SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
Quarterly Report Under Section 13 of the Securities Exchange Act of 1934
For quarter ended: June 30, 2004
Commission File No. 001-16101
BANCORP RHODE ISLAND, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
RHODE ISLAND 05-0509802
--------------------------------- -------------------
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
-------------------------------------------
(Address of Principal Executive Offices)
(401) 456-5000
------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Not Applicable
----------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes (X) No
--- ---
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of August 1, 2004:
--------------
Common Stock - Par Value $0.01 3,987,703 shares
------------------------------ ----------------
(class) (outstanding)
BANCORP RHODE ISLAND, INC.
FORM 10-Q
INDEX
PAGE NUMBER
-----------
Cover Page 1
Index 2
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Changes in
Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7 - 9
Item 2 Management's Discussion and Analysis 10 - 25
Item 3 Quantitative and Qualitative Disclosures About Market Risk 26 - 27
Item 4 Controls and Procedures 27
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 28
Item 2 Changes in Securities 28
Item 3 Defaults upon Senior Securities 28
Item 4 Submission of Matters to a Vote of Security Holders 28
Item 5 Other Information 29
Item 6 Exhibits and Reports on Form 8-K 29
Signature Page 30
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
June 30, December 31,
2004 2003
-------- ------------
(In thousands)
ASSETS:
Cash and due from banks $ 26,711 $ 27,084
Overnight investments 16,007 733
---------- ----------
Total cash and cash equivalents 42,718 27,817
Investment securities available for sale
(amortized cost of $115,629 and $96,828,
respectively) 115,157 98,595
Mortgage-backed securities available for sale
(amortized cost of $153,414 and $106,028,
respectively) 150,933 106,618
Stock in Federal Home Loan Bank of Boston 11,145 9,554
Loans receivable:
Commercial loans 370,224 332,266
Residential mortgage loans 329,131 366,230
Consumer and other loans 140,644 115,786
---------- ----------
Total loans 839,999 814,282
Less allowance for loan losses (11,475) (11,078)
---------- ----------
Net loans 828,524 803,204
Premises and equipment, net 13,031 12,457
Goodwill 10,766 10,766
Accrued interest receivable 5,637 5,597
Investment in bank-owned life insurance 15,811 15,491
Prepaid expenses and other assets 6,228 3,872
---------- ----------
Total assets $1,199,950 $1,093,971
========== ==========
LIABILITIES:
Deposits:
Demand deposit accounts $ 179,608 $ 159,916
NOW accounts 132,520 129,398
Money market accounts 16,624 16,937
Savings accounts 335,285 292,277
Certificate of deposit accounts 223,786 212,755
---------- ----------
Total deposits 887,823 811,283
Overnight and short-term borrowings 16,380 13,460
Federal Home Loan Bank of Boston borrowings 198,788 176,759
Subordinated deferrable interest debentures 18,558 13,403
Other liabilities 5,741 6,959
---------- ----------
Total liabilities 1,127,290 1,021,864
---------- ----------
SHAREHOLDERS' EQUITY:
Preferred stock, par value $0.01 per share,
authorized 1,000,000 shares:
Issued and outstanding: none -- --
Common stock, par value $0.01 per share,
authorized 11,000,000 shares:
Issued and outstanding 3,970,003 shares and
3,891,190 shares, respectively 40 39
Additional paid-in capital 42,450 41,439
Retained earnings 32,120 29,074
Accumulated other comprehensive income, net (1,950) 1,555
---------- ----------
Total shareholders' equity 72,660 72,107
---------- ----------
Total liabilities and shareholders'
equity $1,199,950 $1,093,971
========== ==========
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
2004 2003 2004 2003
---- ---- ---- ----
(In thousands, except per share data)
Interest and dividend income:
Commercial loans $ 5,670 $ 4,830 $ 10,879 $ 9,513
Residential mortgage loans 4,242 4,323 8,937 8,497
Consumer and other loans 1,552 1,336 2,981 2,625
Mortgage-backed securities 1,211 1,332 2,332 2,812
Investment securities 1,019 992 2,115 2,131
Overnight investments 42 45 65 84
Federal Home Loan Bank of Boston stock dividends 61 67 112 129
--------- --------- --------- ---------
Total interest and dividend income 13,797 12,925 27,421 25,791
--------- --------- --------- ---------
Interest expense:
NOW accounts 312 344 689 670
Money market accounts 50 24 105 52
Savings accounts 889 1,066 1,738 2,214
Certificate of deposit accounts 1,371 1,520 2,765 3,120
Overnight and short-term borrowings 31 38 66 89
Federal Home Loan Bank of Boston borrowings 1,772 1,799 3,525 3,561
Subordinated deferrable interest debentures 261 -- 480 --
Company-obligated mandatorily redeemable capital securities -- 140 -- 277
--------- --------- --------- ---------
Total interest expense 4,686 4,931 9,368 9,983
--------- --------- --------- ---------
Net interest income 9,111 7,994 18,053 15,808
Provision for loan losses 200 400 500 800
--------- --------- --------- ---------
Net interest income after provision for loan losses 8,911 7,594 17,553 15,008
--------- --------- --------- ---------
Noninterest income:
Service charges on deposit accounts 1,206 1,043 2,218 1,995
Commissions on nondeposit investment products 268 232 446 406
Income from bank-owned life insurance 154 205 319 408
Loan related fees 96 339 205 443
Commissions on loans originated for others 23 94 40 203
Gain on sale of investment securities 144 279 341 333
Gain on sale of mortgage-backed securities -- -- -- 104
Other income 315 202 635 418
--------- --------- --------- ---------
Total noninterest income 2,206 2,394 4,204 4,310
--------- --------- --------- ---------
Noninterest expense:
Salaries and employee benefits 4,129 3,746 8,022 7,044
Occupancy 652 587 1,332 1,190
Equipment 402 377 788 713
Data processing 722 801 1,392 1,646
Marketing 420 298 775 595
Professional services 357 385 642 662
Loan servicing 253 210 531 438
Loan workout and other real estate owned expense 48 (14) 70 1
Other expenses 997 955 2,003 1,929
--------- --------- --------- ---------
Total noninterest expense 7,980 7,345 15,555 14,218
--------- --------- --------- ---------
Income before income taxes 3,137 2,643 6,202 5,100
Income tax expense 1,042 881 2,043 1,666
--------- --------- --------- ---------
Net income $ 2,095 $ 1,762 $ 4,159 $ 3,434
========= ========= ========= =========
Per share data:
Basic earnings per common share $ 0.53 $ 0.47 $ 1.05 $ 0.91
Diluted earnings per common share $ 0.50 $ 0.43 $ 0.99 $ 0.85
Average common shares outstanding - basic 3,966,526 3,787,881 3,956,597 3,783,444
Average common shares outstanding - diluted 4,214,017 4,053,902 4,203,771 4,036,645
See accompanying notes to consolidated financial statements
4
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity
Accumulated
Other
Compre-
Additional hensive
Common Paid-in Retained Income,
Six months ended June 30, Stock Capital Earnings Net Total
------ ---------- -------- ----------- -----
(In thousands)
2003
----
Balance at December 31, 2002 $38 $40,134 $24,002 $ 2,253 $66,427
Net income -- -- 3,434 -- 3,434
Other comprehensive income,
net of tax:
Unrealized holding gain on
securities available for sale,
net of taxes of $305 567 567
Reclassification adjustment,
net of taxes of $153 (284) (284)
-------
Comprehensive income 3,717
Exercise of stock options -- 134 -- -- 134
Exercise of stock warrants -- 100 -- -- 100
Common stock issued for incentive
stock award, net -- 17 -- -- 17
Dividends on common stock -- -- (1,061) -- (1,061)
--- ------- ------- ------- -------
Balance at June 30, 2003 $38 $40,385 $26,375 $ 2,536 $69,334
=== ======= ======= ======= =======
2004
----
Balance at December 31, 2003 $39 $41,439 $29,074 $ 1,555 $72,107
Net income -- -- 4,159 -- 4,159
Other comprehensive income,
net of tax:
Unrealized holding losses on
securities available for sale,
net of taxes of $1,690 (3,280) (3,280)
Reclassification adjustment,
net of taxes of $116 (225) (225)
-------
Comprehensive income 654
Exercise of stock options -- 294 -- -- 294
Exercise of stock warrants 1 699 -- -- 700
Common stock issued for incentive
stock award, net -- 18 -- -- 18
Dividends on common stock -- -- (1,113) -- (1,113)
--- ------- ------- ------- -------
Balance at June 30, 2004 $40 $42,450 $32,120 $(1,950) $72,660
=== ======= ======= ======= =======
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
Six Months Ended
June 30,
---------------------
2004 2003
---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 4,159 $ 3,434
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization 1,982 2,063
Provision for loan losses 500 800
Gain on sale of investment securities (341) (333)
Gain on sale of mortgage-backed securities -- (104)
Gain on sale of other real estate owned -- (15)
Income from bank-owned life insurance (319) (408)
Compensation expense from restricted stock grant 18 17
(Increase) decrease in:
Accrued interest receivable (40) 497
Prepaid expenses and other assets (551) (519)
Increase (decrease) in:
Other liabilities (1,218) 1,569
Other, net 10 21
-------- --------
Net cash provided (used) by operating activities 4,200 7,022
-------- --------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (5,039) (12,144)
Commercial loans (50,361) (50,002)
Consumer loans (49,080) (28,581)
Purchase of:
Investment securities available for sale (43,993) (27,826)
Mortgage-backed securities available for sale (74,545) (53,834)
Residential mortgage loans (27,445) (112,291)
Federal Home Loan Bank of Boston stock (1,591) (1,251)
Principal payments on:
Investment securities available for sale 21,000 32,139
Mortgage-backed securities available for sale 26,923 52,325
Residential mortgage loans 69,167 91,519
Commercial loans 12,423 17,024
Consumer loans 24,051 17,102
Proceeds from sale of investment securities 4,372 14,394
Proceeds from sale of mortgage-backed securities -- 25,164
Proceeds from sale of other real estate owned -- 56
Capital expenditures for premises and equipment (1,706) (3,098)
-------- --------
Net cash provided (used) by investing activities (95,824) (39,304)
-------- --------
Cash flows from financing activities:
Net increase in deposits 76,540 21,026
Net increase (decrease) in overnight and short-term borrowings 2,920 (13,758)
Proceeds from long-term borrowings 55,155 79,750
Repayment of long-term borrowings (27,971) (55,998)
Proceeds from issuance of common stock 994 234
Dividends on common stock (1,113) (1,061)
-------- --------
Net cash provided (used) by financing activities 106,525 30,193
-------- --------
Net increase (decrease) in cash and cash equivalents 14,901 (2,089)
Cash and cash equivalents at beginning of period 27,817 42,959
-------- --------
Cash and cash equivalents at end of period $ 42,718 $ 40,870
======== ========
Supplementary Disclosures:
Cash paid for interest $ 8,887 $ 10,150
Cash paid for income taxes 2,840 2,162
Non-cash transactions:
Change in other comprehensive income, net of taxes (3,505) 283
See accompanying notes to consolidated financial statements
6
BANCORP RHODE ISLAND, INC.
Notes to Consolidated Financial Statements
(1) Basis of Presentation
Bancorp Rhode Island, Inc. (the "Company"), a Rhode Island
corporation, was organized by Bank Rhode Island (the "Bank") to be a bank
holding company and to acquire all of the capital stock of the Bank. The
reorganization of the Bank into the holding company form of ownership was
completed on September 1, 2000. The Company has no significant operating
entities other than the Bank. For that reason, substantially all of the
discussion in this Quarterly Report on Form 10-Q relates to the operations
of the Bank and its subsidiaries.
Beginning December 31, 2003, the consolidated financial statements
include the accounts of the Company and its wholly-owned direct subsidiary,
the Bank, and its indirect subsidiaries, BRI Investment Corp. (a Rhode
Island passive investment company), BRI Realty Corp. (a real estate holding
company) and Acorn Insurance Agency, Inc. (a licensed insurance agency).
The Company adopted Financial Accounting Standards Board ("FASB")
Interpretation 46-R, "Consolidation of Variable Interest Entities - Revised"
on December 31, 2003, and therefore has deconsolidated its statutory trust
subsidiaries as of that date. The Consolidated Statement of Operations for
the 2003 periods also includes the results of BRI Statutory Trusts I, II and
III (issuers of trust preferred securities). All significant intercompany
accounts and transactions have been eliminated in consolidation.
The interim results of consolidated operations are not necessarily
indicative of the results for any future interim period or for the entire
year. These interim consolidated financial statements do not include all
disclosures associated with annual financial statements and, accordingly,
should be read in conjunction with the annual consolidated financial
statements and accompanying notes included in the Company's Annual Report to
Shareholders filed with the Securities and Exchange Commission.
In preparing the consolidated financial statements, 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 revenues
and expenses for the period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to change
relate to the determination of the allowance for loan losses and goodwill
valuation.
The unaudited interim consolidated financial statements of the Company
have been prepared in accordance with Accounting Principles Generally
Accepted in the United States of America ("GAAP") and prevailing practices
within the banking industry and include all necessary adjustments
(consisting of only normal recurring adjustments), that, in the opinion of
management, are required for a fair presentation of the results and
financial condition of the Company.
(2) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and resulted in the issuance of additional
common stock that then shared in the earnings of the entity.
7
(3) Stock Based Compensation
In December 2002, the FASB issued Statement of Financial Accounting
Standards ("SFAS") 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure". SFAS 148 amends SFAS 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-
based employee compensation. Companies are able to eliminate a "ramp-up"
effect that the SFAS 123 transition rule creates in the year of adoption.
Companies can choose to elect a method that will provide for comparability
amongst years reported. In addition, this Statement amends the disclosure
requirement of SFAS 123 to require prominent disclosures in both annual and
interim financial statements about the fair value based method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. The amendments to SFAS 123 are effective for financial
statements for fiscal years ending after December 15, 2002. The adoption of
this Statement did not have a material impact on the Company's financial
position or results of operations at adoption, but may have a material
impact sometime in the future if the Company were to elect the alternative
method for accounting for stock-based employee compensation.
On March 31, 2004, the FASB issued Exposure Draft "Share-Based Payment
- An Amendment to FASB Statement No. 123 and 95." The Exposure Draft
concluded that all companies should expense the fair value of employee stock
options using the modified prospective grant-date measurement approach as
defined in SFAS 123. Compensation cost would be recognized in the financial
statements over the requisite service period. A final Statement is expected
in the second half of 2004, which could become effective in 2005. Until a
new Statement is issued, the provisions of SFAS 123 and SFAS 148 remain in
effect.
The following table summarizes the differences between the fair value
and intrinsic value methods of accounting for stock-based compensation:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net income (in thousands):
As reported $2,095 $1,762 $4,159 $3,434
Compensation cost, net of taxes (1) (187) (72) (241) (95)
------ ------ ------ ------
Pro forma $1,908 $1,690 $3,918 $3,339
====== ====== ====== ======
Earnings per common share:
Basic:
As reported $ 0.53 $ 0.47 $ 1.05 $ 0.91
Compensation cost, net of taxes (1) (0.05) (0.02) (0.06) (0.03)
------ ------ ------ ------
Pro forma $ 0.48 $ 0.45 $ 0.99 $ 0.88
====== ====== ====== ======
Diluted:
As reported $ 0.50 $ 0.43 $ 0.99 $ 0.85
Compensation cost, net of taxes (1) (0.04) (0.01) (0.06) (0.02)
------ ------ ------ ------
Pro forma $ 0.46 $ 0.42 $ 0.93 $ 0.83
====== ====== ====== ======
The stock-based employee compensation cost, net of related tax
effects, that would have been included in the determination of net
income if the fair value based method had been applied to all awards
granted since 1995. The fair value of each option granted was
estimated as of the date of the grant using the Black-Scholes option-
pricing model.
8
(4) Supplemental Executive Retirement Plans
The Bank maintains Supplemental Executive Retirement Plans ("SERPs")
for certain of its senior executives under which participants designated by
the Board of Directors are entitled to an annual retirement benefit.
Expenses associated with the SERPs were $218,000 and $183,000 for the six
months ending June 30, 2004 and 2003, respectively. Accrued liabilities
associated with the SERPs were $1.1 million and $834,000 for June 30, 2004
and December 31, 2003, respectively.
(5) Recent Accounting Developments
At the November 2003 meeting of FASB's Emerging Issues Task Force
("EITF"), the EITF reached consensus on EITF Issue 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
The consensus requires new disclosure requirements for holders of debt or
marketable equity securities that are accounted for under SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities." The new
disclosure requirements relate to temporarily impaired investments and are
effective for fiscal years ending after December 15, 2003. The requirements
apply only to annual financial statements and comparative disclosures for
prior periods are not required. The Company adopted the EITF's
recommendations on December 31, 2003, and has provided additional
disclosures regarding any possible other-than-temporarily impaired
investments in the footnotes to its 2003 Annual Report to Shareholders.
Adoption of these recommendations did not have a material impact on the
Company's financial position or results of operations.
In December 2003, the FASB issued FASB Interpretation ("FIN") 46-R,
"Consolidation of Variable Interest Entities - Revised." FIN 46-R revises
FIN 46, "Consolidation of Variable Interest Entities" which is an
interpretation of Accounting Research Bulletin 51, "Consolidated Financial
Statements." FIN 46-R provides guidance regarding the consolidation of
special purpose entities, and removed uncertainty over whether FIN 46
required consolidation or deconsolidation of special purpose entities that
issue trust preferred securities. FIN 46-R clarified that even those
entities that issue trust preferred securities with call options must be
deconsolidated. FIN 46-R is effective for financial statements for periods
ending after December 15, 2003, with no requirement for restatement of
previous periods. The Company adopted FIN 46-R on December 31, 2003, and
therefore has deconsolidated its statutory trust subsidiaries as of that
date. Adoption of this Interpretation did not have a material impact on the
Company's financial position or results of operations.
9
BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis
ITEM 2. Management's Discussion and Analysis
Certain statements contained herein are "Forward Looking Statements" within
the meaning of the Private Securities Litigation Reform Act of 1995.
Forward Looking Statements may be identified by reference to a future period
or periods or by the use of forward looking terminology such as "may,"
"believes," "intends," "expects," and "anticipates" or similar terms or
variations of these terms. Actual results may differ materially from those
set forth in Forward Looking Statements as a result of certain risks and
uncertainties, including but not limited to, changes in political and
economic conditions, interest rate fluctuations, competitive product and
pricing pressures, equity and bond market fluctuations, credit risk,
inflation, as well as other risks and uncertainties detailed from time to
time in filings with the Securities and Exchange Commission ("SEC").
GENERAL
-------
The Company's principal subsidiary, Bank Rhode Island, is a commercial
bank chartered as a financial institution in the State of Rhode Island. The
Bank pursues a community banking mission and is principally engaged in
providing banking products and services to individuals and businesses in
Rhode Island and nearby areas of Massachusetts. The Bank is subject to
competition from a variety of traditional and nontraditional financial
service providers both within and outside of Rhode Island. The Bank offers
its customers a wide range of deposit products, nondeposit investment
products, commercial, residential and consumer loans, and other traditional
banking products and services designed to meet the needs of individuals and
small- to mid-sized businesses. The Bank also offers both commercial and
consumer on-line banking products and maintains a web site at
http://www.bankri.com. The Company and Bank are subject to regulation by a
number of federal and state agencies and undergo periodic examinations by
certain of those regulatory authorities. The Bank's deposits are insured by
the Federal Deposit Insurance Corporation ("FDIC"), subject to regulatory
limits. The Bank is also a member of the Federal Home Loan Bank of Boston
("FHLB").
OVERVIEW
--------
The Company's operating results depend primarily on two factors: its
"net interest income" and the quality of its assets.
The Company's net interest income is the difference between its
interest income and its cost of money. Interest income depends on the
amount of interest-earning assets outstanding during the year and the
interest rates earned thereon. Cost of money is a function of the average
amount of deposits and borrowed money outstanding during the year and the
interest rates paid thereon. See discussion under "Results of Operations."
Because the Company's assets are not identical in duration and in repricing
dates to its liabilities, the spread between the two is vulnerable to
changes in market interest rates. This vulnerability is inherent to the
business of banking and is commonly referred to as "interest rate risk."
How to measure such risk and, once measured, how much risk to take are based
on numerous assumptions and other subjective judgments. See discussion
under "Interest Rate Risk."
The quality of the Company's assets also influences its earnings.
Loans that are not being paid on a timely basis and exhibit other weaknesses
can result in the loss of principal and/or interest
10
income. Additionally, the Company must make timely provisions to its loan
loss reserve as a result of its estimates as to potential future losses;
these additions, which are charged against earnings, are necessarily greater
when greater potential losses are expected. Finally, the Company will incur
expenses as a result of resolving troubled assets. All of these form the
"credit risk" that the Company assumes in the ordinary course of its
business and is further discussed under "Financial Condition - Asset
Quality."
The Company's business strategy has been to concentrate its asset
generation efforts on commercial loans and its deposit generation efforts on
checking and savings accounts. These deposit accounts are commonly referred
to as "core accounts." This strategy is based on the Company's belief that
it can distinguish itself from its larger competitors, and indeed attract
customers from them, through a higher level of service and its ability to
set policies and procedures, as well as make decisions, locally. The loan
and deposit products referenced also tend to be geared more toward customers
who are relationship oriented than those who are seeking stand-alone or
single transaction products. The Company believes that its service-oriented
approach enables it to compete successfully for relationship-oriented
customers. Additionally, the Company is predominantly an urban franchise
with a high concentration of businesses, making deployment of funds in the
commercial lending area practicable. Commercial loans are attractive, among
other reasons, because of their higher yields. Similarly, core deposits are
attractive because of their generally lower interest cost.
In recent years, the Company also has sought to promote business
opportunities presented by its customer base, franchise footprint and system
resources through increased efforts in both the areas of consumer lending
and residential mortgage originations.
Currently, approximately 80% of the Company's revenues are dependent
on its level of net interest income. In an effort to diversify its sources
of revenue, the Company has attempted to expand its sources of noninterest
income, primarily fees and charges for products and services it offers. The
Company has increased its percentage of noninterest income to total revenue
from 13% in 1999, to 21% in 2003, by emphasizing core deposit growth which
generates increased service charges, and by introducing additional financial
services, such as nondeposit investment products. Future operating results
will depend on the Company's ability to maintain and expand its net interest
margin, while minimizing its exposure to credit risk, along with increasing
its sources of noninterest income, while controlling the growth of its
noninterest or operating expenses.
Total assets increased $106.0 million, or 9.7%, to $1.2 billion at
June 30, 2004 from December 31, 2003. This increase was centered in the
Company's commercial and consumer loan portfolios, along with its investment
and mortgage-backed security portfolios, and was funded primarily by a
combination of deposit and borrowings growth. Since the end of 2003,
commercial loans increased $38.0 million, or 11.4%, consumer loans increased
$24.9 million, or 21.5%, checking deposits (demand deposits and NOW
accounts) increased $22.8 million, or 7.9%, savings accounts increased $43.0
million, or 14.7%, certificates of deposit increased $11.0 million, or 5.2%,
and total borrowings increased $30.1 million, or 14.8%. Shareholders'
equity was $72.7 million at June 30, 2004, and represented 6.1% of total
assets, compared to $72.1 million, or 6.6% of total assets, at December 31,
2003.
11
CRITICAL ACCOUNTING POLICIES
----------------------------
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying
value of certain assets or net income, are considered critical accounting
policies. The Company considers the following to be its critical accounting
policies: allowance for loan losses and review of goodwill for impairment.
There have been no significant changes in the methods or assumptions used in
accounting policies that require material estimates or assumptions.
Allowance for loan losses
Arriving at an appropriate level of allowance for loan losses
necessarily involves a significant degree of judgment. First and foremost
in arriving at an appropriate allowance is the creation and maintenance of a
risk rating system that accurately classifies all loans into varying
categories by degree of credit risk. Such a system also establishes a level
of allowance associated with each category of loans and requires early
identification and reclassification of deteriorating credits. Besides
numerous subjective judgments as to the number of categories, appropriate
level of allowance with respect to each category and judgments as to
categorization of any individual loan, additional subjective judgments are
involved when ascertaining the probability as well as the extent of any
potential losses. The Company's ongoing evaluation process includes a
formal analysis of the allowance each quarter, which considers, among other
factors, the character and size of the loan portfolio, business and economic
conditions, loan growth, delinquency trends, nonperforming loan trends,
charge-off experience and other asset quality factors. These factors are
based on observable information, as well as subjective assessment and
interpretation. Nonperforming commercial, commercial real estate and small
business loans in excess of a specified dollar amount are deemed to be
"impaired." The estimated reserves necessary for each of these credits is
determined by reviewing the fair value of the collateral, the present value
of expected future cash flows, and where available, the observable market
price of the loans. Provisions for losses on the remaining commercial,
commercial real estate, small business, residential mortgage and consumer
loans are based on pools of similar loans using a combination of payment
status, historical loss experience, industry loss experience, market
economic factors, delinquency rates and qualitative adjustments. Management
uses available information to establish the allowance for loan losses at the
level it believes is appropriate. However, future additions to the
allowance may be necessary based on changes in estimates or assumptions
resulting from changes in economic conditions and other factors. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to recognize adjustments to
the allowance based on their judgments about information available to them
at the time of their examination.
Review of goodwill for impairment
In March 1996, the Bank acquired certain assets and assumed certain
liabilities from Fleet National Bank of Connecticut and related entities.
This acquisition was accounted for utilizing the purchase method of
accounting and generated $17.5 million of goodwill. This goodwill was
amortized in the years prior to 2002, resulting in a net balance of $10.8
million on the Company's balance sheet as of December 31, 2001. Effective
January 1, 2002, in accordance with SFAS 142 "Goodwill and Other Intangible
Assets" and SFAS 147 "Acquisitions of Certain Financial Institutions", the
Company was required to cease amortizing this goodwill and to review it at
least annually for impairment. Goodwill is evaluated for impairment using
market value comparisons for similar institutions, such as price to earnings
multiples, price to deposit multiples and price to equity
12
multiples. This valuation technique utilizes verifiable market multiples,
as well as subjective assessment and interpretation. The application of
different market multiples, or changes in judgment as to which market
transactions are reflective of the Company's specific characteristics, could
affect the conclusions reached regarding possible impairment. In the event
that the Company were to determine that its goodwill were impaired, the
recognition of an impairment charge could have an adverse impact on its
results of operations in the period that the impairment occurred or on its
financial position.
13
FINANCIAL CONDITION
-------------------
-- Investments. Total investments (consisting of overnight
investments, investment securities, mortgage-backed securities ("MBSs"), and
stock in the FHLB) totaled $293.2 million, or 24.4% of total assets, at June
30, 2004, compared to $215.5 million, or 19.7% of total assets, at December
31, 2003. All $266.1 million of investment securities and MBSs at June 30,
2004 were classified as available for sale and carried a total of $3.0
million in net unrealized losses at the end of June. The increase in total
investments of $77.7 million, or 36.1%, since the end of last year was the
result of cash inflows from deposit growth, residential loan prepayments and
borrowings being partially deployed in investments.
-- Loans. Total loans were $840.0 million, or 70.0% of total assets,
at June 30, 2004, compared to $814.3 million, or 74.4% of total assets, at
December 31, 2003. The Company attempts to concentrate its asset growth in
its loan portfolios to maximize the yield on new assets and to take
advantage of continued strong demand for both commercial and home equity
loan products in its market area.
The commercial loan portfolio (consisting of commercial & industrial,
small business, leases, commercial real estate, multi-family real estate,
and construction loans) increased $38.0 million, or 11.4%, during the first
half of 2004. The Company believes it is well positioned for continued
commercial loan growth. Particular emphasis is placed on generation of
small- to medium-sized commercial relationships (those relationships with
$7.0 million or less in loan commitments). The Company is also active in
small business lending (loans of $250,000 or less) in which it utilizes
credit scoring, in conjunction with traditional review standards, and
employs streamlined documentation. The Bank is a participant in the U.S.
Small Business Administration ("SBA") Preferred Lender Program in Rhode
Island and the 7a Guarantee Loan Program in Massachusetts. From time to
time, the Company also invests in short-term leases. These leases are
primarily with the U.S. Government and its agencies. All leases are
structured to achieve payment in full over the term of the lease and, absent
default, are not dependent on residual collateral values.
The consumer loan portfolio increased $24.9 million, or 21.5%, during
the first two quarters of 2004. This growth has been centered in ten- to
twenty-year fixed-rate home equity loans with maximum loan-to-values of 85%.
In the current interest rate environment, these fixed-rate products provide
an attractive alternative to first-mortgage refinances and the Company
anticipates that growth in this product will continue.
While origination efforts continue to be concentrated on commercial
and consumer loan opportunities, the Company also originates residential
mortgage loans on a limited basis. Additionally, until such time as the
Company can generate sufficient commercial and consumer loans to utilize
available cash flow, or to otherwise meet investment objectives, it also
intends to continue purchasing residential mortgage loans as opportunities
develop.
The residential mortgage loan portfolio decreased $37.1 million, or
10.1%, since the beginning of the year as repayments ($69.2 million) were
greater than originations ($5.0 million) and purchases ($27.4 million).
Before purchasing residential mortgage loans, the Company performs a risk-
adjusted analysis of the whole loans compared to MBSs and purchases the
residential whole loans if there is sufficient spread versus the securitized
product. During the second quarter of 2004, spreads on residential whole
loans tightened and the Company believed that MBSs were a more attractive
investment. As a result, the Company reduced its purchasing of residential
mortgage loans and
14
increased its purchasing of MBSs. At June 30, 2004, the Company did not
have any commitments to purchase residential mortgage loans in the next 60
days.
The following is a breakdown of loans receivable:
June 30, December 31,
2004 2003
-------- ------------
(In thousands)
Commercial loans:
Commercial real estate - nonowner occupied $ 83,911 $ 78,083
Commercial real estate - owner occupied 84,699 77,317
Commercial and industrial 81,625 67,925
Small business 32,814 30,429
Multi-family real estate 32,107 28,730
Construction 34,015 30,632
Leases and other 21,430 19,548
-------- --------
Subtotal 370,601 332,664
Net deferred loan origination fees (377) (398)
-------- --------
Total commercial loans $370,224 $332,266
======== ========
Residential mortgage loans:
One- to four-family adjustable rate $201,872 $232,543
One- to four-family fixed rate 125,529 131,743
-------- --------
Subtotal 327,401 364,286
Premium on loans acquired 1,812 2,026
Net deferred loan origination fees (82) (82)
-------- --------
Total residential mortgage loans $329,131 $366,230
======== ========
Consumer loans:
Home equity - term loans $ 91,457 $ 68,523
Home equity - lines of credit 45,239 42,067
Automobile 897 1,455
Installment 483 662
Savings secured 369 631
Unsecured and other 1,344 1,787
-------- --------
Subtotal 139,789 115,125
Premium on loans acquired 27 44
Net deferred loan origination costs 828 617
-------- --------
Total consumer loans $140,644 $115,786
======== ========
Total loans receivable $839,999 $814,282
======== ========
15
-- Deposits and Borrowings. Total deposits increased by $76.5
million, or 9.4%, during the first half of 2004, from $811.3 million, or
74.2% of total assets, at December 31, 2003, to $887.8 million, or 74.0% of
total assets, at June 30, 2004. The slight decrease in the relative
percentage of total assets resulted from a portion of the Company's asset
growth being funded by FHLB borrowings and subordinated deferrable interest
debentures. In addition, the composition of total deposits changed during
2004. Core deposit accounts (checking and savings) increased $65.5 million,
or 10.9%, in the first half of 2004, while certificates of deposit increased
$11.0 million, or 5.2%, during this time period. The Bank continues its
strategy of emphasizing core deposit growth over certificate of deposit
growth, but from time-to-time will promote certificates of deposit. At June
30, 2004, core deposit accounts comprised 74.8% of total deposits, compared
to 73.8% of total deposits at December 31, 2003.
The following table sets forth certain information regarding deposits:
June 30, 2004 December 31, 2003
--------------------------------- --------------------------------
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
------ ------- -------- ------ ------- --------
(Dollars in thousands)
NOW accounts $132,520 14.9% 0.90% $129,398 16.0% 1.13%
Money market accounts 16,624 1.9% 1.25% 16,937 2.1% 1.29%
Savings accounts 335,285 37.8% 1.22% 292,277 36.0% 1.18%
Certificate of deposit accounts 223,786 25.2% 2.49% 212,755 26.2% 2.55%
-------- ----- -------- -----
Total interest bearing deposits 708,215 79.8% 1.56% 651,367 80.3% 1.62%
Noninterest bearing accounts 179,608 20.2% -- 159,916 19.7% --
-------- ----- -------- -----
Total deposits $887,823 100.0% 1.25% $811,283 100.0% 1.30%
======== ===== ==== ======== ===== ====
The Company, through the Bank's membership in the FHLB, has access to
a variety of borrowing alternatives, and management will from time-to-time
take advantage of these opportunities to fund asset growth. During the
first half of 2004, FHLB borrowings increased $22.0 million, or 12.5%, as
the Company sought to take advantage of lower borrowing rates to fund a
portion of its asset growth. The proceeds from these new borrowings were
primarily reinvested in the purchase of MBSs and allowed the Company to
continue to grow its balance sheet. However, on a long-term basis, the
Company intends to continue concentrating on increasing its core deposits.
In March 2004, the Company issued $5.2 million of subordinated
deferrable interest debentures to a related entity, which in turn issued
trust preferred securities. This transaction generated $5.0 million of Tier
I capital for regulatory purposes that can be used to support continued
growth of the Company.
Asset Quality
-------------
The definition of nonperforming assets includes nonperforming loans
and other real estate owned ("OREO"). OREO consists of real estate acquired
through foreclosure proceedings and real estate acquired through acceptance
of a deed in lieu of foreclosure. Nonperforming loans are defined as
nonaccrual loans, loans past due 90 days or more, but still accruing and
impaired loans. Under certain circumstances the Company may restructure the
terms of a loan as a concession to a borrower. These restructured loans are
considered impaired loans.
-- Nonperforming Assets. At June 30, 2004, the Company had
nonperforming assets of $381,000, which represented 0.03% of total assets.
This compares to nonperforming assets of $2.5
16
million, or 0.23% of total assets, at December 31, 2003. The decline in
nonperforming assets was primarily the result of the successful resolution
of a commercial relationship aggregating $2.1 million. Total nonperforming
assets at June 30, 2004, consisted of nonaccrual residential mortgage loans
aggregating $173,000 and nonaccrual commercial loans aggregating $208,000.
Included in nonaccrual loans were $148,000, at June 30, 2004, and $2.1
million, at December 31, 2003, of impaired loans. There were no specific
reserves necessary against impaired loans at either June 30, 2004 or
December 31, 2003. The Company evaluates the underlying collateral of each
nonperforming loan and continues to pursue the collection of interest and
principal. Management believes that the current level of nonperforming
assets is very low relative to the size of the Company's loan portfolio. As
the loan portfolio continues to grow and mature, or if economic conditions
worsen, management believes it possible that the level of nonperforming
assets will increase, as will its level of charged-off loans.
Delinquencies. At June 30, 2004, loans with an aggregate balance of
$9,000 were 60 to 89 days past due, a decrease of $588,000, or 98.5%, from
the $597,000 reported at December 31, 2003. The majority of these loans at
December 31, 2003 were residential mortgage loans and were secured. As with
the level of nonperforming assets, management believes the level of
delinquent loans is unusually low and that as the loan portfolio continues
to grow and mature, or if economic conditions worsen, delinquencies could
increase.
The following table sets forth information regarding nonperforming
assets and loans 60-89 days past due as to interest at the dates indicated.
June 30, December 31,
2004 2003
-------- ------------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $ 381 $2,462
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
----- ------
Total nonperforming loans 381 2,462
Other real estate owned -- --
----- ------
Total nonperforming assets $ 381 $2,462
===== ======
Delinquent loans 60-89 days past due $ 9 $ 597
Nonperforming loans as a percent of total loans 0.05% 0.30%
Nonperforming assets as a percent of total assets 0.03% 0.23%
Delinquent loans 60-89 days past due as a percent of total loans 0.00% 0.07%
Adversely Classified Assets. The Company's management adversely
classifies certain assets as "substandard," "doubtful" or "loss" based on
criteria established under banking regulations. An asset is considered
substandard if inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Substandard
assets include those characterized by the "distinct possibility" that the
insured institution will sustain "some loss" if existing deficiencies are
not corrected. Assets classified as doubtful have all of the weaknesses
inherent in those classified substandard with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the
basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as loss are those
considered "uncollectible" and of such little value that their continuance
as assets without the establishment of a specific loss reserve is not
warranted.
17
At June 30, 2004, the Company had $3.5 million of assets that were
classified as substandard. This compares to $5.5 million of assets that
were classified as substandard at December 31, 2003. The Company had no
assets that were classified as doubtful or loss at either date. Performing
loans may or may not be adversely classified depending upon management's
judgment with respect to each individual loan. At June 30, 2004, included
in the assets that were classified as substandard, were $3.2 million of
performing loans. This compares to $3.1 million of adversely classified
performing loans as of December 31, 2003. These amounts constitute assets
that, in the opinion of management, could potentially migrate to
nonperforming status. Any downturn in the New England economy may lead to
future deteriorations in commercial credit quality and increases in
nonaccrual loans. This in turn may necessitate an increase to the provision
for loan losses in future periods.
Allowance for Loan Losses
-------------------------
During the first half of 2004, the Company made provisions to the
allowance for loan losses totaling $500,000 and had $103,000 of net charge-
offs, bringing the balance in the allowance to $11.5 million, compared to
$11.1 million at December 31, 2003. The allowance, expressed as a
percentage of total loans, was 1.37% as of June 30, 2004, compared to 1.36%
at the prior year end and stood at 3011.8% of nonperforming loans at June
30, 2004, compared to 450.0% of nonperforming loans at December 31, 2003.
Assessing the adequacy of the allowance for loan losses involves
substantial uncertainties and is based upon management's evaluation of the
amounts required to meet estimated charge-offs in the loan portfolio after
weighing various factors. Management's methodology to estimate loss
exposure includes an analysis of individual loans deemed to be impaired,
reserve allocations for various loan types based on payments status or loss
experience and an unallocated allowance that is maintained based on
management's assessment of many factors including the growth, composition
and quality of the loan portfolio, historical loss experiences, general
economic conditions and other pertinent factors. Based on this evaluation,
management believes that the allowance for loan losses, as of June 30, 2004,
is adequate.
A portion of the allowance for loan losses is not allocated to any
specific segment of the loan portfolio. This non-specific allowance is
maintained for two primary reasons: (i) there exists an inherent
subjectivity and imprecision to the analytical processes employed, and (ii)
the prevailing business environment, as it is affected by changing economic
conditions and various external factors, may impact the portfolio in ways
currently unforeseen. Management, therefore, has established and maintains
a non-specific allowance for loan losses. The amount of this measurement
imprecision allocation was $2.8 million at June 30, 2004, compared to $3.1
million at December 31, 2003.
While management evaluates currently available information in
establishing the allowance for loan losses, future adjustments to the
allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review a financial institution's allowance for loan losses and carrying
amounts of other real estate owned. Such agencies may require the financial
institution to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
18
RESULTS OF OPERATIONS
---------------------
Comparison of Three Months Ended June 30, 2004 and 2003
-------------------------------------------------------
-- General. The Company reported net income for the second quarter of
2004 of $2.1 million, up $333,000, or 18.9%, from the second quarter of
2003. Diluted earnings per common share were $0.50 for the second quarter
of 2004, compared to $0.43 for the second quarter of 2003.
The Company reported a return on average assets of 0.74% and a return
on average equity of 11.45% for the 2004 period, as compared to a return on
average assets of 0.68% and a return on average equity of 10.36% for the
2003 period.
During the second quarter of 2003, the Company completed a significant
investment in the future of the Bank by converting its core data processing
system to a new service provider. This conversion resulted in approximately
$300,000 of start-up charges for the 2003 quarter which were not present
during the 2004 period.
-- Net Interest Income. For the quarter ended June 30, 2004, net
interest income was $9.1 million, compared to the $8.0 million reported for
the 2003 period. The net interest margin for the second quarter of 2004 was
3.40% compared to a net interest margin of 3.29% for the 2003 period. The
increase in net interest income of $1.1 million, or 14.0%, was primarily
attributable to the continued growth of the Company. Average earnings
assets were $102.1 million, or 10.5%, higher and average interest-bearing
liabilities were $65.4 million, or 7.9%, higher, than the comparable period
a year earlier. The increase of 11 basis points in the net interest margin
primarily resulted from the growth in demand deposit accounts funding
interest earning assets.
-- Interest Income. Investments. Total investment income was $2.3
million for the quarter ended June 30, 2004, compared to $2.4 million for
the second quarter of 2003. The decrease in total investment income of
$103,000, or 4.2%, was primarily attributable to a decrease of $17.4
million, or 12.8%, in the average balance of MBSs between the two periods.
The overall average balance of investments decreased $7.7 million, or 3.1%,
while the overall average yield on investments decreased 4 basis points,
from the second quarter of 2003 to the second quarter of 2004. The majority
of the Company's investments are comprised of US Agency securities and MBSs
with repricing periods or expected remaining maturities of less than five
years.
-- Interest Income. Loans. Interest from loans was $11.5 million for
the three months ended June 30, 2004, and represented a yield on total loans
of 5.51%. This compares to $10.5 million of interest, and a yield of 5.79%,
for the second quarter of 2003. Interest from commercial loans increased
$840,000, or 17.4%, and consumer and other loan income increased $216,000,
or 16.2%, as increased average balances more than offset any decline in
average yields. Declining market interest rates, coupled with increased
prepayment activity, resulted in residential mortgage loan interest
decreasing $81,000, or 1.9%, from the second quarter of 2003. The average
balance of the various components of the loan portfolio changed from the
second quarter of 2003 as follows: commercial loans increased $53.7
million, or 17.6%, consumer and other loans increased $27.8 million, or
27.1%, and residential mortgage loans increased $28.4 million, or 8.9%. In
response to declining market interest rates, the yields on the various loan
portfolio components changed as follows: residential mortgage loans
decreased 54 basis points, to 4.91%; consumer and other loans decreased 44
basis points, to 4.79%; and commercial loans remained stable at 6.35%.
Since its inception, the Company has concentrated its origination efforts on
commercial and consumer loan opportunities, while purchasing residential
mortgage loans, and to a limited degree, automobile
19
loans, as cash flows dictated. More recently, the Company has increased its
home equity loan origination capacity in response to strong demand for this
product.
-- Interest Expense. Interest paid on deposits and borrowings
decreased $245,000, or 5.0%, to $4.7 million for the three months ended June
30, 2004, from $4.9 million paid during the same period in 2003. The
decrease in total interest expense was primarily attributable to a decrease
in market interest rates, partially offset by an increase in the average
balance of deposits and borrowings. The overall average cost for interest-
bearing liabilities decreased 28 basis points from 2.40% for the second
quarter of 2003, to 2.12% for the second quarter of 2004. Liability costs
are dependent on a number of factors including general economic conditions,
national and local interest rates, competition in the local deposit
marketplace, interest rate tiers offered and the Company's cash flow needs.
Average costs for the various components of interest-bearing liabilities
changed from the second quarter of 2003 as follows: NOW accounts decreased
28 basis points, to 0.97%, savings accounts decreased 28 basis points, to
1.15%, certificate of deposit accounts decreased 39 basis points, to 2.49%,
and borrowings decreased 25 basis points to 3.91%, while money market
accounts increased 32 basis points, to 1.24% (primarily the result of
increased balances in higher rate tiers). Meanwhile, the average balance of
interest-bearing liabilities increased $65.4 million, from $823.0 million in
the second quarter of 2003 to $888.4 million in the second quarter of 2004,
as deposit growth, along with additional borrowings, were utilized to fund
the Company's asset growth.
-- Provision for Loan Losses. The provision for loan losses was
$200,000 for the quarter ended June 30, 2004, down $200,000, or 50.0%, from
the same quarter last year. Management evaluates several factors including
new loan originations, actual and estimated charge-offs, the risk
characteristics of the loan portfolio and general economic conditions when
determining the provision for each quarter. Also see discussion under
"Allowance for Loan Losses." While nonperforming loans decreased
significantly during the quarter and actual loan charge-offs were minimal,
additions to the allowance for loan losses were made during the quarter in
response to growth in total loans outstanding and concern for economic
conditions. The allowance expressed as a percentage of total loans was
1.37% at June 30, 2004, compared to 1.36% at December 31, 2003. As the loan
portfolio continues to grow and mature, or if economic conditions worsen,
management believes it possible that the level of nonperforming assets will
increase, which in turn may lead to increases in the provision for loan
losses in future periods.
-- Noninterest Income. Total noninterest income decreased $188,000,
or 7.9%, to $2.2 million for the second quarter of 2004, from $2.4 million
for the 2003 quarter. While the Company experienced growth in a number of
its noninterest income categories, four of the categories experienced
significant declines primarily as a result of changes in market interest
rates between the two periods. On the positive side, Service charges on
deposit accounts, which continues to represent the largest source of
noninterest income for the Company, increased $163,000, or 15.6%, in
response to continued growth in checking accounts and changes in how the
Bank assesses NSF fees. Commissions on nondeposit investment products
increased $36,000, or 15.5%, compared to the second quarter of 2003, as
consumer interest in investment products rebounded. Other income increased
$113,000, or 55.9%, primarily from commissions generated from sales of tax
credits, along with increased credit card activity and tuition payment
activity associated with the Bank's CampusMate(R) program. However, more
than offsetting these increases, the Company realized $135,000, or 48.4%,
less in Gains on sale of investment securities; $51,000, or 24.9%, less in
Income from Bank Owned Life Insurance ("BOLI"); and $71,000, or 75.5%, less
in Commissions on loans originated for others. In addition, the 2003 period
contained the receipt of a loan prepayment penalty aggregating $246,000,
which was not duplicated in the 2004 period.
20
-- Noninterest Expense. Total noninterest expense for the second
quarter of 2004 increased $635,000, or 8.6%, to $8.0 million from $7.3
million in 2003. This increase occurred primarily as a result of the
overall growth of the Company, coupled with increased marketing efforts
timed to correspond with the Bank of America acquisition of Fleet Bank, and
was centered in the following areas: Salaries and employee benefits (up
$383,000, or 10.2%), Occupancy and Equipment (up $90,000, or 9.3%) and
Marketing (up $122,000, or 40.9%). In addition to incurring increased
operating costs as a result of continuing growth in both loans and core
deposits, the 2004 period includes incentive bonus accruals which the 2003
period did not. Partially offsetting these increases was a decrease in Data
processing (down $79,000, or 9.9%), as the 2003 contained expenses
associated with the Bank's data processing conversion that were not present
in the 2004 period. The Company's efficiency ratio improved 20 basis
points, from 70.71% for the second quarter of 2003, to 70.51% for the second
quarter of 2004.
-- Income Tax Expense. Income tax expense of $1.0 million was
recorded for the quarter ended June 30, 2004, compared to $881,000 for the
2003 period. This represented total effective tax rates of 33.2% and 33.3%,
respectively. Tax-favored income from U.S. Agency securities and BOLI,
along with the utilization of a Rhode Island passive investment company, has
reduced the Company's effective tax rate from the 39.9% combined statutory
federal and state tax rates.
Comparison of Six Months Ended June 30, 2004 and 2003
-----------------------------------------------------
-- General. Net income for the first half of 2004, increased
$725,000, or 21.1%, to $4.2 million, or $0.99 per diluted common share, from
$3.4 million, or $0.85 per diluted common share, for the first half of 2003.
This performance represented a return on average assets of 0.74% and a
return on average equity of 11.36% for the 2004 period, as compared to a
return on average assets of 0.68% and a return on average equity of 10.27%
for the 2003 period.
During the first half of 2003, the Company made some significant
investments in the future of the Bank, including converting to a new core
data processing system in May, as well as opening a new Operations Center in
January. These investments included start-up charges of approximately
$600,000 during the first half of 2003 which were not present during the
2004 period.
-- Net Interest Income. For the six months ended June 30, 2004, net
interest income was $18.1 million, compared to $15.8 million for the first
half of 2003. The net interest margin for the first six months of 2004 was
3.41% compared to a net interest margin of 3.31% for the 2003 period. The
increase in net interest income of $2.2 million, or 14.2%, was primarily
attributable to the overall growth of the Company. Average earning assets
increased $102.3 million, or 10.6%, and average interest-bearing liabilities
increased $65.4 million, or 8.0%, over the comparable period a year earlier.
The increase of 10 basis points in the net interest margin was primarily
caused by a slowdown in prepayment activity on mortgage related assets,
coupled with continued growth in demand deposit balances (which do not pay
interest).
-- Interest Income. Investments. Total investment income was $4.6
million for the six months ended June 30, 2004, compared to $5.2 million
for the first half of 2003. This decrease in total investment income of
$532,000, or 10.3%, was primarily attributable to a $25.4 million, or 18.7%,
decrease in the average balance of MBSs, coupled with a 7 basis point
decrease in the overall yield on investments, from 4.04% in 2003, to 3.97%
in 2004, in response to lower market interest rates and increased prepayment
activity.
21
-- Interest Income. Loans. Interest from loans was $22.8 million for
the six months ended June 30, 2004, and represented a yield on total loans
of 5.51%. This compares to $20.6 million of interest, and a yield of 5.88%,
for the first half of 2003. Increased interest income resulting from growth
in the average balance of loans of $124.5 million, or 17.7%, was partially
offset by a decrease in the average yield of loans of 37 basis points. The
decrease in the average yield on loans resulted from the drop in market
interest rates and increased prepayment activity that has occurred over the
past year. The average balance of the various components of the loan
portfolio changed as follows: commercial loans increased $53.2 million, or
17.9%; residential mortgage loans increased $46.8 million, or 15.2%; and
consumer and other loans increased $24.5 million, or 24.6%. The average
yield on the various components of the loan portfolio changed as follows:
commercial loans decreased 23 basis points, to 6.23%; residential mortgage
loans decreased 48 basis points, to 5.04%; and consumer and other loans
decreased 49 basis points, to 4.82%. The Company has continued to
concentrate its origination efforts on commercial and consumer loan
opportunities, but also originates residential mortgage loans for its
portfolio on a limited basis. Until such time as the Bank can originate
sufficient commercial, consumer and residential loans to utilize available
cash flow, it intends to continue purchasing residential mortgage loans as
opportunities develop.
-- Interest Expense. Interest paid on deposits and borrowings
decreased $615,000, or 6.2%, to $9.4 million for the six months ended June
30, 2004, compared to $10.0 million for the same period during 2003. The
decrease in total interest was primarily attributable to the drop in market
interest rates over the past year and was partially offset by growth in
deposit and borrowing balances. The overall average cost for interest-
bearing liabilities decreased 33 basis points from 2.48% for the first half
of 2003, to 2.15% for the first half of 2004. Deposit costs are dependent
on a number of factors including general economic conditions, national and
local interest rates, competition in the local marketplace, interest rate
tiers offered, and the Company's cash flow needs. Partially offsetting the
effect of the decline in market interest rates, the average balance of
interest-bearing liabilities increased $65.4 million, or 8.0%, from $812.5
million in 2003, to $877.9 million in 2004. The Company continued to
experience strong average balance growth in core deposit accounts,
specifically NOW accounts (up $24.3 million, or 22.9%), primarily from
growth in the Asset Manager product (a premium rate checking product). In
addition, the Company increased its utilization of FHLB borrowings (up $21.5
million, or 14.1%) and subordinated deferrable interest debentures (up $7.9
million, or 98.9%).
-- Provision for Loan Losses. The provision for loan losses was
$500,000 for the six months ended June 30, 2004, compared to $800,000 for
the same period last year. The allowance, expressed as a percentage of
total loans, was 1.37% as of June 30, 2004, compared to 1.36% at the prior
year-end and stood at 3011.8% of nonperforming loans at June 30, 2004,
compared to 450.0% of nonperforming loans at December 31, 2003. While total
nonperforming loans decreased from the end of last year, net charge-offs
have increased slightly from the 2003 period. Net charge-offs for the six
month period ending June 30, 2004 were $103,000, compared to $65,000 for the
six month period ending June 30, 2003. Management evaluates several factors
including new loan originations, actual and estimated charge-offs, and the
risk characteristics of the loan portfolio when determining the provision
for the quarter. Also see discussion under "Allowance for Loan Losses."
-- Noninterest Income. Total noninterest income decreased $106,000,
or 2.5%, from $4.3 million for the first half of 2003, to $4.2 million for
the first six months of 2004. While the Company experienced growth in a
number of its noninterest income categories, a few of the categories
declined between the two periods. On the positive side, Service charges on
deposit accounts, which continues to represent the largest source of
noninterest income for the Company, increased
22
$223,000, or 11.2%, in response to continued growth in checking accounts and
NSF fee enhancements. Commissions on nondeposit investment products
increased $40,000, or 9.9%, as consumer interest in investment products
rebounded. Other income increased $217,000, or 51.9%, primarily from
commissions generated from sales of tax credits, along with increased credit
card and tuition payment activity. However, more than offsetting these
increases, the Company realized $96,000, or 22.0%, less in Gains on sale of
investment securities and MBSs; $89,000, or 21.8%, less in Income from BOLI;
and $163,000, or 80.3%, less in Commissions on loans originated for others.
Lastly, the 2003 period contained a loan prepayment penalty aggregating
$246,000, which was not present in the 2004 period.
-- Noninterest Expense. Noninterest expenses for the first half of
2004 increased a total of $1.3 million, or 9.4%, to $15.6 million. This
increase occurred primarily as a result of the continued overall growth of
the Company and was centered in the following areas: Salaries and employee
benefits (up $978,000, or 13.9%), Occupancy and Equipment (up $217,000, or
11.4%), Marketing (up $180,000, or 30.3%), Loan Servicing (up $93,000, or
21.2%) and Other expenses (up $74,000, or 3.8%). In addition to incurring
increased operating costs as a result of continuing growth in both loans and
core deposits, the 2004 period includes incentive bonus accruals which the
2003 period did not. Partially offsetting these increases was a decrease in
Data processing (down $254,000, or 15.4%) as the 2003 contained expenses
associated with the Bank's data processing conversion that were not present
in the 2004 period. The Company's efficiency ratio improved to 69.89% for
the 2004 period, from 70.67% for the 2003 period.
-- Income Tax Expense. The Company recorded income tax expense of
$2.0 million for the first half of 2004, compared to $1.7 million for the
same period during 2003. This represented total effective tax rates of
32.9% and 32.7%, respectively. Tax-favored income from U.S. Agency
securities and BOLI, along with its utilization of a Rhode Island passive
investment company, has reduced the Company's effective tax rate from the
39.9% combined statutory federal and state tax rates.
23
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
-- Liquidity. Liquidity is defined as the ability to meet current and
future financial obligations of a short-term nature. The Company further
defines liquidity as the ability to respond to the needs of depositors and
borrowers, as well as to earnings enhancement opportunities, in a changing
marketplace.
The primary source of funds for the payment of dividends and expenses
by the Company is dividends paid to it by the Bank. Bank regulatory
authorities generally restrict the amounts available for payment of
dividends if the effect thereof would cause the capital of the Bank to be
reduced below applicable capital requirements. These restrictions
indirectly affect the Company's ability to pay dividends. The primary
sources of liquidity for the Bank consist of deposit inflows, loan
repayments, borrowed funds, maturity of investment securities and sales of
securities from the available for sale portfolio. Management believes that
these sources are sufficient to fund the Bank's lending and investment
activities.
Management is responsible for establishing and monitoring liquidity
targets as well as strategies and tactics to meet these targets. In
general, the Company seeks to maintain a high degree of flexibility. At
June 30, 2004, overnight investments, investment securities and MBSs
available for sale amounted to $282.1 million, or 23.5% of total assets.
This compares to $205.9 million, or 18.8% of total assets at December 31,
2003. The Bank is a member of the FHLB and, as such, has access to both
short- and long-term borrowings. In addition, the Bank maintains a line of
credit at the FHLB as well as a line of credit with a correspondent bank.
There have been no adverse trends in the Company's liquidity or capital
reserves. Management believes that the Company has adequate liquidity to
meet its commitments.
-- Capital Resources. Total shareholders' equity of the Company at
June 30, 2004 was $72.7 million, as compared to $72.1 million at December
31, 2003. This increase of $553,000 was primarily the result of net income
for the six months of $4.2 million, plus proceeds from issuance of stock of
$994,000, less dividends of $1.1 million and reductions in other
comprehensive income of $3.5 million.
All FDIC-insured institutions must meet specified minimal capital
requirements. These regulations require banks to maintain a minimum
leverage capital ratio. In addition, the FDIC has adopted capital
guidelines based upon ratios of a bank's capital to total assets adjusted
for risk. The risk-based capital guidelines include both a definition of
capital and a framework for calculating risk-weighted assets by assigning
balance sheet assets and off-balance sheet items to broad risk categories.
These regulations require banks to maintain minimum capital levels for
capital adequacy purposes and higher capital levels to be considered "well
capitalized."
Capital guidelines have also been issued by the Federal Reserve Board
("FRB") for bank holding companies. These guidelines require the Company to
maintain minimum capital levels for capital adequacy purposes. In general,
the FRB has adopted substantially identical capital adequacy guidelines as
the FDIC. Such standards are applicable to bank holding companies and their
bank subsidiaries on a consolidated basis.
As of June 30, 2004, the Company and the Bank met all applicable
minimum capital requirements and were considered "well capitalized" by both
the FRB and the FDIC.
24
The recent decision by the SEC to require the deconsolidation of
"special purpose entities" under the Financial Accounting Standards Board's
Interpretation 46-R, "Consolidation of Variable Interest Entities -
Revised," has lead to uncertainty regarding whether the FRB would disallow,
or further limit, the inclusion of trust preferred securities in Tier I
capital calculations. To date, the Company has issued a total of $18.0
million of trust preferred securities and utilized their proceeds as Tier I
capital to help support the Company's growth. If trust preferred securities
are no longer available as a source of Tier I capital, the Company expects
to use other forms of capital (e.g., common or preferred equity) to support
its future growth, which, because of less favorable tax treatment, may be a
somewhat more expensive source of capital than trust preferred securities.
The Company's and the Bank's actual and required capital amounts and
ratios are as follows:
Minimum Required Minimum Required
For Capital To Be Considered
Actual Adequacy Purposes "Well Capitalized"
------------------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
At June 30, 2004:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $81,843 7.21% $34,051 3.00% $56,752 5.00%
Tier I capital (to risk weighted assets) 81,843 10.05% 32,590 4.00% 48,886 6.00%
Total capital (to risk weighted assets) 92,037 11.30% 65,181 8.00% 81,476 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $78,756 6.94% $34,039 3.00% $56,732 5.00%
Tier I capital (to risk weighted assets) 78,756 9.67% 32,568 4.00% 48,852 6.00%
Total capital (to risk weighted assets) 88,950 10.92% 65,136 8.00% 81,420 10.00%
At December 31, 2003:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $72,690 6.76% $32,255 3.00% $53,759 5.00%
Tier I capital (to risk weighted assets) 72,690 9.71% 29,954 4.00% 44,931 6.00%
Total capital (to risk weighted assets) 81,784 10.92% 59,908 8.00% 74,885 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $70,835 6.59% $32,570 3.00% $54,283 5.00%
Tier I capital (to risk weighted assets) 70,835 9.46% 29,938 4.00% 44,907 6.00%
Total capital (to risk weighted assets) 79,929 10.68% 59,876 8.00% 74,845 10.00%
25
BANCORP RHODE ISLAND, INC.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK
------------------
The principal market risk facing the Company is interest rate risk.
The Company's objective regarding interest rate risk is to manage its assets
and funding sources to produce results which are consistent with its
liquidity, capital adequacy, growth and profitability goals, while
minimizing the vulnerability of its operations to changes in market interest
rates. The Company's actions in this regard are taken under the guidance of
the Bank's Asset/Liability Committee ("ALCO"). The ALCO manages the
Company's interest rate risk position using both income simulation and
interest rate sensitivity "gap" analysis. The ALCO has established internal
parameters for monitoring the Company's interest rate risk. These
guidelines serve as benchmarks for evaluating actions to balance the current
position against overall strategic goals. The ALCO monitors current
exposures and reports these to the Board of Directors.
Simulation is used as the primary tool for measuring the interest rate
risk inherent in the Company's balance sheet at a given point in time by
showing the effect on net interest income, over a 24-month period, of
interest rate ramps of up to 200 basis points. These simulations take into
account repricing, maturity and prepayment characteristics of individual
products. The ALCO reviews simulation results to determine whether the
downside exposure resulting from changes in market interest rates remains
within established tolerance levels over both a 12-month and 24-month
horizon, and develops appropriate strategies to manage this exposure. The
Company's guidelines for interest rate risk specify that if interest rates
were to shift up or down 200 basis points over a 12-month period, estimated
net interest income for those 12-months and the subsequent 12 months, should
decline by no more than 5.0% or 10.0%, respectively. As of June 30, 2004,
net interest income simulation indicated that the Company's exposure to
changing interest rates was within these tolerances. The ALCO reviews the
methodology utilized for calculating interest rate risk exposure and may,
from time to time, adopt modifications to this methodology. While the ALCO
reviews simulation assumptions and methodology to ensure that they reflect
historical experience, it should be noted that income simulation may not
always prove to be an accurate indicator of interest rate risk because the
actual repricing, maturity and prepayment characteristics of individual
products may differ from the estimates used in the simulations.
26
The following table presents the estimated impact of changes in market
interest rates on the Company's estimated net interest income over a twenty-
four month period beginning July 1, 2004:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 basis points $ (103) (0.26%)
Up 100 basis points 106 0.27%
Down 100 basis points 50 0.13%
Down 200 basis points (211) (0.54%)
Subsequent Twelve Month Period:
Up 200 basis points $ (973) (2.44%)
Up 100 basis points 78 0.20%
Down 100 basis points (366) (0.92%)
Down 200 basis points (3,330) (8.36%)
The Company also uses interest rate sensitivity gap analysis to
provide a more general overview of its interest rate risk profile. The
interest rate sensitivity gap is defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing within
a given time period. At June 30, 2004, the Company's one year cumulative
gap was a negative $31.6 million, or 2.64% of total assets.
For additional discussion on interest rate risk see the section titled
"Asset and Liability Management" on pages 38 to 40 of the Company's 2003
Annual Report to Shareholders.
ITEM 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), the Company carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures as of the end of the period covered by this report.
This evaluation was carried out under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer. Based upon
that evaluation, the Chief Executive Officer and the 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 reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.
There was no significant change in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter that has materially affected, or is reasonably likely to affect, the
Company's internal control over financial reporting.
27
BANCORP RHODE ISLAND, INC.
Other Information
PART II. Other Information
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company
or its subsidiaries are a party, or to which any of their property is
subject, other than ordinary routine litigation incidental to the
business of banking.
ITEM 2. CHANGE IN SECURITIES
No information to report.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
No defaults upon senior securities have taken place.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
At the Annual Meeting of Shareholders, held May 19, 2004, holders of
Common Stock elected the Board's nominees to the Board of Directors,
ratified the appointment of independent public accountants and amended
and restated the Company's 2002 Incentive and Non-Qualified Stock
Option Plan, now renamed the "2002 Equity Incentive Plan".
The vote for Class II director nominees with terms expiring in 2007
was:
FOR WITHHELD
John R. Berger 3,752,346 25,740
Karl F. Ericson 3,752,146 25,940
Margaret D. Farrell 3,690,334 87,752
Mark E. Feinstein 3,752,246 25,840
Pablo Rodriquez 3,674,674 103,412
The vote for ratifying the appointment of KPMG LLP as independent
public accountants for the Company was:
FOR AGAINST ABSTAIN
3,769,728 6,578 1,780
The vote for amending and restating the Company's 2002 Incentive and
Non-Qualified Stock Option Plan to provide for the grant of restricted
stock, phantom stock, performance shares and other forms of equity
based compensation and to rename such plan the "2002 Equity Incentive
Plan" was:
BROKER
FOR AGAINST ABSTAIN NON-VOTE
2,247,505 225,539 150,330 1,154,712
28
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.2 By-laws, as amended through May 19, 2004.
10.13 2002 Equity Incentive Plan (incorporated by reference to
Appendix B to the Company's Definitive Proxy Statement
on Schedule 14A filed on April 13, 2004).
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Current Report on Form 8-K dated April 20, 2004, announcing the
Company's first quarter consolidated earnings.
29
BANCORP RHODE ISLAND, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Bancorp Rhode Island, Inc.
August 3, 2004 /s/ Merrill W. Sherman
-------------- -----------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
August 3, 2004 /s/ Albert R. Rietheimer
-------------- -------------------------
(Date) Albert R. Rietheimer
Chief Financial Officer
and Treasurer
30