SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
Quarterly Report Under Section 13 of the Securities Exchange Act of 1934
For quarter ended: March 31, 2004
Commission File No. 001-16101
BANCORP RHODE ISLAND, INC.
- ---------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
RHODE ISLAND 05-0509802
- ------------------------------------------ -----------------------------
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
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(Address of Principal Executive Offices)
(401) 456-5000
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(Issuer's Telephone Number, Including Area Code)
Not Applicable
- ---------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X)
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of May 10, 2004:
Common Stock - Par Value $0.01 3,972,028 shares
------------------------------ ----------------
(class) (outstanding)
BANCORP RHODE ISLAND, INC.
FORM 10-Q
INDEX
PAGE NUMBER
-----------
Cover Page 1
Index 2
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Changes in
Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7 - 9
Item 2 Management's Discussion and Analysis 10 - 21
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 22 - 23
Item 4 Controls and Procedures 23
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 24
Item 2 Changes in Securities 24
Item 3 Default upon Senior Securities 24
Item 4 Submission of Matters to a Vote of Security Holders 24
Item 5 Other Information 24
Item 6 Exhibits and Reports on Form 8-K 24
Signature Page 25
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
March 31, December 31,
2004 2003
--------- ------------
(In thousands)
ASSETS:
Cash and due from banks $ 27,789 $ 27,084
Overnight investments 28,585 733
---------- ----------
Total cash and cash equivalents 56,374 27,817
Investment securities available for sale
(amortized cost of $95,705 and $96,828
at March 31, 2004 and December 31, 2003,
respectively) 98,010 98,595
Mortgage-backed securities available for sale
(amortized cost of $99,738 and $106,028 at
March 31, 2004 and December 31, 2003,
respectively) 101,006 106,618
Stock in Federal Home Loan Bank of Boston 9,554 9,554
Loans receivable:
Commercial loans 348,494 332,266
Residential mortgage loans 356,233 366,230
Consumer and other loans 122,050 115,786
---------- ----------
Total loans 826,777 814,282
Less allowance for loan losses (11,296) (11,078)
---------- ----------
Net loans 815,481 803,204
Premises and equipment, net 12,886 12,457
Goodwill 10,766 10,766
Accrued interest receivable 5,541 5,597
Investment in bank owned life insurance 15,657 15,491
Prepaid expenses and other assets 4,341 3,872
---------- ----------
Total assets $1,129,616 $1,093,971
========== ==========
LIABILITIES:
Deposits:
Demand deposit accounts $ 169,212 $ 159,916
NOW accounts 134,246 129,398
Money market accounts 17,059 16,937
Savings accounts 293,806 292,277
Certificate of deposit accounts 222,335 212,755
---------- ----------
Total deposits 836,658 811,283
Overnight and short-term borrowings 18,692 13,460
Federal Home Loan Bank of Boston borrowings 173,778 176,759
Subordinated deferrable interest debentures 18,558 13,403
Other liabilities 6,624 6,959
---------- ----------
Total liabilities 1,054,310 1,021,864
---------- ----------
SHAREHOLDERS' EQUITY:
Preferred stock, par value $0.01 per share,
authorized 1,000,000 shares:
Issued and outstanding: none -- --
Common stock, par value $0.01 per share,
authorized 11,000,000 shares:
Issued and outstanding 3,971,153 shares
and 3,891,190 shares, respectively 40 39
Additional paid-in capital 42,327 41,439
Retained earnings 30,581 29,074
Accumulated other comprehensive income, net 2,358 1,555
---------- ----------
Total shareholders' equity 75,306 72,107
---------- ----------
Total liabilities and shareholders'
equity $1,129,616 $1,093,971
========== ==========
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
Three Months Ended
March 31,
------------------------
2004 2003
---- ----
(In thousands, except per share data)
Interest and dividend income:
Commercial loans $ 5,209 $ 4,683
Residential mortgage loans 4,695 4,174
Consumer and other loans 1,429 1,289
Mortgage-backed securities 1,121 1,480
Investment securities 1,096 1,139
Overnight investments 23 39
Federal Home Loan Bank of Boston stock dividends 51 62
--------- ---------
Total interest and dividend income 13,624 12,866
--------- ---------
Interest expense:
NOW accounts 377 326
Money market accounts 55 28
Savings accounts 849 1,148
Certificate of deposit accounts 1,394 1,600
Overnight and short-term borrowings 35 51
Federal Home Loan Bank of Boston borrowings 1,753 1,762
Subordinated deferrable interest debentures 219 --
Company-obligated mandatorily redeemable
capital securities -- 137
--------- ---------
Total interest expense 4,682 5,052
--------- ---------
Net interest income 8,942 7,814
Provision for loan losses 300 400
--------- ---------
Net interest income after provision for
loan losses 8,642 7,414
--------- ---------
Noninterest income:
Service charges on deposit accounts 1,012 952
Commissions on nondeposit investment products 178 174
Income from bank owned life insurance 165 203
Loan related fees 109 104
Commissions on loans originated for others 17 109
Gains on sales of investment securities 197 54
Gains on sales of mortgage-backed securities -- 104
Other income 320 216
--------- ---------
Total noninterest income 1,998 1,916
--------- ---------
Noninterest expense:
Salaries and employee benefits 3,893 3,298
Occupancy 680 603
Equipment 386 336
Data processing 670 845
Marketing 355 297
Professional services 285 277
Loan servicing 278 228
Loan workout and other real estate owned expense 22 15
Other expenses 1,006 974
--------- ---------
Total noninterest expense 7,575 6,873
--------- ---------
Income before income taxes 3,065 2,457
Income tax expense 1,001 785
--------- ---------
Net income $ 2,064 $ 1,672
========= =========
Per share data:
Basic earnings per common share $ 0.52 $ 0.44
Diluted earnings per common share $ 0.49 $ 0.42
Average common shares outstanding - basic 3,946,668 3,779,007
Average common shares outstanding - diluted 4,193,328 4,021,127
See accompanying notes to consolidated financial statements
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity
Accumulated
Other
Compre-
Additional hensive
Common Paid-in Retained Income
Three months ended March 31, Stock Capital Earnings (Loss), Net Total
- ---------------------------- ------ ---------- -------- ------------ -----
2003
Balance at December 31, 2002 $38 $40,134 $24,002 $2,253 $66,427
Net income -- -- 1,672 -- 1,672
Other comprehensive income,
net of tax:
Unrealized holding loss on
securities available for sale,
net of taxes of $85 (158) (158)
Reclassification adjustment,
net of taxes of $55 (103) (103)
-------
Comprehensive income 1,411
Exercise of stock options -- 134 -- -- 134
Common stock issued for
incentive stock award, net -- 8 -- -- 8
Dividends on common stock -- -- (531) -- (531)
--- ------- ------- ------ -------
Balance at March 31, 2003 $38 $40,276 $25,143 $1,992 $67,449
=== ======= ======= ====== =======
2004
Balance at December 31, 2003 $39 $41,439 $29,074 $1,555 $72,107
Net income -- -- 2,064 -- 2,064
Other comprehensive income,
net of tax:
Unrealized holding gain on
securities available for sale,
net of taxes of $504 936 936
Reclassification adjustment,
net of taxes of $64 (133) (133)
-------
Comprehensive income 2,867
Exercise of stock options 1 179 -- -- 180
Exercise of stock warrants -- 700 -- -- 700
Common stock issued for
incentive stock award, net -- 9 -- -- 9
Dividends on common stock -- -- (557) -- (557)
--- ------- ------- ------ -------
Balance at March 31, 2004 $40 $42,327 $30,581 $2,358 $75,306
=== ======= ======= ====== =======
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
Three Months Ended
March 31,
----------------------
2004 2003
---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 2,064 $ 1,672
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation and amortization 874 922
Provision for loan losses 300 400
Gain on sale of investment securities (197) (54)
Gain on sale of mortgage-backed securities -- (104)
Gain on sale of other real estate owned -- 10
Income from bank-owned life insurance (165) (204)
Compensation expense from restricted stock grant 9 8
(Increase) decrease in:
Accrued interest receivable 56 99
Prepaid expenses and other assets (882) (403)
Increase (decrease) in:
Other liabilities (335) (581)
Other, net 3 4
-------- --------
Net cash provided (used) by operating activities 1,727 1,769
-------- --------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (3,003) (6,032)
Commercial loans (22,432) (24,597)
Consumer loans (17,658) (17,725)
Purchase of:
Investment securities available for sale (9,998) (16,573)
Mortgage-backed securities available for sale (5,016) (33,640)
Residential mortgage loans (17,091) (50,081)
Federal Home Loan Bank of Boston stock -- (217)
Principal payments on:
Investment securities available for sale 9,000 18,000
Mortgage-backed securities available for sale 11,212 22,645
Residential mortgage loans 29,955 49,313
Commercial loans 6,179 6,982
Consumer loans 11,313 8,166
Proceeds from sale of investment securities 2,243 2,060
Proceeds from sale of mortgage-backed securities -- 25,164
Capital expenditures for premises and equipment (978) (1,970)
-------- --------
Net cash provided (used) by investing activities (6,274) (18,505)
-------- --------
Cash flows from financing activities:
Net increase (decrease) in deposits 25,375 1,041
Net increase (decrease) in overnight and short-term
borrowings 5,232 (8,673)
Proceeds from long-term borrowings 22,155 29,000
Repayment of long-term borrowings (19,981) (14,944)
Proceeds from issuance of common stock 880 134
Dividends on common stock (557) (531)
-------- --------
Net cash provided (used) by financing activities 33,104 6,027
-------- --------
Net increase (decrease) in cash and cash equivalents 28,557 (10,709)
Cash and cash equivalents at beginning of period 27,817 42,959
-------- --------
Cash and cash equivalents at end of period $ 56,374 $ 32,250
======== ========
Supplementary Disclosures:
Cash paid for interest $ 4,567 $ 5,244
Cash paid for income taxes 1,225 27
Non-cash transactions:
Change in other comprehensive income, net of taxes 803 (261)
See accompanying notes to consolidated financial statements
6
BANCORP RHODE ISLAND, INC.
Notes to Consolidated Financial Statements
(1) Basis of Presentation
Bancorp Rhode Island, Inc. (the "Company"), a Rhode Island
corporation, was organized by Bank Rhode Island (the "Bank") to be a bank
holding company and to acquire all of the capital stock of the Bank. The
reorganization of the Bank into the holding company form of ownership was
completed on September 1, 2000. The Company has no significant operating
entities other than the Bank. For that reason, substantially all of the
discussion in this Quarterly Report on Form 10-Q relates to the operations
of the Bank and its subsidiaries.
Beginning December 31, 2003, the consolidated financial statements
include the accounts of the Company and its wholly-owned direct subsidiary,
the Bank, and its indirect subsidiaries, BRI Investment Corp. (a Rhode
Island passive investment company), BRI Realty Corp. (a real estate holding
company) and Acorn Insurance Agency, Inc. (a licensed insurance agency).
The Company adopted FASB Interpretation 46-R, "Consolidation of Variable
Interest Entities - Revised" on December 31, 2003, and therefore has
deconsolidated its statutory trust subsidiaries as of that date. The
Consolidated Statement of Operations for the 2003 period also included the
results of BRI Statutory Trusts I and II (issuers of trust preferred
securities). All significant intercompany accounts and transactions have
been eliminated in consolidation.
The interim results of consolidated operations are not necessarily
indicative of the results for any future interim period or for the entire
year. These interim consolidated financial statements do not include all
disclosures associated with annual financial statements and, accordingly,
should be read in conjunction with the annual consolidated financial
statements and accompanying notes included in the Company's Annual Report to
Shareholders filed with the Securities and Exchange Commission.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts
of assets and liabilities as of the date of the balance sheet and revenues
and expenses for the period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to change
relate to the determination of the allowance for loan losses and goodwill
valuation.
The unaudited interim consolidated financial statements of the Company
have been prepared in accordance with Accounting Principles Generally
Accepted in the United States of America ("GAAP") and prevailing practices
within the banking industry and include all necessary adjustments
(consisting of only normal recurring adjustments), that, in the opinion of
management, are required for a fair presentation of the results and
financial condition of the Company.
(2) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and resulted in the issuance of additional
common stock that then shared in the earnings of the entity.
7
(3) Stock Based Compensation
In December 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure". SFAS 148 amends
SFAS 123, "Accounting for Stock-Based Compensation", to provide alternative
methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. Companies are able to
eliminate a "ramp-up" effect that the SFAS 123 transition rule creates in
the year of adoption. Companies can choose to elect a method that will
provide for comparability amongst years reported. In addition, this
Statement amends the disclosure requirement of SFAS 123 to require prominent
disclosures in both annual and interim financial statements about the fair
value based method of accounting for stock-based employee compensation and
the effect of the method used on reported results. The amendments to SFAS
123 are effective for financial statements for fiscal years ending after
December 15, 2002. The adoption of this Statement did not have a material
impact on the Company's financial position or results of operations at
adoption, but may have a material impact sometime in the future if the
Company were to elect the alternative method for accounting for stock-based
employee compensation.
On March 31, 2004, the FASB issued Exposure Draft "Share-Based Payment
- - An Amendment to FASB Statement No. 123 and 95." The Exposure Draft
concluded that all companies should expense the fair value of employee stock
options using the modified prospective grant-date measurement approach as
defined in SFAS 123. Compensation cost would be recognized in the financial
statements over the requisite service period. A final Statement is expected
in the second half of 2004, which could become effective in 2005. Until a
new Statement is issued, the provisions of SFAS 123 and SFAS 148 remain in
effect.
The following table summarizes the differences between the fair value
and intrinsic value methods of accounting for stock-based compensation:
Three Months Ended March 31,
----------------------------
2004 2003
---- ----
Net income (in thousands):
As reported $ 2,064 $ 1,672
Compensation cost, net of taxes (1) (54) (23)
------- -------
Pro forma $ 2,010 $ 1,649
======= =======
Earnings per common share:
Basic:
As reported $ 0.52 $ 0.44
Compensation cost, net of taxes (1) (0.01) (0.00)
------- -------
Pro forma $ 0.51 $ 0.44
======= =======
Diluted:
As reported $ 0.49 $ 0.42
Compensation cost, net of taxes (1) (0.01) (0.01)
------- -------
Pro forma $ 0.48 $ 0.41
======= =======
The stock-based employee compensation cost, net of related tax
effects, that would have been included in the determination of net
income if the fair value based method had been applied to all awards
granted since 1995. The fair value of each option granted was
estimated as of the date of the grant using the Black-Scholes option-
pricing model.
8
(4) Supplemental Executive Retirement Plans
The Bank maintains Supplemental Executive Retirement Plans ("SERPs")
for certain of its senior executives under which participants designated by
the Board of Directors are entitled to an annual retirement benefit.
Expenses associated with the SERPs were $107,000 and $95,000 for the three
months ending March 31, 2004 and 2003, respectively. Accrued liabilities
associated with the SERPs were $940,000 and $834,000 for March 31, 2004 and
December 31, 2003, respectively.
(5) Recent Accounting Developments
At the November 2003 meeting of FASB's Emerging Issues Task Force
("EITF"), the EITF reached consensus on EITF Issue 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
The consensus requires new disclosure requirements for holders of debt or
marketable equity securities that are accounted for under SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities." The new
disclosure requirements relate to temporarily impaired investments and are
effective for fiscal years ending after December 15, 2003. The requirements
apply only to annual financial statements and comparative disclosures for
prior periods are not required. The Company adopted the EITF's
recommendations on December 31, 2003, and has provided additional
disclosures regarding any possible other-than-temporarily impaired
investments in the footnotes to its 2003 Annual Report to Shareholders.
Adoption of these recommendations did not have a material impact on the
Company's financial position or results of operations.
In December 2003, the FASB issued FASB Interpretation ("FIN") 46-R,
"Consolidation of Variable Interest Entities - Revised." FIN 46-R revises
FIN 46, "Consolidation of Variable Interest Entities" which is an
interpretation of Accounting Research Bulletin 51, "Consolidated Financial
Statements." FIN 46-R provides guidance regarding the consolidation of
special purpose entities, and removed uncertainty over whether FIN 46
required consolidation or deconsolidation of special purpose entities that
issue trust preferred securities. FIN 46-R clarified that even those
entities that issue trust preferred securities with call options must be
deconsolidated. FIN 46-R is effective for financial statements for periods
ending after December 15, 2003, with no requirement for restatement of
previous periods. The Company adopted FIN 46-R on December 31, 2003, and
therefore has deconsolidated its statutory trust subsidiaries as of that
date. Adoption of this Interpretation did not have a material impact on the
Company's financial position or results of operations.
9
BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis
ITEM 2. Management's Discussion and Analysis
Certain statements contained herein are "Forward Looking Statements" within
the meaning of the Private Securities Litigation Reform Act of 1995.
Forward Looking Statements may be identified by reference to a future period
or periods or by the use of forward looking terminology such as "may,"
"believes," "intends," "expects," and "anticipates" or similar terms or
variations of these terms. Actual results may differ materially from those
set forth in Forward Looking Statements as a result of certain risks and
uncertainties, including but not limited to, changes in political and
economic conditions, interest rate fluctuations, competitive product and
pricing pressures, equity and bond market fluctuations, credit risk,
inflation, as well as other risks and uncertainties detailed from time to
time in filings with the Securities and Exchange Commission ("SEC").
GENERAL
- -------
The Company's principal subsidiary, Bank Rhode Island, is a commercial
bank chartered as a financial institution in the State of Rhode Island. The
Bank pursues a community banking mission and is principally engaged in
providing banking products and services to individuals and businesses in
Rhode Island and nearby areas of Massachusetts. The Bank is subject to
competition from a variety of traditional and nontraditional financial
service providers both within and outside of Rhode Island. The Bank offers
its customers a wide range of deposit products, nondeposit investment
products, commercial, residential and consumer loans, and other traditional
banking products and services designed to meet the needs of individuals and
small- to mid-sized businesses. The Bank also offers both commercial and
consumer on-line banking products and maintains a web site at
http://www.bankri.com. The Company and Bank are subject to regulation by a
number of federal and state agencies and undergo periodic examinations by
certain of those regulatory authorities. The Bank's deposits are insured by
the Federal Deposit Insurance Corporation ("FDIC"), subject to regulatory
limits. The Bank is also a member of the Federal Home Loan Bank of Boston
("FHLB").
OVERVIEW
- --------
The Company's operating results depend primarily on two factors: its
"net interest income" and the quality of its assets.
The Company's net interest income is the difference between its
interest income and its cost of money. Interest income depends on the
amount of interest-earning assets outstanding during the year and the
interest rates earned thereon. Cost of money is a function of the average
amount of deposits and borrowed money outstanding during the year and the
interest rates paid thereon. See discussion under "Results of Operations -
Comparison of Three Months Ended March 31, 2004 and 2003." Because the
Company's assets are not identical in duration and in repricing dates to its
liabilities, the spread between the two is vulnerable to changes in market
interest rates. This vulnerability is inherent to the business of banking
and is commonly referred to as "interest rate risk." How to measure such
risk and, once measured, how much risk to take are based on numerous
assumptions and other subjective judgments. See discussion under "Interest
Rate Risk."
10
The quality of the Company's assets also influences its earnings.
Loans that are not being paid on a timely basis and exhibit other weaknesses
can result in the loss of principal and/or interest income. Additionally,
the Company must make timely provisions to its loan loss reserve as a result
of its estimates as to potential future losses; these additions, which are
charged against earnings, are necessarily greater when greater potential
losses are expected. Finally, the Company will incur expenses as a result
of resolving troubled assets. All of these form the "credit risk" that the
Company assumes in the ordinary course of its business and is further
discussed under "Financial Condition - Asset Quality."
The Company's business strategy has been to concentrate its asset
generation efforts on commercial loans and its deposit generation efforts on
checking and savings accounts. These deposit accounts are commonly referred
to as "core accounts." This strategy is based on the Company's belief that
it can distinguish itself from its larger competitors, and indeed attract
customers from them, through a higher level of service and its ability to
set policies and procedures, as well as make decisions, locally. The loan
and deposit products referenced also tend to be geared more toward customers
who are relationship oriented than those who are seeking stand-alone or
single transaction products. The Company believes that its service-oriented
approach enables it to compete successfully for relationship-oriented
customers. Additionally, the Company is predominantly an urban franchise
with a high concentration of businesses making deployment of funds in the
commercial lending area practicable. Commercial loans are attractive, among
other reasons, because of their higher yields. Similarly, core deposits are
attractive because of their generally lower interest cost.
In recent years, the Company also has sought to promote business
opportunities presented by its customer base, franchise footprint and system
resources through increased efforts in both the areas of consumer lending
and residential mortgage originations.
Currently, approximately 80% of the Company's revenues are dependent
on its level of net interest income. In an effort to diversify its sources
of revenue, the Company has attempted to expand its sources of noninterest
income, primarily fees and charges for products and services it offers. The
Company has increased its percentage of noninterest income to total revenue
from 13% in 1999, to 21% in 2003, by emphasizing core deposit growth which
generates increased service charges, and by introducing additional financial
services, such as nondeposit investment products. Future operating results
will depend on the Company's ability to maintain and expand its net interest
margin, while minimizing its exposure to credit risk, along with increasing
its sources of noninterest income, while controlling the growth of its
noninterest or operating expenses.
Total assets increased $35.6 million, or 3.3%, to $1.1 billion at
March 31, 2004 from December 31, 2003. This increase was centered in the
Company's commercial and consumer loan portfolios, along with its overnight
investments, and was funded primarily by a combination of deposit and
borrowings growth. Since the end of 2003, commercial loans increased $16.2
million, or 4.9%, consumer loans increased $6.3 million, or 5.4%, checking
deposits (demand deposits and NOW accounts) increased $14.1 million, or
4.9%, certificates of deposit increased $9.6 million, or 4.5%, and total
borrowings increased $7.4 million, or 3.6%. Shareholders' equity was $75.3
million at March 31, 2004, and represented 6.7% of total assets.
11
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying
value of certain assets or net income, are considered critical accounting
policies. The Company considers the following to be its critical accounting
policies: allowance for loan losses and review of goodwill for impairment.
There have been no significant changes in the methods or assumptions used in
accounting policies that require material estimates or assumptions.
Allowance for loan losses
Arriving at an appropriate level of allowance for loan losses
necessarily involves a significant degree of judgment. First and foremost
in arriving at an appropriate allowance is the creation and maintenance of a
risk rating system that accurately classifies all loans into varying
categories by degree of credit risk. Such a system also establishes a level
of allowance associated with each category of loans and requires early
identification and reclassification of deteriorating credits. Besides
numerous subjective judgments as to the number of categories, appropriate
level of allowance with respect to each category and judgments as to
categorization of any individual loan, additional subjective judgments are
involved when ascertaining the probability as well as the extent of any
potential losses. The Company's ongoing evaluation process includes a
formal analysis of the allowance each quarter, which considers, among other
factors, the character and size of the loan portfolio, business and economic
conditions, loan growth, delinquency trends, nonperforming loan trends,
charge-off experience and other asset quality factors. These factors are
based on observable information, as well as subjective assessment and
interpretation. Nonperforming commercial, commercial real estate and small
business loans in excess of a specified dollar amount are deemed to be
"impaired." The estimated reserves necessary for each of these credits is
determined by reviewing the fair value of the collateral, the present value
of expected future cash flows, and where available, the observable market
price of the loans. Provisions for losses on the remaining commercial,
commercial real estate, small business, residential mortgage and consumer
loans are based on pools of similar loans using a combination of payment
status, historical loss experience, industry loss experience, market
economic factors, delinquency rates and qualitative adjustments. Management
uses available information to establish the allowance for loan losses at the
level it believes is appropriate. However, future additions to the
allowance may be necessary based on changes in estimates or assumptions
resulting from changes in economic conditions and other factors. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to recognize adjustments to
the allowance based on their judgments about information available to them
at the time of their examination.
Review of goodwill for impairment
In March 1996, the Bank acquired certain assets and assumed certain
liabilities from Fleet National Bank of Connecticut and related entities.
This acquisition was accounted for utilizing the purchase method of
accounting and generated $17.5 million of goodwill. This goodwill was
amortized in the years prior to 2002, resulting in a net balance of $10.8
million on the Company's balance sheet as of December 31, 2001. Effective
January 1, 2002, in accordance with Statement of Financial Accounting
Standards ("SFAS") 142 "Goodwill and Other Intangible Assets" and SFAS 147
"Acquisitions of Certain Financial Institutions", the Company was required
to cease amortizing this goodwill and to review it at least annually for
impairment. Goodwill is evaluated for
12
impairment using market value comparisons for similar institutions, such as
price to earnings multiples, price to deposit multiples and price to equity
multiples. This valuation technique utilizes verifiable market multiples,
as well as subjective assessment and interpretation. The application of
different market multiples, or changes in judgment as to which market
transactions are reflective of the Company's specific characteristics, could
affect the conclusions reached regarding possible impairment. In the event
that the Company were to determine that its goodwill were impaired, the
recognition of an impairment charge could have an adverse impact on its
results of operations in the period that the impairment occurred or on its
financial position.
FINANCIAL CONDITION
- -------------------
-- Investments. Total investments (consisting of overnight
investments, investment securities, mortgage-backed securities ("MBSs") and
stock in the FHLB) totaled $237.2 million, or 21.0% of total assets, at
March 31, 2004, compared to $215.5 million, or 19.7% of total assets, at
December 31, 2003. All $199.0 million of investment securities and MBSs at
March 31, 2004 were classified as available for sale and carried a total of
$3.6 million in net unrealized gains at the end of the quarter. The
increase in total investments of $21.7 million, or 10.0%, was the result of
cash inflows being held temporally in overnight investments before being
redeployed in the Bank's loan or MBS portfolios.
-- Loans. Total loans were $826.8 million, or 73.2% of total assets,
at March 31, 2004, compared to $814.3 million, or 74.4% of total assets, at
December 31, 2003. The Company attempts to concentrate its asset growth in
its loan portfolios to maximize the yield on new assets and to take
advantage of continued strong demand for both commercial and home equity
loan products in its market area.
The commercial loan portfolio (consisting of commercial & industrial,
small business, leases, commercial real estate, multi-family real estate,
and construction loans) increased $16.2 million, or 4.9%, during the first
quarter of 2004. The Company believes it is well positioned for continued
commercial loan growth. Particular emphasis is placed on generation of
small- to medium-sized commercial relationships (those relationships with
$6.0 million or less in loan commitments). The Company is also active in
small business lending (loans of $250,000 or less) in which it utilizes
credit scoring, in conjunction with traditional review standards, and
employs streamlined documentation. The Bank is a participant in the U.S.
Small Business Administration ("SBA") Preferred Lender Program in Rhode
Island and the 7a Guarantee Loan Program in Massachusetts. From time to
time, the Company also invests in short-term leases. These leases are
solely with the U.S. Government and its agencies. All leases are structured
to achieve payment in full over the term of the lease and, absent default,
are not dependent on residual collateral values.
The consumer loan portfolio increased $6.3 million, or 5.4%, during
the first quarter. This growth was centered in fifteen-year fixed-rate home
equity loans with maximum loan-to-values of 85%. In the current interest
rate environment, this fifteen-year fixed-rate product provides an
attractive alternative to first-mortgage refinances and the Company
anticipates that growth in this product will continue.
While origination efforts continue to be concentrated on commercial
and consumer loan opportunities, the Company also originates residential
mortgage loans on a limited basis. Additionally, until such time as the
Company can generate sufficient commercial and consumer
13
loans to utilize available cash flow, or to otherwise meet investment
objectives, it also intends to continue purchasing residential mortgage and
automobile loans as opportunities develop.
The residential mortgage loan portfolio decreased $10.0 million, or
2.7%, during the quarter, as repayments ($30.0 million) were greater than
originations ($3.0 million) and purchases of residential mortgage loans
($17.1 million). As long as market interest rates remain low, the Company
expects prepayment activity to be above average historical levels. At March
31, 2004, the Bank had commitments to purchase approximately $10 million of
hybrid ARM loans within the next 60 days.
The following is a breakdown of loans receivable:
March 31, December 31,
2004 2003
--------- ------------
(In thousands)
Commercial loans:
Commercial real estate - nonowner occupied $ 82,354 $ 78,083
Commercial real estate - owner occupied 80,564 77,317
Commercial and industrial 72,599 67,925
Small business 33,004 30,429
Construction 29,133 30,632
Multi-family real estate 29,457 28,730
Leases and other 21,788 19,548
-------- --------
Subtotal 348,899 332,664
Net deferred loan origination fees (405) (398)
-------- --------
Total commercial loans $348,494 $332,266
======== ========
Residential mortgage loans:
One- to four-family adjustable rate $224,540 $232,543
One- to four-family fixed rate 129,756 131,743
-------- --------
Subtotal 354,296 364,286
Premium on loans acquired 2,012 2,026
Net deferred loan origination fees (75) (82)
-------- --------
Total residential mortgage loans $356,233 $366,230
======== ========
Consumer loans:
Home equity - term loans $ 75,667 $ 68,523
Home equity - lines of credit 41,974 42,067
Automobile 1,169 1,455
Installment 510 662
Savings secured 535 631
Unsecured and other 1,492 1,787
-------- --------
Subtotal 121,347 115,125
Premium on loans acquired 35 44
Net deferred loan origination costs 668 617
-------- --------
Total consumer loans $122,050 $115,786
======== ========
Total loans receivable $826,777 $814,282
======== ========
14
-- Deposits and Borrowings. Total deposits increased by $25.4 million, or
3.1%, during the first quarter of 2004, from $811.3 million, or 74.2% of
total assets, at December 31, 2003, to $836.7 million, or 74.1% of total
assets, at March 31, 2004. The decrease in the relative percentage of total
assets resulted from first quarter total asset growth also being funded by
overnight borrowings and subordinated deferrable interest debentures. In
addition, the composition of total deposits also changed during the quarter.
Core deposit accounts (checking and savings) increased $15.8 million, or
2.6%, during the quarter, while certificates of deposit increased $9.6
million, or 4.5%, during this time period. The Bank continues its strategy
of emphasizing core deposit growth over certificate of deposit growth, but
from time-to-time will promote certificates of deposit. At March 31, 2004,
core deposit accounts comprised 73.4% of total deposits, compared to 73.8%
of total deposits at December 31, 2003.
The following table sets forth certain information regarding deposits:
March 31, 2004 December 31, 2003
------------------------------ ------------------------------
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
----- ------- -------- ------ ------- --------
(Dollars in thousands)
NOW accounts $134,246 16.1% 1.15% $129,398 16.0% 1.13%
Money market accounts 17,059 2.0% 1.31% 16,937 2.1% 1.29%
Savings accounts 293,806 35.1% 1.18% 292,277 36.0% 1.18%
Certificate of deposit accounts 222,335 26.6% 2.53% 212,755 26.2% 2.55%
-------- ----- -------- -----
Total interest bearing deposits 667,446 79.8% 1.63% 651,367 80.3% 1.62%
Noninterest bearing accounts 169,212 20.2% -- 159,916 19.7% --
-------- ----- -------- -----
Total deposits $836,658 100.0% 1.30% $811,283 100.0% 1.30%
======== ===== ==== ======== ===== ====
The Company, through the Bank's membership in the FHLB, has access to
a variety of borrowing alternatives, and management will from time-to-time
take advantage of these opportunities to fund asset growth. However, on a
long-term basis, the Company intends to continue concentrating on increasing
its core deposits.
In March 2004, the Company issued $5.2 million of subordinated
deferrable interest debentures to a related entity, which in turn issued
trust preferred securities. This transaction generated $5.0 million of Tier
I capital for regulatory purposes that can be used to support continued
growth of the Company.
Asset Quality
- -------------
The definition of nonperforming assets includes nonperforming loans
and other real estate owned ("OREO"). OREO consists of real estate acquired
through foreclosure proceedings and real estate acquired through acceptance
of a deed in lieu of foreclosure. Nonperforming loans are defined as
nonaccrual loans, loans past due 90 days or more, but still accruing and
impaired loans. Under certain circumstances the Company may restructure the
terms of a loan as a concession to a borrower. These restructured loans are
generally considered impaired loans.
-- Nonperforming Assets. At March 31, 2004, the Company had
nonperforming assets of $2.4 million, which represented 0.21% of total
assets. This compares to nonperforming assets of $2.5 million, or 0.23% of
total assets, at December 31, 2003. Total nonperforming assets at March 31,
2004, consisted of nonaccrual residential mortgage loans aggregating
$255,000, nonaccrual
15
commercial loans aggregating $2.1 million and nonaccrual consumer loans
aggregating $20,000. Included in nonaccrual loans at both March 31, 2004
and December 31, 2003, were $2.1 million of impaired loans. No specific
reserves were needed against these impaired loans at either date. During
April 2004, the Company resolved $2.1 million of its impaired and
nonperforming loans, returning the amount to earning assets. The Company
evaluates the underlying collateral of each nonperforming loan and continues
to pursue the collection of interest and principal. Management believes
that the current level of nonperforming assets is low relative to the size
of the Company's loan portfolio. As the loan portfolio continues to grow
and mature, or if economic conditions worsen, management believes it
possible that the level of nonperforming assets will increase, as will its
level of charged-off loans.
Delinquencies. At March 31, 2004, loans with an aggregate balance of
$22,000 were 60 to 89 days past due, a decrease of $575,000, or 96.3%, from
the $597,000 reported at December 31, 2003. The majority of these loans are
residential mortgage loans and are secured.
The following table sets forth information regarding nonperforming
assets and loans 60-89 days past due as to interest at the dates indicated.
March 31, December
31,
2004 2003
--------- --------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $ 2,397 $ 2,462
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
------- -------
Total nonperforming loans 2,397 2,462
Other real estate owned -- --
------- -------
Total nonperforming assets $ 2,397 $ 2,462
======= =======
Delinquent loans 60-89 days past due $ 22 $ 597
Nonperforming loans as a percent of total loans 0.29% 0.30%
Nonperforming assets as a percent of total assets 0.21% 0.23%
Delinquent loans 60-89 days past due as a percent
of total loans 0.00% 0.07%
Adversely Classified Assets. The Company's management adversely
classifies certain assets as "substandard," "doubtful" or "loss" based on
criteria established under banking regulations. An asset is considered
substandard if inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Substandard
assets include those characterized by the "distinct possibility" that the
insured institution will sustain "some loss" if existing deficiencies are
not corrected. Assets classified as doubtful have all of the weaknesses
inherent in those classified substandard with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the
basis of currently existing facts, conditions and values, "highly
questionable and improbable." Assets classified as loss are those
considered "uncollectible" and of such little value that their continuance
as assets without the establishment of a specific loss reserve is not
warranted.
At March 31, 2004, the Company had $7.0 million of assets that were
classified as substandard. This compares to $5.5 million of assets that
were classified as substandard at December 31, 2003. The Company had no
assets that were classified as doubtful or loss at either date. Performing
loans may or may not be adversely classified depending upon management's
judgment with respect to each individual loan. At March 31, 2004, included
in the assets that were classified as substandard, were $4.6 million of
performing loans. This compares to $3.1 million of adversely classified
performing
16
loans as of December 31, 2003. These amounts constitute assets that, in the
opinion of management, could potentially migrate to nonperforming or
doubtful status. Any downturn in the New England economy may lead to future
deteriorations in commercial credit quality and increases in nonaccrual
loans. This in turn may necessitate an increase to the provision for loan
losses in future periods.
Allowance for Loan Losses
- -------------------------
During the first quarter of 2004, the Company made provisions to the
allowance for loan losses totaling $300,000 and had $82,000 of net charge-
offs, bringing the balance in the allowance to $11.3 million, compared to
$11.1 million at December 31, 2003. The allowance, expressed as a
percentage of total loans, was 1.37% as of March 31, 2004, compared to 1.36%
at the prior year end and stood at 471.3% of nonperforming loans at March
31, 2004, compared to 450.0% of nonperforming loans at December 31, 2003.
Assessing the adequacy of the allowance for loan losses involves
substantial uncertainties and is based upon management's evaluation of the
amounts required to meet estimated charge-offs in the loan portfolio after
weighing various factors. Management's methodology to estimate loss
exposure includes an analysis of individual loans deemed to be impaired,
reserve allocations for various loan types based on payments status or loss
experience and an unallocated allowance that is maintained based on
management's assessment of many factors including the growth, composition
and quality of the loan portfolio, historical loss experiences, general
economic conditions and other pertinent factors. Based on this evaluation,
management believes that the allowance for loan losses, as of March 31,
2004, is adequate.
A portion of the allowance for loan losses is not allocated to any
specific segment of the loan portfolio. This non-specific allowance is
maintained for two primary reasons: (i) there exists an inherent
subjectivity and imprecision to the analytical processes employed, and (ii)
the prevailing business environment, as it is affected by changing economic
conditions and various external factors, may impact the portfolio in ways
currently unforeseen. Management, therefore, has established and maintains
a non-specific allowance for loan losses. The amount of this measurement
imprecision allocation was $3.0 million at March 31, 2004, compared to $3.1
million at December 31, 2003.
While management evaluates currently available information in
establishing the allowance for loan losses, future adjustments to the
allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review a financial institution's allowance for loan losses and carrying
amounts of other real estate owned. Such agencies may require the financial
institution to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
RESULTS OF OPERATIONS
- ---------------------
Comparison of Three Months Ended March 31, 2004 and 2003
- --------------------------------------------------------
-- General. The Company reported net income for the first quarter of
2004 of $2.1 million, up $392,000, or 23.4%, from the first quarter of 2003.
Diluted earnings per common share were $0.49 for the first quarter of 2004,
compared to $0.42 for the first quarter of 2003.
17
The Company reported a return on average assets of 0.75% and a return
on average equity of 11.27% for the 2004 period, as compared to a return on
average assets of 0.67% and a return on average equity of 10.18% for the
2003 period.
-- Net Interest Income. For the quarter ended March 31, 2004, net
interest income was $8.9 million, compared to $7.8 million for the 2003
period. The net interest margin for the first quarter of 2004 was 3.42%
compared to a net interest margin of 3.33% for the 2003 period. The
increase in net interest income of $1.1 million, or 14.4%, was primarily
attributable to the continued growth of the Company. Average earning assets
were $99.7 million, or 10.5%, higher, and average interest-bearing
liabilities were $66.9 million, or 8.3%, higher, than the comparable period
a year earlier. The increase of 9 basis points in the net interest margin
primarily resulted from the growth in demand deposit accounts funding
interest earning assets.
-- Interest Income. Investments. Total investment income was $2.3
million for the quarter ended March 31, 2004, compared to $2.7 million for
the 2003 quarter. The decrease in total investment income was $429,000, or
15.8%, and was primarily attributable to a decrease in average balances,
along with a decrease in market interest rates. The average balance of
investments decreased $39.8 million, and the average yield on investments
decreased 4 basis points, and from the first quarter of 2003 to the first
quarter of 2004. The majority of the Company's investments are comprised of
U.S. Agency securities and MBSs with repricing periods or expected remaining
maturities of less than five years.
-- Interest Income. Loans. Interest from loans was $11.3 million for
the three months ended March 31, 2004, and represented a yield on total
loans of 5.51%. This compares to $10.1 million of interest, and a yield of
5.97%, for the first quarter of 2003. Interest from commercial loans
increased $526,000, or 11.2%, interest from residential mortgage loans
increased $521,000, or 12.5%, and interest from consumer and other loans
increased $140,000, or 10.9%, as increased average balances more than offset
any decline in average yields. The average balance of the various
components of the loan portfolio changed from the first quarter of 2003 as
follows: commercial loans increased $52.8 million, or 18.2%, residential
mortgage loans increased $65.3 million, or 21.9%, and consumer and other
loans increased $21.3 million, or 21.9%. In response to declining market
interest rates, the yields on the various loan portfolio components changed
from the first quarter of 2003 as follows: commercial loans decreased 44
basis points, to 6.11%, residential mortgage loans decreased 43 basis
points, to 5.17%, and consumer and other loans decreased 53 basis points, to
4.84%. Since its inception, the Company has concentrated its origination
efforts on commercial and consumer loan opportunities, while purchasing
residential mortgage loans, and to a limited degree, automobile loans, as
cash flows dictated. More recently, the Company has increased its
residential mortgage and consumer loan origination capacities in response to
strong demand for these products.
-- Interest Expense. Interest paid on deposits and borrowings
decreased $370,000, or 7.3%, to $4.7 million for the three months ended
March 31, 2004, from $5.1 million for the same period during 2003. The
decrease in total interest expense was primarily attributable to a decrease
in market interest rates. The overall average cost for interest-bearing
liabilities decreased 39 basis points from 2.55% for the first quarter of
2003 to 2.16% for the first quarter of 2004. Liability costs are dependent
on a number of factors including general economic conditions, national and
local interest rates, competition in the local deposit marketplace, interest
rate tiers offered and the Company's cash flow needs. Average costs for the
various components of interest-bearing liabilities changed from the first
quarter of 2003 as follows: NOW accounts decreased 17 basis points, to
1.16%; money market accounts increased 41 basis points, to 1.42% (as a
result of growth in higher
18
rate tiers); savings deposits decreased 41 basis points, to 1.17%;
certificate of deposit accounts decreased 42 basis points, to 2.54%; and
borrowings decreased 60 basis points to 3.81%. Meanwhile, the average
balance of total interest-bearing liabilities increased $66.9 million, from
$803.3 million in the first quarter of 2003 to $870.2 million in the first
quarter of 2004, as NOW account average balances increased $31.1 million, or
31.1%, and FHLB borrowings increased $31.9 million, or 22.5%.
-- Provision for Loan Losses. The provision for loan losses was
$300,000 for the quarter ended March 31, 2004, down $100,000 from the same
quarter last year. Management evaluates several factors including new loan
originations, actual and estimated charge-offs, the risk characteristics of
the loan portfolio and general economic conditions when determining the
provision for each quarter. Also see discussion under "Allowance for Loan
Losses." Additions to the allowance for loan losses during the first
quarter of 2004 were primarily in response to growth in total loans
outstanding and concern for economic conditions. The allowance expressed as
a percentage of total loans was 1.37% at March 31, 2004, compared to 1.36%
at December 31, 2003. As the loan portfolio continues to grow and mature,
or if economic conditions worsen, management believes it possible that the
level of nonperforming assets will increase, which in turn may lead to
increases in the provision for loan losses in future periods.
-- Noninterest Income. Total noninterest income increased $82,000, or
4.3%, to $2.0 million for the first quarter of 2004, from $1.9 million for
the first quarter of 2003. Service charges on deposit accounts, which
continues to represent the largest source of noninterest income for the
Company, increased $60,000, or 6.3%, from $952,000 for the three months
ended March 31, 2003, to $1.0 million for the same period in 2004 in
response to continued growth in checking and savings accounts. Gains from
sales of investment securities and MBSs was $39,000, or 24.7%, higher in the
2004 period, as compared to the 2003 period. The gains in both of these
periods resulted from the Company restructuring a portion of its investment
portfolio and may not be present at these levels in future periods. Other
income increased $104,000, or 48.1%, primarily from increased volumes of
credit card and tuition payment transactions. Partially offsetting these
increases, Commissions on loans originated for others decreased $92,000, or
84.4%, as mortgage loan refinancing activity declined significantly from the
same quarter a year ago.
-- Noninterest Expense. Noninterest expenses for the first quarter of
2004 increased a total of $702,000, or 10.2%, to $7.6 million from $6.9
million in 2003. This increase occurred primarily as a result of the
overall growth of the Company and was centered in the following areas:
Salaries and employee benefits (up $595,000, or 18.0%), Occupancy and
Equipment (up $127,000, or 13.5%), and Marketing (up $58,000, or 19.5%). In
addition to incurring increased operating costs as a result of the
continuing growth in both loans and core deposits, the 2004 period includes
incentive accruals which the 2003 period did not. Partially offsetting
these increases was a decrease in Data processing (down $175,000, or 20.7%),
as the 2003 period contained expenses associated with the Bank's data
processing conversion that were not present in the 2004 period. The
Company's efficiency ratio improved to 69.24% in 2004, from 70.64% in the
2003 period.
-- Income Tax Expense. Income tax expense of $1.0 million was
recorded for the three months ended March 31, 2004, compared to $785,000 for
the same period during 2003. This represented total effective tax rates of
32.7% and 31.9%, respectively. Tax-favored income from U.S. Agency
securities and BOLI, along with the utilization of a Rhode Island passive
investment company has reduced the effective tax rate from the 39.9%
combined statutory federal and state tax rates.
19
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
-- Liquidity. Liquidity is defined as the ability to meet current and
future financial obligations of a short-term nature. The Company further
defines liquidity as the ability to respond to the needs of depositors and
borrowers, as well as to earnings enhancement opportunities, in a changing
marketplace.
The primary source of funds for the payment of dividends and expenses
by the Company is dividends paid to it by the Bank. Bank regulatory
authorities generally restrict the amounts available for payment of
dividends if the effect thereof would cause the capital of the Bank to be
reduced below applicable capital requirements. These restrictions
indirectly affect the Company's ability to pay dividends. The primary
sources of liquidity for the Bank consist of deposit inflows, loan
repayments, borrowed funds, maturity of investment securities and sales of
securities from the available for sale portfolio. Management believes that
these sources are sufficient to fund the Bank's lending and investment
activities.
Management is responsible for establishing and monitoring liquidity
targets as well as strategies and tactics to meet these targets. In
general, the Company seeks to maintain a high degree of flexibility. At
March 31, 2004, overnight investments, investment securities and MBSs
available for sale amounted to $227.6 million, or 20.1% of total assets.
This compares to $205.9 million, or 18.8% of total assets at December 31,
2003. The Bank is a member of the FHLB and, as such, has access to both
short- and long-term borrowings. In addition, the Bank maintains a line of
credit at the FHLB as well as a line of credit with a correspondent bank.
There have been no adverse trends in the Company's liquidity or capital
reserves. Management believes that the Company has adequate liquidity to
meet its commitments.
-- Capital Resources. Total shareholders' equity of the Company at
March 31, 2004 was $75.3 million, as compared to $72.1 million at December
31, 2003. This increase of $3.2 million was the result of net income for
the quarter of $2.1 million, plus proceeds from issuance of stock of
$880,000 and increases in accumulated other comprehensive income of
$803,000, less dividends of $557,000.
All FDIC-insured institutions must meet specified minimal capital
requirements. These regulations require banks to maintain a minimum
leverage capital ratio. In addition, the FDIC has adopted capital
guidelines based upon ratios of a bank's capital to total assets adjusted
for risk. The risk-based capital guidelines include both a definition of
capital and a framework for calculating risk-weighted assets by assigning
balance sheet assets and off-balance sheet items to broad risk categories.
These regulations require banks to maintain minimum capital levels for
capital adequacy purposes and higher capital levels to be considered "well
capitalized."
Capital guidelines have also been issued by the Federal Reserve Board
("FRB") for bank holding companies. These guidelines require the Company to
maintain minimum capital levels for capital adequacy purposes. In general,
the FRB has adopted substantially identical capital adequacy guidelines as
the FDIC. Such standards are applicable to bank holding companies and their
bank subsidiaries on a consolidated basis.
As of March 31, 2004, the Company and the Bank met all applicable
minimum capital requirements and were considered "well capitalized" by both
the FRB and the FDIC.
20
The recent decision by the SEC to require the deconsolidation of
"special purpose entities" under the Financial Accounting Standards Board's
Interpretation 46-R, "Consolidation of Variable Interest Entities -
Revised," has lead to uncertainity regarding whether the FRB would disallow,
or further limit, the inclusion of trust preferred securities in Tier I
capital calculations. To date, the Company has issued a total of $18.0
million of trust preferred securities and utilized their proceeds as Tier I
capital to help support the Company's growth. If trust preferred securities
are no longer available as a source of Tier I capital, the Company expects
to use other forms of capital (e.g., common or preferred equity) to support
its future growth, which, because of less favorable tax treatment, may be a
somewhat more expensive source of capital than trust preferred securities.
The Company's and the Bank's actual and required capital amounts and
ratios are as follows:
Minimum Required Minimum Required
For Capital To Be Considered
Actual Adequacy Purposes "Well Capitalized"
---------------- ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
At March 31, 2004:
Bancorp Rhode Island, Inc.
- --------------------------
Tier I capital (to average assets) $80,182 7.28% $33,025 3.00% $55,041 5.00%
Tier I capital (to risk weighted assets) 80,182 10.31% 31,122 4.00% 46,683 6.00%
Total capital (to risk weighted assets) 89,921 11.56% 62,244 8.00% 77,805 10.00%
Bank Rhode Island
- -----------------
Tier I capital (to average assets) $77,259 7.03% $32,962 3.00% $54,936 5.00%
Tier I capital (to risk weighted assets) 77,259 9.94% 31,103 4.00% 46,654 6.00%
Total capital (to risk weighted assets) 86,998 11.19% 62,205 8.00% 77,757 10.00%
At December 31, 2003:
Bancorp Rhode Island, Inc.
- --------------------------
Tier I capital (to average assets) $72,690 6.76% $32,255 3.00% $53,759 5.00%
Tier I capital (to risk weighted assets) 72,690 9.71% 29,954 4.00% 44,931 6.00%
Total capital (to risk weighted assets) 81,784 10.92% 59,908 8.00% 74,885 10.00%
Bank Rhode Island
- -----------------
Tier I capital (to average assets) $70,835 6.59% $32,570 3.00% $54,283 5.00%
Tier I capital (to risk weighted assets) 70,835 9.46% 29,938 4.00% 44,907 6.00%
Total capital (to risk weighted assets) 79,929 10.68% 59,876 8.00% 74,845 10.00%
21
BANCORP RHODE ISLAND, INC.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK
- ------------------
The principal market risk facing the Company is interest rate risk.
The Company's objective regarding interest rate risk is to manage its assets
and funding sources to produce results which are consistent with its
liquidity, capital adequacy, growth and profitability goals, while
minimizing the vulnerability of its operations to changes in market interest
rates. The Company's actions in this regard are taken under the guidance of
the Bank's Asset/Liability Committee ("ALCO"). The ALCO manages the
Company's interest rate risk position using both income simulation and
interest rate sensitivity "gap" analysis. The ALCO has established internal
parameters for monitoring the income simulation and gap analysis. These
guidelines serve as benchmarks for evaluating actions to balance the current
position against overall strategic goals. The ALCO monitors current
exposures and reports these to the Board of Directors.
Simulation is used as the primary tool for measuring the interest rate
risk inherent in the Company's balance sheet at a given point in time by
showing the effect on net interest income, over a 24-month period, of
interest rate ramps of up to 200 basis points. These simulations take into
account repricing, maturity and prepayment characteristics of individual
products. The ALCO reviews simulation results to determine whether the
downside exposure resulting from changes in market interest rates remains
within established tolerance levels over both a 12-month and 24-month
horizon, and develops appropriate strategies to manage this exposure. The
Company's guidelines for interest rate risk specify that if interest rates
were to shift up or down 200 basis points over a 12-month period, estimated
net interest income for those 12 months and the subsequent 12 months, should
decline by no more than 5.0% or 10.0%, respectively. As of March 31, 2004,
net interest income simulation indicated that the Company's exposure to
changing interest rates was outside of the 10% tolerance level established
for the second year of a 200 basis point decline. This exposure primarily
results from the unusually low current rates paid on deposit accounts and
the extremely high prepayment speeds anticipated for mortgage-related assets
if market rates declined 200 basis points. The current rates on many
deposit accounts are so low, that they cannot decline 200 basis points
without becoming negative. This results in a floor of zero percent for
these deposit accounts, and this floor causes compression of the net
interest margin for modeling purposes. The ALCO reviews the methodology
utilized for calculating interest rate risk exposure and may, from time to
time, adopt modifications to this methodology. While the ALCO reviews
simulation assumptions and methodology to ensure that they reflect
historical experience, it should be noted that income simulation may not
always prove to be an accurate indicator of interest rate risk because the
actual repricing, maturity and prepayment characteristics of individual
products may differ from the estimates used in the simulations.
22
The following table presents the estimated impact of interest rate
ramps on the Company's estimated net interest income over a twenty-four
month period beginning April 1, 2004:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 basis points $ 495 1.38%
Up 100 basis points 362 1.01%
Down 100 basis points (109) (0.30%)
Down 200 basis points (612) (1.71%)
Subsequent Twelve Month Period:
Up 200 basis points $ 532 1.48%
Up 100 basis points 702 1.96%
Down 100 basis points (823) (2.29%)
Down 200 basis points (4,138) (11.53%)
The Company also uses interest rate sensitivity gap analysis to
provide a more general overview of its interest rate risk profile. The
interest rate sensitivity gap is defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing within
a given time period. At March 31, 2004, the Company's one year cumulative
gap was a positive $65.0 million, or 5.75% of total assets.
For additional discussion on interest rate risk see the section titled
"Asset and Liability Management" on pages 38 to 40 of the Company's 2003
Annual Report to Shareholders.
ITEM 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), the Company carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures as of the end of the period covered by this report.
This evaluation was carried out under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer. Based upon
that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.
There was no significant changes in the Company's internal control
over financial reporting that occurred during the Company's most recent
fiscal quarter that has materially affected, or is reasonably likely to
affect, the Company's internal control over financial reporting.
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BANCORP RHODE ISLAND, INC.
Other Information
PART II. Other Information
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Company or its subsidiaries are a party, or to which any of their
property is subject, other than ordinary routine litigation
incidental to the business of banking.
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS
No information to report.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
No defaults upon senior securities have taken place.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
No information to report.
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Current report on Form 8-K dated January 27, 2004, announcing
the Company's fiscal 2003 consolidated earnings.
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BANCORP RHODE ISLAND, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Bancorp Rhode Island, Inc.
May 11, 2004 /s/ Merrill W. Sherman
- ------------ -----------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
May 11, 2004 /s/ Albert R. Rietheimer
- ------------ -------------------------
(Date) Albert R. Rietheimer
Chief Financial Officer
and Treasurer
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