FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
----- ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
Commission file number 000-23904
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SLADE'S FERRY BANCORP.
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(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-3061936
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(State or other jurisdiction of (I.R.S. Employer
in Company or organization) Identification Number)
100 Slade's Ferry Avenue
Somerset, Massachusetts 02726
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 675-2121
Securities registered pursuant to Section 12(b) of the Act: Common Stock,
$.01 par value
Name of each exchange on which registered: Nasdaq Capital Market
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer [ ] Accelerated Filer [ ] Non Accelerated Filer [X]
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Act).
Yes [ ] No [X]
The aggregate market value of the common equity of Slade's Ferry Bancorp., held
by nonaffiliates of the registrant as of June 30, 2006 was approximately
$61,137,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement for the 2007 Annual Meeting of
Shareholders to be filed pursuant to Regulation 14A within 120 days after the
Registrant's fiscal year end of December 31, 2006 are incorporated by reference
into Part III of this Form 10-K.
TABLE OF CONTENTS
Part I
Forward-Looking Statements 2
ITEM 1 - Business 3
ITEM 1A - Risk Factors 18
ITEM 1B - Unresolved Staff Comments 20
ITEM 2 - Properties 21
ITEM 3 - Legal Proceedings 22
ITEM 4 - Submission of Matters to a Vote of Security Holders 22
Part II
ITEM 5 - Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 23
ITEM 6 - Selected Consolidated Financial Data 26
ITEM 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 27
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk 45
ITEM 8 - Financial Statements and Supplementary Data 47
ITEM 9 - Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 47
ITEM 9A - Controls and Procedures 47
ITEM 9B - Other Information 47
Part III
ITEM 10 - Directors, Executive Officers and Corporate Governance 48
ITEM 11 - Executive Compensation 48
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 48
ITEM 13 - Certain Relationships and Related Transactions, and
Director Independence 49
ITEM 14 - Principal Accountant Fees and Services 49
Part IV
ITEM 15 - Exhibits, Financial Statement Schedules 50
Signatures 51
1
PART I
FORWARD-LOOKING STATEMENTS
This Form 10-K 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. Such
statements may be identified by words such as "believes," "will," "expects,"
"project," "may," "could," "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 our 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.
As used throughout this report, the terms "we," "our," "us," or the "Company"
refer to Slade's Ferry Bancorp. and its consolidated subsidiaries, unless
context otherwise requires.
2
ITEM 1
BUSINESS
GENERAL
Slade's Ferry Bancorp., a Massachusetts corporation, is a bank holding company
headquartered in Somerset, Massachusetts with assets of $607.8 million, net
loans of $422.4 million, deposits of $424.0 million and stockholders' equity of
$51.2 million as of December 31, 2006. We conduct our business principally
through our wholly-owned subsidiary, Slade's Ferry Trust Company (referred to
herein as the "Bank"), a Massachusetts-chartered trust company. As a bank
holding company, we are subject to the Bank Holding Company Act of 1956, as
amended (the "BHCA"), and the rules and regulations of the Federal Reserve
Board (the "FRB") under the BHCA. We are additionally subject to the provisions
of the Massachusetts General Laws applicable to commercial bank and trust
companies and other depository institutions and their holding companies and
applicable regulations of the Massachusetts Division of Banks (the "Division").
We are also subject to the rules and regulations of the Securities and Exchange
Commission (the "SEC") as our common stock is registered with the SEC and is
quoted on the Nasdaq Capital Market. The Bank's deposit accounts are insured up
to applicable limits by the Deposit Insurance Fund of the Federal Deposit
Insurance Company (the "FDIC"). The Bank is subject to extensive regulation,
examination and supervision by the Division as its primary corporate regulator,
and by the FDIC as its deposit insurer and primary federal regulator. Any
change in laws and regulations, whether by the Division, the FDIC, the FRB or
the SEC or through legislation, could have a material adverse impact on our
operation.
Our main office is located at 100 Slade's Ferry Avenue, Somerset,
Massachusetts, 02726, and our telephone number is (508) 675-2121. Slade's Ferry
Bancorp. was organized for the purpose of becoming the holding company of the
Bank. Slade's Ferry Bancorp.'s acquisition of the Bank was completed on April
1, 1990.
We had asset growth of $21.8 million or 3.7% and our level of deposits
increased by $8.2 million, or by 2.0%, during 2006. Aside from deposits, we
increased borrowings from the Federal Home Loan Bank of Boston (the "FHLB") by
$11.2 million, or by 10.4% during 2006. This activity funded an increase in
loans totaling $12.8 million or 3.1%, and an increase in investments totaling
$7.2 million or 5.5%.
While we evaluate opportunities to acquire other banks or bank facilities as
they arise and may in the future acquire other banks, financial institutions,
or bank facilities, we do not currently have plans for in any such acquisition.
We are committed to the philosophy of serving the needs of customers within our
market area. We believe that our comprehensive retail, small business,
commercial and industrial, and commercial real estate products enable us to
compete effectively. We do not have any major target accounts, nor do we derive
a material portion of our deposits from any single depositor. We concentrate
our operations in the area of retail banking and we service the needs of the
local communities. Our loans are not concentrated within any single industry or
group of related industries.
We currently have nine full service banking facilities, plus a drive up
complex, which extend east from Seekonk, Massachusetts to Fairhaven,
Massachusetts. These facilities service numerous communities in Southeastern
Massachusetts and contiguous areas of Rhode Island. We also provide limited
banking services at the Somerset High School in Somerset, Massachusetts. We
opened our newest facility, located in Assonet, Massachusetts in early 2005.
This branch is a state-of-the-art, full-service banking office, designed to
provide superior customer convenience and service. We own and operate eight
full service automated teller machines ("ATM") and one ATM dispenser.
The Bank maintains three wholly-owned subsidiaries. Two of these, Slade's Ferry
Securities Corporation ("SFSC"), and Slade's Ferry Securities Corporation II
("SFSCII") are Massachusetts securities corporations on which, under current
Massachusetts law, income is taxed at 1.32%, as compared to the Massachusetts
bank taxation rate of 10.5%. In exchange for this lower tax rate, the assets of
any Massachusetts security corporation are limited to certain securities,
including United States Treasury and agency securities, obligations of
government-sponsored enterprises, mortgage-backed securities, corporate debt
securities and marketable equity securities. Investment securities with book
values totaling $18.9 million and $27.2 million were held at SFSC and SFSC II,
respectively, at December 31, 2006.
Slade's Ferry Realty Trust ("SFRT") owns and manages our land and buildings.
3
Slade's Ferry Loan Company ("SFLC") was a Rhode Island Company founded for the
purpose of generating loans in the State of Rhode Island. Because the Bank has
received authorization to generate loans in Rhode Island directly, SFLC was
dissolved in early 2005.
Slade's Ferry Statutory Trust I, a Connecticut statutory trust was formed on
March 17, 2004 by the Company, and completed the sale of $10,000,000 of
floating rate trust preferred securities in a private placement as part of a
pooled trust preferred securities transaction.
Our major customer accounts as of December 31, 2006 consisted of approximately
32,000 personal savings, checking and money market accounts, and approximately
6,930 personal and commercial certificates of deposit and individual retirement
accounts. Our commercial base consists of approximately 3,340 checking, money
market, and corporate accounts.
As we continued to grow in 2006, we maintained our commitment to customer
service. We continued our systems upgrades during 2006 with the introduction of
check imaging, document imaging, inquiry and report-writer enhancements, and
bio-identity security measures. All of the upgrades allow customers to more
easily access their own personal information, while simultaneously allowing our
employees the ability to serve our customers more effectively and efficiently.
SERVICES
We engage in a broad range of banking activities, including demand, savings and
time deposits, related personal and commercial checking account services, real
estate mortgages, commercial and installment lending, payroll services, money
orders, travelers checks, Visa, MasterCard, ATM card, safe deposit rentals and
automatic teller machines. We also offer certain non-traditional banking
services including investments, life insurance, annuities, and cash management
services, and we also provide a range of internet-based services for both
consumer and commercial customers.
LENDING ACTIVITIES
Our loan portfolio consists primarily of residential, multi-family and
commercial real estate, construction and land development, and commercial
loans, home equity lines of credit and consumer loans originated primarily in
our market area. There are no foreign loans outstanding. The interest rates we
charge on loans are affected principally by the demand for such loans, the
supply of money available for lending purposes and the rates offered by our
competitors. These factors are affected by general and economic conditions,
monetary policies of the federal government, including the FRB, legislative tax
policies and governmental budgetary matters. We originate residential mortgage
loans, home equity lines of credit, fixed-rate equity loans, commercial
business loans, consumer loans and commercial real estate loans. Total net
loans were 69.5% of total assets at December 31, 2006, as compared to 69.9% of
total assets at December 31, 2005. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operation", for detailed
portfolio information.
Multi-Family and Commercial Real Estate Lending
We originate multi-family and commercial real estate loans that are generally
secured by five or more unit apartment buildings and properties used for
business purposes such as small office buildings, restaurants or retail
facilities. Our multi-family and commercial real estate underwriting policies
provide that such real estate loans may be made in amounts of up to 80% of the
appraised value of the property, subject to our current loans-to-one-borrower
limit, which was $11.5 million at December 31, 2006. Our multi-family and
commercial real estate loans are generally made with terms of up to 20 years
and are offered with interest rates that adjust periodically. In reaching a
decision on whether to make a multi-family or commercial real estate loan, we
consider the net operating income of the property, the borrower's expertise,
credit history and profitability and the value of the underlying property. We
have generally required that the properties securing these real estate loans
have debt service coverage ratios (earnings before debt service to debt service
requirements) of at least 1.20 times. Environmental impact surveys are
generally required for all commercial real estate loans. Generally, all
multi-family and commercial real estate loans made to companies, partnerships
and other business entities require personal guarantees by the principals. We
may choose not to require a personal guarantee on such loans depending on the
creditworthiness of the borrower and the amount of the down payment and other
mitigating circumstances.
4
Loans secured by multi-family and commercial real estate properties generally
involve larger principal amounts and a greater degree of risk than one-to-four
family residential mortgage loans. Because payments on loans secured by
multi-family and commercial real estate properties are often dependent on
successful operation or management of the properties, repayment of such loans
may be subject to adverse conditions in the real estate market or the economy.
We seek to minimize these risks through our underwriting standards.
Multi-family and commercial real estate loans totaled $209.2 million and
comprised 49.0% of our total gross loan portfolio at December 31, 2006. At
December 31, 2005, multi-family and commercial real estate loans totaled $213.8
million, or 51.6% of our total gross loan portfolio.
Residential Lending
We currently offer fixed-rate, one-to-four family mortgage loans with terms
from 10 to 30 years and a number of adjustable-rate mortgage ("ARM") loans with
terms of up to 30 years and interest rates which adjust every one or three
years from the outset of the loan. The interest rates for the ARM loans are
generally indexed to the applicable Constant Maturity Treasury ("CMT") Index,
or other comparable indices. Our ARM loans generally provide for periodic (not
more than 2%) and overall (not more than 6%) caps on the increase or decrease
in the interest rate at any adjustment date and over the life of the loan.
The origination of adjustable-rate residential mortgage loans and short-term
fixed-rate mortgage loans, as opposed to 30-year, fixed-rate residential
mortgage loans, generally helps reduce our exposure to increases in interest
rates. However, adjustable-rate loans generally pose credit risks not inherent
in fixed-rate loans, primarily because as interest rates rise, the underlying
payments of the borrower rise, thereby increasing the potential for default.
Periodic and lifetime caps on interest rate increases help to reduce the risks
associated with adjustable-rate loans but also limit the interest rate
sensitivity of such loans. Prior to 2006, there was a continued period of low
market interest rates that was the impetus for our customers to continue to
finance home purchases with fixed-rate loans or to refinance ARM loans into
fixed-rate loans. Interest rates began to rise in 2006 but were accompanied by
declines in property values resulting in a dearth of residential lending and
refinancing activity slowed considerably during 2006.
Generally, we originate one-to-four family residential mortgage loans in
amounts of up to 95% of the appraised value or selling price of the property
securing the loan, whichever is lower. Certain loans in our "First-Time Home
Buyer" program allow for a 97% loan-to-value ("LTV") ratio. Private mortgage
insurance ("PMI") is required for loans with a LTV ratio of greater than 80%.
Mortgage loans we originate generally include due-on-sale clauses, which
provide us with the contractual right to deem the loan immediately due and
payable in the event the borrower transfers ownership of the property without
our consent. Due-on-sale clauses are an important means of adjusting the yields
on our fixed-rate mortgage loan portfolio and we have generally exercised our
rights under these clauses. We require fire, casualty, title, and, in certain
cases, flood insurance on all properties securing real estate loans we make.
In an effort to provide financing for moderate income and first-time
homebuyers, we offer Federal Housing Authority ("FHA") and Veterans
Administration ("VA") loans and we have our own First-Time Home Buyer loan
program. These programs offer residential mortgage loans to qualified
individuals. These loans are offered with adjustable and fixed rates of
interest and terms of up to 30 years. Such loans may be secured by a one-
to-four family residential property, in the case of FHA and VA loans, and must
be secured by a single-family, owner-occupied unit in the case of First-Time
Home Buyer loans. These loans are originated using modified underwriting
guidelines, in the case of FHA and VA loans, and the same underwriting
guidelines as our other one-to-four family mortgage loans in the case of
First-Time Home Buyer loans. Such loans may be originated in amounts of up to
97% of the lower of the property's appraised value or the sale price. Private
mortgage insurance is required on all such loans with loan to values in excess
of 80%.
We generally underwrite our residential real estate loans to comply with
secondary market standards established by the Federal National Mortgage
Association. Although loans are underwritten to standards that make them
readily salable, we have not chosen to sell these loans, rather to maintain
them in portfolio, consistent with our income and interest rate risk management
targets.
Residential real estate loans totaled $132.4 million and comprised 31.0% of our
total gross loan portfolio at December 31, 2006. At December 31, 2005,
residential real estate loans totaled $120.3 million, or 29.1% of our total
gross loan portfolio.
5
Commercial Loans
Our commercial business loan portfolio consists of loans and lines of credit
predominantly collateralized by inventory, furniture and fixtures, and accounts
receivable. In assessing the collateral for these loans, 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. Like
commercial real estate loans, the successful repayment of these loans is
dependent on the operations of the business to which the loan is made.
Accordingly, these loans carry a higher level of credit risk than loans secured
by real estate. To alleviate some of this risk, credit enhancements, such as
personal guarantees or additional collateral are often taken.
Commercial loans totaled $47.7 million and comprised 11.2% of our total gross
loan portfolio at December 31, 2006. At December 31, 2005, commercial loans
totaled $38.1 million, or 9.2% of our total gross loan portfolio.
Construction Lending
We originate fixed-rate construction loans for the development of one-to-four
family residential properties. In certain situations, construction loans are
underwritten to allow borrowers to prefund reserves which are the source of
interest repayments during the construction phase of the project. Although we
do not generally make loans secured by raw land, our policies permit the
origination of such loans. Construction loans are generally offered to
experienced local developers operating in our primary market area and to
individuals for the construction of their primary residences. Construction
loans are generally offered with terms of up to 24 months and may be made in
amounts of up to 70% of the appraised value of the property, as improved. In
the case of construction loans to individuals for the construction of their
primary residences, loans up to 90% of the appraisal value may be made. Loans
made to individuals are generally written on a construction-to-permanent basis.
Land loans of up to 80% of the appraised value may be made. Construction loan
proceeds are disbursed periodically in increments as construction progresses
and as inspections by an independent construction specialist warrant.
Generally, if the borrower is a company, partnership or other business entity,
personal guarantees by the principals are required for all construction loans.
Construction financing is generally considered to involve a higher degree of
credit risk than long-term financing on improved, owner-occupied real estate.
Risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction
compared to the estimated cost (including interest) of construction and other
assumptions, including the estimated time to sell residential properties. If
the estimate of value proves to be inaccurate, we may be confronted with a
project, when completed, having a value which is insufficient to assure full
repayment.
Construction and land development loans totaled $21.0 million and comprised
4.9% of our total gross loan portfolio at December 31, 2006. At December 31,
2005, construction and land development loans totaled $21.5 million, or 5.2% of
our total gross loan portfolio.
Home Equity Lines of Credit
Substantially all of our home equity lines of credit are secured by second
mortgages on owner-occupied, one-to-four family residences located in our
primary market area. Our home equity lines of credit generally have interest
rates, indexed to the Wall Street Journal Prime Rate, that adjust on a monthly
basis. Home equity lines of credit generally have an 18% lifetime limit on
interest rates. Generally, the maximum combined loan-to-value ratio on home
equity lines of credit is 80%. The underwriting standards we employ for home
equity lines of credit include a determination of the applicant's credit
history and an assessment of the applicant's ability to meet existing
obligations and payments on the proposed loan and the value of the collateral
securing the loan. The stability of the applicant's monthly income may be
determined by verification of gross monthly income from primary employment and,
additionally, from any verifiable secondary income. Creditworthiness of the
applicant is a primary consideration.
Home equity lines of credit totaled $13.9 million and comprised 3.3% of our
total gross loan portfolio at December 31, 2006. At December 31, 2005, home
equity lines of credit totaled $17.9 million, or 4.3% of our total gross loan
portfolio.
Consumer Lending
Loans secured by rapidly depreciable assets such as recreational vehicles and
automobiles entail greater risks than one-to-four family, residential mortgage
loans. In such cases, repossessed collateral for a defaulted loan may not
provide an adequate source of repayment of the outstanding loan balance, since
there is a greater likelihood of damage, loss or
6
depreciation of the underlying collateral. Further, collections on these loans
are dependent on the borrower's continuing financial stability and, therefore,
are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Finally, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered on such loans in the event of a default.
Accordingly, we originate consumer loans typically based on the borrower's
ability to repay the loan through continued financial stability. We endeavor 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. Because of the proliferation of manufacturers' discount financing and
automobile leasing, origination of automobile loans has diminished
significantly in the last five years, accounting for the continued decrease in
consumer loans as a percentage of our loan portfolio.
Consumer loans totaled $2.8 million and comprised 0.6% of our total gross loan
portfolio at December 31, 2006. At December 31, 2005, consumer loans totaled
$2.6 million, or 0.6% of our total gross loan portfolio.
Loan Approval Procedures and Authority
The Bank's Board of Directors establishes the Bank's lending policies and loan
approval limits. The Board has authorized certain officers to consider and
approve loans within their designated authority as established by the Board,
typically at ranges up to $500,000 for commercial loans, and up to $417,000 for
residential loans. The President and Chief Executive Officer and the Senior
Vice President of Lending have authority to approve loans to $500,000
individually, or up to $1 million upon their joint concurrence. In addition,
the Bank's Board of Directors has established an Executive Committee that
approves or denies all loan requests in excess of individual lending
authorities up to a maximum of $5,000,000. All loan relationships in excess of
$5,000,000 require the approval of the Board.
INVESTING ACTIVITIES
We utilize our investment portfolio as a temporary means of warehousing
liquidity until the funds can be lent. The investment portfolio also serves to
secure certain deposits and borrowings. We manage the investment portfolio to
optimize earnings, while using the portfolio as a tool in managing interest
rate risk. We use an independent investment advisor to assist us in our
portfolio management function.
We utilize both a "held-to-maturity" category and an "available-for-sale"
category, as defined in Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", to manage
the investment portfolio. Our investment policy requires Board approval before
a trading account can be established. The held-to-maturity category was
originally established for holding high-yielding municipal securities.
Beginning in the third quarter of 2004, certain mortgage-backed securities
designated as collateral for FHLB advances were also designated as
held-to-maturity. Management has the ability and intent to hold these
securities to their contractual maturity. Held-to-maturity securities totaled
$24.6 million at December 31, 2006, while available-for-sale securities totaled
$105.6 million as compared to $29.3 million and $94.3 million, respectively, at
December 31, 2005.
We primarily utilize obligations of U.S. Government-sponsored enterprises and
mortgage-backed securities as investment vehicles. High-quality corporate bonds
and municipal securities are purchased when an exceptional opportunity to
enhance investment yields arises. Purchases of these investments are limited to
securities that carry a rating of "Baa1" (Moody's) or "BBB+" (Standard and
Poor's), in order to control credit risk within the investment portfolio. Among
other investment criteria, it is management's goal to maintain a total
portfolio duration of less than 5 years. At December 31, 2006, the portfolio
duration was estimated at 3.14 years.
Excess cash is sold on an overnight basis into federal funds or overnight
deposits at the FHLB. At December 31, 2006 federal funds sold totaled $1.9
million or 0.3% of total assets, as compared to $2.2 million, or 0.4% of total
assets at December 31, 2005.
Under Massachusetts Law, the Bank is permitted to invest in marketable equity
securities. Management views equity securities as a source of current income as
well as a source of capital gain income, given appreciation in the portfolio.
Limits on asset quality, holding size, overall portfolio size and composition
are in place to protect us from undue market risk. All equity securities are
classified as available-for-sale.
7
DEPOSIT ACTIVITIES
We seek to develop relationships with our customers in order to become the
customer's primary bank. We have developed programs that stress multiple
account relationships in order to increase the level of "core deposits" in our
portfolio. Management views a customer's checking account as the primary
relationship account and, accordingly, emphasizes the growth of checking
accounts in its strategic plans. Aside from checking accounts being a
consistent, low-cost source of funds, they provide a source of non-interest
income in the form of service charges and insufficient funds fees.
Deposits are obtained from individuals and from small and medium-sized
businesses in the local market area. Our customer base is diverse, and
accordingly different product suites are offered to different groups of
customers. The suites range from accounts that serve the basic service needs of
any customer, such as free checking and statement savings accounts, to our
"Coastal" product suite, which addresses the particular needs of high-balance
customers. Additionally, small and medium-sized businesses have suites of
products that address their particular needs. We also attract deposits from
municipalities and other government agencies. We do not solicit or accept
brokered deposits. We offer a full line of deposit products including checking
and NOW accounts, savings accounts, money market accounts, and certificates of
deposit. We offer debit cards for our checking and savings accounts.
Customers have access to deposit funds at any of our ten office locations, all
of which are equipped with Automated Teller Machines. Additionally, the Bank is
a member of the NYCE Network, enabling customers to have access to their funds
worldwide. We also provide balance inquiry and funds transfer telephonically.
Our website, www.sladesferry.com, provides customers with the ability to manage
their accounts and pay bills online. Business customers who utilize our cash
management program have the ability to transfer funds and originate wire
transfers or Automatic Clearing House transactions through the website as well.
As a general rule, management systematically reviews the deposit accounts it
offers to determine if the products meet both the customers' needs and our
asset/liability management goals. This review is the responsibility of the
Pricing Committee, which meets weekly to determine products and pricing
practices consistent with overall earnings and growth goals. The Pricing
Committee establishes deposit interest rates based on a variety of factors,
including local economy, market interest rates, competitors' interest rates,
and the need to fund loan demand. We set rates to be competitive, but not
necessarily the highest rates in our market area. As competition for deposits
has intensified with the larger financial institutions in our market area, we
introduced the use of off-maturity "special" certificate accounts. We actively
market our other products to new depositors garnered through the use of
promotions, in order to cross-sell additional products and services, and
thereby establish a continued banking relationship.
In order to offset the potentially adverse effects of early withdrawal, we
generally charge an early withdrawal penalty on certificates of deposit in an
amount equal to three months' interest on accounts with original maturities of
one year or less, and six months' interest on accounts with an original
maturity of greater than one year. Interest credited to a certificate account
during any term may be withdrawn without penalty at any time during the term.
Upon renewal of a certificate account, only interest credited during the
renewal term may be withdrawn without penalty.
NON-DEPOSIT INVESTMENT PRODUCTS
We offer a variety of stock, bonds and other registered securities, mutual
funds, annuities, and insurance products offered through third-party sales
arrangements with Linsco Private Ledger, Inc. and the Savings Bank Life
Insurance Company of Massachusetts ("SBLI").
BORROWING ACTIVITIES
In order to fund additional asset growth, we have the ability to borrow at the
FHLB of Boston. The FHLB limits borrowings to 30% of assets, and requires an
investment in FHLB stock in an amount equal to 4.5% of total borrowings. These
borrowings are collateralized by our residential loan portfolio, certain
commercial real estate loans, and certain obligations and mortgage-backed
securities of government-sponsored enterprises. Management views borrowing as
not only a funding mechanism, but as a tool to manage the levels of interest
rate risk inherent in the balance sheet. In addition, we maintain borrowing
lines of credit with correspondent banks to meet short-term liquidity needs.
8
During 2006 we utilized FHLB advances to enhance our interest rate risk
position. In prior years, we had used amortizing advances to "match-fund"
certain commercial loans. As management has taken a whole-balance sheet
approach to interest rate risk management, the use of matched funding
strategies has decreased, in favor of the use of bullet and community
development advances, deployed in a laddered approach. Because the FHLB
attaches significant prepayment penalties to long-term advances, management
does not anticipate prepayment of the amortizing advances.
COMPETITION
The banking business in our market area is highly competitive. We actively
compete for both loans and deposits with local branches of nationwide and
regional banks, as well as local banks and credit unions. We also compete with
consumer mortgage and finance companies, financing subsidiaries of durable
goods manufacturers, and insurance companies. Many of the major commercial
banks or other affiliates in our service areas offer services such as
international banking and trust services that we do not currently offer
directly.
In order to expand our market area, we opened our newest facility located in
Assonet, Massachusetts in early 2005. This branch is a state-of-the-art,
full-service banking office, designed to provide superior customer convenience
and service. We believe that the addition of this branch has added to the
diversity in our loan portfolio and add a new pool of potential depositors.
EMPLOYEES
At December 31, 2006, we had 111 full-time and 27 part-time employees. We
believe that employee relations are good, and there are no known disputes
between management and employees.
All employees are eligible to participate in our Retirement Savings 401(k) Plan
and Profit Sharing Plan. Additionally, certain officers may participate in the
Slade's Ferry Bancorp. Stock Option Plan, and certain executive officers may
participate in a supplemental executive retirement program.
Our performance-based incentive programs for officers and employees have
supported, and we believe they will continue to support our growth, by giving
employees a stake in our overall performance and for balancing profit, growth
and productivity.
HOLDING COMPANY REGULATION
FEDERAL REGULATION
Capital Requirements
The FRB has adopted capital adequacy guidelines pursuant to which it assesses
the adequacy of capital in examining and supervising a bank holding company and
in analyzing applications to it under the BHCA. The FRB capital adequacy
guidelines generally require bank holding companies to maintain total capital
equal to 8% of total risk-adjusted assets, with at least one-half of that
amount consisting of Tier I, or core capital, and up to one-half of that amount
consisting of Tier II, or supplementary capital. Tier I capital for bank
holding companies generally consists of the sum of common shareholders' equity
and perpetual preferred stock (subject in the case of the latter to limitations
on the kind and amount of such stocks which may be included as Tier I capital),
less goodwill and, with certain exceptions, intangibles. Tier II capital
generally consists of hybrid capital instruments; perpetual preferred stock
which is not eligible to be included as Tier I capital; term subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories
ranging from 0% (requiring no additional capital) for assets such as cash to
100% for the bulk of assets which are typically held by a bank holding company,
including multi-family residential and commercial real estate loans, commercial
business loans and consumer loans. Single-family residential first mortgage
loans which are not past-due (90 days or more) or non-performing and which have
been made in accordance with prudent underwriting standards are assigned a 50%
level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
9
In addition to the risk-based capital requirements, the FRB requires bank
holding companies to maintain a minimum leverage capital ratio of Tier I
capital to total assets of 3.0%. Total assets for this purpose does not include
goodwill and any other intangible assets and investments that the FRB
determines should be deducted from Tier I capital. The FRB has announced that
the 3.0% Tier I leverage capital ratio requirement is the minimum for the
top-rated bank holding companies without any supervisory, financial or
operational weaknesses or deficiencies or those that are not experiencing or
anticipating significant growth. Other bank holding companies are expected to
maintain Tier I leverage capital ratios of at least 4.0% to 5.0% or more,
depending on their overall condition.
The Company is in compliance with the above-described FRB regulatory capital
requirements.
Activities
The BHCA prohibits a bank holding company from acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any bank, or
increasing such ownership or control of any bank, without prior approval of the
FRB. No approval under the BHCA is required, however, for a bank holding
company already owning or controlling 50% of the voting shares of a bank to
acquire additional shares of such bank.
The BHCA also prohibits a bank holding company, with certain exceptions, from
acquiring more than 5% of the voting shares of any company that is not a bank
and from engaging in any business other than banking or managing or controlling
banks. Under the BHCA, the FRB is authorized to approve the ownership of shares
by a bank holding company in any company, the activities of which the FRB has
determined to be so closely related to banking or to managing or controlling
banks as to be a proper incident thereto. In making such determinations, the
FRB is required to weigh the expected benefit to the public, such as greater
convenience, increased competition or gains in efficiency, against the possible
adverse effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices.
In addition, a bank holding company that does not qualify and elect to be
treated as a financial holding company under the Gramm-Leach-Bliley Financial
Services Modernization Act is generally prohibited from engaging in, or
acquiring, direct or indirect control of any company engaged in non-banking
activities. One of the principal exceptions to this prohibition is for
activities found by the FRB to be so closely related to banking or managing or
controlling banks as to be permissible. Bank holding companies that do qualify
as a financial holding company may engage in activities that are financial in
nature or incident to activities which are financial in nature. Bank holding
companies may qualify to become a financial holding company if they meet
certain criteria set forth by the FRB. The Company has not elected to become a
financial holding company.
Beginning June 1, 1997, the Interstate Banking Act permitted federal banking
agencies to approve merger transactions between banks located in different
states, regardless of whether the merger would be prohibited under the law of
the two states. The Interstate Banking Act also permitted a state to "opt in"
to the provisions of the Interstate Banking Act before June 1, 1997, and
permitted a state to "opt out" of the provisions of the Interstate Banking Act
by adopting appropriate legislation before that date. Accordingly, beginning
June 1, 1997, the Interstate Banking Act permitted a bank, such as the Bank, to
acquire an institution by merger in a state other than Massachusetts unless the
other state had opted out of the Interstate Banking Act. The Interstate Banking
Act also authorizes de novo branching into another state if the host state
enacts a law expressly permitting out of state banks to establish such branches
within its borders.
MASSACHUSETTS REGULATION
The Company as a Massachusetts-chartered corporation is governed by the
Massachusetts Business Company Law and the Company's Articles of Organization
and Bylaws. Under the Massachusetts banking laws, a company owning or
controlling two or more banking institutions, including a savings bank, is
regulated as a bank holding company. The Company or the Bank would become a
Massachusetts bank holding company if the Company acquired a second banking
institution and operated it separately from the Bank or the Bank acquired a
banking institution.
ACQUISITION OF THE COMPANY OR THE BANK
Federal Restrictions
Under the federal Change in Bank Control Act, any person (including a company),
or group acting in concert, seeking to acquire control of the Company or the
Bank will be required to submit prior notice to the FRB. Under the Change in
Bank Control Act, the FRB has 60 days within which to act on such notices,
taking into consideration factors, including the financial and managerial
resources of the acquirer, the convenience and needs of the communities served
by the
10
Company and the Bank, and the anti-trust effects of the acquisition. The term
"control" is defined generally under the BHCA to mean the ownership or power to
vote 25% or more of any class of voting securities of an institution or the
ability to control in any manner the election of a majority of the
institution's directors. Additionally under the Bank Merger Act sections of the
Federal Deposit Insurance Act, the prior approval of an insured institution's
primary federal regulator is required for an insured institution to merge with
or transfer assets to another insured institution or an uninsured institution.
Similarly, Massachusetts law requires 60-days notice to, and a nonobjection
from, the Commissioner of the Division in advance of any acquisition of control
of the Company or the Bank.
BANK REGULATION
MASSACHUSETTS BANKING REGULATION
General
The Bank is subject to Massachusetts statute and the rules and regulations of
the Division establishing the powers of the Bank, investment limitations and
minimum standards relative to the security and protection of the Bank for the
benefit of Bank employees and the general public.
Loans-to-One-Borrower Limitations
With specified exceptions, the total obligations of a single borrower to a
Massachusetts-chartered commercial bank and trust company may not exceed 20% of
the Bank's capital. A commercial bank and trust company may lend additional
amounts up to 100% of its retained earnings account if secured by collateral
meeting the requirements of the Massachusetts banking laws. The Bank currently
complies with applicable loans-to-one-borrower limitations.
Dividends
Under the Massachusetts banking laws, a commercial bank and trust company may,
subject to several limitations, declare and pay a dividend on its capital stock
out of the Bank's net profits. A dividend may not be declared, credited or paid
by a stock trust company so long as there is any impairment of capital stock.
No dividend may be declared on the Bank's common stock for any period other
than for which dividends are declared upon preferred stock, except as
authorized by the Commissioner of the Division. The approval of the
Commissioner is also required for a commercial bank and trust company to
declare a dividend, if the total of all dividends declared by the commercial
bank and trust company in any calendar year shall exceed the total of its net
profits for that year combined with its retained net profits of the preceding
two years, less any required transfer to surplus or a fund for the retirement
of any preferred stock.
In addition, federal law may also limit the amount of dividends that may be
paid by the Bank. See "- Federal Banking Regulation - Prompt Corrective
Action."
Examination and Enforcement
The Division is required to periodically examine commercial bank and trust
companies at least once every calendar year or at least once each 18-month
period if the commercial bank and trust company qualifies as well capitalized
under the prompt corrective action provisions of the Federal Deposit Insurance
Act. See "- Federal Banking Regulation - Prompt Corrective Action."
Community Reinvestment Act
The Bank is subject to provisions of the Massachusetts Community Reinvestment
Act, which are similar to those imposed by the federal Community Reinvestment
Act with the exception of the assigned exam ratings. Massachusetts banking law
provides for an additional exam rating of "high satisfactory" in addition to
the federal Community Reinvestment Act ratings of "outstanding,"
"satisfactory," "needs to improve" and "substantial noncompliance." The
Division is required to consider a bank's Massachusetts Community Reinvestment
Act rating when reviewing the Bank's application to engage in certain
transactions, including mergers, asset purchases and the establishment of
branch offices or automated teller machines, and provides that such assessment
may serve as a basis for the denial of any such application. The Massachusetts
Community Reinvestment Act requires the Division to assess a bank's compliance
and to make such
11
assessment available to the public. The Bank's latest Massachusetts Community
Reinvestment Act rating, from an exam dated July 18, 2005, was a rating of
"Satisfactory."
FEDERAL BANKING REGULATION
Capital Requirements
FDIC regulations require insured banks, such as the Bank, to maintain minimum
levels of capital. The FDIC regulations define two classes of capital known as
Tier 1 and Tier 2 capital.
The FDIC regulations establish a minimum leverage capital requirement for banks
in the strongest financial and managerial condition, with a rating of 1 (the
highest examination rating of the FDIC for banks) under the Uniform Financial
Institutions Rating System, of not less than a ratio of 3.0% of Tier 1 capital
to total assets. For all other banks, the minimum leverage capital requirement
is 4.0%, unless a higher leverage capital ratio is warranted by the particular
circumstances or risk profile of the depository institution.
The FDIC regulations also require that banks meet a risk-based capital
standard. The risk-based capital standard requires the maintenance of a ratio
of total capital (which is defined as the sum of Tier 1 capital and Tier 2
capital) to risk-weighted assets of at least 8% and a ratio of Tier 1 capital
to risk-weighted assets of at least 4%. In determining the amount of
risk-weighted assets, all assets, plus certain off balance sheet items, are
multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes
are inherent in the type of asset or item.
The federal banking agencies, including the FDIC, have also adopted regulations
to require an assessment of an institution's exposure to declines in the
economic value of a bank's capital due to changes in interest rates when
assessing the Bank's capital adequacy. Under such a risk assessment, examiners
will evaluate a bank's capital for interest rate risk on a case-by-case basis,
with consideration of both quantitative and qualitative factors.
Institutions with significant interest rate risk may be required to hold
additional capital. The agencies also issued a joint policy statement providing
guidance on interest rate risk management, including a discussion of the
critical factors affecting the agencies' evaluation of interest rate risk in
connection with capital adequacy. The Bank was considered "well-capitalized"
under FDIC guidelines at December 31, 2006.
Activity Restrictions on State-Chartered Banks
Section 24 of the Federal Deposit Insurance Act ("FDIA"), as amended, which was
added by the Federal Deposit Insurance Company Improvement Act of 1991
("FDICIA"), generally limits the activities and investments of state-chartered
FDIC insured banks and their subsidiaries to those permissible for national
banks and their subsidiaries, unless such activities and investments are
specifically exempted by Section 24 or consented to by the FDIC.
Section 24 provides an exception for investments by a bank in common and
preferred stocks listed on a national securities exchange or the shares of
registered investment companies if:
(1) The Bank held such types of investments during the 14-month period
from September 30, 1990 through November 26, 1991;
(2) The state in which the Bank is chartered permitted such investments
as of September 30, 1991; and
(3) The Bank notifies the FDIC and obtains approval from the FDIC to
make or retain such investments. Upon receiving such FDIC approval,
an institution's investment in such equity securities will be
subject to an aggregate limit up to the amount of its Tier 1
capital.
The Bank received approval from the FDIC to retain and acquire such equity
investments subject to a maximum permissible investment equal to the lesser of
100% of the Bank's Tier 1 capital or the maximum permissible amount specified
by the FDIA. Section 24 also provides an exception for majority owned
subsidiaries of a bank, but Section 24 limits the activities of such
subsidiaries to those permissible for a national bank, permissible under
Section 24 of the FDIA and the FDIC regulations issued pursuant thereto, or as
approved by the FDIC.
Before making a new investment or engaging in a new activity not permissible
for a national bank or not otherwise permissible under Section 24 or the FDIC
regulations thereunder, an insured bank must seek approval from the FDIC to
12
make such investment or engage in such activity. The FDIC will not approve the
activity unless the Bank meets its minimum capital requirements and the FDIC
determines that the activity does not present a significant risk to the FDIC
insurance funds.
Enforcement
The FDIC has extensive enforcement authority over insured state-chartered
commercial bank and trust companies, including the Bank. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist orders and to remove directors and
officers. In general, these enforcement actions may be initiated in response to
violations of laws and regulations and to unsafe or unsound practices.
The FDIC is required, with certain exceptions, to appoint a receiver or
conservator for an insured state bank if that bank is "critically
undercapitalized." For this purpose, "critically undercapitalized" means having
a ratio of tangible capital to total assets of less than 2%. The FDIC may also
appoint a conservator or receiver for a state bank on the basis of the
institution's financial condition or upon the occurrence of certain events.
Deposit Insurance
The FDIC merged the Bank Insurance Fund and the Savings Association Insurance
Fund to form the Deposit Insurance Fund on March 31, 2006. The Bank is a member
of the Deposit Insurance Fund and pays its deposit insurance assessments to the
Deposit Insurance Fund.
Pursuant to the FDICIA, the Federal Deposit Insurance Corporation established a
system for setting deposit insurance premiums based upon the risks a particular
bank or savings association posed to its deposit insurance fund. Effective
January 1, 2007, the FDIC established a risk-based assessment system for
determining the deposit insurance assessments to be paid by insured depository
institutions. Under the assessment system, the FDIC assigns an institution to
one of four risk categories, with the first category having two sub-categories
based on the institution's most recent supervisory and capital evaluations,
designed to measure risk. Assessment rates currently range from 0.05% of
deposits for an institution in the highest sub-category of the highest category
to 0.43% of deposits for an institution in the lowest category. The FDIC is
authorized to raise the assessment rates as necessary to maintain the required
reserve ratio of 1.25%. The FDIC allows the use of credits for assessments
previously paid, and the Bank has been notified that it has credits that will
offset certain assessments.
In addition, all FDIC-insured institutions are required to pay assessments to
the FDIC to fund interest payments on bonds issued by the Financing
Corporation, an agency of the federal government established to recapitalize
the predecessor to the Savings Association Insurance Fund. These assessments,
set by the FDIC quarterly, will continue until the Financing Corporation bonds
mature in 2017 through 2019.
Under the FDIA, the FDIC may terminate the insurance of an institution's
deposits upon a finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by
the FDIC. The Bank's management does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
Transactions with Affiliates of the Bank
Transactions between an insured bank, such as the Bank, and any of its
affiliates are governed by Sections 23A and 23B of the Federal Reserve Act (the
"FRA"), as interpreted by the FRB's Regulation W. An affiliate of a bank is any
company or entity that controls, is controlled by or is under common control
with the Bank. A subsidiary of a bank that is not also a depository institution
is not treated as an affiliate of the Bank for purposes of Sections 23A and
23B.
13
Section 23A:
* limits the extent to which the Bank or its subsidiaries may engage
in "covered transactions" with any one affiliate to an amount equal
to 10% of such bank's capital stock and retained earnings, and
limit on all such transactions with all affiliates to an amount
equal to 20% of such capital stock and retained earnings; and
* requires that all such transactions be on terms that are consistent
with safe and sound banking practices.
The term "covered transaction" includes the making of loans, purchase of
assets, issuance of guarantees and other similar types of transactions.
Further, most loans by a bank to any of its affiliates must be secured by
collateral in amounts ranging from 100 to 130 percent of the loan amounts. In
addition, any covered transaction by a bank with an affiliate and any purchase
of assets or services by a bank from an affiliate must be on terms that are
substantially the same, or at least as favorable to the Bank, as those that
would be provided to a non-affiliate.
Under Section 23B, affiliated transactions, including covered transactions
under Section 23A and other transactions between the Bank and its affiliates,
must be on terms which are as favorable to the Bank as comparable transactions
with non-affiliates. The Bank is also prohibited, in most cases, from acquiring
low-quality assets from an affiliate.
Loans to Insiders
The Bank's authority to extend credit to its directors, executive officers and
10% shareholders, as well as to entities controlled by such persons, is
currently governed by the requirements of Sections 22(g) and 22(h) of the FRA
and Regulation O of the FRB. Among other things, these provisions require that
extensions of credit to insiders (a) be made on terms that are substantially
the same as, and follow credit underwriting procedures that are not less
stringent than, those prevailing for comparable transactions with unaffiliated
persons and that do not involve more than the normal risk of repayment or
present other unfavorable features and (b) not exceed certain limitations on
the amount of credit extended to such persons, individually and in the
aggregate, which limits are based, in part, on the amount of the Bank's
capital. The regulations allow small discounts on fees on residential mortgages
for directors, officers and employees. In addition, extensions for credit in
excess of certain limits must be approved by the Bank's Board of Directors.
Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension of
personal loans to directors and executive officers of issuers (as defined in
Sarbanes-Oxley). The prohibition, however, does not apply to mortgages advanced
by an insured depository institution, such as the Bank, that are subject to the
insider lending restrictions of Section 22(h) of the Federal Reserve Act.
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), any insured depository
institution, including the Bank, has a continuing and affirmative obligation
consistent with its safe and sound operation to help meet the credit needs of
its entire community, including low and moderate income neighborhoods. The CRA
does not establish specific lending requirements or programs for financial
institutions nor does it limit an institution's discretion to develop the types
of products and services that it believes are best suited to its particular
community. The CRA requires the FDIC, in connection with its examination of a
commercial bank and trust company, to assess the depository institution's
record of meeting the credit needs of its community and to take such record
into account in its evaluation of certain applications by such institution,
including applications for additional branches and acquisitions.
The CRA requires the FDIC to provide a written evaluation of an institution's
CRA performance utilizing a four-tiered descriptive rating system and requires
public disclosure of an institution's CRA rating. The Bank received a
"Satisfactory" rating on its last CRA exam July 18, 2005. The Bank's obligation
under the CRA are generally consistent with its obligations under the
Massachusetts Community Reinvestment Act. See "- Massachusetts Banking
Regulation - Community Reinvestment Act."
14
Nontraditional Mortgage Product Risk
In September of 2006, the federal banking agencies, including the FDIC,
published final guidance for institutions that originate or service
nontraditional or alternative mortgage products, defined to include all
residential mortgage loan products that allow borrowers to defer repayment on
principal or interest, such as interest-only mortgages and payment option
adjustable-rate mortgages. At this time the Bank does not originate or service
nontraditional or alternative mortgage products.
Concentrations in Commercial Real Estate Loans
In December of 2006, the FDIC along with other federal banking regulators
adopted guidance entitled "Concentrations in Commercial Real Estate (CRE)
Lending, Sound Risk Management Practices," or the CRE Guidance, to address
concentrations of commercial real estate loans in institutions. The CRE
Guidance reinforces and enhances the FDIC's existing regulations and guidelines
for real estate lending and loan portfolio management, and establishes specific
commercial real estate lending thresholds at which a concentration of
commercial real estate loan is deemed to exist. The CRE Guidance applies to
institutions with an accumulation of credit concentration exposures and asks
that the banks quantify the additional risk such exposures may pose, including
stratification of the commercial real estate portfolio by, among other things,
property type, geographic market, tenant concentrations, tenant industries,
developer concentrations and risk rating. In addition, an institution should
perform periodic market analyses for the various property types and geographic
markets represented in its portfolio. Further, an institution with commercial
real estate concentration risk should also perform portfolio level stress tests
or sensitivity analysis to quantify the impact of changing economic conditions
on asset quality, earnings and capital. The Bank believes that the CRE Guidance
will not have a material impact on the conduct of its business, and the Bank
will be able to effectively implement requirements and suggestions set forth in
the CRE Guidance during 2007.
Safety and Soundness Standards
Pursuant to the requirements of the FDICIA, as amended by the Riegle Community
Development and Regulatory Improvement Act of 1994, each federal banking
agency, including the FDIC, has adopted guidelines establishing general
standards relating to internal controls, information and internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth, asset quality, earnings and compensation, fees and benefits. In
general, the guidelines require, among other things, appropriate systems and
practices to identify and manage the risks and exposures specified in the
guidelines. The guidelines prohibit excessive compensation as an unsafe and
unsound practice and describe compensation as excessive when the amounts paid
are unreasonable or disproportionate to the services performed by an executive
officer, employee, director, or principal stockholder.
In addition, the FDIC adopted regulations to require a bank that is given
notice by the FDIC that it is not satisfying any of such safety and soundness
standards to submit a compliance plan to the FDIC. If, after being so notified,
a bank fails to submit an acceptable compliance plan or fails in any material
respect to implement an accepted compliance plan, the FDIC may issue an order
directing corrective and other actions of the types to which a significantly
undercapitalized institution is subject under the "prompt corrective action"
provisions of the FDICIA. If a bank fails to comply with such an order, the
FDIC may seek to enforce such an order in judicial proceedings and to impose
civil monetary penalties.
Prompt Corrective Action
The FDICIA also established a system of prompt corrective action to resolve the
problems of undercapitalized institutions. The FDIC, as well as the other
federal banking regulators, adopted regulations governing the supervisory
actions that may be taken against undercapitalized institutions. The
regulations establish five categories, consisting of "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
and "critically undercapitalized." The severity of the action authorized or
required to be taken under the prompt corrective action regulations increases
as a bank's capital decreases within the three undercapitalized categories. All
banks are prohibited from paying dividends or other capital distributions or
paying management fees to any controlling person if, following such
distribution, the Bank would be undercapitalized.
FEDERAL RESERVE SYSTEM
Under Federal Reserve Board regulations, the Bank is required to maintain
noninterest-earning reserves against its transaction accounts. Current FRB
regulations generally require that reserves of 3% must be maintained against
aggregate transaction accounts of $45.8 million or less, subject to adjustment
by the Federal Reserve Board. Total transaction accounts in excess of $45.8
million are required to have a reserve of 10% held against them, which are also
subject to adjustment by the FRB. The first $8.0 million of otherwise
reservable balances, subject to adjustments by the FRB, are exempted from the
reserve requirements. The Bank is in compliance with these requirements.
Because required reserves must be maintained in the form of vault cash, a
noninterest-bearing account at a Federal Reserve Bank or a pass-through account
as defined by the FRB, the effect of this reserve requirement is to reduce the
Bank's interest-earning assets.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the Federal Home Loan Bank system, which consists of 12
regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central
credit facility primarily for member institutions. The Bank, as a member of the
Federal Home Loan Bank of Boston (the "FHLB"), is required to acquire and hold
shares of capital stock in the FHLB in an amount equal to at least 1% of the
aggregate principal amount of its unpaid residential mortgage loans and similar
obligations at the beginning of each year, or 1/20 of its advances (borrowings)
from the FHLB, whichever is greater. The Bank was in compliance with this
requirement with an investment in FHLB stock at December 31, 2006 of $6.9
million. The Federal Home Loan Banks are required to provide funds for certain
purposes including contributing funds for affordable housing programs. These
requirements could reduce the amount of dividends that the Federal Home Loan
Banks pay to their members and result in the Federal Home Loan Banks imposing a
higher rate of interest on advances to their members.
15
THE U.S.A. PATRIOT ACT
The Bank is subject to the USA PATRIOT Act, which gives the federal government
new powers to address money laundering and terrorist threats through enhanced
domestic security measures, expanded surveillance powers, increased information
sharing, and amendments to the Bank Secrecy Act. Title III of the USA PATRIOT
Act takes measures intended to encourage information sharing among financial
institutions, bank regulatory agencies and law enforcement bodies. Further,
certain provisions of Title III impose affirmative obligations on a broad range
of financial institutions, including banks, thrifts, brokers, dealers, credit
unions, money transfer agents, and parties registered under the Commodity
Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the
following obligations on financial institutions:
* Pursuant to Section 352, all financial institutions must establish
anti-money laundering programs that include, at minimum: (i)
internal policies, procedures, and controls; (ii) specific
designation of an anti-money laundering compliance officer; (iii)
ongoing employee training programs; and (iv) an independent audit
function to test the anti-money laundering program.
* Pursuant to Section 326, rules establishing minimum standards for
customer due diligence, identification and verification became
effective on October 1, 2003.
* Section 312 requires financial institutions that establish,
maintain, administer, or manage private banking accounts or
correspondent accounts in the United States for non-United States
persons or their representatives (including foreign individuals
visiting the United States) to establish appropriate, specific,
and, where necessary, enhanced due diligence policies, procedures,
and controls designed to detect and report instances of money
laundering through those accounts.
* Section 318, which became effective December 25, 2001, prohibits
financial institutions from establishing, maintaining,
administering, or managing correspondent accounts for foreign shell
banks (foreign banks that do not have a physical presence in any
country), and requires financial institutions to take reasonable
steps to ensure that correspondent accounted provided to foreign
banks are not being used to indirectly provide banking services to
foreign shell banks.
* Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Bank
Holding Company Act and Bank Merger Act applications.
THE SARBANES-OXLEY ACT
The Sarbanes-Oxley Act of 2002 implements a broad range of corporate governance
and accounting measures for public companies designed to promote honesty and
transparency in corporate America and protect investors from corporate
wrongdoing. The Sarbanes-Oxley Act's principal legislation and derivative
regulation and rulemaking promulgated by the SEC includes:
* The creation of an independent accounting oversight board;
* Auditor independence provisions which restrict non-audit services
that accountants may provide to their audit clients;
* Additional corporate governance and responsibility measures,
including the requirement that the chief executive officer and
chief financial officer certify financial statements;
* A requirement that companies establish and maintain a system of
internal control over financial reporting and that management
provide an annual report regarding its assessment of the
effectiveness of such internal control over financial reporting
which, for the Company, is effective as of December 31, 2007.
16
The Company's independent registered public accounting firm will be
required to provide an attestation report with respect to
management's assessment of the effectiveness of the Company's
internal control over financial reporting effective as of December
31, 2008.
* The forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and
senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
* An increase in the oversight of, and enhancement of, certain
requirements relating to audit committees of public companies and
how they interact with the Company's independent auditors;
* Requirement that audit committee members must be independent and
are absolutely barred from accepting consulting, advisory or other
compensatory fees from the issuer;
* Requirement that companies disclose whether at least one member of
the committee is an "audit committee financial expert" (as such
term is defined by the Securities and Exchange Commission) and if
not, why not;
* Expanded disclosure requirements for corporate insiders, including
accelerated reporting of stock transactions by insiders and a
prohibition on insider trading during pension blackout periods;
* A prohibition on personal loans to directors and officers, except
certain loans made by insured financial institutions;
* Disclosure of a code of ethics and filing a Form 8-K for a change
or waiver of such code;
* Mandatory disclosure by analysts of potential conflicts of
interest; and
* A range of enhanced penalties for fraud and other violations.
Although the Company has and will continue to incur additional expense in
complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, such compliance is not expected to have a material impact on its
results of operations or financial condition.
FEDERAL SECURITIES LAWS
The Company's common stock is registered with the SEC under Section 12(b) of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Thus, the
Company is subject to information, proxy solicitation, insider trading
restrictions, and other requirements under the Exchange Act.
17
ITEM 1A
RISK FACTORS
Our loan portfolio includes loans with a higher risk of loss. We originate
multi-family and commercial real estate loans, construction and land
development loans, commercial loans, consumer loans, residential mortgage loans
and home equity lines of credit primarily within our market area. Commercial
mortgage, construction and land development loans, commercial, and consumer
loans may expose a lender to greater credit risk than loans secured by
residential real estate because the collateral securing these loans may not be
sold as easily as residential real estate. In addition, commercial real estate
and commercial loans may also involve relatively large loan balances to
individual borrowers or groups of borrowers. These loans also have greater
credit risk than residential real estate for the following reasons:
* Commercial Real Estate Loans. Repayment is dependent upon income
being generated in amounts sufficient to cover operating expenses
and debt service. Commercial mortgage loans represented 49.0% of
total gross loans as of December 31, 2006.
* Commercial Loans. Repayment is generally dependent upon the
successful operation of the borrower's business. Commercial loans
represented 11.2% of total gross loans as of December 31, 2006.
* Construction and Land Development Loans. Construction financing is
generally considered to involve a higher degree of credit risk than
long-term financing on improved, owner-occupied real estate. Risk
of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at
completion of construction compared to the estimated cost
(including interest) of construction and other assumptions,
including the estimated time to sell residential properties.
Construction and land development loans represented 4.9% of total
gross loans as of December 31, 2006.
* Consumer Loans. Consumer loans (such as personal lines of credit)
may or may not be collateralized with assets that provide an
adequate source of payment of the loan due to depreciation, damage,
or loss. Consumer loans represented 0.6% of total gross loans as of
December 31, 2006.
Any downturn in the real estate market or local economy could adversely affect
the value of the properties securing the loans or revenues from the borrower's
business thereby increasing the risk of non-performing loans.
If our allowance for loan losses is not sufficient to cover actual loan losses,
our earnings could decrease. Our loan customers may not repay their loans
according to their terms and the collateral securing the payment of these loans
may be insufficient to pay any remaining loan balance. We therefore may
experience significant loan losses, which could have a material adverse effect
on our operating results.
Material additions to our allowance for loan losses also would materially
decrease our net income, and the charge-off of loans may cause us to increase
the allowance. We make various assumptions and judgments about the
collectibility of our loan portfolio, including the creditworthiness of our
borrowers and the value of the real estate and other assets serving as
collateral for the repayment of many of our loans. We rely on our loan quality
reviews, our historical loss experience and our evaluation of economic
conditions, among other factors, in determining the amount of the allowance for
loan losses. If our assumptions prove to be incorrect, our allowance for loan
losses may not be sufficient to cover losses inherent in our loan portfolio,
resulting in additions to our allowance. As of December 31, 2006, the allowance
for loan losses as a percent of year-end loans was 1.03%.
Changes in interest rates could adversely affect our results of operations and
financial condition. Our profitability, like that of most financial
institutions, depends substantially on our net interest income, which is the
difference between the interest income earned on our interest-earning assets
and the interest expense paid on our interest-bearing liabilities. Increases in
interest rates may decrease loan demand and make it more difficult for
borrowers to repay adjustable rate loans. In addition, as market interest rates
rise, we will have competitive pressures to increase the rates we pay on
deposits, which will result in a decrease of our net interest income.
18
We also are subject to reinvestment risk associated with changes in interest
rates. Changes in interest rates may affect the average life of loans and
mortgage-related securities. Decreases in interest rates can result in
increased prepayments of loans and mortgage-related securities as borrowers
refinance to reduce borrowing costs. Under these circumstances, we are subject
to reinvestment risk to the extent that we are unable to reinvest the cash
received from such prepayments at rates that are comparable to the rates on
existing loans and securities.
Our earnings may be adversely impacted by an increase in interest rates because
a significant portion of our interest-earning assets are long-term, fixed rate
mortgage-related assets that will not reprice as long-term interest rates
increase, while a majority of our interest-bearing liabilities are expected to
reprice as interest rates increase. Therefore, in an increasing interest rate
environment, our cost of funds is expected to increase more rapidly than the
yields earned on our loan portfolio and securities portfolio. An increasing
rate environment is expected to cause a narrowing of our net interest rate
spread and a decrease in our net interest income. The rising interest rate
environment has compressed our net interest margin from 3.39% for the year
ended December 31, 2005 to 3.26% for the year ended December 31, 2006.
Our local economy may affect our future growth possibilities. Our market area
is principally located in southeastern Massachusetts and contiguous areas of
Rhode Island. Our future growth opportunities depend on the growth and
stability of our regional economy and our ability to expand our market area. A
downturn in our local economy may limit funds available for deposit and may
negatively affect our borrowers' ability to repay their loans on a timely
basis, both of which could have an impact on our profitability.
Competition in our primary market area may reduce our ability to attract and
retain deposits and originate loans. We operate in a competitive market for
both attracting deposits, which is our primary source of funds, and originating
loans. Historically, our most direct competition for savings deposits has come
from credit unions, community banks, large commercial banks and thrift
institutions in our primary market area. Particularly in times of extremely low
or extremely high interest rates, we have faced additional significant
competition for investors' funds from brokerage firms and other firms'
short-term money market securities and corporate and government securities. Our
competition for loans comes principally from mortgage brokers, commercial
banks, other thrift institutions, and insurance companies. Competition for loan
originations and deposits may limit our future growth and earnings prospects.
We operate in a highly regulated environment, and changes in laws and
regulations to which we are subject may adversely affect our results of
operations. We are subject to extensive regulation, supervision and examination
by the state of Massachusetts, as the Bank's chartering authority, and by the
FDIC as the insurer of our deposits up to certain limits. We also belong to the
FHLB System and, as a member, we are subject to certain limited regulations
promulgated by the FHLB of Boston. This regulation and supervision limits the
activities in which we may engage. The purpose of regulation and supervision is
primarily to protect our depositors and borrowers and, in the case of FDIC
regulation, the FDIC's insurance fund. Regulatory authorities have extensive
discretion in the exercise of their supervisory and enforcement powers. They
may, among other things, impose restrictions on the operation of a banking
institution, the classification of assets by such institution and such
institution's allowance for loan losses. Regulatory and law enforcement
authorities also have wide discretion and extensive enforcement powers under
various consumer protection and civil rights laws, including the
Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Housing Act,
and the Real Estate Settlement Procedures Act. Any change in the laws or
regulations applicable to us, or in banking regulators' supervisory policies or
examination procedures, whether by the Massachusetts Commissioner of Banks, the
FDIC, other state or federal regulators, the United States Congress or the
Massachusetts legislature could have a material adverse effect on our business,
financial condition, results of operations and cash flows.
We depend on our executive officers and key personnel to continue the
implementation of our long-term business strategy and could be harmed by the
loss of their services. We believe that our continued growth and future success
will depend in large part upon the skills of our management team. The
competition for qualified personnel in the financial services industry is
intense, and the loss of our key personnel or an inability to continue to
attract, retain and motivate key personnel could adversely affect our business.
We cannot assure you that we will be able to retain our existing key personnel
or attract additional qualified personnel. Although we have employment
agreements with our president and chief executive officer, our executive vice
president and chief financial officer/chief operations officer, and one senior
vice president that contain non-compete provisions, the loss of the services of
one or more of our executive officers and key personnel could impair our
ability to continue to develop our business strategy.
19
If we fail to maintain an effective system of internal control over financial
reporting, we may not be able to accurately report our financial results or
prevent fraud, and, as a result, investors and depositors could lose confidence
in our financial reporting, which could adversely affect our business, the
trading price of our stock and our ability to attract additional deposits. We
will be required to include in our annual reports filed with the SEC a report
of our management regarding internal control over financial reporting beginning
with our annual report for the fiscal year ending December 31, 2007. In
anticipation of this new obligation, we have continued to document and evaluate
our internal control over financial reporting in order to satisfy the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and SEC rules and
regulations, which require an annual management report on our internal control
over financial reporting, including, among other matters, management's
assessment of the effectiveness of internal control over financial reporting.
In addition, for the fiscal year ended December 31, 2008, our independent
auditors will be required to render an opinion on both management's assessment
and on the Company's internal control over financial reporting. Accordingly,
management has retained outside consultants to assist us in (i) assessing and
documenting the adequacy of our internal control over financial reporting, (ii)
improving control processes, where appropriate, and (iii) verifying through
testing that controls are functioning as documented. If we fail to identify and
correct (remediate) any significant deficiencies in the design or operating
effectiveness of our internal control over financial reporting or fail to
prevent fraud, current and potential stockholders and depositors could lose
confidence in our financial reporting, which could adversely affect our
business, financial condition and results of operations, the trading price of
our stock and our ability to attract additional deposits.
ITEM 1B
UNRESOLVED STAFF COMMENTS
There were no unresolved staff comments as of December 31, 2006.
20
ITEM 2
PROPERTIES
Our main office is located at 100 Slade's Ferry Avenue, Somerset, Massachusetts
at the junctions of U.S. Routes 6, 138, and 103. We operate our business from
nine office locations and one drive up complex in Assonet, Fairhaven, Fall
River, New Bedford, Seekonk, Somerset and Swansea, Massachusetts. As of
December 31, 2006, the following properties were owned through the Bank's
wholly-owned subsidiary, Slade's Ferry Realty Trust:
Location Sq. Footage
-------- -----------
Main Office 100 Slade's Ferry Avenue Somerset, MA 42,000
North Somerset 2722 County Street Somerset, MA 3,025
Linden Street 244-253 Linden Street Fall River, MA 1,750
Brayton Avenue 855 Brayton Avenue Fall River, MA 3,325
North Swansea 2388 G.A.R. Highway Swansea, MA 2,960
Seekonk 1400 Fall River Avenue Seekonk, MA 2,300
Fairhaven 75 Huttleston Avenue Fairhaven, MA 13,000
Ashley Boulevard 833 Ashley Boulevard New Bedford, MA 2,655
The office listed below is leased by the Bank with a lease that expires in
February 2010 with two options to extend the term for five year periods.
Assonet 58B South Main Street Assonet, MA 2,000
The facility listed below is owned by the Bank, however, the land is leased
with a lease that expires in November 2015.
Brayton Avenue
Drive-Up Complex 16 Stevens Street Fall River, MA 549
The main office building contains approximately 42,000 square feet of usable
space which we occupy for retail, administrative office, and banking operations
space. The Seekonk office is an 8,800 square foot building of which we lease
out 6,500 square feet to unrelated third party tenants.
We own an ATM dispenser, located at 58A South Main Street, Assonet,
Massachusetts. We sublease the space on which the ATM dispenser is located. The
original term of lease expires October 2010.
We have embarked on a multi-year project to upgrade, modernize and present a
common design theme at all of our retail locations. As part of this project,
the Company has signed agreements to remodel three of its facilities -
Somerset, New Bedford, and North Somerset, Massachusetts. At December 31, 2006,
commitments related to these agreements aggregated $1,649,000.
21
ITEM 3
LEGAL PROCEEDINGS
We are not involved in any pending legal proceedings that would have a material
impact on our consolidated financial condition and results of operations.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2006, no matters were submitted to a vote of our
stockholders.
22
PART II
ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is listed in the Nasdaq Capital Market under the symbol SFBC.
The following table sets forth the range of high and low bid price for our
common stock as reported for the Nasdaq Capital Market by quarter for the
two-year period ended:
December 31,
--------------------------------------------------------------
2006 2005
--------------------------- ---------------------------
High Price Low Price High Price Low Price
---------- --------- ---------- ---------
First Quarter $20.09 $17.30 $20.80 $18.01
Second Quarter $18.40 $16.10 $19.00 $18.01
Third Quarter $19.49 $16.25 $20.25 $17.75
Fouth Quarter $19.30 $16.88 $21.68 $18.18
During 2006, there were 42,443 shares of the Company's stock repurchased
pursuant to a repurchase program announced in July, 2006. Additionally, there
were 48,277 shares acquired pursuant to a deferred compensation arrangement
whereby these shares may be awarded to directors and/or executives. No shares
were awarded during the fiscal year ended December 31, 2006.
This table provides certain information with respect to our purchase of our
common stock during the three months ended December 2006.
Total Number of Shares Maximum Number of
Purchased as Part of Shares that may yet be
Total Number of Average Price Publicly Announced Plans Purchased under the
Period Shares Purchased(2) Paid per Share or Programs Plans or Programs(1)
------ ------------------- -------------- ------------------------ ----------------------
October 1, 2006 through
October 31, 2006 11,425 $18.82 5,615 184,316
November 1, 2006 through
November 30, 2006 15,131 $18.26 4,441 179,875
December 1, 2006 through
December 31, 2006 9,178 $17.29 1,282 178,593
------ ------ ------
Total 35,734 $18.19 11,338
====== ====== ======
(1) On July 18, 2006, the Company announced that its Board of Directors approved a repurchase program pursuant to which the
Company may repurchase up to 208,036 shares of its common stock.
(2) During the fourth quarter of 2006, 24,396 shares were repurchased in open market transactions to fund possible future
restricted stock grants. These shares were purchased by an independent trustee and held in trust.
23
Holders
As of March 16, 2007, the record date for the annual meeting of shareholders,
there were 1,220 holders of an aggregate of 4,050,291 shares of common stock
issued and outstanding.
Dividends - History and Policy
Since the Company's inception in 1990, and prior thereto the Bank, has
consistently paid dividends to shareholders since 1961. We paid four quarterly
cash dividends of $.09 per share for a total of $.36 per share during each of
2005 and 2006.
The declaration of cash dividends is dependent on a number of factors,
including regulatory limitations, and our operating results and financial
condition. Our shareholders will be entitled to dividends only when, and if,
declared by the Board of Directors out of funds legally available. Under the
Massachusetts Business Corporation Law, a dividend may not be declared if the
Company is insolvent or if the declaration of the dividend would render the
Company insolvent.
24
Performance Graph
The following graph compares the performance of the Company for the periods
indicated with the performance of the NASDAQ Stock Market and the performance
of a group of banks in the $250 million to $500 million, $500 million to $1
billion and New England Bank indices assuming reinvestment of dividends.
[GRAPHIC OMITTED]
Period Ending
--------------------------------------------------------------------
Index 12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06
--------------------------------------------------------------------------------------------------
Slade's Ferry Bancorp. 100.00 91.38 157.18 143.03 142.79 129.15
NASDAQ Composite 100.00 68.76 103.67 113.16 115.57 127.58
SNL $250M-$500M Bank Index 100.00 128.95 186.31 211.46 224.51 234.58
SNL $500M-$1B Bank Index 100.00 127.67 184.09 208.62 217.57 247.44
SNL New England Bank Index 100.00 75.43 124.46 131.63 131.49 155.20
Source: SNL Financial LC, Charlottesville, VA
25
ITEM 6
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data of Slade's Ferry
Bancorp. The following information is only a summary and should be read in
conjunction with our consolidated financial statements and notes.
At of for the Years Ended December 31,
----------------------------------------------------------------
2006 2005 2004 2003 2002
----------------------------------------------------------------
(In thousands except per share data)
EARNINGS DATA
Interest and dividend income $ 33,401 $ 28,919 $ 24,106 $ 20,617 $ 22,037
Interest expense 15,338 10,995 7,946 6,073 7,928
Net interest income 18,063 17,924 16,160 14,544 14,109
Provision (credit) for loan losses 39 167 376 (602) (310)
Noninterest income 2,747 2,320 2,505 2,213 2,533
Noninterest expense 14,903 13,896 12,785 12,668 12,877
Income before income taxes 5,868 6,181 5,504 4,691 4,075
Provision for income taxes 2,249 2,161 1,887 2,007 1,124
Net income 3,619 4,020 3,617 2,684 2,951
Return on average assets 0.61% 0.70% 0.70% 0.64% 0.74%
Return on average equity 8.59% 8.36% 8.28% 6.47% 7.52%
Net interest margin 3.26% 3.39% 3.44% 3.91% 3.89%
Net interest spread 2.70% 2.96% 3.07% 3.48% 3.31%
Basic earnings per share $ 0.87 $ 0.98 $ 0.89 $ 0.68 $ 0.75
Diluted earnings per share $ 0.87 $ 0.97 $ 0.88 $ 0.67 $ 0.75
Cash dividends declared per share $ 0.36 $ 0.36 $ 0.36 $ 0.36 $ 0.36
Dividend payout ratio 41.61% 36.84% 40.31% 53.32% 47.50%
BALANCE SHEET DATA
Assets $ 607,760 $ 585,914 $ 549,398 $ 439,234 $ 398,347
Loans, net of deferred loan fees 426,755 413,943 366,366 335,651 264,670
Allowance for loan losses 4,385 4,333 4,101 4,154 4,854
Loans, net 422,370 409,610 362,265 331,497 259,816
Goodwill 2,173 2,173 2,173 2,173 2,173
Securities and FHLB Stock 137,082 129,908 126,305 61,487 80,618
Deposits 424,006 415,846 399,905 333,145 335,633
Borrowings 129,368 118,175 100,596 60,475 19,185
Stockholders' equity 51,245 48,855 46,601 42,537 40,623
Average equity as a percentage of average assets 7.12% 8.40% 8.49% 9.97% 9.80%
Shares outstanding at end of period 4,102,242 4,132,200 4,068,423 3,995,857 3,937,763
Book value (at end of period) $ 12.49 $ 11.82 $ 11.45 $ 10.65 $ 10.32
26
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The purpose of Management's Discussion and Analysis is to focus on certain
significant factors which have affected our operating results and financial
condition, and to provide shareholders a more comprehensive review of the
financial data contained in this report. The following discussion should be
read in conjunction with our audited financial statements and notes thereto,
included as pages F-1 through F-42 of this report.
2006 ITEMS OF SIGNIFICANCE
* In 2006, we recorded net income of $3.6 million or $0.87 per share
on a diluted basis compared to $4.0 million or $0.97 per share on a
diluted basis in 2005. This represents a decrease of $401,000 or
10.0% in net income and $0.10 or 10.3% per share on a diluted basis
between 2006 and 2005. The decrease was primarily due to a 39.5%
increase in interest expense that was only partially offset by an
increase in interest income of 15.5%. This resulted from a
substantial migration of deposit monies to higher cost products
combined with the higher costs of borrowed funds. Our return on
average equity for the year ended December 31, 2006 was 8.59%
compared to 8.36% for the year ended December 31, 2005.
* 2006 experienced an inverted yield curve throughout the year. As a
result, our net interest margin has compressed from 3.39% for the
year ended December 31, 2005 to 3.26% for the year ended December
31, 2006.
* The book value of our common stock increased from $11.82 per share
at December 31, 2005 to $12.49 at December 31, 2006.
* Total assets increased by $21.8 million, or 3.7% from the fiscal
year ended December 31, 2005.
* Total gross loans increased by $12.7 million, or 3.1% from the
fiscal year ended December 31, 2005.
* Capital adequacy ratios continue to meet the criteria of "well
capitalized" under regulatory guidelines.
* We continued our commitment to customer service by implementing
check imaging, document imaging, inquiry and report-writer
enhancements, and bio-identity security measures for employees in
our efforts to serve customers more effectively and efficiently.
FINANCIAL CONDITION
Total assets increased by $21.8 million, or 3.7%, from $585.9 million at
December 31, 2005 to $607.8 million at December 31, 2006. The increase in total
assets during 2006 is the result of planned growth across the balance sheet.
Total net loans increased from $409.6 million at December 31, 2005 to $422.4
million, an increase of $12.8 million or 3.1%, while the investment portfolio
increased from $129.9 million at December 31, 2005 to $137.1 million at
December 31, 2006, an increase of 5.5%. The combination of growth in deposits
and FHLB advances funded the increase in loans and investments. Total deposits
increased from $415.8 million at December 31, 2005 to $424.0 million at
December 31, 2006, an increase of $8.2 million or 2.0%. Total FHLB advances
increased by $11.2 million or 10.4%, to $119.1 million at December 31, 2006
from $107.9 million at December 31, 2005.
27
INVESTMENT PORTFOLIO
The main objectives of our investment portfolio are to achieve a competitive
rate of return over a reasonable time period and to provide liquidity.
Our total investment portfolio increased from $129.9 million at December 31,
2005 to $137.1 million at December 31, 2006, an increase of 5.5%. The increase
is the result of the investment of excess funds from both deposits and
borrowings into obligations of government-sponsored entities and
mortgage-backed securities, which were raised in accordance with our strategic
plans. On June 20, 2006, the Board of Directors approved a strategy to
restructure the available-for-sale investment portfolio through the sale of
approximately $14.5 million of low-yielding obligations of government-sponsored
enterprises. Realized losses amounted to $176,000 or 1.2% of the underlying
cost basis of these securities.
Our current investment strategy has concentrated on the purchase of state and
municipal obligations generally maturing or callable within five to seven
years. Our investment policy also permits investments in mortgage-backed
securities, usually having a longer weighted average life. Our investment
policy, however, limits the duration of the aggregate investment portfolio to 5
years. At December 31, 2006, the portfolio duration was 3.1 years. We do not
purchase investments with imbedded derivative characteristics, or free-standing
derivative instruments such as swaps, options, or futures.
Securities Held to Maturity
The held-to-maturity portfolio consists of mortgage-backed securities and
securities issued by states and municipalities. Held-to-maturity securities
decreased from $29.3 million at December 31, 2005 to $24.6 million at December
31, 2006. The decrease resulted from the maturity, calls and paydowns of
certain state and municipal obligations and mortgage-backed securities. Those
funds were used to increase the available-for-sale portfolio to provide
liquidity for future loan growth. Management has designated these
mortgage-backed securities to secure advances from the FHLB. We have the
positive intent and ability to hold these securities to maturity.
The following table shows the amortized cost basis and fair value of the major
categories of investment securities held to maturity for the years indicated:
December 31,
--------------------------------------------------------------------------
2006 2005 2004
--------------------- --------------------- ---------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Basis Value Cost Basis Value Cost Basis Value
--------------------- --------------------- ---------------------
(In thousands)
State and municipal obligations $ 5,001 $ 5,069 $ 6,766 $ 6,892 $ 8,588 $ 8,928
Mortgage-backed securities 19,622 19,150 22,540 21,966 29,185 29,184
------- ------- ------- ------- ------- -------
Total securities held to maturity $24,623 $24,219 $29,306 $28,858 $37,773 $38,112
======= ======= ======= ======= ======= =======
28
The following table shows the amortized cost basis of securities held to
maturity with the weighted average interest yield for each maturity range.
December 31, 2006
---------------------------------------------
State and
Municipal Mortgage-Backed
Obligations (2) Securities (1) Total
---------------------------------------------
(Dollars in thousands)
Maturity
--------
Within 1 year $1,611 $ - $ 1,611
Yield 5.87% 0.00% 5.87%
After 1 year through 5 years 1,446 - 1,446
Yield 6.34% 0.00% 6.34%
After 5 year through 10 years 1,223 - 1,223
Yield 6.52% 0.00% 6.52%
Over 10 years 721 19,622 20,343
Yield 6.95% 4.88% 4.95%
------ ------- -------
Amount $5,001 $19,622 $24,623
====== ======= =======
Yield 6.32% 4.88% 5.17%
====== ======= =======
1) Mortgage-backed securities stated using contractual maturity.
2) On fully taxable equivalent basis based on tax rate of 35.0%.
Securities Available for Sale
Securities not designated as held-to-maturity are designated as available for
sale. Although we do not anticipate the sale of these securities, the
designation as available for sale allows us the flexibility to alter our
investment strategies and sell these securities when conditions warrant.
Additionally, marketable equity securities that have no maturity date must be
designated as available-for-sale. These securities are carried at fair value.
The available for sale securities portfolio includes obligations and
mortgage-backed securities of government-sponsored enterprises, corporate debt
and equity securities.
The following table shows the amortized cost basis and fair value of the major
categories of securities available for sale at the dates indicated:
December 31,
--------------------------------------------------------------------------
2006 2005 2004
---------------------- -------------------- ---------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Basis Value Cost Basis Value Cost Basis Value
---------------------- -------------------- ---------------------
(In thousands)
Debt Securities:
Government-sponsored enterprises $ 34,462 $ 33,957 $50,443 $49,581 $41,419 $41,206
Corporate 9,221 9,080 9,564 9,014 9,364 9,485
Mortgage-backed securities 57,946 57,980 31,574 31,232 27,805 28,207
Marketable equity securities 3,139 3,389 3,426 3,271 3,859 3,751
Mutual funds 1,215 1,197 1,205 1,200 1,216 1,233
-------- -------- ------- ------- ------- -------
$105,983 $105,603 $96,212 $94,298 $83,663 $83,882
======== ======== ======= ======= ======= =======
29
The following table shows the amortized cost basis of debt securities available
for sale with the weighted average interest yield for each maturity range.
December 31, 2006
---------------------------------------------------
Government-
Sponsored Mortgage-Backed
Enterprises Securities (1) Corporate Total
----------- -------------- --------- -----
Maturity
Within 1 year $12,000 $ 65 $ - $ 12,065
Yield 3.74% 4.04% 0.00% 3.74%
After 1 year through 5 years 22,462 986 9,221 32,669
Yield 6.34% 5.00% 5.06% 4.38%
After 5 year through 10 years - 4,397 - 4,397
Yield 0.00% 4.59% 0.00% 4.59%
Over 10 years - 52,498 - 52,498
Yield 0.00% 5.59% 0.00% 5.59%
------- ------- ------ --------
Amount $34,462 $57,946 $9,221 $101,629
======= ======= ====== ========
Yield 3.96% 5.50% 5.06% 4.94%
======= ======= ====== ========
1) Mortgage-backed securities stated using contractual maturity.
LOANS
Our total loan portfolio increased from $409.6 million at December 31, 2005 to
$422.4 million at December 31, 2006, an increase of $12.8 million or 3.1%. The
increase is the result of continued loan growth initiatives designed to invest
the deposits and borrowings that were raised in accordance with our strategic
plans.
Although multi-family and commercial real estate loans and business loans have
traditionally been our leading loan products, management has made considerable
effort to diversify the loan portfolio by adding significant levels of
residential real estate and commercial and industrial loan products to the
balance sheet. Management believes these loans both produce higher yielding
products and for residential real estate loans enhance our overall credit risk
profile . At December 31, 2006, our one-to-four family mortgage loans totaled
$132.4 million or 31.0% of total gross loans, compared with $120.3 million, or
29.1% of total gross loans outstanding at December 31, 2005, while home equity
lines of credit totaled $13.9 million, or 3.3% of our total gross loans,
compared to $17.9 million or 4.3% of total gross loans at December 31, 2005.
Originations of residential real estate loans for the year ended December 31,
2006 totaled $24.7 million as compared to $27.0 million for the year ended
December 31, 2005. Gross home equity lines of credit totaled $13.9 million and
unadvanced funds committed under home equity lines of credit totaled $16.9
million at December 31, 2006.
The multi-family and commercial real estate loan portfolio was $209.2 million
or 49.0% of total loans at December 31, 2006. At December 31, 2005, commercial
real estate loans totaled $213.8 million or 51.6% of total gross loans.
Multi-family and commercial real estate loan originations totaled $36.1 million
for the year ended December 31, 2006. At December 31, 2006, we had $21.0
million of advanced construction loans that amounted to 4.9% of our total gross
loans, compared to $21.5 million or 5.2% of total gross loans at December 31,
2005. Construction loan originations totaled $19.1 million for the year ended
December 31, 2006. Unfunded portions of construction loans totaled $12.2
million at December 31, 2006. Other commercial loans totaled $47.7 million or
11.2% of the total gross loan portfolio at December 31, 2006, compared to $38.1
million or 9.2% at December 31, 2005.
Consumer loans at December 31, 2006 amounted to $2.8 million, or 0.6% of total
gross loans, as compared to $2.6 million or 0.6% of total gross loans at
December 31, 2005.
30
The following table summarizes loans by category at the end of each of the last
five years.
December 31,
-------------------------------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(In thousands)
Real estate mortgage loans:
Multi-family and commercial $209,172 $213,815 $192,822 $181,401 $154,161
Residential 132,381 120,345 97,496 88,019 50,495
Construction 20,988 21,490 24,240 10,346 14,078
Home equity lines of credit 13,917 17,915 23,131 18,330 8,606
Commercial 47,736 38,111 26,606 33,980 30,455
Consumer 2,766 2,623 2,510 4,018 7,217
-------- -------- -------- -------- --------
Total loans 426,960 414,299 366,805 336,094 265,012
Less: Allowance for loan losses (4,385) (4,333) (4,101) (4,154) (4,854)
Net deferred loan fees (205) (356) (439) (443) (342)
-------- -------- -------- -------- --------
Loans, net $422,370 $409,610 $362,265 $331,497 $259,816
======== ======== ======== ======== ========
We have no foreign loans nor do we have any reportable concentrations of loans.
Loan portfolio rate sensitivity
Because of the relatively low residential mortgage interest rate environment
for the last few years, we have originated a minimal number of adjustable-rate
loans. Additionally, our customer base tends to prefer fixed-rate mortgage
loans to adjustable-rate loans. Accordingly, the portfolio of adjustable-rate
loans has declined significantly during the past three years. Adjustable-rate
mortgage loans totaled $5.8 million, or 4.9% of residential real estate loans
at December 31, 2006. Substantially all of our home equity lines of credit have
interest rates that adjust monthly with the Wall Street Journal prime rate.
Additionally, the market for commercial and multi-family and commercial real
estate loans in our market area is intense. In response to the competition, we
offer commercial real estate loans that adjust every five years, based on
either the Wall Street Journal prime rate or the Treasury rate matching the
adjustment period. Of the total multi-family and commercial real estate loan
portfolio, $184.2 million, or 88.1% have adjustable interest rates at December
31, 2006.
The following table shows the contractual maturity distributions of all loan
categories at December 31, 2006:
One to After
Five Five
Within Year Years Years Total
----------- ----- ----- -----
(In thousands)
Real estate mortgage loans:
Multi-family and commercial $ 2,762 $ 9,222 $197,188 $209,172
Residential 731 2,997 128,653 132,381
Construction 73 - 20,915 20,988
Home equity lines of credit 516 2,574 10,827 13,917
Commercial 20,623 6,928 20,185 47,736
Consumer 1,365 1,401 - 2,766
------- ------- -------- --------
$26,070 $23,122 $377,768 $426,960
======= ======= ======== ========
31
The following table shows the amounts, included in the preceding table, which
are due after one year and which have fixed interest rates and adjustable
interest rates:
Total Due After One Year
------------------------------------------
Fixed Rate Adjustable Rate Total
---------- --------------- -----
(In thousands)
Real estate mortgage loans:
Multi-family and commercial $ 22,224 $184,186 $206,410
Residential 128,502 3,148 131,650
Construction 3,719 17,196 20,915
Home equity lines of credit - 13,401 13,401
Commercial 8,861 18,252 27,113
Consumer 1,175 226 1,401
-------- -------- --------
$164,481 $236,409 $400,890
======== ======== ========
Loan Delinquencies
It is our policy to manage our loan portfolio in order to recognize problem
loans at an early stage and thereby minimize loan losses. Loans are considered
delinquent when any payment of principal or interest is one month or more past
due. We generally commence collection procedures when accounts are 15 days past
due. Generally, when a loan becomes past due 90 days or more, management
discontinues the accrual of interest and reverses previously accrued interest,
unless the credit is well-secured and in process of collection. Loans are
returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are reasonably
assured. When a loan is determined to be uncollectible, it is charged to the
allowance for loan losses or, if applicable, any real estate that is securing
the loan is acquired through foreclosure, and recorded as other real estate
owned.
Management defines non-performing loans to include non-accrual loans, loans
past due 90 days or more and still accruing, and restructured loans not
performing in accordance with amended terms.
The following table presents information regarding non-performing loans in the
portfolio:
----------------------------------------------------
December 31,
----------------------------------------------------
2006 2005 2004 2003 2002
----------------------------------------------------
(Dollars in thousands)
Non-accrual loans $ 600 $ 906 $ 506 $ 407 $ 635
Loans 90 days or more past due and still accruing - - - - 8
----------------------------------------------------
Total non-performing assets $ 600 $ 906 $ 506 $ 407 $ 643
----------------------------------------------------
Restructured debt performing in accordance with amended
terms, not included above $ - $ - $ - $ 198 $ 166
----------------------------------------------------
Percentage of non-accrual loans to total loans 0.14% 0.22% 0.14% 0.12% 0.24%
Percentage of allowance for loan losses to non-accrual loans 730.8% 478.3% 810.5% 1020.6% 764.4%
For the year ended December 31, 2006, interest income that would have been
recorded if non-accrual loans at December 31, 2006 had been current in
accordance with their original terms amounted to $77,000. The actual interest
recorded on these loans amounted to $67,000 for the year ended December 31,
2006.
32
Allowance for Loan Losses
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans
in light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that generally have been identified as
impaired. For such loans, an allowance is established when the discounted cash
flows (or collateral value or observable market price) of the impaired loan is
lower than the carrying value of that loan. The general component covers
non-classified loans and is based on historical loss experience adjusted for
qualitative factors. An unallocated component is maintained to cover
uncertainties that could affect management's estimate of probable losses. The
unallocated component of the allowance reflects the margin of imprecision
inherent in the underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review our allowance for loan losses.
As the composition of the loan portfolio gradually changes and diversifies from
higher credit risk weighted loans, such as commercial real estate and
commercial, to residential and home equity loans, a lower overall reserve
allowance rate will be required. During 2006 and 2005, stronger underwriting
guidelines and overall improvement in credit quality of existing loans resulted
in a decrease in the degree of credit risk embedded in the loan portfolio.
Consequently, the allowance for loan losses as a percentage of total loans
outstanding declined from 1.05% at December 31, 2005 to 1.03% at December 31,
2006. After thorough review and analysis of the adequacy of the loan loss
allowance during 2006, we recorded a provision for loan losses of $39,000,
compared to $167,000 recorded for the year ended December 31, 2005. There were
$16,000 of loan charge-offs in 2006 with no loans charged off in 2005. We
realized recoveries of previously charged-off loans totaling $29,000 for the
year ended December 31, 2006 compared with recoveries totaling $65,000 for the
year ended December 31, 2005. Management believes that the allowance for loan
losses of $4.4 million as of December 31, 2006 is adequate to cover potential
losses in the loan portfolio, based on current information available to
management.
33
The table below illustrates the changes in the allowance for loan losses for
the periods indicated.
December 31,
------------------------------------------------------------
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
(Dollars in thousands)
Balance at beginning of year $4,333 $4,101 $4,154 $4,854 $5,485
Charge-offs:
Real estate mortgage loans:
Multi-family and commercial - - (446) (169) -
Residential - - - - -
Home equity lines of credit - - - - (20)
Commercial - - (62) (10) (337)
Consumer (16) - (17) (32) (26)
------ ------ ------ ------ ------
(16) - (525) (211) (383)
------ ------ ------ ------ ------
Recoveries:
Real estate mortgage loans:
Multi-family and commercial - 39 8 43 18
Residential 5 - - - -
Home equity lines of credit - 16 17 1 20
Commercial 11 - 60 55 17
Consumer 13 10 11 14 7
------ ------ ------ ------ ------
29 65 96 113 62
------ ------ ------ ------ ------
Net loan recoveries (charge-offs) 13 65 (429) (98) (321)
Provision (credit) for loan losses 39 167 376 (602) (310)
------ ------ ------ ------ ------
Balance at end of year $4,385 $4,333 $4,101 $4,154 $4,854
====== ====== ====== ====== ======
Allowance for loan losses as a percent of year-end loans 1.03% 1.05% 1.12% 1.24% 1.83%
====== ====== ====== ====== ======
Ratio of net charge-offs to average loans outstanding 0.00% 0.00% -0.12% 0.03% -0.13%
====== ====== ====== ====== ======
34
The table below shows an allocation of the allowance for loan losses at the
dates indicated:
December 31, 2006 December 31, 2005 December 31, 2004 December 31, 2003 December 31, 2002
-------------------- -------------------- -------------------- -------------------- --------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category to Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
-------------------- -------------------- -------------------- -------------------- --------------------
(Dollars in thousands)
Commercial $ 718 11.2% $ 905 9.2% $ 743 7.3% $ 943 10.1% $1,155 11.6%
Real estate
constuction 260 4.9% 248 5.2% 236 6.6% 52 3.1% 70 5.3%
Real estate
mortgage 3,181 83.3% 3,056 85.0% 2,989 85.4% 3,071 85.6% 3,465 80.5%
Consumer 226 0.6% 124 0.6% 133 0.7% 88 1.2% 164 2.6%
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$4,385 100.0% $4,333 100.0% $4,101 100.0% $4,154 100.0% $4,854 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
35
DEPOSITS AND BORROWED FUNDS
We solicit deposits from our primary market area using rates and services
designed to appeal to customers across a broad spectrum of ages and income
levels. We compete for deposit customers with community banks and credit
unions, as well as local branches of regional and national banks. Despite this
level of competition, our total deposits increased from $415.8 million at
December 31, 2005 to $424.0 million at December 31, 2006, an increase of $8.2
million or 2.0%. Implementation of our "Coastal" product line in 2005 was
designed to attract high-balance customers with whom we have multiple-product
relationships. During the year ended December 31, 2006, there were significant
migrations from lower cost deposit products to higher cost products.
The following table sets forth the average amount and the average rate paid on
deposits for the periods indicated:
December 31,
----------------------------------------------------------------------
2006 2005 2004
-------------------- -------------------- --------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
-------------------- -------------------- --------------------
(Dollars in thousands)
Noninterest-bearing deposits $ 74,042 0.00% $ 78,960 0.00% $ 76,815 0.00%
NOW deposits 55,124 1.26 49,787 1.06 42,533 0.74
Savings deposits 80,875 1.39 92,578 1.14 87,983 1.00
Money market deposits 26,897 2.31 33,543 1.28 36,929 1.35
Time deposits 180,152 3.93 147,360 2.77 150,839 2.18
-------- -------- --------
$417,090 2.28% $402,228 1.51% $395,099 1.26%
======== ======== ========
As of December 31, 2006, the aggregate amount of time deposits in denominations
of $100,000 or more had the following maturities:
Amount
--------------
(In thousands)
Within three months $ 9,382
After three months through six months 45,050
After six months through twelve months 11,024
Over twelve months 1,438
--------
$ 66,894
========
As of December 31, 2006, the aggregate amount of time deposits in denominations
of less than $100,000 had the following maturities:
Amount
--------------
(In thousands)
Within three months $ 22,055
After three months through six months 63,779
After six months through twelve months 28,993
Over twelve months 6,903
--------
$121,730
========
36
As a member of the FHLB, the Bank is entitled to participate in the FHLB's
advance programs. The advance programs allow the Bank to borrow up to 30% of
total assets, but limited, based on the amount of qualified collateral (as
defined by the FHLB) pledged, and the amount of FHLB preferred stock held. FHLB
advances are utilized as an additional funding source for loans and investments
as well as a tool for controlling the levels of interest rate risk on the
balance sheet. FHLB advances are secured by a blanket lien on qualified
collateral, consisting primarily of loans with first mortgages secured by
one-to-four family properties and certain unencumbered investment securities.
In addition qualified commercial real estate loans are used as collateral to
obtain additional FHLB advances.
Short-term borrowings include funds drawn under lines of credit with the FHLB
and FHLB advances with an original maturity of less than one year. Total
short-term borrowings decreased from $7.0 million at December 31, 2005 to zero
at December 31, 2006. The average balance of short-term borrowings did not
exceed 30% of stockholders' equity at any time during the year ended December
31, 2006.
Long-term FHLB advances increased from $100.9 million at December 31, 2005 to
$119.1 million at December 31, 2006, an increase of $18.2 million or 18.0%. The
proceeds were utilized to fund loan and investment growth in excess of deposit
growth, as well as to hedge the effects of rising short-term interest rates on
net interest income. At December 31, 2006, outstanding long-term FHLB advances
had the following scheduled maturities and weighted average interest rates:
Weighted
Final Maturity Amount Average Rate
-------------- -------------- ------------
(In thousands)
2007 $ 27,000 3.4%
2008 25,139 4.4%
2009 40,000 5.0%
2010 7,000 4.5%
Thereafter 19,919 6.2%
--------
$119,058 4.7%
========
Although most advances are payable at maturity, advances totaling $14.1 million
are payable on an amortizing basis, in terms ranging from 120 to 240 months.
Amortizing advances are being repaid in equal monthly payments and are being
amortized from the date of the advance to the maturity date on a direct
reduction basis. Also, certain advances are redeemable at the option of the
FHLB, at par value on the call date and quarterly thereafter.
In March 2004, we issued $10.3 million in subordinated debentures. The
debentures mature in 2034, and carry an adjustable interest rate equivalent to
the three-month LIBOR plus 279 basis points. The rate adjusts every three
months based on the change in the LIBOR. At December 31, 2006, the interest
rate on the subordinated debentures was 8.18%. Current bank and bank holding
company regulations view these debentures as "tier 1 capital." As such, we may
leverage this regulatory capital in order to expand our franchise or otherwise
enhance our earnings.
STOCKHOLDERS' EQUITY
Total stockholders' equity increased from $48.9 million at December 31, 2005 to
$51.2 million at December 31, 2006, primarily the result of net income of $3.6
million. Net income was reduced by cash dividends declared totaling $1.5
million. Other factors increasing stockholders' equity were the issuance of
common stock through option exercises and our dividend reinvestment plans,
totaling $891,000, and an increase in other comprehensive income of $734,000
pertaining to a reduction in net unrealized losses on securities available for
sale offset by an adjustment to initially apply FASB Statement No. 158 for
unrecognized pension plan losses. Other factors decreasing stockholders' equity
were the repurchase of stock totaling $778,000 under our stock repurchase
program, and the purchase of shares of common stock in the open market totaling
$887,000 to fund restricted stock awards.
RESULTS OF OPERATIONS
Our operating performance is dependent on net interest 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 impacted by several factors such as economic conditions, interest
rates, asset/liability management, and corporate tax and strategic planning.
37
The following table sets forth our average assets, liabilities, and
stockholders' equity, interest earned and interest paid, average rates earned
and paid, net interest spread and the net interest margin. Average balances
reported are daily averages.
Years Ended December 31,
-------------------------------------------------------------------------------------------------
2006 2005 2004
------------------------------- ------------------------------- -------------------------------
Average Interest Average Average Interest Average Average Interest Average
Balance Income/Expense Rate Balance Income/Expense Rate Balance Income/Expense Rate
------------------------------- ------------------------------- -------------------------------
(Dollars in thousands)
Assets:
-------
Interest earning assets (1)
Loans:
Commercial $ 47,256 $ 3,668 7.76% $ 32,560 $ 2,160 6.63% $ 31,536 $ 1,717 5.44%
Commercial real estate 228,535 15,042 6.58% 223,355 13,613 6.09% 207,937 12,499 6.01%
Residential real estate 146,729 8,346 5.69% 135,714 7,267 5.35% 114,832 5,867 5.11%
Consumer 2,645 207 7.83% 2,405 144 5.99% 3,233 180 5.57%
------------------- ------------------- -------------------
Total loans 425,165 27,263 6.41% 394,034 23,184 5.88% 357,538 20,263 5.67%
Federal funds sold 3,708 196 5.29% 8,754 247 2.82% 19,351 185 0.96%
Taxable debt securities 112,511 5,156 4.58% 112,637 4,708 4.18% 71,657 2,962 4.13%
Tax-exempt debt securities (2) 5,791 386 6.67% 7,837 520 6.64% 9,666 633 6.55%
Marketable equity securities 4,396 149 3.39% 4,612 160 3.47% 3,730 93 2.49%
FHLB stock 6,471 348 5.38% 5,868 257 4.38% 3,422 98 2.86%
Other investments 650 38 5.85% 650 25 3.85% 10,401 89 0.86%
------------------- ------------------- -------------------
Total interest earning
assets 558,692 33,536 6.00% 534,392 29,101 5.45% 475,765 24,323 5.11%
------- ------- -------
Allowance for loan losses (4,366) (4,212) (4,324)
Deferred loan fees (321) (415) (473)
Cash and due from banks 13,192 16,249 18,411
Other assets 24,806 26,311 25,058
-------- -------- --------
$592,003 $572,325 $514,437
======== ======== ========
Liabilities and Stockholders'
-----------------------------
Equity:
-------
Interest bearing liabilities
Savings accounts $ 80,875 $ 1,123 1.39% $ 92,578 $ 1,051 1.14% $ 87,983 $ 882 1.00%
NOW accounts 55,124 694 1.26% 49,787 529 1.06% 42,533 314 0.74%
Money market accounts 26,897 621 2.31% 33,543 428 1.28% 36,929 497 1.35%
Time deposits 180,152 7,086 3.93% 147,360 4,076 2.77% 150,839 3,289 2.18%
FHLB advances 112,048 4,986 4.45% 108,450 4,274 3.94% 63,390 2,594 4.09%
Subordinated debt 10,310 828 8.03% 10,282 637 6.20% 8,248 370 4.49%
------------------- ------------------- -------------------
Total interest bearing
liabilities 465,406 15,338 3.30% 442,000 10,995 2.49% 389,922 7,946 2.04%
------- ------- -------
Demand deposits 74,042 78,960 76,815
Other liabilities 10,404 3,304 4,001
-------- -------- --------
Total liabilities 549,852 524,264 470,738
Total stockholders' equity 42,151 48,061 43,699
-------- -------- --------
$592,003 $572,325 $514,437
======== ======== ========
Net interest income $18,198 $18,106 $16,377
======= ======= =======
Net interest spread 2.70% 2.96% 3.07%
==== ==== ====
Net interest margin 3.26% 3.39% 3.44%
==== ==== ====
(1) Average balance includes non-accruing loans. The effect of including such loans, although not material, is to reduce the
average rate earned on the Company's loans.
(2) On a fully taxable equivalent basis based on tax rate of 35.0% for 2006 and 2005, and 34.3% for 2004. Interest income on
investments and net interest income includes a fully taxable equivalent adjustment of $135,000 in 2006, $182,000 in 2005 and
$217,000 in 2004.
38
RATE - VOLUME ANALYSIS
----------------------
The following table presents the changes in components of net interest income
for the years ended December 31, which are the result of changes in interest
rates and the changes that are the result of changes in volume of the
underlying asset or liability. Changes that are attributable to changes in both
rate and volume have been allocated equally to rate and volume.
NET INTEREST INCOME - CHANGES DUE TO VOLUME AND RATE
2006 vs. 2005 Increase (Decrease) 2005 vs. 2004 Increase (Decrease)
--------------------------------- ---------------------------------
Total Due to Due to Total Due to Due to
Change Volume Rate Change Volume Rate
--------------------------------- ---------------------------------
(In thousands)
Commercial loans $1,508 $1,095 $ 413 $ 443 $ 62 $ 381
Commercial real estate 1,429 321 1,108 1,114 933 181
Residential real estate 1,079 611 468 1,400 1,093 307
Consumer loans 63 15 48 (36) (48) 12
Federal funds sold (51) (205) 154 62 (200) 262
Taxable debt securities 448 (6) 454 1,746 1,703 43
Tax-exempt debt securities (1) (134) (136) 2 (113) (121) 8
Marketable equity securities (11) (7) (4) 67 26 41
FHLB Stock 91 28 63 159 89 70
Other investments 13 - 13 (64) (229) 165
-------------------------------- --------------------------------
Total interest income 4,435 1,716 2,719 4,778 3,308 1,470
-------------------------------- --------------------------------
Savings accounts 72 (148) 220 169 49 120
NOW accounts 165 61 104 215 65 150
Money market accounts 193 (119) 312 (69) (45) (24)
Time deposits 3,010 1,039 1,971 787 (86) 873
FHLB advances 712 146 566 1,680 1,810 (130)
Subordinated debt 191 2 189 267 109 158
-------------------------------- --------------------------------
Total interest expense 4,343 981 3,362 3,049 1,902 1,147
-------------------------------- --------------------------------
Net interest income $ 92 $ 735 $ (643) $1,729 $1,406 $ 323
================================ ================================
(1) The change in interest income on investments and net interest income includes interest on a fully
tax equivalent basis based on a tax rate of 35.0% for 2006 and 2005, and 34.3% for 2004.
39
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
We realized net income totaling $3.6 million for the year ended December 31,
2006, equivalent to basic and diluted earnings per share of $0.87. This
represents a 10.0% decrease in net income from the year ended December 31,
2005, where net income totaled $4.0 million, or $0.98 per share (basic) and
$0.97 per share (diluted). Net interest income increased marginally from $17.9
million for the year ended December 31, 2005 to $18.1 million for the year
ended December 31, 2006, primarily the result of the migration to higher cost
funding sources that was present throughout most of the year. We recognized a
provision for loan losses of $39,000 and $167,000 for the years ended December
31, 2006 and 2005, respectively. We continue concerted efforts to enhance the
credit quality of our loan portfolio. The dedication to loan quality that
management has undertaken has resulted in a loan loss provision that management
believes is in line with the risks inherent in its loan portfolio. Non-interest
income increased from $2.3 million for the year ended December 31, 2005 to $2.7
million for the year ended December 31, 2006. During the same period,
non-interest expense increased from $13.9 million for the year ended December
31, 2005 to $14.9 million for the year ended December 31, 2006. Income before
taxes was $5.9 million and $6.2 million, for the years ended December 31, 2006
and 2005, respectively. Income taxes remained flat at $2.2 million for the
years ended December 31, 2005 and 2006.
Interest income increased from $28.9 million for the year ended December 31,
2005, to $33.4 million for the year ended December 31, 2006, an increase of
15.5%. This increase can be attributed to the growth in the loan portfolio, as
the average balance of loans increased by $31.1 million or 7.90%. The yield on
the loan portfolio increased from 5.88% for the year ended December 31, 2005,
to 6.41% for the year ended December 31, 2006. Interest and dividends on
investments increased by $0.4 million, on a fully taxable equivalent basis,
from $5.7 million for the year ended December 31, 2005 to $6.1 million for the
year ended December 31, 2006, the result of the higher yielding securities. The
portfolio decreased from an average balance of $131.6 million to $129.8
million. Income from federal funds sold decreased from $247,000 to $196,000,
the result of increased rates on lower volumes of overnight money.
Interest expense increased from $11.0 million for the year ended December 31,
2005 to $15.3 million for the year ended December 31, 2006, resulting primarily
from the migration of deposits to higher cost certificates of deposits during
2006. The average balance of FHLB advances increased from $108.5 million for
the year ended December 31, 2005 to $112.0 million for the year ended December
31, 2006. Management used borrowings to fund a substantial portion of our loan
growth in 2006. As a result of the timing of borrowings, the average rate paid
on FHLB advances increased from 3.94% for the year ended December 31, 2005 to
4.45% for the year ended December 31, 2006. Interest expense on deposits
increased from $6.1 million for the year ended December 31, 2005 to $9.5
million for the year ended December 31, 2006. We also continued to increase
certain interest rates in response to increases in market interest rates and
corresponding increases in deposit interest rates offered by our competitors,
in order to continue to fund loan growth. This increase was the result of the
deposit campaigns, both for certificates of deposit and core accounts. A
marketing strategy, begun in 2005 and continued in 2006, was employed whereby
certificates of deposit were offered at premium rates, and the customer was
cross-sold basic banking products to establish a long-term relationship with
the customer. At the same time, a suite of products was offered to high-balance
customers. These campaigns served to increase the levels of all deposit types,
including non-interest bearing demand deposits. The $10.3 million of
subordinated debentures carry an interest rate equal to the three-month LIBOR
plus 279 basis points which equated to 8.18% and 7.29% at December 31, 2006 and
2005, respectively. The cost of interest-bearing liabilities increased from
2.49% in 2005 to 3.30% in 2006.
Net interest income increased from $17.9 million for the year ended December
31, 2005 to $18.1 million for the year ended December 31, 2006, an increase of
0.8%. This increase was the result of a substantial growth in interest income
(15.5%), offset by an even greater increase in the cost of funds (39.5%),
compressing our net interest margin from 3.39% for the year ended December 31,
2005 to 3.26% for the year ended December 31, 2006.
The provision for loan losses is a charge against earnings and funds the
allowance for loan losses. We maintain the allowance for loan losses at a level
that we believe is adequate to absorb inherent 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, the nature of the portfolio mix and the balance of non-performing
and classified loans. We assess the allowance for loan losses on a quarterly
basis. After thorough review and analysis of the adequacy of the allowance and
the continued improvement in asset quality in the loan portfolio, management
deemed it prudent to provide $39,000 and $167,000 for possible loan losses for
the years ended December 31, 2006 and 2005, respectively.
40
Non-interest income increased from $2.3 million for the year ended December 31,
2005 to $2.7 million for the year ended December 31, 2006, an increase of
18.4%. The increase was primarily attributable to the introduction of a check
"bounce" protection program, and the increase in deposit fees attributable to
this program. The increase in fees were partially offset by an approximate
$176,000 loss on the sale of some low yielding investment securities for higher
yielding investment securities. The loss was completely earned out with
increased interest income attributable to the higher yielding investment
securities.
Non-interest expense increased from $13.9 million for the year ended December
31, 2005 to $14.9 million for the year ended December 31, 2006, an increase of
7.2%. Salaries and employee benefits increased by $24,000, or 0.3%, from $8.06
million for the year ended December 31, 2005, to $8.09 million for the year
ended December 31, 2006. Salary and benefits increases in 2006 related normal
increases, and the adoption of FAS 123R were offset by staff layoffs and
retirements associated with outsourcing initiatives and increased deferrals of
loan origination costs. Occupancy and equipment expense increased from $1.7
million for the year ended December 31, 2005 to $1.9 million for the year ended
December 31, 2006. The increase in occupancy expense is primarily the result of
a full year of operations during 2006 at the new Assonet branch opened in April
2005 and outsourced property management services. Professional fees increased
by approximately $50,000 primarily due to outsourcing our internal audit
function when comparing the years ended December 31, 2006 and 2005. Marketing
costs decreased $185,000 for the year ended December 31, 2006 from $549,000 for
the year ended December 31, 2005. This was the result of reduced promotional
programs during 2006 and a delayed promotional program that will be rolled out
early in the second quarter of 2007. Other expenses increased approximately
$600,000 due to the outsourcing of the Bank's item processing and statement
rendering functions that were formerly completed in the Bank's internal
backroom operations. Other expense in 2006 versus 2005 were increased by
approximately $100,000 attributable to fraud losses and other losses combined
with and increased Board of Director committee fees of an additional $100,000.
Income before income taxes was $5.9 million for the year ended December 31,
2006, compared to $6.2 million for the year ended December 31, 2005. Provision
for income taxes totaled $2.2 million for the years ended December 31, 2006 and
2005, representing overall effective tax rates of 38.3% and 35.0%,
respectively.
41
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
We realized net income totaling $4.0 million for the year ended December 31,
2005, equivalent to basic earnings per share of $0.98 and diluted earnings per
share of $0.97. This represents a 11.1% increase in net income from the year
ended December 31, 2004, where net income totaled $3.6 million, or $0.89 per
share (basic) and $0.88 per share (diluted). Net interest income increased from
$16.2 million for the year ended December 31, 2004 to $17.9 million for the
year ended December 31, 2005, the direct result of our growth over the year. We
recognized a provision for loan losses of $167,000 and $376,000 for the years
ended December 31, 2005 and 2004, respectively. During the past three years, we
have made concerted efforts to enhance the credit quality of our loan
portfolio. Continuing the dedication to loan quality that management has taken
has resulted in a loan loss provision that management believes is in line with
its growing loan portfolio. Non-interest income decreased from $2.5 million for
the year ended December 31, 2004 to $2.3 million for the year ended December
31, 2005. During the same period, non-interest expense increased from $12.8
million for the year ended December 31, 2004 to $13.9 million for the year
ended December 31, 2005. Income before taxes was $6.2 million and $5.5 million,
for the years ended December 31, 2005 and 2004, respectively. Income taxes
increased from $1.9 million for the year ended December 31, 2004, to $2.2
million for the year ended December 31, 2005.
Interest income increased from $24.1 million for the year ended December 31,
2004, to $28.9 million for the year ended December 31, 2005, an increase of
20.0%. This increase can be attributed to the growth in the loan portfolio, as
the average balance of loans increased by $36.5 million or 10.21%. The yield on
the loan portfolio increased from 5.67% for the year ended December 31, 2004,
to 5.88% for the year ended December 31, 2005. Interest and dividends on
investments increased by $1.8 million, on a fully taxable equivalent basis,
from $3.9 million for the year ended December 31, 2004 to $5.7 million for the
year ended December 31, 2005, the result of the growth in the investment
portfolio. The portfolio grew from an average balance of $98.9 million to
$131.6 million. Income from federal funds sold increased from $185,000 to
$247,000, the result of increased volume of overnight money.
Interest expense increased from $7.9 million for the year ended December 31,
2004 to $11.0 million for the year ended December 31, 2005, resulting primarily
from the increased use of borrowings in 2005. The average balance of FHLB
advances increased from $63.4 million for the year ended December 31, 2004 to
$108.5 million for the year ended December 31, 2005. Management used borrowings
to fund a substantial portion of our loan growth in 2005. During the period of
low interest rates, we utilized longer-term advances to fund loan originations
in order to control interest rate risk. As a result of the timing of
borrowings, the average rate paid on FHLB advances decreased from 4.09% for the
year ended December 31, 2004 to 3.94% for the year ended December 31, 2005.
Interest on deposits increased from $5.0 million for the year ended December
31, 2004 to $6.1 million for the year ended December 31, 2005. We have
increased certain interest rates in response to increases in market interest
rates and corresponding increases in deposit interest rates offered by our
competitors, in order to continue to fund loan growth. This increase was the
result of the deposit campaigns, both for certificates of deposit and core
accounts. A marketing strategy was employed whereby certificates of deposit
were offered at premium rates, and the customer was cross-sold basic banking
products to establish a long-term relationship with the customer. At the same
time, a suite of products was offered to high-balance customers. These
campaigns served to increase the levels of all deposit types, including
non-interest bearing demand deposits. We also issued $10.3 million of
subordinated debentures in March 2004. The debentures carry an interest rate
equal to the three-month LIBOR plus 279 basis points. The effect of the issue
was to increase interest expense by $267,000. The cost of interest-bearing
liabilities increased from 2.04% to 2.49%.
Net interest income increased from $16.2 million for the year ended December
31, 2004 to $17.9 million for the year ended December 31, 2005, an increase of
10.9%. This increase was the result of our growth, offset by a compression of
our net interest margin from 3.44% for the year ended December 31, 2004 to
3.39% for the year ended December 31, 2005, and the continued period of low
market interest rates, combined with intense competition for deposits in our
market area.
The provision for loan losses is a charge against earnings and funds the
allowance for loan losses. We maintain the allowance for loan losses at a level
that we believe is adequate to absorb inherent 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, the nature of the portfolio mix and the balance of non-performing
and classified loans. We assess the allowance for loan losses on a monthly
basis. After thorough review and analysis of the adequacy of the allowance and
the continued improvement in
42
asset quality in the loan portfolio, management deemed it prudent to provide
$167,000 and $376,000 for possible loan losses for the year ended December 31,
2005 and 2004, respectively.
Non-interest income decreased from $2.5 million for the year ended December 31,
2004 to $2.3 million for the year ended December 31, 2005, a decrease of 7.4%.
The decrease can be attributed to a one-time sale of impaired loans, which
resulted in a gain of $196,000 for the year ended December 31, 2004, as
compared to $49,000 for the year ended December 31, 2005, a decrease of 75%.
Also, contributing to the decrease is the result of the introduction of free
checking account products. In response to competitive pressure, we offered and
promoted free checking accounts and realized a significant shift of accounts
into this product, resulting in decreased fee income. Service charges on
deposit accounts declined $124,000 from $1.0 million for the year ended
December 31, 2004 to $914,000 for the year ended December 31, 2005. Other
income increased from $844,000 for the year ended December 31, 2004 to $860,000
for the year ended December 31, 2005, an increase of 1.9%. This increase was
the result of official check fees, ATM and debit card income offset by the
decrease of commissions on sales of non-deposit investment products.
Non-interest expense increased from $12.8 million for the year ended December
31, 2004 to $13.9 million for the year ended December 31, 2005, an increase of
8.7%. Salaries and employee benefits increased by $423,000, or 5.5%, from $7.6
million for the year ended December 31, 2004, to $8.0 million for the year
ended December 31, 2005. Salary increases in 2005 were offset by increased
levels of deferred loan origination costs. Occupancy and equipment expense
increased from $1.3 million for the year ended December 31, 2004 to $1.7
million for the year ended December 31, 2005. The increase is a result of cost
savings realized from closing branches in 2004 that have been offset by costs
associated with opening the new Assonet branch in April 2005. Equipment expense
increased due to modernization of and investments in teller and platform
systems initiatives that we believe will ultimately result in a more efficient
customer service. Professional fees increased by $320,000 when comparing the
years ended December 31, 2005 and 2004. The increase is the result of
accounting and consulting costs associated with our restatement of certain
financial statements and related information totaling $211,000. Also
professional fees increased by $25,000 in 2005 due to costs associated with the
anticipated implementation of Section 404 of the Sarbanes-Oxley Act of 2002 and
implementing section 305 for the FDIC Improvement Act of 1991. Marketing costs
increased from $510,000 for the year ended December 31, 2004 to $549,000 for
the year ended December 31, 2005. This is the result of increased advertising
and promotional costs associated with our "Coastal" product line and other
deposit gathering initiatives. As we continue to launch new deposit products
and services, such as the Coastal Savings account and the Bank at Work Program,
we expect marketing costs to rise. Other expenses decreased from $2.3 million
for the year ended December 31, 2004 to $2.2 million for the year ended
December 31, 2005, a decrease of $6,000.
Income before income taxes was $6.2 million for the year ended December 31,
2005, compared to $5.5 million for the year ended December 31, 2004. Provision
for income taxes totaled $2.2 million and $1.9 million for the years ended
December 31, 2005 and 2004, respectively, representing overall effective tax
rates of 35.0% and 34.3%, respectively.
IMPACT OF INFLATION
The consolidated financial statements and related consolidated financial data
presented herein have been prepared in accordance with generally accepted
accounting principles, which require the measurement of financial position and
results of operations in terms of historical dollars without considering
changes in the relative purchasing power of money over time due to inflation.
The primary effect of inflation on our operations is reflected in increased
operating costs. Unlike most industrial companies, virtually all assets of a
financial institution are monetary in nature. As a result, interest rates have
a more significant effect on a financial institution's performance than the
effect of general levels of inflation. Interest rates do not necessarily move
in the same direction or in the same magnitude as the prices of goods and
services.
43
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
Our principal sources of funds are customer deposits, amortization and payoff
of existing loan principal, and sales, maturities or paydowns of various
investment securities. The Bank is a voluntary member of the Federal Home Loan
Bank of Boston (the "FHLB") and as such, may take advantage of the FHLB's
borrowing programs to enhance liquidity and leverage its favorable capital
position. The Bank also may draw on lines of credit at the FHLB or the Federal
Reserve Board (the "FRB"), and enter into repurchase or reverse repurchase
agreements with authorized brokers. These various sources of liquidity are used
to fund withdrawals, new loans, and investments.
Management seeks to promote deposit growth while controlling cost of funds.
Sales-oriented programs to attract new depositors and the cross-selling of
various products to its existing customer base are currently in place.
Management reviews, on an ongoing basis, possible new products, with particular
attention to products and services, which will aid in retaining our base of
lower-costing deposits.
Maturities, paydowns and sales of investment securities provide us with
significant liquidity. Our policy of purchasing shorter-term debt securities
reduces market risk in the bond portfolio while providing significant cash
flow. For the year ended December 31, 2006, cash flow from maturities of
securities was $14.3 million, proceeds from sales of securities totaled $17.0
million, compared to maturities of securities of $21.1 million, and proceeds
from sales of securities of $2.6 million for the year ended December 31, 2005.
Purchases of securities during 2006 and 2005 totaled $36.7 million and $28.0
million, respectively.
Amortization and pay-offs of the loan portfolio also provide us with
significant liquidity. Traditionally, amortization and pay-offs are reinvested
into loans. Excess liquidity is invested in federal funds sold and overnight
investments at the FHLB.
We have also used borrowed funds as a source of liquidity. At December 31,
2006, the Bank's outstanding borrowings from the FHLB were $119.1 million. The
Bank has the capacity to borrow in excess of $20.9 million additional at the
FHLB.
Loan originations for the year ended December 31, 2006 totaled $101.9 million.
Commitments to originate loans at December 31, 2006 were $8.4 million,
excluding unadvanced construction funds totaling $12.4 million, unadvanced
commercial lines of credit totaling $24.4 million and unadvanced home equity
lines totaling $16.9 million. Management believes that adequate liquidity is
available to fund loan commitments utilizing deposits, loan amortization,
maturities of securities, or borrowings.
CAPITAL RESOURCES
At December 31, 2006, our total stockholders' equity was $51.2 million, an
increase of $2.4 million from $48.9 million reported on December 31, 2005. The
increase in capital was a combination of several factors. Additions consisted
primarily of net income of $3.6 million for the year ended December 31, 2006.
There were also 32,762 shares issued at a value of $586,000, pursuant to our
Dividend Reinvestment Program, in lieu of cash dividends or for optional cash
contributions and exercised stock options resulted in the issuance of 28,000
shares common stock at a value of $305,000, including a tax benefit.
Additionally, there was an increase in accumulated other comprehensive income
attributable to a net reduction in unrealized losses on available-for-sale
securities of $957,000, partially offset by an adjustment of $223,000 to
initially apply FASB Statement No. 158 regarding the Company's defined benefit
pension plan. Other reductions related to dividends paid of $1.5 million, the
repurchase of 42,443 shares of common stock under our stock repurchase program
at a cost of $778,000 and the purchase of 48,277 shares of stock at a cost of
$887,000 to be used to grant potential stock awards.
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.
In addition to meeting the required levels, Slade's Ferry Bancorp.'s and the
Bank's capital ratios meet the criteria of the "well capitalized" category
established by the federal banking agencies as of December 31, 2006 and 2005;
refer to Note 13 to the consolidated Financial Statements included herein for
additional information.
44
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We consider interest rate risk to be a significant market risk as it could
potentially have an effect on our financial condition and results of operation.
The definition of interest rate risk is the exposure of our earnings to adverse
movements in interest rates, arising from the differences in the timing of the
repricing of assets and liabilities; the differences in the various pricing
indices inherent in our assets and liabilities; and the effects of overt and
embedded options in our assets and liabilities. Our Asset/Liability Committee,
comprised of executive management, is responsible for managing and monitoring
interest rate risk, and reviewing with the Board of Directors, at least
quarterly, the interest rate risk positions, the impact changes in interest
rates would have on net interest income, and the maintenance of interest rate
risk exposure within approved guidelines.
The potentially volatile nature of market interest rates requires us to manage
interest rate risk on an active and dynamic basis. Our objective is to reduce
and control the volatility of net interest income to within tolerance levels
established by the Board of Directors, by managing the relationship of
interest-earning assets and interest-bearing liabilities. In order to manage
this relationship, the Asset/Liability Committee utilizes an income simulation
model to measure the net interest income at risk under differing interest rate
scenarios. Additionally, the Committee uses an Economic Value of Equity ("EVE")
analysis to measure the effects of changing interest rates on the market values
of rate-sensitive assets and liabilities, taken as a whole. The Board of
Directors and management believe that static measures of timing differences,
such as "gap analysis", do not accurately assess the levels of interest rate
risk inherent in our balance sheet. Gap analysis does not reflect the effects
of overt and embedded options on net interest income, given a shift in interest
rates; nor does it take into account basis risk, the risk arising from using
various different indices on which to base pricing decisions.
The income simulation model currently utilizes a 200 basis point increase in
interest rates and a 200 basis point decrease in rates. The interest rate
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
rates. Prepayment speeds for loans are based on median dealer forecasts for
each interest rate scenario.
The Board of Directors has established a risk limit of a 5.00% change in net
interest income for each 100 basis point shift in market interest rates. The
limit established by the Board provides an internal tolerance level to control
interest rate risk. We were slightly outside our policy-mandated risk limit for
net interest income at risk due to a management decision, with the Board of
Directors concurrence, not to extend long-term funding in light of what we
believe to be temporarily overpriced short and long term funding costs.
The following table reflects our estimated exposure as a percentage of net
interest income and the change in basis points for the next twelve months,
assuming an immediate change in interest rates set forth below:
Rate Change Estimated Exposure as a Percentage Change
(Basis Points) of Net Interest Income (Basis Points)
------------------------------------------------------------------------
+200 -14.19% (24)
-200 6.68% 12
Additionally we use the model to estimate the effects of changes in interest
rates on our EVE. EVE represents our theoretical market value, given the rate
shocks applied in the model. The Board of Directors has established a risk
limit for EVE which provides that the EVE will not fall below 6.00%, the FDIC's
minimum capital level to be classified as "well capitalized". We are within our
risk limit for EVE.
45
The following table presents the changes in EVE given rate shocks.
Rate Change Change from
(Basis Points) Economic Value of Equity Flat Rates
-----------------------------------------------------------
Flat 13.24% N/A
+200 11.69% -1.55%
-200 13.22% -0.02%
46
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, together with the reports of independent
registered public accounting firms, appear beginning on page F-1 of this Annual
Report on Form 10-K.
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Effective March 14, 2005, the Audit Committee of our Board of Directors
dismissed Shatswell, MacLeod & Company, P.C. and engaged Wolf & Company, P.C.
as our independent registered public accounting firm for the fiscal year ended
December 31, 2005. We had no disagreements with Shatswell, MacLeod & Company on
accounting and financial disclosure matters.
ITEM 9A
CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934, within
the 90 days prior to the date of this report, the Company carried out an
evaluation under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer of the effectiveness of the design and operation of the Company's
disclosure controls and procedures. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective to ensure that information
required to be disclosed by the Company in the reports it files or submits
under the Exchange Act is (i) recorded, processed, summarized and reported,
within the time periods specified in the Securities and Exchange Commission's
rules and forms and (ii) accumulated and communicated to the Company's
management, including its principal executive officer and principal accounting
officer, as appropriate to allow timely decisions regarding disclosure. In
connection with the rules regarding disclosure and control procedures, we
intend to continue to review and document our disclosure controls and
procedures, including our internal controls and procedures for financial
reporting, and may from time to time make changes aimed at enhancing their
effectiveness and to ensure that our systems evolve with our business.
There has been no change in the Company's internal controls over financial
reporting identified in connection with the Company's evaluation of its
disclosure controls and procedures that occurred during the Company's last
fiscal quarter that have materially affected, or are reasonably likely to
materially affect the Company's internal control over financial reporting.
ITEM 9B
OTHER INFORMATION
None.
47
PART III
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information required by this Item is incorporated herein by reference to our
Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed
pursuant to Regulation 14A within 120 days following our December 31, 2006
fiscal year end.
ITEM 11
EXECUTIVE COMPENSATION
Information required by this Item is incorporated herein by reference to our
Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed
pursuant to Regulation 14A within 120 days following our December 31, 2006
fiscal year end.
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
Information required by this Item is incorporated herein by reference to our
Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed
pursuant to Regulation 14A within 120 days following our December 31, 2006
fiscal year end.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth information pertaining to our equity
compensation plans in effect as of December 31, 2006.
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted-average equity compensation
exercise of outstanding exercise price of plans (excluding
options, warrants outstanding options, securities reflected
Plan Category and rights warrants and rights in column (a))
------------- ----------------------- -------------------- -----------------------
(a) (b) (c)
Equity compensation plans approved by
security holders 230,945 $18.18 121,800
Equity compensation plans not approved by
security holders - - -
------- ------ -------
230,945 $18.18 121,800
======= ====== =======
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information required by this Item is incorporated herein by reference to our
Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed
pursuant to Regulation 14A within 120 days following our December 31, 2006
fiscal year end.
ITEM 14
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required by this Item is incorporated herein by reference to our
Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed
pursuant to Regulation 14A within 120 days following our December 31, 2006
fiscal year end.
48
PART IV
ITEM 15
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) Financial Statement Schedules
All financial statement schedules required by Item 15(a)(2) have
been omitted because they are inapplicable or because the required
information has been included in the Consolidated Financial
Statements or Notes thereto.
(2) Exhibits: see attached Exhibit Index
49
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Slade's Ferry Bancorp.
By /s/ Mary Lynn D. Lenz 3/30/07
-------------------------------------
Mary Lynn D. Lenz,
President/Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ Peter G. Collias 03/30/07 /s/ Anthony F. Cordeiro 03/30/07
----------------------------------------------- -----------------------------------------
Peter G. Collias Anthony F. Cordeiro
Director Director
/s/ Scott W. Costa, PE 03/30/07 /s/ Paul C. Downey 03/30/07
----------------------------------------------- -----------------------------------------
Scott W. Costa, PE Paul C. Downey
Director Lead Independent Director
/s/ Melvyn A. Holland 03/30/07 /s/ Mary Lynn D. Lenz 03/30/07
----------------------------------------------- -----------------------------------------
Melvyn A. Holland Mary Lynn D. Lenz
Director President/CEO
(Principal Executive Officer)
/s/ Jean F. MacCormack, Ed.D 03/30/07 /s/ Francis A. Macomber 03/30/07
----------------------------------------------- -----------------------------------------
Jean F. MacCormack, Ed.D Francis A. Macomber
Director Director
/s/ Joan Parkos Moran 03/30/07 /s/ Majed Mouded, MD 03/30/07
----------------------------------------------- -----------------------------------------
Joan Parkos Moran Majed Mouded, MD
Director Director
/s/ Shaun O'Hearn Sr. 03/30/07 /s/ Lawrence J. Oliveira, DDS 03/30/07
----------------------------------------------- -----------------------------------------
Shaun O'Hearn Sr. Lawrence J. Oliveira, DDS
Director Director
/s/ William J. Piccerelli, CPA, CVA 03/30/07 /s/ Carl Ribeiro 03/30/07
----------------------------------------------- -----------------------------------------
William J. Piccerelli, CPA, CVA Carl Ribeiro
Director Director
/s/ William J. Sullivan 03/30/07 /s/ David F. Westgate 03/30/07
----------------------------------------------- -----------------------------------------
William J. Sullivan David F. Westgate
Director Director
/s/ Deborah A. McLaughlin 03/30/07
-----------------------------------------------
Deborah A. McLaughlin
Executive Vice President
Chief Financial Officer/Chief
Operations Officer
(Principal Financial and
Accounting Officer)
50
EXHIBIT INDEX
-------------
Exhibit No. Description Item
----------- ----------- ----
3.1 Amended and Restated Articles of Incorporation of (1)
Slade's Ferry Bancorp.
3.2 Amended and Restated Bylaws of Slade's Ferry Bancorp. (2)
3.3 Articles of Amendment to the Amended and Restated Articles (3)
of Incorporation of Slade's Ferry Bancorp.
10.1 Slade's Ferry Bancorp. 1996 Stock Option Plan, as amended (4)
10.2 Supplemental Executive Retirement Agreement between (5)
Slade's Ferry Bancorp. and Manuel J. Tavares
10.3 Form of Director Supplemental Retirement Program Director (6)
Agreement, Exhibit 1 thereto (Slade's Ferry Trust Company
Director Supplemental Retirement Program Plan) and
Endorsement Method Split Dollar Plan Agreement thereunder.
10.4 Form of Directors' Paid-up Insurance Policy (part of the (7)
Director Supplemental Retirement Program).
10.5 Supplemental Executive Retirement Agreement between (8)
Slade's Ferry Bancorp. and Mary Lynn D. Lenz
10.6 Employment Agreement between Slade's Ferry Bancorp. (9)
and Mary Lynn D. Lenz
10.7 Employment Agreement between Slade's Ferry Bancorp. (10)
and Deborah A. McLaughlin
10.8 Employment Agreement between Slade's Ferry Bancorp. (11)
and Manuel J. Tavares
10.9 Form Change of Control Agreement (12)
10.10 Severance Pay Plan (13)
10.11 Slade's Ferry Bancorp. 2004 Equity Incentive Plan (14)
10.12 Form of Amendment to Directors' Supplemental Retirement
Program for Non-Employee Directors (15)
10.13 Form of Amendment to Directors' Supplemental Retirement (15)
Program for Francis A. Macomber and Melvyn A. Holland
14.1 Code of Ethics (16)
21.1 List of Subsidiaries (17)
23.1 Consent of Wolf & Company, P.C.
23.2 Consent of Shatswell, MacLeod & Company, P.C.
31.1 Rule 13a-14(a)/15d-14(a) Certification of the CEO
31.2 Rule 13a-14(a)/15d-14(a) Certification of the CFO
32.1 Section 1350 Certification of the CEO
32.2 Section 1350 Certification of the CFO
51
--------------------
(1) Incorporated by reference to the Registrant's Registration Statement on
Form SB-2 filed with the Commission on April 14, 1997.
(2) Incorporated by reference to the Registrant's Form 10-Q filed with the
Commission on May 12, 2005.
(3) Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on December 21, 2004.
(4) Incorporated by reference to the Registrant's Form 10-Q for the quarter
ended June 30, 1999.
(5) Incorporated by reference to the Registrant's Form 10-KSB for the fiscal
year ended December 31, 1996.
(6) Incorporated by reference to Exhibit 10 to the Registrant's Form 10-Q for
the quarter ended March 31, 1999.
(7) Incorporated by reference to Exhibit 10 to the Registrant's Form 10-QSB
for the quarter ended June 30, 1998.
(8) Incorporated by reference to Exhibit 10.10 to the Registrant's Form 10-Q
for the quarter ended March 31, 2003.
(9) Incorporated by reference to Exhibit 10.11 to the Registrant's Form 10-Q
for the quarter ended June 30, 2004.
(10) Incorporated by reference to Exhibit 10.7 to the Registrant's Form 10-Q
for the quarter ended September 30, 2004.
(11) Incorporated by reference to Exhibit 10.8 to the Registrant's Form 10-Q
for the quarter ended September 30, 2004.
(12) Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on January 13, 2005.
(13) Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on January 14, 2005.
(14) Incorporated by reference to Appendix C to the Registrant's Proxy
Statement filed on April 9, 2004.
(15) Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on December 22, 2006.
(16) Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended December 31, 2003.
(17) Incorporated by reference to Part I, Item 1 - "General."
52
INDEX TO FINANCIAL STATEMENTS
Slade's Ferry Bancorp. and Subsidiary Page
----
Report of Independent Registered Public Accounting Firm -
Wolf & Company, P.C. F-2
Report of Independent Registered Public Accounting Firm -
Shatswell, MacLeod & Company, P.C. F-3
Consolidated Balance Sheets as of December 31, 2006 and
December 31, 2005 F-4
Consolidated Statements of Income for the years ended
December 31, 2006, 2005 and 2004 F-5
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 2006, 2005 and 2004 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2006, 2005 and 2004 F-7
Notes to Consolidated Financial Statements F-9
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Slade's Ferry Bancorp.
We have audited the accompanying consolidated balance sheets of Slade's Ferry
Bancorp. and subsidiary (the "Company") as of December 31, 2006 and 2005, and
the related consolidated statements of income, changes in stockholders' equity
and cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Slade's Ferry
Bancorp. and subsidiary as of December 31, 2006 and 2005, and the results of
their operations and their cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
March 23, 2007
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Slade's Ferry Bancorp.
We have audited the accompanying consolidated statements of income, changes in
stockholders' equity and cash flows of Slade's Ferry Bancorp. and subsidiary
for the year ended December 31, 2004. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and
cash flows of Slade's Ferry Bancorp. and subsidiary for the year ended December
31, 2004, in conformity with accounting principles generally accepted in the
United States of America.
/s/ Shatswell, MacLeod & Company, P.C.
West Peabody, Massachusetts
January 13, 2005
F-3
Slade's Ferry Bancorp. and Subsidiary
Consolidated Balance Sheets
December 31,
---------------------
2006 2005
---------------------
Assets (In thousands)
------
Cash and due from banks $ 19,448 $ 17,232
Interest-bearing deposits with other banks 1,007 586
Federal funds sold 1,900 2,200
-------- --------
Cash and cash equivalents 22,355 20,018
Interest-bearing certificates of deposit with other banks 100 100
Securities available for sale 105,603 94,298
Securities held to maturity (fair value approximates $24,219
at December 31, 2006 and $28,858 at December 31, 2005) 24,623 29,306
Federal Home Loan Bank stock, at cost 6,856 6,304
Loans, net of allowance for loan losses of $4,385 at December 31, 2006
and $4,333 at December 31, 2005 422,370 409,610
Premises and equipment, net 5,587 5,917
Goodwill 2,173 2,173
Accrued interest receivable 2,311 2,298
Bank-owned life insurance 12,317 11,884
Deferred tax asset, net 2,039 2,089
Other assets 1,426 1,917
-------- --------
$607,760 $585,914
======== ========
Liabilities and Stockholders' Equity
------------------------------------
Deposits:
Noninterest-bearing $ 79,101 $ 80,705
Interest-bearing 344,905 335,141
-------- --------
Total deposits 424,006 415,846
Short-term borrowings - 7,000
Long-term borrowings 119,058 100,865
Subordinated debentures 10,310 10,310
Accrued expenses and other liabilities 3,141 3,038
-------- --------
Total liabilities 556,515 537,059
Commitments and contingencies (Notes 5, 11 and 12)
Stockholders' equity:
Common stock, par value $0.01 per share; authorized 10,000,000 shares;
issued and outstanding 4,102,242 shares in 2006 and 4,132,200
shares in 2005 41 41
Additional paid-in capital 31,444 31,014
Retained earnings 21,111 18,998
Accumulated other comprehensive loss (464) (1,198)
Unearned compensation (887) -
-------- --------
Total stockholders' equity 51,245 48,855
-------- --------
$607,760 $585,914
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
F-4
Slade's Ferry Bancorp. and Subsidiary
Consolidated Statements of Income
Years Ended December 31,
-------------------------------------
2006 2005 2004
------- ------- -------
(In thousands, except per share data)
Interest and dividend income:
Interest and fees on loans $27,263 $23,184 $20,263
Interest and dividends on securities:
Taxable 5,653 5,125 3,153
Tax-exempt 251 338 416
Interest on federal funds sold 196 247 185
Other interest 38 25 89
------- ------- -------
Total interest and dividend income 33,401 28,919 24,106
------- ------- -------
Interest expense:
Interest on deposits 9,524 6,084 4,982
Interest on Federal Home Loan Bank advances 4,986 4,274 2,594
Interest on subordinated debentures 828 637 370
------- ------- -------
Total interest expense 15,338 10,995 7,946
------- ------- -------
Net interest and dividend income 18,063 17,924 16,160
Provision for loan losses 39 167 376
------- ------- -------
Net interest income, after provision for loan losses 18,024 17,757 15,784
------- ------- -------
Noninterest income:
Service charges on deposit accounts 1,394 914 1,038
Gain (loss) on sales and calls of available-for-sale
securities, net (116) 29 (5)
Gain on sales of loans, net - 49 196
Increase in cash surrender value of life insurance policies 433 468 432
Other income 1,036 860 844
------- ------- -------
Total noninterest income 2,747 2,320 2,505
------- ------- -------
Noninterest expense:
Salaries and employee benefits 8,087 8,063 7,640
Occupancy and equipment expense 1,950 1,680 1,345
Professional fees 1,414 1,360 1,040
Marketing expense 364 549 510
Data processing 847 303 207
Other expense 2,241 1,941 2,043
------- ------- -------
Total noninterest expense 14,903 13,896 12,785
------- ------- -------
Income before income taxes 5,868 6,181 5,504
Provision for income taxes 2,249 2,161 1,887
------- ------- -------
Net income $ 3,619 $ 4,020 $ 3,617
======= ======= =======
Earnings per share:
Basic $ 0.87 $ 0.98 $ 0.89
======= ======= =======
Diluted $ 0.87 $ 0.97 $ 0.88
======= ======= =======
The accompanying notes are an integral part of these consolidated financial statements.
F-5
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2006, 2005 and 2004
Shares of Additional Accumulated Other
Common Common Paid-in Retained Comprehensive Unearned
Stock Stock Capital Earnings Income (Loss) Compensation Total
--------- ------ ---------- -------- ----------------- ------------ -----
(In thousands, except per share data)
Balance, December 31, 2003 3,995,857 $40 $28,609 $14,300 $ (412) $ - $42,537
Comprehensive income:
Net income - - 3,617 - - 3,617
Other comprehensive income - - - 537 - 537
-------
Total comprehensive income 4,154
-------
Issuance of common stock 33,588 - 710 - - - 710
Stock options exercised 42,390 1 532 - - - 533
Tax benefit of stock options exercised - 157 - - - 157
Common stock retired (3,412) - (32) - - - (32)
Dividends declared ($.36 per share) - - (1,458) - - (1,458)
--------- --- ------- ------- ------- ----- -------
Balance at December 31, 2004 4,068,423 41 29,976 16,459 125 - 46,601
Comprehensive income:
Net income - - 4,020 - - 4,020
Other comprehensive loss - - - (1,323) - (1,323)
-------
Total comprehensive income 2,697
-------
Issuance of common stock 33,777 - 627 - - - 627
Stock options exercised 30,000 - 316 - - - 316
Tax benefit of stock options exercised - 95 - - - 95
Dividends declared ($.36 per share) - - (1,481) - - (1,481)
--------- --- ------- ------- ------- ----- -------
Balance at December 31, 2005 4,132,200 41 31,014 18,998 (1,198) - 48,855
Comprehensive income:
Net income - - 3,619 - - 3,619
Other comprehensive income - - - 957 - 957
-------
Total comprehensive income 4,576
-------
Issuance of common stock 32,762 - 586 - - - 586
Stock options exercised 28,000 - 305 - - - 305
Tax benefit of stock options exercised - 82 - - - 82
Stock-based compensation - 235 - - - 235
Purchase of treasury stock (42,443) - (778) - - - (778)
Unearned compensation (48,277) - - - - (887) (887)
Dividends declared ($.36 per share) - - (1,506) - - (1,506)
Adjustment to initially apply FASB Statement
No. 158, net of tax effect (223) (223)
--------- --- ------- ------- ------- ----- -------
Balance at December 31, 2006 4,102,242 $41 $31,444 $21,111 $ (464) $(887) $51,245
========= === ======= ======= ======= ===== =======
The accompanying notes are an integral part of these consolidated financial statements.
F-6
Slade's Ferry Bancorp. and Subsidiary
Consolidated Statements of Cash Flows
Years Ended December 31,
----------------------------------
2006 2005 2004
---- ---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 3,619 $ 4,020 $ 3,617
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization, net of accretion of securities 129 294 247
(Gain) loss on sales and calls of available-for-sale
securities, net 116 (29) 5
Amoritization of net deferred loan fees (151) (83) (4)
Provision for loan losses 39 167 376
Deferred tax provision (benefit) (373) (195) 686
Depreciation and amortization 894 813 659
Gain on sale of loans, net - (49) (196)
Increase in cash surrender value of life insurance (433) (468) (432)
Stock-based compensation 235 - -
Excess tax benefits from stock-based compensation 82 95 157
Net change in:
Other assets 114 477 (1,301)
Accrued interest receivable (13) (329) (472)
Other liabilities 103 933 (105)
-------- -------- --------
Net cash provided by operating activities 4,361 5,646 3,237
-------- -------- --------
Cash flows from investing activities:
Decrease in interest-bearing time deposits with
other banks - - 100
Activity in available-for-sale securities:
Purchases (36,655) (28,027) (57,976)
Sales 17,021 2,590 1,646
Maturities, calls and pay-downs 9,690 12,837 19,536
Activity in held-to-maturity securities:
Purchases - - (30,109)
Maturities, calls and pay-downs 4,611 8,253 3,586
Purchases of Federal Home Loan Bank stock (552) (1,654) (1,626)
Investment in unconsolidated subsidiary - - (310)
Loan originations, net of principal payments (12,677) (47,494) (39,528)
Recoveries of loans previously charged off 29 65 96
Capital expenditures (589) (1,221) (886)
Proceeds from sale of property and equipment - 13 -
Proceeds from sale of investment real estate - 653 -
Proceeds from sales of loans 25 49 8,487
Investment in life insurance policies - - (135)
Redemption of life insurance policy - 132 -
Investment in limited partnership - - (119)
-------- -------- --------
Net cash used in investing activities (19,097) (53,804) (97,238)
-------- -------- --------
(continued)
The accompanying notes are an integral part of these consolidated financial statements.
F-7
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded)
Years Ended December 31,
----------------------------------
2006 2005 2004
---- ---- ----
(In thousands)
Cash flows from financing activities:
Net (decrease) increase in noninterest-bearing deposits (1,604) 473 6,979
Net increase in interest-bearing deposits 9,764 15,468 59,780
Short-term advances from Federal Home Loan Bank - 15,500 -
Long-term advances from Federal Home Loan Bank 43,000 29,500 35,476
Payments on Federal Home Loan Bank short-term advances (7,000) (8,500) (4,300)
Payments on Federal Home Loan Bank long-term advances 24,807 (18,921) (1,364)
Proceeds from issuance of common stock 586 627 710
Stock options exercised 305 316 533
Retirement of shares of common stock - - (32)
Proceeds from issuance of subordinated debentures - - 10,160
Purchase of treasury stock (778) - -
Unearned compensation (887) - -
Dividends paid on common stock (1,506) (1,481) (1,453)
-------- -------- --------
Net cash provided by financing activities 17,073 32,982 106,489
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 2,337 (15,176) 12,488
Cash and cash equivalents at beginning of year 20,018 35,194 22,706
-------- -------- --------
Cash and cash equivalents at end of year $ 22,355 $ 20,018 $ 35,194
======== ======== ========
Supplemental disclosures:
Interest paid $ 15,355 $ 10,576 $ 7,804
Income taxes paid, net $ 2,406 $ 1,749 $ 1,106
The accompanying notes are an integral part of these consolidated financial statements.
F-8
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Slade's
Ferry Bancorp. (the "Company"), its wholly-owned subsidiary, Slade's
Ferry Trust Company (the "Bank") and the Bank's wholly-owned
subsidiaries. All significant intercompany balances and transactions have
been eliminated in consolidation. The Company accounts for its other
wholly-owned subsidiary, Slade's Ferry Statutory Trust I, using the
equity method. (See Note 9.)
Nature of Operations
The Company is a Massachusetts company that was organized in 1990 to
become the holding company of the Bank. The Bank is a state-chartered
bank, which was incorporated in 1959 and is headquartered in Somerset,
Massachusetts. The Bank operates its business from nine banking offices
located in southeastern Massachusetts. The Bank is engaged principally in
the business of attracting deposits from the general public and investing
those deposits in commercial and residential real estate, commercial,
consumer and small business loans.
Use of Estimates
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance
sheet and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant change in the
near term relate to the determination of the allowance for loan losses
and other-than-temporary impairment losses.
Significant Group Concentrations of Credit Risk
Most of the Company's activities are with customers located within
southeastern Massachusetts and Rhode Island. Note 3 discusses the types
of securities that the Company invests in and Note 4 discusses the types
of lending that the Company engages in. The Company does not have any
significant concentrations to any one industry or customer.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash and balances due from banks, interest-bearing
deposits with other banks and federal funds sold, all of which mature
within ninety days.
Interest-bearing Certificates of Deposit with other Banks
Interest-bearing certificates of deposit with other banks mature within
one year and are carried at cost.
Reclassification
Certain amounts in the 2005 and 2004 consolidated financial statements
have been reclassified to conform to the 2006 presentation.
F-9
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Securities
Debt securities that management has the positive intent and ability to
hold to maturity are classified as "held to maturity" and recorded at
amortized cost. Securities not classified as held to maturity, including
equity securities with readily determinable fair values, are classified
as "available for sale" and recorded at fair value, with unrealized gains
and losses excluded from earnings and reported in other comprehensive
income, net of income tax effects.
Purchase premiums and discounts are recognized in interest income using
the interest method over the terms of the securities. Declines in the
fair value of held-to-maturity and available-for-sale securities below
their cost that are deemed to be other than temporary are reflected in
earnings as realized losses. In estimating other-than-temporary-impairment
losses, management considers (1) the length of time and the extent to
which the fair value has been less than cost, (2) the financial condition
and near-term prospects of the issuer, and (3) the intent and ability of
the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. Gains and
losses on the sale of securities are recorded on the trade date and are
determined using the specific identification method.
Loans
The Company grants mortgage, commercial and consumer loans to customers.
A substantial portion of the loan portfolio is represented by mortgage
loans throughout southeastern Massachusetts and Rhode Island. The ability
of the Company's debtors to honor their contracts is dependent upon the
real estate and general economic conditions in this area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
outstanding unpaid principal balances adjusted for charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated
loans. Interest income is accrued on the unpaid principal balance. Loan
origination fees, net of certain direct origination costs, are deferred
and recognized as an adjustment of the related loan yield using the
interest method.
The accrual of interest on mortgage and commercial loans is discontinued
at the time the loan is 90 days past due unless the credit is
well-secured and in process of collection. Other personal loans are
typically charged off no later than when they are 180 days past due. Past
due status is based on contractual terms of the loan. In all cases, loans
are placed on nonaccrual status or charged-off at an earlier date if
collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on
nonacccrual status or charged off is reversed against interest income.
The interest on these loans is accounted for on the cash-basis or
cost-recovery method until qualifying for return to accrual. Loans are
returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are reasonably
assured.
F-10
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings.
Loan losses are charged against the allowance when management believes
the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by
management and is based upon management's periodic review of the
collectibility of the loans in light of historical experience, the nature
and volume of the loan portfolio, adverse situations that may affect the
borrower's ability to repay, estimated value of any underlying collateral
and prevailing economic conditions. This evaluation is inherently
subjective as it requires estimates that are susceptible to significant
revision as more information becomes available.
The allowance consists of specific, general and unallocated components.
The specific component relates to loans that generally have been
identified as impaired. For such loans an allowance is established when
the discounted cash flows (or collateral value or observable market
price) of the impaired loan is lower than the carrying value of that
loan. The general component covers all other loans and is based on
historical loss experience adjusted for qualitative factors. An
unallocated component is maintained to cover uncertainties that could
affect management's estimate of probable losses. The unallocated
component of the allowance reflects the margin of imprecision inherent in
the underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect the
scheduled payments of principal or interest according to the contractual
terms of the loan agreement. Factors considered by management in
determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the
significance of payment delays and payment shortfalls on a case-by-case
basis, taking into consideration all of the circumstances surrounding the
loan and the borrower, including the length of the delay, the reasons for
the delay, the borrower's prior payment record, and the amount of the
shortfall in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis by either the present value of expected
future cash flows discounted at the loan's effective rate, or the fair
value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. The Company does not separately identify
consumer loans for impairment disclosures. Prior to 2005, the Company did
not separately identify residential loans for impairment disclosures.
Bank-owned Life Insurance
Bank-owned life insurance policies are reflected on the consolidated
balance sheet at cash surrender value. Changes in cash surrender value
are reflected in non-interest income on the consolidated statement of
income.
Premises and Equipment
Land is carried at cost. Buildings and equipment are carried at cost,
less accumulated depreciation and amortization computed on the
straight-line method over the estimated useful lives of the assets or the
expected terms of the leases, if shorter. Expected terms include lease
option periods to the extent that the exercise of such options is
reasonably assured.
F-11
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Goodwill
Goodwill is evaluated for impairment on an annual basis using the
consolidated Company as the reporting unit for measurement purposes. No
impairment has been recognized to date.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control
over the assets has been surrendered. Control over transferred assets is
deemed to be surrendered when (1) the assets have been isolated from the
Company, (2) the transferee obtains the right to pledge or exchange the
transferred assets, and (3) the Company does not maintain effective
control over the transferred assets through an agreement to repurchase
them before their maturity.
Advertising Costs
Advertising costs are expensed as incurred.
Retirement Plan
The compensation cost of an employee's pension benefit is recognized on
the projected unit credit method over the employee's approximate service
period. The unit credit cost method is utilized for funding purposes.
In September 2006, the Financial Accounting Standards Board ("FASB")
issued Statement No. 158, "Employers' Accounting for Defined Benefit
Pension and Other Postretirement Plans" ("SFAS 158"), which requires
employers to (a) recognize in its statement of financial position the
funded status of a benefit plan, (b) measure a plan's assets and its
obligations that determine its funded status as of the end of the
employer's fiscal year, (c) recognize, through other comprehensive
income, net of tax, changes in the funded status of the benefit plan that
are not recognized as net periodic benefit cost, and (d) disclose
additional information about certain effects on net periodic benefit cost
for the next fiscal year that relate to the delayed recognition of
certain benefit cost elements. The requirement to recognize the funded
status of a benefit plan and provide additional disclosures is effective
as of December 31, 2006. The requirement to measure plan assets and
benefit obligations as of the date of the employer's fiscal year-end is
effective for the year ending December 31, 2008.
The following table illustrates the incremental effect of applying SFAS
158 on individual line items in the consolidated balance sheet as of
December 31, 2006.
Before After
Application Application
of SFAS 158 Adjustments of SFAS 158
----------- ----------- -----------
(In thousands)
Prepaid pension benefit $ 607 $(377) $ 230
Net deferred tax asset 1,885 154 2,039
Total assets 607,983 (223) 607,760
Accumulated other comprehensive loss (241) (223) (464)
Total stockholders' equity 51,468 (223) 51,245
F-12
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock Compensation Plans
In December 2004, the FASB issued Statement No. 123 (revised 2004),
"Share-Based Payment" ("SFAS 123(R)" or the "Statement") which requires
that the compensation cost relating to share-based payment transactions
be recognized in financial statements. That cost is measured based on the
fair value of the equity or liability instruments issued. SFAS 123(R)
covers a wide range of share-based compensation arrangements including
stock options, restricted share plans, performance-based awards, share
appreciation rights, and employee share purchase plans. SFAS 123(R) is a
replacement of SFAS No. 123, "Accounting for Stock-Based Compensation",
and supersedes Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees", and its related interpretive guidance.
The Statement requires the Company to measure the cost of employee
services received in exchange for stock options based on the grant-date
fair value of the award, and to recognize the cost over the period the
employee is required to provide services for the award. SFAS 123(R)
permits the use of any option-pricing model that meets the fair value
objective in the Statement.
The Company adopted SFAS 123(R) effective January 1, 2006, using the
"modified prospective" method. Under this transition method, compensation
costs include costs recognized for the non-vested portion of awards that
were granted prior to January 1, 2006, based on the grant-date fair value
of those awards under the original provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
(SFAS 123). Effective January 1, 2006 the Company is recognizing the cost
of option grants on a straight line basis over the vesting period.
As a result of implementing the provisions of SFAS 123R, the Company
recognized stock-based compensation expense of $235,000 ($184,000 net of
tax effects) for the year ended December 31, 2006. The recognition of
stock-based compensation expense resulted in a $0.04 decrease in basic
and diluted earnings per share for the year ended December 31, 2006.
Prior to January 1, 2006, stock compensation cost was measured using the
intrinsic value-based method of accounting in accordance with APB Opinion
No. 25, which, for the Company, resulted in no compensation expense to be
recognized.
The following table illustrates the effect on the Company's reported net
income and earnings per share if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation
prior to the adoption of SFAS 123R:
Years Ended December 31,
------------------------
2005 2004
---- ----
(In thousands, except per share data)
Net income, as reported $4,020 $3,617
Additional expense had the Company
adopted SFAS No. 123 (168) (233)
Related tax benefit 69 80
------ ------
Pro forma net income $3,921 $3,464
====== ======
Earnings per share (basic):
As reported $ 0.98 $ 0.89
Pro forma $ 0.95 $ 0.86
Earnings per share (diluted):
As reported $ 0.97 $ 0.88
Pro forma $ 0.94 $ 0.85
F-13
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Unearned Compensation
In May 2006, the Company's Board of Directors authorized the purchase of
50,000 shares of common stock to be held in trust for future restricted
stock awards under the 2004 Equity Incentive Plan. At December 31, 2006,
$887,000 is reflected on the consolidated balance sheet as unearned
compensation which reduces stockholder's equity. This amount represents
the cost of 48,277 shares that have been acquired by the trust. No shares
have been awarded to date. Accordingly, no shares held by the trust are
deemed outstanding for earnings per share calculations. In January 2007,
the Board of Directors authorized the purchase of an additional 25,000
shares to be held in the trust for future restricted stock awards.
Income Taxes
Deferred income tax assets and liabilities are determined using the
liability (or balance sheet) method. Under this method, the net deferred
tax asset or liability is determined based on the tax effects of the
temporary differences between the book and tax basis of the various
balance sheet assets and liabilities and gives current recognition to
changes in tax rates and laws.
Earnings Per Common Share
Basic earnings per share represents income available to common
stockholders divided by the weighted-average number of common shares
outstanding during the period. Diluted earnings per share reflects
additional common shares that would have been outstanding if dilutive
potential common shares had been issued, as well as any adjustment to
income that would result from the assumed issuance. Potential common
shares that may be issued by the Company relate solely to outstanding
stock options, and are determined using the treasury stock method.
Earnings per common share have been computed based on the following:
Years Ended December 31,
----------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Net income $3,619 $4,020 $3,617
====== ====== ======
Average number of common shares outstanding 4,146 4,111 4,046
Effect of dilutive options 15 27 49
------ ------ ------
Average number of common shares outstanding used
to calculate diluted earnings per common share 4,161 4,138 4,095
====== ====== ======
Earnings per share:
Basic $ 0.87 $ 0.98 $ 0.89
====== ====== ======
Diluted $ 0.87 $ 0.97 $ 0.88
====== ====== ======
F-14
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income
Accounting principles generally require that recognized revenue,
expenses, gains and losses be included in net income. Although certain
changes in assets and liabilities, such as unrealized gains and losses on
available-for-sale securities and certain pension liability adjustments,
are reported as a separate component of the equity section of the balance
sheet, such items, along with net income, are components of comprehensive
income.
The components of other comprehensive income (loss) and related tax
effects are as follows:
Years Ended December 31,
----------------------------
2006 2005 2004
---- ---- ----
(In thousands)
Unrealized gains (losses) on securities
available for sale $1,418 $(2,104) $ 122
Reclassification adjustment for losses
(gains) realized in income 116 (29) 5
------ ------- -----
Net unrealized gains (losses) 1,534 (2,133) 127
Tax effect (577) 810 7
------ ------- -----
Net-of-tax amount 957 (1,323) 134
------ ------- -----
Minimum pension liability adjustment - - 682
Tax effect - - (279)
------ ------- -----
Net-of-tax amount - - 403
------ ------- -----
Adjustment to initially apply SFAS No. 158 (377) - -
Tax effect 154 - -
------ ------- -----
Net-of-tax amount (223) - -
------ ------- -----
$ 734 $(1,323) $ 537
====== ======= =====
The components of accumulated other comprehensive income (loss), included
in stockholders' equity, are as follows:
December 31,
-------------------
2006 2005
---- ----
(In thousands)
Net unrealized losses on securities available for sale $(380) $(1,914)
Tax effect 139 716
----- -------
Net-of-tax amount
(241) (1,198)
----- -------
Unrecognized net actuarial loss pertaining to defined
benefit plan (377) -
Tax effect 154 -
----- -------
Net-of-tax amount (223) -
----- -------
$(464) $(1,198)
===== =======
Of the total actuarial loss included in accumulated other comprehensive
income at December 31, 2006, $19,000 is expected to be recognized as a
component of net periodic pension cost for the year ending December 31,
2007.
F-15
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Concluded)
Recent Accounting Pronouncements
In July 2006, the FASB issued Financial Accounting Standards
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN
48) which clarifies the accounting for uncertainty in income taxes
recognized in an entity's financial statements in accordance with FASB
Statement No. 109, "Accounting for Income Taxes". FIN 48 prescribes a
recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected
to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in
interim periods, disclosures and transitions. FIN 48 is effective for
fiscal years beginning after December 15, 2006. Management is currently
evaluating the impact on the Company's consolidated financial statements.
In September 2006, the FASB issued Statement No. 157, "Fair Value
Measurements" which defines fair value, establishes a framework for
measuring fair value in accordance with generally accepted accounting
principles, and expands disclosures about fair value measurements. This
Statement is effective for the Company on January 1, 2008 and is not
expected to have a material impact on the Company's consolidated
financial statements.
On February 15, 2007, the FASB issued Statement No. 159, "The Fair Value
Option for Financial Assets and Liabilities", which provides companies
with an option to report selected financial assets and liabilities at
fair value. Statement No. 159 also establishes presentation and
disclosure requirements designed to facilitate comparisons between
companies that choose different measurement attributes for similar types
of assets and liabilities. This Statement is effective for the company's
2008 calendar year with early adoption in 2007 permitted, and is not
expected to have a material impact on the Company's consolidated
financial statements.
In September 2006, the FASB ratified EITF 06-4, "Accounting for Deferred
Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements," which addresses accounting for
split-dollar life insurance arrangements whereby the employer purchases a
policy to insure the life of an employee or a director, and separately
enters into an agreement to split the policy benefits between the
employer and the employee/director. This EITF states that an obligation
arises as a result of a substantive agreement with an employee or
director to provide future postretirement benefits. Under EITF 06-4, the
obligation is not settled upon entering into an insurance arrangement.
Since the obligation is not settled, a liability should be recognized in
accordance with applicable authoritative guidance. EITF 06-4 is effective
for fiscal years beginning after December 15, 2007. The Company is in the
process of evaluating the potential impacts of adopting EITF 06-4 on its
consolidated financial statements.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 108, which provides interpretive guidance
on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a potential current
year misstatement. Prior to SAB 108, companies might evaluate the
materiality of financial-statement misstatements using either the income
statement or balance sheet approach, with the income statement approach
focusing on new misstatements added in the current year, and the balance
sheet approach focusing on the cumulative amount of misstatement present
in a company's balance sheet. Misstatements that would be material under
one approach could be viewed as immaterial under another approach, and
not be corrected. SAB 108 now requires that companies view financial
statement misstatements as material if they are material according to
either the income statement or balance sheet approach. SAB 108 is
applicable to all financial statements issued by the Company for the year
ended December 31, 2006.
F-16
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS
The Bank is required to maintain average balances on hand or with the
Federal Reserve Bank. At December 31, 2006 and 2005, these reserve
balances amounted to $3,799,000 and $3,920,000, respectively.
3. SECURITIES
The amortized cost and fair value of securities, with gross unrealized
gains and losses, follows:
December 31, 2006
------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- --------
(In thousands)
Securities Available for Sale
-----------------------------
Debt securities:
Government-sponsored enterprises $ 34,462 $ - $ 505 $ 33,957
Corporate 9,221 - 141 9,080
Mortgage-backed 57,946 514 480 57,980
-------- ---- ------ --------
Total debt securities 101,629 514 1,126 101,017
Marketable equity securities 3,139 302 52 3,389
Mutual funds 1,215 - 18 1,197
-------- ---- ------ --------
Total securities available for sale $105,983 $816 $1,196 $105,603
======== ==== ====== ========
Securities Held to Maturity
---------------------------
State and municipal obligations $ 5,001 $ 79 $ 11 $ 5,069
Mortgage-backed securities 19,622 - 472 19,150
-------- ---- ------ --------
$ 24,623 $ 79 $ 483 $ 24,219
======== ==== ====== ========
F-17
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (Continued)
December 31, 2005
------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- --------
(In thousands)
Securities Available for Sale
-----------------------------
Debt securities:
Government-sponsored enterprises $50,443 $ - $ 862 $49,581
Corporate 9,564 5 555 9,014
Mortgage-backed 31,574 75 417 31,232
------- ---- ------ -------
Total debt securities 91,581 80 1,834 89,827
Marketable equity securities 3,426 116 271 3,271
Mutual funds 1,205 - 5 1,200
------- ---- ------ -------
Total securities available for sale $96,212 $196 $2,110 $94,298
======= ==== ====== =======
Securities Held to Maturity
---------------------------
State and municipal obligations $ 6,766 $138 $ 12 $ 6,892
Mortgage-backed securities 22,540 - 574 21,966
------- ---- ------ -------
$29,306 $138 $ 586 $28,858
======= ==== ====== =======
At December 31, 2006 and 2005, obligations of government-sponsored
enterprises with a carrying value of $3,860,000, were pledged to secure
public deposits and for other purposes required or permitted by law.
Also, obligations of government-sponsored enterprises and mortgage-backed
securities,with a carrying value of $44,835,000 and $54,464,000 were
pledged to secure Federal Home Loan Bank advances at December 31, 2006
and 2005, respectively.
F-18
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (Continued)
The amortized cost and fair value of debt securities by contractual
maturity at December 31, 2006 follows:
Available for Sale Held to Maturity
--------------------- --------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- -------- --------- -------
(In thousands)
Within 1 year $ 12,000 $ 11,890 $ 1,611 $ 1,612
After 1 year through 5 years 31,683 31,147 1,446 1,462
After 5 years through 10 years - - 1,223 1,241
Over 10 years - - 721 754
-------- -------- ------- -------
43,683 43,037 5,001 5,069
Mortgage-backed securities 57,946 57,980 19,622 19,150
-------- -------- ------- -------
$101,629 $101,017 $24,623 $24,219
======== ======== ======= =======
For the years ended December 31, 2006, 2005 and 2004, proceeds from sales
of securities available for sale amounted to $17,021,000, $2,590,000, and
$1,646,000, respectively. Gross realized gains amounted to $269,000,
$244,000 and $176,000, respectively. Gross realized losses amounted to
$385,000, $215,000 and $65,000, respectively. The tax provision (benefit)
applicable to these net realized gains and losses amounted to $(46,000),
$10,000 and $39,000, respectively.
F-19
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (Continued)
Information pertaining to securities with gross unrealized losses at
December 31, 2006 and 2005, aggregated by investment category and length
of time that individual securities have been in a continuous loss
position, follows:
Less Than Twelve Months Over Twelve Months
----------------------- --------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ------- ---------- -------
December 31, 2006: (In thousands)
Securities Available for Sale
-----------------------------
Debt securities:
Government-sponsored enterprises $ 19 $ 2,481 $ 486 $31,476
Corporate debt securities 13 2,025 128 7,053
Mortgage-backed securities 8 1,675 472 19,580
---- ------- ------ -------
40 6,181 1,086 58,109
Marketable equity securities 49 657 3 335
Mutual funds 18 1,197 - -
---- ------- ------ -------
$107 $ 8,035 $1,089 $58,444
==== ======= ====== =======
Securities Held to Maturity
---------------------------
State and municipal obligations $ - $ - $ 11 $ 783
Mortgage--backed securities - - 472 19,150
---- ------- ------ -------
$ - $ - $ 483 $19,933
==== ======= ====== =======
December 31, 2005:
Securities available for sale
-----------------------------
Debt securities:
Government-sponsored enterprises $284 $24,170 $ 578 $25,411
Corporate debt securities 319 5,868 236 1,812
Mortgage-backed securities 313 20,913 104 4,063
---- ------- ------ -------
916 50,951 918 31,286
Marketable equity securities 61 650 210 1,134
Mutual funds 5 1,200 - -
---- ------- ------ -------
$982 $52,801 $1,128 $32,420
==== ======= ====== =======
Securities Held to Maturity
---------------------------
State and municipal obligations $ 12 $ 783 $ - $ -
Mortgage-backed securities 472 16,542 102 5,424
---- ------- ------ -------
$484 $17,325 $ 102 $ 5,424
==== ======= ====== =======
F-20
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (Concluded)
Management evaluates securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market
concerns warrant such evaluation.
At December 31, 2006, debt securities available for sale with unrealized
losses for a period greater than twelve months had aggregate depreciation
of 1.8% from the Company's cost basis. No single security has depreciated
more than 4.0% from the Company's cost basis. Unrealized losses on
corporate bonds include $108,000 relating to the finance corporations of
three automotive companies with an amortized cost of $5.1 million that
have been affected by the weaker operating results in the automotive
industry. These bonds have maturity dates ranging from October 1, 2008 to
September 1, 2009. The Company has reviewed the financial condition of
these issuers and has determined that none of the declines are other than
temporary.
At December 31, 2006, debt securities available for sale with unrealized
losses for a period of less than twelve months had aggregate depreciation
of less than 1% of the Company's cost basis, with unrealized depreciation
for any single debt security not exceeding 1.0% of the Company's cost
basis. The Company has determined that these temporary losses relate
primarily to the increase in market interest rates over the past few
years and the effect on market price for debt securities. The Company has
the intent and ability to hold all of its debt securities until maturity,
or for the foreseeable future if available for sale, and no declines are
deemed to be other than temporary.
At December 31, 2006, debt securities held to maturity with unrealized
losses for a period greater than twelve months had aggregate depreciation
of less than 2.4% of the company's cost basis, with unrealized
depreciation for any single debt security not exceeding 4% of the
Company's cost basis. Similar to the available-for-sale portfolio, the
Company has determined that these temporary losses relate primarily to
the increase in market interest rates and the corresponding effect on the
market price for debt securities.
At December 31, 2006, there were no marketable equity securities that had
unrealized losses with aggregate depreciation of 30% from the Company's
cost basis, which is management's guideline for evaluating
other-than-temporary impairment. Evaluation will also occur at an earlier
stage if conditions warrant. Equity securities are reviewed for
impairment by examining several factors, such as financial condition and
near-term prospects of the issuer, credit deterioration of the issuer,
rating downgrades, business segment dynamics, extent to which the market
value is less than cost, length of time held, and buy/hold/sell
recommendations of investment advisors or market analyst. At December 31,
2006, no unrealized losses were deemed to be other than temporary.
F-21
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. LOANS
A summary of the balances of loans follows:
December 31,
------------------------------
2006 2005
-------- --------
(In thousands)
Real estate mortgage loans:
Multi-family and commercial $209,172 $213,815
Residential 132,381 120,345
Construction 20,988 21,490
Home equity lines of credit 13,917 17,915
Commercial 47,736 38,111
Consumer 2,766 2,623
-------- --------
Total loans 426,960 414,299
Less: Allowance for loan losses (4,385) (4,333)
Net deferred loan fees (205) (356)
-------- --------
Loans, net $422,370 $409,610
======== ========
An analysis of the allowance for loan losses follows:
Years Ended December 31,
---------------------------
2006 2005 2004
------ ------ ------
(In thousands)
Balance at beginning of year $4,333 $4,101 $4,154
Provision for loan losses 39 167 376
Loans charged-off (16) - (525)
Recoveries of loans previously charged-off 29 65 96
------ ------ ------
Balance at end of year $4,385 $4,333 $4,101
====== ====== ======
F-22
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
LOANS (Concluded)
The following is a summary of information pertaining to impaired and
non-accrual loans:
December 31,
--------------------
2006 2005
---- ----
(In thousands)
Impaired loans without a valuation allowance $341 $ 49
Impaired loans with a valuation allowance - 906
---- ----
Total impaired loans $341 $955
==== ====
Valuation allowance related to impaired loans $ - $ 87
==== ====
Total non-accrual loans $600 $906
==== ====
Total loans past-due ninety days or more and still - -
==== ====
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(In thousands)
Average investment in impaired loans $298 $485 $933
==== ==== ====
Interest income recognized on impaired loans $ 43 $ 26 $111
==== ==== ====
Interest income recognized on a cash basis on
impaired loans $ 43 $ 26 $ 17
==== ==== ====
No additional funds are committed to be advanced in connection with
impaired loans.
F-23
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation and amortization of
premises and equipment follows:
December 31,
------------------- Estimated
2006 2005 Useful Lives
---- ---- --------------
(In thousands)
Premises:
Land $ 1,600 $ 1,600 -
Buildings 6,508 6,407 39 years
Leasehold improvements 436 436 4 - 24 years
Furniture and equipment 5,212 4,812 3 - 5 years
Assets in process 54 - -
------- -------
13,810 13,255
Accumulated depreciation
and amortization (8,223) (7,338)
------- -------
$ 5,587 $ 5,917
======= =======
Depreciation and amortization expense for the years ended December 31,
2006, 2005 and 2004 amounted to $894,000, $813,000 and $659,000,
respectively.
The Company has embarked on a multi-year project to upgrade, modernize
and present a common design theme at all of its retail locations. As part
of this project, the Company has signed agreements to remodel three of
its facilities - Somerset, New Bedford, and North Somerset,
Massachusetts. At December 31, 2006, commitments related to these
agreements aggregated $1,649,000.
Pursuant to the terms of noncancelable lease agreements in effect at
December 31, 2006, pertaining to premises and equipment, future minimum
rent commitments under various operating leases are as follows:
Year Ending
December 31, Amount
------------ -------------
(In thousands)
2007 $ 97
2008 83
2009 83
2010 87
2011 84
Thereafter 759
------
$1,193
======
Certain leases contain provisions for escalation of minimum lease
payments contingent upon increases in real estate taxes and percentage
increases in the consumer price index. In addition, the leases contain
options to extend for periods from five to ten years. The cost of such
rental extensions is included above. Total rent expense for the years
ended December 31, 2006, 2005 and 2004 amounted to $103,000, $127,000 and
$85,000, respectively.
F-24
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. DEPOSITS
A summary of deposits by type is as follows:
December 31,
---------------------------
2006 2005
-------- --------
(In thousands)
Demand deposits $ 79,101 $ 80,705
NOW 55,071 55,493
Regular and other savings 77,189 87,146
Money market deposits 24,021 29,835
-------- --------
Total non-certificate accounts 235,382 253,179
-------- --------
Term certificates less than $100,000 121,730 116,861
Term certificates of $100,000 or more 66,894 45,806
-------- --------
Total certificate accounts 188,624 162,667
-------- --------
Total deposits $424,006 $415,846
======== ========
At December 31, 2006 and 2005, the scheduled maturities of time deposits
are as follows:
2006 2005
------------------------------ ---------------------------------
Weighted Weighted
Maturing In Amount Average Rate Amount Average Rate
----------- ------------- ------------ ------------- ------------
(In thousands) (In thousands)
2006 $ - - $135,606 3.2%
2007 180,284 4.3% 22,182 3.8
2008 3,704 3.1 2,341 3.4
2009 2,858 3.4 1,372 3.5
2010 850 4.0 1,166 4.0
2011 928 5.7 - -
-------- --------
$188,624 4.3% $162,667 3.3%
======== ========
7. SHORT-TERM BORROWINGS
Short-term borrowings consist of Federal Home Loan Bank of Boston
("FHLB") advances amounting to $7,000,000 at December 31, 2005, with an
original maturity of less than one year at a weighted average rate of
4.07%. There were no short-term borrowings at December 31, 2006.
The Bank also has an available line of credit in the amount of $500,000
with the FHLB at an interest rate that adjusts daily. Borrowings under
the line are limited to 2% of the Bank's total assets. All borrowings
from the FHLB are secured by a blanket lien on qualified collateral,
defined principally as 75% of the carrying value of first mortgage loans
on owner-occupied residential property and 90% of the market value of
obligations of government-sponsored enterprises.
F-25
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. LONG-TERM BORROWINGS
Long-term borrowings at December 31, 2006 and 2005 consist of the
following FHLB advances:
Amount Weighted Average Rate
----------------------- ---------------------
2006 2005 2006 2005
----------------------- ---------------------
(In thousands)
Fixed-rate advances maturing:
2006 $ - 8,000 - 2.7%
2007 27,000 27,000 3.4% 3.4
2008 14,500 14,500 3.8 3.8
2009 10,000 21,000 4.2 3.2
2010 7,000 7,000 4.5 4.5
Thereafter* 6,430 6,430 5.2 5.2
-------- --------
64,930 83,930 3.9 3.6
-------- --------
Floating-rate advances maturing:
2008** 10,000 - 5.3 -
2009** 30,000 - 5.3 -
-------- --------
40,000 - 5.3 -
-------- --------
Fixed-rate amortizing advances maturing:
2008 639 739 6.0 6.0
2011 13,489 16,196 6.7 6.8
-------- --------
14,128 16,935 6.7 6.7
-------- --------
Total FHLB advances $119,058 $100,865 4.7% 4.1%
======== ========
* Includes $3,000,000 maturing in 2015 and callable hereafter.
** Advances reprice every 28 days and are redeemable at the option of the
Company at each repricing date.
See Note 7 for collateral securing all FHLB borrowings.
F-26
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. SUBORDINATED DEBENTURES
On March 17, 2004, Slade's Ferry Statutory Trust I (the "Trust") , a
Connecticut Statutory trust formed by the Company, completed the sale of
$10,000,000 of floating rate trust preferred securities (liquidation
amount of $1,000 per security) in a private placement as part of a pooled
trust preferred securities transaction. The Trust also issued common
securities in the amount of $310,000 to the Company and used the net
proceeds from the preferred and common securities to purchase
subordinated debentures of the Company. The subordinated debentures are
the sole assets of the Trust. The Company contributed $10,000,000 of the
proceeds from the sale of the subordinated debentures to the Bank as Tier
I Capital to support the Bank's growth. Total expenses associated with
the offering approximating $150,000 are included in other assets and are
being amortized on a straight-line basis over the life of the
subordinated debentures.
The subordinated debentures and the trust preferred securities accrue and
pay distributions quarterly at a floating rate of 3-Month LIBOR plus
2.79%. At December 31, 2006 and 2005, this rate was 8.18% and 7.29%,
respectively. The Company has the option to defer interest payments on
the subordinated debentures for up to five years and, accordingly, the
trust may defer dividend distributions for up to five years. The Company
has fully and unconditionally guaranteed all of the obligations of the
Trust, including the semi-annual distributions and payments on
liquidation or redemption of the trust preferred securities.
The Company has the right to redeem the subordinated debentures, in whole
or in part, on or after March 17, 2009 at par value, plus any accrued but
unpaid interest to the redemption date. Redemption may occur prior to
March 17, 2009 under certain conditions, at a premium to par value. The
trust preferred securities are mandatorily redeemable upon the maturing
of the subordinated debentures on March 17, 2034, or upon earlier
redemption of the subordinated debentures.
10. INCOME TAXES
Allocation of federal and state income taxes between current and deferred
portions is as follows:
Years Ended December 31,
---------------------------------
2006 2005 2004
------ ------ ------
(In thousands)
Current tax provision
Federal $1,998 $1,854 $ 878
State 624 502 323
------ ------ ------
2,622 2,356 1,201
------ ------ ------
Deferred tax provision (benefit):
Federal (296) (153) 540
State (77) (42) 161
Change in the valuation allowance
for deferred tax assets - - (15)
------ ------ ------
(373) (195) 686
------ ------ ------
Total provision for income taxes $2,249 $2,161 $1,887
====== ====== ======
F-27
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (Concluded)
The reasons for the differences between the statutory federal income tax
rate and effective tax rates are summarized as follows:
Years Ended December 31,
--------------------------------
2006 2005 2004
---- ---- ----
Statutory federal tax rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
Tax-exempt income (1.6) (1.7) (2.5)
Dividends received deduction (0.4) (0.4) (0.4)
State tax, net of federal tax benefit 6.2 4.9 5.8
Officers' life insurance (2.5) (2.4) (2.7)
Employee benefit and stock-based
compensation plans 0.5 - -
Change in valuation allowance - - (0.3)
Other, net 2.1 0.6 0.4
---- ---- ----
Effective tax rate 38.3% 35.0% 34.3%
==== ==== ====
The components of the net deferred tax asset are as follows:
December 31,
------------------
2006 2005
------------------
(In thousands)
Deferred tax assets:
Allowance for loan losses $1,635 $1,568
Deferred loan fees 84 118
Interest on non-performing loans 45 48
Accrued employee benefits 35 117
Deferred compensation 104 145
Employee benefit and stock-based compensation plans 202 -
Write-down of securities 19 18
Minimum pension liability 154 -
Net unrealized holding loss on available
for sale securities 139 716
------ ------
2,417 2,730
------ ------
Deferred tax liabilities:
Accelerated depreciation (128) (283)
Prepaid pension contribution (249) (358)
Discount Accretion (1) (2)
------ ------
(378) (641)
------ ------
Net deferred tax asset $2,039 $2,089
====== ======
Deferred tax assets as of December 31, 2006 and 2005 have not been
reduced by a valuation allowance because management believes that it is
more likely than not that the full amount of deferred taxes will be
realized.
F-28
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. OFF-BALANCE SHEET ACTIVITIES
The Company is a party to credit related financial instruments with
off-balance-sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments include
commitments to extend credit, standby letters of credit and commercial
letters of credit. Such commitments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets. The Company's exposure to credit loss is
represented by the contractual amount of these commitments. The Company
follows the same credit policies in making commitments as it does for
on-balance-sheet instruments.
At December 31, 2006 and 2005, the following financial instruments were
outstanding for which the contract amounts represent credit risk:
Contract Amount
-------------------
2006 2005
------- -------
(In thousands)
Commitments to grant loans $ 8,379 $ 6,375
Unfunded commitments under lines of credit 24,402 25,041
Unfunded commitments under construction loans 12,444 14,863
Equity lines of credit 16,927 17,711
Standby letters of credit 3,423 3,188
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. The commitments for equity
lines of credit may expire without being drawn upon. Therefore, the total
commitment amounts do not necessarily represent future cash requirements.
The amount of collateral obtained, if it is deemed necessary by the
Company, is based on management's credit evaluation of the customer.
Unfunded commitments under commercial lines-of-credit, revolving credit
lines and overdraft protection agreements are commitments for possible
future extensions of credit to existing customers. These lines-of-credit
are uncollateralized and usually do not contain a specified maturity date
and may not be drawn upon to the total extent to which the Company is
committed.
Standby letters-of-credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party.
Those letters-of-credit are primarily issued to support public and
private borrowing arrangements. Essentially all letters of credit issued
have expiration dates within one year. The credit risk involved in
issuing letters-of-credit is essentially the same as that involved in
extending loan facilities to customers. The Company generally holds
collateral supporting those commitments, and at December 31, 2006 and
2005 such collateral amounted to $3,406,000 and $3,128,000, respectively.
Guarantees that are not derivative contracts have been recorded on the
Company's consolidated balance sheet at their fair value at inception.
The Company considers standby letters of credit to be guarantees, and the
amount of the recorded liability related to such guarantees at December
31, 2006 and 2005 was $18,000, and $65,000, respectively.
F-29
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12. LEGAL CONTINGENCIES
Various claims also arise from time to time in the normal course of
business which, in the opinion of management, will have no material
effect on the Company's consolidated financial statements.
13. MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate
certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material effect on
the Company's and the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting
practices. Their capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings
and other factors. Prompt corrective action provisions are not applicable
to bank holding companies.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and
ratios (set forth in the following table) of total and Tier 1 capital (as
defined in the regulations) to risk-weighted assets (as defined) and of
Tier 1 capital (as defined) to average assets (as defined). Management
believes, as of December 31, 2006 and 2005, that the Company and the Bank
meet all capital adequacy requirements to which they are subject.
F-30
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
MINIMUM REGULATORY CAPITAL REQUIREMENTS (Concluded)
As of December 31, 2006, the most recent notification from the Federal
Deposit Insurance Company categorized the Bank as well capitalized under
the regulatory framework for prompt corrective action. To be categorized
as well capitalized, an institution must maintain minimum total
risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in
the following tables. There are no conditions or events since the
notification that management believes have changed the Bank's category.
The Company's and the Bank's actual capital amounts and ratios as of
December 31, 2006 and 2005 are also presented in the table.
To Be Well Capitalized
Under Prompt Corrective
Actual Minimum Capital Requirement Action Provisions
----------------- --------------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------- ------ ------ ------ ------- -----
(Dollars in thousands)
As of December 31, 2006:
Total Capital to Risk Weighted
Assets:
Consolidated $64,343 15.25% $33,755 8.0% N/A N/A
Bank 57,485 13.67 33,654 8.0 $42,067 10.0%
Tier 1 Capital to Risk Weighted
Assets:
Consolidated 59,846 14.18 16,878 4.0 N/A N/A
Bank 52,988 12.60 16,827 4.0 25,240 6.0
Tier 1 Capital to Average
Assets:
Consolidated 59,846 9.90 24,184 4.0 N/A N/A
Bank 52,988 8.78 24,133 4.0 30,166 5.0
As of December 31, 2005:
Total Capital to Risk Weighted
Assets:
Consolidated $62,240 15.72% $31,668 8.0% N/A N/A
Bank 53,555 13.58 31,540 8.0 $39,425 10.0%
Tier 1 Capital to Risk Weighted
Assets:
Consolidated 58,014 14.66 15,834 4.0 N/A N/A
Bank 49,329 12.51 15,770 4.0 23,655 6.0
Tier 1 Capital to Average
Assets:
Consolidated 58,014 10.07 23,038 4.0 N/A N/A
Bank 49,329 8.56 23,038 4.0 28,797 5.0
F-31
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. EMPLOYEE BENEFIT PLANS
Pension Plan
The Company has a defined benefit plan that up to January 1, 1998 covered
substantially all of its full time employees who met certain eligibility
requirements. On January 1, 1998, the Bank suspended the plan so that
employees no longer earn additional defined benefits for future service.
The benefits paid are based on 1.5% of total salary plus .5% of
compensation in excess of the integration level per year of service. The
integration level was the first $750 of monthly compensation. The accrued
benefit is based on years of service. Information pertaining to the
activity in the plan is as follows:
Years Ended December 31,
--------------------------------------
2006 2005 2004
------ ------ ------
(In thousands)
Change in benefit obligation:
Benefit obligation at beginning of year $1,287 $1,663 $1,747
Interest cost 61 86 105
Actuarial loss 63 148 74
Settlements (535) (610) (263)
Benefits paid (1) -- --
------ ------ ------
Benefit obligation at end of year 875 1,287 1,663
------ ------ ------
Change in plan assets:
Fair value of plan assets at beginning of year 1,573 2,094 622
Actual return on plan assets 129 89 25
Employer contribution - - 1,710
Benefits paid (1) - -
Settlements (535) (610) (263)
Administrative expense (61) - -
------ ------ ------
Fair value of plan assets at end of year 1,105 1,573 2,094
------ ------ ------
Funded status 230 286 431
Unrecognized net actuarial loss - 583 687
------ ------ ------
Prepaid pension cost recognized on balance sheet $ 230 $ 869 $1,118
====== ====== ======
The assumptions used to determine the benefit obligation are as follows:
December 31,
--------------------
2006 2005
---- ----
Discount rate 6.00% 5.75%
Lump sum interest rate 5.25 -
F-32
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (Continued)
Pension Plan (Continued)
The components of net periodic pension cost are as follows:
Years Ended December 31,
-----------------------------------
2006 2005 2004
----- ----- -----
(In thousands)
Interest cost $ 61 $ 86 $ 105
Expected return on assets (106) (148) (107)
Settlements 280 276 109
Recognized net actuarial loss 26 35 42
----- ----- -----
$ 261 $ 249 $ 149
===== ===== =====
For the years ended December 31, 2005, 2004 and 2003, the assumptions
used to determine the
The assumptions used to determine net periodic pension cost are as
follows:
Years Ended December 31,
------------------------------
2006 2005 2004
---- ---- ----
Discount rate 5.75% 6.25% 6.25%
Expected long term rate of return on
plan assets 8.00 8.00 8.00
Lump sum interest rate 5.25 - -
The expected long-term rate of return on plan assets reflects
management's expectations of long-term average rates of returns on funds
invested to provide benefits included in the projected benefit
obligations. The expected rate of return is based on the outlook for
inflation, fixed income returns, and equity returns, which in turn is
based upon historical returns and asset allocation. Applying the actual
allocation percentages to the anticipated rate of return results in an
overall rate of compensation assumption of 8.00%.
The Company's pension plan weighted average asset allocations are as
follows:
Percentage of Plan Assets
at December 31,
-------------------------
2006 2005
------ ------
Asset Category
--------------
Equity securities 65.50% 65.50%
Debt securities 33.80 32.70
Money market funds 0.70 1.80
------ ------
Total 100.00% 100.00%
====== ======
F-33
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (Continued)
Pension Plan (Concluded)
Equity securities do not include any of the Company's common stock at
December 31, 2006 and 2005, respectively.
The investment portfolio serves as the primary source of earnings for the
defined benefit pension plan and provides the plan with a source of
liquidity. As funds are available to invest, the Company obtains the
recommendation from investment advisors regarding the best and most
suitable type of security to purchase. Debt securities are purchased with
the ability and intent to hold the security to its stated maturity, or in
the case of equity securities, viewed as a long-term hold. Securities may
be sold from time to time prior to maturity should liquidity requirements
necessitate the sale.
No contribution is expected for the plan year beginning January 1, 2007.
Estimated future benefit payments are as follows:
Years Ending December 31, Amount
------------------------- ------
(In thousands)
2007 $121
2008 16
2009 12
2010 11
2011 11
2012 - 2016 362
401(k) Plan
The Company has a 401(k) Plan whereby substantially all employees who
attain the age of 21 and complete three months of service are eligible to
participate in the Plan. Employees may contribute up to 100 percent of
their compensation subject to certain limits based on federal tax laws.
The Company makes matching contributions equal to 3 percent of the first
6 percent of an employee's compensation contributed to the Plan. Matching
contributions vest to the employee after a one-year period. For the years
ended December 31, 2006, 2005 and 2004, expense attributable to the Plan
amounted to $104,000, $97,000 and $104,000, respectively.
Employees who attain age 21 and complete one year of service (1,000
hours) are also eligible to receive profit sharing contributions under
the 401(k) plan. The Company contributes amounts at the Company's
discretion. Costs recognized by the Company for profit-sharing amounted
to $85,000, $114,000 and $101,000 for the years ended December 31, 2006,
2005 and 2004, respectively.
F-34
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (Continued)
Employment and Change of Control Agreements
The Company has entered into an Employment Agreement with the President
of the Company and two additional executive officers. Under the
agreements, the President and executive officers are entitled to
severance benefits upon a change-in-control as defined in the agreements.
The severance benefits include, among other things, the value of the cash
compensation, value of employer contributions to employer-provided
benefit plans and continued fringe benefits that the President would have
received had she worked an additional three years and the executive
officers would have received had they worked an additional two years. In
addition, the President and executive officers would be entitled to
accelerated vesting in other benefit plans upon a change of control or
termination without cause. The President would also be indemnified for
any impact from excise taxes due under Section 4999 of the Code, while
the executive officers would have any benefits limited to avoid excise
taxes under Section 4999 of the Code.
In October 2006 and December 2006, the Bank entered into Change of
Control Agreements with two additional executive officers of the Bank.
These agreements provide for a one-year severance payment upon a change
of control that results in a termination of the executives' employment.
Supplemental Retirement Plans
The Company has entered into supplemental retirement plans with certain
executive officers and directors that provide for supplemental benefits
commencing with retirement. The present value of estimated future
benefits payable is accrued over the required service periods. During
2006, the Company approved the termination of all supplemental plan
arrangements with its directors and accrued all termination benefits. For
the years ended December 31, 2006, 2005 and 2004, expense attributable to
the supplemental retirement plans amounted to $44,000, $40,000 and
$30,000, respectively.
In connection with the supplemental retirement plans, the Bank has
purchased life insurance policies applicable to the executive officers
and Directors included in the plans.
Endorsement Split-Dollar Life Insurance Arrangements
The Company is the sole owner of life insurance policies pertaining to
certain of the Company's executives. The Company has entered into
agreements with these executives whereby the Company will pay to the
executives' estates or beneficiaries a portion of the death benefit that
the Company will receive as beneficiary of such policies. No liability
has been recognized on the consolidated balance sheet for such death
benefits. In September 2006, the Emerging Issues Task Force reached a
consensus on Issue No. 06-4, "Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements." As a result, effective for fiscal years beginning after
December 15, 2007, the Company will be required to recognize a liability
for future death benefits, and may choose to retroactively apply the
accounting change to all periods presented, or to cumulatively adjust the
financial statements as of the beginning of the year of adoption.
Management is in the process of evaluating the impact of Issue No. 06-4
on the Company's consolidated financial statements. See Note 1 - Recent
Accounting Pronouncements.
F-35
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. STOCK COMPENSATION PLANS
Slade's Ferry Bancorp. Stock Option Plan (Stock Option Plan)
The Stock Option Plan includes a Discretionary Grant Program and an
Automatic Grant Program. The maximum number of shares of common stock
issuable over the term of the Stock Option Plan may not exceed 275,625
shares and the maximum aggregate number of shares issuable under both
programs in any plan year may not exceed 55,125 shares. The Stock Option
Plan expired on March 11, 2006.
Under the Discretionary Grant Program, key employees, including officers,
were granted incentive stock options to purchase shares of common stock
of the Company. The exercise price per share could not be less than one
hundred percent of the fair market value of common stock at the grant
date and options became exercisable upon grant. The maximum term of each
option was ten years.
The Automatic Grant Program was limited to non-employee directors of the
Company or its subsidiary. A non-statutory option for 2,000 shares of
common stock was granted each plan year to eligible directors. The
exercise price per share was equal to one hundred percent of the fair
market value of common stock at the grant date and options became
exercisable upon grant. The maximum term of each option was five years.
Slade's Ferry Bancorp. 2004 Equity Incentive Plan (2004 Plan)
The maximum number of shares of stock reserved and available for issuance
under the 2004 Plan is 300,000 shares, subject to adjustment as provided
in the Plan (through the application of certain anti-dilution
provisions); provided that not more than 100,000 shares shall be issued
in the form of Unrestricted Stock Awards, Restricted Stock Awards or
Deferred Stock Awards.
Stock options granted under the 2004 Plan may be either incentive stock
options or non-qualified stock options. The exercise price for incentive
stock options granted to employees shall not be less than 100 percent of
the fair market value at grant date. No stock option shall be exercisable
more than 10 years after the date the stock option is granted.
Each non-employee director who is serving as director of the Company on
the day after each annual meeting of shareholders or any special meeting
in lieu thereof, beginning with the 2004 annual meeting, shall
automatically be granted on such day a non-qualified stock option to
acquire 2,000 shares of stock with an exercise price equal to the fair
market value of the stock on date of grant. No stock option shall be
exercisable more than 10 years after the grant date.
Unrestricted Stock Awards may be granted in respect of past services or
other valid consideration. Restricted Stock Awards entitle the recipient
to acquire, at such purchase price as determined by the Company, shares
of stock subject to such restrictions and conditions as the Company may
determine at time of grant. A Deferred Stock Award is an award of a
restricted unit to a grantee, subject to restrictions and conditions as
the Company may determine at the time of grant. If any Restricted Stock
Award or Deferred Stock Award granted is intended to qualify as
"Performance-based Compensation", such Award shall comply with provisions
as set forth in the 2004 Plan. As of December 31, 2006, no Unrestricted
Stock Awards have been granted by the Company.
F-36
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK COMPENSATION PLANS (Concluded)
Slade's Ferry Bancorp. 2004 Equity Incentive Plan (2004 Plan) (Concluded)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions:
Years Ended December 31,
----------------------------------------------
2006 2005 2004
------- -------- -------
Expected Dividends 2.0% 1.9% 1.9%
Expected Term 5 years 10 years 9 years
Expected Volatility 24% 28% 27%
Risk-free interest rate 5.1% 4.2% 4.1%
The expected volatility is based on historical volatility. The risk-free
interest rates for periods within the contractual life of the awards are
based on the U.S. Treasury yield curve in effect at the time of the
grant. The expected life is based on historical exercise experience. The
dividend yield assumption is based on the Company's history and
expectation of dividend payouts.
A summary of options under the Plan as of December 31, 2006, and changes
during the year then ended, (shares in thousands) is presented below:
Weighted
Average
Remaining
Contractual
Weighted Average Term Aggregate
Shares Exercise Price (in years) Intrinsic Value
------------- ---------------- ------------ ---------------
Outstanding at January 1, 2006 255 $17.35
Granted 8 18.40
Exercised (28) 10.89
Forfeited (2) 18.85
Expired (2) 9.50
----- ------ ----- ----
Outstanding at December 31, 2006 231 18.18 4.3 $ -
===== ====== ===== ====
Exercisable at December 31, 2006 199 $18.04 4.1 $ -
===== ====== ===== ====
The weighted-average grant-date fair value of options granted during the
years ended December 31, 2006, 2005 and 2004 was $4.56, $6.46, and $6.08,
respectively. The total intrinsic value of options exercised during the
year ended December 31, 2006 was $200,000.
For the year ended December 31, 2006, stock-based compensation expense
applicable to the Plan was $235,000, and the recognized tax benefit
related to this expense was $51,000.
As of December 31, 2006, unrecognized stock-based compensation expense
related to nonvested options amounted to $61,000. This amount is expected
to be recognized during the year ending December 31, 2007.
When issuing shares upon the exercise of a stock option, the Company
issues new shares from the authorized but unissued pool.
F-37
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16. RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to
principal officers and directors and their affiliates amounting to
$10,448,000 at December 31, 2006 and $11,455,000 at December 31, 2005. In
addition, the beginning balance was decreased by $4,915,000 to account
for certain individuals who are no longer deemed to be related parties
and other non-material revisions. During the year ended December 31,
2006, total principal additions were $7,522,000 and total principal
payments were $3,614,000.
Deposits from related parties held by the Bank at December 31, 2006 and
2005 amounted to $4,231,000 and $3,867,000, respectively.
17. RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES
Federal and state banking regulations place certain restrictions on
dividends paid and loans or advances made by the Bank to the Company. The
total amount of dividends which may be paid at any date is generally
limited to the retained earnings of the Bank, and loans or advances are
limited to 10 percent of the Bank's capital stock and surplus on a
secured basis.
In addition, dividends paid by the Bank to the Company would be
prohibited if the effect thereof would cause the Bank's capital to be
reduced below applicable minimum capital requirements.
At December 31, 2006, the Bank's retained earnings available for the
payment of dividends was $5,474,000. Accordingly, $49,269,000 of the
Company's equity in the net assets of the Bank was restricted at December
31, 2006. Funds available for loans or advances by the Bank to the
Company amounted to $10,949,000.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that would
be exchanged between willing parties, other than in a forced liquidation.
Fair value is best determined based upon quoted market prices. However,
in many instances, there are no quoted market prices for the Company's
various financial instruments. In cases where quoted market prices are
not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected
by the assumptions used, including the discount rate and estimates of
future cash flows. Accordingly, the fair value estimates may not be
realized in an immediate settlement of the instrument. SFAS 107 excludes
certain financial instruments and all nonfinancial instruments from its
disclosure requirements. Accordingly, the aggregate fair value amounts
presented may not necessarily represent the underlying fair value of the
Company.
The following methods and assumptions were used by the Company in
estimating fair value disclosures for financial instruments:
Cash and cash equivalents - The carrying amounts of cash and cash
equivalents approximate fair values.
Interest-bearing certificates of deposit with other banks -The carrying
amounts of interest-bearing deposits maturing within ninety days
approximate their fair values. Fair values of other interest-bearing
deposits are estimated using discounted cash flow analyses based on
current rates for similar types of deposits.
Securities - Fair values for securities, excluding Federal Home Loan Bank
stock, are based on quoted market prices. The carrying value of Federal
Home Loan Bank stock approximates fair value based on the redemption
provisions of the Federal Home Loan Bank.
Loans receivable - For variable-rate loans that reprice frequently and
with no significant change in credit risk, fair values are based on
carrying values. Fair values for other loans are estimated using
discounted cash flow analyses, using interest rates currently being
offered for loans with similar terms to borrowers of similar credit
quality. Fair values for non-performing loans are estimated using
discounted cash flow analyses or underlying collateral values, where
applicable.
F-38
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Deposit liabilities - The fair values disclosed for demand deposits
(e.g., interest and noninterest checking, regular and other savings, and
certain types of money market accounts) are, by definition, equal to the
amount payable on demand at the reporting date (i.e., their carrying
amounts). The carrying amounts of variable-rate market accounts and
certificates of deposit approximate their fair values at the reporting
date. Fair values for fixed-rate certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated
expected monthly maturities on time deposits.
Short-term borrowings - For short-term borrowings maturing within ninety
days, carrying values approximate fair values. Fair values of other
short-term borrowings are estimated using discounted cash flow analyses
based on the Company's current incremental borrowing rates for similar
types of borrowing arrangements.
Long-term borrowings and subordinated debt - The fair values of the
Company's long-term borrowings and subordinated debt are estimated using
discounted cash flow analyses based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
Accrued interest - The carrying amounts of accrued interest approximate
fair value.
Off-balance sheet credit-related instruments - Fair values for
off-balance-sheet, credit related financial instruments are based on fees
currently charged to enter into similar agreements, taking into account
the remaining terms of the agreements and the counterparties' credit
standing and are not material.
The estimated fair values, and related carrying or notional amounts, of
the Company's financial instruments are as follows:
December 31,
-----------------------------------------------
2006 2005
--------------------- ---------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- -------- -------- --------
(In thousands)
Financial assets:
Cash and cash equivalents $ 22,355 $ 22,355 $ 20,018 $ 20,018
Interest-bearing certificates of deposit with
other banks 100 100 100 100
Securities available for sale 105,603 105,603 94,298 94,298
Securities held to maturity 24,623 24,219 29,306 28,858
Federal Home Loan Bank stock 6,856 6,856 6,304 6,304
Loans, net 422,370 418,980 409,610 403,712
Accrued interest receivable 2,311 2,311 2,298 2,298
Financial liabilities:
Deposits 424,006 424,008 415,846 415,728
Short-term borrowings - - 7,000 7,000
Long-term borrowings 119,058 119,165 100,865 101,035
Subordinated debt 10,310 10,310 10,310 10,310
F-39
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
19. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial information pertaining only to Slade's Ferry Bancorp. is as
follows:
December 31,
-------------------
2006 2005
------- -------
(In thousands)
BALANCE SHEETS
--------------
Assets
------
Cash and cash equivalents $ 834 $ 2,621
Securities available for sale 5,812 5,868
Investment in Bank subsidiary 54,743 50,480
Investment in Trust subsidiary 310 310
Other assets 365 266
------- -------
Total assets $62,064 $59,545
======= =======
Liabilities and Stockholders' Equity
------------------------------------
Subordinated debentures $10,310 $10,310
Accrued expenses and other liabilities 509 380
------- -------
Total liabilities 10,819 10,690
------- -------
Stockholders' equity 51,245 48,855
------- -------
Total liabilities and stockholders' equity $62,064 $59,545
======= =======
STATEMENTS OF INCOME
--------------------
Years Ended December 31,
--------------------------
2006 2005 2004
------ ------ ------
(In thousands)
Income:
Dividends from Bank subsidiary $1,125 $1,470 $1,440
Dividends from Trust subsidiary 25 19 10
Interest on investments 243 240 193
Management fee income from subsidiary 54 316 412
Loss on sale of asset (5) - -
Gain (loss) on sale of securities available
for sale, net (18) - 3
------ ------ ------
1,424 2,045 2,058
Operating expenses
(1,731) (1,256) (1,143)
------ ------ ------
Income (loss) before income taxes and
equity in undistributed net income of
subsidiaries (307) 789 915
Applicable income tax benefit (456) (231) (175)
------ ------ ------
149 1,020 1,090
Equity in undistributed net income of
Bank subsidiary 3,470 3,000 2,527
------ ------ ------
Net income $3,619 $4,020 $3,617
====== ====== ======
F-40
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (Concluded)
Years Ended December 31,
-----------------------------------------
2006 2005 2004
------- ------- -------
(In thousands)
Cash flows from operating activities:
Net income $ 3,619 $ 4,020 $ 3,617
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in undistributed net income of Bank subsidiary (3,470) (3,000) (2,527)
Loss on sale of asset 5 - -
(Increase) decrease in other assets (132) 437 (109)
Stock-based compensation 235 - -
Excess tax benefits from stock-based compensation 82 95 157
Loss (gain) on sales of available-for-sale securities 18 - (3)
Increase (decrease) in accrued expenses and other liabilities 129 (564) 46
------- ------- -------
Net cash provided by operating activities 486 988 1,181
------- ------- -------
Cash flows from investing activities:
Purchases of securities available for sale (921) - (3,183)
Proceeds from maturities of securities available for sale 982 500 -
Investment in Bank subsidiary - - (10,000)
Investment in Trust subsidiary - - (310)
Capital expenditures (54) - (48)
------- ------- -------
Net cash (used in) provided by investing activities 7 500 (13,541)
------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock 586 627 710
Stock options exercised 305 316 533
Dividends paid on common stock (1,506) (1,481) (1,453)
Retirement of shares of common stock - - (32)
Purchase of treasury stock (778) - -
Unearned compensation (887) - -
Proceeds from issuance of subordinated debentures - - 10,160
------- ------- -------
Net cash (used in) provided by financing activities (2,280) (538) 9,918
------- ------- -------
Net increase (decrease) in cash and cash equivalents (1,787) 950 (2,442)
Cash and cash equivalents at beginning of year 2,621 1,671 4,113
------- ------- -------
Cash and cash equivalents at end of year $ 834 $ 2,621 $ 1,671
======= ======= =======
F-41
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
20. QUARTERLY DATA (UNAUDITED)
Years Ended December 31,
-----------------------------------------------------------------------------------------
2006 2005
------------------------------------------- -------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------------------------------------------- -------------------------------------------
(In thousands, except per share date)
Interest and dividend income $ 8,821 $ 8,693 $ 8,030 $ 7,856 $ 7,691 $ 7,462 $ 7,109 $ 6,657
Interest expense (4,383) (4,029) (3,635) (3,291) (3,123) (2,980) (2,686) (2,206)
------------------------------------------- -------------------------------------------
Net interest income 4,438 4,664 4,395 4,565 4,568 4,482 4,423 4,451
Provision for loan losses - - - (39) (58) (44) (15) (50)
------------------------------------------- -------------------------------------------
Net interest income, after
provision for loan losses 4,438 4,664 4,395 4,526 4,510 4,438 4,408 4,401
Noninterest income 767 732 546 703 609 602 540 569
Noninterest expense (3,462) (3,738) (3,952) (3,750) (3,277) (3,682) (3,622) (3,315)
------------------------------------------- -------------------------------------------
Income before income taxes 1,743 1,658 989 1,479 1,842 1,358 1,326 1,655
Provision for income taxes (700) (615) (363) (572) (670) (458) (478) (555)
------------------------------------------- -------------------------------------------
Net income $ 1,043 $ 1,043 $ 626 $ 907 $ 1,172 $ 900 $ 848 $ 1,100
=========================================== ===========================================
Earnings per common share:
Basic $ 0.25 $ 0.25 $ 0.15 $ 0.22 $ 0.28 $ 0.22 $ 0.21 $ 0.27
=========================================== ===========================================
Diluted $ 0.25 $ 0.25 $ 0.15 $ 0.22 $ 0.28 $ 0.22 $ 0.21 $ 0.27
=========================================== ===========================================
F-42