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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
Commission file number 000-23904
---------
SLADE'S FERRY BANCORP.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-3061936
- ------------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
100 Slade's Ferry Avenue
Somerset, Massachusetts 02726
- ------------------------ -----
(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: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.01 par value
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
------- ------
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-K contained in this form, and no disclosure will 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 an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes No X
------- ------
The aggregate market value of the voting stock of Slade's Ferry Bancorp.
held by nonaffiliates of the registrant as of June 30, 2003 was $50,051,961,
based on the last reported sale price on the Nasdaq Small Cap Market system
on that date.
As of March 19, 2004, there were 4,024,216 shares of Slade's Ferry Bancorp.
Common Stock, $.01 par value outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's Proxy Statement for its Annual Meeting of Stockholders
scheduled to be held May 10, 2004, which is to be filed with the Securities
Exchange Commission, is incorporated by reference into Part III.
TABLE OF CONTENTS
ITEM 1 - Business 3
ITEM 2 - Properties 31
ITEM 3 - Legal Proceedings 32
ITEM 4 - Submissions of Matters to a Vote of Security Holders 32
ITEM 5 - Market for Registrant's Common Equity and Related
Stockholder Matters 33
ITEM 6 - Selected Financial Data 34
ITEM 7 - Management's Discussion and Analysis 35
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk 52
ITEM 8 - Consolidated Financial Statements and Supplementary Data 52
ITEM 9 - Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure 52
ITEM 9A - Controls and Procedures 52
ITEM 10 - Directors and Executive Officers of the Registrant 53
ITEM 11 - Executive Compensation 53
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management 53
ITEM 13 - Certain Relationships and Related Transactions 53
ITEM 14 - Principal Accountant Fees and Services 56
ITEM 15 - Exhibits, Financial Statement Schedules,
and Reports on Form 8-K 56
2
PART I
ITEM 1
BUSINESS
Description of Business
Business of Slade's Ferry Bancorp. and Slade's Ferry Trust Company
- ------------------------------------------------------------------
Slade's Ferry Bancorp. (the "Company") is a business corporation that
was organized under the laws of the Commonwealth of Massachusetts on June
13, 1989 as Weetamoe Bancorp. The name Weetamoe Bancorp. was changed to
Slade's Ferry Bancorp. effective January 1, 1997. The office of Slade's
Ferry Bancorp. is located at 100 Slade's Ferry Avenue, Somerset,
Massachusetts, 02726, and its telephone number is (508) 675-2121.
The Company was organized for the purpose of becoming the holding
company of Slade's Ferry Trust Company (the "Bank"). The Bank is a wholly-
owned subsidiary of Slade's Ferry Bancorp.
On September 30, 1959, the Slade's Ferry Trust Company opened for
business as a state chartered trust company incorporated under the laws of
the Commonwealth of Massachusetts and as a member of the Federal Deposit
Insurance Corporation (FDIC). The founders were a group of individuals from
Somerset, Swansea, Fall River and Seekonk, Massachusetts who recognized the
need for a local bank committed to personalized services.
Over the past three years, assets of the Bank have increased by $44.7
Million. At December 31, 2003 assets were $439.4 Million, deposits were
$333.1 Million, and stockholders' equity was $42.7 Million. The Bank
currently has eleven banking facilities extending east from Seekonk,
Massachusetts to Fairhaven, Massachusetts. The Bank also provides limited
banking services at the Somerset High School. In addition, the Bank, in
1999, received regulatory approval to establish a loan production office in
Rhode Island. The office is named the Slade's Ferry Loan Company and is a
subsidiary of Slade's Ferry Trust Company. The purpose for the loan
production office is to solicit commercial and consumer borrowers in the
Rhode Island area. The office is prohibited from accepting deposits and
payments.
In June 1999, the Bank established a Real Estate Investment Trust
(REIT) as a subsidiary of Slade's Ferry Trust Company. The REIT, named the
Slade's Ferry Preferred Capital Corporation, provided the means for the Bank
to invest into the REIT certain designated, bank-owned real estate mortgage
loans. The income derived on these loans was taxed at a reduced state tax
rate. Following a change in law that terminated the preferential tax
treatment, on December 8, 2003, the Bank, acting in its capacity as sole
common stockholder of Slade's Ferry Preferred Capital Corporation,
authorized the liquidation and dissolution of Slade's Ferry Preferred
Capital Corporation, and adopted the Plan of Liquidation and Dissolution.
Slade's Ferry Preferred Capital Corporation was subsequently liquidated and
dissolved as of December 16, 2003.
The Bank currently services numerous communities in Southeastern
Massachusetts and contiguous areas of Rhode Island through its eleven
facilities in Fall River, Somerset, Swansea, Seekonk, New Bedford and
Fairhaven, and its loan production office in Warwick, Rhode Island.
The Bank's major customer base consists of almost 27,100 personal
savings, checking and money market accounts, and 8,620 personal certificates
of deposit and individual retirement accounts. Its commercial base consists
of over 2,530 checking, money market, corporate, and certificate of deposit
accounts.
The Bank does not have any major target accounts, nor does it derive a
material portion of its deposits from any single depositor. It is a retail
bank that services the needs of the local communities, and its loans are not
concentrated within any single industry or group of related industries that
would have any possible adverse effect on the business of the Bank.
3
The Bank's business is not seasonal and its loan demand is well diversified.
As of December 31, 2003, commitments under standby letters of credit
aggregate approximately $113,900.
Competition
- -----------
The primary business of Slade's Ferry Bancorp. is the ongoing business of
the Bank. The competitive conditions facing Slade's Ferry Bancorp. are the
same as those faced by the Bank. The Company competes with other holding
companies engaged in bank-related activities.
The banking business in the market area served by the Bank is highly
competitive. The Bank actively competes with other banks, financial
institutions, and credit unions, including major banks and bank holding
companies which have numerous offices and affiliates operating over wide
geographic areas. The Bank competes for deposits, loans, and other business
with these institutions. Many of the major commercial banks, or other
affiliates in the service areas of the Bank, offer services such as
international banking, internet banking, and trust services which are not
currently offered directly by the Bank.
Personnel
- ---------
As of December 31, 2003, the Company employed three full-time
employees and the Bank had 157 full-time equivalent employees.
Services
- --------
The Bank engages in a broad range of banking services and its
principal business is gathering deposits from customers within its market
area, and investing these funds in commercial and residential real estate
loans, commercial loans, construction loans, home equity and other consumer
loans. In addition, a portion of the funds is used in purchasing investment
securities. The investment portfolio of the Bank consists of U. S.
Government and agency securities, mortgage-backed securities, obligations of
state and political subdivisions, corporate bonds, and a small portion of
marketable equity securities. The Bank provides a variety of deposit
products to both individual and business customers, including demand deposit
checking accounts, NOW accounts, money market deposit accounts, savings
accounts, Individual Retirement accounts, and various term certificates of
deposit.
The Bank's deposits are insured by Federal Deposit Insurance
Corporation (FDIC) up to the maximum of $100,000. In addition to loan and
deposit products, the Bank provides other services such as offering money
orders, travelers checks, safe deposit rentals, access to automated teller
machines, and debit and charge cards. The Bank is a member of the Federal
Home Loan of Boston which serves as a source of liquidity to fund lending
and investment activities.
The service area of the Bank is approximately 300 square miles,
including the southern geographic area of Bristol County, Massachusetts and
extends over to the towns of Tiverton, Warren, Bristol and Barrington in the
state of Rhode Island.
The following supplementary information should be read in conjunction
with the related financial statements and notes thereto, which are a part of
this report.
4
I. DISTRIBUTION OF ASSETS, LIABILITIES, AND STOCKHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
The following table sets forth the Company's average assets, liabilities,
and stockholders' equity, interest income earned and interest paid, average
rates earned and paid, net interest spread and the net interest margin for
the periods ending December 31, 2003, December 31, 2002, and December 31,
2001. Averages are daily averages.
2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Average Interest(1) Avg. Int. Average Interest(1) Avg. Int. Average Interest(1) Avg. Int.
(Dollars In Thousands) Balance Inc/Exp Rate Balance Inc/Exp Rate Balance Inc/Exp Rate
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Loans(2)
Commercial $ 32,044 $ 1,739 5.43% $ 40,088 $ 2,337 5.83% $ 47,036 $ 4,757 10.11%
Commercial Real Estate 172,299 10,955 6.36 157,900 10,947 6.93 153,395 12,989 8.47
Residential Real Estate 85,648 4,604 5.37 48,069 3,446 7.17 38,819 2,868 7.39
Consumer 5,043 305 6.04 8,447 547 6.48 12,093 940 7.77
------------------ ------------------ ------------------
Total Loans 295,034 17,603 5.97 254,504 17,277 6.79 251,343 21,554 8.57
------------------ ------------------ ------------------
Federal Funds Sold & FHLB
Overnight Deposit 15,720 148 0.94 24,033 348 1.45 23,136 819 3.54
U.S. Treas/Govt Agencies 53,807 2,195 4.08 70,385 3,688 5.24 72,778 4,258 5.85
State & Political
Subdivision Obligations 12,659 895 7.07 14,044 799 5.69 12,498 777 6.22
Mutual Funds 81 5 6.17 117 7 5.98 45 2 4.44
Marketable Equity
Securities 3,031 94 3.10 4,087 106 2.59 4,116 91 2.21
Other Investments 1,714 60 3.50 1,182 33 2.79 1,037 67 6.46
------------------ ------------------ ------------------
Total Interest Earning Assets 382,046 21,000 5.50 368,352 22,258 6.04 364,953 27,568 7.55
------------------ ------------------ ------------------
Allowance for Loan Losses (4,607) (5,462) (5,109)
Unearned Income (388) (347) (443)
Cash and Due From Banks 17,091 15,250 13,351
Other Assets 22,293 22,760 21,837
-------- -------- --------
Total Assets $416,435 $400,553 $394,589
======== ======== ========
LIABILITIES & STOCKHOLDERS' EQUITY:
Deposits
Savings $ 67,487 349 0.52% $ 62,078 570 0.92% $ 53,613 $ 878 1.64%
NOW Accounts 42,908 222 0.52 42,259 348 0.82 37,834 700 1.85
Money Market Accounts 19,838 235 1.18 9,250 24 0.26 9,415 120 1.27
CD's > $100M 27,735 640 2.31 32,384 1,117 3.45 34,483 1,796 5.21
Other Time Deposits 113,204 3,059 2.70 124,974 4,644 3.72 141,698 7,839 5.53
FHLB Advances & Other
Borrowings 28,824 1,568 5.44 18,553 1,225 6.60 15,734 993 6.31
------------------ ------------------ ------------------
Total Interest-bearing
Liabilities 299,996 6,073 2.02 289,498 7,928 2.74 292,777 12,326 4.21
------------------ ------------------ ------------------
Demand Deposits 72,602 69,787 64,549
Other Liabilities 1,947 1,466 1,738
-------- -------- --------
Total Liabilities 374,545 360,751 359,064
-------- -------- --------
Common Stock 40 39 38
Paid-in Capital 28,205 27,343 26,264
Retained Earnings 13,711 12,684 9,516
Accumulated Other
Comprehensive Loss (66) (264) (293)
-------- -------- --------
Total Stockholders' Equity 41,890 39,802 35,525
-------- -------- --------
Total Liabilities &
Stockholders' Equity $416,435 $400,553 $394,589
======== ======== ========
Net Interest Income $14,927 $14,330 $15,242
======= ======= =======
Net Interest Spread 3.48% 3.30% 3.34%
==== ==== ====
Net Interest Margin 3.91% 3.89% 4.18%
==== ==== ====
- --------------------
On a fully taxable equivalent basis based on tax rate of 42.80% for
2003, 27.70% for 2002, and 31.40% for 2001. Interest income on
investments and net interest income includes a fully taxable equivalent
adjustment of $383,000 in 2003, $221,000 in 2002, and $244,000 in 2001.
Average balance includes non-accruing loans. The effect of including
such loans is to reduce the average rate earned on the Company's loans.
5
The following table sets forth the net interest income changes due to
volume and rate:
NET INTEREST INCOME - CHANGES DUE TO VOLUME AND RATE(1)
2003 vs. 2002 2002 vs. 2001
Increase Increase
(Decrease) (Decrease)
- -----------------------------------------------------------------------------------------------------------
Total Due to Due to Total Due to Due to
(In Thousands) Change(2) Volume Rate Change(2) Volume Rate
- -----------------------------------------------------------------------------------------------------------
Interest Income:
Commercial Loans $ (598) $ (453) $ (145) $ (2,420) $(554) $(1,866)
Commercial Real Estate Loans 8 950 (942) (2,042) 347 (2,389)
Residential Real Estate Loans 1,158 2,358 (1,200) 578 673 (95)
Consumer Loans (242) (214) (28) (393) (260) (133)
Federal Funds Sold & FHLB
Overnight Deposit (200) (100) (100) (471) 23 (494)
US Treas/Govt Agencies (1,493) (773) (720) (570) (133) (437)
State & Political Subdivision
Obligations 96 (88) 184 22 92 (70)
Mutual Funds (2) (2) 0 5 3 2
Marketable Equity Securities (12) (31) 19 15 (1) 16
Other Investments 27 17 10 (34) 7 (41)
------- ------ ------- -------- ----- -------
Total Interest Income (1,258) 1,664 (2,922) (5,310) 197 (5,507)
------- ------ ------- -------- ----- -------
Interest Expense:
Savings (221) 39 (260) (308) 109 (417)
NOW (126) 4 (130) (352) 59 (411)
Money Market Accounts 211 77 134 (96) (1) (95)
CD's > $100 M (477) (134) (343) (679) (774) 95
Other Time Deposits (1,585) (375) (1,210) (3,195) (91) (3,104)
FHLB Advances & Other
Borrowings 343 618 (275) 232 182 50
------- ------ ------- -------- ----- -------
Total Interest Expense (1,855) 229 (2,084) (4,398) (516) (3,882)
------- ------ ------- -------- ----- -------
Net Interest Income $ 597 $1,435 $ (838) $ (912) $ 713 $(1,625)
======= ====== ======= ======== ===== =======
- --------------------
Changes in interest income and interest expense attributable to changes
in both volume and rate have been allocated equally to changes due to
volume and changes due to rate.
The change in interest income on investments and net interest income
includes interest on a fully taxable equivalent basis based on a tax
rate of 42.80% for 2003, 27.70% for 2002, and 31.40% for 2001.
6
Interest Rate Risk
- ------------------
The Company considers interest rate risk to be its primary significant
market risk exposure as it could potentially have an effect on the Company's
financial condition and results of operation. The definition of interest
rate risk is the exposure of the Company's earnings to movements in interest
rates. Volatility in interest rates requires the Company to manage interest
rate risk, which arises from the differences in the timing of repricing of
assets and liabilities. Market risk is the risk of loss arising from adverse
changes in the fair market value of financial instruments due to changes in
interest rates, exchange rates, equity prices, or the credit quality of debt
securities. Interest rate risk arises from the exposure of holding interest-
sensitive financial instruments such as government, corporate, and municipal
bonds.
The Company's Finance/Investment Committee, comprised of designated
executive management and directors, 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 Company's objective is to reduce and control the volatility of its
net interest income by managing the relationship of interest-earning assets
and interest-bearing liabilities. In order to manage this relationship, the
Committee utilizes a quarterly GAP report.
The GAP report provides a static analysis of repricing opportunities
of rate-sensitive assets and rate-sensitive liabilities. It is prepared by
categorizing these assets and liabilities into time periods based upon
either their contractual or anticipated maturity or repricing. The analysis
determines the net dollar amount of assets less liabilities that are
repricing in various time frames. This, in conjunction with certain
assumptions and other related factors, such as anticipated changes in
interest rates, projected cash flows from loans, investments and deposits,
provides a means of evaluating interest rate risk. Management also takes
into consideration that certain assets and liabilities react differently to
changes in interest rates.
The interest sensitivity gap is determined by subtracting the amount
of liabilities from the amount of assets that reprice in a particular time
period. When more liabilities than assets reprice or mature within a given
time frame, a liability sensitive position results (negative gap). A
negative gap position would tend to increase net interest income when
interest rates are falling, and decrease net interest income when rates are
rising. Conversely, an asset sensitive position (positive gap) results when
more assets than liabilities reprice within a given period. In this
scenario, net interest income would increase when interest rates rise and
decrease when rates fall.
At December 31, 2003, the following GAP report indicates the Company's
interest rate risk to have a reliance on short-term liabilities. This
position would have an adverse effect on earnings in a rising rate
environment and a positive effect on earnings in a decreasing rate
environment.
7
INTEREST RATE - SENSITIVITY GAP
Repricing Period at December 31, 2003
Within 1-2 2-3 3-5 Over 5
(In Thousands) 1 Year Years Years Years Years Total
- ----------------------------------------------------------------------------------------------------------------
Interest-Earning Assets:
Loans $117,925 $ 37,404 $27,182 $52,996 $100,587 $336,094
Federal Funds Sold &
FHLB Overnight Deposit 4,000 0 0 0 0 4,000
Investment Securities(1) 8,627 14,017 9,752 22,256 3,719 58,371
-----------------------------------------------------------------------
Total Earning Assets $130,552 $ 51,421 $36,934 $75,252 $104,306 $398,465
-----------------------------------------------------------------------
Interest-Bearing Liabilities:
NOW Checking and Savings
Deposits $ 31,779 $ 15,890 $15,890 $42,372 $ 0 $105,931
Money Market Deposits 7,271 3,635 3,635 9,694 0 24,235
Term Deposits 109,310 12,621 6,634 1,040 45 129,650
FHLB Advances 5,300 8,000 8,000 17,423 21,752 60,475
-----------------------------------------------------------------------
Total Interest-bearing Liabilities $153,735 $ 40,146 $34,159 $70,529 $ 21,797 $320,366
-----------------------------------------------------------------------
Net Interest Sensitivity Gap $(23,183) $ 11,275 $ 2,775 $ 4,723 $ 82,509 $ 78,099
Cumulative Gap $(23,183) $(11,908) $(9,133) $(4,410) $ 78,099
Cumulative Gap as a Percent of
Total Assets (5.28%) (2.71%) (2.08%) (1.00%) 17.77%
=======================================================================
- -------------------
Excludes money market mutual funds which are carried in cash and
cash equivalents.
In addition to the GAP report the Company quantifies its interest rate
risk exposure using a simulation model. This simulation analysis is used to
measure the exposure to net interest income to changes in interest rates
over a specified time frame. The simulation analysis projects future
interest income and interest expense under different rate scenarios.
Internal guidelines on limitations on interest rate risk specify that for
every 100 basis points of immediate change in interest rate, projected net
interest income over the next twelve months should not decline by more than
5%.
The simulation model currently utilizes a 300 basis point increase in
interest rates and a 50 basis point decrease in rates. Due to the existing
low interest rate environment in effect with the average Federal Funds
overnight trading at approximately 1.00%, the simulation model only reduces
rates downward by 50 basis points. 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 following table reflects the Company's estimated exposure as a
percentage of net interest income and the dollar impact for the next twelve
months, assuming an immediate change in interest rates set forth below:
Rate Change Estimated Exposure as a Percentage of
(Basis Points) Net Interest Income Dollar Impact
--------------------------------------------------------------------------
+300 (10.63%) ($1,757,000)
- 50 (0.36%) ($ 60,000)
The model used to monitor earnings-at-risk provides management a
measurement tool to assess the effect of changes in interest rates on the
Company's current and future earnings. The limit established by the Company
provides an internal tolerance level to control interest rate risk exposure.
8
II. INVESTMENT PORTFOLIO
The following table shows the amortized cost basis of the Company's
major categories of investment securities Held-to-Maturity for the years
indicated:
At December 31,
- -------------------------------------------------------------------------------
(In Thousands) 2003 2002 2001
- -------------------------------------------------------------------------------
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $ 0 $ 0 $ 2,750
State and Political Subdivision Obligations 11,299 13,693 13,528
Mortgage-backed Securities 1 2 3
Foreign Debt Securities 0 1 1
- -------------------------------------------------------------------------------
Total $11,300 $13,696 $16,282
===============================================================================
In the following table, the amortized cost basis of the Company's
Held-to-Maturity securities maturing within stated periods as of December
31, 2003, is shown with the weighted average interest yield from securities
falling within the range of maturities:
U.S. Treasury State &
& Government Political Mortgage-
Corporations Subdivision Backed
(In Thousands) & Agencies Obligations(1) Securities(2) Total
- -----------------------------------------------------------------------------------------
Due in 1 year or less:
Amount $ 0 $ 2,704 $ 0 $ 2,704
Yield 0.00% 5.67% 0.00% 5.67%
Due in 1 to 5 years:
Amount 0 5,808 1 5,809
Yield 0.00% 7.35% 7.73% 7.35%
Due in 5 to 10 years:
Amount 0 1,526 0 1,526
Yield 0.00% 7.69% 0.00% 7.69%
Due after 10 years:
Amount 0 1,261 0 1,261
Yield 0.00% 8.30% 0.00% 8.30%
- -----------------------------------------------------------------------------------------
Amount $ 0 $11,299 $ 1 $11,300
=========================================================================================
Yield 0.00% 7.10% 7.73% 7.10%
=========================================================================================
- --------------------
Rates of tax exempt securities are shown assuming a 42.80% tax rate.
Mortgage-backed securities stated using average life.
9
The following table shows the amortized cost basis of the Company's
major categories of Available-for-Sale securities for the years indicated:
At December 31,
- -------------------------------------------------------------------
(In Thousands) 2003 2002 2001
- -------------------------------------------------------------------
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $27,932 $26,424 $34,240
Mortgage-backed Securities 14,034 32,512 36,129
Corporate Debt Securities 1,658 2,673 2,941
Marketable Equity Securities 3,511 3,986 6,015
- -------------------------------------------------------------------
Total $47,135 $65,595 $79,325
===================================================================
In the following table, the amortized cost basis of the Company's
Available-for-Sale securities (other than equity securities) maturing within
stated periods as of December 31, 2003, is shown with the weighted average
interest yield from securities falling within the range of maturities:
U.S. Treasury
& Government Mortgage- Corporate
Corporations Backed Debt
(In Thousands) & Agencies Securities(1) Securities Total
- -------------------------------------------------------------------------------------
Due in 1 year or less:
Amount $ 0 $ 1,776 $ 700 $ 2,476
Yield 0.00% 4.93% 6.41% 5.35%
Due in 1 to 5 years:
Amount 27,932 11,826 958 40,716
Yield 3.04% 4.88% 5.91% 3.64%
Due in 5 to 10 years:
Amount 0 0 0 0
Yield 0.00% 0.00% 0.00% 0.00%
Due after 10 years:
Amount 0 432 0 432
Yield 0.00% 4.58% 0.00% 4.58%
- -------------------------------------------------------------------------------------
Amount $27,932 $14,034 $1,658 $43,624
=====================================================================================
Yield 3.04% 4.88% 6.12% 3.75%
=====================================================================================
- --------------------
Mortgage-backed securities stated using average life.
10
The following table shows the amortized cost basis and fair value of
the Company's major categories of Held-to-Maturity securities as of December
31, 2003:
Gross Gross
Amortized Unrealized Unrealized
(In Thousands) Cost Basis Holding Gains Holding Losses Fair Value
- --------------------------------------------------------------------------------------------------
U.S. Treasury Securities and
Obligation of U.S. Government
Corporations and Agencies $11,299 $552 $ 0 $11,851
Mortgage-backed Securities 1 0 0 1
- ------------------------------------------------------------------------------------------------
Total $11,300 $552 $ 0 $11,852
================================================================================================
The Company's investments in Available-for-Sale securities are carried
at fair value on the balance sheet and are summarized as follows as of
December 31, 2003:
Gains in Losses in
Accumulated Accumulated
Other Other
Amortized Comprehensive Comprehensive
(In Thousands) Cost Basis Income Income Fair Value
- -------------------------------------------------------------------------------------------------
Debt securities issued by the
U.S. Government corporations
and Agencies $27,932 $ 73 $351 $27,654
Mortgage-backed Securities 14,034 449 3 14,480
Corporate Debt Securities 1,658 70 0 1,728
Marketable Equity Securities 3,511 198 345 3,364
- -----------------------------------------------------------------------------------------------
Total $47,135 $790 $699 $47,226
===============================================================================================
11
III. LOAN PORTFOLIO
The following table shows the Company's amount of loans by category at
the end of each of the last five years.
At December 31,
- ----------------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 33,980 $ 30,455 $ 45,238 $ 49,331 $ 46,354
Real Estate - construction and land development 10,346 14,078 7,600 8,601 5,014
Residential Real Estate 147,178 90,330 60,936 55,871 52,330
Commercial Real Estate 140,572 122,932 128,888 128,327 127,938
Consumer 3,961 6,881 10,643 12,872 9,393
Other 57 336 579 1,151 1,020
- ----------------------------------------------------------------------------------------------------------------
Total Gross Loans 336,094 265,012 253,884 256,153 242,049
Allowance for Loan Losses (4,154) (4,854) (5,484) (4,776) (3,766)
Unamortized adjustment to fair value (0) (0) (0) (9) (20)
Unearned Income (443) (342) (382) (519) (594)
- ----------------------------------------------------------------------------------------------------------------
Net Loans $331,497 $259,816 $248,018 $250,849 $237,669
================================================================================================================
The following table shows the maturity distributions and interest rate
sensitivity of selected loan categories at December 31, 2003:
Within One One to Five After Five
(In Thousands) Year Years Years Total
- ----------------------------------------------------------------------------------------------------------
Commercial, financial, and agricultural $ 26,931 $ 5,586 $ 1,463 $ 33,980
Real Estate - construction and land development 222 4,171 5,953 10,346
Residential Real Estate 25,586 57,681 63,911 147,178
Commercial Real Estate 61,883 49,432 29,257 140,572
Consumer 3,246 712 3 3,961
Other 57 0 0 57
- ----------------------------------------------------------------------------------------------------------
Total $117,925 $117,582 $100,587 $336,094
==========================================================================================================
The following table shows the amounts, included in the table above,
which are due after one year and which have fixed interest rates and
adjustable rates:
Total Due After One Year
- -----------------------------------------------------------------------------------------------
(In Thousands) Fixed Rate Adjustable Rate Total
- -----------------------------------------------------------------------------------------------
Commercial, financial, and agricultural $ 3,677 $ 3,372 $ 7,049
Real Estate - construction and land development 6,251 3,873 10,124
Residential Real Estate 86,988 34,604 121,592
Commercial Real Estate 30,715 47,974 78,689
Consumer 715 0 715
- -----------------------------------------------------------------------------------------------
Total $128,346 $89,823 $218,169
===============================================================================================
12
The table set forth below shows nonaccrual, past due and restructured
loans:
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
December 31,
- -----------------------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------
Nonaccrual loans $ 407 $ 635 $1,138 $2,415 $1,777
Loans 90 days or more past due
and still accruing 0 8 444 335 248
Real estate acquired by foreclosure
or substantively repossessed 0 0 0 0 353
- -----------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 407 $ 643 $1,582 $2,750 $ 2,378
- -----------------------------------------------------------------------------------------------------------
Restructured debt performing in accordance with
amended terms, not included above $ 198 $ 166 $ 186 $ 53 $ 518
- -----------------------------------------------------------------------------------------------------------
Percentage of nonaccrual loans to total loans 0.12% 0.24% 0.45% 0.94% 0.73%
Percentage of nonaccrual loans, restructured loans
and real estate acquired by foreclosure or
substantively repossessed to total assets 0.14% 0.20% 0.34% 0.64% 0.74%
Percentage of allowance for loan losses to
nonaccrual loans 1,020.64% 764.20% 481.90% 197.76% 211.92%
Nonaccrual loans include restructured loans of $107,000 at December
31, 2003; $121,000 at December 31, 2002; $137,000 at December 31, 2001;
$153,000 at December 31, 2000; and $0 at December 31, 1999.
Information with respect to nonaccrual and restructured loans for the
past five years ended December 31 is as follows:
December 31,
- ---------------------------------------------------------------------------------------------
(In Thousands) 2003 2002 2001 2000 1999
- ---------------------------------------------------------------------------------------------
Nonaccrual loans $407 $635 $1,138 $2,415 $1,777
Interest income that would have been
recorded under original terms $ 41 $303 $ 109 $ 228 $ 146
Interest income recorded during the period $ 30 $121 $ 6 $ 22 $ 37
Nonperforming assets include nonaccrual loans, loans past due 90 days
or more and still accruing, restructured loans not performing in accordance
with amended terms, and other real estate acquired through foreclosure.
Nonperforming assets as a total decreased to $407,000 at year end 2003, from
$643,000 reported at year end 2002.
Nonaccrual loans is the largest component of nonperforming assets, and
at December 31, 2003, this category decreased by approximately $228,000 from
December 31, 2002. There are no loans greater than $200,000 in this
category, which is comprised of $165,000 of residential mortgages and
$242,000 of other types of loans.
The Company places a loan on nonaccrual status when, in the opinion of
management, the collectability of the principal and interest becomes
doubtful. Generally, when a commercial loan, commercial real estate loan or
a residential real estate loan becomes past due 90 days or more, the
13
Company discontinues the accrual of interest and reverses previously accrued
interest. The loan remains in the nonaccrual status until the loan is
current and six consecutive months of payments are made, then it is
reclassified as an accruing loan. When it is determined that the
collectability of the loan no longer exists, it is charged off to the
Allowance for Loan Losses or, if applicable, any real estate that is
collateralizing the loan is acquired through foreclosure, at which time it
is categorized as Other Real Estate Owned.
IV. SUMMARY OF LOAN LOSS EXPERIENCE
The table below illustrates the changes in the Allowance for Loan
Losses for the periods indicated.
(In Thousands) 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------
Balance at January 1 $4,854 $5,484 $4,776 $3,766 $3,569
- ------------------------------------------------------------------------------------------------
Charge-offs:
Commercial, financial and agricultural (10) (336) (73) (194) (221)
Commercial Real Estate (0) (0) (0) (0) (0)
Residential Real Estate (169) (20) (0) (23) (23)
Consumer (32) (26) (28) (138) (158)
- ------------------------------------------------------------------------------------------------
(211) (382) (101) (355) (402)
- ------------------------------------------------------------------------------------------------
Recoveries:
Commercial, financial and agricultural 55 17 14 50 11
Commercial Real Estate 0 0 0 0 0
Residential Real Estate 44 38 29 92 24
Consumer 14 7 16 23 14
- ------------------------------------------------------------------------------------------------
113 62 59 165 49
- ------------------------------------------------------------------------------------------------
Net Charge-offs (98) (320) (42) (190) (353)
Provision (benefit) charged to operations (602) (310) 750 1,200 550
- ------------------------------------------------------------------------------------------------
Balance at December 31 $4,154 $4,854 $5,484 $4,776 $3,766
================================================================================================
Allowance for Loan Losses as a percent of
year end loans 1.24% 1.83% 2.16% 1.86% 1.56%
Ratio of net charge-offs to average loans
outstanding (0.03%) (0.13%) (0.02%) (0.08%) (0.15%)
14
The Company's Allowance for Loan Losses at year end December 31, 2003
was $4,154,394 and $4,854,388, $5,484,519, $4,776,360, and $3,765,872 for
years ending 2002, 2001, 2000, and 1999, respectively. The Allowance for
Loan Losses as a percent of year end loans was 1.24% in 2003, 1.83% in 2002,
2.16% in 2001, 1.86% in 2000, and 1.56% in 1999.
The level of the allowance for loan losses is evaluated monthly by
management and reviewed by the Board of Directors. Factors considered in the
evaluation process include growth of the loan portfolio, risk
characteristics of the loan types in the portfolio, the value of underlying
collateral, delinquency and charge off trends, current economic conditions
within our market area, and various other external and internal factors. The
allowance for loan losses is maintained at a level that management considers
to be adequate to absorb estimated losses within our loan portfolio.
Management's assessment of the adequacy of the allowance for loan losses is
reviewed annually by an independent loan review consultant, the Company's
independent accountants, and regulatory agencies.
As the composition of our loan portfolio gradually changes and
diversifies from higher credit risk weighted loans, such as commercial real
estate and commercial and industrial, to residential and home equity loans,
less reserve allowance will be required. During 2003, diversifications in
the loan portfolio, stronger underwriting guidelines, the sale of loans
previously deemed substandard, and overall improvement in credit quality of
existing loans, resulted in a decrease in the overall credit risk imbedded
in the loan portfolio. After thorough review and analysis of the adequacy of
the loan loss reserve during 2003, the Bank recovered $602,000 of previously
provided loan loss provisions, compared to a provision benefit of $310,000
recorded for 2002. Loans charged off were $211,000 in 2003 and prior years'
charge offs were $382,000, $101,000, $355,000 and $402,000 in 2002, 2001,
2000, and 1999, respectively. In 2003, the Company realized recoveries of
previously charged-off loans of $113,000. Recoveries recorded in previous
years were $62,000, $59,000, $165,000, and $49,000 in 2002, 2001, 2000, and
1999, respectively. Management believes that the Allowance for Loan Losses
of approximately $4,154,000 as of December 31, 2003 is adequate to cover
potential losses in the loan portfolio, based on current information
available to management.
The Bank must maintain an Allowance for Loan and Lease Losses (ALLL)
at a level that is sufficient to absorb the projected credit losses
associated with the loan portfolio. Projected credit losses should reflect
consideration of all significant factors that affect repayment as of the
evaluation date. Projected losses on loan categories should reflect
historical net charge-off levels for similar loans, adjusted for changes in
current conditions or other relevant factors. Calculation of historical
charge-off rates can range from a simple average of net charge-offs over a
relevant period, to more complex techniques such as migration analysis.
Portions of the ALLL can be attributed to, or based upon, the risks
associated with individual loans or groups of loans. The monthly Asset Watch
List Review process forms the basis of identification of loans with
quantifiable loss potential as well as the remaining group of Criticized and
Classified loans.
Loan quality ratings are utilized as the primary criteria in preparing
the Asset Watch List, which primarily includes loans determined to be
Criticized and Classified. Loans with ratings of "4" (Special Mention), "5"
(Substandard), or "6" (Doubtful) are included in the Asset Watch List.
Appropriate ratings changes are made when facts that warrant an upgrade or
downgrade in a particular loan rating are evident. Loan ratings are
generally reviewed on a quarterly basis.
Loans that are rated Substandard are inadequate to the current sound
net worth and paying capacity of the borrower or of the collateral pledged.
These loan types have a defined weakness that
15
could jeopardize the liquidation of the debt, and are characterized by the
distinct possibility that the Bank will sustain some loss if the
deficiencies are not corrected. Loans classified as Doubtful have all the
weaknesses inherent in loans rated Substandard, with the added
characteristic that the weaknesses make collection or liquidation in full,
on the basis of currently known facts, highly questionable and improbable.
Loans which do not currently expose the Bank to any significant risk to
warrant classification into one of the aforementioned risk ratings, but
possess potential weaknesses that deserve management's attention, are
designated Special Mention.
The Bank utilizes an independent third party to conduct semi-annual
credit analyses of its commercial and commercial real estate loan
portfolios.
The Bank utilizes an assessment methodology that incorporates both
target (or specific) reserves for individual loans where loss potential and
anticipated charge-off, both partial and complete, can be accurately
assessed, as well as the application of general loss ratios to arrive at a
comprehensive reserve calculation. The Bank uses this reserve methodology to
identify target reserves of 50% to 100% where appropriate on Criticized and
Classified loans based on internal risk ratings. This methodology also
incorporates delinquency trends, charge-off experience, new loan volume and
mix, credit exposure, and various other risks as they may arise in the
ongoing analysis of loan portfolio management, off balance sheet
commitments, which include pending loan commitments, as well as, historical
extension of credit under existing construction loans, lines of credit, and
amounts due borrower.
The groups of loans rated "Pass" will be reserved, utilizing weighting
factors deemed appropriate given the Bank's loan loss experience over an
extended period of time, as well as including a factor to account for
unforeseen loan loss potential. This approach allows for the recognition of
a well-defined loss profile, while still providing for unforeseen or
unanticipated losses within the portfolio.
A "Pass" loan is a loan which does not expose the Bank to significant
risk. Loans in this category have the following characteristics: borrower is a
well to recently established business, borrower is operating in an industry
where conditions are good, borrower has capable management team, borrower has
above average performance in comparison to industry peers, loan is typically
well secured by collateral, and borrower's financial statements evidence the
ability to adequately service the indebtedness.
Based on the Bank's loss experience as well as the perceived levels of
risk associated with the various loan portfolio, reserve factors are applied
to the loan portfolio i.e., commercial and industrial, commercial real
estate, residential mortgage, home equity, and consumer loans.
A loan is defined as being "impaired" when it becomes probable (most
likely to occur) that the Bank will be unable to collect all amounts due
(principal and interest) according to the contractual terms of the loan
agreement. When a loan is 90 days past due, it will be evaluated for
impairment status.
Loans that have been placed on non-accrual because payments are
sporadic or no payments have been made, or because collateral coverage is
insufficient and current financial data is not available, are evaluated for
impairment status. Based on the market value or discounted cash flow
methods, if the loan is not deemed to be repaid in full according to the
terms of the relevant loan agreement, a watch list reserve will be
instituted and the subject loan will be classified as "impaired".
Loans that are rated substandard, may or may not be on non-accrual.
Substandard loans will be evaluated, no less than annually, for possible
impairment status. Either the market value or discounted cash flow method is
used. In the case of unsecured loans which are rated substandard, the
discounted
16
cash flow method will be used and a watch list reserve (if applicable) will
be instituted and the loan will be classified as "impaired". In addition,
all restructured and renegotiated debt will be classified as "impaired". All
loans that have been classified as "impaired" will be placed on the Bank's
Impaired Loan Report. This report is reviewed monthly by the Board of
Directors. Reviewing of the impaired loans includes, but is not limited to
evaluation and adjustment of watch list reserves (if necessary) and/or
determination of any charge-offs.
The table below shows an allocation of the allowance for loan losses
as of the end of each of the last five years:
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
December 31, 2003 December 31, 2002 December 31, 2001 December 31, 2000 December 31, 1999
- -------------------------------------------------------------------------------------------------------------------------------
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
- ----------------------------------------------------------------------------------------------------------------------------------
(In Thousands)
Commercial(5) $ 943(1) 10.11% $1,155(1) 11.60% $1,629(1) 17.91% $1,466(1) 19.66% $1,356(1) 19.52%
Commercial
Real Estate 52 3.08 70 5.31 41 2.99 47 3.36 34 2.07
Residential
Real Estate 3,071(2) 85.62 3,465(2) 80.48 3,585(2) 74.77 2,970(2) 71.91 1,924(2) 74.48
Consumer(3) 88(4) 1.19 164(4) 2.61 229(4) 4.33 293(4) 5.07 452(4) 3.93
- -------------------------------------------------------------------------------------------------------------------------------
$4,154 100.00% $4,854 100.00% $5,484 100.00% $4,776 100.00% $3,766 100.00%
===============================================================================================================================
- --------------------
Includes amounts specifically reserved for impaired loans of $251,280
as of December 31, 2003, $412,761 as of December 31, 2002, $780,029 as
of December 31, 2001, $281,248 as of December 31, 2000, and $234,205
as of December 31, 1999, as required by Financial Accounting Standard
No. 114, Accounting for Impairment of Loans.
Includes amounts specifically reserved for impaired loans of $23,621 as
of December 31, 2003, $34,757 as of December 31, 2002, $413,663 as of
December 31, 2001, $132,911 as of December 31, 2000, and $147,884 as of
December 31, 1999, as required by Financial Accounting Standard No. 114,
Accounting for Impairment of Loans.
Includes consumer, obligations of states and political subdivisions and
other.
Includes amounts specifically reserved for impaired loans of $170 as of
December 31, 2003, $29,606 as of December 31, 2002, $1,632 as of
December 31, 2001, $10,398 as of December 31, 2000, and $39,241 as
of December 31, 1999 as required by Financial Accounting Standard No.
114, Accounting for Impairment of Loans.
Includes commercial, financial, agricultural and nonprofit.
The composition of the loan portfolio has become more diversified in
2003, resulting in a lesser degree of credit risk, and therefore a reduction
was made in the allowance for loan losses maintained to cover inherent
losses in the loan portfolio.
The loan portfolio's largest segment of loans has changed from
commercial real estate to residential real estate and home equity loans
which represented 43.8% of gross loans at December 31, 2003 compared to
34.1% at December 31, 2002. Commercial real estate loans, with a higher
degree of credit risk, represented 41.8% in 2003, compared to 46.4% at in
2002. The Bank requires a loan to value ratio of 80% in both commercial and
residential mortgages. These real estate loans are secured by real
properties which have a readily ascertainable value.
17
Real estate residential loans include both loans secured by one-to
four-family property, home equity loans, and multi-family residential loans.
Home equity loans are generally revolving lines of credit and are typically
secured by second mortgages on one-to four-family owner-occupied properties.
Generally, commercial real estate loans have a higher degree of credit
risk than residential real estate loans because they depend primarily on the
success of the business. When granting these loans, the Company evaluates
the financial condition of the borrower(s), the location of the real estate,
the quality of management, and general economic and competitive conditions.
When granting a residential mortgage, the Company reviews the borrower(s)
repayment history on past debts, and assesses the borrower(s) ability to
meet existing obligations and payments on the proposed loans.
Real estate construction loans is comprised of both residential and
commercial construction loans throughout our market area. As of December 31,
2003, these loans represented 3.1% of the loan portfolio compared to 5.3% at
December 31, 2002.
Commercial loans consist of loans predominantly collateralized by
inventory, furniture and fixtures, and accounts receivable. In assessing the
collateral for this type of loan, management applies a 50% liquidation value
to inventories; 25% to furniture, fixtures and equipment; and 70% to
accounts receivable less than 90 days of invoice date. Commercial loans
represent 10.1% of the loan portfolio as of December 31, 2003, compared to
11.5% as of December 31, 2002.
Consumer loans are both secured and unsecured borrowings and at
December 31, 2003 represents only 1.2% of the total loan portfolio compared
to 2.6% at December 31, 2002. These loans have a higher degree of risk than
residential mortgage loans. The underlying collateral of a secured consumer
loan tends to depreciate in value. Consumer loans are typically made based
on the borrower's ability to repay the loan through continued financial
stability. The Company endeavors to minimize risk by reviewing the
borrower's repayment history on past debts, and assessing the borrower's
ability to meet existing obligations on the proposed loans.
Total loan charge-offs in 2003 amounted to $211,000, as compared to
charge offs of $382,000 in 2002, $101,000 in 2001, $355,000 in 2000, and
$402,000 in 1999. The residential real estate category incurred a loss of
$169,000 in 2003 compared to a loss of $20,000 in 2002, no losses in 2001,
$23,000 in 2000, and $23,000 in 1999.
V. DEPOSITS
Deposits are obtained from individuals and from small and medium sized
businesses in the local market area. The Bank also attracts deposits from
municipalities and other government agencies. The Bank does not solicit or
accept brokered deposits.
18
The following table sets forth the average amount and the average rate
paid on deposits for the periods indicated.
2003 2002 2001
- ------------------------------------------------------------------------------------------------
Average Average Average Average Average Average
(In Thousands) Balance Rate Balance Rate Balance Rate
- ------------------------------------------------------------------------------------------------
Demand Deposits $ 72,602 0.00% $ 69,787 0.00% $ 64,549 0.00%
NOW Accounts 42,908 0.52 42,259 0.82 37,834 1.85
Savings Accounts 67,487 0.52 62,078 0.92 53,613 1.64
Money Market Accounts 19,838 1.18 9,250 0.26 9,415 1.27
CD's >$100M 27,735 2.31 32,384 3.45 34,483 5.21
Other Time Deposits 113,204 2.70 124,974 3.72 141,698 5.53
-------- -------- --------
Totals $343,774 1.66% $340,732 2.47% $341,592 4.09%
======== ======== ========
As of December 31, 2003, time certificates of deposit in amounts of
$100,000 or more had the following maturities:
(In Thousands)
Three months or less $ 6,739
Over three months through six months 9,113
Over six months through twelve months 5,428
Twelve months and over 4,150
-------
$25,430
=======
VI. RETURNS ON EQUITY AND ASSETS
The following table shows consolidated operating and capital ratios of
the Company for each of the last three years:
Year Ended December 31,
2003 2002 2001
----------------------------
Return on Average Assets 0.65% 0.74% 0.81%
Return on Average Equity 6.42% 7.45% 9.04%
Dividend Payout Ratio 53.22% 47.50% 52.63%
Equity to Assets Ratio (Average) 10.06% 9.94% 9.00%
VII. SHORT TERM BORROWINGS
The Bank has the ability to borrow funds from the Federal Home Loan
Bank to partially fund their loan commitments and other liquidity needs.
Advances from the Federal Home Loan Bank are collateralized by a blanket
pledge on the Banks' first mortgages on one-to four-family owner occupied
residential property and securities issued or guaranteed by the U.S.
Government and its agencies. In addition the Bank maintains borrowing lines
of credit with correspondent banks to meet short-term liquidity needs.
Short-term borrowings include funds advanced from the Federal Home
Loan Bank, correspondent banks, and funds held for U.S. Treasury Tax and
Loan Notes.
19
The following table shows the Company's short-term borrowings at the
end of each of the last three years, the maximum amount of borrowings and
the average amounts outstanding as well as weighted average interest rates
for the last three years.
(In Thousands) 2003 2002 2001
- -------------------------------------------------------------------------------
Balance at December 31 $5,300 $ 0 $ 465
Maximum Amount Outstanding at Any Month's End $5,300 $1,222 $1,237
Average Amount Outstanding During the Year $1,047 $ 484 $ 706
Weighted Average Interest Rate During the Year 1.80% 1.69% 4.03%
REGULATION
General
The Bank is a Massachusetts-chartered trust company, and its deposit
accounts are insured up to applicable limits by the Bank Insurance Fund of
the FDIC. The Bank is subject to extensive regulation, examination and
supervision by the Commonwealth of Massachusetts Division of Banks as its
primary corporate regulator, and by the FDIC as the deposit insurer.
The Company, as a bank holding company controlling the Bank, is
subject to the Bank Holding Company Act of 1956, as amended, and the rules
and regulations of the Federal Reserve Board under the Bank Holding Company
Act. The Bank and the Company are also subject to the provisions of the
Massachusetts General Laws applicable to trust companies and other
depository institutions and their holding companies (the Massachusetts
banking laws) and the regulations of the Massachusetts Division of Banks
under the Massachusetts banking laws applicable to bank holding companies.
The Company is also subject to the rules and regulations of the Securities
and Exchange Commission.
Any change in such laws and regulations, whether by the Division, the
FDIC, the Federal Reserve Board, or the Securities and Exchange Commission
or through legislation, could have a material adverse impact on the Company
and the Bank and their operations and stockholders.
Massachusetts Banking Regulation
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 with
the Massachusetts Community Reinvestment Act and to make such assessment
available to the public. The Bank's latest Massachusetts Community
Reinvestment Act rating, received by letter, dated November 13, 2002, from
the Division was a rating of "Satisfactory."
20
Loans-to-One-Borrower Limitations. With specified exceptions, the
total obligations of a single borrower to a Massachusetts chartered trust
company may not exceed 20% stockholders' equity. A 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 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. The approval of the Commissioner
is also required for a trust company to declare a dividend, if the total of
all dividends declared by the 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 savings banks at least once every calendar year or at least once
each 18-month period if the 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."
Federal Banking Regulation
Capital Requirements. FDIC regulations require BIF-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.
21
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, 2003.
Activity Restrictions on State-Chartered Banks. Section 24 of the
Federal Deposit Insurance Act, as amended (FDIA), which was added by the
Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA),
generally limits the activities and investments of state-chartered FDIC
insured banks and their subsidiaries to those permissible for federally
chartered 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 Banking Act. 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 otherwise permissible under Section 24 of
the FDIC regulations thereunder, an insured bank must seek approval from the
FDIC to 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
savings banks, 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.
22
Deposit Insurance. Pursuant to FDICIA, the FDIC established a system
for setting deposit insurance premiums based upon the risks a particular
institution poses to its deposit insurance fund. Under the risk-based
deposit insurance assessment system, the FDIC assigns an institution to one
of three capital categories based on the institution's financial
information, as of the most recent quarterly report filed with the
applicable bank regulatory agency prior to the assessment period. The three
capital categories are (1) well capitalized, (2) adequately capitalized and
(3) undercapitalized using capital ratios that are substantially similar to
the prompt corrective action capital ratios discussed below. See "-Federal
Banking Regulation - Prompt Corrective Action" below. The FDIC also assigns
an institution to supervisory subgroup based on a supervisory evaluation
provided to the FDIC by the institution's primary federal regulator and
information that the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds (which
may include, if applicable, information provided by the institution's state
supervisor). An institution's assessment rate depends on the capital
category and supervisory category to which it is assigned. Any increase in
insurance assessments could have an adverse effect on the earnings of
insured institutions, including the Bank.
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 management of the Bank 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 is governed by
Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is
any company or entity that controls, is controlled by or is under common
control with the Bank. Currently, 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, but the Federal Reserve Board has proposed
a comprehensive regulation implementing Sections 23A and 23B, which would
establish certain exceptions to this policy.
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.
Effective April 1, 2003, the Federal Reserve Board, or FRB, rescinded
its interpretations of Sections 23A and 23B of the FRA and replaced these
interpretations with Regulation W. In addition, Regulation W makes various
changes to existing law regarding Sections 23A and 23B, including
23
expanding the definition of what constitutes an affiliate subject to
Sections 23A and 23B and exempting certain subsidiaries of state-chartered
banks from the restrictions of Sections 23A and 23B.
Under Regulation W, all transactions entered into on or before
December 12, 2002, which either became subject to Sections 23A or 23B solely
because of Regulation W, and all transactions covered by Sections 23A and
23B, the treatment of which will change solely because of Regulation W,
became subject to Regulation W on July 1, 2003. All other covered affiliate
transactions become subject to Regulation W on April 1, 2003. The Federal
Reserve Board expects each depository institution that is subject to
Sections 23A and 23B to implement policies and procedures to ensure
compliance with Regulation W. We do not expect that the changes made by
Regulation W will have a material adverse effect on our business.
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 Federal Reserve Board. 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 that 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 savings bank,
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 in 2002.
Safety and Soundness Standards. Pursuant to the requirements of
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
24
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 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. 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. The
Federal Reserve Board regulations generally require that reserves of 3% must
be maintained against aggregate transaction accounts of $38.8 million or
less, subject to adjustment by the Federal Reserve Board. Total transaction
accounts in excess of $38.8 million are required to have a reserve of 10%
held against them, which are also subject to adjustment by the Federal
Reserve Board. The first $6.6 million of otherwise reservable balances,
subject to adjustments by the Federal Reserve Board, are exempted from the
reserve requirements. The Bank is in compliance with these requirements.
Because required reserves must be maintained in the form of either vault
cash, a noninterest-bearing account at a Federal Reserve Bank, or a pass-
through account as defined by the Federal Reserve Board, the effect of this
reserve requirement is to reduce the Bank's interest-earning assets.
The USA PATRIOT Act
In response to the events of September 11th, 2001, President George W.
Bush signed into law the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001,
or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the
federal government new powers to address terrorist threats through enhanced
domestic security measures, expanded surveillance powers, increased
information sharing, and broadened anti-money laundering requirements. By
way of amendments to The Bank Secrecy Act, Title III of the USA PATRIOT Act
takes measures intended to encourage information sharing among bank
regulatory agencies and law enforcement bodies. Further, certain provisions
of Title III impose affirmative
25
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 requirements with respect to financial institutions:
X 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.
X Pursuant to Section 326, on May 9, 2003, the Secretary of the
Department of Treasury, in conjunction with other bank regulators
issued Joint Final Rules that provide for minimum standards with
respect to customer identification and verification. These rules
became effective on October 1, 2003.
X 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 money laundering.
X Effective December 25, 2001, financial institutions are prohibited
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 will be subject to
certain record keeping obligations with respect to correspondent
accounts of foreign banks.
X Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal
Reserve Act and Bank Merger Act applications.
Recent Regulatory Examination
During 2002, the Bank continued to operate under an informal agreement
(Memorandum of Understanding) with the Federal Deposit Insurance Corporation
and Massachusetts Commissioner of Banks. This agreement was originally
entered into in December 2000. Following completion of a joint examination
in 2002, a revised Memorandum of Understanding was entered into during the
first quarter of 2003.
Subsequent to December 31, 2003, as a result of the improved condition
and operation of the Bank, as detailed in the Joint Report of Examination
dated September 22, 2003, the FDIC with concurrence from the Massachusetts
Commissioner of Banks, has terminated the Aforementioned Memorandum of
Understanding effective January 22, 2004. All conditions and reporting
requirements previously imposed cease immediately.
Holding Company Regulation
Federal Regulation. As a bank holding company, the Company is required
to obtain the prior approval of the Federal Reserve Board to acquire all, or
substantially all, of the assets of any bank or bank holding company. Prior
Federal Reserve Board approval will be required for The Company to acquire
26
direct or indirect ownership or control of any voting securities of any bank
or bank holding company if, after giving effect to such acquisition, it
would, directly or indirectly, own or control more than 5% of any class of
voting shares of such bank or bank holding company.
A bank holding company is required to give the Federal Reserve Board
prior written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or
redemptions during the preceding 12 months, will be equal to 10% or more of
the Company's consolidated net worth. The Federal Reserve Board may
disapprove such a purchase or redemption if it determines that the proposal
would constitute an unsafe and unsound practice, or would violate any law,
regulation, Federal Reserve Board order or directive, or any condition
imposed by, or written agreement with, the Federal Reserve Board. Such
notice and approval is not required for a bank holding company that would be
treated as "well capitalized" under applicable regulations of the Federal
Reserve Board, that has received a composite "1" or "2" rating at its most
recent bank holding company inspection by the Federal Reserve Board, and
that is not the subject of any unresolved supervisory issues.
In addition, a bank holding company which does not qualify 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 Federal Reserve Board 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 it meets certain criteria set forth
by the Federal Reserve Board.
Under the Federal Deposit Insurance Act, depository institutions are
liable to the FDIC for losses suffered or anticipated by the FDIC in
connection with the default of a commonly controlled depository institution
or any assistance provided by the FDIC to such an institution in danger of
default. This law would potentially be applicable to the Company if it ever
acquired as a separate subsidiary a depository institution in addition to
the Bank.
Massachusetts Regulation
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 term "company" is defined by the Massachusetts
banking laws similarly to the definition of "company" under the Bank Holding
Company Act. Each Massachusetts bank holding company:
* must obtain the approval of the Massachusetts Board of Bank
Incorporation before engaging in certain transactions, such as
the acquisition of more than 5% of the voting stock of another
banking institution;
* must register, and file reports, with the Division; and
* is subject to examination by the Division.
The Company will become a Massachusetts bank holding company if it
acquires a second banking institution and hold and operate it separately
from the Bank.
27
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 10% or more of the outstanding shares of the Company's common stock
will be required to submit prior notice to the Federal Reserve Board, unless
the Federal Reserve Board has found that the acquisition of such shares will
not result in a change in control of the Company. Under the Change in Bank
Control Act, the Federal Reserve Board 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 Company and the Bank, and the anti-trust effects
of the acquisition. Under the Bank Holding Company Act, any company would be
required to obtain prior approval from the Federal Reserve Board before it
may obtain "control," within the meaning of the Bank Holding Company Act, of
the Company. The term "control" is defined generally under the Bank Holding
Company Act to mean the ownership or power to vote 25% 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. An existing bank
holding company would require FRB approval prior to acquiring more than 5%
of any class of voting stock of the Company.
Massachusetts Restrictions. Under the Massachusetts banking laws, the
prior approval of the Division is required before any person may acquire a
Massachusetts bank holding company. For this purpose, the term "person" is
defined broadly to mean a natural person or a corporation, company,
partnership, or other forms of organized entities. The term "acquire" is
defined differently for an existing bank holding company and for other
companies or persons. A bank holding company will be treated as "acquiring"
a Massachusetts bank holding company if a bank holding company acquires more
than 5% of any class of the voting shares of Bank Holding Company. Any other
person will be treated as "acquiring" a Massachusetts bank holding company
if it acquires ownership or control of more than 25% of any class of the
voting shares of a bank holding company.
The Sarbanes-Oxley Act
On July 30, 2002, President George W. Bush signed into law the
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act implements a broad range
of corporate governance and accounting measures for public companies
designed to promote honesty and transparency in corporate America and better
protect investors from the type of corporate wrongdoing that occurred in
Enron, WorldCom and similar companies. The Sarbanes-Oxley Act's principal
legislation includes:
X the creation of an independent accounting oversight board;
X auditor independence provisions which restrict non-audit services that
accountants may provide to their audit clients;
X additional corporate governance and responsibility measures, including
the requirement that the chief executive officer and chief financial
officer certify financial statements;
X 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;
X 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;
28
X requirement that audit committee members must be independent and are
absolutely barred from accepting consulting, advisory or other
compensatory fees from the issuer;
X requirement that companies disclose whether at least one member of the
committee is a "financial expert" (as such term is defined by the
Securities and Exchange Commission) and if not, why not;
X expanded disclosure requirements for corporate insiders, including
accelerated reporting of stock transactions by insiders and a
prohibition on insider trading during pension blackout periods;
X a prohibition on personal loans to directors and officers, except
certain loans made by insured financial institutions;
X disclosure of a code of ethics and filing a Form 8-K for a change or
waiver of such code;
X mandatory disclosure by analysts of potential conflicts of interest;
and
X a range of enhanced penalties for fraud and other violations.
Although we anticipate that we will incur additional expense in
complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, management does not expect that such compliance will have a
material impact on our results of operations or financial condition.
Federal Securities Law
Our common stock is registered with the Securities and Exchange
Commission under Section 12(g) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). We are subject to information, proxy
solicitation, insider trading restrictions, and other requirements under the
Exchange Act.
29
ITEM 2
PROPERTIES
The main office of the Bank is located at 100 Slade's Ferry Avenue,
Somerset, Massachusetts at the junctions of U.S. Routes 6, 138, and 103. The
Bank operates its business from eleven banking offices located in Fairhaven,
Fall River, New Bedford, Seekonk, Somerset and Swansea, Massachusetts, and a
Loan Production Office in Warwick, Rhode Island. As of December 31, 2003,
the following Bank properties, which include Automated Teller Machines
(ATM's), are owned through the Bank's subsidiary, the 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
South Main Street 1601 South Main Street Fall River, MA 6,604
Ashley Boulevard 833 Ashley Boulevard New Bedford, MA 2,655
Offices listed below are leased by the Bank with the indicated lease
expiration dates.
Brayton Avenue**
Drive Up Complex 16 Stevens St. Fall River, MA 549
(expires 2005)
Walgreen's Drug Store 838 Pleasant St. New Bedford, MA 835
(expires 2004)
- --------------------
* The ATM at this location dispenses cash only.
** There is no ATM at this location.
Office listed below is rented by the Bank as a tenant at will:
Loan Production Office 3280 Post Road Warwick, RI 150
The main office building contains approximately 42,000 square feet of
usable space which the Bank occupies. The Bank also has a school banking
facility located in the Somerset High School, Grandview Avenue, Somerset,
Massachusetts that consists of 200 square feet which provides basic banking
services to students and school staff. The Seekonk office is an 8,800 square
foot building of which the Bank is utilizing 2,300 square feet and leasing
out the remainder.
30
ITEM 3
LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries are a party to, and
none of their properties are the subject of, any material legal proceedings,
other than routine litigation incidental to the Company's business.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2003, no matters were submitted to a vote
of stockholders of the Company.
31
PART II
ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
The Company's common stock is listed in the NASDAQ Small Cap Market
under the symbol SFBC. The following table sets forth the range of high and
low bids as reported for the NASDAQ Small Cap Market by quarters for the
two-year period ended December 31, 2003:
2003 2002
------------------------------------
High Low High Low
------------------------------------
1st Quarter $14.26 $13.25 $15.40 $13.55
------------------------------------
2nd Quarter $15.77 $14.18 $15.35 $13.81
------------------------------------
3rd Quarter $18.50 $15.60 $15.00 $13.05
------------------------------------
4th Quarter $23.00 $18.55 $13.74 $11.66
------------------------------------
As of March 19, 2004, there were approximately 1,352 holders of the
Company's common stock.
Dividends - History and Policy
The Company paid four quarterly cash dividends of $.09 per share for a
total of $.36 per share paid in 2003 and 2002, and expects to continue to
pay comparable dividends in the future.
The declaration of cash dividends, however, is dependent on a number
of factors, including regulatory limitations, and the Bank's operating
results and financial condition. The stockholders of the Company will be
entitled to dividends only when, and if, declared by the Company's Board of
Directors out of funds legally available. Under the Massachusetts Business
Corporation Law, a dividend may not be declared if the corporation is
insolvent or if the declaration of the dividend would render the corporation
insolvent.
Chapter 172 Section 28 of the Massachusetts Statutes on Bank and
Banking provides that a bank's Board of Directors may, subject to the
restriction contained in the section, declare and pay dividends on capital
stock out of net profits from time to time and to such extent as they deem
advisable. However, under this provision, no cash dividend shall be paid
unless, following the payment of such dividend, the capital stock and
retained earnings account will be unimpaired.
32
ITEM 6
SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the last
five years:
Year Ended December 31,
- -----------------------------------------------------------------------------------------------------------
(In Thousands Except per Share Data) 2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------
EARNINGS DATA
Interest Income $ 20,617 $ 22,037 $ 27,324 $ 28,186 $ 25,553
Interest Expense 6,073 7,928 12,327 12,699 10,754
-----------------------------------------------------------------
Net Interest Income 14,544 14,109 14,997 15,487 14,799
Provision (Benefit) for Loan Losses (602) (310) 750 1,200 550
Noninterest Income 2,214 2,533 1,769 1,857 2,086
Noninterest Expense 12,662 12,852 11,408 10,206 10,556
-----------------------------------------------------------------
Income Before Income Taxes 4,698 4,100 4,608 5,938 5,779
Applicable Income Taxes 2,010 1,134 1,398 1,864 1,923
-----------------------------------------------------------------
Net Income $ 2,688 $ 2,966 $ 3,210 $ 4,074 $ 3,856
=================================================================
PER SHARE DATA (1)
Net Income-Basic $ 0.68 $ 0.76 $ 0.84 $ 1.09 $ 1.06
Net Income-Diluted $ 0.67 $ 0.75 $ 0.84 $ 1.09 $ 1.05
Cash Dividends $ 0.36 $ 0.36 $ 0.44 $ 0.40 $ 0.35
Book Value (at end of period) $ 10.70 $ 10.45 $ 9.94 $ 9.41 $ 8.57
Avg. Shs. Outstanding (Basic) 3,969,737 3,908,901 3,830,575 3,743,138 3,650,275
Shares Outstanding Year End 3,995,857 3,937,763 3,869,924 3,789,503 3,520,409
BALANCE SHEET DATA
Assets $ 439,449 $ 398,375 $ 394,761 $ 388,619 $ 358,121
Loans 336,094 265,012 253,884 256,153 242,049
Unearned Income 443 342 382 519 594
Allowance for Loan Losses 4,154 4,854 5,484 4,776 3,766
Loans, Net 331,497 259,816 248,018 250,849 237,669
Goodwill 2,173 2,173 2,173 2,400 2,627
Investments 61,487 80,618 96,401 88,109 81,806
Deposits 333,145 335,633 337,043 337,001 316,431
Stockholders' Equity 42,742 41,167 38,466 35,674 31,664
FINANCIAL RATIOS
Net Interest Margin(2) 3.91% 3.89% 4.18% 4.58% 4.71%
Net Interest Spread (2) 3.48 3.30 3.34 3.75 3.99
Net Income as a Percentage of
Average Assets 0.65 0.74 0.81 1.09 1.11
Average Equity 6.42 7.45 9.04 12.92 12.56
Dividend Payout Ratio 53.22 47.50 52.63 36.84 34.36
Average Equity to Average Assets 10.06 9.94 9.00 8.45 8.85
- --------------------
(1) Earnings per share are computed based on the average number of shares
of common stock outstanding during the year, adjusted to reflect a 5%
stock dividend paid in 2000.
(2) Calculated on a fully taxable equivalent basis.
33
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS
The purpose of Management's Discussion and Analysis is to focus on
certain significant factors which have affected the Company's operating
results and financial condition, and to provide stockholders a more
comprehensive review of the figures contained in the financial data of this
report. This discussion should be read in conjunction with our audited
financial statements and the related notes for the year ended December 31,
2003.
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. Other such statements may be identified by words such as
"believes," "will," "expects," "project," "may," "developments,"
"strategic," "launching," "opportunities," "anticipates," "estimates,"
"intends," "plans," "targets" and similar expressions. These statements are
based upon the current beliefs and expectations of the Company's management
and are subject to significant risks and uncertainties. Actual results may
differ materially from those set forth in the forward-looking statements as
a result of numerous factors.
The following factors, among others, could cause actual results to
differ materially from the anticipated results or other expectations
expressed in our forward-looking statements: (1) enactment of adverse
government regulation; (2) competitive pressures among depository and other
financial institutions may increase significantly and have an effect on
pricing, spending, third-party relationships and revenues; (3) the strength
of the United States economy in general and specifically the strength of the
New England economies may be different than expected, resulting in, among
other things, a deterioration in overall credit quality and borrowers'
ability to service and repay loans, or a reduced demand for credit,
including the resultant effect on the Bank's loan portfolio, levels of
charge-offs and non-performing loans and allowance for loan losses; (4)
changes in the interest rate environment may reduce interest margins and
adversely impact net interest income; and (5) changes in assumptions used in
making such forward-looking statements. Should one or more of these risks
materialize or should underlying beliefs or assumptions prove incorrect, the
Company's actual results could differ materially from those discussed. All
subsequent written and oral forward-looking statements attributable to the
Company or any person acting on its behalf are expressly qualified in their
entirety by the cautionary statements set forth above. The Company 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.
Overview
Slade's Ferry Trust Company is a community bank that strives to meet
the financial service needs of our local community and provide quality
service to individuals and businesses within our market area. Historically,
the Bank has been a provider of traditional banking products and services to
businesses and individuals, including loan products such as commercial and
residential real estate, home equity, commercial and industrial loans, and
various deposit products. The Bank gathers substantially all of its deposits
within its market area and uses these deposits, as well as other financial
sources, to fund its investment and loan portfolio.
34
The year ending December 31, 2003 was a very important year for the
Bank. We worked diligently to strengthen our balance sheet and made great
strides in marketing our products and services. During 2003, our loan
portfolio increased by 26.8%, attributable primarily to an aggressive
marketing campaign to promote home equity loans and residential mortgages.
This was part of our overall strategy to diversify our loan portfolio, which
historically was heavily weighted toward commercial real estate loans that
carried a higher credit risk to the loan portfolio. This strategy enabled
the Bank to help its customers take advantage of the low interest rate
environment while reducing the loan portfolio's risk profile. On the deposit
side of the business, a campaign to promote money market accounts was very
successful, generating more than $16.0 Million in core deposits.
The Bank also focused on strengthening and expanding its retail
banking division, introducing a sales culture, developing and marketing
various deposit products and planning to implement products such as Internet
banking and cash management services during the second quarter of 2004.
The Bank closely adhered to its strategic plan during 2003 to
reorganize, improve efficiencies, increase assets, diversify the loan
portfolio, enhance retail products and services, and reinvest in the bank
infrastructure to remain competitive. As a result, the Bank intends to
continue its efforts to increase its assets, earnings, and improve its
market presence.
You should read our financial results for the year ended December 31,
2003 in the context of this strategy.
The following overview is a summary of the items management focuses on
when evaluating the condition of the Company, including items of significant
importance for the Company's year ended December 31, 2003:
* In 2003, Slade's Ferry Bancorp. recorded net income of $2,687,886 or
$0.67 per share on a diluted basis compared to $2,965,552 or $0.75 per
share on a diluted basis in 2002. This represents a decrease of
$277,666 or 9.4% in net income and $0.08 or 10.67% per share on a
diluted basis between 2003 and 2002. This decrease is due to an
increase in income tax expense of $876,000 primarily a result of the
REIT tax settlement, and a decrease in noninterest income of $319,000,
offset partially by an increase in net interest income after benefit
for loan loss of $727,000 and a decrease in noninterest expenses of
$190,000.
* Return on average equity for 2003 was 6.42%, down by 1.03% when
compared to 7.45% reported in 2002. Return on average assets for 2003
was .65%, down by .09% when compared to .74% reported in 2002. The
decrease in both these ratios for 2003 is primarily due to the
increase in income tax expense and interest of $658,168 as a result of
the settlement with the Massachusetts Department of Revenue related to
the Bank's REIT subsidiary, as described below.
* On June 20, 2003, the Bank and its subsidiary real estate investment
trust, Slade's Ferry Preferred Capital Corporation, entered into an
agreement with the Massachusetts Department of Revenue (the "DOR")
settling the dispute concerning the dividends received deduction
through calendar year 2002 claimed or to be claimed by the Bank. Under
the agreement, the Bank agreed to pay and the DOR agreed to abate 50%
of all tax and interest assessed or unassessed relating to the REIT
dividend deduction. This resulted in a charge of $658,168 for state
income taxes and interest, net of federal income tax benefits.
35
* Book value of the Company's common stock increased to $10.70 in 2003
from $10.45 reported in 2002 and $9.94 reported in 2001. This is the
result of an increase of $1.6 Million in total stockholders' equity
and only 58,094 additional shares issued during 2003.
* Total assets increased by $41.1 Million, or 10.3% from $398.4 Million
in 2002 to $439.4 Million in 2003. This increase was directly related
to the increase of $41.3 Million in advances from the Federal Home
Loan Bank.
* Total gross loans increased by $71.1 Million or 26.8% from $265.0
Million in 2002 to $336.1 Million in 2003. This is due to the increase
of $56.8 Million in residential mortgage and home equity loans, $17.6
Million in commercial real estate loans, and $3.5 Million in
commercial, financial, and agricultural loans, offset by a decrease of
$3.7 Million in real estate construction loans, and $3.2 Million in
consumer, nonprofit and other loans. This is consistent with the
Bank's strategic plan, which emphasizes growth in consumer loan
mortgages and loan diversification.
* Asset quality improved; nonperforming assets, as a percentage of total
loans, decreased from 0.24% in 2002 to 0.12% reported in 2003. Total
loan charge-offs also decreased from $382,000 in 2002 to $211,000 in
2003, as credit quality in the loan portfolio improved.
* Capital adequacy ratios continue to meet criteria of "well
capitalized" under regulatory guidelines. These ratios in 2003 were
13.64% for total capital, 12.39% for Tier 1, and 9.33% for leverage
capital.
* Subsequent to December 31, 2003, as a result of the improved condition
and operation of the Bank, as detailed in the Joint Report of
Examination dated September 22, 2003, the FDIC with concurrence from
the Massachusetts Commissioner of Banks, has terminated the
aforementioned Memorandum of Understanding effective January 22, 2004.
All conditions and reporting requirements previously imposed cease
immediately.
Critical Accounting Policies
Our significant accounting policies are described in Note 2 to our
Consolidated Financial Statements. In preparing financial information,
management is required to make significant judgments, estimates, and
assumptions that impact the reported amounts of certain assets, liabilities,
revenues and expenses. The accounting principles followed by the Company and
the methods of applying these principles conform to accounting principles
generally accepted in the United States, and general banking practices. The
Company considers the following to be its critical accounting policies:
allowance for loan losses, goodwill and other intangible assets other than
temporary impairment of investments, and deferred taxes.
Allowance for Loan Losses. Establishing an appropriate level of
allowance for loan losses involves a high degree of judgment. The allowance
for loan losses is established through a charge or credit to the provision
for loan losses, and is based on management's projection of the adequate
level of the allowance in relation to the inherent loss exposure in the loan
portfolio. On a monthly basis, management evaluates the adequacy of the
allowance which includes a formal analysis which considers, among other
factors, business and economic conditions and industry trends, the size and
characteristics of the loan portfolio, delinquency trends, charge-off
experience, loan growth, nonaccrual loan trends, and
36
portfolio migration information. Although management uses available
information to project the appropriate level of the allowance which is based
on factors and risk identification procedures discussed in "Item I Business
- - Summary of Loan Loss Experience", the use of judgments and projections may
change in the future. Changes in factors or assumptions used by management
to determine the adequacy of the allowance or the availability of new
information could cause the allowance for loan losses to be increased or
decreased in future periods. In addition, bank regulatory agencies, as part
of their examination process, may require the Bank to recognize adjustments
to the allowance based on their judgments and projections.
Accounting for Acquisitions and Review of Goodwill. The Company
completed an acquisition in 1996 and used the purchase method of accounting.
For acquisitions under this method, the Company recorded assets acquired and
liabilities assumed at their estimated fair value, which in some instances
involves estimates based on internal and third party pressures, or other
valuation techniques. In addition, this purchase acquisition resulted in
goodwill, which is subject to ongoing periodic impairment tests, and is
evaluated using fair value techniques that contain estimates. If the
estimated fair value is less than the carrying amount, a loss due to
impairment would be recognized to reduce the carrying value to fair value.
Other Than Temporary Impairment. Management records a writedown
impairment charge when it believes an investment experiences a decrease in
value that is other than temporary. In making a decision whether an
investment is permanently impaired, management reviews current and
forecasted information about the underlying investment that is available,
applicable industry data, and analyst reports. When an investment is deemed
to be permanently impaired, it is written down to current fair market value.
Future adverse changes in economic and market conditions, deterioration in
credit quality, and continued poor financial results of underlying
investments or other factors could result in further losses that may not be
reflected in an investment's current book value that could result in future
writedown charges due to impairment.
Deferred Tax Estimates. The Company uses the asset and liability
method of accounting for income taxes. Under this method, deferred tax
assets and liabilities are recognized for the future tax attributable to
differences between the financial statement carrying amounts of assets and
liabilities and their respective tax basis. The Company must also assess the
probability that deferred tax assets will be recovered from future taxable
income, and establish a valuation allowance for any assets determined not
likely to be recovered. Management exercises judgment in evaluating the
amount and timing of recognition of the resulting deferred tax assets and
liabilities, including projections of future taxable income. These judgments
are estimates and assumptions and are reviewed on a continuing basis.
RESULTS OF OPERATIONS
The Company's operating performance is dependant 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. On a fully tax equivalent basis, our
net interest income was $14.9 Million in 2003, compared to $14.3 Million in
2002, and $15.2 Million in 2001. The increase in net income of $600,000 from
2002 to 2003 has been primarily attributable to the growth in the loan
portfolio and the continued reduction in the rates paid on interest-bearing
liabilities and borrowings. Average earning assets produced a yield of 5.50%
in 2003, compared to 6.04% in 2002, and 7.55% in 2001. The low interest rate
environment continues to
37
decrease our earning asset yields as loans and investments reprice at lower
interest rates due to refinancing opportunities and prepayments.
The loan portfolio, which generally generates higher interest yields
than our investment portfolio represented 70.9% of average assets in 2003,
compared to 63.5% in 2002, and 63.7% in 2001. The increase of 7.4% from 2002
to 2003 was primarily the result of growth in originations of both
residential real estate and home equity loans. This increase reflected the
lower interest rate environment, aggressive solicitation and pricing of
these loan types, and the Bank's strategic plan to diversify the loan
portfolio by increasing these loan types, resulting in a reduction in credit
risk exposure within the overall loan portfolio. The Bank intends to
continue its competitive pricing of these loans within our market area,
however, our marketing and pricing strategy may vary as necessary to achieve
our goals for diversifying the loan portfolio.
Partially offsetting the decrease in the earning asset yield of .54%
from 6.04% as of December 31, 2002 to 5.50% as of year end 2003 was a
reduction of .72% in the cost of funding the earning assets from 2.74% as of
year end 2002 to 2.02% as of 2003. The decrease in the cost of funds in 2003
reflects the low interest rate environment resulting in the repricing of
certificates of deposit and other deposit products to lower rates.
Our net interest spread, representing the difference between the
weighted average yield earned on our earning assets and the average cost of
interest bearing liabilities increased to 3.48% in 2003 from 3.30% in 2002
and 3.34% reported in 2001. The increase in the net interest spread from
2002 to 2003 was the result of the decrease in the Bank's cost of interest-
bearing liabilities due to the low interest rate environment. The average
interest rate on these liabilities decreased by 72 basis points from 2.74%
in 2002 to 2.02% in 2003. In comparison, the average interest rate on
earning assets decreased by 54 basis points, from 6.04% in 2002 to 5.50% in
2003.
Net interest margin, which represents net interest income as a
percentage of average earning assets increased slightly to 3.91% in 2003
from 3.89% in 2002, and 4.18% in 2001. This increase was the result of the
lower interest rate environment and asset/liability management objectives to
manage balance sheet coordination and interest rate risk in achieving
reasonable and stable net interest income throughout various interest rate
cycles.
The provision for loan losses is a charge against earnings and funds
the Allowance for Loan Losses. It is management's intent to maintain the
allowance for loan losses at a level that 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 condition, evaluations of
underlying collateral, the volume of the loan portfolio and the balance of
nonperforming and classified loans. Management assesses the allowance for
loan losses on a monthly basis. After thorough review and analysis of the
adequacy of the loan loss reserve, the diversification of the loan portfolio
into residential mortgages and home equity loans resulting in a reduction in
overall credit risk, the continued improvement in asset quality in the loan
portfolio, and the reduction and sale of loans deemed substandard, it was
deemed prudent by management to recover $602,326 of previously provided loan
loss provisions during 2003. The Bank's provision for 2003 was a benefit to
earnings of $602,326 compared to a benefit of $301,000 in 2002, and a
provision of $750,000 in 2001.
Total other income for 2003 decreased by $319,272 or 12.6% from
$2,532,817 recorded during 2002 to $2,213,545 in 2003. This decrease is
predominantly the result of a decrease in net gains of sales
38
of available- for-sale securities from $625,832 recognized during 2002 to
$1,944 in 2003 and $14,934 in 2001. The gains recognized during 2002
resulted from sales of various securities to partially offset a writedown
charge of $1,240,868, discussed further below, due to various impairment
adjustments of equity securities that were deemed to be other than
temporary. No securities writedown charges were necessary during 2003 or
2001.
Partially offsetting the decrease of $623,888 in security gains from
2002 to 2003 was increases in both service charges on deposit accounts and
overdraft service charges of $234,075. Service charges on deposit accounts
increased in 2003 to $569,189 when compared to $551,060 in 2002, and
$561,370 in 2001. Overdraft service charges increased by $215,946 from
$333,977 recorded in 2002 to $549,923 in 2003. In 2001 overdraft fees were
$257,586. This increase was due to a new overdraft fee pricing schedule and
procedure implemented during the second quarter of 2003.
The cash surrender values of Bank Owned Life Insurance policies
associated with both the Directors' and officers' life insurance programs
increased by $67,524 from 2002 to 2003 due additional earnings generated
from the purchase of additional policies for newly hired vice presidents
during 2003 and two new directors. It is anticipated that new policies for
officers hired as vice presidents would be purchased in accordance with this
program.
Other income increased slightly, by $3,017 from $578,728 recorded in
2002 to $581,745 in 2003. This income represents earnings derived from fees
associated with safe deposit box rentals, ATM/debit card usage, customer
investment commissions, and other miscellaneous income.
Total Other Expense, made up of various noninterest expenses decreased
by $190,073 to $12,661,729, as compared to $12,851,802 recorded in 2002.
Total other expense was $11,408,387 in 2001. Salaries and employee benefits,
which is the largest component in this category, increased by $410,423, (or
5.6%) from $7,368,364 for 2002 to $7,778,787 for 2003. In 2001, salaries and
benefits were $7,124,377. The increase was attributable to additions to
staff to support consumer lending activities, sales incentive commissions
paid for achieving sales production targets, general salary increases due to
annual performance reviews, and annual bonuses. A Chief Operating
Officer/Chief Financial Officer was also hired in the second quarter of
2003, and during the third quarter of 2003, a Director of Retail and an
Investment Executive was hired. In addition, employee benefit expense
increased as the Company increased its contribution to a pension plan during
2003.
Occupancy and Equipment expense combined totaled $1,428,247 in 2003,
an increase of $104,834 when compared to $1,323,413 reported in 2002.
Occupancy and equipment expense was $1,426,855 in 2001. The increase from
2002 to 2003 was primarily due to increased snow removal cost resulting from
a cold, severe winter, and higher energy cost during the first quarter of
2003. In addition, real estate taxes on bank owned properties increased
during 2003, and costs associated with closing a branch office in Swansea
were recorded during the third quarter of 2003.
Stationary and supplies expense decreased by $63,749 from $276,824
recorded in 2002 to $213,075 in 2003. This decrease was due to new inventory
control procedures, and the closing of one branch office. This cost was
$241,186 in 2001.
39
Professional fees increased by $479,734 or 87.4%, from $549,036 in
2002 to $1,028,770 in 2003. These expenses in 2001 were $364,680. This
increase reflects costs associated with consultants contracted for
marketing, advertising, investment advisory, strategic planning, pension
actuaries, and information technology. In addition, legal expenses for both
corporate and loan related matters increased in 2003. The substantial
increase in 2003 was attributed to improving efficiencies throughout the
Bank and implementing best practice procedures. In addition, the
introduction of a new sales culture, the enhancement and expansion of our
consumer loan products and operations, the promotion of the Bank through
marketing and advertising, the introduction of new retail deposit products,
and the significant upgrade and improvement of our information technology
and computer systems required additional cost and investments. These
expenses are expected to continue, but stabilize, as the Bank, through its
strategic planning process, focuses on growth and profitability.
Marketing Expenses attributed to production and media costs, print
advertising, and other direct marketing increased by $19,923, from $355,203
recorded in 2002 to $375,126 in 2003. This expense in 2001 was $421,480.
Many new loan and deposit products and promotions were introduced during
2003.
The assessment for FDIC deposit insurance decreased by $2,565 in 2003,
from $158,115 in 2002 to $155,550 in 2003. In 2001, this cost was $160,305.
Included in Total Expenses in 2002 was a writedown of securities of
$1,240,868 due to the recognition of impairment adjustments on equity
securities that were deemed to be other than temporary. During 2003 and
2001, no writedowns were necessary. The investment portfolio is reviewed at
least quarterly to determine if declines in market values are other than
temporary and deemed impaired. In managing and evaluating its investment
portfolio and reporting on its performance and condition, the Bank applies a
methodology to identify whether a decline in market value below cost of an
individual security is other than temporary. If the decline is judged to be
other than temporary, the cost basis of the security will be written down to
a new cost basis and the writedown will be accounted for as a realized loss.
Using a variety of factors to estimate the outcome of future events,
management performs an analysis of the Bank's investments to identify those
securities that may be permanently impaired. Generally accepted accounting
principles (GAAP) provide and reflect interpretive guidance for directing
management on impairment decisions. All securities will be monitored and
evaluated to determine whether a recommendation will be made to sell or
impair securities.
The methodology used to determine whether losses are other than
temporary involve projecting the outcome of future events. Judgments are
required in determining whether factors exist that indicate that an
impairment loss has occurred. These judgments are based on subjective and
objective factors, including knowledge and experience about past and current
events and assumptions about future events.
If the fair market value of a security is significantly below
amortizing cost, the following factors would be applied to determine if a
loss is other than temporary: the decline is due to adverse conditions
specifically related to the security or to conditions in an industry or
geographic area, the decline has existed for an extended period of time,
management does not possess both the intent and ability to hold the security
for a period of time sufficient to allow for any anticipated recovery of
fair value, the security has been downgraded by a rating agency, the
financial condition of the issuer has deteriorated, and dividends have been
reduced or eliminated, or scheduled interest payments have not been made
40
The following table sets forth the components of Other Expense:
2003 2002 2001
- --------------------------------------------------------------------------
Amortization of Goodwill $ 0 $ 0 $ 226,800
Communications 336,136 322,020 326,234
Committee Fees 178,250 212,250 190,900
Interest Expense -(Associated
with REIT Settlement) 128,977 0 0
Other Various Expenses 1,038,811 1,045,709 925,570
- --------------------------------------------------------------------------
Other Expense Total $1,682,174 $1,579,979 $1,669,504
==========================================================================
Goodwill arising from the Company's acquisition of Fairbank, Inc. in
1996 has been amortized on a straight-line basis over a period of fifteen
years. The amortization of goodwill discontinued upon the adoption of
Statement of Financial Accounting Standards No. 142 effective January 1,
2002, which requires that goodwill no longer be amortized, but instead be
reviewed and tested for impairment on an annual basis. In accordance with
the accounting standard, the Company tested its goodwill for impairment as
of June 30, 2003 and determined that its goodwill as of that date was not
impaired.
As previously mentioned, the Bank entered into an agreement to settle
the dispute concerning the REIT dividends received deduction through
calendar year 2002. The interest assessed on this additional state tax
liability amounted to $128,977 for calendar years 1999 through 2002.
Income before income taxes totaled $4,697,602 as of year-end 2003, an
increase of $597,867 as compared to $4,099,735 reported as of December 31,
2002. Applicable taxes increased by $875,533 to $2,009,716 when compared to
$1,134,183 reported in the prior year.
During 2003 the Company recorded a state income tax provision of
$529,191, net of federal and state income tax benefits, as a result of the
settlement with the Massachusetts Department of Revenue that retroactively
disallowed the REIT dividend deduction for the years ended December 31, 1999
through December 31, 2002. Due to the impact of this additional tax
provision and the related $128,977 of interest charge, the effective tax
rate for 2003 was 42.80% compared to 27.70% for 2002. This increase from
2002 primarily reflects the impact of the State of Massachusetts' change in
tax law that eliminated the tax benefit derived from REIT dividends.
The Company's net earnings were $2,687,886, $2,965,552, and $3,210,253
for 2003, 2002, and 2001, respectively. Diluted earnings per share were $.67
for twelve months ending December 31, 2003 compared to $.75 for the same
period in 2002 and $.84 in 2001.
41
Unaudited Quarterly Financial Summary
(In Thousands)
- -----------------------------------------------------------------------------------
March 31 June 30 September 30 December 31
- -----------------------------------------------------------------------------------
2003:
Revenues $5,535 $5,678 $5,699 $5,918
Operating Income 622 1,597 1,019 1,459
Net Income (Loss) (692) 1,609 700 1,071
Earnings (loss) per share
Basic $(0.18) $ 0.41 $ 0.18 $ 0.27
Diluted $(0.17) $ 0.40 $ 0.17 $ 0.27
2002:
Revenues $6,250 $5,991 $6,534 $5,795
Operating Income (Loss) 1,078 (8) 1,588 1,442
Net Income 782 57 1,251 876
Earnings per share
Basic $ 0.20 $ 0.01 $ 0.32 $ 0.23
Diluted $ 0.20 $ 0.01 $ 0.32 $ 0.22
FINANCIAL CONDITION
Total assets increased by $41.0 Million, or 10.3%, from $398.4 Million
at December 31, 2002 to $439.4 Million at December 31, 2003. The increase in
total assets during 2003 is most significant in the gross loan portfolio
that experienced a 26.8% increase. The increase in total assets was
primarily the result of an increase in advances from the Federal Home Loan
Bank of $41.3 Million, from $19.2 Million at December 31, 2002 to $60.5
Million at December 31, 2003.
Loans
- -----
The loan portfolio represents the largest component of the Company's
assets. Total loans increased by $71.1 Million, or 26.8%, from $265.0
Million at December 31, 2002 to $336.1 Million at December 31, 2003. The
increases in 2003 were primarily due to increases of $56.9 Million in
residential mortgage and home equity loans, $21.2 Million in commercial and
commercial real estate loans, offset by decreases in consumer and
construction loans of $6.7 Million. The growth in the commercial and
commercial real estate loan portfolios was encouraging in light of the
impact of the economic slowdown and strong competition for these customers.
The consumer loan portfolio consisting of direct and indirect auto loans and
other consumer installment loans decreased by $2.9 Million. Additionally,
during 2003, aggressive plans to improve the quality of our loan portfolio
resulted in the sale of approximately $2.0 Million of loans.
The composition of our loan portfolio has changed since December 31,
2002. Loan demand for residential real estate and home equity loans
increased throughout 2003 as new and existing homeowners took advantage of
the lower interest rates. The largest segment of the loan portfolio is now
residential real estate and home equity loans which accounts for 43.8% of
the loan portfolio, and is comprised of first mortgages on one-to four-
family properties, mortgages on multi-family properties, and second
mortgages on one-to four-family properties. These loan types were 34.1% of
the loan portfolio as of December 31, 2002. Credit is granted based on
income to debt ratio, a satisfactory credit report, and the appraised value
42
of the property. The Bank also provides a program to encourage home
ownership for first time homebuyers.
Another component of the loan portfolio is commercial real estate
loans representing 41.8% of total loans compared to 46.3% as of December 31,
2002. These loans are collateralized by various types of commercial
properties, without any predominate type of property or concentration of
credit in any one industry. The properties consist of apartment complexes,
medical centers, strip malls, factories, and retail units located in the
Bank's market area extending throughout Southeastern Massachusetts and
cities and towns in Rhode Island. Commercial real estate loans generally
have a higher degree of credit because they are predominately dependent on
the success of the business. The Bank adheres to a credit criteria policy
that strives to maintain the quality of the loan portfolio. The process of
granting a commercial loan consists of an independent analysis of the
financial condition of the borrower and the business entity by the Bank's
credit risk division. In turn, the borrowing request is further evaluated by
the Loan Committee and all loans in excess of $500,000 are submitted to the
Executive Committee of the Board of Directors for final approval. Annually,
analysis of financial statements of the business is performed to determine
if there are any weaknesses or negative trends developing, and if so,
contact with the borrower is made to ascertain the cause and what remedial
action is planned.
Other types of loans total 14.4% of the loan portfolio and are
comprised of commercial and industrial loans, which are generally short-term
loans to finance business inventory, consumer installment loans, automobile
financing, nonprofit, and real estate construction loans. These loan types
represented 19.6% of the loan portfolio in 2002.
Investments
- -----------
The main objectives of the investment portfolio are to achieve a
competitive rate of return over a reasonable time period and provide
liquidity.
The investment portfolio represents the second largest component of
the Company's assets and consists of securities in the Available-for-Sale
category and securities in the Held-to-Maturity category. The designation is
determined at the time of the purchase. Securities in the Available-for-Sale
category are securities that the Company intends to hold for an indefinite
period of time, but not necessarily to maturity. These securities may be
sold in response to interest rate changes, liquidity needs or other factors.
Any unrecognized gain or loss, net of taxes for the Available-for Sale
securities, is reflected in Stockholders' Equity as a separate component.
The Held-to-Maturity category consists mostly of securities issued by
states of the United States and political subdivisions of states. The
Company has the positive intent and ability to hold these securities to
maturity.
Total investments decreased by $19.1 Million, or 23.7%, to $61.5
Million as of December 31, 2003, from $80.6 Million reported as of December
31, 2002. This decrease in investments of $19.1 Million during 2003,
primarily the result of scheduled maturities and call features, combined
with an increase of $41.3 Million in FHLB borrowings and a decrease of $15.5
Million in federal funds sold and overnight FHLB deposits, provided the
liquidity to fund the $71.1 Million increase in the loan portfolio. Included
in investments in 2003 is $3.0 Million of stock of the FHLB, compared to
$1.0 Million in 2002. The Bank is required to invest in FHLB stock in an
amount determined on the basis of the Bank's
43
residential mortgage loans and borrowings from the FHLB. This stock is
redeemable at par and earns a quarterly dividend at the discretion of the
FHLB.
The Company's current investment strategy is to concentrate on the
purchase of U.S. Government and agency obligations, and corporate bonds
generally maturing or callable within five to seven years. Our investment
policy permits investments in mortgage-backed securities, usually having a
longer weighted average life.
As of December 31, 2003, the net unrealized gain on securities
classified as Available-for-Sale was $91,000, consisting of net unrealized
gains of $238,000 on debt securities offset by net unrealized losses of
$147,000 on marketable equity securities.
Off Balance Sheet Arrangements
- ------------------------------
The Company does not have any off-balance sheet arrangements that have
or are reasonably likely to have a current or future effect on the Company's
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.
Recent Accounting Pronouncements:
- ---------------------------------
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). This
Statement requires that a liability for a cost associated with an exit or
disposal activity be recognized and measured initially at fair value only
when the liability is incurred. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31, 2002. This
Statement did not have a material impact on the Company's consolidated
financial statements.
In October 2002, the FASB issued SFAS No. 147 "Acquisitions of Certain
Financial Institutions" ("SFAS No. 147"), an Amendment of SFAS Nos. 72 and
144 and FASB Interpretation No. 9. SFAS No. 72 "Accounting for Certain
Acquisitions of Banking or Thrift Institutions" and FASB Interpretation No.
9 "Applying APB Opinions No. 16 and 17 When a Savings and Loan Association
or a Similar Institution Is Acquired in a Business Combination Accounted for
by the Purchase Method" provided interpretive guidance on the application of
the purchase method to acquisitions of financial institutions. Except for
transactions between two or more mutual enterprises, SFAS No. 147 removes
acquisitions of financial institutions from the scope of both Statement 72
and Interpretation 9 and requires that those transactions be accounted for
in accordance with SFAS No. 141 "Business Combinations" and SFAS No. 142
"Goodwill and Other Intangible Assets." Thus, the requirement in paragraph 5
of 72 to recognize (and subsequently amortize) any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset no longer
applies to acquisitions within the scope of SFAS No. 147. In addition, SFAS
No. 147 amends SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets" to include in its scope long-term customer-relationship
intangible assets of financial institutions such as depositor- and borrower-
relationship intangible assets and credit cardholder intangible assets.
Consequently, those intangible assets are subject to the same undiscounted
cash flow recoverability test and impairment loss recognition and
measurement provisions that SFAS No. 144 requires for other long-lived
assets that are held and used.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("FIN
44
45"). FIN 45 elaborates on the disclosure to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. FIN 45
clarifies that a guarantor is required to disclose (a) the nature of the
guarantee; (b) the maximum potential amount of future payments under the
guarantee; (c) the carrying amount of the liability; (d) the nature and
extent of any recourse provisions or available collateral that would enable
the guarantor to recover the amounts paid under the guarantee.
Paragraph 5 of SFAS No. 147, which relates to the application of the
purchase method of accounting, was effective for acquisitions for which the
date of acquisition is on or after October 1, 2002. The provisions in
paragraph 6 related to accounting for the impairment or disposal of certain
long-term customer-relationship intangible assets were effective on October
1, 2002. Transition provisions for previously recognized unidentifiable
intangible assets in paragraphs 8-14 were effective on October 1, 2002, with
earlier application permitted. There was no impact on the Company's
consolidated financial statements on adoption of this Statement.
The initial recognition and initial measurement provisions of FIN 45
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements in FIN 45 are effective for
financial statements of interim or annual periods ending after December 15,
2002. The Company adopted the initial recognition and initial measurement
provisions of FIN 45 effective as of January 1, 2003 and adopted the
disclosure requirements effective as of December 31, 2002. The adoption of
this interpretation did not have a material effect on the Company's
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-
Based Compensation - Transition and Disclosure, an amendment of SFAS
Statement No. 123" ("SFAS No. 148"). SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In addition, SFAS No.
148 amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method
of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition provisions and disclosure
provisions are required for financial statements for fiscal years ending
after December 15, 2002. The Company adopted the disclosure provisions of
SFAS No. 148 as of December 31, 2002 and currently uses the intrinsic value
method of accounting for stock options.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
No. 133 on Derivative Instruments and Hedging Activities" ("SFAS No. 149"),
which amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This Statement (a) clarifies
under what circumstances a contract with an initial net investment meets the
characteristic of a derivative, (b) clarifies when a derivative contains a
financing component, (c) amends the definition of an underlying to conform
to language used in FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," and (d) amends certain other existing
pronouncements. The provisions of SFAS No. 149 are effective for contracts
entered into or modified after June 30, 2003. There was no substantial
impact on the Company's consolidated financial statements on adoption of
this Statement.
45
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS No. 150"). This Statement establishes standards for the
classification and measurement of certain financial instruments with
characteristics of both liabilities and equity. SFAS No. 150 requires that
certain financial instruments that were previously classified as equity must
be classified as a liability. Most of the guidance in SFAS No. 150 is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. This Statement did not have any
material effect on the Company's consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"), in an effort to expand upon and
strengthen existing accounting guidance that addresses when a company should
include in its financial statements the assets, liabilities and activities
of another entity. In December 2003, the FASB revised Interpretation No. 46,
also referred to as Interpretation 46 (R) ("FIN 46(R)"). The objective of
this interpretation is not to restrict the use of variable interest entities
but to improve financial reporting by companies involved with variable
interest entities. Until now, one company generally has included another
entity in its consolidated financial statements only if it controlled the
entity through voting interests. This interpretation changes that, by
requiring a variable interest entity to be consolidated by a company only if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The Company is required to apply FIN 46,
as revised, to all entities subject to it no later than the end of the first
reporting period ending after March 15, 2004. However, prior to the required
application of FIN 46, as revised, the Company shall apply FIN 46 or FIN 46
(R) to those entities that are considered to be special-purpose entities as
of the end of the first fiscal year or interim period ending after December
15, 2003. The adoption of this interpretation has not and is not expected to
have a material effect on the Company's consolidated financial statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits -
an amendment of SFAS No. 87, SFAS No. 88 and SFAS No. 106" ("SFAS No. 132
(revised 2003)"). This Statement revises employers' disclosures about
pension plans and other postretirement benefit plans. It does not change the
measurement or recognition of those plans required by SFAS No. 87,
"Employers' Accounting for Pensions," SFAS No. 88, "Employers' Accounting
for Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits," and SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions." This Statement retains the
disclosure requirements contained in SFAS No. 132, "Employers' Disclosures
About Pensions and Other Postretirement Benefits," which it replaces. It
requires additional disclosures to those in the original Statement 132 about
assets, obligations, cash flows and net periodic benefit cost of defined
benefit pension plans and other defined benefit postretirement plans. This
Statement is effective for financial statements with fiscal years ending
after December 15, 2003 and interim periods beginning after December 15,
2003. Adoption of this Statement did not have a material impact on the
Company's consolidated financial statements.
Deposits and Borrowed Funds
- ---------------------------
The Bank's major source of funds are deposits, borrowings and
amortization from principal payments or payoffs on loans and mortgage-backed
securities, and maturities or calls of investments.
Total deposits decreased by $2.5 Million from $335.6 Million at
December 31, 2002 to $333.1 Million at December 31, 2003. Total interest-
bearing deposits decreased by $3.5 Million, from $263.4
46
Million at December 31, 2002 to $259.9 Million at December 31, 2003. This
decrease was primarily the result of declining interest rates for these
products and depositors attempting to find better yielding alternative
investments. Non-interest bearing deposits increased by $1.0 Million, from
$72.3 Million at December 31, 2002 to $73.3 Million at December 31, 2003.
The Bank does not engage in gathering brokered deposits. The Bank's
marketing campaign during 2003 to promote new money market account products
has been very successful generating more than $10.0 Million in new core
deposits.
Borrowings are generally used to fund long-term fixed rate loans and
short-term liquidity requirements, or to manage interest rate risk.
The Bank is a member of the Federal Home Loan Bank of Boston and is
authorized to borrow funds to meet deposit withdrawals or to expand the loan
or investment portfolios. These borrowing advances are subject to collateral
requirements and borrowing limitations. The Bank also has available a
federal funds purchase line of credit with a correspondent bank. The Bank
may also obtain funds from the discount window of the Federal Reserve Bank
of Boston.
As of December 31, 2003, Federal Home Loan Bank advances increased by
$41.3 Million, from $19.2 Million at December 31, 2002 to $60.5 Million at
December 31, 2003. This substantial increase was primarily to fund loan
growth. The Bank took advantage of the low interest rate environment to
obtain advances from the Federal Home Loan Bank to augment its funding
sources, and also as a tool to hedge against interest rate risk.
Asset/Liability Management and Interest Rate Risk
- -------------------------------------------------
The Company's Finance/Investment Committee, comprised of designated
members of the Company's executive management and Board of Directors 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 Company's objective is to reduce and control the volatility of its
net interest income by managing the relationship of interest-earning assets
and interest-bearing liabilities. In order to manage this relationship, the
Committee utilizes a quarterly GAP report.
The GAP report provides a static analysis of repricing opportunities
of rate-sensitive assets and rate-sensitive liabilities. It is prepared by
categorizing these assets and liabilities into time periods based upon
either their contractual or anticipated maturity or repricing. The analysis
determines the net dollar amount of assets less liabilities that are
repricing in various time frames. This, in conjunction with certain
assumptions and other related factors, such as anticipated changes in
interest rates, projected cash flows from loans, investments and deposits,
provides a means of evaluating interest rate risk. Management also takes
into consideration that certain assets and liabilities react differently to
changes in interest rates.
A positive gap results when more assets than liabilities are expected
to reprice within a certain time frame, and a negative gap reflects an
excess of liabilities repricing in that period. A positive gap would tend to
increase net interest income when rates are rising and decrease net interest
income when rates are falling. A negative gap position would tend to produce
the opposite effect. At December 31, 2003, for the period from 1 day to 2
years, the Company had a cumulative negative gap position of $11.9 Million.
This equates to a percentage of total assets of a negative 2.71% which is
within the specific target
47
for interest rate sensitivity established by the Company. The negative gap
occurs as a result of the amount of deposits, especially term deposits that
are subject to repricing during this time period.
For further discussion of the Company's estimated exposure as a
percentage of net interest income and the dollar impact for the next twelve
months, see "Item 1 - Interest Rate Sensitivity Gap" on page 8.
Nonperforming Assets
- --------------------
Nonperforming assets as a total decreased to $407,000 at year end
2003, from $643,000 reported at year end 2002. At year end 2001,
nonperforming assets totaled $1,582,000. Nonaccrual loans is the largest
component of nonperforming assets, and at December 31, 2003, this category
decreased to $407,000 from $635,000 reported at end of previous year.
The Company places a loan on nonaccrual status when, in the opinion of
management, the collectability of the principal and interest becomes
doubtful. Generally, when a commercial loan or a commercial real estate loan
becomes past due 90 days or more, or a residential real estate loan becomes
past due 120 days or more, the Company discontinues the accrual of interest
and reverses previously accrued interest. The loan remains in the nonaccrual
status until the loan is current and six months of payments are made.
If it is determined that collectability of the loan no longer exists,
the loan is charged-off to the Allowance for Loan Losses, or if applicable,
any real estate collateralizing the loan is acquired through foreclosure and
categorized as Other Real Estate Owned. Prior to foreclosure, the Bank will
generally obtain an updated appraisal of the property.
As of December 31, 2003, there were no loans 90 days or more past due
compared to $7,700 reported at year end 2002. Management continues to accrue
on these loans due to the excess values of collateral securing these loans
compared to their outstanding balances.
There was no real estate acquired by foreclosure or substantively
repossessed at December 31, 2003 and at the end of the prior year.
The percentage of nonaccrual loans to total loans decreased by 50%
from the prior year due to the decrease of loans in nonaccrual status and
the increase of the loan portfolio. In addition, the percentage of
nonaccrual loans, restructured loans and real estate acquired by foreclosure
to total assets decreased as a result of increased asset levels. The
$107,000 of restructured loans represents one borrower where the original
loan term was amended and payments are current under the amended terms.
Statement of Financial Accounting Standards No. 114 "Accounting by
Creditors for Impairment of a Loan" applies to all loans except large groups
of smaller-balance homogeneous loans that are collectively evaluated for
impairment, loans measured at fair value or at a lower of cost or fair
value, leases, and debt securities as defined in Statement 115. Statement
114 requires that impaired loans be valued at the present value of expected
future cash flows discounted at the loan's effective interest rate or at the
loan's obtainable market value, or the fair value of the collateral if the
loan is collateral dependent. Smaller-balance homogeneous loans are
considered by the Company to include residential loans, consumer loans, and
credit card loans.
48
Loans are considered impaired when it is probable that the Company
will not be able to collect principal, interest, and fees according to the
contractual terms of the loan agreement. At December 31, 2003, there were
$1,964,791 in loans which the Company has determined to be impaired, of
which $1,858,135 have a related allowance for credit losses of $275,071. As
of December 31, 2002, the recorded investment in impaired loans was
$2,497,626, of which $2,497,626 have a related allowance for credit losses
of $477,124. Management is not aware of any other loans that pose a
potential credit risk or where the loans are current but the borrowers are
experiencing financial difficulty.
Allowance for Loan Losses
- -------------------------
The Allowance for Loan Losses is established through provisions for
loan losses based on management's ongoing evaluation of credit risk within
the loan portfolios. The Allowance for Loan Losses is available to absorb
losses on loans deemed by management as uncollectable. In assessing the
adequacy of the level of the allowance, management considers the status of
nonaccrual loans and specific borrower situations, the current economic
climate of the area, including national credit trends and the historical
credit experiences within the region. Additions to the allowance are
provided by charges to earnings and recoveries on previously charged-off
loans. Deductions from the Allowance are transacted as a charge-off when a
loan is deemed uncollectable. The Allowance for Loan Losses as a percentage
of outstanding loans at December 31, 2003, was 1.24% compared to 1.83%
reported at year end 2002. The ratios at years ending 2001, 2000, and 1999
were 2.16%, 1.86% and 1.56%, respectively. In 2003, the Company deducted
$211,000 from the Allowance and recovered $113,000 from previously charged-
off loans.
Loans charged-off during 2003 totaled $211,000 resulting in net
charge-offs of $98,000. Net charge-offs for prior years were $320,000,
$42,000, $190,000, and $353,000 for 2002, 2001, 2000 and 1999, respectively.
In addition to management's assessment of the Allowance for Loan
Losses, the Allowance is also evaluated by independent loan review
consultants, regulatory agencies, and independent accountants as part of
their examination and audit procedures.
Liquidity
- ---------
Liquidity represents the ability of the Bank to meet its funding
requirements. In assessing the appropriate level of liquidity, the Bank
considers deposit levels, lending funding requirements and investment
maturities in light of prevailing economic conditions. Through this
assessment, the Bank manages its liquidity level to optimize earnings and
respond to fluctuations in customer borrowing needs and cash withdrawals
from deposit accounts.
The Company's principle sources of funds are customer deposits,
borrowings, principal and interest payments on outstanding loans and
mortgage-backed securities, maturities of investment securities and funds
provided from operations. Although scheduled payments from amortization of
loans, mortgage-backed securities, and maturing investment securities are
predictable sources of liquidity, deposit cash flows and loan prepayments
are influenced by interest rate movement. In addition, deposit flow could be
impacted by other instruments available to the public such as mutual funds
and annuities.
The largest source of funds is provided by depositors. The greatest
component of the Company's deposit base is term certificates which extend
out to a maximum of five years. The Company does not
49
participate in brokered deposits. Deposits are obtained from consumers and
commercial customers within the Bank's community reinvestment area, being
Bristol County, Massachusetts and several abutting towns in Rhode Island.
Deposit flows are influenced by the level of interest rates, economic
conditions, and the attractiveness of competing deposits and other
investment alternatives.
The Bank also has the ability to borrow funds for liquidity purposes
from correspondent banks, and the Federal Home Loan Bank, as well as the
Federal Reserve Bank of Boston, by pledging various investment securities as
collateral, and in the case of FHLB borrowings, one to four family
residential loans are secured as collateral. Borrowings from the FHLB
increased by $41.3 Million from $19.2 Million at December 31, 2002 to $60.5
Million at December 31, 2003. During 2003, the Bank took advantage of the
low interest rate environment to draw down some longer term structured
funding opportunities, and to hedge against any possible interest rate risk
as a result of the increase in long term, fixed rate residential mortgages.
As of December 31, 2003, the Bank had approximately $14.0 Million in
available borrowing capacity with the FHLB that is contingent upon the
purchase of additional FHLB stock.
Excess available funds are invested on a daily basis into Federal
Funds Sold. An appropriate level of Federal Funds Sold is maintained to meet
loan commitments, anticipated loan growth and deposit forecasts. Funds
exceeding this level are then used to purchase investment securities that
are suitable in yields and maturities for the investment portfolio.
The Bank's primary source of funds during 2003 was provided by new
advances from the FHLB of $41.6 Million, which is net of payments on
existing borrowings, proceeds from maturities, calls, and sales of
investment securities totaling $59.2 Million, proceeds from sale of loans
totaling $2.5 Million, and a decrease of $15.5 Million from Federal Funds
Sold and FHLB overnight deposits.
The use of these funds totaling $118.1 Million in both operating and
financing activities as follows: $71.6 Million in new loan originations net
of principal collections, $38.7 Million in investment purchases, $2.0
Million in purchases of FHLB stock, $1.1 Million in investments in life
insurance policies, and $2.2 Million in purchases of loans. In addition,
total deposits, due to a decrease in time deposits, declined by $2.5
Million.
Based on historical trends, the avoidance of using brokered deposits,
the Bank's current competitive pricing strategy, and the addition of new
deposit products, retail services and targeted promotions, management
believes that the Bank will continue to attract new customer relationships
in both deposits and loans. Our ability to attract new customers, however,
will be influenced by, among other things, regional bank consolidations.
50
Contractual Obligations
- -----------------------
The following table is a summary of the Company's contractual
obligations as of December 31, 2003 to commitments under contractual leases,
FHLB advances and borrowed funds by contractual maturity date for the next
five years.
Payment due by period
---------------------------------------------------------------------------
Less than 1 More than 5
Contractual Obligations Total year 1-3 years 3-5 years years
- ----------------------- ----- ----------- --------- --------- -----------
FHLB Advances and Borrowed Funds $60,474,864 $8,644,736 $16,769,290 $17,795,748 $17,265,090
Operating Lease Obligations 120,165 66,509 53,656 0 0
---------------------------------------------------------------------------
Total $60,595,029 $8,711,245 $16,822,946 $17,795,748 $17,265,090
===========================================================================
Capital
- -------
Total Stockholders' equity was $42.7 Million at December 31, 2003, as
compared to $41.2 Million at December 31, 2002, for an increase of $1.5
Million. This increase during 2003 resulted from net income of $2.7 Million
for the year then ended, which was partially offset by dividends declared of
$1.4 Million.
The increase in capital was a combination of several factors,
including twelve months earnings of $2.7 Million and transactions
originating through the Dividend Reinvestment Program whereby 7,712 shares
were issued for optional cash contributions of $113,394 and 42,028 shares
were issued for $682,786 in lieu of cash dividend payments. There were also
stock options exercised resulting in the issuance of common stock totaling
$93,850, including a tax benefit. These additions were offset by dividends
paid of $1,434,626.
Capital also increased as a result of accumulated other comprehensive
income (loss), which reflects net unrealized gains or losses, net of taxes,
on securities classified as Available-for-Sale and the minimum pension
liability adjustment. On December 31, 2002, the Available-for-Sale portfolio
had unrealized gains, net of taxes, of $223,272, and on December 31, 2003,
as a result of current market values, the portfolio reflects unrealized
losses, net of taxes, of $9,740. There was an increase in the minimum
pension liability adjustment from $234,180, net of taxes, recorded December
31, 2002 to $595,879 as of December 31, 2003.
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, the Company and the Bank's
Capital ratios meet the criteria of the "well capitalized" category
established by the federal banking agencies as of December 31, 2003.
51
The following table illustrates the capital position of Slade's Ferry
Bancorp. and Slade's Ferry Trust Company for years ending December 31, 2003
and 2002.
Slade's Ferry Bancorp. 2003 2002
- ------------------------------------------------------------------------------------------------
(In Thousands) Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets) $ 44,510 13.64% $ 41,540 14.84%
Minimum required 26,113 8.00 22,291 8.00
Excess 18,397 5.64 19,249 6.84
Tier I Capital (to Risk Weighted Assets) 40,429 12.39 38,040 13.59
Minimum required 13,056 4.00 11,146 4.00
Excess 27,373 8.39 26,894 9.59
Risk Adjusted Assets, net of goodwill,
Nonqualifying intangibles, excess allowance
and excess deferred tax assets 326,300 278,650
Tier I Capital (Leverage Ratio) 40,429 9.33 38,040 9.48
Minimum required 17,335 4.00 16,053 4.00
Excess 23,094 5.33 21,987 5.48
Quarterly average total assets, net of goodwill,
Nonqualifying intangibles and excess deferred
tax assets 433,320 401,325
Slade's Ferry Trust Company 2003 2002
- ------------------------------------------------------------------------------------------------
(In Thousands) Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets) $ 37,384 11.48% $ 35,240 12.63%
Minimum required 26,057 8.00 22,208 8.00
Excess 11,327 3.48 13,032 4.63
Tier I Capital (to Risk Weighted Assets) 33,312 10.23 31,753 11.38
Minimum required 13,028 4.00 11,104 4.00
Excess 20,284 6.23 20,649 7.38
Risk Adjusted Assets, net of goodwill,
Nonqualifying intangibles, excess allowance
and excess deferred tax assets 325,625 277,600
Tier I Capital (Leverage Ratio) 33,312 7.75 31,753 8.00
Minimum required (1) 17,198 4.00 15,868 4.00
Excess 16,114 3.75 15,885 4.00
Quarterly average total assets, net of goodwill,
Nonqualifying intangibles and excess deferred
tax assets 429,830 396,700
- --------------------
The Bank was required to maintain a 7% Tier 1 Leverage Capital ratio
while under the informal agreement with the Massachusetts Commissioner
of Banks and the Federal Deposit Insurance Corporation originally
entered into in 2000, revised in 2002 and subsequently to December 31,
2003, as a result of the improved condition and operation of the Bank,
terminated effective January 22, 2004.
52
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The most significant market risk factor affecting the financial
condition and operating results of Slade's Ferry Bancorp. is interest rate
risk. See pages 10 and 11, under the headings "Interest Rate Risk" and
"Interest Rate Sensitivity-GAP Report" for a discussion of our market risk.
ITEM 8
CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements, together with the
independent auditors' report, 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
The Company had no disagreements with its independent accountants on
accounting and financial disclosure matters.
ITEM 9A
CONTROLS AND PROCEDURES
Management of the Company, including the Company's President and Chief
Executive Officer and Chief Financial Officer and Chief Operations Officer,
has evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of
the end of the period covered by this report. Based upon that evaluation,
the Company's President and Chief Executive Officer and Chief Financial
Officer and Chief Operations Officer concluded that the disclosure controls
and procedures were effective, in all material respects, to ensure that
information required to be disclosed in the reports the Company files and
submits under the Exchange Act is recorded, processed, summarized and
reported as and when required.
There have been no changes in the Company's internal control over
financial reporting identified in connection with the evaluation that
occurred during the Company's last fiscal quarter that has materially
affected, or that is reasonably likely to materially affect, the Company's
internal control over financial reporting.
53
PART III
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is hereby made to the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held May 10, 2004. The
information set forth under the headings "Directors and Executive Officers",
"Information About the Board of Directors and Management" and "Section 16(a)
Beneficial Ownership Reporting Compliance" of such Proxy Statement is
incorporated herein by reference.
The Company has adopted a Code of Conduct and Ethics, which applies to
the Company's officers, directors and employees, including the Company's
principal executive officer, principal financial officer, principal
accounting officer or controller or person performing similar functions for
the Company. Our Code of Conduct and Ethics meets the requirements of a
"code of ethics" as defined by Item 406 of Regulation S-K and is filed as
Exhibit 14 to this annual report on Form 10-K.
ITEM 11
EXECUTIVE COMPENSATION
Reference is hereby made to the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held May 10, 2004. The
information set forth under the headings "Executive Compensation",
"Performance Graph", "Summary Compensation Table", "Benefit Plans" and
"Employment Contracts, Termination of Employment and Change In Control
Amendments" of such Proxy Statement is incorporated herein by reference.
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is hereby made to the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held May 10, 2004. The
information set forth under the headings "Security Ownership of Certain
Beneficial Owners and Management" and "Equity Compensation Plan Information"
of such Proxy Statement is incorporated herein by reference.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is hereby made to the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held May 10, 2004. The
information set forth under the heading "Certain Relationships and Related
Transactions" of such Proxy Statement is incorporated herein by reference.
54
ITEM 14
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Reference is hereby made to the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held May 10, 2004. The
information set forth under the heading "Audit Fees and Pre-approval
Policies" of such Proxy Statement is incorporated herein by reference.
ITEM 15
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Consolidated Financial Statements Page
--------------------------------- ----
Independent Auditors' Report F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Income F-4
Consolidated Statements of Changes in
Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-9
(2) 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.
(3) Exhibits:
--------
Exhibit No. Description Item
- ----------- ----------- ----
3.1 Articles of Incorporation of Slade's Ferry Bancorp. as (1)
amended
3.2 By-laws of Slade's Ferry Bancorp. as amended (2)
4.1 Articles of Incorporation of Slade's Ferry Bancorp. (see Exhibit 3.1) (1)
4.2 Bylaws of Slade's Ferry Bancorp. as amended (see Exhibit 3.2) (2)
10.1 Slade's Ferry (formerly Weetamoe) Bancorp. 1996 Stock (3)
Option Plan as amended
10.2 Noncompetition Agreement between Slade's Ferry Trust Company and (4)
Edward S. Machado (A substantially identical contract exists with
Peter Paskowski)
10.3 Supplemental Executive Retirement Agreement between Slade's Ferry (5)
(formerly Weetamoe) Bancorp. and Donald T. Corrigan
10.4 Supplemental Executive Retirement Agreement as amended between Slade's Ferry (2)
(formerly Weetamoe) Bancorp. and James D. Carey
55
10.5 Supplemental Executive Retirement Agreement between Slade's Ferry (2)
(formerly Weetamoe) Bancorp. and Manuel J. Tavares
10.6 Swansea Mall Lease (4)
10.7 Form of Director Supplemental Retirement Program Director Agreement, (6)
Exhibit 1 thereto (Slade's Ferry Trust Company Director Supplemental
Retirement Program Plan) and Endorsement Method Split Dollar Plan
Agreement thereunder for Thomas B. Almy. (Similar forms of agreement
entered into between Slade's Ferry Trust Company and the other
directors)
10.8 Form of Directors' Paid-up Insurance Policy for Thomas B. Almy (part (7)
of the Director supplemental Retirement Program). (Similar forms of
policy entered into by Company for other directors).
10.9 Form of Officers' Paid-up Endorsement Method Split Dollar Plan Agreement and (8)
Insurance Policies for Janice Partridge (Similar forms of policies entered into
by Company for its President and other Vice Presidents)
10.10 Severance Agreement ("Release of All Demands") with James D. Carey (9)
10.11 Supplemental Executive Retirement Agreement between Slade's Ferry Bancorp (10)
and Mary Lynn D. Lenz.
10.12 Change-in-Control Severance Agreement between Slade's Ferry Bancorp, Slade's (10)
Ferry Trust Company and Mary Lynn D. Lenz
10.13 Confidentiality and Non-Solicitation Agreement between Slade's Ferry Bancorp (10)
and Mary Lynn D. Lenz
14 Code of Conduct and Ethics
21 List of subsidiaries of Slade's Ferry Bancorp. (11)
23 Consent of Independent Public Accounts
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
- --------------------
Incorporated by reference to the Registrant's Registration Statement
on Form SB-2 filed with the Commission on April 14, 1997.
Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1996.
Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended March 31, 1996.
Incorporated by reference to the Registrant's Registration Statement
on Form S-4 File No. 33-32131.
Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1994.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended March 31, 1999.
Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended June 30, 1998.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended June 30, 2000.
Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended December 31, 2002.
56
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended March 31, 2003.
Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended December 31, 1999.
(b) A report on Form 8-K dated October 21, 2003 was furnished to the
Securities and Exchange Commission reporting under Items 9 and 12 the
issuance of a press release disclosing certain information concerning our
third quarter results of operation and financial condition and furnishing
the release as an exhibit.
A report on Form 8-K dated January 29, 2004 was furnished to the
Securities and Exchange Commission reporting under Items 9 and 12 the
issuance of a press release disclosing certain information concerning our
third quarter results of operation and financial condition and furnishing
the release as an exhibit.
(c) See Item 15(a)(3) above.
57
SIGNATURES
- ----------
Pursuant to the requirements of Section 13 or 15(d) of the 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
---------------------------
Mary Lynn D. Lenz, President/
Chief Executive Officer and
Director
March 29, 2004
Pursuant to the requirements of the Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
/s/ Thomas B. Almy 03/29/04 /s/ Peter G. Collias 03/29/04
- --------------------------------------- -------------------------------------
Thomas B. Almy Peter G. Collias
Director Director
/s/ Anthony F. Cordeiro 03/29/04 /s/ Paul C. Downey 03/29/04
- --------------------------------------- -------------------------------------
Anthony F. Cordeiro Paul C. Downey
Director Director
/s/ Mary Lynn D. Lenz 03/29/04 /s/ Melvyn A. Holland 03/29/04
- --------------------------------------- -------------------------------------
Mary Lynn D. Lenz Melvyn A. Holland
President/CEO and Director Director
/s/ William Q. MacLean Jr. 03/29/04 /s/ Francis A. Macomber 03/29/04
- --------------------------------------- -------------------------------------
William Q. MacLean Jr. Francis A. Macomber
Director Director
/s/ Majed Mouded, MD 03/29/04 /s/ Shaun O'Hearn Sr. 03/29/04
- --------------------------------------- -------------------------------------
Majed Mouded, MD Shaun O'Hearn Sr.
Director Director
/s/ Lawrence J. Oliveira, DDS 03/29/04 /s/ Peter Paskowski 03/29/04
- --------------------------------------- -------------------------------------
Lawrence J. Oliveira, DDS Peter Paskowski
Director Director
/s/ Kenneth R. Rezendes 03/29/04 /s/ William J. Sullivan 03/29/04
- --------------------------------------- -------------------------------------
Kenneth R. Rezendes William J. Sullivan
Chairman of the Board and Director Director
/s/ Charles Veloza 03/29/04 /s/ David F. Westgate 03/29/04
- --------------------------------------- -------------------------------------
Charles Veloza David F. Westgate
Director Vice Chairman and Director
/s/ Deborah A. McLaughlin 03/29/04
- --------------------------------------- -------------------------------------
Deborah A. McLaughlin
Chief Financial Officer/Chief
Operations Officer
58
INDEX TO FINANCIAL STATEMENTS
Slade's Ferry Bancorp. and Subsidiaries Page
Independent Auditors' Report F-2
Consolidated Balance Sheets as of
December 31, 2003 and December 31, 2002 F-3
Consolidated Statements of Income for the years ended
December 31, 2003, December 31, 2002 and December 31, 2001 F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 2003, December 31, 2002
and December 31, 2001 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, December 31, 2002 and December 31, 2001 F-7
Notes to Consolidated Financial Statements F-9
F-1
[LOGO]
SHATSWELL, MACLEOD & COMPANY, P.C.
----------------------------------
CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
and Stockholders
Slade's Ferry Bancorp.
Somerset, Massachusetts
INDEPENDENT AUDITORS' REPORT
----------------------------
We have audited the accompanying consolidated balance sheets of Slade's
Ferry Bancorp. and Subsidiary as of December 31, 2003 and 2002 and the
related consolidated statements of income, changes in stockholders' equity
and cash flows for each of the years in the three-year period ended
December 31, 2003. 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
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 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 consolidated financial
position of Slade's Ferry Bancorp. and Subsidiary as of December 31, 2003
and 2002, and the consolidated results of their operations and their cash
flows for each of the years in the three-year period ended December 31,
2003, in conformity with accounting principles generally accepted in the
United States of America.
/S/Shatswell, MacLeod & Company, P.C.
Shatswell, MacLeod & Company, P.C.
West Peabody, Massachusetts
January 13, 2004 (except for Note 14
as to which the date is January 22, 2004)
F-2
SLADE'S FERRY BANCORP. AND SUBSIDIARY
-------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31, 2003 and 2002
--------------------------
ASSETS 2003 2002
- ------ ------------ ------------
Cash and due from banks $ 18,428,932 $ 14,985,461
Interest bearing demand deposits with other banks 213,438 8,508
Money market mutual funds 63,539 222,567
Federal Home Loan Bank overnight deposit 10,000,000
Federal funds sold 4,000,000 9,500,000
------------ ------------
Cash and cash equivalents 22,705,909 34,716,536
Interest bearing time deposits with other bank 200,000 200,000
Investments in available-for-sale securities
(at fair value) 47,162,852 65,907,926
Investments in held-to-maturity securities
(fair values of $11,851,713 as of December 31, 2003
and $14,262,405 as of December 31, 2002) 11,300,402 13,696,254
Federal Home Loan Bank stock 3,023,800 1,013,400
Loans, net of allowance for loan losses of
$4,154,394 in 2003 and $4,854,388 in 2002 331,496,525 259,816,056
Premises and equipment 5,894,736 6,067,879
Goodwill 2,173,368 2,173,368
Accrued interest receivable 1,497,104 1,492,591
Cash surrender value of life insurance 10,980,879 9,750,661
Deferred taxes 1,996,213 1,849,723
Other assets 1,016,753 1,690,589
------------ ------------
Total assets $439,448,541 $398,374,983
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits:
Noninterest-bearing $ 73,253,462 $ 72,277,469
Interest-bearing 259,891,355 263,355,063
------------ ------------
Total deposits 333,144,817 335,632,532
Federal Home Loan Bank advances 60,474,864 19,185,338
Other liabilities 3,086,719 2,336,109
------------ ------------
Total liabilities 396,706,400 357,153,979
------------ ------------
Preferred stockholders' equity in a subsidiary company 54,000
------------ ------------
Stockholders' equity:
Common stock, par value $.01 per share; authorized
10,000,000 shares; issued and outstanding 3,995,857.1 shares
in 2003 and 3,937,762.9 shares in 2002 39,959 39,378
Paid-in capital 28,609,206 27,693,199
Retained earnings 14,698,595 13,445,335
Accumulated other comprehensive loss (605,619) (10,908)
------------ ------------
Total stockholders' equity 42,742,141 41,167,004
------------ ------------
Total liabilities and stockholders' equity $439,448,541 $398,374,983
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
SLADE'S FERRY BANCORP. AND SUBSIDIARY
-------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
Years Ended December 31, 2003, 2002 and 2001
--------------------------------------------
2003 2002 2001
----------- ----------- -----------
Interest and dividend income:
Interest and fees on loans $17,602,784 $17,276,773 $21,554,165
Interest and dividends on securities:
Taxable 2,349,161 3,826,659 4,410,499
Tax-exempt 511,761 577,982 533,287
Interest on federal funds sold 100,791 227,229 598,934
Other interest 52,133 127,831 226,785
----------- ----------- -----------
Total interest and dividend income 20,616,630 22,036,474 27,323,670
----------- ----------- -----------
Interest expense:
Interest on deposits 4,505,217 6,703,002 11,333,086
Interest on Federal Home Loan Bank advances 1,567,953 1,216,559 965,008
Interest on other borrowed funds 8,193 28,436
----------- ----------- -----------
Total interest expense 6,073,170 7,927,754 12,326,530
----------- ----------- -----------
Net interest and dividend income 14,543,460 14,108,720 14,997,140
(Benefit) provision for loan losses (602,326) (310,000) 750,000
----------- ----------- -----------
Net interest and dividend income after (benefit)
provision for loan losses 15,145,786 14,418,720 14,247,140
----------- ----------- -----------
Other income:
Service charges on deposit accounts 569,189 551,060 561,370
Overdraft service charges 549,923 333,977 257,586
Gain on sales and calls of available-for-sale securities, net 1,944 625,832 14,934
Increase in cash surrender value of life insurance policies 510,744 443,220 351,023
Other income 581,745 578,728 584,619
----------- ----------- -----------
Total other income 2,213,545 2,532,817 1,769,532
----------- ----------- -----------
Other expense:
Salaries and employee benefits 7,778,787 7,368,364 7,124,377
Occupancy expense 886,287 845,366 861,407
Equipment expense 541,960 478,047 565,448
Stationary and supplies 213,075 276,824 241,186
Professional fees 1,028,770 549,036 364,680
Marketing expense 375,126 355,203 421,480
FDIC deposit insurance premium 155,550 158,115 160,305
Writedown of securities 1,240,868
Other expense 1,682,174 1,579,979 1,669,504
----------- ----------- -----------
Total other expense 12,661,729 12,851,802 11,408,387
----------- ----------- -----------
Income before income taxes 4,697,602 4,099,735 4,608,285
Income taxes 2,009,716 1,134,183 1,398,032
----------- ----------- -----------
Net income $ 2,687,886 $ 2,965,552 $ 3,210,253
=========== =========== ===========
Earnings per common share $ .68 $ .76 $ .84
=========== =========== ===========
Earnings per common share assuming dilution $ .67 $ .75 $ .84
=========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
SLADE'S FERRY BANCORP. AND SUBSIDIARY
-------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
Years Ended December 31, 2003, 2002 and 2001
--------------------------------------------
Accumulated
Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings Loss Total
------ -------- -------- -------------- ------
Balance, December 31, 2000 $37,895 $25,885,220 $10,371,944 $(620,686) $35,674,373
Comprehensive income:
Net income 3,210,253
Other comprehensive income 393,497
Comprehensive income 3,603,750
Issuance of common stock from dividend
reinvestment plan 732 803,201 803,933
Stock issuance relating to optional
cash contribution plan 73 73,576 73,649
Dividends declared ($.44 per share) (1,689,574) (1,689,574)
------- ----------- ----------- --------- -----------
Balance, December 31, 2001 38,700 26,761,997 11,892,623 (227,189) 38,466,131
Comprehensive income:
Net income 2,965,552
Other comprehensive income 216,281
Comprehensive income 3,181,833
Issuance of common stock from dividend
reinvestment plan 472 675,841 676,313
Stock issuance relating to optional
cash contribution plan 100 138,012 138,112
Stock options exercised 106 94,963 95,069
Tax benefit of stock options 22,386 22,386
Dividends on minority interest preferred
stock ($40.00 per share) (4,320) (4,320)
Dividends declared ($.36 per share) (1,408,520) (1,408,520)
------- ----------- ----------- --------- -----------
Balance, December 31, 2002 39,378 27,693,199 13,445,335 (10,908) 41,167,004
Comprehensive income:
Net income 2,687,886
Other comprehensive loss (594,711)
Comprehensive income 2,093,175
Issuance of common stock from dividend
reinvestment plan 424 682,362 682,786
Stock issuance relating to optional
cash contribution plan 73 113,321 113,394
Stock options exercised 84 93,766 93,850
Tax benefit of stock options 26,558 26,558
Dividends on minority interest preferred
stock ($40.00 per share) (4,040) (4,040)
Dividends declared ($.36 per share) (1,430,586) (1,430,586)
------- ----------- ----------- --------- -----------
Balance, December 31, 2003 $39,959 $28,609,206 $14,698,595 $(605,619) $42,742,141
======= =========== =========== ========= ===========
F-5
SLADE'S FERRY BANCORP. AND SUBSIDIARY
-------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
Years Ended December 31, 2003, 2002 and 2001
--------------------------------------------
(continued)
2003 2002 2001
--------- --------- ---------
Other comprehensive income and reclassification
disclosure for the years ended December 31:
Unrealized (losses) gains on securities
Net unrealized (losses) gains on available-for-sale
securities $(442,358) $ 53,577 $ 853,519
Reclassification adjustment for realized
(gains) losses in net income (1,944) 615,036 (14,934)
--------- --------- ---------
Net unrealized (losses) gains on securities (444,302) 668,613 838,585
Income tax benefit (expense) 211,290 (324,398) (362,985)
--------- --------- ---------
Net of tax amount (233,012) 344,215 475,600
--------- --------- ---------
Minimum pension liability adjustment (612,323) (216,583) (138,992)
Income tax benefit 250,624 88,649 56,889
--------- --------- ---------
Net of tax amount (361,699) (127,934) (82,103)
--------- --------- ---------
Other comprehensive (loss) income, net of tax $(594,711) $ 216,281 $ 393,497
========= ========= =========
Accumulated other comprehensive loss consists
of the following as of December 31:
2003 2002 2001
--------- --------- ---------
Net unrealized (losses) gains on available-for-sale
securities, net of taxes $ (9,740) $ 223,272 $(120,943)
Minimum pension liability adjustment, net of taxes (595,879) (234,180) (106,246)
--------- --------- ---------
Accumulated other comprehensive loss $(605,619) $ (10,908) $(227,189)
========= ========= =========
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, 2003, 2002 and 2001
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 2,687,886 $ 2,965,552 $ 3,210,253
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization, net of accretion of securities 184,489 162,144 152,995
Gain on sales and calls of available-for-sale securities, net (1,944) (625,832) (14,934)
Writedown of securities 1,240,868
Change in unearned income 102,159 (40,927) (137,081)
(Benefit) provision for loan losses (602,326) (310,000) 750,000
Depreciation and amortization 639,402 637,342 685,577
(Gain) loss on sale of property and equipment (1,400) 501 (107,109)
Increase in cash surrender value of life insurance policies (510,744) (443,220) (351,023)
Amortization of goodwill 226,800
Accretion, net of amortization of
fair market value adjustments (8,550)
Decrease (increase) in other assets 39,511 (29,839) 12,061
Decrease (increase) in prepaid expenses 51,976 142,237 (28,262)
Decrease (increase) in income taxes receivable 607,674 (714,639) (120,379)
(Increase) decrease in interest receivable (4,513) 461,398 397,937
Increase (decrease) in other liabilities 78,062 211,588 (4,085)
Increase (decrease) in accrued expenses 3,033 159,259 (158,468)
Increase (decrease) in interest payable 46,853 (13,394) (53,826)
Deferred tax expense (benefit) 315,424 116,667 (196,033)
Decrease in taxes payable (180,512)
------------ ------------ ------------
Net cash provided by operating activities 3,635,542 3,919,705 4,075,361
------------ ------------ ------------
Cash flows from investing activities:
Increase in interest bearing time deposits with other banks (100,000) (100,000)
Purchases of available-for-sale securities (33,726,207) (37,391,128) (61,088,695)
Proceeds from sales of available-for-sale securities 864,217 16,853,893 891,375
Proceeds from maturities of available-for-sale securities 50,993,737 33,638,864 49,790,967
Purchases of held-to-maturity securities (4,926,305) (3,417,675) (4,156,673)
Proceeds from maturities of held-to-maturity securities 7,308,637 5,990,548 6,971,893
Purchases of Federal Home Loan Bank stock (2,010,400)
Loan originations and principal collections, net (71,600,640) (11,209,891) 19,935,261
Purchases of loans (2,176,873) (300,000) (17,767,255)
Proceeds from sale of loans 2,484,080
Recoveries of loans previously charged off 113,131 62,397 58,821
Capital expenditures (459,857) (253,582) (464,323)
Proceeds from sale of property and equipment 1,400 10,099 202,109
Redemption of life insurance policy 331,026
Investment in life insurance policies (1,050,500) (1,610,000) (515,500)
------------ ------------ ------------
Net cash (used in) provided by investing activities (53,854,554) 2,273,525 (6,242,020)
------------ ------------ ------------
F-7
SLADE'S FERRY BANCORP. AND SUBSIDIARY
-------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
Years Ended December 31, 2003, 2002 and 2001
--------------------------------------------
(continued)
2003 2002 2001
------------ ------------ ------------
Cash flows from financing activities:
Net increase in demand deposits, NOW and savings accounts 12,376,880 22,661,421 7,818,060
Net decrease in time deposits (14,864,595) (24,072,231) (7,775,619)
Long-term advances from Federal Home Loan Bank 37,279,000 3,450,000 6,428,000
Payments on Federal Home Loan Bank long-term advances (289,474) (1,247,749) (2,170,821)
Net change in short-term advances from Federal Home Loan Bank 4,300,000
Net decrease in other borrowed funds (465,216) (734,784)
Proceeds from issuance of common stock 796,180 814,425 877,582
Stock options exercised 93,850 95,069
Dividends paid (1,429,456) (1,405,723) (1,644,158)
Repurchase of minority interest preferred stock (56,000) (1,500)
ssuance of minority interest preferred stock 2,000 2,500
------------ ------------ ------------
Net cash provided by (used in) financing activities 38,208,385 (169,004) 2,798,260
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (12,010,627) 6,024,226 631,601
Cash and cash equivalents at beginning of year 34,716,536 28,692,310 28,060,709
------------ ------------ ------------
Cash and cash equivalents at end of year $ 22,705,909 $ 34,716,536 $ 28,692,310
============ ============ ============
Supplemental disclosures:
Interest paid $ 6,026,317 $ 7,941,148 $ 12,380,356
Income taxes paid 1,086,618 1,732,155 1,894,956
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
------------------------------------------
Years Ended December 31, 2003, 2002 and 2001
--------------------------------------------
NOTE 1 - NATURE OF OPERATIONS
- -----------------------------
Slade's Ferry Bancorp. (Company) is a Massachusetts corporation that was
organized in 1990 to become the holding company of Slade's Ferry Trust
Company (Bank). The Company's primary activity is to act as the holding
company for 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 eleven banking offices located in
Massachusetts and a loan company in Rhode Island. The Bank is engaged
principally in the business of attracting deposits from the general public
and investing those deposits in residential and commercial real estate
loans, and in commercial, consumer and small business loans.
NOTE 2 - ACCOUNTING POLICIES
- ----------------------------
The accounting and reporting policies of the Company and its subsidiary
conform to accounting principles generally accepted in the United States of
America and predominant practices within the banking industry. The
consolidated financial statements were prepared using the accrual basis of
accounting. The significant accounting policies are summarized below to
assist the reader in better understanding the consolidated financial
statements and other data contained herein.
USE OF ESTIMATES:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those
estimates.
BASIS OF PRESENTATION:
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, the Bank and the Bank's
wholly-owned subsidiaries, Slade's Ferry Realty Trust, Slade's Ferry
Securities Corporation, Slade's Ferry Loan Company and Slade's Ferry
Preferred Capital Corporation. Slade's Ferry Realty Trust was formed
to hold ownership of real estate, Slade's Ferry Securities
Corporation was formed to hold securities for tax benefits in
Massachusetts, Slade's Ferry Loan Company provides the opportunity to
solicit commercial and consumer borrowers in the Rhode Island area
and Slade's Ferry Preferred Capital Corporation, a real estate
investment trust, was formed to hold real estate mortgage loans.
This Corporation was dissolved effective December 16, 2003 and is no
longer in existence. The assets and liabilities were transferred to
Slade's Ferry Trust Company. All significant intercompany accounts
and transactions have been eliminated in the consolidation.
CASH AND CASH EQUIVALENTS:
For purposes of reporting cash flows, cash and cash equivalents
include cash on hand, cash items, due from banks, interest bearing
demand deposits with other banks, money market mutual funds, Federal
Home Loan Bank overnight deposit and federal funds sold.
F-9
Cash and due from banks as of December 31, 2003 and 2002 includes
$1,936,000 and $2,640,000, respectively, which is subject to
withdrawals and usage restrictions to satisfy the reserve
requirements of the Federal Reserve Bank.
SECURITIES:
Investments in debt securities are adjusted for amortization of
premiums and accretion of discounts. Gains or losses on sales of
investment securities are computed on a specific identification
basis.
The Company classifies debt and equity securities into one of three
categories: held-to-maturity, available-for-sale, or trading. This
security classification may be modified after acquisition only under
certain specified conditions. In general, securities may be
classified as held-to-maturity only if the Company has the positive
intent and ability to hold them to maturity. Trading securities are
defined as those bought and held principally for the purpose of
selling them in the near term. All other securities must be
classified as available-for-sale.
-- Held-to-maturity securities are measured at amortized cost in
the consolidated balance sheets. Unrealized holding gains and
losses are not included in earnings or in a separate component
of capital. They are merely disclosed in the notes to the
consolidated financial statements.
-- Available-for-sale securities are carried at fair value on the
consolidated balance sheets. Unrealized holding gains and
losses are not included in earnings, but are reported as a net
amount (less expected tax) in a separate component of capital
until realized.
-- Trading securities are carried at fair value on the
consolidated balance sheets. Unrealized holding gains and
losses for trading securities are included in earnings.
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.
LOANS:
Loans receivable that management has the intent and ability to hold
until maturity or payoff are reported at their outstanding principal
balances adjusted for amounts due to borrowers on unadvanced loans,
by any charge-offs, the allowance for loan losses and any deferred
fees or costs on originated loans, or unamortized premiums or
discounts on purchased loans.
Interest on loans is recognized on a simple interest basis.
Loan origination and commitment fees and certain direct origination
costs are deferred, and the net amount amortized as an adjustment of
the related loan's yield. The Company is amortizing these amounts
over the contractual life of the related loans.
Residential real estate loans are generally placed on nonaccrual when
reaching 120 days past due or in process of foreclosure. All closed-
end consumer loans 90 days or more past due and any equity line in
the process of foreclosure are placed on nonaccrual status. Secured
consumer loans are written down to realizable value and unsecured
consumer loans are charged-off upon reaching 120 or 180 days past due
depending on the type of loan. Commercial real estate loans and
commercial business loans and leases which are 90 days or more past
due are generally placed on nonaccrual status, unless secured by
sufficient cash or other assets immediately convertible to cash.
When a loan has been placed on
F-10
nonaccrual status, previously accrued and uncollected interest is
reversed against interest on loans. A loan can be returned to
accrual status when collectibility of principal is reasonably assured
and the loan has performed for a period of time, generally six
months.
Cash receipts of interest income on impaired loans is credited to
principal to the extent necessary to eliminate doubt as to the
collectibility of the net carrying amount of the loan. Some or all
of the cash receipts of interest income on impaired loans is
recognized as interest income if the remaining net carrying amount of
the loan is deemed to be fully collectible. When recognition of
interest income on an impaired loan on a cash basis is appropriate,
the amount of income that is recognized is limited to that which
would have been accrued on the net carrying amount of the loan at the
contractual interest rate. Any cash interest payments received in
excess of the limit and not applied to reduce the net carrying amount
of the loan are recorded as recoveries of charge-offs until the
charge-offs are fully recovered.
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.
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 when due 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 when due. 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 for commercial and construction
loans by either the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's
obtainable market price, 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. Accordingly, the Company does not
separately identify individual consumer and residential loans for
impairment disclosures.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost, less accumulated
depreciation and amortization. Cost and related allowances for
depreciation and amortization of premises and equipment retired or
otherwise disposed of are removed from the respective accounts with
any gain or loss included in income or
F-11
expense. Depreciation and amortization are calculated principally on
the straight-line method over the estimated useful lives of the
assets. Estimated lives are 3 to 40 years for buildings and 1 to 20
years for furniture and equipment. Leasehold improvements are
amortized over the lesser of the life of the lease or the estimated
life of the improvements.
OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURES:
Other real estate owned includes properties acquired through
foreclosure and properties classified as in-substance foreclosures in
accordance with Statement of Financial Accounting Standards (SFAS)
No. 15, "Accounting by Debtors and Creditors for Troubled Debt
Restructuring." These properties are carried at the lower of cost or
estimated fair value less estimated cost to sell. Any writedown from
cost to estimated fair value required at the time of foreclosure or
classification as in-substance foreclosure is charged to the
allowance for loan losses. Expenses incurred in connection with
maintaining these assets, subsequent writedowns and gains or losses
recognized upon sale are included in other expense.
In accordance with SFAS No. 114 "Accounting by Creditors for
Impairment of a Loan," the Company classifies loans as in-substance
repossessed or foreclosed if the Company receives physical possession
of the debtor's assets regardless of whether formal foreclosure
proceedings take place.
ADVERTISING:
The Company directly expenses costs associated with advertising as
they are incurred.
INCOME TAXES:
The Company recognizes income taxes under the asset and liability
method. Under this method, deferred tax assets and liabilities are
established for the temporary differences between the accounting
basis and the tax basis of the Company's assets and liabilities at
enacted tax rates expected to be in effect when the amounts related
to such temporary differences are realized or settled.
FAIR VALUES OF FINANCIAL INSTRUMENTS:
SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," requires that the Company disclose estimated fair value
for its financial instruments. Fair value methods and assumptions
used by the Company in estimating its fair value disclosures are as
follows:
Cash and cash equivalents: The carrying amounts reported in the
balance sheet for cash and cash equivalents approximate those assets'
fair values.
Securities (including mortgage-backed securities): Fair values for
securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments.
Loans receivable: For variable-rate loans that reprice frequently
and with no significant change in credit risk, fair values are based
on carrying values. The 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.
Accrued interest receivable: The carrying amount of accrued interest
receivable approximates its fair value.
F-12
Deposit liabilities: The fair values disclosed for demand deposits
(e.g., interest and non-interest checking, passbook savings, and
money market accounts) are, by definition, equal to the amount
payable on demand at the reporting date (i.e., their carrying
amounts). 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.
Federal Home Loan Bank advances: Fair values for Federal Home Loan
Bank advances are estimated using a discounted cash flow technique
that applies interest rates currently being offered on advances to a
schedule of aggregated expected monthly maturities on Federal Home
Loan Bank advances.
Other borrowed funds: Fair values for other borrowed funds are
estimated using discounted cash flow analyses based on the Company's
current incremental borrowing rates for similar borrowings.
Off-balance sheet instruments: The fair value of commitments to
originate loans is estimated using the fees currently charged to
enter similar agreements, taking into account the remaining terms of
the agreements and the present creditworthiness of the
counterparties. For fixed-rate loan commitments and the unadvanced
portion of loans, fair value also considers the difference between
current levels of interest rates and the committed rates. The fair
value of letters of credit is based on fees currently charged for
similar agreements or on the estimated cost to terminate them or
otherwise settle the obligation with the counterparties at the
reporting date.
EARNINGS PER 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.
STOCK BASED COMPENSATION:
At December 31, 2003, the Company has a stock-based employee
compensation plan which is described more fully in Note 15. The
Company accounts for the plan under the recognition and measurement
principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. No stock-based employee
compensation cost is reflected in net income (except for appreciation
from options surrendered as described in Note 15), as all options
granted under this plan had an exercise price equal to the market
value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition
provisions of SFAS Statement No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation.
F-13
For the years ended
December 31,
--------------------------------------
2003 2002 2001
---------- ---------- ----------
Net income, as reported $2,687,886 $2,965,552 $3,210,253
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects 131,920 59,377 80,475
---------- ---------- ----------
Pro forma net income $2,555,966 $2,906,175 $3,129,778
========== ========== ==========
Earnings per share:
Basic - as reported $.68 $.76 $.84
Basic - pro forma $.64 $.74 $.82
Diluted - as reported $.67 $.75 $.84
Diluted - pro forma $.64 $.74 $.81
RECENT ACCOUNTING PRONOUNCEMENTS:
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). This
Statement requires that a liability for a cost associated with an
exit or disposal activity be recognized and measured initially at
fair value only when the liability is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after
December 31, 2002. This Statement did not have a material impact on
the Company's consolidated financial statements.
In October 2002, the FASB issued SFAS No. 147 "Acquisitions of
Certain Financial Institutions" ("SFAS No. 147"), an Amendment of
SFAS Nos. 72 and 144 and FASB Interpretation No. 9. SFAS No. 72
"Accounting for Certain Acquisitions of Banking or Thrift
Institutions" and FASB Interpretation No. 9 "Applying APB Opinions
No. 16 and 17 When a Savings and Loan Association or a Similar
Institution Is Acquired in a Business Combination Accounted for by
the Purchase Method" provided interpretive guidance on the
application of the purchase method to acquisitions of financial
institutions. Except for transactions between two or more mutual
enterprises, SFAS No. 147 removes acquisitions of financial
institutions from the scope of both Statement 72 and Interpretation 9
and requires that those transactions be accounted for in accordance
with SFAS No. 141 "Business Combinations" and SFAS No. 142 "Goodwill
and Other Intangible Assets." Thus, the requirement in paragraph 5
of 72 to recognize (and subsequently amortize) any excess of the fair
value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired as an unidentifiable
intangible asset no longer applies to acquisitions within the scope
of SFAS No. 147. In addition, SFAS No. 147 amends SFAS No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" to
include in its scope long-term customer-relationship intangible
assets of financial institutions such as depositor- and borrower-
relationship intangible assets and credit cardholder intangible
assets. Consequently, those intangible assets are subject to the
same undiscounted cash flow recoverability test and impairment loss
recognition and measurement provisions that SFAS No. 144 requires for
other long-lived assets that are held and used.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
FIN 45 elaborates on the disclosure to be made by a guarantor in its
interim and annual financial statements about its obligations under
certain guarantees that it has issued. It also clarifies that a
guarantor is required to recognize, at the inception of a guarantee,
a liability for the fair value of the obligation undertaken in
issuing the guarantee. FIN 45 clarifies that a guarantor is required
to disclose (a) the nature of the guarantee; (b) the maximum
potential amount of future payments under
F-14
the guarantee; (c) the carrying amount of the liability; (d) the
nature and extent of any recourse provisions or available
collateral that would enable the guarantor to recover the amounts
paid under the guarantee.
Paragraph 5 of SFAS No. 147, which relates to the application of the
purchase method of accounting, was effective for acquisitions for
which the date of acquisition is on or after October 1, 2002. The
provisions in paragraph 6 related to accounting for the impairment or
disposal of certain long-term customer-relationship intangible assets
were effective on October 1, 2002. Transition provisions for
previously recognized unidentifiable intangible assets in paragraphs
8-14 were effective on October 1, 2002, with earlier application
permitted. There was no impact on the Company's consolidated
financial statements on adoption of this Statement.
The initial recognition and initial measurement provisions of FIN 45
are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure requirements in FIN
45 are effective for financial statements of interim or annual
periods ending after December 15, 2002. The Company adopted the
initial recognition and initial measurement provisions of FIN 45
effective as of January 1, 2003 and adopted the disclosure
requirements effective as of December 31, 2002. The adoption of this
interpretation did not have a material effect on the Company's
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of
SFAS Statement No. 123" ("SFAS No. 148"). SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of
the method used on reported results. The transition provisions and
disclosure provisions are required for financial statements for
fiscal years ending after December 15, 2002. The Company adopted the
disclosure provisions of SFAS No. 148 as of December 31, 2002 and
currently uses the intrinsic value method of accounting for stock
options.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
No. 133 on Derivative Instruments and Hedging Activities" ("SFAS No.
149"), which amends and clarifies financial accounting and reporting
for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities."
This Statement (a) clarifies under what circumstances a contract with
an initial net investment meets the characteristic of a derivative,
(b) clarifies when a derivative contains a financing component, (c)
amends the definition of an underlying to conform to language used in
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," and (d) amends certain other existing
pronouncements. The provisions of SFAS No. 149 are effective for
contracts entered into or modified after June 30, 2003. There was no
substantial impact on the Company's consolidated financial statements
on adoption of this Statement.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS No. 150"). This Statement establishes standards for
the classification and measurement of certain financial instruments
with characteristics of both liabilities and equity. SFAS No. 150
requires that certain financial instruments that were previously
classified as equity must be classified as a liability. Most of the
guidance in SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is
F-15
effective at the beginning of the first interim period beginning
after June 15, 2003. This Statement did not have any material effect
on the Company's consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), in an
effort to expand upon and strengthen existing accounting guidance
that addresses when a company should include in its financial
statements the assets, liabilities and activities of another entity.
In December 2003, the FASB revised Interpretation No. 46, also
referred to as Interpretation 46 (R) ("FIN 46(R)"). The objective of
this interpretation is not to restrict the use of variable interest
entities but to improve financial reporting by companies involved
with variable interest entities. Until now, one company generally
has included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. This
interpretation changes that, by requiring a variable interest entity
to be consolidated by a company only if that company is subject to a
majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual
returns or both. The Company is required to apply FIN 46, as
revised, to all entities subject to it no later than the end of the
first reporting period ending after March 15, 2004. However, prior
to the required application of FIN 46, as revised, the Company shall
apply FIN 46 or FIN 46 (R) to those entities that are considered to
be special-purpose entities as of the end of the first fiscal year or
interim period ending after December 15, 2003. The adoption of this
interpretation has not and is not expected to have a material effect
on the Company's consolidated financial statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement
Benefits - an amendment of SFAS No. 87, SFAS No. 88 and SFAS No. 106"
("SFAS No. 132 (revised 2003)"). This Statement revises employers'
disclosures about pension plans and other postretirement benefit
plans. It does not change the measurement or recognition of those
plans required by SFAS No. 87, "Employers' Accounting for Pensions,"
SFAS No. 88, "Employers' Accounting for Settlements and Curtailments
of Defined Benefit Pension Plans and for Termination Benefits," and
SFAS No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions." This Statement retains the disclosure
requirements contained in SFAS No. 132, "Employers' Disclosures About
Pensions and Other Postretirement Benefits," which it replaces. It
requires additional disclosures to those in the original Statement
132 about assets, obligations, cash flows and net periodic benefit
cost of defined benefit pension plans and other defined benefit
postretirement plans. This Statement is effective for financial
statements with fiscal years ending after December 15, 2003 and
interim periods beginning after December 15, 2003. Adoption of this
Statement did not have a material impact on the Company's
consolidated financial statements.
F-16
NOTE 3 - INVESTMENTS IN SECURITIES
Debt and equity securities have been classified in the consolidated balance
sheets according to management's intent. The amortized cost of securities
and their approximate fair values are as follows as of December 31:
Gains In Losses In
Accumulated Accumulated
Amortized Other Other
Cost Comprehensive Comprehensive Fair
Basis Income Income Value
--------- ------------- ------------- -----
Available-for-sale securities:
December 31, 2003:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $27,932,088 $ 72,545 $350,469 $27,654,164
Mortgage-backed securities 14,033,905 449,213 3,389 14,479,729
Corporate debt securities 1,657,969 70,453 1,728,422
Marketable equity securities 3,510,877 198,505 345,306 3,364,076
----------- ---------- -------- -----------
47,134,839 790,716 699,164 47,226,391
Money market mutual funds included in cash
and cash equivalents (63,539) (63,539)
----------- ---------- -------- -----------
$47,071,300 $ 790,716 $699,164 $47,162,852
=========== ========== ======== ===========
December 31, 2002:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $26,423,978 $ 239,307 $ 80 $26,663,205
Mortgage-backed securities 32,511,788 921,833 56 33,433,565
Corporate debt securities 2,672,502 105,771 2,778,273
Marketable equity securities 3,986,371 52,916 783,837 3,255,450
----------- ---------- -------- -----------
65,594,639 1,319,827 783,973 66,130,493
Money market mutual funds included in cash
and cash equivalents (222,567) (222,567)
----------- ---------- -------- -----------
$65,372,072 $1,319,827 $783,973 $65,907,926
=========== ========== ======== ===========
Gains In Losses In
Accumulated Accumulated
Amortized Other Other
Cost Comprehensive Comprehensive Fair
Basis Income Income Value
--------- ------------- ------------- -----
Held-to-maturity securities:
December 31, 2003:
Debt securities issued by states of the
United States and political subdivisions
of the states $11,299,521 $ 551,281 $ $11,850,802
Mortgage-backed securities 881 30 911
----------- ---------- -------- -----------
$11,300,402 $ 551,311 $ $11,851,713
=========== ========== ======== ===========
December 31, 2002:
Debt securities issued by states of the
United States and political subdivisions
of the states $13,693,091 $ 573,177 $ 7,127 $14,259,141
Mortgage-backed securities 2,163 101 2,264
Foreign debt securities 1,000 1,000
----------- ---------- -------- -----------
$13,696,254 $ 573,278 $ 7,127 $14,262,405
=========== ========== ======== ===========
F-17
The scheduled maturities of debt securities were as follows as of December
31, 2003:
Available-For-Sale Held-To-Maturity
------------------ --------------------------
Fair Amortized Fair
Value Cost Basis Value
----------- ----------- -----------
Due within one year $ 713,357 $ 2,703,809 $ 2,738,213
Due after one year through five years 28,170,383 5,807,889 6,156,441
Due after five years through ten years 498,846 1,526,582 1,624,760
Due after ten years 1,261,241 1,331,388
Mortgage-backed securities 14,479,729 881 911
----------- ----------- -----------
$43,862,315 $11,300,402 $11,851,713
=========== =========== ===========
During 2003, proceeds from sales of available-for-sale securities amounted
to $864,217. Gross realized gains and gross realized losses on those sales
amounted to $12,528 and $10,584, respectively. During 2002, proceeds from
sales of available-for-sale securities amounted to $16,853,893. Gross
realized gains and gross realized losses on those sales amounted to
$725,961 and $97,410, respectively. During 2001, proceeds from sales of
available-for-sale securities amounted to $891,375. Gross realized gains
and gross realized losses on those sales amounted to $57,588 and $42,654,
respectively. The tax expense applicable to these net realized gains
amounted to $1,529, $245,565 and $6,112 for the years ended December 31,
2003, 2002 and 2001, respectively.
There were no securities of issuers whose aggregate carrying amount
exceeded 10% of stockholders' equity as of December 31, 2003.
Total carrying amounts of $18,089,060 and $2,657,945 of debt securities
were pledged to secure treasury tax and loan, trust department and public
funds on deposit, and Federal Home Loan Bank advances as of December 31,
2003 and 2002, respectively.
The aggregate fair value and unrealized losses of securities that have been
in a continuous unrealized-loss position for less than twelve months and
for twelve months or more, and are not other than temporarily impaired, are
as follows as of December 31, 2003:
Less than 12 Months 12 Months or Longer Total
------------------------- ------------------------ -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------- ---------- ---------- ---------- ---------- -----------
Debt securities issued by the U.S.
Treasury and other U.S. government
corporations and agencies $20,579,620 $350,469 $ $ $20,579,620 $350,469
Mortgage-backed securities 750,335 3,389 750,335 3,389
Marketable equity securities 196,230 13,196 1,351,487 332,110 1,547,717 345,306
----------- -------- ---------- -------- ----------- ---------
Total temporarily impaired securities $21,526,185 $367,054 $1,351,487 $332,110 $22,877,672 $699,164
=========== ======== ========== ======== =========== ========
The investments in the Company's investment portfolio that are temporarily
impaired as of December 31, 2003 consist of both debt securities guaranteed
or issued by government agencies with strong credit ratings, and common
stock securities issued by U.S. corporations. The unrealized losses
associated with debt securities issued by government agencies are
attributable to changes in market interest rates, the principal is not at
risk at this point since the Company does not anticipate selling any of
these impaired securities in the near future. Equity securities are
reviewed for impairment by examining several factors used in evaluating
whether the decline in fair value below its cost represents an "other than
temporary" decline in value, such as financial condition, near term
prospects, 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
F-18
recommendations of investment advisors or market analyst. Based on the
Bank's December 31, 2003 quarterly review of securities in the investment
portfolio, management deemed securities with unrealized losses as of year
end 2003 to be temporarily impaired.
NOTE 4 - LOANS
- --------------
Loans consisted of the following as of December 31:
2003 2002
------------ -------------
Commercial, financial and agricultural $ 33,980,019 $ 30,454,898
Real estate - construction and land development 10,346,259 14,077,763
Real estate - residential 147,177,989 90,330,046
Real estate - commercial 140,571,818 122,931,918
Consumer 3,961,487 6,881,094
Nonprofit 9,154 293,202
Other 47,586 42,757
------------ ------------
336,094,312 265,011,678
Allowance for loan losses (4,154,394) (4,854,388)
Unearned income (443,393) (341,234)
------------ ------------
Net loans, carrying amount $331,496,525 $259,816,056
============ ============
Certain directors and executive officers of the Company and companies in
which they have significant ownership interest were customers of the Bank
during 2003. Total loans to such persons and their companies amounted to
$6,795,087 as of December 31, 2003. During the year ended December 31,
2003, $12,114,926 of advances were made and principal payments totaled
$11,310,296.
Changes in the allowance for loan losses were as follows for the years
ended December 31:
2003 2002 2001
---------- ---------- ----------
Balance at beginning of period $4,854,388 $5,484,519 $4,776,360
Loans charged off (210,799) (382,528) (100,662)
(Benefit) provision for loan losses (602,326) (310,000) 750,000
Recoveries of loans previously charged off 113,131 62,397 58,821
---------- ---------- ----------
Balance at end of period $4,154,394 $4,854,388 $5,484,519
========== ========== ==========
The following table sets forth information regarding nonaccrual loans and
accruing loans 90 days or more overdue as of December 31:
2003 2002
-------- --------
Nonaccrual loans $407,363 $635,227
======== ========
Accruing loans which are 90 days or more overdue $ 0 $ 7,747
======== ========
F-19
Information about loans that meet the definition of an impaired loan in
Statement of Financial Accounting Standards No. 114 is as follows as of
December 31:
2003 2002
------------------------- -------------------------
Recorded Related Recorded Related
Investment Allowance Investment Allowance
In Impaired For Credit In Impaired For Credit
Loans Losses Loans Losses
----------- ---------- ----------- ----------
Loans for which there is a related
allowance for credit losses $1,858,135 $275,071 $2,497,626 $477,124
Loans for which there is no related
allowance for credit losses 106,656 0
---------- -------- ---------- --------
Totals $1,964,791 $275,071 $2,497,626 $477,124
========== ======== ========== ========
Average recorded investment in impaired loans
during the year ended December 31 $2,193,189 $3,283,438
========== ==========
Related amount of interest income recognized
during the time, in the year ended December 31,
that the loans were impaired
Total recognized $ 124,281 $ 254,159
========== ==========
Amount recognized using a
cash-basis method of accounting $ 30,000 $ 99,081
========== ==========
NOTE 5 - PREMISES AND EQUIPMENT
- -------------------------------
The following is a summary of premises and equipment as of December 31:
2003 2002
----------- -----------
Land $ 1,710,368 $ 1,710,368
Buildings 6,968,527 6,955,758
Furniture and equipment 5,054,017 4,677,474
Leasehold improvements 383,436 383,436
----------- -----------
14,116,348 13,727,036
Accumulated depreciation and amortization (8,221,612) (7,659,157)
----------- -----------
$ 5,894,736 $ 6,067,879
=========== ===========
NOTE 6 - DEPOSITS
- -----------------
The aggregate amount of time deposit accounts in denominations of $100,000
or more as of December 31, 2003 and 2002 was $25,430,252 and $27,915,361,
respectively.
For time deposits as of December 31, 2003, the scheduled maturities for
each of the following five years ended December 31, and thereafter, are:
2004 $109,309,905
2005 12,620,680
2006 6,634,448
2007 25,399
2008 1,014,311
Thereafter 44,944
------------
Total $129,649,687
============
F-20
Deposits from related parties held by the Company as of December 31, 2003
and 2002 amounted to $2,723,564 and $2,286,572, respectively.
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
- ----------------------------------------
Advances consist of funds borrowed from the Federal Home Loan Bank (FHLB).
Maturities of advances from the FHLB for the five years ending after
December 31, 2003, and thereafter, are summarized as follows:
AMOUNT
------
2004 $ 8,644,736
2005 8,371,809
2006 8,397,481
2007 10,919,369
2008 6,876,379
Thereafter 17,265,090
-----------
$60,474,864
===========
Interest rates on FHLB advances ranged from 1.08 percent to 7.72 percent.
At December 31, 2003, the weighted average interest rate on FHLB advances
was 3.95 percent.
As of December 31, 2003, a $3,000,000 advance from the FHLB maturing in
January 2015 is redeemable at par at the option of the FHLB on January 7,
2004 and each calendar quarter thereafter.
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.
Borrowings from the FHLB are secured by a blanket lien on qualified
collateral, consisting primarily of loans with first mortgages secured by
one to four family properties, certain unencumbered investment securities
and other qualified assets.
NOTE 8 - INCOME TAXES
- ---------------------
The components of income tax expense are as follows for the years ended
December 31:
2003 2002 2001
---------- ---------- ----------
Current:
Federal $ 498,670 $ 920,469 $1,513,874
State 1,195,622 97,047 80,191
---------- ---------- ----------
1,694,292 1,017,516 1,594,065
---------- ---------- ----------
Deferred:
Federal 309,650 79,782 (162,866)
State 93,762 36,885 (56,212)
Change in the valuation allowance (87,988) 23,045
---------- ---------- ----------
315,424 116,667 (196,033)
---------- ---------- ----------
Total income tax expense $2,009,716 $1,134,183 $1,398,032
========== ========== ==========
F-21
The reasons for the difference between the tax at the statutory federal
income tax rate and the effective tax rate are summarized as follows for
the years ended December 31:
2003 2002 2001
------ ------ ------
% of % of % of
Income Income Income
------ ------ ------