the Trust Department as a Trust Investment Officer and will be managing new and existing trust client investment portfolios. Prior to joining us, John was an Assistant Portfolio Manager in the Global Asset Division at Fidelity Investments. When you are in the Bank please come up and introduce yourself to John; he will be pleased to meet you.