| CHITTENDEN CORP /VT/ ITEM 1A RISK FACTORS The risks and uncertainties described below are not the only ones that we face |
| Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us and our business |
| If any of these risks were to occur, our business, financial condition or results of operations could be materially and adversely affected |
| We face significant competition for banking services in New England, our primary market, and in the local markets in which we operate |
| Competition in the local banking industries may limit our ability to attract and retain customers |
| We may face competition now and in the future from the following: other banking institutions, including larger New England and other commercial banking organizations; savings banks; credit unions; other financial institutions; and non-bank financial services companies serving New England and adjoining areas |
| In particular, our competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns |
| Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits, which enable them to serve the credit needs of larger customers |
| We also face competition from out-of-state financial intermediaries that have opened low-end production offices or that solicit deposits in their respective market areas |
| If we are unable to attract and retain banking customers we may be unable to continue our loan growth and level of deposits and our results of operations and financial condition may otherwise be negatively affected |
| In the past, we have expanded our operations into non-banking activities such as asset management and wealth advisory services, insurance-related products, credit cards, payroll processing and brokerage services |
| We may have difficulty competing with more established providers of these products and services due to the intense competition in many of these industries, especially in the New England region |
| In addition, we may be unable to attract and retain non-banking customers due to a lack of market and product knowledge or other industry specific matters or an inability to attract and retain qualified, experienced employees |
| Our failure to attract and retain customers with respect to these non-banking activities could negatively impact our future earnings |
| Our main source of income from operations is net interest income, which is equal to the difference between the interest income received on loans, investment securities and other interest-bearing assets and the interest expense incurred in connection with deposits, borrowings and other interest-bearing liabilities |
| These rates are highly sensitive to many factors beyond our control, including general economic conditions, both domestic and foreign, and the monetary and fiscal policies of various governmental and regulatory authorities |
| We have adopted asset and liability management policies to try to minimize the potential adverse effects of changes in interest rates on our net interest income, primarily by altering the mix and maturity of loans, investments and funding sources |
| However, even with these policies in place, we cannot provide assurance that changes in interest rates will not negatively impact our operating results |
| 15 ______________________________________________________________________ [44]Table of Contents An increase in interest rates also could have a negative impact on our business by reducing the ability of borrowers to repay their current loan obligations, which could not only result in increased loan defaults, foreclosures and write-offs, but also necessitate further increases to our allowance for loan losses |
| Increases in interest rates also may reduce the demand for loans and, as a result, the amount of loan and commitment fees |
| In addition, fluctuations in interest rates may result in disintermediation, which is the flow of funds away from depository institutions into direct investments that pay higher rates of return, and may affect the value of our investment securities and other interest-earning assets |
| If our customers default on the repayment of their loans, our profitability could be adversely affected |
| A borrower’s default on its obligations under one or more of our loans may result in lost principal and interest income and increased operating expenses as a result of the allocation of management time and resources to the collection and work-out of the loans |
| If collection efforts are unsuccessful or acceptable workout arrangements cannot be reached, we may have to write-off the loans in whole or in part |
| Although we may acquire any real estate or other assets that secure the defaulted loans through foreclosure or other similar remedies, the amount owed under the defaulted loans may exceed the value of the assets acquired |
| Our management periodically makes a determination of our allowance for loan losses based on available information, including the quality of our loan portfolio, economic conditions, the value of the underlying collateral and the level of our non-accruing loans |
| If our assumptions prove to be incorrect, our allowance may not be sufficient |
| Increases in this allowance will result in an expense for the period |
| If, as a result of general economic conditions or an increase in non-performing loans, management determines that an increase in our allowance for loan losses is necessary, we may incur additional expenses |
| In addition, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses and the value we attribute to real estate acquired through foreclosure or other similar remedies |
| These regulatory agencies may require us to adjust our determination of the value for these items |
| These adjustments could negatively impact our results of operations or financial condition |
| Because we serve primarily individuals and smaller businesses located in New England and adjoining areas, the ability of our customers to repay their loans is impacted by the economic conditions in these areas |
| As of December 31, 2005, approximately 71prca of our loan portfolio consisted of commercial loans, defined as commercial and industrial, municipal, multi-family, commercial real estate and construction loans |
| Thus, our results of operations, both in terms of the origination of new loans and the potential default of existing loans, is heavily dependent upon the strength of local businesses |
| In addition, a substantial portion of our loans are secured by real estate located primarily in Vermont, Massachusetts, New Hampshire and Maine |
| Consequently, our ability to continue to originate real estate loans may be impaired by adverse changes in local and regional economic conditions in these real estate markets or by acts of nature |
| These events also could have an adverse effect on the value of our collateral and, due to the concentration of our collateral in real estate, on our financial condition |
| We have traditionally obtained funds principally through deposits and borrowings |
| As a general matter, deposits are a cheaper source of funds than borrowings, because interest rates paid for deposits are typically less than interest rates charged for borrowings |
| If, as a result of competitive pressures, market interest rates, general economic conditions or other events, the balance of our deposits decrease relative to our overall banking operations, we may have to rely more heavily on borrowings as a source of funds in the future |
| Such an increased reliance on borrowings could have a negative impact on our results of operations or financial condition |
| In the course of our business, we may acquire, through foreclosure, properties securing loans that are in default |
| Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties |
| In this event, we might be required to remove these substances from the affected properties at our sole cost and expense |
| The cost of this removal could substantially exceed the value of the 16 ______________________________________________________________________ [45]Table of Contents affected properties |
| We may not have adequate remedies against the prior owners or other responsible parties and could find it difficult or impossible to sell the affected properties |
| The occurrence of one or more of these events could adversely affect our financial condition or operating results |
| Bank holding companies and state and federally chartered banks operate in a highly regulated environment and are subject to supervision and examination by federal and state regulatory agencies |
| We are subject to the Bank Holding Company Act of 1956, as amended, and to regulation and supervision by the Federal Reserve Board, or FRB Our state chartered banks are subject to regulation and supervision by the Federal Deposit Insurance Corporation, or FDIC, and the applicable state banking authorities, including the Vermont Commissioner of Banking, Insurance, Securities and Health Care Administration, the Maine Superintendent of the Bureau of Banking and the Massachusetts Commissioner of Banks |
| Our national bank subsidiary is subject to regulation by the Office of the Comptroller of the Currency, or the OCC The cost of compliance with regulatory requirements may adversely affect our results of operations or financial condition |
| Federal and state laws and regulations govern numerous matters including: changes in the ownership or control of banks and bank holding companies; maintenance of adequate capital and the financial condition of a financial institution; permissible types, amounts and terms of extensions of credit and investments; permissible non-banking activities; the level of reserves against deposits; and restrictions on dividend payments |
| The FDIC, the OCC and state banking authorities possess cease and desist powers to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the FRB possesses similar powers with respect to bank holding companies |
| These and other restrictions limit the manner in which we may conduct our business and obtain financing |
| Furthermore, our banking business is affected not only by general economic conditions, but also by the monetary policies of the FRB Changes in monetary or legislative policies may affect the interest rates we must offer to attract deposits and the interest rates we can charge on our loans, as well as the manner in which we offer deposits and make loans |
| These monetary policies have had, and are expected to continue to have, significant effects on the operating results of depository institutions, including our banks |
| We will continue to consider the acquisition of other businesses |
| However, we may not have the opportunity to make suitable acquisitions on favorable terms in the future, which could negatively impact the growth of our business |
| We expect that other banking and financial companies will compete with us to acquire compatible businesses |
| This competition could increase prices for acquisitions that we would likely pursue, and our competitors may have greater resources than us |
| Also, acquisitions of regulated businesses such as banks are subject to various regulatory approvals |
| If we fail to receive the appropriate regulatory approvals, we will not be able to complete an acquisition that we believe is in our best interests |
| We have in the past acquired, and will in the future consider the acquisition of, other banking and related businesses |
| If we acquire other companies in the future, our business may be negatively impacted by risks related to those acquisitions |
| These risks include the following: the risk that the acquired business will not perform in accordance with management’s expectations; the risk that difficulties will arise in connection with the integration of the operations of the acquired business with our operations; the risk that management will divert its attention from other aspects of our business; the risk that we may lose key employees of the acquired business; the risks associated with entering into geographic and product markets in which we have limited or no direct prior experience; and the risks of the acquired company that we may assume in connection with an acquisition |
| As a result of these risks, any given acquisition, if and when consummated, may adversely affect our results of operations or financial condition |
| In addition, because the consideration for an acquisition may involve cash, debt or the issuance of shares of our common stock and may involve the payment of a premium over book and market values, existing holders of our common stock could experience dilution in connection with the acquisition |
| 17 ______________________________________________________________________ [46]Table of Contents We rely heavily on communications and information systems to conduct our business |
| Any failure or interruptions or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposits, servicing or loan origination systems |
| The occurrence of any failures or interruptions could result in a loss of customer business and have a material adverse effect on our results of operations and financial condition |
| Under regulatory capital adequacy guidelines and other regulatory requirements, we and our Banks must meet guidelines that include quantitative measures of assets, liabilities, and certain off-balance sheet items, subject to qualitative judgments by regulators about components, risk weightings and other factors |
| If we fail to meet these minimum capital guidelines and other regulatory requirements, our financial condition would be materially and adversely affected |
| Our failure to maintain the status of “well capitalized” under our regulatory framework could affect the confidence of our customers in us, thus compromising our competitive position |
| In addition, failure to maintain the status of “well capitalized” under our regulatory framework or “well managed” under regulatory examination procedures could compromise our status as a bank holding company and related eligibility for a streamlined review process for acquisition proposals |