Annual Report (Form 10-K), fiscal year 1994

Item 1. Business
(a) General Development of Business
CFX CORPORATION (the "Company" formerly Cheshire Financial Corporation) is a New Hampshire corporation chartered in August 1986 for the purpose of becoming the bank holding company parent of Cheshire County Savings Bank ("Cheshire"), a New Hampshire state-chartered savings bank with its principal place of business in Keene, New Hampshire. Cheshire was organized under the laws of New Hampshire in 1897.
The Company acquired 100% of the stock of Cheshire upon completion of its conversion from a New Hampshire-chartered mutual savings bank in February 1987 (the "Conversion"). Upon completion of the Conversion, the Company's assets initially consisted of 100% of the stock of Cheshire and approximately 70% of the net proceeds of the sale of the Company's common stock in a subscription offering made in connection with the Conversion.
The Company issued a total of 4,000,000 shares of its common stock in connection with the Conversion. The net proceeds to the Company from the subscription offering were $56,646,000. From the net proceeds, $16,994,000 was transferred to Cheshire to purchase all of the capital stock issued by Cheshire in the Conversion. The funds were added to Cheshire's working capital and continued to be used for general business purposes.
Subsequent to the Conversion, the Company acquired the Monadnock Bank ("Monadnock"), a New Hampshire trust company headquartered in Jaffrey, New Hampshire, on May 31, 1988. On April 30, 1990, the Company acquired all of the outstanding capital stock of The Valley Bank ("Valley"), a state-chartered commercial bank headquartered in Hillsborough, New Hampshire. On June 22, 1990, the Company acquired all of the outstanding capital stock of Village Savings Bank ("Village"), a state-chartered guaranty savings bank headquartered in Greenville, New Hampshire. On October 18, 1990, Village was merged into Monadnock in order to eliminate an overlap of market areas between these two banking affiliates. On September 6, 1991, Valley acquired certain assets and assumed all deposits of Family Bank and Trust ("Family"), a state chartered trust company headquartered in Allenstown, New Hampshire which had been declared insolvent by the New Hampshire Bank Commissioner and placed into receivership with the Federal Deposit Insurance Corporation.
On July 12, 1993, the Company merged Monadnock into Cheshire to eliminate an overlap of market areas between these two banking affiliates. On November 15, 1993, the Company merged Valley into Cheshire to create a single united bank with a greater array of products and services to better serve central and southwestern New Hampshire. The resulting entity was renamed CFX BANK. These mergers resulted in greater controls and operating efficiencies through the consolidation of administrative and operational functions.
On September 1, 1993, Cheshire acquired the remaining 52.4% of the outstanding shares of Colonial Mortgage, Inc., a mortgage banking company headquartered in Amherst, New Hampshire, for $5,187,000, including $80,000 in acquisition costs. Cheshire had previously owned 47.6% of this corporation, which is now known as CFX MORTGAGE, INC. ("CFX Mortgage").
On December 9, 1993, the Company began operating a new subsidiary, CFX FUNDING L.L.C. ("Funding") specializing in small-ticket lease financing and securitization. Funding is owned 51% by CFX Financial Services, Inc. (a wholly-owned subsidiary of CFX BANK), and owned 49% by Novel Leasing Limited (which is not affiliated with the Company). The objective of Funding is to provide a lease financing and securitization program specializing in small- ticket lease portfolios generated by a select group of independent lessors located throughout the country. In order to accumulate lease receivables for securitization, CFX BANK provides short-term warehousing lines of credit to the leasing companies. The strategy is designed to increase the availability of credit to a select group of lessors while controlling the risks inherent in lease portfolios through credit enhancements. The warehouse lines of credit are planned to be paid down every 90 to 180 days through securitization or sales of various lease portfolios. The operating results of Funding are not anticipated to materially affect, positively or negatively, the operating results of the Company in 1995.
On July 26, 1994, the Company signed a definitive agreement to acquire all of the outstanding capital stock of Orange Savings Bank ("Orange"), a Massachusetts-chartered savings bank, headquartered in Orange, Massachusetts. The acquisition is anticipated to be accounted for as a pooling-of-interests. Pursuant to the definitive agreement, each of Orange's 724,412 outstanding shares of common stock (except for any dissenting shares and shares beneficially held by the Company or Orange) will be converted into and exchangeable for the number of shares of the Company's common stock determined by multiplying .8750 by a fraction, the numerator of which is $17.1429 and the denominator of which is the average closing sale price per share of the Company's common stock on the American Stock Exchange for the ten trading days ending on the business day before the date on which the required approval of the Massachusetts Commissioner of Banks is obtained. This exchange ratio is subject to adjustment in the event that (i) such average closing price is above $20.00 or below $15.2381, (ii) the Company is a party to certain business combinations or (iii) the Company issues shares of stock in certain transactions, including, without limitation, stock splits and stock dividends.
The proposed transaction received approval from Orange's shareholders and remains subject to regulatory approval. The transaction has already been approved by the Board of Directors of the Company and Orange. At December 31, 1994, Orange had assets of $83,268,000, deposits of $73,383,000, and stockholders' equity of $8,444,000.
(b) Financial Information About Industry Segments
See Note Z--Segment Information in Item 8(a).
(c) Narrative Description of Business
General
The Company's primary retail banking markets are Cheshire County, western Hillsborough County and southern Merrimack County. The mortgage banking company has loan production offices in four locations throughout central and southern New Hampshire attracting loan applications from throughout New Hampshire, Maine, Vermont and northern Massachusetts.
The Company's principal business is to serve as a financial intermediary, attracting deposits from, and making loans to, consumers and small-to-mid sized businesses. CFX BANK (the "Bank") uses customer deposits and loan payments to fund first mortgage loans on residential real estate. In addition to originating mortgage loans, the Bank also makes commercial, consumer and other term and installment loans. Other traditional services available at the Bank include: a wide range of deposit programs designed to attract both short-term and long-term deposits from the general public, businesses and local government; safe deposit boxes; travelers checks and money orders, and many other similar services.
To further the Bank's goals of providing a broad range of retail services and to generate additional fee income, the Bank has remote service units located at various business locations in its service area. In addition, the Bank is a subscriber to INVEST[TM] Financial Corporation which enables customers to buy and sell securities and obtain investment advice at the Bank. A full line of trust and investment management services are also available to the customer, on premise, through an affiliation with a local trust company.
CFX MORTGAGE originates and purchases residential and construction mortgage loans and sells these loans to the Bank and the secondary market, while retaining the servicing of these loans. CFX MORTGAGE is an approved seller and servicer of Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA"), Department of Housing and Urban Development ("HUD"), Veteran's Administration ("VA"), and New Hampshire Housing Financing Authority loans. CFX MORTGAGE also services loans owned by private investors.
The Company operates a small-ticket lease financing and securitization business through Funding. Funding's strategy is to increase the availability of credit to a select group of lessors while controlling the risk inherent in lease portfolios through credit enhancements. The business will be built on stable relationships with a limited number of well-qualified lease originators (lessors) who will adhere to specified underwriting guidelines. The warehouse lines of credit are planned to be paid down every 90 to 180 days through securitization or sales of the various lease portfolios.
The operating results of the Company depend primarily on its net interest and dividend income, which is the difference between (i) interest and dividend income on earning assets, primarily loans, leases, trading and investment securities, and (ii) interest expense on interest bearing liabilities, which consist of deposits and borrowings. The Company's results of operations are also affected by the provision for loan and lease losses, resulting from the Company's assessment of the adequacy of the allowance for loan and lease losses; the level of its other operating income, including gains and losses on the sale of loans and securities, and loan and other fees; operating expenses; and income tax expenses and benefits.
Market Area and Competition
The Bank operates primarily in Cheshire, Hillsborough and Merrimack Counties, which are located in southwestern and south-central New Hampshire. Based on total deposits as of December 31, 1994, the Bank had the largest market share in the southwestern New Hampshire banking market.
The banking business in the Bank's market areas has become increasingly competitive over the past several years. The Bank's major competitors in attracting deposits and lending funds are other New Hampshire-based banks, and, to a certain extent, regional, money center and non-bank financial institutions. A number of New Hampshire-based banks maintain branches in cities and towns where the Bank maintains offices.
The principal factors in successfully competing for deposits are convenient office locations, flexible hours, remote service units, interest rates and services, while those relating to loans are interest rates, the range of lending services offered and lending fees. Additionally, the Bank believes that the local character of its businesses and its "supercommunity bank" management philosophy enables it to compete successfully in its market area.
Risk Elements
Nonperforming assets are evaluated quarterly by management to ensure proper classification and to confirm that the recorded carrying values of the assets are reasonable and in accordance with generally accepted accounting principles, regulatory requirements, and the Company's policies. Loans are placed on nonaccrual status when management determines that significant doubt exists as to the collectibility of principal or interest on a loan. In addition, commencing in the third quarter of 1993, all loans past due 90 days or more as to principal or interest were placed on nonaccrual status. Previously, such loans which, in management's judgment, were fully secured and in the process of collection (through legal action or, in appropriate circumstances, through collection efforts reasonably expected to result in repayment of the debt or in its restoration to a current status in the near future) continued to accrue interest.
The following table provides information with respect to the Company's nonperforming loans and assets at the dates indicated:
The following table provides information with respect to the Company's nonperforming loans and assets at the dates indicated:
The following table provides a rollforward of the Company's foreclosed real estate at the dates indicated:
During the fourth quarter of 1993, the Company sold $6,600,000 in nonperforming assets to a private investor. This bulk sale of nonperforming assets, along with other efforts to reduce nonperforming assets, yielded a $13,186,000 (57%) reduction in nonperforming assets during 1993. During 1994, total nonperforming assets decreased by $1,716,000, or 17.5%.
Asset/Liability Management
The Company's primary objective regarding asset/liability management is to position the Company so that changes in interest rates do not have a materially adverse impact upon forecasted net income and the net fair value of the Company. The Company's primary strategy for accomplishing its asset/liability management objective is achieved by matching the weighted average maturities of assets, liabilities, and off-balance-sheet items (duration matching).
To measure the impact of interest rate changes, the Company utilizes a comprehensive financial planning model that recalculates the fair value of the Company assuming both instantaneous, permanent parallel shifts in the yield curve of both up and down 100 and 200 basis points, or four separate calculations. Larger increases or decreases in forecasted net income and the net market value of the Company as a result of these interest rate changes represents greater interest rate risk than do smaller increases or decreases in net fair value. In connection with these recalculations, the Company makes assumptions regarding probable changes in cash flows of its assets, liabilities, and off-balance-sheet positions that would be expected in those various interest rate environments. Accordingly, the Company adjusts the pro forma net income and net fair values as it believes appropriate on the basis of historical experience and prudent business judgment. The Company endeavors to maintain a position where it experiences no material change in net fair value and no material fluctuation in forecasted net income as a result of assumed 100 and 200 basis point increases and decreases in interest rates. However, there can be no assurance that the Company's projections in this regard will be achieved.
Management believes that the above method of measuring and managing interest rate risk is consistent with the FDIC regulation regarding an interest rate risk component of regulatory capital.
The following table summarizes the timing of the Company's anticipated maturities or repricing of interest earning assets and interest bearing liabilities as of December 31, 1994. This table has been generated using certain assumptions which the Company believes fairly and accurately represent repricing volumes in a dynamic interest rate environment. Specifically, contractual maturities are used on all time deposits and investments other than asset-backed securities. For asset-backed securities and loans, contractual maturities, repricing and prepayment assumptions are used. The prepayment assumptions are based on current experience and industry statistics. The gap maturity categories for savings deposits (including NOW, savings, and money market accounts) are based on management's philosophy of repricing core deposits in reaction to changes in the interest rate environment. Repricing frequencies will vary at different points in the interest cycle and as supply and demand for credit changes.
The ability to assess interest rate risk using gap analysis is limited. Gap analysis does not capture the impact of cash flow or balance sheet mix changes over a forecasted future period and it does not measure the amount of price change expected to occur in the various asset and liability categories. Thus, management does not use gap analysis exclusively in its assessment of interest risk. The Company's interest rate risk exposure is also measured by the forecasted net income and discounted cash flow market value sensitivities referred to above.
Subsidiary
CFX BANK owns two subsidiary companies--CFX CAPITAL SYSTEMS, INC., ("CFX CAPITAL") and CFX FINANCIAL SERVICES, INC. ("CFX FINANCIAL"). CFX CAPITAL is a service corporation which owns CFX MORTGAGE, INC. ("CFX MORTGAGE") and certain investment securities. CFX CAPITAL previously owned 47.6% of CFX MORTGAGE with the remaining 52.4% purchased in 1993. CFX FINANCIAL owns 51% of CFX FUNDING L.L.C., a company which facilitates lease financing and securitization.
Owning 100% of CFX MORTGAGE allows CFX BANK to fully integrate mortgage banking into the retail banking franchise, providing the retail lending units (mortgage and consumer) with a strong sales-oriented culture and a larger variety of products. In addition, the distribution network that CFX MORTGAGE has developed allows access to a larger volume of loans for CFX BANK's in- house residential loan portfolio. Moreover, CFX MORTGAGE'S operation should enhance the Company's non-interest income sources. As of December 31, 1994, CFX MORTGAGE had a servicing portfolio for others of approximately $645,000,000.
CFX BANK provides CFX MORTGAGE with warehouse and working capital funding. The warehouse line of credit, which is secured by mortgage loans originated, bought and packaged for sale by CFX MORTGAGE, allowed CFX MORTGAGE to borrow up to $30,000,000 during 1994, with advances on December 31, 1994 of $15,095,000. In addition, CFX BANK has provided CFX MORTGAGE with secured lines of credit for working capital purposes, allowing CFX MORTGAGE to borrow up to $6,500,000 with no advances taken in 1994. CFX BANK also provided CFX MORTGAGE with secured term loans which totaled $600,000 at December 31, 1994. All such loans are made on substantially the same terms as those prevailing at the time for comparable transactions with non-affiliated borrowers. CFX MORTGAGE maintains a deposit relationship with CFX BANK in connection with these funding arrangements.
Employees
As of December 31, 1994, the Company and its subsidiaries had 336 full- time and 102 part-time employees. The employees of the Company and its subsidiaries are not represented by any collective bargaining unit. Relations between management and employees are considered good.
Regulation
General
As a bank holding company, the Company is subject to regulation by the Federal Reserve Board. The Company's bank subsidiary, CFX BANK, is a state- chartered bank; as such, it is subject to regulation by bank regulators in New Hampshire. The deposits of the Bank are insured by the FDIC, and therefore, CFX BANK is subject to FDIC supervision and regulation. The Company is also subject to limitations on the scope of their activities and to continuing regulation, supervision and examination by the Federal Reserve Board under the Bank Holding Company Act of 1956 and related federal statutes. As a New Hampshire corporation, the Company must comply with the general corporation law of New Hampshire.
Although the Northeast is gradually recovering from the severe recession of the late 1980's and early 1990's, the banking environment continues to be affected by a slow recovery of commercial real estate values and substantial increases in regulatory requirements as a result of the failure of numerous banking and thrift institutions. In addition to the Company's own monitoring activities, the credit quality of the assets held by CFX BANK is subject to periodic review by the state and federal bank regulatory agencies noted above. While the Company believes its present allowance for loan and lease losses is adequate in light of prevailing economic conditions or regulatory environment, there can be no assurance that CFX BANK will not be required to make certain adjustments to its allowance for loan and lease losses and charge-off policies in response to changing economic conditions or regulatory examinations.
Neither the Company nor any of its subsidiaries has entered into formal written agreements with state or federal regulators. The Company and its subsidiaries continue to evaluate and refine oversight and reporting systems and procedures to enhance the ability of such companies to respond to current economic conditions. The following references to applicable statutes and regulations are brief summaries thereof and do not purpose to be complete.
In addition to extensive existing government regulation, federal and state statutes and regulations are subject to changes that may have significant impact on the way in which banks may conduct business. The likelihood and potential effects of any such changes cannot be predicted. Legislation enacted in recent years has substantially increased the level of competition among commercial banks, thrift institutions and nonbanking institutions, including insurance companies, brokerage firms, mutual funds, investment banks, and major retailers. In addition, the enactment of banking legislation such as the Financial Institutions Reform Recovery and Enforcement Act ("FIRREA") and the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") have affected the banking industry by, among other things, broadening the regulatory powers of the federal banking agencies in a number of areas and restricting the powers of state-chartered banks. The following summary is qualified in its entirety by the text of the relevant statutes and regulations.
As a result of the enactment of FIRREA, any or all of the Company's subsidiary banks can be held liable for any loss incurred by, or reasonably expected to be incurred by the FDIC in connection with (a) the default of any other of the Company's subsidiary banks or (b) any assistance provided by the FDIC to any other of CFX's subsidiary banks in danger of default. "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur without regulatory assistance.
Federal Deposit Insurance Corporation
CFX BANK's deposits are insured by the FDIC up to a maximum of $100,000 per depositor. The FDIC issues regulations, conducts periodic examinations, imposes minimum capital requirements, requires the filing of reports and generally supervises the operations of its insured banks. The approval of the FDIC is required prior to any merger or consolidation, or the establishment or relocation of an office. Such supervision and regulation is intended primarily for the protection of depositors.
Any insured bank which does not operate in accordance with or conform to FDIC regulations, policies and directives may be sanctioned for non- compliance. For example, proceedings may be instituted against any insured bank or any director, officer or employee of such bank who engages in unsafe and unsound practices, including the violation of applicable laws and regulations.
Federal Deposit Insurance Corporation Improvement Act of 1991
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") provides for, among other things, increased funding for the Bank Insurance Fund (the "BIF") of the FDIC and expanded regulation of depository institutions and their affiliates, including parent holding companies. A summary of certain provisions of FDICIA and its implementing regulations is described below.
Risk Based Deposit Insurance Assessments
A significant portion of the additional funding to BIF is in the form of borrowings to be repaid by insurance premiums assessed on BIF members. In addition, FDICIA provides for an increase in the ratio of the reserves to insured deposits of the BIF to 1.25% by the end of the 15 year period that began with the semi-annual assessment period ending December 31, 1991, also to be financed by insurance premiums. The result of these provisions could be a significant increase in the assessment rate on deposits of BIF members during the balance of this 15 year period. FDICIA also provides authority for special assessments against insured deposits and for the development of a general risk-based assessment system. FDIC has set assessment rates for BIF- insured institutions ranging from 0.23% to 0.31%, based on a risk assessment of the institution. Each financial institution is assigned to one of three capital groups; "well capitalized"; "adequately capitalized"; or "undercapitalized"; and further assigned to one of three subgroups within each capital group, on the basis of supervisory evaluations by the institution's primary federal and, if applicable, state supervisors and other information relevant to the institution's financial condition and the risk posed to the insurance fund. For purposes of the risk-based assessment system, a well- capitalized institution is one that has a total risk-based capital ratio of 10% or more, a Tier 1 risk-based capital of 6% or more, and a leverage ratio of 5% or more. An adequately capitalized institution has a total risk-based capital ratio of 8% or more, a Tier 1 risk-based capital ratio of 4% or more, and a leverage ratio of 4% or more. An undercapitalized institution is one that does not meet either of the foregoing definitions. The actual assessment rate applicable to a particular institution, therefore, depends in part upon the risk assessment classification so assigned to the institution by the FDIC.
Prompt Corrective Action
FDICIA also provides the federal banking agencies with broad powers to take prompt corrective action to resolve problems of insured depository institutions, depending upon a particular institution's level of capital. FDICIA established five tiers of capital measurement for regulatory purposes ranging from "well-capitalized" to "critically undercapitalized". Under prompt corrective action regulation adopted by the federal banking agencies, a depository institution is (a) "well-capitalized" if it has a total risk-based capital ratio of 10% or more, a Tier 1 risk-based capital ratio of 6% or more, a leverage ratio of 5% or more and is not subject to any written agreement, order or capital measure; (b) "adequately capitalized" if it has a total risk- based capital ratio of 8% or more, a Tier 1 risk-based capital ratio 4% or more and a leverage ratio of 4% or more (3% if the bank is rated composite I under the CAMEL rating system in its most recent examination and is not experiencing or anticipating significant growth) and does not qualify as "well-capitalized"; (c) "undercapitalized" if it has a total risk-based capital ratio that is less than 8%, a Tier 1 risk-based capital ratio that is less than 4% or a leverage ratio that is less than 4% (3% if the bank is rated composite I under the CAMEL rating system in its most recent examination and is not experiencing or anticipating significant growth); (d) "significantly undercapitalized" if the bank has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3% or a leverage ratio that is less than 3%; and (e) "critically undercapitalized" if the depository institution has a tangible equity to total assets ratio that is equal to or less than 2% of total assets, or otherwise fails to meet certain established critical capital levels. A depository institution may be in a capitalization category that is lower than is indicated by its actual capital position under certain circumstances. At December 31, 1994, CFX BANK was classified as "well-capitalized" under the prompt corrective action regulations described above.
Any depository institution that is undercapitalized and which fails to meet regulatory capital requirements specified in FDICIA must submit a capital restoration plan guaranteed by the bank holding company controlling such institution. The regulatory agencies may place limits on the asset growth and restrict activities of the institution (including transactions with affiliates), and require the institution to raise additional capital, dispose of subsidiaries or assets or be acquired and, ultimately, require the appointment of a receiver. The guarantee of a controlling bank holding company under FDICIA of performance of a capital restoration plan is limited to the lower of 5% of an undercapitalized banking subsidiary's assets or the amount required for the bank to be classified as adequately capitalized. Federal banking agencies may not accept a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan within the time required (generally 45 days after receiving notice that the institution is undercapitalized, significantly undercapitalized or critically undercapitalized), it is treated as if it were significantly undercapitalized. If the controlling bank holding company fails to fulfill its guaranty obligations under FDICIA and files (or has filed against it) a petition under Federal Bankruptcy Code, the applicable regulatory agency would have a claim as a general creditor of the bank holding company and, if the capital restoration plan were deemed to be a commitment to maintain capital under the Federal Bankruptcy Code, the claim would be entitled to a priority in such bankruptcy proceedings over unsecured third party creditors of the bank holding company.
In addition to the requirement of mandatory submission of a capital restoration plan, under FDICIA, an undercapitalized institution may not pay management fees to any person having control of the institution nor may an institution, except under certain circumstances and with prior regulatory approval, make any capital distribution if, after making such payment or distribution, the institution would be undercapitalized. Further, undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System.
Undercapitalized and significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. In addition, significantly undercapitalized depository institutions also are prohibited from awarding bonuses or increasing compensation of senior executive officers until approval of a capital restoration plan. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator.
Brokered Deposit and Pass Through Deposit Insurance Limitation
Under FDICIA, a depository institution that is not well-capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits "significantly higher" than the prevailing rate in its market. A depository institution that is adequately capitalized may accept brokered deposits if it obtains the prior approval of the FDIC. Effective in November 1993, the FDIC modified the definitions of "well-capitalized" and "adequately capitalized" to conform to the definitions described above for prompt corrective action. In addition, "pass-through" insurance coverage may not be available for certain employee benefit accounts. In the Company's opinion, these limitations do not have a material effect on the Company.
Safety and Soundness Standards
The Federal Deposit Insurance Act, as amended by FDICIA and as further amended by the Reigle Community Development and Regulatory Improvement Act of 1994, directs each federal banking agency to prescribe standards for insured depository institutions relating to asset quality, earnings and stock valuation. The ultimate cumulative effect of these standards cannot currently be forecast.
FDICIA also contains a variety of other provisions that may affect the Company's operations, including new reporting requirements, regulatory standards for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch. Many of the provisions in FDICIA have recently been or will be implemented through the adoption of regulations by the various federal banking agencies and, therefore, the precise impact on the Company cannot be assessed at this time.
Capital Guidelines
The Federal Reserve Board and the FDIC have issued risk-based capital guidelines for bank holding companies, state-chartered member banks and state- chartered non-member banks. Under these guidelines, the minimum ratio of total capital to risk-adjusted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8%. At least half of the total capital is to be comprised of common equity, retained earnings, minority interests in the equity accounts of consolidated subsidiaries and a limited amount of perpetual preferred stock, less goodwill ("Tier 1 capital"). The remainder may consist of perpetual debt, mandatory convertible debt securities, a limited amount of subordinate debt, other preferred stock and a limited amount of loan loss reserves (supplementary capital). In addition, the Federal Reserve Board and the FDIC have adopted a leverage ratio (Tier 1 capital to total assets, net of goodwill) of 3% for bank holding companies and banks that meet certain specified criteria, including that they have the highest regulatory rating. The rule indicates that the minimum leverage ratio should be 1% to 2% higher for holding companies and banks undertaking major expansion programs or that do not have the highest regulatory rating.
As of December 31, 1994, the Company and CFX BANK had capital ratios on a historical basis which exceeded all minimum regulatory capital requirements.
Under FIRREA and FDICIA, failure to meet the minimum regulatory capital requirements could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including the termination of deposit insurance by the FDIC and seizure of the institution.
New Hampshire Banking Department
As a state-chartered institution, CFX BANK is subject to the applicable provisions of New Hampshire banking law. CFX BANK derives its lending and investment powers from these laws and is subject to periodic examination and reporting requirements by the New Hampshire Bank Commissioner (the "Commissioner"), who also has specific statutory jurisdiction over certain banking activities such as mergers and the creation of new powers. Conversion from mutual to stock form and the establishment of branches are subject to approval of the New Hampshire Board of Trust Company Incorporation (the "BTCI").
Federal Reserve Board
The Federal Reserve Board requires banks to maintain reserves against its transaction accounts, and non-personal time deposits based on the amount of the banks' deposits.
The Company is a "bank holding company" within the meaning of the Bank Holding Company Act. Under the Bank Holding Company Act, a bank holding company is required to file annually with the Federal Reserve Board a report of its operations and, with its subsidiaries, is subject to examination by the Federal Reserve Board. The Bank Holding Company Act prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting share of any bank, or increasing such ownership or control of any bank, without prior approval of the Federal Reserve Board. No approval under the Act is required, however, for a bank holding company already owning or controlling over 50% of the voting shares of a bank to acquire additional shares of such bank.
The Bank Holding Company Act further precludes a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any non-banking entity engaged in any activities other than those which the Federal Reserve Board has determined to be closely related to banking or managing and controlling banks so as to be a proper incident thereto. The Federal Reserve Board has determined that certain activities, including, but not limited to, mortgage banking, operating small loan companies, discount brokerage activities, factoring, certain data processing operations, providing investment and financial advice and leasing personal property on a full payout basis are closely related, and a proper incident to banking. A bank holding company and its subsidiaries are also prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or lease or sale of property or furnishing of services.
Interstate Banking
The Bank Holding Company Act currently prohibits a bank holding company from acquiring any bank located outside of the state in which the existing banking subsidiaries of the bank holding company are located unless specifically authorized by applicable law.
Interstate banking legislation has been enacted in New Hampshire which permits out-of-state banks and bank holding companies to establish new banks or to affiliate with existing banks and bank holding companies in New Hampshire. The legislation establishes the procedures for the creation of new banks in New Hampshire and the acquisition of five percent more of a New Hampshire bank or bank holding company . Application for an affiliation certificate must be made to the Board of Trust Incorporation ("BTCI") and the Commissioner is charged with promulgating the rules relating to the application procedures and the standards to be applied to the application by the BTCI. The Commissioner has the further responsibility of monitoring certificate holders, new banks and bank holding companies affiliated under the law and of adopting rules to carry out this responsibility. Violation of the legislation may result in the imposition of a fine of up to $5,000 per day for each day the violation continues and the divestiture of any prohibited affiliation.
Under the legislation, no bank holding company may acquire ownership or control of the voting stock of any bank if upon such acquisition (1) the bank holding company would have more than 12 affiliates in New Hampshire; or (2) the dollar amount of the total deposits of the bank holding company and all its affililates in New Hampshire would exceed 20 percent of the dollar volume of total deposits in New Hampshire of all state and federal banks. This 20 percent deposit concentration limitation is subject to waiver by the Commissioner in cases involving troubled institutions.
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Riegle-Neal"), effective September 29, 1995 existing restrictions under the Bank Holding Company Act which prevent the acquisition by a bank holding company of banks located outside the bank holding company's home state unless authorized by the state law of the target bank will be eliminated. State law restrictions regarding deposit concentrations will continue to apply, provided that such restrictions do not discriminate against out-of-state bank holding companies. The New Hampshire 20 percent deposit concentration limitation applies to acquisitions by both in-state and out-of-state bank holding companies. Such acquisitions will be subject to approval by the Federal Reserve Board.
Under Riegle-Neal, effective June 1, 1997, (unless the New Hampshire Legislature enacts a statute "opting out" of interstate branching) out-of- state banks will be authoriized to merge with New Hampshire banks and to establish branches in New Hampshire. Such mergers and the establishment of branches will continue to be subject to state deposit concentration restrictions and conditions that may be imposed by New Hampshire regulatory authorities, provided that such restrictions and conditions do not discriminate against out-of-state banks. The resulting New Hampshire banks and branches will continue to be subject to regulation by New Hampshire regulatory authorities provided that such regulations do not discriminate against out-of-state banks.
Federal Home Loan Bank System
CFX BANK is a member of the Federal Home Loan Bank of Boston (the "FHLB"), which is one of twelve regional Federal Home Loan Banks. The FHLB serves as a reserve or central bank for its members. It makes advances to members in accordance with policies and procedures established by the Board of Directors of the FHLB. As a member of the FHLB, CFX BANK is required to purchase and hold stock in the FHLB. As of December 31, 1994, CFX BANK held stock in the FHLB in the amount of $6,471,000.
Securities and Exchange Commission
The Company has registered its common stock with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. As a result of such registration, the proxy and tender offer rules, periodic reporting requirements, and insider trading restrictions and reporting requirements, as well as certain other requirements, of such Act are applicable to the Company.
Restrictions on the Payment of Dividends
Under the New Hampshire Business Corporation Act, a distribution including dividends and the purchase or redemption of a corporation's own shares, must be authorized by the Board of Directors and may not be paid if the corporation, after the payment is made, would not be able to pay its debts as they become due in the usual course of business, or the corporation's total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.
CFX BANK is not subject to the Business Corporation Act, but is subject to state banking and federal regulations restricting the payment of dividends. Under New Hampshire state law, the Company's banking subsidiary may declare dividends only from its earnings remaining after deducting all losses, all sums due for expenses and all overdue debts upon which no interest has been paid for a period of six months, unless such debts are well secured and in process of collection. In addition, New Hampshire-chartered guaranty savings banks such as CFX BANK are required by New Hampshire law to maintain a "guaranty fund" for the security of their depositors. Funds accumulated in the guaranty fund can be used only for absorbing losses incurred and thus cannot be used for the payment of dividends on deposits or capital stock. In order to pay dividends, a transfer to the guaranty fund from net earnings is required so as to maintain an unimpaired guaranty fund of 3% of total deposits. As of December 31, 1994, CFX BANK's guaranty fund amounted to $18,750,000 or 3.27% of total deposits. Furthermore, the Federal Deposit Insurance Act prohibits CFX BANK from paying dividends on its capital stock if it is in default in the payment of any assessment to the FDIC.
Applicable rules prohibit the payment of a cash dividend if the effect thereof would cause the net worth of CFX BANK to be reduced below either the amount required for the liquidation account established in connection with the conversion or the net worth requirements imposed by New Hampshire law or federal laws or regulations.
Earnings appropriated to bad debt reserves for losses and deducted for federal income tax purposes are not available for dividends without the payment of taxes at the current income tax rates on the amount used.
The Company generally could not, for a period of three years from the effective date of the Conversion, repurchase any of its stock from any person, except in the event of an offer to repurchase by the Company on a pro rata basis to all shareholders that would be approved by the Commissioner. The Company received the required regulatory approval in March 1988 to institute a five percent (5%) open-market common stock repurchase program. Pursuant to such approval and subsequent approvals to acquire additional shares, the Company acquired 577,265 shares of its outstanding common stock in open-market purchases since March 1988, the last such purchase being December 22, 1990.
Restrictions on the Acquisition of the Company
The acquisition of more than 10% of the Company's outstanding shares may, in certain circumstances, be subject to the provisions of the Change in Bank Control Act of 1978, and the acquisition of control of the Company by any company would be subject to regulatory approval under the Bank Holding Company Act of 1986.
Other Regulations
The policies of regulatory authorities, including the Federal Reserve Board and the FDIC, have had a significant effect on the operating results of financial institutions in the past and are expected to do so in the future. An important function of the Federal Reserve Board is to regulate aggregate national credit and money supply through such means as open market dealings in securities, establishment of the discount rate on bank borrowings and changes in reserve requirements against bank deposits. Policies of these agencies may be influenced by many factors, including inflation, unemployment, short-term and long-term changes in the international trade balance and fiscal policies of the United States government. Supervision, regulation or examination of the Company by these regulatory agencies is not intended for the protection of the Company's shareholders.
The United States Congress has periodically considered and adopted legislation which has resulted in and could result in further deregulation of both banks and other financial institutions. Such legislation could relax or eliminate geographic restrictions on banks and bank holding companies and could place the Company in more direct competition with other financial institutions, including mutual funds and securities brokerage firms. No assurance can be given as to whether any additional legislation will be enacted or as to the effect of such legislation on the business of the Company.
The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") was enacted on August 9, 1989. FIRREA was a major piece of legislation which was intended to restore the public's confidence in the savings and loan industry, ensure a safe and stable system of affordable housing finance through major regulatory reforms, strengthen capital standards and provide safeguards for the disposal of recoverable assets. Although CFX BANK was not directly affected by FIRREA, the legislation has generally had a significant impact on the nation's insured financial institutions.
FIRREA abolished the Federal Home Loan Bank Board and the position of Chairman of the Bank Board as chief regulator of the thrift industry. The Office of Thrift Supervision was created as an office in the Department of the Treasury. The Director of the Office of Thrift Supervision is responsible for the examination and supervision of all savings institutions. FIRREA abolished the Federal Savings and Loan Insurance Corporation and gave the Federal Deposit Insurance Corporation the duty of insuring the deposits of savings associations as well as banks. The insurance funds are maintained separately and were renamed. The Bank Insurance Fund generally serves banks, while the Savings Association Insurance Fund serves thrift institutions.
The additional statistical disclosure describing the business of the Company and CFX BANK required by Industry Guide 3 under the Securities Exchange Act of 1934, as amended, is provided in Appendix A to this Annual Report.
(d) Financial Information About Foreign and Domestic Operations and Export Sales
Not applicable.
Item 2.



Item 2. Properties
The Company neither owns nor leases any real property. It utilizes the premises and equipment of CFX BANK (the "Bank") with no payment of any rental fee to the Bank. However, the management fees charged to the Bank by the Company are reduced by, among other things, an occupancy factor.
The Bank owns its main office and two branch offices in Keene, New Hampshire. The Bank also owns branches in Jaffrey, Troy, Greenville, New Ipswich, Peterborough, Hillsborough, Henniker and Allenstown, New Hampshire while leasing other branches in Rindge, Hinsdale and Loudon, New Hampshire. The Bank also owns 50 automated teller and remote service units located in New Hampshire and operates five "mini-branches" at various retail establishments in its market area. CFX MORTGAGE owns its main office in Amherst, New Hampshire while it leases additional office space in Bedford and Portsmouth, New Hampshire.
The following table sets forth the location of the Company's offices (including administrative offices) as well as the net book value of such offices at December 31, 1994.
At December 31, 1994, the total net book value of the Company's premises and equipment was $13,643,000.
Item 3.

Item 3. Legal Proceedings
There are no pending legal proceedings to which the Company is a party or any of its property is the subject. There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of banking, to which the Bank is a party or of which the Bank's property is subject. There are no material pending legal proceedings to which any director, officer or affiliate of the Company, any owner of record or beneficially of more than five percent (5%) of the common stock of the Company, or any associate of any such director, officer, affiliate of the Company or any security holder is a party adverse to the Company or has a material interest adverse to the Company or the Bank.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Information relating to the market for the Company's common equity and related stockholder matters on page 68 of the Annual Report to Shareholders for the fiscal year ended December 31, 1994 is incorporated herein by reference.
Item 6.

Item 6. Selected Financial Data
Information relating to selected financial data on page 1 of the Annual Report to Shareholders for the fiscal year ended December 31, 1994 is incorporated herein by reference.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 14 to 29 inclusive of the Annual Report to Shareholders for the fiscal year ended December 31, 1994 is incorporated herein by reference.
Item 8.


Item 8. Financial Statements and Supplementary Data
(a) Financial Statements Required by Regulation S-X
Information relating to financial statements on pages 30 to 63 inclusive of the Annual Report to Shareholders for the fiscal year ended December 31, 1994 is incorporated herein by reference.
(b) Supplementary Financial Information
(1) Selected Quarterly Financial Data
Information relating to selected quarterly financial data on page 63 of the Annual Report to Shareholders for the fiscal year ended December 31, 1994 is incorporated herein by reference.
(2) Information About Oil and Gas Producing Activities
Not applicable.
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
(a)(i) On March 8, 1993, the Board of Directors of CFX CORPORATION ("the Company") voted to engage Wolf & Company, P.C. as its auditors for fiscal year 1993. The Company's former auditor, Ernst & Young LLP, was dismissed as of such date.
(ii) The auditor's report on the financial statements for the 1992 fiscal year did not contain an adverse opinion or disclaimer of opinion and was not qualified as to uncertainty, audit scope or accounting principles.
(iii) The decision to change the Company's auditors was recommended by the Audit Committee of the Board of Directors and was approved by the Company's Board of Directors.
(iv) In connection with the audit for the 1992 fiscal year, there were no disagreements of the type described in Item 304 (a) (1) (iv) of Regulation S-K with the Company's former auditor on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure.
(v) During the Company's 1992 fiscal year and the subsequent interim period preceding the change in accountants, no reportable event, as set forth in Item 304 (a) (1) (iv) of Regulation S-K, occurred.
(vi) The letter from the Company's former auditor required by Item 304 (a) (1) (iv) of Regulation S-K was filed by amendment to the Form 8-K on Form 8 on March 17, 1993.
(b) As set forth in (a) (i) above, the Company engaged Wolf & Company, P.C. on March 8, 1993. During the Company's 1992 fiscal year and the subsequent interim period preceding the change in accountants, the Company did not consult Wolf & Company, P.C. on any accounting matters.
PART III
Item 10.



Item 10. Directors and Executive Officers of the Registrant
Information regarding directors and executive officers of the registrant on pages 2 to 6 inclusive and on pages 16 and 17 inclusive of the Proxy Statement for the 1995 Annual Meeting of Shareholders is incorporated herein by reference.
Item 11.

Item 11. Executive Compensation
Information regarding executive compensation on pages 7 to 12 inclusive of the Proxy Statement for the 1995 Annual Meeting of Shareholders is incorporated herein by reference.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding security ownership of certain beneficial owners and management on pages 2 to 4 of the Proxy Statement for the 1995 Annual Meeting of Shareholders is incorporated herein by reference.
Item 13.

Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions on pages 15 to 16 of the Proxy Statement for the 1995 Annual Meeting of Shareholders is incorporated herein by reference.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) List of Documents Filed as Part of This Report:
(1) Financial Statements
The financial statements listed below are incorporated herein by reference from the Annual Report to Shareholders for the year ended December 31, 1994 at Item 8. Page references are to such Annual Report.
(2) Financial Statement Schedules
See Item 14 (d)
(3) Exhibits Required by Item 601
See Item 14 (c)
(b) Reports on Form 8-K
On December 19, 1994, a Form 8-K was filed announcing the Company's declaration of its regular quarterly dividend on its common stock, the declaration of its regular quarterly dividend on its Series A Preferred Stock and the declaration of a 5% common stock dividend.
(c) Exhibits
The exhibits listed below are filed herewith or are incorporated herein by reference to other filings.
(d) Financial Statement Schedules
Schedules to the Consolidated Financial Statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable, and therefore have been omitted.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CFX CORPORATION
Date: March 28, 1995 By: /s/ PETER J. BAXTER Peter J. Baxter, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
APPENDIX A
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY: INTEREST RATES AND INTEREST DIFFERENTIAL
Information regarding interest rates and interest differentials on pages 21 and 22 inclusive of the Annual Report to Shareholders for the fiscal year ended December 31, 1994 is incorporated herein by reference.
INVESTMENT PORTFOLIO
The following table sets forth the book value of securities available for sale and securities held to maturity at the dates indicated. The book value of securities available for sale in 1994 and 1993 is fair value. The book value of securities held for sale in 1992 is the lower of aggregate cost or fair value. The book value of debt securities held to maturity or held for investment is amortized cost, while the book value of marketable equity securities held for investment is the lower of aggregate cost or fair value.
The following table sets forth an analysis of the maturity distributions and the weighted average yields of all debt securities of the Company at December 31, 1994:
LOAN PORTFOLIO
The following table shows the Company's loan distribution at the dates indicated:
The following table shows the maturity of loans (excluding residential mortgages of 1 - 4 family residences and consumer/other loans) outstanding at December 31, 1994. Also provided are the amounts due after one year, classified according to sensitivity to changes in interest rates.
NONACCRUAL, PAST DUE, RESTRUCTURED, AND POTENTIAL PROBLEM LOANS
The following table summarizes the Company's nonaccrual, past due, and potential problem loans:
Interest income that would have been recorded under original terms of nonaccrual and restructured loans andthe interest income actually recognized for the year ended December 31, 1994 was $549,000 and $255,000, respectively.
At December 31, 1994, the Company has $10,930,000 in commercial and commercial real estate loans for which payments presently are current and future cash flows appear to be sufficient to service the loan, but the borrowers currently are experiencing financial difficulties. These loans, while not severe enough to be classified as potential problem loans, are subject to constant management attention and their classification is reviewed quarterly.
While the Company considers the allowance for loan and lease losses to be adequate at December 31, 1994, it is uncertain to what extent an economic recovery will materialize in the region. Therefore, given this uncertainty, the Company can give no assurance that it will not experience an increase in nonperforming assets in the future.
SUMMARY OF LOAN AND LEASE LOSS EXPERIENCE
This table summarizes the Company's loan and lease loss experience for the years ended December 31, 1994, 1993, 1992, 1991 and 1990.
ALLOWANCE FOR LOAN AND LEASE LOSS ALLOCATION
This table shows an allocation of the allowance for loan and lease losses as of December 31, 1994, 1993, 1992, 1991 and 1990.
DEPOSITS
The average daily amount of deposits and of rates paid on such deposits is summarized for the periods indicated in the following table:
Maturities of time certificates of deposit and other time deposits of $100,000 or more outstanding at December 31, 1994, are summarized as follows:
RETURN ON EQUITY AND ASSETS
The following table shows consolidated operating and capital ratios of the Company for the periods indicated:
SHORT-TERM BORROWINGS
The following t able shows various information on short-term borrowings front he Federal Home Loan Bank of Boston (FHLBB):
CFX BANK has an available line of credit with the FHLBB at an interest rate that adjusts daily. Borrowings under the line are limited to 2% of CFX BANK's total assets. All borrowings from the FHLBB are secured by a blanket lien on certain qualified collateral, defined principally as 90% of the fair value of U.S. Government and federal agency obligations and 75% of the carrying value of first mortgage loans on owner-occupied residential property. The maximum amount of short-term advances from the FHLBB at any month-end during the twelve months ended December 31, 1994 and 1993 were $114,216,000 and $104,614,000, respectively. The approximate average short-term advances from FHLBB for the twelve months ending December 31, 1994 and 1993 were $94,759,000 and $72,620,000, respectively with weighted average interest costs of 4.57% and 3.10%, respectively. There were no advances from the FHLBB by CFX BANK during 1992.