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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
Commission file number 000-23904
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SLADE'S FERRY BANCORP.
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(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-3061936
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
100 Slade's Ferry Avenue
Somerset, Massachusetts 02726
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 675-2121
Securities registered pursuant to Section 12(b) of the Act: 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 [ ]
Indicate by check mark if disclosure of delinquent filers persuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
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, 2004 was
approximately $63,100,223. On that date, there were 3,347,492 shares of
Slade's Ferry Bancorp Common Stock, $.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for Annual Meeting of Shareholders May 11, 2005 is
incorporated by reference into Part III.
TABLE OF CONTENTS
ITEM 1 - Business 4
ITEM 2 - Properties 19
ITEM 3 - Legal Proceedings 20
ITEM 4 - Submissions of Matters to a Vote of Security Holders 20
ITEM 5 - Market for Registrant's Common Equity and Related Stockholder
Matters and Issuer Purchases of Equity Securities 21
ITEM 6 - Selected Financial Data 23
ITEM 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operation 24
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk 48
ITEM 8 - Financial Statements and Supplementary Data 48
ITEM 9 - Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 48
ITEM 9A - Controls and Procedures 48
ITEM 9B - Other Information 48
ITEM 10 - Directors and Executive Officers of the Registrant 49
ITEM 11 - Executive Compensation 49
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management 49
ITEM 13 - Certain Relationships and Related Transactions 49
ITEM 14 - Principal Accountant Fees and Services 49
ITEM 15 - Exhibits, Financial Statement Schedules 50
2
PART I
Forward-looking Statements
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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 Slade's Ferry Bancorp's
management and are subject to significant risks and uncertainties. Actual
results may differ materially from those set forth in the forward-looking
statements as a result of numerous factors.
The following factors, among others, could cause actual results to
differ materially from the anticipated results or other expectations
expressed in our forward-looking statements:
(1) enactment of adverse government regulation;
(2) competitive pressures among depository and other financial
institutions may increase significantly and have an effect on
pricing, spending, third-party relationships and revenues;
(3) the strength of the United States economy in general and
specifically the strength of the New England economies may be
different than expected, resulting in, among other things, a
deterioration in overall credit quality and borrowers' ability
to service and repay loans, or a reduced demand for credit,
including the resultant effect on the Bank's loan portfolio,
levels of charge-offs and non-performing loans and allowance for
loan losses;
(4) changes in the interest rate environment may reduce interest
margins and adversely impact net interest income; and
(5) changes in assumptions used in making such forward-looking
statements.
Should one or more of these risks materialize or should underlying
beliefs or assumptions prove incorrect, Slade's Ferry Bancorp's actual
results could differ materially from those discussed.
All subsequent written and oral forward-looking statements
attributable to Slade's Ferry Bancorp or any person acting on its behalf are
expressly qualified in their entirety by the cautionary statements set forth
above. Slade's Ferry Bancorp does not intend or undertake any obligation to
update any forward-looking statement to reflect circumstances or events that
occur after the date the forward-looking statements are made.
As used throughout this report, the terms "we," "our," "us," or the
"Company" refer to Slade's Ferry Bancorp and its consolidated subsidiaries.
3
ITEM 1
BUSINESS
General
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Slade's Ferry Bancorp., a Massachusetts corporation, is a bank holding
company headquartered in Somerset, Massachusetts with consolidated assets of
$549.8 million, consolidated net loans and leases of $362.3 million,
consolidated deposits of $399.9 million and consolidated shareholders'
equity of $47.0 million as of December 31, 2004. We conduct our business
principally through our wholly-owned subsidiary, Slade's Ferry Trust Company
(referred to herein as the "Bank"), a Massachusetts-chartered trust company.
As a bank holding company, we are subject to the Bank Holding Company Act of
1956, as amended (the "BHCA"), and the rules and regulations of the Federal
Reserve Board (the "FRB") under the BHCA. We are additionally subject to
the provisions of the Massachusetts General Laws applicable to commercial
bank and trust companies and other depository institutions and their holding
companies and applicable regulations of the Massachusetts Division of Banks
(the "Division"). We are also subject to the rules and regulations of the
Securities and Exchange Commission (the "SEC") as our common stock is
registered with the SEC and is quoted on the Nasdaq Small Cap Market. The
Bank's deposit accounts are insured up to applicable limits by the Bank
Insurance Fund of the Federal Deposit Insurance Corporation (the "FDIC").
The Bank is subject to extensive regulation, examination and supervision by
the Division as its primary corporate regulator, and by the FDIC as its
deposit insurer and primary federal regulator. Any change in such laws and
regulations, whether by the Division, the FDIC, the FRB or the SEC or
through legislation, could have a material adverse impact on our operation.
Our main office is located at 100 Slade's Ferry Avenue, Somerset,
Massachusetts, 02726, and our telephone number is (508) 675-2121. Slade's
Ferry Bancorp was organized for the purpose of becoming the holding company
of the Bank. Slade's Ferry Bancorp acquisition of the Bank was completed on
April 1, 1990.
We had consolidated asset growth of $110.4 million or 25.1% and our
level of deposits increased by $66.8 million, or by 20.0%, during 2004.
Aside from deposits, we increased borrowings from the Federal Home Loan Bank
of Boston (the "FHLB") by $29.8 million and the issue of subordinated
debentures in March 2004 totaling $10.3 million. This activity funded an
increase in loans totaling $30.8 million or 9.3%, and an increase in
investments totaling $63.2 million or 108.1%.
While we evaluate opportunities to acquire other banks or bank
facilities as they arise and may in the future acquire other banks,
financial institutions, or bank facilities, we are not currently engaged in
any such acquisition.
We are committed to the philosophy of serving the needs of customers
within our market area. We believe that our comprehensive retail, small
business, and commercial real estate products enable us to compete
effectively. We do not have any major target accounts, nor do we derive a
material portion of our deposits from any single depositor. We concentrate
our operations in the area of retail banking and we service the needs of the
local communities. Our loans are not concentrated within any single
industry or group of related industries that would have any possible adverse
effect on our business.
We currently have eight full service banking facilities extending east
from Seekonk, Massachusetts to Fairhaven, Massachusetts. These facilities
service numerous communities in Southeastern Massachusetts and contiguous
areas of Rhode Island. We also provide limited banking services at the
Somerset High School in Somerset, Massachusetts. We will open a tenth
facility, located in Assonet, Massachusetts in early 2005. This branch will
be a full-service banking office and will be a state-of-the-art facility,
designed to provide superior customer convenience and service. Two branches,
one each in the cities of New Bedford and Fall River were closed in 2004, as
these offices were deemed by management to be unprofitable.
In June 1999, we established Slade's Ferry Preferred Capital
Corporation, a real estate investment trust (the "REIT"). The REIT was
formed to purchase certain designated, bank-owned real estate mortgage
loans. The interest income derived on these loans was taxed at a reduced
state tax rate.
4
On June 20, 2003, the Bank and the REIT entered into an agreement with
the Massachusetts Department of Revenue (the "DOR") settling a 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. Therefore, the
previously unrecorded tax liability of $881,790, interest of $128,977 and
federal and state tax benefits of $352,599 were recognized during the year
ended December 31, 2003.
On December 8, 2003, the Bank, acting in its capacity as sole common
stockholder of the REIT authorized the REIT's liquidation and dissolution.
The REIT was subsequently liquidated and dissolved as of December 16, 2003.
We maintain four subsidiaries, all of which are wholly-owned by the
Bank. Two of these, Slade's Ferry Securities Corporation ("SFSC"), and
Slade's Ferry Securities Corporation II ("SFSCII") are Massachusetts
securities corporations on which, under current Massachusetts law, income is
taxed at 1.32%, as compared to the Massachusetts bank taxation rate of
10.5%. In exchange for this lower tax rate, the assets of any Massachusetts
security corporation are limited to certain investment securities, including
United States Treasury and agency securities, mortgage-backed investments,
corporate debt securities and marketable equity securities. Investment
securities with book values totaling $19.0 million and $36.8 million were
held at SFSC and SFSC II respectively.
Slade's Ferry Realty Trust ("SFRT") owns and manages our land and
buildings.
Slade's Ferry Loan Company ("SFLC") is a Rhode Island corporation
founded for the purpose of generating loans in the State of Rhode Island.
As the Bank has received authorization to generate loans in Rhode Island
directly, SFLC is in the process of liquidation and dissolution. We expect
the ultimate legal dissolution to occur in early 2005.
Our major customer base as of December 31, 2004 consists of
approximately 24,800 personal savings, checking and money market accounts,
and 6,550 personal certificates of deposit and individual retirement
accounts. Our commercial base consists of approximately 1,700 checking,
money market, corporate and certificate of deposit accounts.
As we grew in 2004, we remained committed to customer service. We are
currently upgrading the systems utilized on the teller platform and in
customer service areas to allow employees to serve customers more
efficiently.
Services
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We engage in a broad range of banking activities, including demand,
savings, time deposits, related personal and commercial checking account
services, real estate mortgages, commercial and installment lending, payroll
services, money orders, travelers checks, Visa, MasterCard, debit card, safe
deposit rentals and automatic teller machines. We also offer certain non-
traditional banking services including investments, life insurance,
annuities, and cash management services and we also provide a range of
internet-based services for both consumer and commercial customers.
Lending Activities
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Our loan portfolio consists primarily of residential and commercial
real estate, construction and land development, commercial, home equity
lines of credit and consumer loans originated primarily in our market area.
There are no foreign loans outstanding. Interest rates charged by the Bank
on loans are affected principally by the demand for such loans, the supply
of money available for lending purposes and the rates offered by its
competitors. These factors are affected by general and economic conditions,
monetary policies of the federal government, including the FRB, legislative
tax policies and governmental budgetary matters. We originate residential
equity lines of credit, fixed-rate equity loans, commercial business loans,
consumer loans and commercial real estate loans. Total net loans were 65.9%
of total assets at December 31, 2004, as compared to 75.4% of total assets
at December 31, 2003. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Operating Results", for detailed portfolio
information.
5
Multi-Family and Commercial Real Estate Lending. We originate multi-
family and commercial real estate loans that are generally secured by five
or more unit apartment buildings and properties used for business purposes
such as small office buildings, restaurants or retail facilities primarily
located in our primary market area. Our multi-family and commercial real
estate underwriting policies provide that such real estate loans may be made
in amounts of up to 80% of the appraised value of the property, subject to
our current loans-to-one-borrower limit of $8.0 million at December 31,
2004. Our multi-family and commercial real estate loans are generally made
with terms of up to 20 years and are offered with interest rates that adjust
periodically. In reaching a decision on whether to make a multi-family or
commercial real estate loan, we consider the net operating income of the
property, the borrower's expertise, credit history and profitability and the
value of the underlying property. We have generally required that the
properties securing these real estate loans have debt service coverage
ratios (the ratio of earnings before debt service) of at least 1.20 times.
Environmental impact surveys are generally required for all commercial real
estate loans. Generally, all multi-family and commercial real estate loans
made to corporations, partnerships and other business entities require
personal guarantees by the principals. We may choose not to require a
personal guarantee on such loans depending on the creditworthiness of the
borrower and the amount of the down payment and other mitigating
circumstances.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one-to-four family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties are often
dependent on successful operation or management of the properties, repayment
of such loans may be subject to adverse conditions in the real estate market
or the economy. We seek to minimize these risks through its underwriting
standards.
Multi-family and commercial real estate loans totaled $192.8 million
and comprised 52.6% of the total gross loan portfolio at December 31, 2004.
At December 31, 2003, the multi-family and commercial real estate loan
portfolio totaled $181.4 million, or 53.9% of total gross loans.
Residential Lending. We currently offer fixed-rate one-to-four family
mortgage loans with terms from 10 to 30 years and a number of adjustable
rate mortgage ("ARM") loans with terms of up to 30 years and interest rates
which adjust every one or three years from the outset of the loan. The
interest rates for the ARM loans are generally indexed to the applicable
Constant Maturity Treasury ("CMT") Index, or other comparable indices. Our
ARM loans generally provide for periodic (not more than 2%) and overall (not
more than 6%) caps on the increase or decrease in the interest rate at any
adjustment date and over the life of the loan.
The origination of adjustable-rate residential mortgage loans and
short term fixed-rate mortgage loans, as opposed to 30-year fixed-rate
residential mortgage loans, generally helps reduce our exposure to increases
in interest rates. However, adjustable-rate loans generally pose credit
risks not inherent in fixed-rate loans, primarily because as interest rates
rise, the underlying payments of the borrower rise, thereby increasing the
potential for default. Periodic and lifetime caps on interest rate increases
help to reduce the risks associated with adjustable-rate loans but also
limit the interest rate sensitivity of such loans. The continued period of
low market interest rates has been the impetus for the Bank's customers to
continue finance home purchases with fixed-rate loans or to refinance ARM
loans into fixed-rate loans.
Generally, we originate one-to-four family residential mortgage loans
in amounts of up to 95% of the appraised value or selling price of the
property securing the loan, whichever is lower. Certain loans in our "First-
Time Home Buyer" program allow for a 97% loan-to-value ("LTV") ratio.
Private mortgage insurance ("PMI") may be required for loans with a LTV
ratio of greater than 80%. Mortgage loans we originate generally include
due-on-sale clauses, which provide us with the contractual right to deem the
loan immediately due and payable in the event the borrower transfers
ownership of the property without our consent. Due-on-sale clauses are an
important means of adjusting the yields on our fixed-rate mortgage loan
portfolio and we have generally exercised our rights under these clauses. We
require fire, casualty, title, and, in certain cases, flood insurance on all
properties securing real estate loans we make.
In an effort to provide financing for moderate income and first-time
homebuyers, we offer Federal Housing Authority ("FHA") and Veterans
Administration ("VA") loans and we have our own First-Time Home Buyer loan
program. These programs offer residential mortgage loans to qualified
individuals. These loans are offered with adjustable- and fixed-rates of
interest and terms of up to 30 years. Such loans may be secured by a one-
to-four family residential property, in the case of FHA and VA loans, and
must be secured by a single-family owner-occupied unit in the case of First-
Time Home Buyer loans. These loans are originated using modified
underwriting guidelines, in the case
6
of FHA and VA loans, and the same underwriting guidelines as our other one-
to-four family mortgage loans in the case of First-Time Home Buyer loans.
Such loans may be originated in amounts of up to 97% of the lower of the
property's appraised value or the sale price. Private mortgage insurance is
required on all such loans with loan to values in excess of 80%.
We generally underwrite our residential real estate loans to comply
with secondary market standards established by the Federal National Mortgage
Association. Although loans are underwritten to standards that make them
readily salable, we have not chosen to sell these loans, rather to maintain
them in portfolio, consistent with our income and interest rate risk
management targets.
Residential real estate loans totaled $97.5 million and comprised
26.6% of the total loan portfolio at December 31, 2004. At December 31,
2003, the residential real estate loan portfolio totaled $88.0 million, or
26.1% of total gross loans.
Commercial loans. Our commercial business loan portfolio consists of
loans and lines of credit predominantly collateralized by inventory,
furniture and fixtures, and accounts receivable. In assessing the
collateral for these loans, management applies a 50% liquidation value to
inventories; 25% to furniture, fixtures and equipment; and 70% to accounts
receivable less than 90 days of invoice date. Like commercial real estate
loans, the successful repayment of these loans is dependent on the
operations of the business to which the loan is made. Accordingly, these
loans carry a higher level of credit risk than loans secured by real estate.
To alleviate some of this risk, credit enhancements, such as personal
guarantees or additional collateral are often taken.
Commercial loans totaled $26.6 million and comprised 7.3% of the total
gross loan portfolio at December 31, 2004. At December 31, 2003, the
commercial loan portfolio totaled $34.0 million, or 10.1% of total gross
loans.
Construction Lending. We originate fixed-rate construction loans for
the development of one-to-four family residential properties, primarily
located in our primary market area. Although we do not generally make loans
secured by raw land, our policies permit the origination of such loans.
Construction loans are generally offered to experienced local developers
operating in our primary market area and, to a lesser extent, to individuals
for the construction of their primary residence. Construction loans are
generally offered with terms of up to 12 months and may be made in amounts
of up to 70% of the appraised value of the property, as improved. In the
case of construction loans to individuals for the construction of their
primary residence, loans up to 90% of the appraisal value may be made.
Loans made to individuals are generally written on a construction-to-
permanent basis. Land loans of up to 80% of the appraised value may be
made. Construction loan proceeds are disbursed periodically in increments as
construction progresses and as inspections by our lending officers warrant.
Generally, if the borrower is a corporation, partnership or other business
entity, personal guarantees by the principals are required for all
construction loans.
Construction financing is generally considered to involve a higher
degree of credit risk than long-term financing on improved, owner-occupied
real estate. Risk of loss on a construction loan is dependent largely upon
the accuracy of the initial estimate of the property's value at completion
of construction compared to the estimated cost (including interest) of
construction and other assumptions, including the estimated time to sell
residential properties. If the estimate of value proves to be inaccurate, we
may be confronted with a project, when completed, having a value which is
insufficient to assure full repayment.
Construction and land development loans totaled $24.2 million and
comprised 6.6% of the total gross loan portfolio at December 31, 2004. At
December 31, 2003, the construction and land development loan portfolio
totaled $10.3 million, or 3.1% of total gross loans.
Home Equity Lines of Credit. Substantially all of our home equity
lines of credit are secured by second mortgages on owner-occupied one-to-
four family residences located in our primary market area. Our home equity
lines of credit generally have interest rates, indexed to the Wall Street
Journal Prime Rate, that adjust on a monthly basis. Home equity lines of
credit generally have an 18% lifetime limit on interest rates. Generally,
the maximum combined loan-to-value ratio on home equity lines of credit is
80%. The underwriting standards we employ for home equity lines of credit
include a determination of the applicant's credit history and an assessment
of the applicant's ability to meet existing obligations and payments on the
proposed loan and the value of the collateral securing the loan. The
stability
7
of the applicant's monthly income may be determined by verification of gross
monthly income from primary employment and, additionally, from any
verifiable secondary income. Creditworthiness of the applicant is a primary
consideration.
Home equity lines of credit totaled $23.1 million and comprised 6.3%
of the total gross loan portfolio at December 31, 2004. At December 31,
2003, home equity line of credit portfolio totaled $18.3 million, or 5.5% of
total gross loans.
Consumer Lending. Loans secured by rapidly depreciable assets such as
recreational vehicles and automobiles entail greater risks than one-to-four
family residential mortgage loans. In such cases, repossessed collateral for
a defaulted loan may not provide an adequate source of repayment of the
outstanding loan balance, since there is a greater likelihood of damage,
loss or depreciation of the underlying collateral. Further, consumer loan
collections on these loans are dependent on the borrower's continuing
financial stability and, therefore, are more likely to be adversely affected
by job loss, divorce, illness or personal bankruptcy. Finally, the
application of various federal and state laws, including federal and state
bankruptcy and insolvency laws, may limit the amount which can be recovered
on such loans in the event of a default. Accordingly, we originate consumer
loans typically based on the borrower's ability to repay the loan through
continued financial stability. We endeavor to minimize risk by reviewing
the borrower's repayment history on past debts, and assessing the borrower's
ability to meet existing obligations on the proposed loans. Because of the
proliferation of manufacturers' discount financing and automobile leasing,
origination of automobile loans has diminished significantly in the last
five years, accounting for the continued drop in volume of consumer loans.
Consumer loans totaled $2.5 million and comprised 0.7% of the total
gross loan portfolio at December 31, 2004. At December 31, 2003, the
consumer loan portfolio totaled $4.0 million, or 1.2% of total gross loans.
Loan Approval Procedures and Authority. The Bank's Board of Directors
establishes the Bank's lending policies and loan approval limits. The Bank's
Board of Directors has established a Loan Committee that considers and
approves all loans within its designated authority as established by the
Board. In addition, the Bank's Board of Directors has authorized certain
officers to consider and approve all loans within their designated authority
as established by the Board. The President, CEO and Senior Vice President
have authority to approve loans to $250,000, and the Executive Committee has
authority to approve loans to $500,000. For loans above $500,000, full
Board approval is necessary.
Investing Activities
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We utilize our investment portfolio as a temporary means of
warehousing liquidity until the funds can be lent. The investment portfolio
also serves to secure certain deposits and borrowings. We manage the
investment portfolio to optimize earnings, while using the portfolio as a
tool in managing interest rate risk. We use an independent investment
advisor to assist us in our portfolio management function.
We utilize both a "held-to-maturity" account and an "available-for-
sale" account, as defined in Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities", to
manage the investment portfolio. Our investment policy requires Board approval
before a trading account can be established. The held-to-maturity account was
originally established for holding high-yielding municipal securities. During
2004, certain mortgage-backed securities designated as collateral for FHLB
advances were also designated as held-to-maturity. Management has the ability
and intent to hold these securities to their contractual maturity. Held-to-
maturity securities totaled $37.8 million at December 31, 2004 while
available-for-sale securities totaled $83.9 million as compared to $11.3
million and $47.2 million, respectively, at December 31, 2003.
We primarily utilize U.S. Government agency securities and agency-
insured mortgage-backed securities as investment vehicles. High-quality
corporate bonds and municipal securities are purchased when an exceptional
opportunity to enhance investment yields arises. Purchases of these
investments are limited to securities that carry a rating of "Baa1"
(Moody's) or "BBB+" (Standard and Poor's), in order to control credit risk
within the investment portfolio. Among other investment criteria, it is
management's goal to maintain a total portfolio duration of less than
5 years. At December 31, 2004, the portfolio duration was estimated at 2.65
years, which is within the established portfolio duration limit.
8
Excess cash is sold on an overnight basis into federal funds or
overnight deposits at the FHLB. At December 31, 2004 federal funds sold and
overnight deposits totaled $18.8 million or 3.4% of total assets, as
compared to $4.0 million, or 0.9% of total assets at December 31, 2003.
Under Massachusetts Law, the Bank is permitted to invest in marketable
equity securities. Management views equity securities as a source of
current income with tax advantages, as well as a source of capital gain
income, given appreciation in the portfolio. Limits on asset quality,
holding size, overall portfolio size and composition are in place to protect
us from undue market risk. All equity securities are classified as
available-for-sale.
Deposit Activities
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We seek to develop relationships with our customers in order to become
the customer's primary bank. We have developed programs that stress multiple
account relationships in order to increase the level of "core deposits" in
our portfolio. Management views a customer's checking account as the
primary relationship account and, accordingly, emphasizes the growth of
checking accounts in its strategic plans. Aside from checking accounts
being a consistent, low-cost source of funds, they provide a source of non-
interest income in the form of service charges and insufficient funds fees.
Deposits are obtained from individuals and from small and medium-sized
businesses in the local market area. Our customer base is diverse, and
accordingly different product suites are offered to different groups of
customers. The suites range from accounts that serve the basic service
needs of any customer, such as free checking and statement savings accounts,
to our "Coastal" product suite, which addresses the particular needs of
high-balance customers. Additionally, small and medium-sized businesses
have suites of products that address their particular needs. We also
attract deposits from municipalities and other government agencies. We do
not solicit or accept brokered deposits. We offer a full line of deposit
products including checking and NOW accounts, savings accounts, money market
accounts, and certificates of deposit. We offer debit cards to its checking
and savings customers.
Customers have access to deposit funds at any of our nine branch
offices, all of which are equipped with Automated Teller Machines.
Additionally, the Bank is a member of the NYCE Network, enabling customers
to have access to their funds worldwide. We also provide balance inquiry
and funds transfer telephonically. Our website, www.sladesferry.com,
provides customers with the ability to manage their accounts and pay bills
online. Business customers who utilize our cash management program have the
ability to transfer funds and originate wire transfers or ACH transactions
through the website as well.
As a general rule, management systematically reviews the deposit
accounts it offers to determine if the products meet both the customers'
needs and our asset/liability management goals. This review is the
responsibility of the Pricing Committee of the Bank's Board of Directors,
which meets weekly to determine products and pricing practices consistent
with overall earnings and growth goals. The Pricing Committee establishes
deposit interest rates based on a variety of factors, including local
economy, market interest rates, competitors' interest rates, and the need to
fund loan demand. We set rates to be competitive, but not necessarily the
highest rates in its market area. As competition for deposits has
intensified with the larger financial institutions in our market area, we
introduced the use of off-maturity "special" certificate accounts. We
actively market our other products to new depositors garnered through the
use of specials, in order to cross-sell additional products and services,
and thereby establish a continued banking relationship.
In order to offset the potentially adverse effects of early
withdrawal, we generally charge an early withdrawal penalty on certificates
of deposit in an amount equal to three months' interest on accounts with
original maturities of one year or less, and six months' interest on
accounts with an original maturity of greater than one year. Interest
credited to a certificate account during any term may be withdrawn without
penalty at any time during the term. Upon renewal of a certificate account,
only interest credited during the renewal term may be withdrawn without
penalty.
9
Non-Deposit Investment Products
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We offer a variety of mutual funds, annuities, and insurance products
offered through third-party sales arrangements with Linsco Private Ledger,
Inc. and the Savings Bank Life Insurance Company of Massachusetts ("SBLI").
Borrowing Activities
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In order to fund additional asset growth, we have the ability to
borrow at the FHLB of Boston. The FHLB limits borrowings to 30% of assets,
and limits FHLB stock purchases to 4.5% of total borrowings. These
borrowings are collateralized by our residential loan portfolio, certain
commercial real estate loans, and certain U.S. agency securities and agency-
insured mortgage-backed securities. Management views borrowing as not only
a funding mechanism, but as a tool to manage the levels of interest rate
risk inherent in the balance sheet. In addition, we maintain borrowing
lines of credit with correspondent banks to meet short-term liquidity needs.
During this period of historically low market interest rates we have
utilized FHLB advances to enhance our interest rate risk position. In prior
years, we had used amortizing advances to "match-fund" certain commercial
loans. As management has taken a whole-balance sheet approach to interest
rate risk management, the use of matched funding strategies, and
consequently, the use of long-term amortizing advances, has decreased, in
favor of the use of bullet advances, deployed in a laddered approach.
Because the FHLB attaches significant prepayment penalties to long-term
advances, management does not anticipate prepayment of the amortizing
advances.
Competition
- -----------
The banking business in our market area is highly competitive. We
actively compete for both loans and deposits with local branches of
nationwide and regional banks, as well as local banks and credit unions. We
also compete with money market funds, consumer mortgage and finance
companies, financing subsidiaries of durable goods manufacturers, and
insurance companies. Many of the major commercial banks or other affiliates
in our service areas offer services such as international banking and trust
services that we do not currently offer directly.
In order to expand our market area, we are opening a new branch office
located in the town of Assonet, Massachusetts. We believe that the addition
of this branch will add to the diversity in our loan portfolio and add a new
pool of potential depositors.
Employees
- ---------
At December 31, 2004, we had 125 full-time and 47 part time employees.
We believe that employee relations are good, and there are no known disputes
between management and employees.
All employees are eligible to participate in our Retirement Savings
401(k) Plan and Profit Sharing Plan. Additionally, certain officers may
participate in the Slade's Ferry Bancorp Stock Option Plan, and certain
executive officers may participate in a supplemental executive retirement
program.
Our performance-based incentive programs for officers and employees
have supported, and will continue to support our growth, by giving employees
a stake in our overall performance and for balancing profit, growth and
productivity.
10
Holding Company Regulation
Federal Regulation
- ------------------
Capital Requirements. The FRB has adopted capital adequacy guidelines
pursuant to which it assesses the adequacy of capital in examining and
supervising a bank holding company and in analyzing applications to it under
the BHCA. The FRB capital adequacy guidelines generally require bank holding
companies to maintain total capital equal to 8% of total risk-adjusted
assets, with at least one-half of that amount consisting of Tier I, or core
capital, and up to one-half of that amount consisting of Tier II, or
supplementary capital. Tier I capital for bank holding companies generally
consists of the sum of common shareholders' equity and perpetual preferred
stock (subject in the case of the latter to limitations on the kind and
amount of such stocks which may be included as Tier I capital), less
goodwill and, with certain exceptions, intangibles. Tier II capital
generally consists of hybrid capital instruments; perpetual preferred stock
which is not eligible to be included as Tier I capital; term subordinated
debt and intermediate-term preferred stock; and, subject to limitations,
general allowances for loan losses. Assets are adjusted under the risk-based
guidelines to take into account different risk characteristics, with the
categories ranging from 0% (requiring no additional capital) for assets such
as cash to 100% for the bulk of assets which are typically held by a bank
holding company, including multi-family residential and commercial real
estate loans, commercial business loans and consumer loans. Single-family
residential first mortgage loans which are not past-due (90 days or more) or
non-performing and which have been made in accordance with prudent
underwriting standards are assigned a 50% level in the risk-weighing system,
as are certain privately-issued mortgage-backed securities representing
indirect ownership of such loans. Off-balance sheet items also are adjusted
to take into account certain risk characteristics.
In addition to the risk-based capital requirements, the FRB requires
bank holding companies to maintain a minimum leverage capital ratio of Tier
I capital to total assets of 3.0%. Total assets for this purpose does not
include goodwill and any other intangible assets and investments that the
FRB determines should be deducted from Tier I capital. The FRB has announced
that the 3.0% Tier I leverage capital ratio requirement is the minimum for
the top-rated bank holding companies without any supervisory, financial or
operational weaknesses or deficiencies or those that are not experiencing or
anticipating significant growth. Other bank holding companies are expected
to maintain Tier I leverage capital ratios of at least 4.0% to 5.0% or more,
depending on their overall condition.
The Company is in compliance with the above-described FRB regulatory
capital requirements.
Activities. The BHCA prohibits a bank holding company from acquiring
direct or indirect ownership or control of more than 5% of the voting shares
of any bank, or increasing such ownership or control of any bank, without
prior approval of the FRB. No approval under the BHCA is required, however,
for a bank holding company already owning or controlling 50% of the voting
shares of a bank to acquire additional shares of such bank.
The BHCA also prohibits a bank holding company, with certain
exceptions, from acquiring more than 5% of the voting shares of any company
that is not a bank and from engaging in any business other than banking or
managing or controlling banks. Under the BHCA, the FRB is authorized to
approve the ownership of shares by a bank holding company in any company,
the activities of which the FRB has determined to be so closely related to
banking or to managing or controlling banks as to be a proper incident
thereto. In making such determinations, the FRB is required to weigh the
expected benefit to the public, such as greater convenience, increased
competition or gains in efficiency, against the possible adverse effects,
such as undue concentration of resources, decreased or unfair competition,
conflicts of interest or unsound banking practices.
In addition, a bank holding company that does not qualify and elect to
be treated as a financial holding company under the Gramm-Leach-Bliley
Financial Services Modernization Act is generally prohibited from engaging
in, or acquiring, direct or indirect control of any company engaged in non-
banking activities. One of the principal exceptions to this prohibition is
for activities found by the FRB to be so closely related to banking or
managing or controlling banks as to be permissible. Bank holding companies
that do qualify as a financial holding company may engage in activities that
are financial in nature or incident to activities which are financial in
nature. Bank holding companies may qualify to become a financial holding
company if it meets certain criteria set forth by the FRB.
11
Beginning June 1, 1997, the Interstate Banking Act permitted federal
banking agencies to approve merger transactions between banks located in
different states, regardless of whether the merger would be prohibited under
the law of the two states. The Interstate Banking Act also permitted a state
to "opt in" to the provisions of the Interstate Banking Act before June 1,
1997, and permitted a state to "opt out" of the provisions of the Interstate
Banking Act by adopting appropriate legislation before that date.
Accordingly, beginning June 1, 1997, the Interstate Banking Act permitted a
bank, such as the Bank, to acquire an institution by merger in a state other
than Massachusetts unless the other state had opted out of the Interstate
Banking Act. The Interstate Banking Act also authorizes de novo branching
into another state if the host state enacts a law expressly permitting out
of state banks to establish such branches within its borders.
Massachusetts Regulation
- ------------------------
The Company as a Massachusetts-chartered Company is governed by the
Massachusetts Business Corporation Law and the Company's Articles of
Organization and Bylaws. Under the Massachusetts banking laws, a company
owning or controlling two or more banking institutions, including a savings
bank, is regulated as a bank holding company. The Company or the Bank would
become a Massachusetts bank holding company if the Company acquired a second
banking institution and operated it separately from the Bank or the Bank
acquired a banking institution.
Acquisition of the Company or the Bank
- --------------------------------------
Federal Restrictions. Under the federal Change in Bank Control Act,
any person (including a company), or group acting in concert, seeking to
acquire control of the Company or the Bank will be required to submit prior
notice to the FRB. Under the Change in Bank Control Act, the FRB has 60
days within which to act on such notices, taking into consideration factors,
including the financial and managerial resources of the acquirer, the
convenience and needs of the communities served by the Company and the Bank,
and the anti-trust effects of the acquisition. The term "control" is
defined generally under the BHCA to mean the ownership or power to vote 25%
or more of any class of voting securities of an institution or the ability
to control in any manner the election of a majority of the institution's
directors. Additionally under the Bank Merger Act sections of the Federal
Deposit Insurance Act, the prior approval of an insured institution's
primary federal regulator is required for an insured institution to merge
with or transfer assets to another insured institution or an uninsured
institution.
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:
* the creation of an independent accounting oversight board;
* auditor independence provisions which restrict non-audit
services that accountants may provide to their audit clients;
* additional corporate governance and responsibility measures,
including the requirement that the chief executive officer and
chief financial officer certify financial statements;
* the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by directors
and senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
* an increase in the oversight of, and enhancement of, certain
requirements relating to audit committees of public companies
and how they interact with the Company's independent auditors;
12
* requirement that audit committee members must be independent and
are absolutely barred from accepting consulting, advisory or
other compensatory fees from the issuer;
* requirement that companies disclose whether at least one member
of the committee is an "audit committee financial expert" (as
such term is defined by the Securities and Exchange Commission)
and if not, why not;
* expanded disclosure requirements for corporate insiders,
including accelerated reporting of stock transactions by
insiders and a prohibition on insider trading during pension
blackout periods;
* a prohibition on personal loans to directors and officers,
except certain loans made by insured financial institutions;
* disclosure of a code of ethics and filing a Form 8-K for a
change or waiver of such code;
* mandatory disclosure by analysts of potential conflicts of
interest; and
* a range of enhanced penalties for fraud and other violations.
Although the Company has and will continue to incur additional expense
in complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, such compliance will not have a material impact on its results
of operations or financial condition.
Federal Securities Law
- ----------------------
The Company's common stock is registered with the SEC under Section
12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Thus, the Company is subject to information, proxy solicitation,
insider trading restrictions, and other requirements under the Exchange Act.
Bank Regulation
Massachusetts Banking Regulation
- --------------------------------
General. The Bank is subject to Massachusetts statute and the rules
and regulations of the Division establishing the powers of the Bank,
investment limitations and minimum standards relative to the security and
protection of the Bank for the benefit of Bank employees and the general
public.
Loans-to-One-Borrower Limitations. With specified exceptions, the
total obligations of a single borrower to a Massachusetts-chartered
commercial bank and trust company may not exceed 20% of shareholders'
equity. A commercial bank and trust company may lend additional amounts up
to 100% of its retained earnings account if secured by collateral meeting
the requirements of the Massachusetts banking laws. The Bank currently
complies with applicable loans-to-one-borrower limitations.
Dividends. Under the Massachusetts banking laws, a commercial bank
and trust company may, subject to several limitations, declare and pay a
dividend on its capital stock out of the Bank's net profits. A dividend may
not be declared, credited or paid by a stock trust company so long as there
is any impairment of capital stock. No dividend may be declared on the
Bank's common stock for any period other than for which dividends are
declared upon preferred stock, except as authorized by the Commissioner of
the Division. The approval of the Commissioner is also required for a
commercial bank and trust company to declare a dividend, if the total of all
dividends declared by the commercial bank and trust company in any calendar
year shall exceed the total of its net profits for that year combined with
its retained net profits of the preceding two years, less any required
transfer to surplus or a fund for the retirement of any preferred stock.
13
In addition, federal law may also limit the amount of dividends that
may be paid by the Bank. See "- Federal Banking Regulation - Prompt
Corrective Action."
Examination and Enforcement. The Division is required to periodically
examine commercial bank and trust companies at least once every calendar
year or at least once each 18-month period if the commercial bank and trust
company qualifies as well capitalized under the prompt corrective action
provisions of the Federal Deposit Insurance Act. See "- Federal Banking
Regulation - Prompt Corrective Action."
Community Reinvestment Act. The Bank is subject to provisions of the
Massachusetts Community Reinvestment Act, which are similar to those imposed
by the federal Community Reinvestment Act with the exception of the assigned
exam ratings. Massachusetts banking law provides for an additional exam
rating of "high satisfactory" in addition to the federal Community
Reinvestment Act ratings of "outstanding," "satisfactory," "needs to
improve" and "substantial noncompliance." The Division is required to
consider a bank's Massachusetts Community Reinvestment Act rating when
reviewing the Bank's application to engage in certain transactions,
including mergers, asset purchases and the establishment of branch offices
or automated teller machines, and provides that such assessment may serve as
a basis for the denial of any such application. The Massachusetts Community
Reinvestment Act requires the Division to assess a bank's compliance and to
make such assessment available to the public. The Bank's latest
Massachusetts Community Reinvestment Act rating, from an exam dated April 1,
2004, was a rating of "Satisfactory."
Federal Banking Regulation
- --------------------------
Capital Requirements. FDIC regulations require Bank Insurance Fund-
insured banks, such as the Bank, to maintain minimum levels of capital. The
FDIC regulations define two classes of capital known as Tier 1 and Tier 2
capital.
The FDIC regulations establish a minimum leverage capital requirement
for banks in the strongest financial and managerial condition, with a rating
of 1 (the highest examination rating of the FDIC for banks) under the
Uniform Financial Institutions Rating System, of not less than a ratio of
3.0% of Tier 1 capital to total assets. For all other banks, the minimum
leverage capital requirement is 4.0%, unless a higher leverage capital ratio
is warranted by the particular circumstances or risk profile of the
depository institution.
The FDIC regulations also require that banks meet a risk-based capital
standard. The risk-based capital standard requires the maintenance of a
ratio of total capital (which is defined as the sum of Tier 1 capital and
Tier 2 capital) to risk-weighted assets of at least 8% and a ratio of Tier 1
capital to risk-weighted assets of at least 4%. In determining the amount
of risk-weighted assets, all assets, plus certain off balance sheet items,
are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC
believes are inherent in the type of asset or item.
The federal banking agencies, including the FDIC, have also adopted
regulations to require an assessment of an institution's exposure to
declines in the economic value of a bank's capital due to changes in
interest rates when assessing the Bank's capital adequacy. Under such a
risk assessment, examiners will evaluate a bank's capital for interest rate
risk on a case-by-case basis, with consideration of both quantitative and
qualitative factors.
Institutions with significant interest rate risk may be required to
hold additional capital. The agencies also issued a joint policy statement
providing guidance on interest rate risk management, including a discussion
of the critical factors affecting the agencies' evaluation of interest rate
risk in connection with capital adequacy. The Bank was considered "well-
capitalized" under FDIC guidelines at December 31, 2004.
Activity Restrictions on State-Chartered Banks. Section 24 of the
Federal Deposit Insurance Act ("FDIA"), as amended, which was added by the
Federal Deposit Insurance 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 national banks
and their subsidiaries, unless such activities and investments are
specifically exempted by Section 24 or consented to by the FDIC.
14
Section 24 provides an exception for investments by a bank in common
and preferred stocks listed on a national securities exchange or the shares
of registered investment companies if:
(1) The Bank held such types of investments during the 14-month
period from September 30, 1990 through November 26, 1991;
(2) The state in which the Bank is chartered permitted such
investments as of September 30, 1991; and
(3) The Bank notifies the FDIC and obtains approval from the FDIC to
make or retain such investments. Upon receiving such FDIC
approval, an institution's investment in such equity securities
will be subject to an aggregate limit up to the amount of its
Tier 1 capital.
The Bank received approval from the FDIC to retain and acquire such
equity investments subject to a maximum permissible investment equal to the
lesser of 100% of the Bank's Tier 1 capital or the maximum permissible
amount specified by the FDIA. Section 24 also provides an exception for
majority owned subsidiaries of a bank, but Section 24 limits the activities
of such subsidiaries to those permissible for a national bank, permissible
under Section 24 of the FDIA and the FDIC regulations issued pursuant
thereto, or as approved by the FDIC.
Before making a new investment or engaging in a new activity not
permissible for a national bank or not otherwise permissible under Section
24 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 state-chartered commercial bank and trust companies, including the
Bank. This enforcement authority includes, among other things, the ability
to assess civil money penalties, to issue cease and desist orders and to
remove directors and officers. In general, these enforcement actions may be
initiated in response to violations of laws and regulations and to unsafe or
unsound practices.
The FDIC is required, with certain exceptions, to appoint a receiver
or conservator for an insured state bank if that bank is "critically
undercapitalized." For this purpose, "critically undercapitalized" means
having a ratio of tangible capital to total assets of less than 2%. The
FDIC may also appoint a conservator or receiver for a state bank on the
basis of the institution's financial condition or upon the occurrence of
certain events.
Deposit Insurance. 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 a 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 are governed by
Sections 23A and 23B of the Federal Reserve Act (the "FRA"). An affiliate
of a bank
15
is any company or entity that controls, is controlled by or is under common
control with the Bank. A subsidiary of a bank that is not also a depository
institution is not treated as an affiliate of the Bank for purposes of
Sections 23A and 23B.
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 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. 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 than the normal risk of repayment or present other unfavorable
features and (b) not exceed certain limitations on the amount of credit
extended to such persons, individually and in the aggregate, which limits
are based, in part, on the amount of the Bank's capital. The regulations
allow small discounts on fees on residential mortgages for directors,
officers and employees. In addition, extensions for credit in excess of
certain limits must be approved by the Bank's Board of Directors.
Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension
of personal loans to directors and executive officers of issuers (as defined
in Sarbanes-Oxley). The prohibition, however, does not apply to mortgages
advanced by an insured depository institution, such as The Bank, that are
subject to the insider lending restrictions of Section 22(h) of the Federal
Reserve Act.
Community Reinvestment Act. Under the Community Reinvestment Act
("CRA"), any insured depository institution, including the Bank has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including
low and moderate income neighborhoods. The CRA does not establish specific
lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and
services that it believes are best suited to its particular community. The
CRA requires the FDIC, in connection with its examination of a commercial
bank and trust company, to assess the depository institution's record of
meeting the credit needs of its community and to take such record into
account in its evaluation of certain applications by such institution,
including applications for additional branches and acquisitions.
The CRA requires the FDIC to provide a written evaluation of an
institution's CRA performance utilizing a four-tiered descriptive rating
system and requires public disclosure of an institution's CRA rating. The
Bank received a "Satisfactory" rating on its last CRA exam on April 1, 2004.
Safety and Soundness Standards. Pursuant to the requirements of the
FDICIA, as amended by the Riegle
16
Community Development and Regulatory Improvement Act of 1994, each federal
banking agency, including the FDIC, has adopted guidelines establishing
general standards relating to internal controls, information and internal
audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, asset quality, earnings and compensation, fees and
benefits. In general, the guidelines require, among other things,
appropriate systems and practices to identify and manage the risks and
exposures specified in the guidelines. The guidelines prohibit excessive
compensation as an unsafe and unsound practice and describe compensation as
excessive when the amounts paid are unreasonable or disproportionate to the
services performed by an executive officer, employee, director, or principal
stockholder.
In addition, the FDIC adopted regulations to require a bank that is
given notice by the FDIC that it is not satisfying any of such safety and
soundness standards to submit a compliance plan to the FDIC. If, after
being so notified, a bank fails to submit an acceptable compliance plan or
fails in any material respect to implement an accepted compliance plan, the
FDIC may issue an order directing corrective and other actions of the types
to which a significantly undercapitalized institution is subject under the
"prompt corrective action" provisions of the FDICIA. If a bank fails to
comply with such an order, the FDIC may seek to enforce such an order in
judicial proceedings and to impose civil monetary penalties.
Prompt Corrective Action. The FDICIA also established a system of
prompt corrective action to resolve the problems of undercapitalized
institutions. The FDIC, as well as the other federal banking regulators,
adopted regulations governing the supervisory actions that may be taken
against undercapitalized institutions. The regulations establish five
categories, consisting of "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." The severity of the action authorized or required to be
taken under the prompt corrective action regulations increases as a bank's
capital decreases within the three undercapitalized categories. All banks
are prohibited from paying dividends or other capital distributions or
paying management fees to any controlling person if, following such
distribution, the Bank would be undercapitalized.
Federal Reserve System
- ----------------------
Under Federal Reserve Board regulations, the Bank is required to
maintain noninterest-earning reserves against its transaction accounts.
Current Federal Reserve Board regulations generally require that reserves of
3% must be maintained against aggregate transaction accounts of $47.6
million or less, subject to adjustment by the Federal Reserve Board. Total
transaction accounts in excess of $47.6 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 $7.0 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
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.
Federal Home Loan Bank System
- -----------------------------
The Bank is a member of the Federal Home Loan Bank system, which
consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank
provides a central credit facility primarily for member institutions. The
Bank, as a member of the Federal Home Loan Bank of Boston (the "FHLB"), is
required to acquire and hold shares of capital stock in the FHLB in an
amount equal to at least 1% of the aggregate principal amount of its unpaid
residential mortgage loans and similar obligations at the beginning of each
year, or 1/20 of its advances (borrowings) from the FHLB, whichever is
greater. The Bank was in compliance with this requirement with an investment
in FHLB stock at December 31, 2004 of $4.6 million. The Federal Home Loan
Banks are required to provide funds for certain purposes including
contributing funds for affordable housing programs. These requirements could
reduce the amount of dividends that the Federal Home Loan Banks pay to their
members and result in the Federal Home Loan Banks imposing a higher rate of
interest on advances to their members.
The USA PATRIOT Act.
- --------------------
The Bank is subject to the USA PATRIOT Act, which 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
17
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 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:
* Pursuant to Section 352, all financial institutions must
establish anti-money laundering programs that include, at
minimum: (i) internal policies, procedures, and controls; (ii)
specific designation of an anti-money laundering compliance
officer; (iii) ongoing employee training programs; and (iv) an
independent audit function to test the anti-money laundering
program.
* Pursuant to Section 326, 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, which became effective on October 1,
2003, require each financial institution to implement a written
customer identification program appropriate for its size,
location and type of business that includes certain minimum
requirements.
* Section 312 requires financial institutions that establish,
maintain, administer, or manage private banking accounts or
correspondent accounts in the United States for non-United
States persons or their representatives (including foreign
individuals visiting the United States) to establish
appropriate, specific, and, where necessary, enhanced due
diligence policies, procedures, and controls designed to detect
and report instances of money laundering through those accounts.
* Section 318, which became effective December 25, 2001, prohibits
financial institutions from establishing, maintaining,
administering, or managing correspondent accounts for foreign
shell banks (foreign banks that do not have a physical presence
in any country), and requires financial institutions to take
reasonable steps to ensure that correspondent accounted provided
to foreign banks are not being used to indirectly provide
banking services to foreign shell banks.
* Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Bank
Holding Company Act and Bank Merger Act applications.
Recent Regulatory Examinations
- ------------------------------
During 2003, the Bank continued to operate under an informal agreement
(Memorandum of Understanding) with the FDIC 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. The FDIC,
with concurrence from the Massachusetts Commissioner of Banks, terminated
the aforementioned Memorandum of Understanding effective January 22, 2004.
As the result of a 2004 joint examination, on March 14, 2005, the Bank
entered into an informal agreement (Memorandum of Understanding) with the
FDIC and Massachusetts Commissioner of Banks under which the Bank agreed to
certain recommendations designed to strengthen its policies and procedures
for compliance with certain provisions of the Bank Secrecy Act.
18
ITEM 2
PROPERTIES
Our main office is located at 100 Slade's Ferry Avenue, Somerset,
Massachusetts at the junctions of U.S. Routes 6, 138, and 103. We operate
our business from eight full service banking offices located in Fairhaven,
Fall River, New Bedford, Seekonk, Somerset and Swansea, Massachusetts. As
of December 31, 2004, the following properties were owned through the Bank's
wholly-owned subsidiary, Slade's Ferry Realty Trust:
Location Sq. Footage
-------- -----------
Main Office 100 Slade's Ferry Avenue Somerset, MA 42,000
North Somerset 2722 County Street Somerset, MA 3,025
Linden Street 244-253 Linden Street Fall River, MA 1,750
Brayton Avenue 855 Brayton Avenue Fall River, MA 3,325
North Swansea 2388 G.A.R. Highway Swansea, MA 2,960
Seekonk 1400 Fall River Avenue Seekonk, MA 2,300
Fairhaven 75 Huttleston Avenue Fairhaven, MA 13,000
Ashley Boulevard 833 Ashley Boulevard New Bedford, MA 2,655
The office listed below is leased by the Bank with the indicated lease
expiration date.
Brayton Avenue
Drive Up Complex 16 Stevens St. Fall River, MA 549
(expires July 2006)
The main office building contains approximately 42,000 square feet of
usable space which we occupy. We also operate a school banking facility
located in the Somerset High School, Grandview Avenue, Somerset,
Massachusetts that consists of 200 square feet. This facility provides
basic banking services to students and school staff. The Seekonk office is
an 8,800 square foot building of which we utilize 2,300 square feet and
lease out the remainder.
We closed two branches during 2004. The first was a leased facility
located at 838 Pleasant Street, New Bedford. The second was a branch
located at 1601 South Main Street, Fall River. This property was sold in
March 2005.
A new branch, located in Assonet, Massachusetts, was opened in March
2005. The branch will be leased. As of December 31, 2004 the leasing
arrangements had not been finalized.
19
ITEM 3
LEGAL PROCEEDINGS
We are not involved in any pending legal proceedings that would have a
material impact on our consolidated financial condition and results of
operations.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2004, no matters were submitted to a vote
of our shareholders.
20
PART II
ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is listed in the Nasdaq Small Cap Market under the
symbol SFBC. The following table sets forth the range of high and low bid
price for our common stock as reported for the Nasdaq Small Cap Market by
quarter for the two-year period ended December 31, 2004:
2004 2003
---------------- ----------------
High Low High Low
------------------------------------
1st Quarter $24.00 $21.75 $14.26 $13.25
------------------------------------
2nd Quarter $22.00 $17.35 $15.77 $14.18
------------------------------------
3rd Quarter $22.94 $18.65 $18.50 $15.60
------------------------------------
4th Quarter $20.90 $19.01 $23.00 $18.55
------------------------------------
During 2004, there were no shares repurchased.
As of March 15, 2005 there were 1,308 holders of an aggregate of
4,078,333 shares of common stock issued and outstanding.
Dividends - History and Policy
Slade's Ferry Bancorp, since its inception in 1990 and prior thereto
the Bank, has consistently paid dividends to shareholders since 1961. We
paid four quarterly cash dividends of $.09 per share for a total of $.36 per
share during each of 2003 and 2004.
The declaration of cash dividends is dependent on a number of factors,
including regulatory limitations, and the Bank's operating results and
financial condition. Our shareholders will be entitled to dividends only
when, and if, declared by the our 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.
21
The following table sets forth the aggregate information of our equity
compensation plans in effect as of December 31, 2004.
Equity Compensation Plan Information
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation
of outstanding options, outstanding options, plans (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
- -----------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans
approved by security
holders 215,290 $15.92 252,049
Equity compensation plans
not approved by security
holders - - -
- -------------------------------------------------------------------------------------------------
Total 215,290 $15.92 252,049
=================================================================================================
22
ITEM 6
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data for the last
five years from the consolidated financial statements of Slade's Ferry
Bancorp. The following information is only a summary and should be read in
conjunction with our consolidated financial statements and notes (beginning
on page F-3 herein.)
Year Ended December 31,
- -----------------------------------------------------------------------------------------------------------
(Dollars in Thousands Except
per Share Data) 2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
EARNINGS DATA
Interest and Dividend Income $ 24,106 $ 20,617 $ 22,037 $ 27,324 $ 28,186
Interest Expense 7,946 6,073 7,928 12,327 12,699
Net Interest Income 16,160 14,544 14,109 14,997 15,487
Provision (Benefit) for Loan Losses 376 (602) (310) 750 1,200
Noninterest Income 2,505 2,214 2,533 1,769 1,857
Noninterest Expense 12,725 12,662 12,852 11,408 10,206
Income Before Income Taxes 5,564 4,698 4,100 4,608 5,938
Applicable Income Taxes 1,912 2,010 1,134 1,398 1,864
Net Income 3,652 2,688 2,966 3,210 4,074
PER SHARE DATA (1)
Net Income-Basic $ 0.90 $ 0.68 $ 0.76 $ 0.84 $ 1.09
Net Income-Diluted $ 0.89 $ 0.67 $ 0.75 $ 0.84 $ 1.09
Cash Dividends $ 0.36 $ 0.36 $ 0.36 $ 0.44 $ 0.40
Book Value (at end of period) $ 11.56 $ 10.70 $ 10.45 $ 9.94 $ 9.41
Avg. Shs. Outstanding (Basic) 4,045,549 3,969,737 3,908,901 3,830,575 3,743,138
Shares Outstanding Year End 4,068,423 3,995,857 3,937,763 3,869,924 3,789,503
BALANCE SHEET DATA
Assets $ 549,832 $ 439,449 $ 398,375 $ 394,761 $ 88,619
Loans 366,805 336,094 265,012 253,884 256,153
Unearned Income 439 443 342 382 519
Allowance for Loan Losses 4,101 4,154 4,854 5,484 4,776
Loans, Net 362,265 331,497 259,816 248,018 250,849
Goodwill 2,173 2,173 2,173 2,173 2,400
Investments 126,305 61,487 80,618 96,401 88,109
Deposits 399,905 333,145 335,633 337,043 337,001
Shareholders' Equity 47,034 42,742 41,167 38,466 35,674
FINANCIAL RATIOS
Net Interest Margin(2) 3.07% 3.90% 3.89% 4.18% 4.58%
Net Interest Spread (2) 3.43 3.47 3.31 3.34 3.75
Net Income as a Percentage of
Average Assets 0.70 0.64 0.74 0.81 1.09
Average Equity 8.29 6.41 7.45 9.04 12.92
Dividend Payout Ratio 40.00% 53.22% 47.50% 52.63% 36.84%
Average Equity to Average Assets 8.55 10.05 9.93 9.00 8.45
- --------------------
Earnings per share are computed based on the average number of shares
of common stock outstanding during the year. On January 10, 2000, the
Company declared a 5% stock dividend mailed to shareholders on
February 9, 2000.
Calculated on a fully taxable equivalent basis.
23
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
The purpose of Management's Discussion and Analysis is to focus on
certain significant factors which have affected our operating results and
financial condition, and to provide shareholders a more comprehensive review
of the figures contained in the financial data of this report. The
following discussion should be read in conjunction with our audited
financial statements and notes thereto, included as pages F-1 through F-33
of this report.
2004 Items of Significance
* In March, 2004, we issued $10.3 million of subordinated
debentures, which carry an adjustable interest rate of 270 basis
points above the three month LIBOR. These debentures mature
March 17, 2034. These debentures are viewed as "tier 1 capital"
for regulatory purposes. As such, the capital may be leveraged
to further enhance our operations through leverage or
acquisition.
* In 2004, we recorded net income of $3.7 million or $0.89 per
share on a diluted basis compared to $2.7 million or $0.67 per
share on a diluted basis in 2003. This represents an increase
of $964,000 or 35.8% in net income and $0.22 or 32.8% per share
on a diluted basis between 2004 and 2003. This increase is due
to an increase in net interest income of $1.6 million arising
from our growth. Return on average equity for the year ended
December 31, 2004 was 8.29%, as compared to 6.41% for the year
ended December 31, 2003.
* Book value of our common stock increased from $10.70 at December
31, 2003 to $11.56 at December 31, 2004.
* Total assets increased by $110.4 million, or 25.1% from the
fiscal year ended December 31, 2003.
* Total gross loans increased by $30.7 million, or 9.1% from the
fiscal year ended December 31, 2003.
* Capital adequacy ratios continue to meet criteria of "well
capitalized" under regulatory guidelines.
Financial Condition
Total assets increased by $110.4 million, or 25.1%, from $439.4
million at December 31, 2003 to $549.8 million at December 31, 2004. The
increase in total assets during 2004 is the result of planned growth across
the balance sheet. Total net loans increased from $331.5 million at December
31, 2003 to $362.3 million, an increase of $30.8 million or 9.3%, while the
investment portfolio increased from $61.5 million at December 31, 2003 to
$126.3 million at December 31, 2004, an increase of 105.4%. Growth in
deposits funded the majority of the increase, as successful marketing
campaigns and new product launches resulted in an increase in total deposits
from $333.1 million at December 31, 2003 to $399.9 million at December 31,
2004, an increase of $66.8 million or 20.1%. Growth not funded through
deposits was funded through the use of long-term FHLB advances.
Investment Portfolio
- --------------------
The main objectives of our investment portfolio are to achieve a
competitive rate of return over a reasonable time period and to provide
liquidity.
Our total investment portfolio increased from $61.5 million at
December 31, 2003 to $126.3 million at December 31, 2004, an increase of
104.9%. The increase is the result of the investment of excess funds into
agencies and mortgage-backed securities, both deposits and borrowings, which
were raised in accordance with our strategic plans.
24
Certain mortgage-backed securities totaling $30.0 million were purchased
during 2004 as a direct replacement of loans, as loan payoffs exceeded
management's expectations. Mortgage-backed securities represented a
replacement of these loan funds.
The current investment strategy has concentrated on the purchase of
U.S. Government and agency obligations, and corporate bonds generally
maturing or callable within five to seven years. The investment policy also
permits investments in mortgage-backed securities, usually having a longer
weighted average life. The investment policy, however, limits the duration
of the aggregate investment portfolio to 5 years. At December 31, 2004, the
portfolio duration was 2.65 years. We do not purchase investments with off-
balance sheet characteristics, such as swaps, options, futures, or any other
hedging activities that are called derivatives.
The held-to-maturity portfolio consists of mortgage-backed securities
that can potentially secure borrowings from the FHLB and securities issued
by states of the United States and political subdivisions of states. Held-
to-maturity securities increased from $11.3 million at December 31, 2003 to
$37.8 million at December 31, 2004. The increase is the result of the
designation of certain mortgage-backed securities, purchased in replacement
of loans, as held-to-maturity. Management has designated these securities
to secure advances from the FHLB. We have the positive intent and ability
to hold these securities to maturity.
The following table shows the amortized cost basis of the major
categories of investment securities Held-to-Maturity for the years
indicated:
At December 31,
- ----------------------------------------------------------------------
(Dollars in Thousands) 2004 2003 2002
- ----------------------------------------------------------------------
Obligations of States and
Political Subdivisions of the States $ 8,588 $11,299 $13,693
Mortgage-backed securities 29,185 1 2
Foreign Debt Securities 0 0 1
- ----------------------------------------------------------------------
Total $37,773 $11,300 $13,696
======================================================================
The following table shows the amortized cost basis and fair value of
the major categories of Held-to-Maturity securities as of December 31, 2004:
Gross Gross
Amortized Unrealized Unrealized
(Dollars in Thousands) Cost Basis Holding Gains Holding Losses Fair Value
- --------------------------------------------------------------------------------------------------
Debt securities issued by states of
the United States and political
subdivisions of the states $ 8,588 $340 $ 0 $ 8,928
Mortgage-backed securities 29,185 15 16 29,184
- -------------------------------------------------------------------------------------------------
Total $37,773 $355 $16 $38,112
=================================================================================================
25
In the following table, the amortized cost basis of held-to-maturity
securities maturing within stated periods as of December 31, 2004, is shown
with the weighted average interest yield from securities falling within the
range of maturities:
Obligations
of States & Mortgage-
Political Backed
(Dollars in Thousands) Subdivisions(1) Securities(2) Total
- ---------------------------------------------------------------------
Due in 1 year or less:
Amount $1,817 $ 0 $ 1,817
Yield 7.21% 0.00% 7.21%
Due in 1 to 5 years:
Amount 4,222 0 4,222
Yield 5.88% 0.00% 5.88%
Due in 5 to 10 years:
Amount 1,349 0 1,349
Yield 5.87% 0.00% 5.87%
Due after 10 years:
Amount 1,200 29,185 30,385
Yield 6.41% 5.02% 5.07%
- ---------------------------------------------------------------------
Amount $8,588 $29,185 $37,773
=====================================================================
Yield 6.23% 5.02% 5.29%
=====================================================================
- --------------------
Rates of tax-exempt securities are shown assuming a 34.3% tax rate.
Mortgage-backed securities stated using contractual maturity.
26
Securities not designated as held-to-maturity are designated as
available-for-sale. Although we do not anticipate the sale of these
securities, the designation as available for sale allows us the flexibility
to alter our investment strategies and sell these securities without
potentially adverse accounting implications. Additionally, marketable equity
securities have no maturity date must be designated as available-for-sale.
These securities are carried on our books and records at fair value. The
available-for-sale securities portfolio includes United States agency
securities, agency-insured mortgage-backed securities, and corporate debt
and equity securities. Available-for-sale securities increased from $47.2
million at December 31, 2003 to $83.9 million at December 31, 2004. This
increase is the result of investment of excess funds raised in the Bank's
marketing campaigns and investment of funds raised from the sale of non-
performing loans.
The following table shows the amortized cost basis of the major
categories of available-for-sale securities for the years indicated:
At December 31,
- -------------------------------------------------------------------------------
(In Thousands) 2004 2003 2002
- -------------------------------------------------------------------------------
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $41,419 $27,932 $26,424
Mortgage-backed Securities 27,804 14,034 32,512
Corporate Debt Securities 9,364 1,658 2,673
Marketable Equity Securities 3,859 3,511 3,986
Mutual Funds with Maturities 1,217 0 0
- -------------------------------------------------------------------------------
Total $83,663 $47,135 $65,595
===============================================================================
In the following table, the amortized cost basis of available-for-sale
securities (other than mutual funds or equity securities) maturing within
stated periods as of December 31, 2004, is shown with the weighted average
interest yield from securities falling within the range of maturities:
U.S. Treasury Mortgage- Corporate
& Government Backed Debt
(Dollars in Thousands) Agencies Securities(1) Securities Total
- ---------------------------------------------------------------------------------
Due in 1 year or less:
Amount $ 1,505 $ 30 $ 702 $ 2,237
Yield 3.20% 5.80% 5.90% 4.08%
Due in 1 to 5 years:
Amount 37,413 1,547 8,662 47,622
Yield 3.45% 4.94% 4.93% 3.77%
Due in 5 to 10 years:
Amount 2,501 7,196 0 9,697
Yield 4.74% 4.77% 0.00% 4.76%
Due after 10 years:
Amount 0 19,031 0 19,031
Yield 0.00% 4.53% 0.00% 4.58%
- ---------------------------------------------------------------------------------
Amount $41,419 $27,804 $9,364 $78,587
=================================================================================
Yield 3.51% 4.60% 5.01% 4.09%
=================================================================================
- --------------------
Mortgage-backed securities stated using contractual maturity.
27
Investments in available-for-sale securities are carried at fair
value on the balance sheet and are summarized as follows as of December 31,
2004:
Amortized Unrealized Unrealized
(Dollars in Thousands) Cost Basis Gains Losses Fair Value
- -------------------------------------------------------------------------------------------
Debt securities issued by the U.S.
Treasury and other U.S. Government
corporations and agencies $41,419 $ 73 $286 $41,206
Mortgage-backed securities 27,804 468 65 28,207
Corporate debt securities 9,364 149 29 9,484
Mutual funds with maturities 1,217 17 0 1,234
Marketable equity securities 3,859 203 311 3,751
- ------------------------------------------------------------------------------------------
Total $83,663 $910 $691 $83,882
==========================================================================================
Also included in the investment portfolio are the Bank's required
investment in FHLB stock and a $100,000 certificate of deposit that matures
in 2005.
Loans
- -----
Our total loan portfolio increased from $331.5 million at December 31,
2003 to $362.3 million at December 31, 2004, an increase of $ 30.8 million
or 9.3%. The increase is the result of continued loan growth initiatives,
designed to invest the deposits and borrowings that were raised in
accordance with our strategic plans. Loan originations for 2004 were $132.1
million. During the year, we experienced loan runoff of approximately $90.0
million, a higher than expected rate of runoff of existing loans, due to the
result of loan sales and an active refinancing market. We also sold
approximately $8.2 million of impaired and non-performing commercial and
commercial real estate loans.
Although commercial real estate loans and commercial business loans
have traditionally been our leading loan products, management has made
considerable effort to diversify the loan portfolio over the past three
years, adding significant levels of residential real estate loan products to
the balance sheet. Management believes these loans will enhance our overall
credit risk profile. At December 31, 2004, our one-to-four family mortgage
loans totaled $97.5 million or 26.6% of total gross loans, compared with
$88.0 million, or 26.2% of total gross loans outstanding at December 31,
2003, while home equity lines of credit totaled $23.1 million, or 6.3% of
our total gross loans, compared to $18.3 million or 5.4% of total gross
loans at December 31, 2003. Originations of residential real estate loans
for the year ended December 31, 2004 totaled $20.6 million, while gross home
equity lines of credit totaled $15.8 million. Unadvanced funds committed
under home equity lines of credit totaled $19.6 million at December 31,
2004.
The commercial real estate loan portfolio was $192.8 million or 52.6%
of total loans at December 31, 2004. At December 31, 2003, commercial real
estate loans totaled $181.4 million or 54.0% of total gross loans.
Commercial real estate loan originations totaled $54.9 million for the year
ended December 31, 2004. At December 31, 2004, we had $24.2 million of
advanced construction loans that amounted to 6.6% of our total gross loans,
compared to $10.3 million or 3.1% of total gross loans at December 31, 2003.
Construction loan originations totaled $25.3 million for the year ended
December 31, 2003. Unfunded portions of construction loans totaled $11.4
million at December 31, 2004. Other commercial loans totaled $26.6 million
or 7.3% of the total gross loan portfolio at December 31, 2004, compared to
$34.0 million or 10.1% at December 31, 2003. The decline in the level of
commercial loans is attributable to the general market conditions, as well
as intensifying competition in our market area.
Consumer loans at December 31, 2004 amounted to $2.5 million, or 0.7%
of total gross loans, as compared to $4.0 million or 1.2% of total gross
loans at December 31, 2003.
28
The following table summarizes loans by category at the end of each of
the last five years.
At December 31,
- ----------------------------------------------------------------------------------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 26,606 $ 33,980 $ 30,455 $ 45,238 $ 49,331
Real estate - construction and land development 24,240 10,346 14,078 7,600 8,601
Real estate - residential 97,496 88,019 50,495 39,032 35,395
Real estate - commercial 192,822 181,401 154,161 148,415 146,846
Home equity lines of credit 23,131 18,330 8,606 2,377 2,078
Other consumer 2,510 4,018 7,217 11,222 13,902
- ----------------------------------------------------------------------------------------------------------------
Total Gross Loans 366,805 336,094 265,012 253,884 256,153
Allowance for Loan Losses (4,101) (4,154) (4,854) (5,484) (4,776)
Unamortized adjustment to fair value (0) (0) (0) (0) (9)
Unearned Income (439) (443) (342) (382) (519)
- ----------------------------------------------------------------------------------------------------------------
Net Loans $362,265 $331,497 $259,816 $248,018 $250,849
================================================================================================================
We have no foreign loans nor do we have any reportable concentrations
of loans.
Loan portfolio rate sensitivity. In the current period of low interest
rates, the origination of adjustable-rate loans has become increasingly
rare. Additionally, our customer base tends to prefer fixed-rate mortgage
loans to adjustable-rate loans. Accordingly, the portfolio of adjustable-
rate loans has declined significantly during the past three years.
Adjustable-rate mortgage loans totaled $6.1 million, or 6.3% of residential
real estate loans. Substantially all of our equity lines of credit have
interest rates that adjust monthly with the Wall Street Journal prime rate.
Additionally, the market for commercial and commercial real estate
loans in our market area is intense. In response to the competition, we
offer commercial real estate loans that adjust every five years, based on
either the Wall Street Journal prime rate or the Treasury rate matching the
adjustment period. Of the total commercial real estate loan portfolio,
$173.6 million, or 90.1% have adjustable interest rates.
Of the total consumer loan portfolio, $1.1 million have adjustable
interest rates, primarily tied to the rates paid on deposit accounts.
The following table shows the maturity distributions of selected loan
categories at December 31, 2004:
Within One One to Five After Five
(Dollars in Thousands) Year Years Years Total
- ----------------------------------------------------------------------------------------------------------
Commercial, financial, and agricultural $ 11,185 $ 6,657 $ 8,764 $ 26,606
Real estate - construction and land development 0 752 23,488 24,240
Real estate - residential 33 1,521 95,942 97,496
Real estate - commercial 276 4,766 187,780 192,822
Home equity lines of credit 0 469 22,662 23,131
Other consumer 1,088 1,407 15 2,510
- ----------------------------------------------------------------------------------------------------------
Total $ 12,582 $ 15,572 $338,651 $366,805
==========================================================================================================
29
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
- -----------------------------------------------------------------------------------------------
(Dollars in Thousands) Fixed Rate Adjustable Rate Total
- -----------------------------------------------------------------------------------------------
Commercial, financial, and agricultural $ 6,295 $ 9,126 $ 15,421
Real estate - construction and land development 11,082 13,158 24,240
Real estate - residential 91,405 6,058 97,463
Real estate - commercial 19,910 172,636 192,546
Home equity lines of credit 0 23,131 23,131
Other consumer 879 544 1,423
- -----------------------------------------------------------------------------------------------
Total $129,571 $224,653 $354,224
===============================================================================================
Loan Delinquencies. It is our policy to manage our loan portfolio in
order to recognize problem loans at an early stage and thereby minimize loan
losses. Loans are considered delinquent when any payment of principal or
interest is one month or more past due. We generally commence collection
procedures, however, when accounts are 15 days past due. We place a loan on
non-accrual status when principal and interest payments are sporadic or no
payments have been made, collateral coverage is insufficient and current
financial data is not available. Generally, when a loan becomes past due 90
days or more, management discontinues the accrual of interest and reverses
previously accrued interest. The loan remains in non-accrual status until
the loan is current and six consecutive months of payments are made, then it
is reclassified as an accruing loan. When a loan is determined to be
uncollectible, it is charged off to the Allowance for Loan Losses or, if
applicable, any real estate that is securing the loan is acquired through
foreclosure, and recorded on the our books as Other Real Estate Owned.
Management defines non-performing assets to include non-accrual 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.
The following table presents information regarding non-performing
loans in the portfolio:
December 31,
- -------------------------------------------------------------------------------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
Non-accrual loans $ 506 $ 407 $ 635 $1,138 $2,415
Loans 90 days or more past due
and still accruing 0 0 8 444 335
Real estate acquired by foreclosure
or substantively repossessed 0 0 0 0 0
- -------------------------------------------------------------------------------------------------------------
Total non-performing assets $ 506 $ 407 $ 643 $1,582 $2,750
- -------------------------------------------------------------------------------------------------------------
Restructured debt performing in accordance with
amended terms, not included above $ 0 $ 198 $ 166 $ 186 $ 53
- -------------------------------------------------------------------------------------------------------------
Percentage of non-accrual loans to total loans 0.13% 0.12% 0.24% 0.45% 0.94%
Percentage of non-accrual loans, restructured loans
and real estate acquired by foreclosure or
substantively repossessed to total assets 0.13% 0.18% 0.20% 0.34% 0.64%
Percentage of allowance for loan losses to
non-accrual loans 810.47% 1,020.63% 764.20% 481.90% 197.76%
30
Non-accrual loans include restructured loans of $0 at December 31,
2004, $107,000 at December 31, 2003, $121,000 at December 31, 2002, $137,000
at December 31, 2001 and $153,000 at December 31, 2000.
Information with respect to non-accrual and restructured loans for the
past five years ending December 31 is as follows:
December 31,
- -------------------------------------------------------------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------
Non-accrual loans $506 $407 $635 $1,138 $2,415
Interest income that would have been
recorded under original terms $ 67 $ 41 $303 $ 109 $ 228
Interest income recorded during the period $ 44 $ 30 $121 $ 6 $ 22
Allowance for Loan Losses. We maintain an allowance for probable
losses that are inherent in the loan portfolio. The allowance for loan
losses is increased by provisions charged to operations based on the
estimated loan loss exposure inherent in the portfolio. Management uses a
methodology to systematically measure the amount of estimated loan loss
exposure inherent in the portfolio for purposes of establishing a sufficient
allowance for loan losses. The methodology includes three elements: an
analysis of individual loans deemed to be impaired in accordance with the
terms of Statement of Financial Accounting Standard No. 114, "Accounting by
Creditors for Impairment of a Loan", general loss allocations for various
loan types based on loss experience factors and an unallocated allowance
which is maintained based on management's assessment of many factors
including the risk characteristics of the portfolio, concentrations of
credit, current and anticipated economic conditions that may effect
borrowers' ability to pay, and trends in loan delinquencies and charge-offs.
Realized losses, net of recoveries, are charged directly to the allowance.
While management uses the currently available information in establishing
the allowance for loan losses, adjustments to the allowance may be necessary
if future economic conditions differ from the assumptions used in making the
evaluation. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review our allowance for loan
losses.
As the composition of the loan portfolio gradually changes and
diversifies from higher credit risk weighted loans, such as commercial real
estate and commercial, financial and agricultural, to residential and home
equity loans, a lower overall reserve allowance rate will be required.
During 2004, the continued changes in the loan portfolio, stronger
underwriting guidelines, the sale of commercial real estate loans previously
deemed substandard, and overall improvement in credit quality of existing
loans resulted in a decrease in the degree of credit risk embedded in the
loan portfolio. Consequently, the allowance for loan loss remained
relatively constant, decreasing from $4,154,000 at December 31, 2003 to
$4,101,000 at December 31, 2004. After thorough review and analysis of the
adequacy of the loan loss reserve during 2004, we recorded a provision for
loan losses of $376,000, compared to a provision benefit of $602,000
recorded for the year ended December 31, 2003. The increased provision is
primarily the result of the growth in the loan portfolio. Loans charged off
were $525,000 in 2004 compared with $211,000 for the year ended December 31,
2003. We realized recoveries of previously charged-off loans totaling
$96,000 for the year ended December 31, 2004 compared with recoveries
totaling $113,000 for the year ended December 31, 2003. Management believes
that the Allowance for Loan Losses of $4,101,000 as of December 31, 2004 is
adequate to cover potential losses in the loan portfolio, based on current
information available to management.
31
The table below illustrates the changes in the Allowance for Loan
Losses for the periods indicated.
(Dollars in Thousands) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------
Balance at January 1 $4,154 $4,854 $5,485 $4,776 $3,766
- ------------------------------------------------------------------------------------------------
Charge-offs:
Commercial (62) (10) (337) (73) (194)
Real estate-construction (0) (0) (0) (0) (0)
Real estate-mortgage (446) (169) (20) (0) (23)
Installment/Consumer (17) (32) (26) (28) (138)
--------------------------------------------------
(525) (211) (383) (101) (355)
--------------------------------------------------
Recoveries:
Commercial 60 55 17 15 50
Real estate-construction 0 0 0 0 0
Real estate-mortgage 25 44 38 29 92
Installment/Consumer 11 14 7 16 23
--------------------------------------------------
96 113 62 60 165
--------------------------------------------------
Net Charge-offs (429) (98) (321) (41) (190)
Provision (benefit) charged to operations 376 (602) (310) 750 1,200
- ------------------------------------------------------------------------------------------------
Balance at December 31 $4,101 $4,154 $4,854 $5,485 $4,776
================================================================================================
Allowance for Loan Losses as a percent of
year end loans 1.11% 1.23% 1.83% 2.16% 1.86%
Ratio of net charge-offs to average loans
outstanding (0.12%) (0.03%) (0.13%) (0.02%) (0.08%)
32
The table below shows an allocation of the allowance for loan losses
as of the end of each of the last five years:
December 31, 2004 December 31, 2003 December 31, 2002 December 31, 2001 December 31, 2000
- --------------------------------------------------------------------------------------------------------------------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category to Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
- ----------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Commercial(5) $ 743(1) 7.26% $ 943(1) 10.11% $1,155(1) 11.60% $1,629(1) 17.91% $1,466(1) 19.66%
Real estate
Construction 236 6.62% 52 3.08% 70 5.31% 41 2.99% 47 3.36%
Real estate
Mortgage 2,989(2) 85.44% 3,071(2) 85.62% 3,465(2) 80.48% 3,586(2) 74.77% 2,970(2) 71.91%
Consumer(3) 133(4) .68% 88(4) 1.19% 164(4) 2.61% 229(4) 4.33% 293(4) 5.07%
- -------------------------------------------------------------------------------------------------------------------------------
$4,101 100.00% $4,154 100.00% $4,854 100.00% $5,485 100.00% $4,776 100.00%
===============================================================================================================================
- --------------------
Includes amounts specifically reserved for impaired loans of $270,722
at December 31, 2004, $251,280 at December 31, 2003, $412,761 at
December 31, 2002, $780,029 at December 31, 2001, and $281,248 at
December 31, 2000, as required by Financial Accounting Standard No.
114, "Accounting for Impairment of Loans."
Includes amounts specifically reserved for impaired loans of $0 at
December 31, 2004, $23,621 at December 31, 2003, $34,757 at December
31, 2002, $413,663 at December 31, 2001, and $132,911 at December 31,
2000, as required by Financial Accounting Standard No. 114,
"Accounting for Impairment of Loans."
Includes consumer and other loans.
Includes amounts specifically reserved for impaired loans of $76,194
at December 31, 2004, $170 at December 31, 2003, $29,606 at December
31, 2002, $1,632 at December 31, 2001, and $10,398 at December 31,
2000, as required by Financial Accounting Standard No. 114,
"Accounting for Impairment of Loans."
Includes commercial, financial, agricultural and nonprofit loans.
33
Deposits and Borrowed Funds
- ---------------------------
We solicit depositors from our primary market area using rates and
services designed to appeal to customers across a broad spectrum of ages and
income levels. We compete for deposit customers with community banks and
credit unions, as well local branches regional and national banks. Despite
this level of competition, our total deposits increased from $333.1 million
at December 31, 2003 to $399.9 million at December 31, 2004, an increase of
$66.8 million or 20.1%. Increases in savings accounts were the result of
implementing our "Coastal" product line, designed to attract high-balance
customers with whom we have a multiple-product relationship. Time
certificates of deposit increased by 18.7 million when comparing the years
ended December 31, 2003 and 2004, primarily the result of the implementation
of "special" priced deposits, where an off-term certificate is offered at a
premium rate. During the term of the special, the customer is then
presented with offers to retain the customer, and develop a multiple account
relationship.
The following table sets forth the average amount and the average rate
paid on deposits for the periods indicated.
2004 2003 2002
- ------------------------------------------------------------------------------------------------
Average Average Average Average Average Average
(Dollars in Thousands) Balance Rate Balance Rate Balance Rate
- ------------------------------------------------------------------------------------------------
Noninterest-bearing
demand deposits $ 76,815 0.00% $ 72,602 0.00% $ 69,787 0.00%
Interest bearing
demand deposits 42,533 0.73 42,908 0.51 42,259 0.82
Savings deposits 87,983 1.00 67,487 0.51 62,078 0.91
Money market deposits 36,929 1.34 19,838 1.18 9,250 0.25
Time deposits 150,839 2.18 140,939 2.62 157,358 3.60
-------- -------- --------
Totals $395,099 1.26% $343,774 1.66% $340,732 2.47%
======== ======== ========
As of December 31, 2004, time certificates of deposit in amounts of
$100,000 or more had the following maturities:
(Dollars in Thousands)
Three months or less $18,810
Over three months through six months 8,985
Over six months through twelve months 4,863
Twelve months and over 2,748
-------
$35,406
=======
As of December 31, 2004, time certificates of deposit in amounts of
less than $100,000 had the following maturities:
(Dollars in Thousands)
Three months or less $ 51,871
Over three months through six months 27,025
Over six months through twelve months 16,887
Twelve months and over 17,129
--------
$112,912
========
As a member of the FHLB, the Bank is entitled to participate in the
FHLB's advance programs. The advance programs allow the Bank to borrow up
to 30% of total assets, but limited, based on the amount of qualified
collateral
34
(as defined by the FHLB) pledged, and the amount of FHLB preferred stock
held. FHLB advances are utilized as an additional funding source for loans
and investments as well as a tool for controlling the levels of interest
rate risk on the balance sheet. FHLB advances are secured by a blanket lien
on qualified collateral, consisting primarily of loans with first mortgages
secured by one-to-four family properties, certain unencumbered investment
securities and other qualified assets.
Short-term borrowings include funds drawn under lines of credit with
the FHLB, correspondent banks, funds held for U.S. Treasury Tax and Loan
Notes and FHLB advances with an original maturity of less than one year.
Total short-term borrowings decreased from $5.3 million at December 31, 2003
to zero at December 31, 2004. At no time did the average balance of short-
term borrowings exceed 30% of shareholders' equity.
Long-term FHLB advances increased from $55.2 million at December 31,
2003 to $90.3 million at December 31, 2004, an increase of $35.1 million or
63.6%. The proceeds were utilized to fund loan and investment growth in
excess of deposit growth, as well as to hedge the effects of rising short-
term interest rates on net interest income. At December 31, 2004,
outstanding long-term FHLB advances had the following scheduled maturities
and weighted average interest rates:
WEIGHTED
FINAL MATURITY AMOUNT AVERAGE RATE
-------------- ------ ------------
(Dollars in Thousands)
2005 $ 8,421 2.27%
2006 8,449 2.89
2007 20,973 3.37
2008 16,934 2.83
2009 17,426 3.00
Thereafter 18,083 6.63
------- ----
$90,286 3.70%
=======
Although most advances are payable at maturity, advances totaling
$17,356 are payable on an amortizing basis, in terms ranging from 120 to 240
months. Amortizing advances are being repaid in equal monthly payments and
are being amortized from the date of the advance to the maturity date on a
direct reduction basis. Also, certain advances are redeemable at the option
of the FHLB, at par value on the call date and quarterly thereafter. Such
advances are listed below:
MATURITY CALL DATE AMOUNT RATE
-------- --------- ------ ----
2008 September 14, 2005 and quarterly thereafter $10,000,000 2.35%
2009 September 14, 2006 and quarterly thereafter 10,000,000 2.87
Thereafter January 7, 2005 and quarterly thereafter 3,000,000 5.95
The advance callable on January 7, 2005 was not called.
At December 31, 2004, a $4,000,000 advance maturing in 2009 with a
current interest rate of 2.99% is redeemable at par value on September 15,
2005 and each calendar quarter thereafter, if the 3-month LIBOR is greater
than or equal to 4.50 percent.
In March 2004, we issued $10.3 million in subordinated debentures.
The debentures mature in 2034, and carry an adjustable interest rate
equivalent to the three-month LIBOR plus 279 basis points. The rate adjusts
every three months based on the change in the LIBOR. At December 31, 2004
the interest rate on the subordinated debentures was 5.29%. Current Bank
and Bank Holding Company regulations view these debentures as "tier 2
capital." As such, we may leverage this regulatory capital in order to
expand our franchise or otherwise enhance our earnings.
35
Shareholders' Equity
- --------------------
Total shareholders' equity increased from $42.7 million at December
31, 2003 to $47.0 million at December 31, 2004, primarily the result of
increased net income of $3.7 million. The increase in net income was offset
by cash dividends declared totaling $1.5 million. Other factors affecting
total shareholders' equity include comprehensive income of $731,000 and the
issuance of common stock through option and dividend reinvestment plans,
totaling $1.4 million.
Results of Operations
- ---------------------
Our operating performance is dependent on net interest income, which
is the difference between interest income earned on loans and investments
and interest expense paid on deposits and borrowed funds. The level of net
interest income achieved is impacted by several factors such as economic
conditions, interest rates, asset/liability management, and corporate tax
and strategic planning.
36
The following table sets forth our average assets, liabilities, and
shareholders' equity, interest income earned and interest paid, average
rates earned and paid, net interest spread and the net interest margin for
the years ended December 31, 2004, 2003, and 2002. Average balances
reported are daily averages.
2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
Average Interest(1) Avg. Average Interest(1) Avg. Average Interest(1) Avg.
(Dollars In Thousands) Balance Inc/Exp Rate Balance Inc/Exp Rate Balance Inc/Exp Rate
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Loans(2)
Interest earning assets (2)
Commercial loans $ 31,536 $ 1,717 5.44% $ 32,044 $ 1,739 5.42% $ 40,088 $ 2,337 5.82%
Commercial real estate 207,937 12,499 6.01% 172,299 10,955 6.35% 157,900 10,947 6.93%
Residential real estate 114,832 5,867 5.10% 85,648 4,604 5.37% 48,069 3,446 7.16%
Consumer loans 3,233 181 5.59% 5,043 305 6.04% 8,447 547 6.47%
------------------- ------------------- -------------------
Total loans 357,538 20,264 5.66% 295,034 17,603 5.96% 254,504 17,277 6.79%
Federal funds sold 28,842 270 0.93% 15,720 148 0.94% 24,033 348 1.44%
Taxable debt securities 71,657 2,933 4.09% 53,807 2,195 4.07% 70,385 3,688 5.23%
Tax-exempt debt securities 9,666 559 5.78% 12,659 895 7.07% 14,044 799 5.68%
Marketable equity
Securities 3,730 115 3.08% 3,112 99 3.18% 4,204 113 2.68%
FHLB stock 3,422 98 2.86% 1,512 45 2.97% 1,013 29 2.86%
Other Investments 910 32 3.51% 202 15 7.42% 169 4 2.36%
------------------- ------------------- -------------------
Total interest earning assets 475,765 24,271 5.10% 382,046 21,000 5.49% 368,352 22,258 6.04%
Allowance for loan losses (4,324) (4,607) (5,462)
Unearned income (473) (388) (347)
Cash and due from banks 18,411 17,091 15,250
Other assets 25,413 22,293 22,760
-------- -------- --------
Total assets $514,792 $416,435 $400,553
======== ======== ========
LIABILITIES & SHAREHOLDERS' EQUITY:
Savings accounts $ 87,983 882 1.00% $ 67,487 349 0.51% $ 62,078 570 0.91%
NOW accounts 42,533 314 0.73% 42,908 222 0.51% 42,259 348 0.82%
Money market accounts 36,929 497 1.34% 19,838 235 1.18% 9,250 24 0.25%
Time deposits 150,839 3,289 2.18% 140,939 3,699 2.62% 157,358 5,761 3.60%
FHLB advances 63,390 2,594 4.09% 28,824 1,568 5.43% 18,553 1,225 6.60%
Subordinated debt 8,248 370 4.48%
------------------- ------------------- -------------------
Total interest-bearing
Liabilities 389,922 7,946 2.03% 299,996 6,073 2.02% 289,498 7,928 2.73%
Demand deposits 76,815 72,602 69,787
Other liabilities 4,007 1,947 1,466
-------- -------- --------
Total Liabilities 470,744 374,545 360,751
-------- -------- --------
Shareholders' Equity 44,048 41,890 39,802
-------- -------- --------
Total Liabilities &
Shareholders' Equity $514,792 $416,435 $400,553
======== ======== ========
Net Interest Income $16,325 $14,927 $14,330
======= ======= =======
Net Interest Spread 3.07% 3.47% 3.31%
==== ==== ====
Net Interest Margin 3.43% 3.90% 3.89%
==== ==== ====
- --------------------
On a fully taxable equivalent basis based on tax rate of 34.30% for
2004, 42.80% for 2003, and 27.70% for 2002. Interest income on
investments and net interest income includes a fully taxable
equivalent adjustment of $165,000 in 2004, $383,000 in 2003, and
$221,000 in 2002.
Average balance includes non-accruing loans. The effect of including
such loans, although not material, is to reduce the average rate
earned on the Company's loans.
37
Rate-Volume Analysis
- --------------------
The following table presents the changes in components of net interest
income for the years ended December 31, 2004 and 2003, which are the result
of changes in interest rates and the changes that are the result of changes
in volume of the underlying asset or liability. Changes that are
attributable to changes in both rate and volume have been allocated equally
to rate and volume.
NET INTEREST INCOME - CHANGES DUE TO VOLUME AND RATE(1)
2004 vs. 2003 2003 vs. 2002
Increase Increase
(Decrease) (Decrease)
- -----------------------------------------------------------------------------------------------------------
Total Due to Due to Total Due to Due to
(Dollars in Thousands) Change(2) Volume Rate Change(2) Volume Rate
- -----------------------------------------------------------------------------------------------------------
Commercial loans $ (22) $ (28) $ 6 $ (598) $ (453) $ (145)
Commercial real estate 1,544 2,204 (660) 8 957 (949)
Residential real estate 1,263 1,530 (267) 1,158 2,357 (1,199)
Consumer loans (124) (105) (19) (242) (213) (29)
Federal funds sold 122 123 (1) (200) (99) (101)
Taxable debt securities 738 729 9 (1,493) (772) (721)
Tax-exempt securities (336) (192) (144) 96 (88) 184
Marketable equity securities 16 19 (3) (14) (32) 18
FHLB stock 53 56 (3) 16 15 1
Other Investments 17 39 (22) 11 2 9
-----------------------------------------------------------------------
Total Interest Income 3,271 4,375 (1,104) (1,258) 1,674 (2,932)
-----------------------------------------------------------------------
Savings accounts 533 156 377 (221) 39 (260)
NOW accounts 92 (2) 94 (126) 4 (130)
Money market accounts 262 216 46 211 76 135
Time deposits (410) 238 (648) (2,062) (516) (1,546)
FHLB advances 1,026 1,647 (621) 343 618 (275)
Subordinated debt 370 370 0
-----------------------------------------------------------------------
Total Interest Expense (1,873) 2,625 (752) (1,855) 221 (2,076)
-----------------------------------------------------------------------
Net Interest Income $ 1,398 $1,750 $ (352) $ 597 $1,453 $ (856)
=======================================================================
- --------------------
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.
38
Comparison of Operating Results for the Years Ended December 31, 2004 and 2003:
We realized net income totaling $3.7 million for the year ended
December 31, 2004, equivalent to basic earnings per share of $0.90 and
diluted earnings per share of $0.89. This represents a 35.9% increase in
net income from the year ended December 31, 2003, where net income totaled
$2.7 million, or $0.68 per share (basic) and $0.67 per share (diluted). Net
interest income increased from $14.5 million for the year ended December 31,
2003 to $16.2 million for the year ended December 31, 2004, the direct
result of our growth over the year. Commensurate with loan growth, we
recognized a provision for loan losses of $376,000 in 2004, compared with a
loan loss benefit of $602,000 in 2003. During the past two years, we have
made concerted efforts to enhance the credit quality of our loan portfolio,
and the benefit taken in 2003 was the direct result of that effort.
Continuing the dedication to loan quality that management has taken has
resulted in a loan loss provision that management believes is in line with
its growing loan portfolio. Non-interest income increased from $2.2 million
for the year ended December 31, 2004 to $2.5 million for the year ended
December 31, 2004. During the same period, operating expenses remained
relatively constant, at $12.7 million for both the year ended December 31,
2003 and the year ended December 31, 2004. Income before taxes was $5.6
million and $4.7 million, for the years ended December 31, 2004 and 2003,
respectively. Income taxes decreased from $2.0 million for the year ended
December 31, 2003, to $1.9 million for the year ended December 31, 2004.
Interest income increased from $20.6 million for the year ended
December 31, 2003, to $24.1 million for the year ended December 31, 2004, an
increase of $17.0%. This increase can be attributed to the growth in the
loan portfolio, as the average balance of loans increased by $62.5 million
or 21.2%. The effect of the growth in the portfolio was somewhat offset by
lower interest rates on these loans, due to the unprecedented low interest
rates that were present in our market area during 2004. The yield on the
loan portfolio decreased from 5.96% for the year ended December 31, 2003, to
5.66% for the year ended December 31, 2003. Interest and dividends on
investments increased by $490,000, on a fully tax equivalent basis, from
$3.2 million for the year ended December 31, 2003 to $3.7 million for the
year ended December 31, 2004, also the result of the growth in the
investment portfolio. The portfolio grew from an average balance of $71.3
million to $89.4 million. The portfolio continued to grow throughout the
year, which, management believes, will lead to increasing interest income
into 2005. Income from federal funds sold and overnight deposits increased
from $148,000 to $270,000, the result of increased volume of overnight
money, particularly when the campaigns for deposit growth were active.
Interest expense increased from $6.1 million for the year ended
December 31, 2003 to $7.9 million for the year ended December 31, 2004,
resulting primarily from the increased use of borrowings in 2004. The
average balance of FHLB advances increased from $28.8 million for the year
ended December 31, 2003 to $63.4 million for the year ended December 31,
2004. Management took advantage of low interest rates to further grow by
funding loan originations or growth in the investment portfolio. Indicative
of these low rates, the average rate paid on FHLB advances decreased from
5.43% for the year ended December 31, 2003 to 4.09% for the year ended
December 31, 2004. Interest on deposits increased from $4.5 million for the
year ended December 31, 2003 to $5.0 million for the year ended December 31,
2004. This increase was the result of the deposit campaigns, both for
certificates of deposit and core accounts. A marketing strategy was
employed whereby certificates of deposit were offered at premium rates, then
the customer was cross-sold basic banking products to establish a long-term
relationship with the customer. At the same time a suite of products was
offered to high-balance customers. These campaigns served to increase the
levels of all deposit types, including non-interest bearing demand deposits.
However, the cost of interest-bearing deposits rose from 2.02% to 2.03%. We
also issued $10.3 million of subordinated debentures in March 2004. The
debentures carry an interest rate equal to the three-month LIBOR plus 279
basis points. The effect of the issue was to increase interest expense by
$370,000.
Net interest income increased from $14.5 million for the year ended
December 31, 2003 to $16.2 million for the year ended December 31, 2004, an
increase of 11.7%. This increase was the result of our growth, as the
continued period of low market interest rates, combined with intense
competition for deposits in our market area, has compressed our net interest
margin from 3.90% for the year ended December 31, 2003 to 3.43% for the year
ended December 31, 2004.
The provision for loan losses is a charge against earnings and funds
the allowance for loan losses. It is management's desire to maintain the
allowance for loan losses at a level that is adequate to absorb inherent
losses within the loan portfolio. In determining the appropriate level of
the allowance for loan losses, management takes into
39
consideration past and anticipated loss experience, prevailing economic
conditions, evaluations of underlying collateral, and the volume of the loan
portfolio and the balance of non-performing and classified loans. We assess
the allowance for loan losses on a monthly basis. After thorough review and
analysis of the adequacy of the loan loss reserve, the continued improvement
in asset quality in the loan portfolio, and the reduction and sale of loans
deemed substandard, management deemed it prudent to provide $376,000 for
possible loan losses for the year ended December 31, 2004. Our provision
for 2003 was a benefit to earnings of $602,000.
Non-interest income increased from $2.2 million for the year ended
December 31, 2003 to $2.5 million for the year ended December 31, 2004, an
increase of 13.6%. The increase, noted in other income, can be attributed
to a one-time gain on the sale of impaired loans, which totaled $196,000.
Additionally, commissions on sales of non-deposit investment products
increased from $62,000 for the year ended December 31, 2003 to $256,000 for
the year ended December 31, 2004. In 2003, we changed the third party
through whom investment products are sold and in early 2004, added a line of
life insurance products to our non-deposit investment products. Also
contributing to other income was an increase in electronic banking fees of
$36,000, when comparing the years ended December 31, 2004 and 2003, and a
$20,000 gain on the sale of fixed assets. These increases were partially
offset by a decrease in deposit account service charges from $569,000 for
the year ended December 31, 2003 to $520,000 for the year ended December 31,
2004 the result of both migration of customers into free checking accounts
and a decline in the total number of deposit accounts. Overdraft fees also
declined from $550,000 for the year ended December 31, 2003 to $518,000 for
the year ended December 31, 2004, reflective of the decline in the number of
low-balance accounts.
Non-interest expense remained relatively constant when comparing the
years ended December 31, 2004 and 2003, increasing by only $63,000, or 0.5%.
The small magnitude of the change is indicative of management's commitment
to expense control. In 2003 and 2004 three branches were closed, and the
deposits housed therein were transferred to another branch. As a result,
salaries and employee benefits decreased from $7.8 million for the year
ended December 31, 2003 to $7.6 million for the year ended December 31,
2004. Occupancy expense decreased from $886,000 to $781,000 over the same
period. As we are opening the new Assonet branch in 2005, we expect
salaries and employee benefits expense and occupancy expense to increase in
2005. Equipment expense increased from $542,000 for the year ended December
31, 2003 to $564,000 for the year ended December 31, 2004, the result of
adding to our technology infrastructure. These technology upgrades were
necessary, not only to enhance security and operations, but also to support
the new cash management and Internet banking products, which management
believes will have a positive effect on both earnings and customer
retention. Stationary and supplies increased by $25,000 during the same
period, primarily due to replacement costs of materials made obsolete in the
technology upgrades. Professional fees increased by $11,000 when comparing
the years ended December 31, 2004 and 2003. Management anticipates that
professional fees will increase in 2005 due to the costs of implementing
Section 404 of the Sarbanes-Oxley Act of 2002 and implementing section 305
for the FDIC Improvement Act of 1991. Marketing costs increased from
$375,000 for the year ended December 31, 2003 to $510,000 for the year ended
December 31, 2004. This is the result of increased advertising and
promotional costs associated with our "Coastal" product line and other
deposit gathering initiatives. FDIC premiums decreased during 2004 based on
the FDIC's risk-based assessment program. Other expenses increased from
$1.8 million for the year ended December 31, 2003 to $2.0 million for the
year ended December 31, 2004, an increase of $275,000. The increase is
primarily the result of a one-time expense related to the Directors'
retirement plan, resulting in an increase in the expense of $172,000.
Additionally, computer service fees increased by $69,000 because of
implementing the cash management and Internet banking products. Costs other
than those mentioned above typically rose due to increases in general price
levels of inflation.
Income before income taxes was $5.6 million for the year ended
December 31, 2004, compared to $4.7 million for the year ended December 31,
2003. Income taxes totaled $1.9 million and $2.0 million for the years
ended December 31, 2004 and 2003, representing overall tax rates of 34.4%
and 42.8%, respectively. The income tax rate decreased primarily because of
the settlement of a dispute with the Massachusetts Department of Revenue
concerning the dividends received deduction claimed by the Bank from its
REIT subsidiary. Refer to Note 9 to the financial statements and Item 1 of
this report for more details.
40
Comparison of Operating Results for the Years Ended December 31, 2003 and 2002:
Net income for the year ended December 31, 2003 was $2.7 million or
$0.67 per share (diluted), as compared with $3.0 million or $0.75 per share
(diluted) for the year ended December 31, 2002. Net interest income
increased from $14.1 million for the year ended December 31, 2002 to $14.5
million for the year ended December 31, 2003, an increase of 2.8%. We
realized a loan loss benefit of $602,000 in 2003, compared to a benefit of
$310,000 in 2002. Non-interest income decreased by $319,000 in 2003, while
operating expenses decreased by $190,000. Income before taxes increased
from $4.1 million for the year ended December 31, 2002 to $4.7 million for
the year ended December 31, 2003. Income taxes increased from $1.1 million
in 2002 to $2.0 million in 2003, the result of settling a dispute with the
Massachusetts Department of Revenue.
On a fully tax equivalent basis, net interest income was $14.9 million
in 2003, compared to $14.3 million in 2002. The increase in net interest
income was 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 5.49% in 2003,
compared to 6.04% in 2002, and 7.55% in 2001. The low interest rate
environment has resulted in a decrease in the yield on earning assets from
6.04% for the year ended December 31, 2002 to 5.49% for the year ended
December 31, 2003, as loans and investments reprice at lower interest due to
refinancing opportunities and prepayments.
Offsetting the decrease in the earning asset yield was a reduction of
0.71% in the cost of funding the earning assets from 2.73% for the year
ended December 31, 2002 to 2.02% for the year ended December 31, 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.
The net interest spread increased to 3.47% for the year ended December
31, 2003 from 3.31% for the year ended December 31, 2002, while the net
interest margin increased to 3.90% in 2003 from 3.89% in 2002.
The provision for loan losses is a charge against earnings and funds
the allowance for loan losses. It is management's desire to maintain the
allowance for loan losses at a level that is adequate to absorb inherent
losses within the loan portfolio. In determining the appropriate level of
the allowance for loan losses, management takes into consideration past and
anticipated loss experience, prevailing economic conditions, evaluations of
underlying collateral, and 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 continued improvement in asset
quality in the loan portfolio, and the reduction and sale of loans deemed
substandard, management deemed it prudent to recover $602,000 of previously
provided loan loss provisions during 2003. Provision for 2003 was a benefit
to earnings of $602,000 compared to a benefit of $310,000 in 2002, and a
provision of $750,000 in 2001.
Total non-interest income for 2003 decreased by $319,000 or 12.6% from
$2.5 million for the year ended December 31, 2002 to $2.2 million for the
year ended December 31, 2003. This decrease is associated with a decrease
in net gains of sales of available for sale securities from $626,000
recognized during 2002 to $2,000 recognized during 2003. The gains
recognized during 2002 resulted from sales of various securities to
partially offset the charge of $1.2 million due to various impairment
adjustments of equity securities that were deemed to be other than
temporary, as defined by SFAS No.115. No securities impairment charges were
recorded during 2003. Partially offsetting the decrease in security gains
were increases in both service charges on deposit accounts and overdraft
service charges totaling $234,000. Service charges on deposit accounts
increased during 2003 to $569,000 from $551,000 in 2002. Overdraft service
charges increased by $216,000 from $334,000 recorded in 2002 to $550,000 in
2003. This increase was the result of management implementing 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 executive officers' life
insurance programs increased by $68,000 from 2002 to 2003 due additional
earnings generated from the purchase of additional policies for newly hired
executive officers during 2003 as well as the appointment of two new
directors. Other income increased by $3,000 from $579,000 recorded in 2002
to $582,000 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.
41
Total non-interest expenses decreased by $190,000 to $12.7 million for
the year ended December 31, 2003, when compared to $12.8 million for the
year ended December 31, 2002. Salaries and employee benefits increased by
$410,000, or 5.6% from $7.4 million for the year ended December 31, 2002, to
$7.8 million for the year ended December 31, 2003. 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 we increased our contribution to a
pension plan during 2003. Occupancy and equipment expenses totaled $1.4
million in 2003, an increase of $105,000 when compared to $1.3 million
reported in 2002. The increase from 2002 to 2003 was primarily due to
increased snow removal cost resulting from a cold, severe winter, and higher
energy costs 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 $64,000 from
$277,000 recorded in 2002 to $213,000 in 2003. This decrease was due to new
inventory control procedures, and the closing of one branch office.
Professional fees increased by $480,000 or 87.4%, from $549,000 in 2002 to
$1.0 million in 2003. The 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. Marketing expenses attributed to production and media
costs, print advertising, and other direct marketing increased by $20,000,
when comparing the years ended December 31, 2003 and 2002. The assessment
for FDIC deposit insurance decreased by $2,000 in 2003, from $158,000 in
2002 to $156,000 in 2003. Included in total non-interest expenses in 2002
was a writedown of securities of $1,241,000 due to the recognition of
impairment adjustments on equity securities that were deemed to be other
than temporary. During 2003, no writedowns were necessary. Other expenses
increased from $1.7 million for the year ended December 31, 2002 to $1.8
million for the year ended December 31, 2003. The increase is directly
attributable to interest of $129,000 on the tax settlement with the
Massachusetts Department of Revenue associated with the REIT. Other
expenses declined by a total of $27,000 when comparing the years ended
December 31, 2003 and 2002.
Income before income taxes totaled $4.7 million for the year ended
December 31, 2003, an increase of $598,000 when compared to $4.1 million
reported for the year ended December 31, 2002. Applicable taxes increased
by $876,000 to $2.0 million for the year ended December 31, 2003 when
compared to $1.1 million reported for the year ended December 31, 2002.
During 2003, we recorded a state income tax provision of $529,000, 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 $129,000 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 Commonwealth of Massachusetts' change in tax law
that eliminated the tax benefit derived from REIT dividends.
42
Unaudited Quarterly Financial Summary
(Dollars in Thousands)
- ------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
- ------------------------------------------------------------------------------------
2004:
Revenues $6,043 $6,357 $7,063 $7,148
Operating Income 954 963 1,568 2,079
Net Income (Loss) 646 602 1,071 1,333
Earnings (loss) per share
Basic $ 0.16 $ 0.15 $ 0.26 $ 0.33
Diluted $ 0.16 $ 0.15 $ 0.26 $ 0.32
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
Returns on Equity and Assets
The following table shows our consolidated operating and capital
ratios for each of the last three years:
Year Ended December 31,
2004 2003 2002
-------------------------
Return on Average Assets 0.70% 0.64% 0.74%
Return on Average Equity 8.29% 6.41% 7.45%
Dividend Payout Ratio 40.00% 53.22% 47.50%
Equity to Assets Ratio (Average) 8.55% 10.05% 9.93%
Impact of Inflation
The consolidated financial statements and related consolidated
financial data presented herein have been prepared in accordance with
generally accepted accounting principles, which require the measurement of
financial position and results of operations in terms of historical dollars
without considering changes in the relative purchasing power of money over
time due to inflation. The primary effect of inflation on our operations is
reflected in increased operating costs. Unlike most industrial companies,
virtually all assets of a financial institution are monetary in nature. As a
result, interest rates have a more significant effect on a financial
institution's performance than the effect of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the prices of goods and services.
43
Liquidity and Capital Resources
Liquidity
- ---------
Our principal sources of funds are customer deposits, amortization and
payoff of existing loan principal, and sales or maturities of various
investment securities. The Bank is a voluntary member of the Federal Home
Loan Bank of Boston (the "FHLB") and as such, may take advantage of the
FHLB's borrowing programs to enhance liquidity and leverage its favorable
capital position. The Bank also may draw on lines of credit at the FHLB or
the Federal Reserve Board (the "FRB"), and enter into repurchase or reverse
repurchase agreements with authorized brokers. These various sources of
liquidity are used to fund withdrawals, new loans, and investments.
Management seeks to promote deposit growth while controlling cost of
funds. Sales-oriented programs to attract new depositors and the cross-
selling of various products to its existing customer base are currently in
place. Management reviews, on an ongoing basis, possible new products, with
particular attention to products and services, which will aid in retaining
our base of lower-costing deposits.
Maturities and sales of investment securities provide us with
significant liquidity. Our policy of purchasing shorter-term debt securities
reduces market risk in the bond portfolio while providing significant cash
flow. For the year ended December 31, 2004, cash flow from maturities of
securities was $23.1 million, proceeds from sales of securities totaled $1.6
million, compared to maturities of securities of $58.3 million, and proceeds
from sales of securities of $864,000 for the year ended December 31, 2003.
Purchases of securities during 2004 and 2003 totaled $88.1 million and $38.7
million, respectively.
Amortization and pay-offs of the loan portfolio also provide us with
significant liquidity. Traditionally, amortization and pay-offs are
reinvested into loans. Excess liquidity is invested in federal funds sold
and overnight investments at the FHLB.
We have also used borrowed funds as a source of liquidity. At December
31, 2004, the Bank's outstanding borrowings from the FHLB were $90.3
million. The Bank has the capacity to borrow in excess of $50 million
additional at the FHLB.
Loan originations for the year ended December 31, 2004 totaled $132.1
million. Commitments to originate loans at December 31, 2004 were $10.8
million, excluding unadvanced construction funds totaling $11.4 million,
unadvanced commercial lines of credit totaling, $15.6 million and unadvanced
home equity lines totaling $18.2 million. Management believes that adequate
liquidity is available to fund loan commitments utilizing deposits, loan
amortization, maturities of securities, or borrowings.
Capital Resources
- -----------------
At December 31, 2004, our total shareholders' equity was $47.0
million, an increase of $4.3 million from $42.7 million reported on December
31, 2003. The increase in capital was a combination of several factors.
Additions consisted of 2004 net income of $3.7 million, comprehensive income
of $731,000, transactions originating through the Dividend Reinvestment
Program whereby 28,645 net shares were issued in lieu of cash dividends or
for optional cash contributions, and stock options exercised resulting in
the issuance of 42,390 shares common stock at a value of $689,000, including
a tax benefit. These additions were offset by dividends paid of $1.5
million.
Under the requirements for Risk Based and Leverage Capital of the
federal banking agencies, a minimum level of capital will vary among banks
based on safety and soundness of operations. Risk Based Capital ratios are
calculated with reference to risk-weighted assets, which include both on and
off balance sheet exposure.
In addition to meeting the required levels, Slade's Ferry Bancorp's
and the Bank's capital ratios meet the criteria of the "well capitalized"
category established by the federal banking agencies as of December 31, 2004
and 2003.
44
The following table illustrates the capital position of Slade's Ferry
Bancorp and Slade's Ferry Trust Company for years ending December 31, 2004
and 2003.
Slade's Ferry Bancorp. 2004 2003
- ------------------------------------------------------------------------------------------------
(Dollars in Thousands) Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets) $ 59,072 15.92% $ 44,510 13.64%
Minimum required 29,682 8.00 26,113 8.00
Excess 29,390 7.92 18,397 5.64
Tier I Capital (to Risk Weighted Assets) 54,971 14.82 40,429 12.39
Minimum required 14,841 4.00 13,056 4.00
Excess 40,130 10.82 27,373 8.39
Risk Adjusted Assets, net of goodwill,
nonqualifying intangibles, excess allowance
and excess deferred tax assets 371,022 326,300
Tier I Capital (Leverage Ratio) 54,971 10.29 40,429 9.33
Minimum required 21,361 4.00 17,335 4.00
Excess 33,610 6.29 23,094 5.33
Quarterly average total assets, net of goodwill,
nonqualifying intangibles and excess deferred
tax assets 534,021 433,320
Slade's Ferry Trust Company 2004 2003
- ------------------------------------------------------------------------------------------------
(Dollars in Thousands) Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets) $ 50,814 13.78% $ 37,384 11.48%
Minimum required 29,503 8.00 26,057 8.00
Excess 21,311 5.78 11,327 3.48
Tier I Capital (to Risk Weighted Assets) 46,713 12.67 33,312 10.23
Minimum required 14,751 4.00 13,028 4.00
Excess 31,962 8.67 20,284 6.23
Risk Adjusted Assets, net of goodwill,
nonqualifying intangibles, excess allowance
and excess deferred tax assets 368,785 325,625
Tier I Capital (Leverage Ratio) 46,713 8.75 33,312 7.75
Minimum required (1) 21,361 4.00 17,198 4.00
Excess 25,352 4.75 16,114 3.75
Quarterly average total assets, net of goodwill,
nonqualifying intangibles and excess deferred
tax assets 534,021 429,830
- --------------------
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.
For discussion of critical accounting policies see Footnote 2 to our audited
Financial Statements included in this report found on page F-9.
45
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We consider interest rate risk to be a significant market risk as it
could potentially have an effect on our financial condition and results of
operation. The definition of interest rate risk is the exposure of our
earnings to adverse movements in interest rates, arising from the
differences in the timing of repricing of assets and liabilities; the
differences in the various pricing indices inherent in our assets and
liabilities; and the effects of overt and embedded options in our assets and
liabilities. Our Asset/Liability Committee, comprised of the executive
management, is responsible for managing and monitoring interest rate risk,
and reviewing with the Board of Directors, at least quarterly, the interest
rate risk positions, the impact changes in interest rates would have on net
interest income, and the maintenance of interest rate risk exposure within
approved guidelines.
The potentially volatile nature of market interest rates requires us
to manage interest rate risk on an active and dynamic basis. Our objective
is to reduce and control the volatility of its net interest income to within
tolerance levels established by the Board of Directors, by managing the
relationship of interest-earning assets and interest-bearing liabilities.
In order to manage this relationship, the Asset/Liability Committee utilizes
an income simulation model to measure the net interest income at risk under
differing interest rate scenarios. Additionally, the Committee use Economic
Value of Equity ("EVE") analysis to measure the effects of changing interest
rates on the market values of rate-sensitive assets and liabilities, taken
as a whole. The Board of Directors and management believe that static
measures of timing differences, such as "gap analysis", do not accurately
assess the levels of interest rate risk inherent in our balance sheet. Gap
analysis does not reflect the effects of overt and embedded options on net
interest income, given a shift in interest rates; nor does it take into
account basis risk, the risk arising from using various different indices on
which to base pricing decisions.
The income simulation model currently utilizes a 300 basis point
increase in interest rates and a 100 basis point decrease in rates. Due to
the existing low interest rate environment in effect with the average
Federal Funds overnight trading at approximately 2.25% at December 31, 2004,
the simulation model only reduces rates downward by 100 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 Board of Directors has established a risk limit of a 5.00% change
in net interest income for each 100 number basis point shift in market
interest rates. The limit established by the Board provides an internal
tolerance level to control interest rate risk. We are within our policy-
mandated risk limit for net interest income at risk.
The following table reflects our 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 Dollar Impact to Net
(Basis Points) Net Interest Income Interest Income
---------------------------------------------------------------------------------
+300 (7.58%) ($1,371,000)
-100 0.65% $ 118,000
46
Additionally we use the model to estimate the effects of changes in
interest rates on our EVE. EVE represents our theoretical market value,
given the rate shocks applied in the model. The Board of Directors has
established a risk limit for EVE which provides that the EVE will not fall
below 6.00%, the FDIC's minimum capital level to be classified as "well
capitalized". We are within our risk limit for EVE.
The following table presents the changes in EVE given rate shocks.
Rate Change
(Basis Points) Economic Value of Equity Change from Flat Rates
------------------------------------------------------------------------
FLAT 13.20% N/A
+300 11.93% -1.27%
-100 13.05% -0.15%
47
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, together with the independent
auditors' report, appear beginning on page F-1 of the Annual Report on Form
10-K.
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Effective March 14, 2005, the Audit Committee of our Board of
Directors dismissed Shatswell, MacLeod & Company, P.C. and engaged Wolf &
Company, P.C. as our independent public accountant for the fiscal year ended
December 31, 2005. We had no disagreements with our independent accountants
on accounting and financial disclosure matters.
ITEM 9A
CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
within the 90 days prior to the date of this report, the Company carried out
an evaluation under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer of the effectiveness of the design and operation of
the Company's disclosure controls and procedures. Based upon that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in the reports it files
or submits under the Exchange Act is (i) recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms and (ii) accumulated and communicated to the
Company's management, including its principal executive officer and principal
accounting officer, as appropriate to allow timely decisions regarding
disclosure. In connection with the rules regarding disclosure and control
procedures, we intend to continue to review and document our disclosure
controls and procedures, including our internal controls and procedures for
financial reporting, and may from time to time make changes aimed at enhancing
their effectiveness and to ensure that our systems evolve with our business.
ITEM 9B
OTHER INFORMATION
Departures of Directors
On November 8, 2004, William Q. MacLean retired from Slade's Ferry
Bancorp's Board of Directors. Mr. MacLean continues to serve as an honorary
director.
On January 10, 2005, Thomas B. Almy, a longtime director of Slade's
Ferry Bancorp and the Bank, passed away. Mr. Almy will be greatly missed.
48
PART III
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is hereby made to our definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 11, 2005. The information
set forth under the heading "Directors and Executive Officers" and under the
heading "Section 16(a) Beneficial Ownership Reporting Compliance" of such
Proxy Statement is incorporated herein by reference.
ITEM 11
EXECUTIVE COMPENSATION
Reference is hereby made to our definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 11, 2005. The information
set forth under the heading "Executive Compensation Tables and Information"
of such Proxy Statement is incorporated herein by reference.
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is hereby made to our definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 11, 2005. The information
set forth under this heading of such Proxy Statement is incorporated herein
by reference.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is hereby made to our definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 11, 2005. The information
set forth under this heading of such Proxy Statement is incorporated herein
by reference.
ITEM 14
PRINCIPAL ACCOUNTING FEES AND SERVICES
Reference is hereby made to our definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 11, 2005. The information
set forth under this heading of such Proxy Statement is incorporated herein
by reference.
49
ITEM 15
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(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
Shareholders' 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: see attached Exhibits Index Page X-1
50
SIGNATURES
- ----------
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized on March 28, 2005.
Slade's Ferry Bancorp.
By /s/ Mary Lynn D. Lenz
----------------------------------
Mary Lynn D. Lenz, President/
Chief Executive Officer and
Director
In accordance with the requirements of the Exchange Act, this report
has been signed by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
/s/ Anthony F. Cordeiro 03/29/05 /s/ Peter G. Collias 03/29/05
- --------------------------------------- ----------------------------------
Anthony F. Cordeiro Peter G. Collias
Director Director
/s/ Paul C. Downey 03/29/05 /s/ Melvyn A. Holland 03/29/05
- --------------------------------------- ----------------------------------
Paul C. Downey Melvyn A. Holland
Director Director
/s/ Mary Lynn D. Lenz 03/29/05 /s/ Francis A. Macomber 03/29/05
- --------------------------------------- ----------------------------------
Mary Lynn D. Lenz Francis A. Macomber
President/CEO and Director Director
/s/ Majed Mouded, MD 03/29/05 /s/ Shaun O'Hearn Sr. 03/29/05
- --------------------------------------- ----------------------------------
Majed Mouded, MD Shaun O'Hearn Sr.
Director Director
/s/ Lawrence J. Oliveira, DDS 03/29/05 /s/ Peter Paskowski 03/29/05
- --------------------------------------- ----------------------------------
Lawrence J. Oliveira, DDS Peter Paskowski
Director Director
/s/ Kenneth R. Rezendes 03/29/05 /s/ William J. Sullivan 03/29/05
- --------------------------------------- ----------------------------------
Kenneth R. Rezendes William J. Sullivan
Chairman of the Board and Director Director
/s/ Charles Veloza 03/29/05 /s/ David F. Westgate 3/29/05
- --------------------------------------- ----------------------------------
Charles Veloza David F. Westgate
Director Vice Chairman and Director
/s/ Deborah A. McLaughlin 03/29/05
- ---------------------------------------
Deborah A. McLaughlin
Chief Financial Officer/Chief Operations Officer
51
Exhibit Index
-------------
Exhibit No. Description Item
- ----------- ----------- ----
3.1 Amended and Restated Articles of Incorporation of Slade's Ferry Bancorp. (1)
3.2 Amended and Restated Bylaws of Slade's Ferry Bancorp. (2)
3.3 Articles of Amendment to the Amended and Restated Articles of Incorporation (2)
of Slade's Ferry Bank
10.1 Slade's Ferry Bancorp. 1996 Stock Option Plan, as amended (3)
10.2 Supplemental Executive Retirement Agreement between Slade's Ferry Bancorp. (4)
and Manuel J. Tavares
10.3 Form of Director Supplemental Retirement Program Director Agreement, (5)
Exhibit 1 thereto (Slade's Ferry Trust Company Director Supplemental
Retirement Program Plan) and Endorsement Method Split Dollar Plan
Agreement thereunder.
10.4 Form of Directors' Paid-up Insurance Policy (part of the Director Supplemental (6)
Retirement Program).
10.5 Supplemental Executive Retirement Agreement between Slade's Ferry Bancorp. (7)
and Mary Lynn D. Lenz
10.6 Employment Agreement between Slade's Ferry Bancorp. and Mary Lynn D. Lenz (8)
10.7 Employment Agreement between Slade's Ferry Bancorp. and Deborah A. McLaughlin (9)
10.8 Employment Agreement between Slade's Ferry Bancorp. and Manuel J. Tavares (10)
10.9 Form Change of Control Agreement (11)
10.10 Severance Pay Plan (12)
14.1 Code of Ethics (13)
21.1 List of Subsidiaries (14)
23.1 Consent of Independent Public Accountants
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 8-K filed with the
Commission on December 21, 2004.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended June 30, 1999.
X-1
Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1996.
Incorporated by reference to Exhibit 10 to the Registrant's Form 10-Q
for the quarter ended March 31, 1999.
Incorporated by reference to Exhibit 10 to the Registrant's Form
10-QSB for the quarter ended June 30, 1998.
Incorporated by reference to Exhibit 10.10 to the Registrant's Form
10-Q for the quarter ended March 31, 2003.
Incorporated by reference to Exhibit 10.11 to the Registrant's Form
10-Q for the quarter ended June 30, 2004.
Incorporated by reference to Exhibit 10.7 to the Registrant's Form
10-Q for the quarter ended September 30, 2004.
Incorporated by reference to Exhibit 10.8 to the Registrant's Form
10-Q for the quarter ended September 30, 2004.
Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on January 13, 2005.
Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on January 14, 2005.
Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended December 31, 2004.
Incorporated by reference to Part I, Item 1-"General."
X-2
INDEX TO FINANCIAL STATEMENTS
Slade's Ferry Bancorp and Subsidiaries
Page
----
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 2004, and
December 31, 2003 F-3
Consolidated Statements of Income for the years ended
December 31, 2004, December 31, 2003, and December 31, 2002 F-4
Consolidated Statements of Changes in Shareholders' Equity for
the years ended December 31, 2004, December 31, 2003 and
December 31, 2002 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, December 31, 2003, and December 31, 2002 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
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
We have audited the accompanying consolidated balance sheets of Slade's
Ferry Bancorp. and Subsidiary as of December 31, 2004 and 2003 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, 2004. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the 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, 2004
and 2003, and the consolidated results of their operations and their cash
flows for each of the years in the three-year period ended December 31,
2004, 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, 2005
83 PINE STREET * WEST PEABODY, MASSACHUSETTS 01960-3635
TELEPHONE (978) 535-0206 * FACSIMILE (978) 535-9908
smc@shatswell.com www.shatswell.com
F-2
SLADE'S FERRY BANCORP. AND SUBSIDIARY
-------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31, 2004 and 2003
--------------------------
ASSETS 2004 2003
- ------ ------------ ------------
Cash and due from banks $ 15,983,574 $ 18,428,932
Interest bearing demand deposits with other banks 410,450 213,438
Money market mutual funds 63,539
Federal Home Loan Bank overnight deposit 5,000,000
Federal funds sold 13,800,000 4,000,000
------------ ------------
Cash and cash equivalents 35,194,024 22,705,909
Interest bearing time deposits with other bank 100,000 200,000
Investments in available-for-sale securities (at fair value) 83,882,432 47,162,852
Investments in held-to-maturity securities
(fair values of $38,112,316 as of December 31, 2004
and $11,851,713 as of December 31, 2003) 37,773,227 11,300,402
Federal Home Loan Bank stock 4,649,700 3,023,800
Loans, net of allowance for loan losses of
$4,101,026 in 2004 and $4,154,394 in 2003 362,264,873 331,496,525
Premises and equipment 5,527,362 5,894,736
Goodwill 2,173,368 2,173,368
Accrued interest receivable 1,969,151 1,497,104
Cash surrender value of life insurance 11,548,320 10,980,879
Deferred taxes 879,465 1,996,213
Other assets 3,869,831 1,016,753
------------ ------------
Total assets $549,831,753 $439,448,541
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $ 80,232,029 $ 73,253,462
Interest-bearing 319,672,702 259,891,355
------------ ------------
Total deposits 399,904,731 333,144,817
Federal Home Loan Bank advances 90,286,416 60,474,864
Subordinated debentures 10,310,000
Other liabilities 2,296,213 3,086,719
------------ ------------
Total liabilities 502,797,360 396,706,400
------------ ------------
Stockholders' equity:
Common stock, par value $.01 per share; authorized
10,000,000 shares; issued and outstanding 4,068,423.1 shares
in 2004 and 3,995,857.1 shares in 2003 40,684 39,959
Paid-in capital 29,976,062 28,609,206
Retained earnings 16,892,659 14,698,595
Accumulated other comprehensive income (loss) 124,988 (605,619)
------------ ------------
Total stockholders' equity 47,034,393 42,742,141
------------ ------------
Total liabilities and stockholders' equity $549,831,753 $439,448,541
============ ============
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, 2004, 2003 and 2002
--------------------------------------------
2004 2003 2002
----------- ----------- -----------
Interest and dividend income:
Interest and fees on loans $20,263,566 $17,602,784 $17,276,773
Interest and dividends on securities:
Taxable 3,152,633 2,349,161 3,826,659
Tax-exempt 416,235 511,761 577,982
Interest on federal funds sold 184,608 100,791 227,229
Other interest 89,071 52,133 127,831
----------- ----------- -----------
Total interest and dividend income 24,106,113 20,616,630 22,036,474
----------- ----------- -----------
Interest expense:
Interest on deposits 4,981,673 4,505,217 6,703,002
Interest on Federal Home Loan Bank advances 2,594,356 1,567,953 1,216,559
Interest on other borrowed funds 8,193
Interest on subordinated debentures 369,853
----------- ----------- -----------
Total interest expense 7,945,882 6,073,170 7,927,754
----------- ----------- -----------
Net interest and dividend income 16,160,231 14,543,460 14,108,720
Provision (benefit) for loan losses 376,215 (602,326) (310,000)
----------- ----------- -----------
Net interest and dividend income after
provision (benefit) for loan losses 15,784,016 15,145,786 14,418,720
----------- ----------- -----------
Noninterest income:
Service charges on deposit accounts 519,750 569,189 551,060
Overdraft service charges 518,247 549,923 333,977
(Loss) gain on sales and calls of
available-for-sale securities, net (5,589) 1,944 625,832
Gain on sales of mortgage loans, net 195,817
Increase in cash surrender value of life insurance policies 432,441 510,744 443,220
Other income 844,414 581,745 578,728
----------- ----------- -----------
Total noninterest income 2,505,080 2,213,545 2,532,817
----------- ----------- -----------
Noninterest expense:
Salaries and employee benefits 7,580,363 7,778,787 7,368,364
Occupancy expense 780,978 886,287 845,366
Equipment expense 564,141 541,960 478,047
Stationary and supplies 237,807 213,075 276,824
Professional fees 1,039,773 1,028,770 549,036
Marketing expense 509,644 375,126 355,203
Writedown of securities 1,240,868
Other expense 2,012,615 1,837,724 1,738,094
----------- ----------- -----------
Total noninterest expense 12,725,321 12,661,729 12,851,802
----------- ----------- -----------
Income before income taxes 5,563,775 4,697,602 4,099,735
Income taxes 1,911,508 2,009,716 1,134,183
----------- ----------- -----------
Net income $ 3,652,267 $ 2,687,886 $ 2,965,552
=========== =========== ===========
Earnings per common share $ .90 $ .68 $ .76
=========== =========== ===========
Earnings per common share assuming dilution $ .89 $ .67 $ .75
=========== =========== ===========
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, 2004, 2003 and 2002
--------------------------------------------
Accumulated
Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings (Loss) Income Total
------ -------- -------- -------------- ------
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
Comprehensive income:
Net income 3,652,267
Other comprehensive income 730,607
Comprehensive income 4,382,874
Issuance of common stock from dividend
reinvestment plan 286 607,191 607,477
Stock issuance relating to optional
cash contribution plan 49 103,232 103,281
Stock options exercised 424 531,506 531,930
Tax benefit of stock options 157,261 157,261
Retirement of 3,412 shares of common stock (34) (32,334) (32,368)
Dividends declared ($.36 per share) (1,458,203) (1,458,203)
------- ----------- ----------- --------- -----------
Balance, December 31, 2004 $40,684 $29,976,062 $16,892,659 $ 124,988 $47,034,393
======= =========== =========== ========= ===========
F-5
SLADE'S FERRY BANCORP. AND SUBSIDIARY
-------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
Years Ended December 31, 2004, 2003 and 2002
--------------------------------------------
(continued)
2004 2003 2002
---------- --------- ---------
Other comprehensive income and reclassification
disclosure for the years ended December 31:
Unrealized gains (losses) on securities
Net unrealized gains (losses) on available-for-sale
securities $ 122,161 $(442,358) $ 53,577
Reclassification adjustment for realized
losses (gains) in net income 5,589 (1,944) 615,036
---------- --------- ---------
Net unrealized gains (losses) on securities 127,750 (444,302) 668,613
Income tax benefit (expense) 6,978 211,290 (324,398)
---------- --------- ---------
Net of tax amount 134,728 (233,012) 344,215
---------- --------- ---------
Minimum pension liability adjustment 1,008,770 (612,323) (216,583)
Income tax (expense) benefit (412,891) 250,624 88,649
---------- --------- ---------
Net of tax amount 595,879 (361,699) (127,934)
---------- --------- ---------
Other comprehensive income (loss), net of tax $ 730,607 $(594,711) $ 216,281
========== ========= =========
Accumulated other comprehensive income (loss) consists of the following as
of December 31:
2004 2003 2002
---------- --------- ---------
Net unrealized gains (losses) on available-for-sale
securities, net of taxes $ 124,988 $ (9,740) $ 223,272
Minimum pension liability adjustment, net of taxes (595,879) (234,180)
---------- --------- ---------
Accumulated other comprehensive income (loss) $ 124,988 $(605,619) $ (10,908)
========== ========= =========
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, 2004, 2003 and 2002
--------------------------------------------
2004 2003 2002
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 3,652,267 $ 2,687,886 $ 2,965,552
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization, net of accretion of securities 247,288 184,489 162,144
Loss (gain) on sales and calls of available-for-sale
securities, net 5,589 (1,944) (625,832)
Writedown of securities 1,240,868
Change in unearned income (3,946) 102,159 (40,927)
Provision (benefit) for loan losses 376,215 (602,326) (310,000)
Gain on sales of mortgage loans, net (195,817)
Depreciation and amortization 658,915 639,402 637,342
(Gain) loss on sale of property and equipment (1,400) 501
Increase in cash surrender value of life insurance policies (432,441) (510,744) (443,220)
(Increase) decrease in other assets (109,041) 39,511 (29,839)
(Increase) decrease in prepaid expenses (1,637,738) 51,976 142,237
Amortization of deferred costs relating to issuance of
subordinated debentures 4,169
Decrease (increase) in income taxes receivable 94,852 607,674 (714,639)
(Increase) decrease in interest receivable (472,047) (4,513) 461,398
Increase in other liabilities 11,794 78,062 211,588
Increase in accrued expenses 184,338 3,033 159,259
Increase (decrease) in interest payable 141,442 46,853 (13,394)
Deferred tax expense 710,835 315,424 116,667
------------ ------------ ------------
Net cash provided by operating activities 3,236,674 3,635,542 3,919,705
------------ ------------ ------------
Cash flows from investing activities:
Decrease (increase) in interest bearing time deposits
with other banks 100,000 (100,000)
Purchases of available-for-sale securities (57,976,387) (33,726,207) (37,391,128)
Proceeds from sales of available-for-sale securities 1,645,686 864,217 16,853,893
Proceeds from maturities of available-for-sale securities 19,535,749 50,993,737 33,638,864
Purchases of held-to-maturity securities (30,108,838) (4,926,305) (3,417,675)
Proceeds from maturities of held-to-maturity securities 3,586,258 7,308,637 5,990,548
Purchases of Federal Home Loan Bank stock (1,625,900) (2,010,400)
Investment in unconsolidated subsidiary (310,000)
Loan originations and principal collections, net (39,527,683) (71,600,640) (11,209,891)
Purchases of loans (2,176,873) (300,000)
Proceeds from sales of loans 8,487,112 2,484,080
Recoveries of loans previously charged off 95,771 113,131 62,397
Capital expenditures (886,449) (459,857) (253,582)
Proceeds from sale of property and equipment 1,400 10,099
Redemption of life insurance policy 331,026
Investment in life insurance policies (135,000) (1,050,500) (1,610,000)
Increase in limited partnership (119,050)
------------ ------------ ------------
Net cash (used in) provided by investing activities (97,238,731) (53,854,554) 2,273,525
------------ ------------ ------------
F-7
SLADE'S FERRY BANCORP. AND SUBSIDIARY
-------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
Years Ended December 31, 2004, 2003 and 2002
--------------------------------------------
(continued)
2004 2003 2002
------------ ------------ ------------
Cash flows from financing activities:
Net increase in demand deposits, NOW and savings accounts 48,091,783 12,376,880 22,661,421
Net increase (decrease) in time deposits 18,668,131 (14,864,595) (24,072,231)
Long-term advances from Federal Home Loan Bank 35,476,000 37,279,000 3,450,000
Payments on Federal Home Loan Bank long-term advances (1,364,448) (289,474) (1,247,749)
Net change in short-term advances from Federal Home Loan Bank (4,300,000) 4,300,000
Net decrease in other borrowed funds (465,216)
Proceeds from issuance of common stock 710,758 796,180 814,425
Stock options exercised 531,930 93,850 95,069
Retirement of shares of common stock (32,368)
Dividends paid (1,451,614) (1,429,456) (1,405,723)
Proceeds from issuance of subordinated debentures 10,160,000
Repurchase of minority interest preferred stock (56,000) (1,500)
Issuance of minority interest preferred stock 2,000 2,500
------------ ------------ ------------
Net cash provided by (used in) financing activities 106,490,172 38,208,385 (169,004)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 12,488,115 (12,010,627) 6,024,226
Cash and cash equivalents at beginning of year 22,705,909 34,716,536 28,692,310
------------ ------------ ------------
Cash and cash equivalents at end of year $ 35,194,024 $ 22,705,909 $ 34,716,536
============ ============ ============
Supplemental disclosures:
Interest paid $ 7,804,440 $ 6,026,317 $ 7,941,148
Income taxes paid 1,105,821 1,086,618 1,732,155
Transfer from premises and equipment to other assets 601,310
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, 2004, 2003 and 2002
--------------------------------------------
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 nine banking offices located in
Massachusetts. 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 I, Slade's Ferry Securities Corporation II, 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 I and Slade's Ferry Securities Corporation II were
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 Slade's Ferry Loan Company is currently
in the process of dissolution. Its assets and liabilities were transferred
to Slade's Ferry Trust Company. All significant intercompany accounts and
transactions have been eliminated in the consolidation.
Slade's Ferry Statutory Trust I, a subsidiary of the Company, was formed to
sell capital securities to the public through a third party trust pool. In
accordance with FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities" ("FIN 46"), the subsidiary has not been included in the
consolidated financial statements.
F-9
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.
Cash and due from banks as of December 31, 2004 and 2003 includes $2,417,000
and $1,936,000, 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. These
security classifications 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. During the three years ended
December 31, 2004, the Company did not classify any securities as
trading.
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.
F-10
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 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.
F-11
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 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.
Interest-bearing time deposits with banks: The fair values of interest-
bearing time deposits with banks are estimated using discounted cash flow
analyses using interest rates currently being offered for deposits with
similar terms to investors.
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.
F-12
Accrued interest receivable: The carrying amount of accrued interest
receivable approximates its fair value.
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.
Junior subordinated debentures: The fair value of the guaranteed preferred
beneficial interests in junior subordinated debentures are based on the
quoted market prices of the Slade's Ferry Statutory Trust I.
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, 2004, the Company has two stock-based employee compensation
plans which are described more fully in Note 16. The Company accounts for
the plans 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 16), as all options granted under these plans 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 (revised 2004), "Share Based Payments,"
to stock-based employee compensation.
For the years ended
December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Net income, as reported $3,652,267 $2,687,886 $2,965,552
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects 152,960 131,920 59,377
Pro forma net income $3,499,307 $2,555,966 $2,906,175
Earnings per share:
Basic - as reported $.90 $.68 $.76
Basic - pro forma $.86 $.64 $.74
Diluted - as reported $.89 $.67 $.75
Diluted - pro forma $.85 $.64 $.74
F-13
RECENT ACCOUNTING PRONOUNCEMENTS:
In April 2003, the Financial Accounting Standards Board (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 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
did not 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-14
In December 2003, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 03-3 ("SOP 03-3") "Accounting for
Certain Loans or Debt Securities Acquired in a Transfer." SOP 03-3 requires
loans acquired through a transfer, such as a business combination, where
there are differences in expected cash flows and contractual cash flows due
in part to credit quality be recognized at their fair value. The excess of
contractual cash flows over expected cash flows is not to be recognized as
an adjustment of yield, loss accrual, or valuation allowance. Valuation
allowances cannot be created nor "carried over" in the initial accounting
for loans acquired in a transfer on loans subject to SFAS 114, "Accounting
by Creditors for Impairment of a Loan." This SOP is effective for loans
acquired in fiscal years beginning after December 15, 2004, with early
adoption encouraged. The Company does not believe the adoption of SOP 03-3
will have a material impact on the Company's financial position or results
of operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R"). This Statement revises FASB Statement No. 123,
"Accounting for Stock Based Compensation" and supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and its related implementation
guidance. SFAS 123R requires that the cost resulting from all share-based
payment transactions be recognized in the financial statements. It
establishes fair value as the measurement objective in accounting for share-
based payment arrangements and requires all entities to apply a fair-value
based measurement method in accounting for share-based payment transactions
with employees except for equity instruments held by employee share
ownership plans. This Statement is effective for the Company as of the
beginning of the first interim or annual reporting period that begins after
June 15, 2005. The Company does not believe the adoption of this Statement
will have a material impact on the Company's financial position or results
of operations.
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:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
Available-for-sale securities:
December 31, 2004
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $41,418,625 $ 73,050 $285,505 $41,206,170
Mortgage-backed securities 27,804,747 467,956 65,632 28,207,071
Corporate debt securities 9,363,674 149,731 29,391 9,484,014
Mutual funds 1,216,624 17,137 1,233,761
Marketable equity securities 3,859,460 203,342 311,386 3,751,416
----------- -------- -------- -----------
$83,663,130 $911,216 $691,914 $83,882,432
=========== ======== ======== ===========
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
=========== ======== ======== ===========
F-15
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
Held-to-maturity securities:
December 31, 2004
Debt securities issued by states of the
United States and political subdivisions
of the states $ 8,587,702 $339,878 $ $ 8,927,580
Mortgage-backed securities 29,185,525 14,740 15,529 29,184,736
----------- -------- -------- -----------
$37,773,227 $354,618 $ 15,529 $38,112,316
=========== ======== ======== ===========
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
=========== ======== ======== ===========
The scheduled maturities of debt securities were as follows as of December
31, 2004
Available-For-Sale Held-To-Maturity
------------------ --------------------------
Fair Amortized Fair
Value Cost Basis Value
----------- ----------- -----------
Due within one year $ 2,216,105 $ 1,816,602 $ 1,841,747
Due after one year through five years 45,958,815 4,222,142 4,388,882
Due after five years through ten years 2,515,264 1,349,474 1,418,648
Due after ten years 1,199,484 1,278,303
Mortgage-backed securities 28,207,071 29,185,525 29,184,736
----------- ----------- -----------
$78,897,255 $37,773,227 $38,112,316
=========== =========== ===========
During 2004, proceeds from sales of available-for-sale securities amounted
to $1,645,686. Gross realized gains and gross realized losses on those
sales amounted to $175,918 and $65,266, respectively. 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. The tax expense applicable to these net realized gains
amounted to $38,586, $1,529 and $245,565 for the years ended December 31,
2004, 2003 and 2002, respectively.
There were no securities of issuers whose aggregate carrying amount exceeded
10% of stockholders' equity as of December 31, 2004.
Total carrying amounts of $66,231,668 and $18,089,060 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,
2004 and 2003, respectively.
F-16
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, 2004:
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 $15,445,358 $ 58,586 $10,770,149 $226,919 $26,215,507 $285,505
Corporate debt securities 2,034,760 29,391 2,034,760 29,391
Mortgage-backed securities 24,304,191 81,161 24,304,191 81,161
Marketable equity securities 613,740 55,064 1,228,922 256,322 1,842,662 311,386
----------- -------- ----------- -------- ----------- ---------
Total temporarily impaired securities $42,398,049 $224,202 $11,999,071 $483,241 $54,397,120 $707,443
=========== ======== =========== ======== =========== ========
The investments in the Company's investment portfolio that are temporarily
impaired as of December 31, 2004 consist of both debt securities guaranteed
or issued by government agencies with strong credit ratings, and common
stock and debt 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 and corporate debt
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 recommendations of investment
advisors or market analyst. Based on the Company's December 31, 2004
quarterly review of securities in the investment portfolio, management
deemed securities with unrealized losses as of year end 2004 to be
temporarily impaired.
NOTE 4 - LOANS
- --------------
Loans consisted of the following as of December 31:
2004 2003
------------ ------------
Commercial, financial and agricultural $ 26,605,804 $ 33,980,019
Real estate - construction and land development 24,240,417 10,346,259
Real estate - residential 97,496,035 88,018,791
Real estate - commercial 192,822,179 181,401,095
Home equity lines of credit 23,130,602 18,329,921
Consumer 2,510,309 4,018,227
------------ ------------
366,805,346 336,094,312
Allowance for loan losses (4,101,026) (4,154,394)
Unearned income (439,447) (443,393)
------------ ------------
Net loans, carrying amount $362,264,873 $331,496,525
============ ============
Certain directors and executive officers of the Company and companies in
which they have significant ownership interest were customers of the Bank
during 2004. Total loans to such persons and their companies amounted to
$6,954,892 as of December 31, 2004. During the year ended December 31,
2004, $9,648,005 of advances were made and principal payments totaled
$10,776,877.
F-17
Changes in the allowance for loan losses were as follows for the years ended
December 31:
2004 2003 2002
---------- ---------- ----------
Balance at beginning of period $4,154,394 $4,854,388 $5,484,519
Loans charged off (525,354) (210,799) (382,528)
Provision (benefit) for loan losses 376,215 (602,326) (310,000)
Recoveries of loans previously charged off 95,771 113,131 62,397
---------- ---------- ----------
Balance at end of period $4,101,026 $4,154,394 $4,854,388
========== ========== ==========
The following table sets forth information regarding nonaccrual loans and
accruing loans 90 days or more overdue as of December 31:
2004 2003
-------- --------
Nonaccrual loans $505,888 $407,363
======== ========
Accruing loans which are 90 days or more overdue $ 0 $ 0
======== ========
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:
2004 2003
------------------------- -------------------------
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 $ 67,195 $3,359 $1,858,135 $275,071
Loans for which there is no related
allowance for credit losses 48,805 106,656
-------- ----------
Totals $116,000 $3,359 $1,964,791 $275,071
======== ====== ========== ========
Average recorded investment in impaired loans
during the year ended December 31 $933,320 $2,193,189
======== ==========
Related amount of interest income recognized
during the time, in the year ended December 31,
that the loans were impaired
Total recognized $111,888 $ 124,281
======== ==========
Amount recognized using a cash-basis
method of accounting $ 17,011 $ 30,000
======== ==========
NOTE 5 - PREMISES AND EQUIPMENT
- -------------------------------
The following is a summary of premises and equipment as of December 31:
2004 2003
----------- -----------
Land $ 1,600,368 $ 1,710,368
Buildings 6,354,562 6,968,527
Furniture and equipment 5,578,044 5,054,017
Leasehold improvements 22,125 383,436
Assets in process 151,160
----------- -----------
13,706,259 14,116,348
Accumulated depreciation and amortization (8,178,897) (8,221,612)
----------- -----------
$ 5,527,362 $ 5,894,736
=========== ===========
F-18
NOTE 6 - DEPOSITS
- -----------------
The aggregate amount of time deposit accounts in denominations of $100,000
or more as of December 31, 2004 and 2003 was $35,406,479 and $25,430,252,
respectively.
For time deposits as of December 31, 2004, the scheduled maturities for each
of the following five years ended December 31, and thereafter, are:
2005 $128,441,274
2006 14,003,978
2007 3,841,772
2008 849,022
2009 1,172,597
Thereafter 9,175
------------
Total $148,317,818
============
Deposits from related parties held by the Company as of December 31, 2004
and 2003 amounted to $3,599,188 and $2,723,564, respectively.
NOTE 7 - FEDERAL HOME LOAN BANK (FHLB) ADVANCES
- -----------------------------------------------
Maturities and scheduled amortization of advances from the FHLB for the five
years ending after December 31, 2004, and thereafter, are summarized as
follows:
AMOUNT
------
2005 $ 8,421,227
2006 8,449,361
2007 20,973,491
2008 16,933,732
2009 17,425,778
Thereafter 18,082,827
-----------
$90,286,416
===========
As of December 31, 2004, the following advances from the FHLB were
redeemable at par at the option of the FHLB:
MATURITY DATE OPTIONAL REDEMPTION DATE AMOUNT
------------- ------------------------ ------
January 7, 2015 January 7, 2005 and quarterly thereafter $ 3,000,000
September 15, 2008 September 14, 2005 and quarterly thereafter 10,000,000
September 14, 2009 September 14, 2006 and quarterly thereafter 10,000,000
As of December 31, 2004, a $4,000,000 advance from the FHLB maturing in 2009
is redeemable at par on September 15, 2005 and each calendar quarter
thereafter; if and when the 3-month LIBOR is greater than or equal to 4.50
percent.
Interest rates on FHLB advances ranged from 1.84 percent to 7.72 percent.
At December 31, 2004, the weighted average interest rate on FHLB advances
was 3.70 percent.
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.
F-19
NOTE 8 - SUBORDINATED DEBENTURES
- --------------------------------
On March 17, 2004, Slade's Ferry Statutory Trust I (the "Trust") , a
Connecticut Statutory trust formed by the Company, completed the sale of
$10,000,000 of floating rate trust preferred securities (liquidation amount
of $1,000 per security) in a private placement as part of a pooled trust
preferred securities transaction. The Trust also issued common securities
to the Company and used the net proceeds from the offering to purchase a
like amount of floating rate junior subordinated deferrable interest
debentures of the Company. The subordinated debentures are the sole assets
of the Trust. The Company contributed $10,000,000 of the proceeds from the
sale of the subordinated debentures to the Bank as Tier I Capital to support
the Bank's growth. Total expenses associated with the offering
approximating $150,000 are included in other assets and are being amortized
on a straight-line basis over the life of the subordinated debentures.
The trust preferred securities accrue and pay distributions quarterly at a
floating rate of 3-Month LIBOR plus 2.79% of the stated liquidation amount
of $1,000 per trust preferred security. At December 31, 2004, this rate was
5.29%. The Company has fully and unconditionally guaranteed all of the
obligations of the Trust, including the semi-annual distributions and
payments on liquidation or redemption of the trust preferred securities.
The trust preferred securities are mandatorily redeemable upon the maturing
of the subordinated debentures on March 17, 2034 or upon earlier redemption
as provided in the Indenture. The Company has the right to redeem the
subordinated debentures, in whole or in part, on or after March 17, 2009 at
par value, plus any accrued but unpaid interest to the redemption date.
Redemption may occur prior to March 17, 2009 under certain conditions, at a
premium to par value.
NOTE 9 - INCOME TAXES
- ---------------------
The components of income tax expense are as follows for the years ended
December 31:
2004 2003 2002
---------- ---------- ----------
Current:
Federal $ 877,646 $ 498,670 $ 920,469
State 323,027 1,195,622 97,047
---------- ---------- ----------
1,200,673 1,694,292 1,017,516
---------- ---------- ----------
Deferred:
Federal 558,636 309,650 79,782
State 166,981 93,762 36,885
Change in the valuation allowance (14,782) (87,988)
---------- ---------- ----------
710,835 315,424 116,667
---------- ---------- ----------
Total income tax expense $1,911,508 $2,009,716 $1,134,183
========== ========== ==========
The reasons for the differences between the statutory federal income tax
rate and the effective tax rates are summarized as follows for the years
ended December 31:
2004 2003 2002
------ ------ ------
% of % of % of
Income Income Income
------ ------ ------
Federal income tax at statutory rate 34.0% 34.0% 34.0%
Increase (decrease) in tax resulting from:
Tax-exempt income (5.1) (7.4) (8.5)
Dividends received deduction (.4) (.4) (.6)
Unallowable expenses .4 .4 .6
State tax, net of federal tax benefit 5.8 5.7 2.2
Additional state tax, net of federal tax benefit
due to REIT dividend deduction settlement 12.4
Change in valuation allowance (.3) (1.9)
---- ---- ----
Effective tax rates 34.4% 42.8% 27.7%
==== ==== ====
F-20
The Company had gross deferred tax assets and gross deferred tax liabilities
as follows as of December 31:
2004 2003
---------- -----------
Deferred tax assets:
Allowance for loan losses $1,545,289 $1,567,133
Deferred loan fees 185,930 189,949
Interest on non-performing loans 48,005 67,005
Accrued employee benefits 133,015 120,712
Deferred compensation 114,616 33,065
Writedown of securities 52,941 52,941
Minimum pension liability adjustment 412,891
Net unrealized holding loss on available-for-sale equity securities 54,444 54,937
Other adjustments 292
---------- ----------
Gross deferred tax assets 2,134,240 2,498,925
Valuation allowance (69,719)
---------- ----------
2,134,240 2,429,206
---------- ----------
Deferred tax liabilities:
Accelerated depreciation (343,791) (233,247)
Prepaid pensions (757,967) (94,574)
Discount accretion (1,942) (1,563)
Deferred gain on stock conversion (2,317) (2,317)
Net unrealized holding gain on available-for-sale debt securities (148,758) (101,292)
---------- ----------
Gross deferred tax liabilities (1,254,775) (432,993)
---------- ----------
Net deferred tax asset $ 879,465 $1,996,213
========== ==========
Deferred tax assets as of December 31, 2004 have not been reduced by a
valuation allowance because management believes that it is more likely than
not that the full amount of deferred taxes will be realized.
As of December 31, 2004, the Company had no operating loss and tax credit
carryovers for tax purposes.
REIT Dividend Deduction Settlement
- ----------------------------------
Slade's Ferry Preferred Capital Corporation ("SFPCC"), a subsidiary of the
Bank, was established in 1999 as a Massachusetts-chartered real estate
investment trust ("REIT"). The Bank received dividends from SFPCC.
On March 5, 2003, the Commonwealth of Massachusetts enacted tax legislation
which denied the dividends received deduction for dividends received from
real estate investment trusts retroactively to 1999. The additional state
tax liability created by the new law for the Bank would have been $1,763,580
plus previously assessed interest of $257,954 for the calendar years 1999
through 2002.
On June 20, 2003, the Bank and its subsidiary real estate investment trust,
SFPCC, 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. Therefore, the previously unrecorded tax liability of $881,790,
interest of $128,977 and federal and state tax benefits of $352,599 were
recognized during the year ended December 31, 2003.
NOTE 10 - EMPLOYEE BENEFITS
- ---------------------------
The Company has a defined benefit pension plan (plan) that up to January 1,
1998 covered substantially all of its full time employees who met certain
eligibility requirements. On January 1, 1998 the Bank suspended the plan so
that employees no longer earn additional defined benefits for future
service. Employees were eligible under the plan upon attaining age 21 and
completing one year of service. The benefits paid are based on 1.5% of
total salary plus .5% of compensation in excess of the integration level per
year of service. The integration level was the first $750 of monthly
compensation. The accrued benefit is based on years of service.
F-21
The following tables set forth information about the plan as of December 31,
the measurement date, and the years then ended:
2004 2003 2002
---------- ----------- ----------
Change in projected benefit obligation:
Benefit obligation at beginning of year $1,756,398 $1,189,808 $1,125,986
Interest cost 112,200 107,472 70,896
Service cost 16,512 14,227
Actuarial loss 63,798 743,424 106,111
Expected distributions (264,480) (298,533) (113,185)
---------- ---------- ----------
Benefit obligation at end of year 1,684,428 1,756,398 1,189,808
---------- ---------- ----------
Change in plan assets:
Plan assets at estimated fair value at beginning of year 621,729 672,631 830,561
Correction of prior period 138,583
Employer contribution 1,710,300 150,000
Actual return on plan assets 26,610 (40,952) (44,745)
Benefits paid (264,480) (298,533) (113,185)
---------- ---------- ----------
Fair value of plan assets at end of year 2,094,159 621,729 672,631
---------- ---------- ----------
Funded status at end of year 409,731 (1,134,669) (517,177)
Unrecognized net actuarial loss 1,327,750 1,321,204 680,356
Unrecognized prior service cost 44,029 47,541 34,365
Unamortized net obligation existing at date of adoption of SFAS No. 87 70,351 78,358 86,365
---------- ---------- ----------
Net amount recognized $1,851,861 $ 312,434 $ 283,909
---------- ---------- ----------
Amounts recognized in the balance sheet consist of:
Prepaid benefit cost $1,851,861 $ 312,434 $ 283,909
Accrued benefit liability (1,134,669) (517,177)
Intangible asset 125,899 120,730
Accumulated other comprehensive loss before income tax benefit 1,008,770 396,447
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Net amount recognized $1,851,861 $ 312,434 $ 283,909
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The accumulated benefit obligation for all defined benefit pension plans was
$1,684,428 and $1,756,398 at December 31, 2004 and 2003, respectively.
The discount rate used in determining the actuarial present value of the
projected benefit obligation was 6.25% for 2004 and 2003.
Components of net periodic benefit cost:
2004 2003 2002
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