UNITED STATES
SECURITIES AND EXCHANGE COMMISION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For quarter ended June 30, 2003
-----------------
Commission file number 000-23904
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SLADE'S FERRY BANCORP
--------------------------------------------------------
(Exact name of registrant as specified in its character)
Massachusetts 04-3061936
------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
100 Slade's Ferry Avenue
Somerset, Massachusetts 02726
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(Address of principal executive offices) (Zip code)
(508)-675-2121
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(Registrant's telephone number, including area code)
Check whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date:
Common stock ($0.01 par value) 3,967,304.12 shares as of June 30, 2003.
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PART I
ITEM 1
Financial Statements
--------------------
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2003 December 31, 2002
----------------------------------
(Unaudited)
ASSETS:
Cash, due from banks and
interest-bearing demand
deposits with other banks $ 21,701,469 $ 14,993,969
Money market mutual funds 56,227 222,567
Federal Home Loan Bank overnight deposit 3,000,000 10,000,000
Federal funds sold 9,500,000 9,500,000
--------------------------------
Cash and Cash Equivalents 34,257,696 34,716,536
Interest-bearing time deposits
with other banks 200,000 200,000
Investment securities held-to-maturity(1) 16,712,669 13,696,254
Investment securities available-for-sale(2) 56,339,271 65,907,926
Federal Home Loan Bank stock 1,352,400 1,013,400
Loans, net 288,738,132 259,816,056
Premises and equipment 6,070,408 6,067,879
Goodwill 2,173,368 2,173,368
Accrued interest receivable 1,431,140 1,492,591
Cash surrender value of life insurance 10,637,502 9,750,661
Deferred income tax asset, net 1,786,838 1,849,723
Other assets 1,785,629 1,690,589
--------------------------------
TOTAL ASSETS $421,485,053 $398,374,983
================================
LIABILITIES & STOCKHOLDERS' EQUITY:
Deposits $350,015,324 $335,632,532
Federal Home Loan Bank advances 27,046,549 19,185,338
Other liabilities 2,378,884 2,336,109
--------------------------------
Total Liabilities 379,440,757 357,153,979
--------------------------------
Preferred stockholders' equity in a
subsidiary company 49,500 54,000
--------------------------------
STOCKHOLDERS' EQUITY:
Common stock 39,674 39,378
Paid-in-capital 28,113,627 27,693,199
Retained earnings 13,649,992 13,445,335
Accumulated other comprehensive income (loss) 191,503 (10,908)
--------------------------------
Total Stockholders' Equity 41,994,796 41,167,004
--------------------------------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $421,485,053 $398,374,983
================================
--------------------
Investment securities held-to- maturity have a fair market value of
$17,521,557 as of June 30, 2003 and $14,262,405 as of December 31,
2002.
Securities classified as available-for-sale are stated at a fair value
with any unrealized gains or losses reflected as an adjustment in
Stockholders' Equity, net of tax effect.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND EXPENSE
(UNAUDITED)
6 MONTHS ENDING JUNE 30,
2003 2002
---------------------------
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans $ 8,509,284 $ 8,814,539
Interest and dividends on investments 1,586,281 2,358,874
Other interest 108,380 150,757
---------------------------
Total interest and dividend income 10,203,945 11,324,170
---------------------------
INTEREST EXPENSE:
Interest on deposits 2,447,944 3,666,473
Interest on Federal Home Loan Bank
and other borrowed funds 651,206 559,189
---------------------------
Total interest expense 3,099,150 4,225,662
---------------------------
Net interest and dividend income 7,104,795 7,098,508
Provision (benefit) for loan losses (539,357) 375,000
---------------------------
Net interest and dividend income after
provision (benefit) for loan losses 7,644,152 6,723,508
---------------------------
OTHER INCOME:
Service charges on deposit accounts 278,194 281,629
Overdraft service charges 263,126 130,405
Loss on sales of available-for-sale
securities, net (40,918) (2,818)
Increase in cash surrender value of life
insurance policies 216,340 210,275
Other income 293,053 296,744
---------------------------
Total other income 1,009,795 916,235
---------------------------
OTHER EXPENSE:
Salaries and employee benefits 3,738,029 3,559,419
Occupancy expense 485,013 418,445
Equipment expense 255,022 250,713
Stationary and supplies 114,282 152,559
Professional fees 541,676 186,761
Marketing expense 229,617 190,659
Writedown on securities 0 946,895
Loss on sale of loans 103,534 0
Other expense 837,875 864,639
---------------------------
Total other expense 6,305,048 6,570,090
---------------------------
Income before income taxes and
extraordinary item 2,348,899 1,069,653
Income taxes 773,215 230,977
---------------------------
Net Income before extraordinary item 1,575,684 838,676
Extraordinary item, net of income taxes (658,168) 0
---------------------------
NET INCOME $ 917,516 $ 838,676
===========================
Basic earnings (loss) per share:
Income before extraordinary item $ 0.40 $ 0.22
Extraordinary item, net of income taxes (0.17) 0.00
---------------------------
Net income $ 0.23 $ 0.22
===========================
Diluted earnings (loss) per share:
Income before extraordinary item $ 0.40 $ 0.21
Extraordinary item, net of income taxes (0.17) 0.00
---------------------------
Net income $ 0.23 $ 0.21
===========================
Basic averages shares outstanding 3,956,361 3,891,775
===========================
Diluted average shares outstanding 3,979,347 3,922,520
===========================
Dividends per share $ 0.18 $ 0.18
===========================
Comprehensive Income(1) $ 1,119,927 $ 974,082
===========================
--------------------
Calculated using the change in accumulated other comprehensive income
(loss) for the period and net income (loss) for the period.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND EXPENSE
(UNAUDITED)
3 MONTHS ENDING JUNE 30,
2003 2002
---------------------------
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans $ 4,342,772 $ 4,294,794
Interest and dividends on investments 737,332 1,157,692
Other interest 63,057 91,122
---------------------------
Total interest and dividend income 5,143,161 5,543,608
---------------------------
INTEREST EXPENSE:
Interest on deposits 1,220,151 1,717,491
Interest on Federal Home Loan Bank
and other borrowed funds 333,713 295,917
---------------------------
Total interest expense 1,553,864 2,013,408
---------------------------
Net interest and dividend income 3,589,297 3,530,200
Provision (benefit) for loan losses (680,357) 187,500
---------------------------
Net interest and dividend income after
provision (benefit) for loan losses 4,269,654 3,342,700
---------------------------
OTHER INCOME:
Service charges on deposit accounts 144,426 140,039
Overdraft service charges 141,457 70,355
Increase in cash surrender value of life
insurance policies 108,170 95,639
Other income 141,076 140,972
---------------------------
Total other income 535,129 447,005
---------------------------
OTHER EXPENSE:
Salaries and employee benefits 1,948,592 1,768,918
Occupancy expense 222,032 207,252
Equipment expense 131,857 125,263
Stationery and supplies 54,078 77,995
Professional fees 298,796 123,610
Marketing expense 135,344 89,680
Writedown on securities 0 946,895
Loss on sale of loans 103,534 0
Other expense 410,569 458,626
---------------------------
Total other expense 3,304,802 3,798,239
---------------------------
Income (loss) before income taxes (benefit)
and extraordinary item 1,499,981 (8,534)
Income taxes (benefit) 517,183 (65,288)
---------------------------
Net income before extraordinary item 982,798 56,754
Extraordinary item, net of income taxes 626,898 0
---------------------------
NET INCOME $ 1,609,696 $ 56,754
===========================
Basic earnings per share:
Income before extraordinary item $ 0.25 $ 0.01
Extraordinary item, net of income taxes 0.16 0.00
---------------------------
Net income $ 0.41 $ 0.01
===========================
Diluted earnings per share:
Income before extraordinary item $ 0.24 $ 0.01
Extraordinary item, net of income taxes 0.16 0.00
---------------------------
Net income $ 0.40 $ 0.01
===========================
Basic average shares outstanding 3,964,054 3,903,564
===========================
Diluted average shares outstanding 3,989,285 3,934,387
===========================
Dividends per share $ 0.09 $ 0.09
===========================
Comprehensive Income (1) $ 1,729,607 $ 555,751
===========================
--------------------
Calculated using the change in accumulated other comprehensive income
(loss) for the period and net income (loss) for the period.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
-------------------------
(Unaudited)
2003 2002
-----------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 917,516 $ 838,676
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization, net of accretion of securities 102,291 68,504
Loss on sales of available-for-sale securities, net 40,918 2,818
Loss on sale of loans 103,534 0
Change in unearned income (7,579) (49,170)
Provision (benefit) for loan losses (539,357) 375,000
Depreciation and amortization 309,450 307,419
Increase in cash surrender value of life
insurance policies (216,340) (210,275)
Writedown on securities 0 946,895
(Increase) decrease in taxes receivable (64,241) 77,588
Deferred tax expense 52,941 0
(Increase) decrease in other assets 26,300 (415,793)
(Increase) decrease in prepaid expenses (52,300) 76,791
Decrease in interest receivable 61,451 203,009
Increase (decrease) in other liabilities (24,403) 34,492
Increase in accrued expenses 71,481 85,484
Increase (decrease) in interest payable (11,764) 16,063
Decrease in minority interest in subsidiary (4,500) (1,500)
-----------------------------
Net cash provided by operating activities 765,398 2,356,001
-----------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of interest-bearing time deposit
with other bank 0 (100,000)
Purchases of available-for-sale securities (21,955,276) (16,358,558)
Proceeds from maturities and calls of
available-for-sale securities 31,601,021 16,382,314
Purchases of held-to-maturity securities (4,926,305) (2,550,873)
Proceeds from maturities of
held-to-maturity securities 1,901,946 4,376,270
Purchase of Federal Home Loan Bank stock (339,000) 0
Loan originations and principal
collections, net (30,228,939) (3,168,935)
Recoveries of loans previously charged off 52,035 23,082
Proceeds from sales of loans 1,698,230 0
Capital expenditures (311,979) (151,446)
Proceeds from sale of asset 0 10,600
Investment in life insurance policies (670,501) (1,000,000)
-----------------------------
Net cash used in investing activities (23,178,768) (2,537,546)
-----------------------------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
-------------------------
(Unaudited)
(Continued)
2003 2002
-----------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, NOW,
money market and savings accounts 14,589,565 19,458,314
Net decrease in time deposits (206,773) (13,069,233)
Advances in Federal Home Loan Bank borrowings,
net of payments 7,861,211 2,336,524
Net increase in other borrowed funds 0 749,049
Proceeds from issuance of common stock 420,724 493,683
Dividends paid (710,197) (696,825)
-----------------------------
Net cash provided by financing activities 21,954,530 9,271,512
-----------------------------
Net increase (decrease) in cash and cash
equivalents (458,840) 9,089,967
Cash and cash equivalents at beginning of year 34,716,536 28,692,310
-----------------------------
Cash and cash equivalents at the end of period $ 34,257,696 $ 37,782,277
=============================
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 3,110,914 $ 4,209,599
Income taxes paid $ 669,468 $ 377,280
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
SLADE'S FERRY BANCORP AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
June 30, 2003
Note A - Basis of Presentation
------------------------------
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in
the United States of America (GAAP) for interim financial information and
the instructions to Form 10-Q and, accordingly, do not include all of the
information and footnotes required by GAAP for complete financial
statements. In the opinion of the management of Slade's Ferry Bancorp (the
"Company"), all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included.
Operating results for the six months ended June 30, 2003 are not necessarily
indicative of the results that may be expected for the year ending December
31, 2003.
The year-end condensed consolidated balance sheet data was derived from
audited financial statements, but does not include all disclosures required
by GAAP.
Note B - Accounting Policies
----------------------------
The accounting principles followed by Slade's Ferry Bancorp and subsidiary
and the methods of applying these principles which materially affect the
determination of financial position, results of operations, or changes in
financial position are consistent with those used for the year ended
December 31, 2002.
The consolidated financial statements of Slade's Ferry Bancorp include its
wholly-owned subsidiary, Slade's Ferry Trust Company, and its subsidiaries,
Slade's Ferry Realty Trust, Slade's Ferry Securities Corporation, Slade's
Ferry Preferred Capital Corporation, and Slade's Ferry Loan Company. All
significant intercompany balances have been eliminated.
Note C - Stock Based Compensation
---------------------------------
At June 30, 2003, the Company has a stock-based employee compensation plan.
The Company accounts for the plan under the recognition and measurement
principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. No stock-based employee
compensation cost is reflected in net income (except for appreciation from
options surrendered), as all options granted under this plan had an exercise
price equal to the market value of the underlying common stock on the date
of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS Statement No. 123, "Accounting for Stock-Based
Compensation", to stock-based employee compensation.
3 Months Ending June 30, 6 Months Ending June 30,
2003 2002 2003 2002
----------------------------------------------------
Net income, as reported $1,609,696 $56,754 $917,516 $838,676
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects 55,967 59,377 55,967 59,377
----------------------------------------------------
Pro forma net income (loss) $1,553,729 $(2,623) $861,549 $779,299
====================================================
Earnings per share:
Basic - as reported $ 0.41 $ 0.01 $ 0.23 $ 0.22
Basic - pro forma $ 0.39 $ 0.00 $ 0.22 $ 0.20
Diluted - as reported $ 0.40 $ 0.01 $ 0.23 $ 0.21
Diluted - pro forma $ 0.39 $ 0.00 $ 0.22 $ 0.20
7
Note D - Impact of New Accounting Standards
-------------------------------------------
In June 2001, the FASB issued SFAS No. 141, "Business Combinations". This
Statement addresses financial accounting and reporting for business
combinations and supercedes APB Opinion No. 16, "Business Combinations", and
SFAS No. 38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises". Under Opinion 16, business combinations were accounted for
using one of two methods, the pooling-of-interests method or the purchase
method. All business combinations in the scope of SFAS No. 141 are to be
accounted for using one method - the purchase method. The provisions of
SFAS No. 141 apply to all business combinations initiated after June 30,
2001 and to all business combinations accounted for using the purchase
method for which the date of acquisition is July 1, 2001, or later.
The adoption of SFAS No. 141 had no immediate effect on the Company's
consolidated financial statements since it had no pending business
combinations as of June 30, 2001 or as of the date of the issuance of these
consolidated financial statements. If the Company consummates business
combinations in the future, any such combinations that would have been
accounted for by the pooling-of-interests method under Opinion 16 will be
accounted for under the purchase method and the difference in accounting
could have a substantial impact on the Company's consolidated financial
statements.
In June 2001, the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets", which is effective for fiscal years beginning after
December 15, 2001. Under prior accounting standards, goodwill resulting
from a business combination was amortized on a straight-line basis over 15
years. As a result of SFAS No. 142, goodwill is generally no longer
amortized as an expense after 2001, but instead will be reviewed and tested
for impairment using a fair value methodology and assessment. Goodwill will
be tested at least annually for impairment. Management does not anticipate
an impairment adjustment to the goodwill reflected in the accompanying
condensed consolidated balance sheet. In accordance with SFAS No. 142, the
Company, as of January 1, 2002, ceased the amortization of the goodwill
balance of $2.2 Million.
SFAS No. 142 provides that goodwill shall not be amortized. Goodwill is
defined as the excess of the cost of an acquired entity over the net of the
amounts assigned to assets acquired and liabilities assumed. SFAS No. 142
further provides that goodwill shall be tested for impairment at a level of
reporting referred to as a reporting unit. Impairment is the condition that
exists when the carrying amount of goodwill exceeds its implied fair value.
SFAS No. 142 was effective as follows:
All of the provisions of SFAS No. 142 were applied in fiscal years
beginning after December 15, 2001, to all goodwill and intangible
assets recognized in the Company's statement of financial position at
the beginning of that fiscal year, regardless of when those previously
recognized assets were initially recognized.
The Company's assets as of December 31, 2001 included goodwill of $2,173,368
recognized in the acquisition of Fairbank, Inc., in 1997. This goodwill was
being amortized at the rate of $226,800 per year. Under SFAS No. 142 this
amortization was discontinued after December 31, 2001 but is subject to the
impairment review requirements of SFAS No. 142.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived
assets. SFAS No. 144 supercedes SFAS No. 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," but
retains the basic recognition and measurement model for assets held for use
and held for sale. The provisions of SFAS No. 144 are required to be
adopted starting with
8
fiscal years beginning after December 15, 2001. This Statement did not have
a material impact on the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities." This Statement requires that a liability
for a cost associated with an exit or disposal activity be recognized and
measured initially at fair value only when the liability is incurred. SFAS
No. 146 is effective for exit or disposal activities that are initiated
after December 31, 2002. This Statement did not have a material impact on
the Company's consolidated financial statements.
In October 2002, the FASB issued SFAS No. 147 "Acquisitions of Certain
Financial Institutions" an Amendment of SFAS Nos. 72 and 144 and FASB
Interpretation No. 9, SFAS No. 72 "Accounting for Certain Acquisitions of
Banking or Thrift Institutions" and FASB Interpretation No. 9 "Applying APB
Opinions No. 16 and 17 When a Savings and Loan Association or a Similar
Institution is Acquired in a Business Combination Accounted for by the
Purchase Method" provided interpretive guidance on the application of the
purchase method to acquisitions of financial institutions. Except for
transactions between two or more mutual enterprises, SFAS No. 147 removes
acquisitions of financial institutions from the scope of both Statement 72
and Interpretation 9 and requires that those transactions be accounted for
in accordance with SFAS No. 141 "Business Combinations" and SFAS No. 142
"Goodwill and Other Intangible Assets". Thus, the requirement in paragraph 5
of Statement 72 to recognize (and subsequently amortize) any excess of the
fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired as an unidentifiable intangible
asset no longer applies to acquisitions within the scope of SFAS No. 147.
In addition, SFAS No. 147 amends SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets" to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets and credit cardholder
intangible assets. Consequently, those intangible assets are subject to the
same undiscounted cash flow recoverability test and impairment loss
recognition and measurement provisions that SFAS No. 144 requires for other
long-lived assets that are held and used.
Paragraph 5 of SFAS No. 147, which relates to the application of the
purchase method of accounting, is effective for acquisitions for which the
date of acquisition is on or after October 1, 2002. The provisions in
paragraph 6 related to accounting for the impairment or disposal of certain
long-term customer-relationship intangible assets were effective on October
1, 2002. Transition provisions for previously recognized unidentifiable
intangible assets were effective on October 1, 2002. Transition provisions
for previously recognized unidentifiable intangible assets in paragraphs 8-
14 were effective on October 1, 2002, with earlier application permitted.
9
ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of
---------------------------------------------------------------------------
Operation
---------
Forward-looking Statements
--------------------------
This Form 10-Q contains certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements regarding the strength of the company's capital and asset
quality. Other such statements may be identified by words such as
"believes," "will," "expects," "project," "may," "developments,"
"strategic," "launching," "opportunities," "anticipates," "estimates,"
"intends," "plans," "targets" and similar expressions. These statements are
based upon the current beliefs and expectations of Slade's Ferry Bancorp's
management and are subject to significant risks and uncertainties. Actual
results may differ materially from those set forth in the forward-looking
statements as a result of numerous factors.
The following factors, among others, could cause actual results to differ
materially from the anticipated results or other expectations expressed in
our forward-looking statements: (1) enactment of adverse government
regulation; (2) competitive pressures among depository and other financial
institutions may increase significantly and have an effect on pricing,
spending, third-party relationships and revenues; (3) the strength of the
United States economy in general and specifically the strength of the New
England economies may be different than expected, resulting in, among other
things, a deterioration in overall credit quality and borrowers' ability to
service and repay loans, or a reduced demand for credit, including the
resultant effect on the Bank's loan portfolio, levels of charge-offs and
non-performing loans and allowance for loan losses; (4) changes in the
interest rate environment may reduce interest margins and adversely impact
net interest income; and (5) changes in assumptions used in making such
forward-looking statements. Should one or more of these risks materialize
or should underlying beliefs or assumptions prove incorrect, Slade's Ferry
Bancorp's actual results could differ materially from those discussed. All
subsequent written and oral forward-looking statements attributable to
Slade's Ferry Bancorp or any person acting on its behalf are expressly
qualified in their entirety by the cautionary statements set forth above.
Slade's Ferry Bancorp does not intend or undertake any obligation to update
any forward-looking statement to reflect circumstances or events that occur
after the date the forward-looking statements are made.
Financial Condition
-------------------
Total assets increased by $23.1 Million, or 5.8%, from $398.4 Million at
December 31, 2002 to $421.5 Million at June 30, 2003. The increase in
total assets during the first six months of 2003 was most significant in the
loan portfolio experiencing an 11.1% increase. This increase in total
assets was generated by deposit growth of $14.4 Million, additional advances
from the Federal Home Loan Bank of $7.9 Million, and an increase in
Stockholders' Equity of $0.8 Million.
Cash and cash equivalents decreased slightly by $0.5 Million, from $34.7
Million reported as of year-end 2002 to $34.2 Million at June 30, 2003.
Cash and cash equivalents, for purpose of reporting cash flows, include
cash, amounts due from banks, federal funds sold, overnight deposits with
the Federal Home Loan Bank, and other short-term investments, i.e. money
market mutual funds.
The investment portfolio represents the second largest component of the
Company's total assets, and consists of securities available-for-sale and
securities held-to-maturity. The designation of which category a security
is to be classified is determined at the time of the purchase of the
investment instrument.
Total investments, excluding Federal Home Loan Bank stock, decreased by $6.6
Million from $79.6 Million reported at December 31, 2002 to $73.0 Million at
June 30, 2003. The decrease in investments of $6.6 Million
10
combined with the $14.4 Million increase in deposits, and $7.9 Million
increase in advances from the Federal Home Loan Bank provided the liquidity
to fund loan growth of approximately $28.9 Million.
The Held-to-Maturity category consists predominately of securities issued by
states of the United States and political subdivisions of states and short-
term debt securities issued by the U. S. Treasury. The Company has the
positive intent and ability to hold these securities to maturity. In
managing the Held-to-Maturity portfolio, the Company seeks to maximize its
return and maintain consistency to meet short and long term liquidity
forecasts by purchasing securities with maturities laddered within a short-
term period of 1-3 years, a mid-term period of 3-5 years, and some
securities extending out to 10 years. The Company does not purchase
investments with off-balance sheet characteristics, such as swaps, options,
futures, and other hedging activities that are called derivatives. The main
objective of the investment policy is to provide adequate liquidity to meet
reasonable declines in deposits and any anticipated increases in the loan
portfolio, to provide safety of principal and interest, to generate earnings
adequate to provide a stable income, and to fit within the overall
asset/liability management objectives of the Company.
Investment Securities Held-to-Maturity are securities that the Company will
hold to maturity and are carried at amortized cost on the balance sheet, and
are summarized as follows as of June 30, 2003:
Amortized Gross Unrealized Gross Unrealized
(Dollars in Thousands) Cost Basis Holding Gains Holding Losses Fair Value
-----------------------------------------------------------------------------------------------------------
Debt securities issued by the U.S.
Treasury and other U.S. Government
Corporations and Agencies $ 3,999 $ 0 $2 $ 3,997
Debt securities issued by states of the
United States and political
subdivisions of the states 12,711 811 0 $13,522
Mortgage-backed securities 2 0 0 2
Other debt securities 1 0 0 1
----------------------------------------------------------------------------------------------------------
Total $16,713 $811 $2 $17,522
==========================================================================================================
Securities in the Available-for-Sale category are securities that the
Company intends to hold for an indefinite period of time, but not
necessarily to maturity. These securities may be sold in response to
interest rate changes, liquidity needs or other factors. Any unrealized
gains or losses, net of taxes, are excluded from earnings and reflected in
Stockholders' Equity as a separate component in accumulated other
comprehensive income (loss).
Investments in Available-for-Sale securities are carried at fair value on
the balance sheet and are summarized as follows as of June 30, 2003:
Gains in Losses in
Accumulated Accumulated
Other Other
Amortized Comprehensive Comprehensive
(Dollars in Thousands) Cost Basis Income Income Fair Value
--------------------------------------------------------------------------------------------------
Debt securities issued by the U. S.
Treasury and other U. S. Government
Corporations and Agencies $27,569 $ 260 $ 0 $27,829
Marketable Equities 3,671 144 553 3,262
Mortgage-backed securities 22,186 781 0 22,967
Corporate Bonds 2,165 116 0 2,281
-------------------------------------------------------------------------------------------------
Total $55,591 $1,301 $553 $56,339
=================================================================================================
11
Effect on Stockholders' Equity as of June 30, 2003:
(In Whole Dollars)
Net unrealized gain on Available-for-Sale Securities $ 748,209
Less tax effect (322,526)
---------
Net unrealized gain on Available-for-Sale Securities
after tax effect $ 425,683
=========
The Available-for-Sale category at June 30, 2003 had net unrealized gains,
net of taxes, of $425,683 of which $692,472 are net unrealized gains (net of
tax) attributed to securities of the U.S. Treasury, other U.S. Government
corporations and agencies, corporate bonds, and mortgage-backed securities,
and $266,789 are net unrealized losses (net of tax) attributable to
marketable equity securities.
Securities of the U.S. Treasury, U.S. Government corporations and agencies,
and mortgage-backed securities have little or no credit risk, other than
being sensitive to changes in interest rates; and if held-to-maturity, these
securities will mature at par. The Company amortizes premiums and accretes
discounts over the life of the securities.
Marketable equity securities, however, have a greater risk as they are
subject to rapid market fluctuations. These securities are constantly
monitored and evaluated to determine their suitability for sale, retention
in the portfolio, or possible writedowns due to impairment issues.
Management minimizes its risk by limiting the total amount invested into
marketable equity securities. At June 30, 2003, the amount invested in
marketable equity securities was 4.5% of the total investment portfolio
distributed over various business sectors.
Total net loans increased by $28.9 Million or 11.1% from $259.8 Million
reported at December 31, 2002 to $288.7 Million at June 30, 2003.
Residential mortgage loans, home equity, and construction loan products
increased during the six months ending June 30, 2003 as new and existing
customers took advantage of the lower interest rate environment. In the
second quarter of 2003, due to an aggressive marketing campaign to promote
historically low home equity and mortgage rates, the Bank originated more
than $38.0 Million in residential mortgage loans, and $10.7 Million in home
equity loans. These increases were partially offset by decreases in
indirect auto loans and various commercial loans and credit lines. In
addition, loan amortization and prepayments, due to a high level of
refinancing activities, also offset the increase in new loan originations.
Additionally, during the first six months of 2003, management implemented
new loan policies and procedures, and instituted aggressive plans to improve
the asset quality of loans. As a result, in the second quarter of 2003,
approximately $1.6 Million of loans deemed impaired were sold recognizing a
pre-tax loss of $103,534.
The composition of our loan portfolio continues to change. Loan demand for
residential real estate and home equity loans continues to be strong, and
commercial loan borrowers, due to the uncertainty of the economy, focus on
refinancing existing debt to lower borrowing costs.
12
INFORMATION WITH RESPECT TO NONACCRUAL AND PAST DUE LOANS
AT JUNE 30, 2003 AND 2002 AND DECEMBER 31, 2002 AND 2001
At June 30, At December 31,
--------------------------------------------------------------------------------------------------
(Dollars in Thousands) 2003 2002 2002 2001
--------------------------------------------------------------------------------------------------
Nonaccrual Loans $ 517 $ 684 $ 635 $ 1,138
Loans 90 days or more past due and still accruing 0 0 8 444
Real estate acquired by foreclosure
or substantively repossessed 0 0 0 0
Percentage of nonaccrual loans to total gross loans 0.18% 0.27% 0.24% 0.45%
Percentage of nonaccrual loans, restructured loans,
and real estate acquired by foreclosure or
substantively repossessed to total assets 0.12% 0.17% 0.16% 0.34%
Percentage of allowance for loan losses
to nonaccrual loans 840.04% 811.11% 764.41% 481.90%
The $0.5 Million in nonaccrual loans as of June 30, 2003 consists of $0.4
Million of real estate mortgages and $0.1 Million attributed to commercial
loans. Nonaccrual loans include restructured loans of $115,000 at
June 30, 2003.
The Company's nonperforming assets as a total decreased slightly by $0.1
Million, from $0.6 Million reported on December 31, 2002 to $0.5 Million as
of June 30, 2003. The Company considers nonaccrual loans, loans past due 90
days or more but still accruing, and real estate acquired by foreclosure or
substantively repossessed as nonperforming assets. Nonaccrual loans, which
is the largest component of nonperforming assets, decreased by $118,463
during the six months ending June 30, 2003. Loans 90 day or more but still
accruing decreased by $7,747 during the first six months of 2003. As of
June 30, 2003, there was no real estate acquired by foreclosure.
The percentage of nonaccrual loans to total gross loans decreased from 0.24%
reported at the year end 2002 to 0.18% at June 30, 2003 due to a decrease in
the nonaccrual category and the increase in the total loan portfolio. The
percentage of nonaccrual loans and real estate acquired by foreclosure or
substantively repossessed to total assets also decreased due to the decrease
in nonaccrual loans and increase in the loan portfolio total assets.
INFORMATION WITH RESPECT TO INTEREST ON NONACCRUAL AND PAST DUE
LOANS AT JUNE 30, 2003 AND 2002 AND DECEMBER 31, 2002 AND 2001
At June 30, At December 31,
(Dollars in Thousands) 2003 2002 2002 2001
----------------------------------------------------------------------------------
Nonaccrual Loans $517 $684 $635 $1,138
Interest income that would have been recorded
under original terms 21 60 303 109
Interest income recorded during the period 15 42 121 6
The Company stops accruing interest on a loan once it becomes past due 90
days or more unless there is adequate collateral and the financial condition
of the borrower is sufficient. When a loan is placed on nonaccrual status,
all previously accrued but unpaid interest is reversed and charged against
current income. Interest is thereafter recognized in that category only when
payments are received and the loan becomes current.
13
Loans in the nonaccrual category will remain in that category until the
possibility of collection no longer exists, the loan is paid off, or the
loan becomes current. When a loan is determined to be uncollectible, it is
then charged off against the Allowance for Loan Losses.
Statement of Financial Accounting Standards No. 114 "Accounting by Creditors
for Impairment of a Loan" applies to all loans except large groups of
smaller-balance homogeneous loans that are collectively evaluated for
impairment, loans measured at fair value or at a lower of cost or fair
value, leases, and debt securities as defined in Statement 115. Statement
114 requires that impaired loans be valued at the present value of expected
future cash flows discounted at the loan's effective interest rate or as a
practical expedient, at the loan's observable market value of the collateral
if the loan is collateral dependent. Smaller balance homogeneous loans are
considered by the Company to include consumer installment loans and credit
card loans.
At June 30, 2003, there were $2,182,536 of loans which the Company has
determined to be impaired, with a related allowance for credit losses of
$352,495. In addition, principal reductions, loan payoffs, charged off
balances, loan upgrades, and a change in our impairment identification
methodology are other factors resulting in a decrease of impaired loans.
There were no other loans classified for regulatory purposes at June 30,
2003 that management reasonably expects will materially impact future
operating results, liquidity or capital resources.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
Six Months Years Ended
Ended June 30, December 31,
-------------------------------------------------------------------------
(Dollars in Thousands) 2003 2002 2002 2001
-------------------------------------------------------------------------
Balance at January 1 $4,854 $5,484 $5,484 $4,776
-------------------------------------------------------------------------
Charge-offs:
Commercial (0) (288) (336) (73)
Real Estate-construction (0) (0) (0) (0)
Real Estate-mortgage (10) (20) (20) (0)
Installment/consumer (14) (26) (26) (28)
-------------------------------------------------------------------------
Total charge-offs (24) (334) (382) (101)
-------------------------------------------------------------------------
Recoveries:
Commercial 27 10 17 14
Real Estate-construction 0 0 0 0
Real Estate-mortgage 18 11 38 29
Installment/consumer 7 2 7 16
-------------------------------------------------------------------------
Total Recoveries 52 23 62 59
-------------------------------------------------------------------------
Net (charge-offs) recoveries 28 (311) (320) (42)
-------------------------------------------------------------------------
Provision (benefit) charged to
(increasing) operations (539) 375 (310) 750
-------------------------------------------------------------------------
Balance at end of period $4,343 $5,548 $4,854 $5,484
=========================================================================
Ratio of net charge-offs to
Average loans outstanding (0.01%) (0.13%) (0.13%) (0.02%)
The Allowance for Loan Losses at June 30, 2003 was $4,342,967, compared to
$4,854,388 at year-end 2002. The Allowance for Loan Losses as a percentage
of outstanding loans was 1.49% at June 30, 2003, and 1.83% at December 31,
2002.
The Company provides for loan losses to maintain the Allowance for Loan
Losses at a level that management believes to be adequate to absorb
potential losses in the loan portfolio.
14
As the composition of our loan portfolio gradually changes and diversifies
from higher credit risk weighted loans, such as commercial real estate and
commercial and industrial, to residential and home equity loans, less
reserve allowance will be required. Due to the continued changes in the
loan portfolio, stronger underwriting guidelines, the sale of loans
previously deemed substandard, and overall improvement in credit quality of
existing loans, the overall credit risk embedded in the loan portfolio
decreased. After thorough review and analysis of the adequacy of the loan
loss reserve during the second quarter, the Bank recovered $680,357 of
previously provided loan loss provisions, and for the six months ending June
30, 2003, the Bank recorded a provision benefit to earnings of $539,357,
compared to a provision expense of $375,000 recorded for the same period in
the previous year. Loans charged off were $382,000 in 2002, $101,000 in
2001, $24,000 in the six months ended June 30, 2003, and $334,000 for the
same period in 2002. Recoveries of loans previously charged off were
$62,000 in 2002, $59,000 in 2001, $52,000 in the six months ended June 30,
2003, and $23,000 for the same period in 2002. Management believes that the
Allowance for Loan Losses of $4,342,967 as of June 30, 2003 is adequate to
cover potential losses in the loan portfolio, based on current information
available to management.
The level of the Allowance for Loan Losses is evaluated monthly by
management and encompasses several factors. These factors include but are
not limited to recent trends in the nonperforming loans, the adequacy of the
assets that collateralize the nonperforming loans, the level of nonaccrual
loans, current economic conditions in the market area, and various other
external and internal factors. Management's assessment of the adequacy of
the Allowance for Loan Losses is reviewed by regulators, the Company's
independent accountants, and outside loan review consultants.
This table shows an allocation of the allowance for loan losses as of the
end of each of the periods indicated.
June 30, 2003 December 31, 2002 December 31, 2001
---------------------------------------------------------------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Each Each Each
Category Category Category
to Total to Total to Total
Amount Loans Amount Loans Amount Loans
---------------------------------------------------------------------------
(Dollars in Thousands)
Domestic:
Commercial (5) $1,065(1) 11.23% $1,155(1) 11.60% $1,629(1) 17.91%
Real estate - Construction 104 6.48% 70 5.31% 41 2.99%
Real estate - mortgage 3,059(2) 80.65% 3,465(2) 80.48% 3,585(2) 74.77%
Consumer(3) 115(4) 1.64% 164(4) 2.61% 229(4) 4.33%
-------------------------------------------------------------------------
$4,343 100.00% $4,854 100.00% $5,484 100.00%
=========================================================================
--------------------
Includes amounts specifically reserved for impaired loans of $298,327
as of June 30, 2003, $412,761 as of December 31, 2002, and $780,029 as
of December 31, 2001 as required by Financial Accounting Standard No.
114, Accounting for Impairment of Loans.
Includes amounts specifically reserved for impaired loans of $41,724
as of June 30, 2003, $34,757 as of December 31, 2002, and $413,663 as
of December 31, 2001 as required by Financial Accounting Standard No.
114, Accounting for Impairment of Loans.
Includes consumer, obligations of states and political subdivisions
and other.
Includes amounts specifically reserved for impaired loans of $12,444
as of June 30, 2003, $29,606 as of December 31, 2002, and $1,632 as of
December 31, 2001 as required by Financial Accounting Standard No.
114, Accounting for Impairment of Loans.
Includes commercial, financial, agricultural and nonprofit loans.
15
The loan portfolio's largest segment of loans is commercial real estate
loans, which represent 53% of gross loans. Residential real estate
represents 28% of gross loans. The Company requires a loan to value ratio
of 80% in both commercial and residential mortgages. These mortgages are
secured by real properties which have a readily ascertainable appraised
value.
Real estate residential loans are both loans secured by one-to-four family
property and home equity loans. Home equity loans are generally revolving
lines of credit and are typically secured by second mortgages on one-to-four
family owner-occupied properties.
Generally, commercial real estate loans have a higher degree of credit risk
than residential real estate loans because they depend primarily on unit
supply and demand and various conditions. When granting these loans, the
Company evaluates the financial statements of the borrower(s), the location
of the real estate, the quality of management, profitability, and general
economic and competitive conditions. When granting a residential mortgage,
the Company reviews the borrower(s) repayment history on past debts, and
assesses the borrower(s) ability to meet existing obligations and payments
on the proposed loans. Real estate construction loans comprise both
residential and commercial construction loans throughout our market area.
Commercial loans consist of loans predominantly collateralized by inventory,
furniture and fixtures, and accounts receivable. In assessing the
collateral for this type of loan, management applies a 50% liquidation value
to inventories; 25% to furniture, fixtures and equipment; and 70% to
accounts receivable less than 90 days of invoice date. Commercial loans
represent 11% of the loan portfolio as of June 30, 2003, compared to 16% as
of June 30, 2002.
Consumer loans are both secured and unsecured borrowings and represent only
2% of the total loan portfolio as of June 30, 2003. These loans have a
higher degree of risk than residential mortgage loans. The underlying
collateral of a secured consumer loan tends to depreciate in value.
Consumer loans are typically made based on the borrower's ability to repay
the loan through continued financial stability. The Company endeavors to
minimize risk by reviewing the borrower's repayment history on past debts,
and assessing the borrower's ability to meet existing obligations on the
proposed loans.
The allocation of the Allowance for Loan Losses is based on management's
judgement of potential losses in the respective portfolios. While
management has allocated reserves to various portfolio segments, the
allowance is general in nature and is available for the portfolio in its
entirety.
Total deposits at June 30, 2003 were $350.0 Million, an increase of $14.4
Million or 4.3%, compared to $335.6 Million at December 31, 2002. Savings
deposit balances and money market accounts increased by $17.0 Million,
offset by a net decrease in demand deposits and NOW accounts of $2.6
Million. Term certificates of deposit as of June 30, 2003 remained
relatively at the same level as reported at December 31, 2002. The Bank's
marketing campaign to promote new money market account products during the
first six months of 2003 had been very successful, generating more than
$12.0 Million in deposits.
Total borrowed funds were $27.0 Million at June 30, 2003, as compared to
$19.2 Million at December 31, 2002, for an increase of $7.8 Million. The
Bank took advantage of the low interest rate environment to obtain advances
from the Federal Home Loan Bank to augment its funding sources.
Total stockholders' equity was $42.0 Million at June 30, 2003, as compared
to $41.2 Million at December 31, 2002, for an increase of $0.8 Million. The
increase during the first six months of 2003 resulted from net income of
$0.9 Million, and dividend reinvestments of $0.4 Million, partially offset
by dividends declared of $0.7 Million.
16
Results of Operations
---------------------
The Company's operating performance is dependent on net interest and
dividend income, which is the difference between interest income earned on
loans and investments and interest expense paid on deposits and borrowed
funds. The level of net interest income achieved is significantly impacted
by several factors such as economic conditions, interest rates,
asset/liability management, and corporate tax and strategic planning. Net
interest and dividend income for June 30, 2003 increased by $6,287 to
$7,104,795 when compared to $7,098,508 recorded during the same period in
2002. Total interest and dividend income decreased by $1,120,225 offset by
a decrease in total interest expense of $1,126,512. The Company's net
interest margin decreased by 5 basis points from 3.91% reported at June 30,
2002 to 3.86% as of June 30, 2003.
The Provision for Loan Losses is a charge against earnings and funds the
Allowance for Loan Losses. It is management's desire to maintain the
Allowance for Loan Losses at a level that is adequate to absorb potential
losses within the loan portfolio. In determining the appropriate level of
the allowance for loan losses, management takes into consideration past and
anticipated loss experience, prevailing economic conditions, evaluations of
underlying collateral, and the volume of the loan portfolio and balance of
nonperforming and classified loans. Management assesses the allowance for
loan losses on a monthly basis. After thorough review and analysis of the
adequacy of the loan loss reserve, the continued improvement in asset
quality in the loan portfolio, and the reduction and sale of loans deemed
substandard, management deemed it prudent to recover $680,357 of previously
provided loan loss provisions in the second quarter of 2003. As of June 30,
2003 the allowance for loan losses remains adequate to absorb any credit
risk remaining in the portfolio. The Bank's provision for the first six
months of 2003 was a benefit to earnings of $539,357 compared to an expense
provision of $375,000 recorded for the same period 2002.
Total noninterest income increased by $93,560 for the first six months in
2003, when compared to the same period in 2002. Service charges on deposit
accounts and overdraft fees combined increased by $129,286. This increase
was due to a new overdraft fee pricing schedule and procedures implemented
during the first six months of 2003. The increase in deposit account
service charge income was partially offset by a $40,918 net loss recognized
on the sale of certain equity securities. After a downgrade in the rating
of one of these securities, and a negative outlook on the company's future
performance, management felt it prudent to sell this stock and recognize a
loss. The cash surrender value of bank owned life insurance policies
associated with both the directors' and executive officers' life insurance
programs increased slightly by $6,065 when compared to the same period in
2002. This is due to the purchase of life insurance policies for newly
hired executive officers. The line item Other Income decreased slightly by
$3,691 when compared to the first six months of 2002. These income items
represent earnings derived from fees associated with safe deposit box
rentals, checkbook printing, ATM/debit card usage, customer investment
commissions, and other miscellaneous income.
The category Total Other Expense, made up of various noninterest expenses
decreased by $265,042, or 4.0% to $6,305,048 recorded during the first six
months ending June 30, 2003, compared to $6,570,090 reported for the same
period in 2002.
Salaries and employee benefits increased by $178,610, or 5.0% from
$3,559,419 reported for the first six months of 2002, to $3,738,029 expensed
for the same period in 2003. The increase was attributable to additions to
staff to support consumer lending activities, sales incentive commissions
paid for achieving sales production targets, and general salary increases
due to performance reviews. A Chief Operating Officer/Chief Financial
Officer was also hired in May 2003. In addition employee benefits expense
also increased as the Company increased its defined benefit plan
contribution for 2003.
17
Occupancy and equipment expenses combined totaled $740,035 during the first
six months of 2003, compared to $669,158 in 2003, an increase of $70,877,
primarily due to increased snow removal cost resulting from a cold, severe
winter, and higher energy cost.
The expenses for stationery and supplies decreased by $38,277 from $152,559
reported as of year-to-date June 30, 2002 to $114,282 reported for the same
period in 2003.
Professional fees increased by $354,915 from the first six months of 2002
compared to 2003. This increase reflects costs associated with consultants
for marketing, advertising, investment advisory, and information technology.
In addition legal expenses for both corporate matters and loan related
matters increased.
Marketing expenses attributed to production and media costs for radio
commercials, print advertising, and other direct marketing increased by
$38,958. These marketing costs were associated with campaigns for consumer
loan products, and new money market accounts.
Included in total other expenses in 2002 was a writedown on securities of
$946,895 due to the recognition of various impairment adjustments within the
equity securities of the investment portfolio that were deemed to be other
than temporary. During the first six months of 2003, no writedowns were
necessary. The investment portfolio is reviewed at least quarterly with the
Investment Committee to determine if there are any possible impairment
issues within the portfolio.
As previously mentioned, during the first half of 2003, management
implemented new policies and procedures, and instituted aggressive plans to
reduce problem loan relationships. As a result, in the second quarter of
2003, a portion of these loans were sold at a discount recognizing a pre-tax
loss of $103,534 and allowed the Bank to recover previously provided loan
loss provisions directly allocated to these loans. During the first six
months of 2002, no loans were sold.
The following table sets forth the components of the line item Other
Expense. This table reflects a decrease of $48,057 to $410,569 from
$458,626 for the three month period ending June 30, 2003 and a decrease of
$26,764 to $837,875 from $864,639 for the six month period ending June 30,
2003 when compared to June 30, 2002.
Three Months Six Months
---------------------------------------------------------------------
2003 2002 Variance 2003 2002 Variance
---------------------------------------------------------------------
Communications/Postage $ 77,009 $ 82,523 $ (5,514) $167,958 $163,764 $ 4,194
Committee Fees 38,900 46,800 (7,900) 74,500 93,350 (18,850)
Other Expenses 294,660 329,303 (34,643) 595,417 607,525 (12,108)
---------------------------------------------------------------------
$410,569 $458,626 $(48,057) $837,875 $864,639 $(26,764)
=====================================================================
For the six months ended June 30, 2003, Other Expense decreased by $26,764.
Communications/Postage Expense increased by $4,194 due to the increase in
postage cost effective June 2002. Committee Fees decreased by $18,850, from
$93,350 reported for the six months ending June 30, 2002 to $74,500 for the
same period in 2003. Additional committee meetings were necessary during
2002 to review the candidates for the Chief Executive Officer/President, and
Other Miscellaneous Expense decreased by $12,108.
Income before income taxes and extraordinary item was $2,348,899 for the six
month period ending June 30, 2003, compared to $1,069,653 reported for the
same period in 2002. Income taxes before extraordinary item totaled
$773,215, an increase of $542,218 when compared to $230,977 reported for the
same period in 2002 as a result of higher taxable income in 2003. The
increase in taxable income of $1,279,246 is attributable to a combination of
the writedown expense of securities recorded during the first six months of
2002 of $946,895, and the recovery of previously provided loan loss
provisions resulting in a benefit to earnings of $539,357 in
18
2003. Year-to-date net income as of June 30, 2003 increased by 9.4%, or
$78,840 from $838,676 or $0.21 diluted earnings per share reported during
the first six months of 2002 to $917,516 or $0.23 diluted earnings per share
for the same period this year.
As announced in the Company's July 15, 2003 press release, the Bank entered
into a settlement with the Massachusetts Department of Revenue ("DOR") and
paid $855,967 in retroactive state taxes to resolve a dispute involving the
DOR's disallowance of the deduction taken by the Bank for dividends received
from its REIT subsidiary for the tax years 1999, 2000, 2001 and 2002.
During the first quarter of 2003, the Bank accrued a liability of
approximately $1.3 Million, net of taxes, due to new legislation enacted in
Massachusetts in March 2003, expressly disallowing the deduction for
dividends received from a REIT. The Bank has ceased recording the tax
benefits associated with the dividend received deduction in 2003. As a
result of the settlement, the Company recognized income, net of taxes, of
approximately $627,000 or $0.16 per share in the second quarter of 2003,
representing the unused portion of the accrual and therefore reduced the
extraordinary expense item, net of tax benefits, from $1,285,066 recorded in
the first quarter of 2003 to $658,168 as of June 30, 2003.
The results of operation for the second quarter in 2003 indicates that net
interest and dividend income increased slightly by $59,097 to $3,589,297
from $3,530,200 reported for the same period in 2002. Total interest and
dividend income decreased by $400,447 from 2002 to 2003, offset by a
decrease in total interest expense of $459,544. Interest margin
compression, the interest rate environment, and the future direction of the
economy are still concerns although we have been effective in maintaining a
flat net interest margin for the last six months. During this low interest
rate environment, the Bank has lowered interest rates on deposit accounts to
offset the impact of historical lower loan rates, but there is very little
room for further reductions in deposit rates causing pressure on our net
interest margins.
During the second quarter 2003, the Bank implemented procedures to improve
asset quality within the loan portfolio. Due to continued diversification
in the composition of the loan portfolio, stronger underwriting guidelines,
and the sale of $1.6 Million of loans carrying higher credit risk and
reserve allocations, the aggregate credit risk embedded in the loan
portfolio decreased substantially. After review and analysis of the
adequacy of the loan loss reserve, management with the approval of the Board
of Directors, deemed it prudent to recover $680,357 of previously provided
loan loss provisions in the second quarter of 2003. The provision for loan
losses recorded in the three months ending June 30, 2002 was $187,500. The
allowance for loan losses is maintained at a level that management believes
is adequate to cover potential losses in the loan portfolio which are deemed
probable and based on information available to management. Management
assesses the allowance for loan losses on a monthly basis, and believes that
it has been reasonable in the analysis of the allowance for loan losses.
Total Other Income increased by $88,124 for the three months ending June 30,
2003, when compared to the same period in 2002. Service charges on both
deposit accounts and overdrafts combined increased by $75,489. An increase
in the Bank's deposit base and new procedures on overdrawn deposit accounts
are directly responsible for the increase in service charge income. There
was also an increase of $12,531 in the cash surrender value of life
insurance policies associated with purchases of additional policies for new
executive officers. The line item Other Income increased slightly by $104
when compared to the second quarter of 2002. These income items represent
earnings derived from rental fees on safe deposit boxes, checkbook order
fees, ATM/debit card usage fees, and customer investment commission fees.
Total Other Expenses, made up of various noninterest expenses, decreased by
$493,437 from $3,798,239 reported as of quarter end June 30, 2002 to
$3,304,802 as of June 30, 2003. Included in the three months ending June
30, 2002 was the writedown of securities totaling $946,895. No writedowns
were necessary during 2003. Salaries and employee benefits increased by
$179,674 related to staff additions, sales incentive commissions, and
general wage increases due to annual performance evaluations. Occupancy and
equipment
19
expenses combined increased by $21,374 due primarily to an increase in real
estate taxes paid on bank owned properties and additional depreciation
expense on equipment and software purchases. Stationery and supplies
expense decreased by $23,917. Professional fees increased by $175,186 from
the three months ending June 30, 2002 compared to the same period in 2003.
This increase reflects costs associated with marketing, advertisement,
investment advisory, and information technology consulting services to
promote the Bank and improve the efficiencies in the operation of the Bank.
Marketing expenses increased by $45,664 attributed to print advertising and
other direct marketing and business development promotion costs. During the
three months ending June 30, 2002, the Bank recorded a writedown charge of
$946,895 on equity securities with no similar charge in 2003. The Bank sold
$1.6 Million of higher credit risk loans during the second quarter of 2003
recognizing a loss of $103,534. There were no loan sales during the same
quarter in 2002. The item Other Expenses decreased by $48,057 due to the
expense of stock appreciation rights recorded during the second quarter of
2002 of approximately $40,000, with no similar expense recorded in 2003.
Income before taxes and extraordinary item for the second quarter in 2003
increased by $1,508,515 from a pre-tax loss of $8,534 reported in 2002, to
earnings of $1,499,981 this year. This increase in quarterly earnings from
2002 to 2003 is due to the $946,895 security writedown expense recorded in
2002, and the benefit to earnings in 2003 of $680,357 related to the
recovery of previously provided loan loss provisions, offset partially by a
loss of $103,534 on the sale of loans. Associated applicable income taxes
also increased by $582,471 from 2002 to 2003 due to the increase in taxable
income. Net income for the three month period ending June 30, 2003 was
$1,609,696, or an increase of $1,552,942, when compared to $56,754 reported
in the second quarter of 2002. Included in the 2003 quarterly earnings is
the result of the REIT settlement recognizing income of $626,898 as an
extraordinary item, net of taxes representing the unused portion of the
liability accrued by the Bank of $1,285,000 in the first quarter of 2003.
Liquidity
---------
Liquidity represents the ability of the Bank to meet its funding
requirements. In assessing the appropriate level of liquidity, the Bank
considers deposit levels, lending funding requirements and investment
maturities in light of prevailing economic conditions. Through this
assessment, the Bank manages its liquidity level to optimize earnings and
respond to fluctuations in customer borrowing and deposit needs.
The Company's principle sources of funds are customer deposits, loan
amortization, loan payoffs, and the maturities of investment securities.
Through these sources, funds are provided for customer withdrawals from
deposit accounts, loan origination, drawdowns on loan commitments,
acquisitions of investment securities, and other normal business activities.
Investors' capital also provides a source of funding.
The largest source of funds is provided by depositors. The largest
component of the Company's deposit base is term certificates which extend
out to a maximum of five years. The Company does not participate in
brokered deposits. Deposits are obtained from consumers and commercial
customers within the Bank's community reinvestment area, being Bristol
County, Massachusetts and several abutting towns in Rhode Island.
The Company also has the ability to borrow funds for liquidity purposes from
correspondent banks, the Federal Home Loan Bank, as well as the Federal
Reserve Bank of Boston, by pledging various investment securities as
collateral. Borrowings from the Federal Home Loan Bank increased by
approximately $8.0 Million as the Bank took advantage of the favorable low
interest rate environment to draw down some longer term structured funding
opportunities. As of June 30, 2003, there was $27.0 Million in advances
outstanding from the Federal Home Loan Bank.
20
Excess available funds are invested on a daily basis into Federal Funds
Sold. An appropriate level of Federal Funds Sold is maintained to meet loan
commitments, anticipated loan growth and deposit forecasts. Funds exceeding
this level are then used to purchase investment securities that are suitable
in yields and maturities for the investment portfolio.
Liquidity during the first six months of 2003 was primarily provided by a
net increase in deposits of $14.4 Million, advances in Federal Home Loan
Bank borrowings of $7.9 Million, and proceeds from maturities and calls of
securities totaling $33.5 Million. These were offset by purchases of
securities of $27.2 Million, loan originations, principal collections, and
purchased loans of $28.4 Million, and purchases of life insurance policies
for executive officers of $0.7 Million. Other factors affecting liquidity
included cash provided by other operating activities and cash used in
financing activities as indicated in the consolidated statements of cash
flows.
Capital
-------
As of June 30, 2003, the Company had total capital of $41,994,796. This
represents an increase of $827,792 from $41,167,004 reported on December 31,
2002. The increase in capital was a combination of several factors. Six
months earnings resulted in net income of $917,516. Transactions originating
through the Dividend Reinvestment Program resulted in 5,430.597 shares being
issued for cash contributions of $77,309 and 24,148.041 shares being issued
for $343,415 in lieu of cash dividend payments. These additions were offset
by dividends declared of $712,859.
Also, affecting capital is accumulated other comprehensive income (loss)
which reflects net unrealized gains or losses, net of taxes, on securities
classified as Available-for-Sale and the minimum pension liability
adjustment. On December 31, 2002 the Available-for-Sale portfolio had
unrealized losses, net of taxes, of $120,943, and on June 30, 2003, as a
result of current market values, the portfolio reflects unrealized gains,
net of taxes, of $425,683. There was no change in the minimum pension
liability adjustment of $234,180, net of taxes, recorded December 31, 2002.
Under the requirements for Risk Based and Leverage Capital of the federal
banking agencies, a minimum level of capital will vary among banks based on
safety and soundness of operations. Risk Based Capital ratios are
calculated with reference to risk-weighted assets, which include both on and
off balance sheet exposure.
At June 30, 2003 the actual Risk Based Capital of the Bank was $32,559,000
for Tier 1 Capital, exceeding the minimum requirements of $11,908,560 by
$20,650,440. Total Capital of $36,288,000 exceeded the minimum requirements
of $23,817,120 by $12,470,880 and Leverage Capital of $32,559,000 exceeded
the minimum requirements of $16,266,880 by $16,292,120. In addition to the
"minimum" capital requirements, "well capitalized" standards have also been
established by the Federal Banking Regulators.
21
The table below illustrates the capital ratios of the Company and the Bank
on June 30, 2003 and at December 31, 2002.
Well June 30, 2003 December 31, 2002
Capitalized ----------------- -----------------
Requirement Bancorp Bank Bancorp Bank
-------------------------------------------------------------------------------------
Total Capital (to Risk
Weighted Assets) > or =10% 14.39% 12.19% 14.84% 12.63%
Tier 1 Capital (to Risk
Weighted Assets) > or =6% 13.14% 10.94% 13.59% 11.38%
Leverage Capital (to Average
Assets) > or =5% 9.52% 8.01% 9.48% 8.00%
Under the revised informal agreement entered into with the Massachusetts
Commissioner of Banks and the Federal Deposit Insurance Corporation,
effective January 17, 2002, the Bank is required to maintain a seven (7)
percent Tier I Leverage Capital ratio. As of June 30, 2003, this ratio was
8.01% compared to 8.0% at year-end 2002.
In addition to meeting the required levels, the Company and the Bank's
capital ratios meet the criteria of the "well capitalized" category
established by the federal bank regulatory agencies as of June 30, 2003.
22
ITEM 3
Quantitative and Qualitative Disclosure About Market Risk
---------------------------------------------------------
Interest Rate Risk
------------------
Volatility in interest rates requires the Company to manage interest rate
risk that arises from the differences in the timing of repricing of assets
and liabilities. The Company considers interest rate risk, the exposure of
earnings to adverse movements in interest rates, to be a significant market
risk as it could potentially have an affect on the Company's financial
condition and results of operation.
Management's objective is to reduce risk and control the vulnerability of
its net interest margin to changes in interest rates by managing the
relationship of interest-earning assets and interest-bearing liabilities.
The interest rate risk is managed by periodic review and evaluation of the
risk potential in certain balance sheet accounts, and determining the level
of risk considered appropriate for our level of capital. This, in
conjunction with certain assumptions and other related factors, such as
anticipated changes in interest rates, liquidity requirements, performance
objectives and strategic plans, provides management a means of evaluating
interest rate risk.
The Company's Asset/Liability Committee, comprised of the executive
management and designated Board of Directors are responsible for managing
and monitoring interest rate risk, and reviewing with the Board of
Directors, at least quarterly, the Bank's interest rate risk positions, the
impact changes in interest rates would have on net interest income, and the
maintenance of interest rate risks within approved guidelines.
The Company quantifies its interest rate risk exposure using a simulation
model. This simulation analysis is used to measure the exposure to net
interest income to changes in interest rates over a specified time frame.
The simulation analysis projects future interest income and interest expense
under different rate scenarios. Internal guidelines on limitations on
interest rate risk specify that for every 100 basis points of immediate
change in interest rates, projected net interest income over the next twelve
months should not decline by more than 5%.
The simulation model currently utilizes a 300 basis point increase in
interest rates and a 50 basis point decrease in rates. Due to the existing
low interest rate environment in effect with the average Federal Funds
overnight rate trading below 1.50%, the simulation model only reduces rates
downward by 50 basis points. The rate interest movements used assume an
instant and parallel change in interest rates, and no implementation of any
strategic plans are made in response to the change in interest rates.
Prepayment speeds for loans are based on median dealer forecasts for each
interest rate scenario.
The following table reflects the Company's estimated exposure as a
percentage of estimated net interest income for the next twelve months,
assuming an immediate change in interest rates as set forth below:
Estimated Exposure as a Percentage
Rate Change of Net Interest Income
(Basis Points) June 30, 2003
-----------------------------------------------------
+300 (7.33)%
-50 (1.32)%
The model used to monitor earnings-at-risk provides management a measurement
tool to assess the effect of changes in interest rates on the Company's
current and future earnings. The limit established by the Company provides
an internal tolerance level to control interest rate risk exposure.
23
ITEM 4 CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
As required by new Rule 13a-15 under the Securities Exchange Act of 1934, we
carried out an evaluation under the supervision and with the participation
of our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that they believe that,
as of June 30, 2003, our disclosure controls and procedures were effective
to ensure that information required to be disclosed by us in the reports we
file or submit under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms. In connection with the new rules, we will
continue to review and document our disclosure controls and procedures,
including our internal controls and procedures for financial reporting, on
an ongoing basis, and may from time to time make changes aimed at enhancing
their effectiveness and to ensure that our systems evolve with our business.
(b) Changes in internal controls.
None.
24
PART II
Other Information
ITEM 4
The Annual Meeting of the Company's stockholders was held on April 14, 2003
with the following matters being voted upon and with the indicated results.
Proposal One - Election of Class Three Directors
------------------------------------------------
The following five individuals were re-elected to serve as directors of the
Company until the 2004 Annual Meeting of stockholders, and until their
successors are elected and qualified.
VOTES
---------------------------------------------
Nominee For Against
---------------------------------------------
Thomas B. Almy 1,981,598 16,991
Peter G. Collias 1,981,329 17,260
Melvyn A. Holland 1,959,986 38,603
Shaun O'Hearn, Sr. 1,964,561 34,028
William J. Sullivan 1,986,173 12,416
Proposal Two - Election of Clerk/Secretary
The following individual was re-elected by the stockholders to serve as
Clerk/Secretary until the next Annual Meeting of the stockholders, and until
his successor is elected and qualified.
VOTES
---------------------------------------------
Nominee For Against
---------------------------------------------
Peter G. Collias 1,986,424 12,165
The following additional directors continued their terms in office after the
meeting.
Donald T. Corrigan Mary Lynn D. Lenz
William Q. MacLean, Jr. Francis A. Macomber
Majed Mouded, MD Lawrence J. Oliveira, DDS
Peter Paskowski Kenneth R. Rezendes, Sr.
Charles Veloza David F. Westgate
Proposal Three - Ratification of Independent Auditors
-----------------------------------------------------
The following firm was re-elected by the stockholders to serve as
independent certified public accountants for the year 2003.
VOTES
--------------------------------------------------
Nominee For Against
--------------------------------------------------
Shatswell, MacLeod & Co. 1,988,323 10,266
25
ITEM 6
Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits: See exhibit index.
(b) A report on Form 8-K dated April 14, 2003 was filed with the
Securities and Exchange Commission reporting under Item 12 the release
of information concerning the first quarter 2003 results of operations
and financial condition.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SLADE'S FERRY BANCORP
-------------------------------------
(Registrant)
August 13, 2003 /s/ Mary Lynn D. Lenz
------------------------- -------------------------------------
(Date) (Signature) Mary Lynn D. Lenz
President/Chief Executive Officer
August 13, 2003 /s/ Deborah A. McLaughlin
------------------------- -------------------------------------
(Date) (Signature) Deborah A. McLaughlin
Chief Operating Officer/
Chief Financial Officer
27
EXHIBIT INDEX
Exhibit No. Description Note
----------- ----------- ----
3.1 Articles of Incorporation of Slade's Ferry Bancorp as
amended (1)
3.2 By-laws of Slade's Ferry Bancorp as amended (2)
10.1 Slade's Ferry (formerly Weetamoe) Bancorp 1996 Stock
Option Plan (as amended) (3)
10.2 Noncompetition Agreement between Slade's Ferry Trust
Company and Edward S. Machado (A substantially identical
contract exists with Peter Paskowski) (4)
10.3 Supplemental Executive Retirement Agreement between
Slade's Ferry (formerly Weetamoe) Bancorp and
Donald T. Corrigan (5)
10.4 Supplemental Executive Retirement Agreement between
Slade's Ferry (formerly Weetamoe) Bancorp and
James D. Carey (2)
10.5 Supplemental Executive Retirement Agreement between
Slade's Ferry (formerly Weetamoe) Bancorp and
Manuel J. Tavares (2)
10.6 Swansea Mall Lease (4)
10.7 Form of Director Supplemental Retirement Program
Director Agreement, Exhibit I thereto (Slade's Ferry
Trust Company Director Supplemental Retirement Program
Plan) and Endorsement Method Split Dollar Plan Agreement
thereunder for Thomas B. Almy. (Similar forms of
agreement entered into between Slade's Ferry Trust
Company and the other directors) (6)
10.8 Form of Directors' Paid-up Insurance Policy for
Thomas B. Almy (part of the Director Supplemental
Retirement Program). (Similar forms of policy
entered into by Company for other directors). (7)
10.9 Form of Officers' Paid-up Endorsement Method Split
Dollar Plan Agreement and Insurance Policies for
Janice Partridge (Similar forms of policies entered
into by Company for its President and other
Vice Presidents) (8)
10.10 Supplemental Executive Retirement Agreement between
Slade's Ferry Bancorp and Mary Lynn D. Lenz. (9)
10.11 Change-in-Control Severance Agreement between
Slade's Ferry Bancorp, Slade's Ferry Trust Company
and Mary Lynn D. Lenz (9)
10.12 Confidentiality and Non-Solicitation Agreement between
Slade's Ferry Bancorp and Mary Lynn D. Lenz (9)
11.0 Computation of Per Share Earnings (Page 30)
31 Certifications of Chief Executive Officer and
Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) (Page 31 & 32)
32 Certification of Chief Executive Officer and
Chief Financial Officer pursuant to Section 1350 (Page 33)
--------------------
Incorporated by reference to the Registrant's Registration Statement
on Form SB-2 filed with the Commission on April 14, 1997.
Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1996.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended June 30, 1999.
Incorporated by reference to the Registrant's Registration Statement
on Form S-4 File No. 33-32131.
Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1994.
28
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended March 31, 1999.
Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended June 30, 1998.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended June 30, 2000.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended March 31, 2003.
29