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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
Quarterly Report Under Section 13 of the Securities Exchange Act of 1934
For quarter ended: March 31, 2005
Commission File No. 001-16101
BANCORP RHODE ISLAND, INC.
- ----------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
RHODE ISLAND 05-0509802
- ------------------------------------------ ------------------------------
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
- ----------------------------------------------------------------------------
(Address of Principal Executive Offices)
(401) 456-5000
- ----------------------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Not Applicable
- ----------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes (X) No
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes (X) No
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of May 2, 2005:
Common Stock - Par Value $0.01 4,570,279 shares
------------------------------ ----------------
(class) (outstanding)
BANCORP RHODE ISLAND, INC.
FORM 10-Q
INDEX
PAGE NUMBER
-----------
Cover Page 1
Index 2
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Changes in
Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7 - 9
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 10 - 22
Item 3 Quantitative and Qualitative Disclosures About Market Risk 23 - 24
Item 4 Controls and Procedures 24
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 25
Item 2 Changes in Securities 25
Item 3 Default upon Senior Securities 25
Item 4 Submission of Matters to a Vote of Security Holders 25
Item 5 Other Information 25
Item 6 Exhibits and Reports on Form 8-K 25
Signature Page 26
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
(Unaudited)
March 31, December 31,
2005 2004
--------- ------------
(In thousands)
ASSETS:
Cash and due from banks $ 24,475 $ 21,585
Overnight investments 6,780 14,094
---------- ----------
Total cash and cash equivalents 31,255 35,679
Investment securities available for sale
(amortized cost of $131,839 and $103,953
at March 31, 2005 and December 31, 2004,
respectively) 130,021 104,600
Mortgage-backed securities available for sale
(amortized cost of $186,361 and $159,581 at
March 31, 2005 and December 31, 2004,
respectively) 184,518 159,946
Stock in Federal Home Loan Bank of Boston 13,843 13,229
Loans and leases receivable:
Commercial loans and leases 405,043 402,770
Residential mortgage loans 326,579 316,135
Consumer and other loans 174,811 167,396
---------- ----------
Total loans and leases receivable 906,433 886,301
Less allowance for loan and lease losses (12,212) (11,906)
---------- ----------
Net loans and leases receivable 894,221 874,395
Premises and equipment, net 12,106 11,857
Goodwill 10,766 10,766
Accrued interest receivable 6,246 5,666
Investment in bank-owned life insurance 18,304 18,132
Prepaid expenses and other assets 7,101 4,799
---------- ----------
Total assets $1,308,381 $1,239,069
========== ==========
LIABILITIES:
Deposits:
Demand deposit accounts $ 174,750 $ 167,682
NOW accounts 101,269 108,159
Money market accounts 18,081 16,489
Savings accounts 328,026 339,836
Certificate of deposit accounts 278,975 248,508
---------- ----------
Total deposits 901,101 880,674
Overnight and short-term borrowings 24,255 18,050
Wholesale repurchase agreements 19,880 --
Federal Home Loan Bank of Boston borrowings 258,757 234,778
Subordinated deferrable interest debentures 18,558 18,558
Other liabilities 8,040 8,086
---------- ----------
Total liabilities 1,230,591 1,160,146
---------- ----------
SHAREHOLDERS' EQUITY:
Preferred stock, par value $0.01 per share,
authorized 1,000,000 shares:
Issued and outstanding: none -- --
Common stock, par value $0.01 per share,
authorized 11,000,000 shares:
Issued and outstanding 4,019,329 shares
and 4,010,554 shares, respectively 40 40
Additional paid-in capital 42,951 42,852
Retained earnings 37,178 35,373
Accumulated other comprehensive income, net (2,379) 658
---------- ----------
Total shareholders' equity 77,790 78,923
---------- ----------
Total liabilities and shareholders'
equity $1,308,381 $1,239,069
========== ==========
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
(Unaudited)
Three Months Ended
March 31,
------------------------
2005 2004
---------- ----------
(In thousands, except per share data)
Interest and dividend income:
Commercial loans and leases $ 6,370 $ 5,209
Residential mortgage loans 3,969 4,695
Consumer and other loans 2,186 1,429
Mortgage-backed securities 1,797 1,121
Investment securities 1,237 1,096
Overnight investments 56 23
Federal Home Loan Bank of Boston stock dividends 130 51
---------- ----------
Total interest and dividend income 15,745 13,624
---------- ----------
Interest expense:
NOW accounts 177 377
Money market accounts 55 55
Savings accounts 1,012 849
Certificate of deposit accounts 1,722 1,394
Overnight and short-term borrowings 115 35
Wholesale repurchase agreements 8 --
Federal Home Loan Bank of Boston borrowings 1,988 1,753
Subordinated deferrable interest debentures 297 219
---------- ----------
Total interest expense 5,374 4,682
---------- ----------
Net interest income 10,371 8,942
Provision for loan and lease losses 300 300
---------- ----------
Net interest income after provision for
loan and lease losses 10,071 8,642
---------- ----------
Noninterest income:
Service charges on deposit accounts 1,083 1,012
Commissions on nondeposit investment products 200 178
Income from bank owned life insurance 172 165
Loan related fees 283 109
Commissions on loans originated for others 24 17
Gains on sales of investment securities -- 197
Loss on sales of mortgage-backed securities (8) --
Other income 321 320
---------- ----------
Total noninterest income 2,075 1,998
---------- ----------
Noninterest expense:
Salaries and employee benefits 4,623 3,893
Occupancy 732 680
Equipment 399 386
Data processing 752 670
Marketing 321 355
Professional services 488 285
Loan servicing 227 278
Loan workout and other real estate owned expense 11 22
Other expenses 959 1,006
---------- ----------
Total noninterest expense 8,512 7,575
---------- ----------
Income before income taxes 3,634 3,065
Income tax expense 1,227 1,001
---------- ----------
Net income $ 2,407 $ 2,064
========== ==========
Per share data:
Basic earnings per common share $ 0.60 $ 0.52
Diluted earnings per common share $ 0.57 $ 0.49
Average common shares outstanding - basic 4,009,464 3,946,668
Average common shares outstanding - diluted 4,257,036 4,193,328
See accompanying notes to consolidated financial statements
4
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity
(Unaudited)
Accumulated
Other
Compre-
Additional hensive
Common Paid-in Retained Income
Three months ended March 31, Stock Capital Earnings (Loss), Net Total
------ ---------- -------- ----------- -----
(In thousands)
2004
- ----
Balance at December 31, 2003 $39 $41,439 $29,074 $ 1,555 $72,107
Net income -- -- 2,064 -- 2,064
Other comprehensive income,
net of tax:
Unrealized holding gains on
securities available for sale,
net of taxes of $(504) 936 936
Reclassification adjustment,
net of taxes of $64 (133) (133)
-------
Comprehensive income 2,867
Exercise of stock options 1 179 -- -- 180
Exercise of stock warrants -- 700 -- -- 700
Common stock issued for
incentive stock award, net -- 9 -- -- 9
Dividends on common stock
($ 0.14 per common share) -- -- (557) -- (557)
--- ------- ------- ------- -------
Balance at March 31, 2004 $40 $42,327 $30,581 $ 2,358 $75,306
=== ======= ======= ======= =======
2005
- ----
Balance at December 31, 2004 $40 $42,852 $35,373 $ 658 $78,923
Net income -- -- 2,407 -- 2,407
Other comprehensive income,
net of tax:
Unrealized holding losses on
securities available for sale,
net of taxes of $1,631 (3,042) (3,042)
Reclassification adjustment,
net of taxes of $(3) 5 5
-------
Comprehensive loss (630)
Exercise of stock options -- 90 -- -- 90
Common stock issued for
incentive stock award, net -- 9 -- -- 9
Dividends on common stock
($ 0.15 per common share) -- -- (602) -- (602)
--- ------- ------- ------- -------
Balance at March 31, 2005 $40 $42,951 $37,178 $(2,379) $77,790
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
March 31,
---------------------
2005 2004
-------- --------
(In thousands)
Cash flows from operating activities:
Net income $ 2,407 $ 2,064
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation and amortization 701 874
Provision for loan losses 300 300
Gain on sale of investment securities -- (197)
Loss on sale of mortgage-backed securities 8 --
Gain on sale of other real estate owned -- --
Income from bank-owned life insurance (172) (165)
Compensation expense from restricted stock grant 9 9
(Increase) decrease in:
Accrued interest receivable (580) 56
Prepaid expenses and other assets (667) (882)
Increase (decrease) in:
Other liabilities (46) (335)
Other, net 6 3
-------- --------
Net cash provided by operating activities 1,966 1,727
-------- --------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (2,674) (3,003)
Commercial loans (20,964) (22,432)
Consumer loans (16,055) (17,658)
Purchase of:
Investment securities available for sale (27,933) (9,998)
Mortgage-backed securities available for sale (38,929) (5,016)
Residential mortgage loans (22,230) (17,091)
Federal Home Loan Bank of Boston stock (614) --
Principal payments on:
Investment securities available for sale -- 9,000
Mortgage-backed securities available for sale 8,686 11,212
Residential mortgage loans 14,398 29,955
Commercial loans 18,770 6,179
Consumer loans 8,570 11,313
Proceeds from sale of investment securities -- 2,243
Proceeds from sale of mortgage-backed securities 3,423 --
Capital expenditures for premises and equipment (817) (978)
-------- --------
Net cash used by investing activities (76,369) (6,274)
-------- --------
Cash flows from financing activities:
Net increase in deposits 20,427 25,375
Net increase in overnight and short-term
borrowings 6,205 5,232
Proceeds from long-term borrowings 79,880 22,155
Repayment of long-term borrowings (36,021) (19,981)
Proceeds from issuance of common stock 90 880
Dividends on common stock (602) (557)
-------- --------
Net cash provided by financing activities 69,979 33,104
-------- --------
Net increase (decrease) in cash and cash equivalents (4,424) 28,557
Cash and cash equivalents at beginning of period 35,679 27,817
-------- --------
Cash and cash equivalents at end of period $ 31,255 $ 56,374
======== ========
Supplementary Disclosures:
Cash paid for interest $ 5,203 $ 4,567
Cash paid for income taxes 432 1,225
Non-cash transactions:
Change in other comprehensive income, net of taxes (3,037) 803
See accompanying notes to consolidated financial statements
6
BANCORP RHODE ISLAND, INC.
Notes to Consolidated Financial Statements
(1) Basis of Presentation
Bancorp Rhode Island, Inc. (the "Company"), a Rhode Island
corporation, is the holding company for Bank Rhode Island (the "Bank"). The
Company has no significant assets other than the common stock of the Bank.
For that reason, substantially all of the discussion in this Quarterly
Report on Form 10-Q relates to the operations of the Bank and its
subsidiaries.
The audited consolidated financial statements include the accounts of
the Company and its wholly-owned direct subsidiary, the Bank, and its
indirect subsidiaries, BRI Investment Corp. (a Rhode Island passive
investment company), BRI Realty Corp. (a real estate holding company) and
Acorn Insurance Agency, Inc. (a licensed insurance agency). The Company
adopted Financial Accounting Standards Board ("FASB") Interpretation 46-R,
"Consolidation of Variable Interest Entities - Revised" on December 31,
2003, and therefore deconsolidated its statutory trust subsidiaries as of
that date. All significant intercompany accounts and transactions have been
eliminated in consolidation.
The unaudited interim results of consolidated operations are not
necessarily indicative of the results for any future interim period or for
the entire year. These interim consolidated financial statements do not
include all disclosures associated with annual financial statements and,
accordingly, should be read in conjunction with the annual consolidated
financial statements and accompanying notes included in the Company's Annual
Report on Form 10-K filed with the Securities and Exchange Commission
("SEC").
In preparing the unaudited consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance
sheet and revenues and expenses for the period. Actual results could differ
from those estimates. Material estimates that are particularly susceptible
to change relate to the determination of the allowance for loan losses and
goodwill valuation.
The unaudited interim consolidated financial statements of the Company
have been prepared in accordance with U.S. Generally Accepted Accounting
Principles ("GAAP") and prevailing practices within the banking industry and
include all necessary adjustments (consisting of only normal recurring
adjustments), that, in the opinion of management, are required for a fair
presentation of the results and financial condition of the Company.
(2) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and resulted in the issuance of additional
common stock that then shared in the earnings of the Company.
7
(3) Stock Based Compensation
The Company has adopted Statement of Financial Accounting Standards
("SFAS") 123, "Accounting for Stock-Based Compensation." This Statement
establishes a fair value based method of accounting for stock-based
compensation plans under which compensation cost is measured at the grant
date based on the value of the award and is recognized over the service
period. However, the Statement allows a company to continue to measure
compensation cost for such plans using the intrinsic value method under
which no compensation cost is recorded if, at the grant date, the exercise
price of the option is equal to the fair market value of the company's
stock. The Company has elected to continue to follow the intrinsic value
method, accordingly, the Company must disclose in the notes to their
financial statements various information as if the fair value based method
of accounting had been applied.
In December 2004, the FASB issued SFAS 123-R, "Share-Based Payment",
which requires companies to recognize an expense in the income statement for
the grant-date fair value of stock options and other equity-based
compensation issued to employees using the fair value method. This expense
will be recognized over the period during which an employee is required to
provide service in exchange for the award. This Statement carries forward
prior guidance on accounting for awards to non-employees. If an equity award
is modified after grant date, incremental compensation cost will be
recognized in an amount equal to the excess of the fair value of the
modified award over the fair value of the original award immediately prior
to the modification.
On April 14, 2005, the SEC announced the adoption of a new rule that
amends the compliance dates for SFAS 123-R, which requires registrants to
implement SFAS 123-R at the beginning of their next fiscal year, instead of
the next reporting period, that begins after June 15, 2005, which for the
Company is January 1, 2006.
The following table summarizes the differences between the fair value
and intrinsic value methods of accounting for stock-based compensation:
Three Months Ended March 31,
----------------------------
2005 2004
---- ----
Net income (in thousands):
As reported $2,407 $2,064
Compensation cost, net of taxes (1) (38) (54)
------ ------
Pro forma $2,369 $2,010
====== ======
Earnings per common share:
Basic:
As reported $ 0.60 $ 0.52
Compensation cost, net of taxes (1) (0.01) (0.01)
------ ------
Pro forma $ 0.59 $ 0.51
====== ======
Diluted:
As reported $ 0.57 $ 0.49
Compensation cost, net of taxes (1) (0.01) (0.01)
------ ------
Pro forma $ 0.56 $ 0.48
====== ======
The stock-based employee compensation cost, net of related tax
effects, that would have been included in the determination of net
income if the fair value based method had been applied to all awards
granted since 1995. The fair value of each option granted was
estimated as of the date of the grant using the Black-Scholes option-
pricing model.
8
(4) Supplemental Executive Retirement Plans
The Bank maintains Supplemental Executive Retirement Plans ("SERPs")
for certain of its executives under which participants designated by the
Board of Directors are entitled to an annual retirement benefit. Expenses
associated with the SERPs were $144,000 and $107,000 for the three months
ending March 31, 2005 and 2004, respectively. Accrued liabilities associated
with the SERPs were $1.4 million and $1.2 million for March 31, 2005 and
December 31, 2004, respectively.
(5) Recent Accounting Developments
At the November 2003 meeting of FASB's Emerging Issues Task Force
("EITF"), the EITF reached consensus on EITF Issue 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
The consensus requires new disclosure requirements for holders of debt or
marketable equity securities that are accounted for under SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities." The new
disclosure requirements relate to temporarily impaired investments and are
effective for fiscal years ending after December 15, 2003. The requirements
apply only to annual financial statements and comparative disclosures for
prior periods are not required. The guidance also dictates when impairment
is deemed to exist, provides guidance on determining if impairment is other
than temporary, and directs how to calculate impairment loss. The Company
adopted the EITF's recommendations on December 31, 2003, and has provided
additional disclosures regarding any possible other-than-temporarily
impaired investments in its Annual Report on Form 10-K. Adoption of these
recommendations did not have a material impact on the Company's financial
position or results of operations.
In September 2004, the EITF issued EITF 03-1-1, "Effective Date of
Paragraphs 10-20 of EITF Issue 03-1, 'The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments'", which delays the
effective date of those paragraphs to be concurrent with the final issuance
of EITF 03-1-a, "Implementation Guidance for the Application of Paragraph 16
of EITF 03-1, 'The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments'." EITF 03-1-a is currently being debated
by the FASB in regards to final guidance and effective date with a comment
period that ended October 29, 2004. EITF 03-1, as issued, was originally
effective for periods beginning after June 15, 2004. The Company anticipates
that the adoption of EITF 03-1-1 or EITF 03-1-a will not have a material
impact on the Company's financial position or results of operations.
(6) Subsequent Events
On February 23, 2005, the Company filed a registration statement on
Form S-3 with the SEC with respect to a proposed offering of 550,000 shares
of common stock. The underwriters of the offering were also granted a 30-day
option to purchase up to an additional 82,500 shares of common stock to
cover any over-allotments. On April 12, 2005, the SEC declared the Company's
registration statement effective and on April 18, 2005 the Company issued
550,000 shares of common stock for net proceeds (after underwriting
discounts and commissions and expenses) of approximately $18.7 million. The
underwriters may exercise their option to purchase the additional 82,500
shares at any time on or before May 12, 2005. The Company intends to retain
the net proceeds from this offering at the Company level for general
business purposes and working capital and intends to downstream such
proceeds to the Bank as necessary to provide regulatory capital to support
asset growth and continued expansion of the Bank's business, including the
addition of branches.
9
BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis
ITEM 2. Management's Discussion and Analysis
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
- -------------------------------------------------
We make certain forward looking statements in this Quarterly Report on
Form 10-Q and in other documents that we incorporate by reference into this
report that are based upon our current expectations and projections about
current events. We intend these forward looking statements to be covered by
the safe harbor provisions for "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended and Section
21E of the Securities Exchange Act of 1934, as amended, and we are including
this statement for purposes of these safe harbor provisions. You can
identify these statements by reference to a future period or periods by our
use of the words "estimate," "project," "may," "believe," "intend,"
"anticipate," "plan," "seek," "expect" and similar terms or variations of
these terms.
Actual results may differ materially from those set forth in forward
looking statements as a result of risks and uncertainties, including those
detailed from time to time in our filings with the Securities and Exchange
Commission. Our forward looking statements do not reflect the potential
impact of any future acquisition, mergers, dispositions, joint ventures or
investments we may make. We do not assume any obligation to update any
forward looking statements.
GENERAL
- -------
The Company's principal subsidiary, Bank Rhode Island, is a commercial
bank chartered as a financial institution in the State of Rhode Island. The
Bank pursues a community banking mission and is principally engaged in
providing banking products and services to individuals and businesses in
Rhode Island and nearby areas of Massachusetts. The Bank is subject to
competition from a variety of traditional and nontraditional financial
service providers both within and outside of Rhode Island. The Bank offers
its customers a wide range of commercial real estate, business, residential
and consumer loans, deposit products, nondeposit investment products, cash
management, and other banking products and services designed to meet the
financial needs of individuals and small- to mid-sized businesses. The Bank
also offers both commercial and consumer on-line banking products and
maintains a web site at http://www.bankri.com. The Company and Bank are
subject to regulation by a number of federal and state agencies and undergo
periodic examinations by certain of those regulatory authorities. The Bank's
deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"),
subject to regulatory limits. The Bank is also a member of the Federal Home
Loan Bank of Boston ("FHLB").
OVERVIEW
- --------
The Company's operating results depend primarily on two factors: its
"net interest income" and the quality of its assets.
The Company's net interest income is the difference between its
interest income and its cost of money. Interest income depends on the amount
of interest-earning assets outstanding during the period and the interest
rates earned thereon. Cost of money is a function of the average amount of
10
deposits and borrowed money outstanding during the period and the interest
rates paid thereon. See discussion under "Results of Operations - Comparison
of Three Months Ended March 31, 2005 and 2004." Because the Company's assets
are not identical in duration and in repricing dates to its liabilities, the
spread between the two is vulnerable to changes in market interest rates as
well as the overall shape of the yield curve. These vulnerabilities are
inherent to the business of banking and are commonly referred to as
"interest rate risk." How to measure interest rate risk and, once measured,
how much risk to take are based on numerous assumptions and other subjective
judgments. See discussion under "Interest Rate Risk."
The quality of the Company's assets also influences its earnings.
Loans that are not being paid on a timely basis and exhibit other weaknesses
can result in the loss of principal and/or interest income. Additionally,
the Company must make timely provisions to its allowance for loan and lease
losses as a result of its estimates as to potential future losses; these
additions, which are charged against earnings, are necessarily greater when
greater potential losses are expected. Finally, the Company will incur
expenses as a result of resolving troubled assets. All of these form the
"credit risk" that the Company takes on in the ordinary course of its
business and is further discussed under "Financial Condition - Asset
Quality."
The Company's business strategy has been to concentrate its asset
generation efforts on commercial and consumer loans and its deposit
generation efforts on checking and savings accounts. These deposit accounts
are commonly referred to as "core deposit accounts." This strategy is based
on the Company's belief that it can distinguish itself from its larger
competitors, and indeed attract customers from them, through a higher level
of service and through its ability to set policies and procedures, as well
as make decisions, locally. The loan and deposit products referenced also
tend to be geared more toward customers who are relationship oriented than
those who are seeking stand-alone or single transaction products. The
Company believes that its service-oriented approach enables it to compete
successfully for relationship-oriented customers. Additionally, the Company
is predominantly an urban franchise with a high concentration of businesses
making deployment of funds in the commercial lending area practicable.
Commercial loans are attractive, among other reasons, because of their
higher yields. Similarly, core deposits are attractive because of their
generally lower interest cost and potential for fee income.
In recent years, the Company also has sought to promote business
opportunities presented by its customer base, franchise footprint and system
resources through increased efforts in the area of consumer lending and to a
lesser degree, residential mortgage originations.
The deposit market in Rhode Island is highly concentrated. The State's
three largest banks have an aggregate market share of 84% (based upon June
2004 FDIC statistics, excluding one bank that draws its deposits primarily
from the internet) in Providence and Kent Counties, the Bank's primary
marketplace. Competition for loans and deposits has intensified during the
past year. With Bank of America entering New England for the first time
during 2004, numerous institutions in the market have heightened their
advertising and promotional product offerings.
Currently, approximately 80% of the Company's revenues (defined as net
interest income plus noninterest income) are derived from its level of net
interest income. In an effort to diversify its sources of revenue, the
Company has attempted to expand its sources of noninterest income, primarily
fees and charges for products and services it offers. The Company has
increased its percentage of noninterest income to total revenue from 12.0%
in 2000, to 18.4% in 2004, by
11
emphasizing core deposit growth which generates increased service charges,
and by introducing additional financial services, such as nondeposit
investment products.
The future operating results of the Company will depend on its ability
to maintain and expand its net interest margin, while minimizing its
exposure to credit risk, along with increasing its sources of noninterest
income, while controlling the growth of its noninterest or operating
expenses.
Total assets increased $69.3 million, or 5.6%, to $1.3 billion at
March 31, 2005 from December 31, 2004. This increase was centered in the
Company's investment, mortgage-backed and residential loan portfolios and
was funded primarily by a combination of deposit and borrowings growth.
Total deposits increased $20.4 million, or 2.3%, and was centered in demand
deposits (up $7.1 million, or 4.2%) and certificates of deposit (up $30.5
million, or 12.3%). Meanwhile, total borrowings increased $50.1 million, or
18.4%, as softer total deposit growth resulted in the Company utilizing
borrowings (including wholesale repurchase agreements) to fund the majority
of its asset growth. Shareholders' equity was $77.8 million at March 31,
2005, and represented 5.9% of total assets.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying
value of certain assets or net income, are considered critical accounting
policies. The Company considers the following to be its critical accounting
policies: allowance for loan and lease losses and review of goodwill for
impairment. There have been no significant changes in the methods or
assumptions used in accounting policies that require material estimates or
assumptions.
Allowance for loan and lease losses
Arriving at an appropriate level of allowance for loan and lease
losses necessarily involves a significant degree of judgment. First and
foremost in arriving at an appropriate allowance is the creation and
maintenance of a risk rating system that accurately classifies all loans and
leases into varying categories by degree of credit risk. Such a system also
establishes a level of allowance associated with each category of loans and
requires early identification and reclassification of deteriorating credits.
Besides numerous subjective judgments as to the number of categories,
appropriate level of allowance with respect to each category and judgments
as to categorization of any individual loan or lease, additional subjective
judgments are involved when ascertaining the probability as well as the
extent of any potential losses. The Company's ongoing evaluation process
includes a formal analysis of the allowance each quarter, which considers,
among other factors, the character and size of the loan portfolio, business
and economic conditions, loan growth, delinquency trends, nonperforming loan
trends, charge-off experience and other asset quality factors. These factors
are based on observable information, as well as subjective assessment and
interpretation. Nonperforming commercial, commercial real estate and small
business loans in excess of a specified dollar amount are deemed to be
"impaired." The estimated reserves necessary for each of these credits is
determined by reviewing the fair value of the collateral, the present value
of expected future cash flows, and where available, the observable market
price of the loans. Provisions for losses on the remaining commercial,
commercial real estate, small business, residential mortgage and consumer
loans and leases are based on pools of similar loans or leases using a
combination of payment status, historical loss experience, industry loss
experience, market economic factors, delinquency rates and qualitative
adjustments. Management uses available information to establish the
allowance for loan and lease losses at the level it believes is appropriate.
However, future
12
additions to the allowance may be necessary based on changes in estimates or
assumptions resulting from changes in economic conditions and other factors.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
and lease losses. Such agencies may require the Company to recognize
adjustments to the allowance based on their judgments about information
available to them at the time of their examination.
Review of goodwill for impairment
In March 1996, the Bank acquired certain assets and assumed certain
liabilities from Fleet Financial Group, Inc. and related entities. This
acquisition was accounted for utilizing the purchase method of accounting
and generated $17.5 million of goodwill. This goodwill was amortized in the
years prior to 2002, resulting in a net balance of $10.8 million on the
Company's balance sheet as of December 31, 2001. Effective January 1, 2002,
and in accordance with new accounting rules, the Company ceased amortizing
this goodwill and began to review it at least annually for impairment.
Goodwill is evaluated for impairment using market value comparisons for
similar institutions, such as price to earnings multiples, price to deposit
multiples and price to equity multiples. This valuation technique utilizes
verifiable market multiples, as well as subjective assessment and
interpretation. The application of different market multiples, or changes in
judgment as to which market transactions are reflective of the Company's
specific characteristics, could affect the conclusions reached regarding
possible impairment. In the event that the Company were to determine that
its goodwill were impaired, the recognition of an impairment charge could
have an adverse impact on its results of operations in the period that the
impairment occurred or on its financial position.
FINANCIAL CONDITION
- -------------------
-- Investments. Total investments (consisting of overnight
investments, investment securities, mortgage-backed securities ("MBSs") and
stock in the FHLB) totaled $335.2 million, or 25.6% of total assets, at
March 31, 2005, compared to $291.9 million, or 23.6% of total assets, at
December 31, 2004. All $314.5 million of investment securities and MBSs at
March 31, 2005 were classified as available for sale and carried a total of
$3.7 million in net unrealized losses at the end of the quarter. The
increase in total investments of $43.3 million, or 14.8%, was the result of
cash inflows being held temporarily in investments before being redeployed
in the Bank's loan portfolios, as commercial and consumer loan growth was
more modest during the quarter and spreads between residential mortgage
loans and MBSs tightened.
-- Loans and Leases. Total loans and leases were $906.4 million, or
69.3% of total assets, at March 31, 2005, compared to $886.3 million, or
71.5% of total assets, at December 31, 2004. The Company attempts to
concentrate its asset growth in its loan and lease portfolios to maximize
the yield on new assets and to take advantage of demand for both commercial
and home equity loan products in its market area. The Company utilizes the
term "small business loans" to describe business lending relationships of
approximately $250,000 or less.
The commercial loan and lease portfolio (consisting of commercial real
estate, commercial & industrial, equipment leases, multi-family real estate,
construction and small business loans) increased $2.3 million, or 0.6%,
during the first quarter of 2005. While commercial loan and lease growth was
modest for the first quarter, the Company believes it is well positioned for
continued commercial growth. Particular emphasis is placed on generation of
small- to medium-sized commercial relationships (those relationships with
$7.0 million or less in total loan commitments). Unlike many community
banks, the Bank is able to offer asset-based commercial loan facilities that
13
monitor advances against receivables and inventories on a formula basis. The
Bank is also active in small business lending in which it utilizes credit
scoring, in conjunction with traditional review standards, and employs
streamlined documentation. The Bank is a participant in the U.S. Small
Business Administration ("SBA") Preferred Lender Program in both Rhode
Island and Massachusetts, and the 7a Guarantee Loan Program in
Massachusetts. From time to time, the Company purchases equipment leases
from third party originators. These leases generally have maturities of five
years or less and are not dependent on residual collateral values. The U.S.
Government and its agencies are the principal lessees on the vast majority
of these leases. The remaining lessees are generally not-for-profits or
small businesses. The Company is currently negotiating the acquisition of a
small-ticket equipment leasing business and anticipates expanding its
leasing portfolio in the future.
The consumer loan portfolio increased $7.4 million, or 4.4%, during
the first quarter. This growth was centered in home equity term loans and
home equity lines of credit with maximum loan-to-values of 85%. The Company
believes that these ten- and fifteen-year fixed-rate products, along with
the floating lines of credit, possess attractive cash flow characteristics
in the current interest rate environment and the Company anticipates that
growth in these products will continue.
While origination efforts continue to be concentrated on commercial
and consumer loan opportunities, the Company also originates residential
mortgage loans for its own portfolio, as well as for others, on a limited
basis. The Bank does not employ any outside mortgage originators, but from
time to time, purchases residential mortgage loans from third-party
originators. Until such time as the Bank can generate sufficient commercial
and consumer loans to utilize available cash flow, or to otherwise meet
investment objectives, it also intends to continue purchasing residential
mortgage loans as opportunities develop.
The residential mortgage loan portfolio increased $10.4 million, or
3.3%, during the quarter, as originations ($2.7 million) and purchases
($22.2 million) of residential mortgage loans were greater than repayments
($14.4 million). At March 31, 2005, the Bank did not have any commitments to
purchase residential mortgage loans within the next 60 days.
14
The following is a breakdown of loans and leases receivable:
March 31, December 31,
2005 2004
--------- ------------
(In thousands)
Commercial loans and leases:
Commercial real estate - owner occupied $ 94,518 $ 93,027
Commercial real estate - nonowner occupied 89,715 90,716
Commercial and industrial 79,875 78,918
Small business 37,605 37,820
Multi-family real estate 36,108 32,415
Construction 33,560 32,319
Leases and other 34,138 38,116
-------- --------
Subtotal 405,519 403,331
Discount on leases acquired (188) (226)
Net deferred loan origination fees (288) (335)
-------- --------
Total commercial loans $405,043 $402,770
======== ========
Residential mortgage loans:
One- to four-family adjustable rate $212,889 $199,031
One- to four-family fixed rate 111,863 115,350
-------- --------
Subtotal 324,752 314,381
Premium on loans acquired 1,894 1,826
Net deferred loan origination fees (67) (72)
-------- --------
Total residential mortgage loans $326,579 $316,135
======== ========
Consumer loans:
Home equity - term loans $114,599 $110,542
Home equity - lines of credit 57,026 53,551
Automobile 381 488
Installment 415 491
Savings secured 348 439
Unsecured and other 895 801
-------- --------
Subtotal 173,664 166,312
Premium on loans acquired 10 15
Net deferred loan origination costs 1,137 1,069
-------- --------
Total consumer loans $174,811 $167,396
======== ========
Total loans and leases receivable $906,433 $886,301
======== ========
-- Deposits and Borrowings. Total deposits increased by $20.4 million,
or 2.3%, during the first quarter of 2005, from $880.7 million, or 71.1% of
total assets, at December 31, 2004, to $901.1 million, or 68.9% of total
assets, at March 31, 2005. The decrease in the relative percentage of total
assets resulted from first quarter total asset growth being partially funded
by FHLB borrowings and wholesale repurchase agreements. In addition, the
composition of total deposits changed during the quarter. While demand
deposits (DDAs) finished the quarter up $7.1 million, or 4.2%, NOW and
savings accounts experienced softness as they decreased a combined $18.7
million, or 4.2%, as consumers shifted balances to higher yielding
certificates of deposit, which increased $30.5 million, or 12.3%. The Bank
continues its strategy of emphasizing core deposit growth over certificate
of deposit growth, but from time-to-time will promote certificates of
deposit. At March 31, 2005, core deposit accounts comprised 69.0% of total
deposits, compared to 71.8% of total deposits at December 31, 2004.
15
The following table sets forth certain information regarding deposits:
March 31, 2005 December 31, 2004
--------------------------------- ---------------------------------
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
------ ------- -------- ------ ------- --------
(Dollars in thousands)
NOW accounts $101,269 11.2% 0.65% $108,159 12.3% 0.76%
Money market accounts 18,081 2.0% 1.23% 16,489 1.9% 1.22%
Savings accounts 328,026 36.4% 1.25% 339,836 38.6% 1.25%
Certificate of deposit accounts 278,975 31.0% 2.71% 248,508 28.2% 2.55%
-------- ----- -------- -----
Total interest bearing deposits 726,351 80.6% 1.73% 712,992 81.0% 1.63%
Noninterest bearing accounts 174,750 19.4% -- 167,682 19.0% --
-------- ----- -------- -----
Total deposits $901,101 100.0% 1.39% $880,674 100.0% 1.32%
======== ===== ==== ======== ===== ====
FHLB borrowings and wholesale repurchase agreements increased $43.9
million, or 18.7%, during the first quarter. The increases were the result
of the Company utilizing borrowings to partially fund asset growth and
offset some of the deposit softness experienced. The Company, through the
Bank's membership in the FHLB, has access to a variety of borrowing
alternatives, and management will from time-to-time take advantage of these
opportunities to fund asset growth. During the first quarter the Bank also
utilized wholesale repurchase agreements because of favorable spreads to
FHLB borrowings. However, on a long-term basis, the Company intends to
continue concentrating on increasing its core deposits, but will continue to
utilize FHLB borrowings or wholesale repurchase agreements as cashflows
dictate and opportunities present themselves.
Asset Quality
- -------------
The definition of nonperforming assets includes nonperforming loans
and other real estate owned ("OREO"). OREO consists of real estate acquired
through foreclosure proceedings and real estate acquired through acceptance
of a deed in lieu of foreclosure. Nonperforming loans are defined as
nonaccrual loans, loans past due 90 days or more, but still accruing and
impaired loans. Under certain circumstances the Company may restructure the
terms of a loan as a concession to a borrower. These restructured loans are
generally considered impaired loans.
-- Nonperforming Assets. At March 31, 2005, the Company had
nonperforming assets of $1.7 million, which represented 0.13% of total
assets. This compares to nonperforming assets of $733,000, or 0.06% of total
assets, at December 31, 2004. Total nonperforming assets at March 31, 2005,
consisted of nonaccrual commercial loans aggregating $1.3 million and
nonaccrual residential mortgage loans aggregating $449,000. Included in
nonaccrual loans were $1.1 million, at March 31, 2005, and $671,000, at
December 31, 2004, of impaired loans. Specific reserves against these
impaired loans were $64,000 and $170,000 at March 31, 2005 and December 31,
2004, respectively. The Company evaluates the underlying collateral of each
nonperforming loan and continues to pursue the collection of interest and
principal. Management believes that the current level of nonperforming
assets remains low relative to the size of the Company's loan portfolio. As
the loan portfolio continues to grow and mature, or if economic conditions
worsen, management believes it possible that the level of nonperforming
assets will increase, as will its level of charged-off loans.
Delinquencies. At March 31, 2005, loans with an aggregate balance of
$468,000 were 60 to 89 days past due, an increase of $468,000 from December
31, 2004. The majority of these loans are residential mortgage loans and are
secured.
16
The following table sets forth information regarding nonperforming
assets and loans 60-89 days past due as to interest at the dates indicated.
March 31, December 31,
2005 2004
--------- ------------
(Dollars in thousands)
Loans and leases accounted for on a nonaccrual basis $1,713 $ 733
Loans and leases past due 90 days or more, but still accruing -- --
Impaired loans and leases (not included in nonaccrual loans) -- --
------ -----
Total nonperforming loans and leases 1,713 733
Other real estate owned -- --
------ -----
Total nonperforming assets $1,713 $ 733
====== =====
Delinquent loans 60-89 days past due $ 468 $ --
Nonperforming loans as a percent of total loans and leases 0.19% 0.08%
Nonperforming assets as a percent of total assets 0.13% 0.06%
Delinquent loans 60-89 days past due as a percent
of total loans and leases 0.05% 0.00%
Adversely Classified Assets. The Company's management adversely
classifies certain assets as "substandard," "doubtful" or "loss" based on
criteria established under banking regulations. An asset is considered
substandard if inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Substandard
assets include those characterized by the "distinct possibility" that the
insured institution will sustain "some loss" if existing deficiencies are
not corrected. Assets classified as doubtful have all of the weaknesses
inherent in those classified substandard with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the
basis of currently existing facts, conditions and values, "highly
questionable and improbable." Assets classified as loss are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted.
At March 31, 2005, the Company had $6.0 million of assets that were
classified as substandard. This compares to $5.8 million of assets that were
classified as substandard at December 31, 2004. The Company had no assets
that were classified as doubtful or loss at either date. Performing loans
may or may not be adversely classified depending upon management's judgment
with respect to each individual loan. At March 31, 2005, included in the
assets that were classified as substandard, were $4.3 million of performing
loans. This compares to $5.1 million of adversely classified performing
loans as of December 31, 2004. These amounts constitute assets that, in the
opinion of management, could potentially migrate to nonperforming or
doubtful status. Any downturn in the New England economy may lead to future
deteriorations in commercial credit quality and increases in nonaccrual
loans. This in turn may necessitate an increase to the provision for loan
losses in future periods.
Allowance for Loan and Lease Losses
- -----------------------------------
During the first quarter of 2005, the Company made provisions to the
allowance for loan and lease losses totaling $300,000 and had $6,000 of net
recoveries, bringing the balance in the allowance to $12.2 million, compared
to $11.9 million at December 31, 2004. The allowance, expressed as a
percentage of total loans, was 1.35% as of March 31, 2005, compared to 1.34%
at the prior year end and stood at 712.9% of nonperforming loans at March
31, 2005, compared to 1624.3% of nonperforming loans at December 31, 2004.
17
Assessing the adequacy of the allowance for loan and lease losses
involves substantial uncertainties and is based upon management's evaluation
of the amounts required to meet estimated charge-offs in the loan portfolio
after weighing various factors. Management's methodology to estimate loss
exposure includes an analysis of individual loans deemed to be impaired,
reserve allocations for various loan types based on payments status or loss
experience and an unallocated allowance that is maintained based on
management's assessment of many factors including the growth, composition
and quality of the loan portfolio, historical loss experiences, general
economic conditions and other pertinent factors. Based on this evaluation,
management believes that the allowance for loan and lease losses, as of
March 31, 2005, is adequate.
A portion of the allowance for loan and lease losses is not allocated
to any specific segment of the loan portfolio. This non-specific allowance
is maintained for two primary reasons: (i) there exists an inherent
subjectivity and imprecision to the analytical processes employed, and (ii)
the prevailing business environment, as it is affected by changing economic
conditions and various external factors, may impact the portfolio in ways
currently unforeseen. Management, therefore, has established and maintains a
non-specific allowance for loan losses. The amount of this measurement
imprecision allocation was $2.4 million at March 31, 2005, compared to $2.5
million at December 31, 2004.
While management evaluates currently available information in
establishing the allowance for loan and lease losses, future adjustments to
the allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review a financial institution's allowance for loan and lease losses and
carrying amounts of other real estate owned. Such agencies may require the
financial institution to recognize additions to the allowance based on their
judgments about information available to them at the time of their
examination.
RESULTS OF OPERATIONS
- ---------------------
Comparison of Three Months Ended March 31, 2005 and 2004
- --------------------------------------------------------
-- General. The Company reported net income for the first quarter of
2005 of $2.4 million, up $343,000, or 16.6%, from the first quarter of 2004.
Diluted earnings per common share were $0.57 for the first quarter of 2005,
compared to $0.49 for the first quarter of 2004.
The Company reported a return on average assets of 0.78% and a return
on average equity of 12.34% for the 2005 period, as compared to a return on
average assets of 0.75% and a return on average equity of 11.27% for the
2004 period.
-- Net Interest Income. For the quarter ended March 31, 2005, net
interest income was $10.4 million, compared to $8.9 million for the 2004
period. The net interest margin for the first quarter of 2005 was 3.52%
compared to a net interest margin of 3.42% for the 2004 period. The increase
in net interest income of $1.4 million, or 16.0%, was primarily attributable
to the continued growth of the Company. Average earning assets were $143.4
million, or 13.7%, higher, and average interest-bearing liabilities were
$130.1 million, or 14.9%, higher, than the comparable period a year earlier.
The 10 basis point increase in the net interest margin primarily resulted
from earning asset yields increasing in response to Prime Rate increases,
coupled with a relatively stable cost of interest-bearing liabilities
between the two periods.
18
-- Interest Income. Investments. Total investment income was $3.2
million for the quarter ended March 31, 2005, compared to $2.3 million for
the 2004 period. The increase in total investment income was $929,000, or
40.5%, and was primarily attributable to an increase in the average balance
of total investments. The average balance increased $82.3 million, or 36.6%,
from the first quarter of 2004 to the first quarter of 2005, as loan growth
was more modest for the quarter and spreads for MBS products, compared to
residential whole loans, were more attractive. The Company's investments act
as a counterbalance to loan and deposits flows, and in times such as this
past quarter, increase to absorb available cash flows. The majority of the
Company's investments are comprised of U.S. Agency securities and MBSs with
repricing periods or expected remaining maturities of less than five years.
-- Interest Income. Loans. Interest from loans was $12.5 million for
the three months ended March 31, 2005, and represented a yield on total
loans of 5.71%. This compares to $11.3 million of interest, and a yield of
5.51%, for the first quarter of 2004. Interest from commercial loans and
leases increased $1.2 million, or 22.3%, and interest from consumer and
other loans increased $757,000, or 53.0%, as average balances and average
yields increased during the past year. The average balance of the various
components of the loan portfolio changed from the first quarter of 2004 as
follows: commercial loans and leases increased $59.7 million, or 17.4%, and
consumer and other loans increased $53.2 million, or 44.9%, while
residential mortgage loans decreased $51.9 million, or 14.3%. In response to
rising short-term interest rates, along with a flattening of the yield
curve, the yields on the various loan portfolio components changed from the
first quarter of 2004 as follows: commercial loans and leases increased 31
basis points, to 6.42%, and consumer and other loans increased 31 basis
points, to 5.16%, while residential mortgage loans decreased 7 basis points,
to 5.10%. Since its inception, the Company has concentrated its origination
efforts on commercial and consumer loan opportunities, while purchasing
residential mortgage loans, as opportunities developed or cash flows
dictated. More recently, the Company has increased its consumer loan
origination capacities in response to strong demand for home equity
products.
-- Interest Expense. Interest paid on deposits and borrowings
increased $692,000, or 14.8%, to $5.4 million for the three months ended
March 31, 2005, from $4.7 million for the same period during 2004. The
increase in total interest expense was primarily attributable to an increase
in the average balance of interest-bearing liabilities. The average balance
of total interest-bearing liabilities increased $130.1 million, from $870.2
million in the first quarter of 2004 to $1.0 billion in the first quarter of
2005, as savings account average balances increased $41.0 million, or 14.0%,
certificate of deposit ("CD") accounts increased $46.1 million, or 20.9%,
and FHLB borrowings and wholesale repurchase agreements increased $65.5
million, or 37.8%. Some softness in core deposit balances, coupled with
greater consumer willingness to extend maturities, led to increases in CDs
and borrowings. Despite increases in short-term interest rates during the
past year, the overall average cost for interest-bearing liabilities
remained relatively stable at 2.18% for the first quarter of 2005, compared
to 2.16% for the first quarter of 2004. Liability costs are dependent on a
number of factors including general economic conditions, national and local
interest rates, competition in the local deposit marketplace, interest rate
tiers offered and the Company's cash flow needs.
-- Provision for Loan and Lease Losses. The provision for loan and
lease losses was $300,000 for the quarter ended March 31, 2005, similar to
the same quarter last year. Management evaluates several factors including
new loan originations, actual and estimated charge-offs, the risk
characteristics of the loan portfolio and general economic conditions when
determining the provision for each quarter. Additions to the allowance for
loan and lease losses during the first quarter of 2005
19
were primarily in response to changes in the mix of loans and concern for
general economic conditions. The allowance expressed as a percentage of
total loans was 1.35% at March 31, 2005, compared to 1.34% at December 31,
2004. As the loan portfolio continues to grow and mature, or if economic
conditions worsen, management believes it possible that the level of
nonperforming assets will increase, which in turn may lead to increases in
the provision for loan and lease losses in future periods. Also see
discussion under "Allowance for Loan and Lease Losses."
-- Noninterest Income. Total noninterest income increased $77,000, or
3.9%, to $2.1 million for the first quarter of 2005, from $2.0 million for
the first quarter of 2004. Service charges on deposit accounts, which
continues to represent the largest source of noninterest income for the
Company, increased $71,000, or 7.0%, from $1.0 million for the three months
ended March 31, 2004, to $1.1 million for the same period in 2005 in
response to continued growth in checking accounts. Significant differences
between the 2005 and 2004 periods were centered in Loan related fees and
Gains on sale of investments or MBSs. The 2005 period included $187,000 in
loan prepayment penalties (which is included in Loan related fees), compared
to $42,000 during the 2004 period, while Gains from sales of investment
securities and MBSs aggregated $197,000 during the 2004 period compared to a
net loss of $8,000 during the 2005 period. The gains in the 2004 period
resulted from the Company restructuring a portion of its investment
portfolio.
-- Noninterest Expense. Noninterest expenses for the first quarter of
2005 increased a total of $937,000, or 12.4%, to $8.5 million from $7.6
million in 2004. This increase occurred primarily from higher operating
costs resulting from the continued growth of the Company and was centered in
the following areas: Salaries and employee benefits (up $730,000, or 18.8%)
and Professional services (up $203,000, or 71.2%). In addition to incurring
increased operating costs as a result of the continuing growth in both
loans, deposits and branches, the 2005 period includes the cost of partially
outsourcing internal audit activity, continuing outside accounting fees in
connection with ongoing compliance with Sarbanes-Oxley Section 404 and
consulting and legal costs regarding the possible acquisition of a leasing
company. Meanwhile, the Company's overall efficiency ratio improved to
68.39% in 2005, from 69.24% in the 2004 period.
-- Income Tax Expense. Income tax expense of $1.2 million was recorded
for the three months ended March 31, 2005, compared to $1.0 million for the
same period during 2004. This represented total effective tax rates of 33.8%
and 32.7%, respectively. Tax-favored income from BOLI, along with its
utilization of a Rhode Island passive investment company, has reduced the
effective tax rate from the 40.9% combined statutory federal and state tax
rates.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
-- Liquidity. Liquidity is defined as the ability to meet current and
future financial obligations of a short-term nature. The Company further
defines liquidity as the ability to respond to the needs of depositors and
borrowers, as well as to earnings enhancement opportunities, in a changing
marketplace.
The primary source of funds for the payment of dividends and expenses
by the Company is dividends paid to it by the Bank. Bank regulatory
authorities generally restrict the amounts available for payment of
dividends if the effect thereof would cause the capital of the Bank to be
reduced below applicable capital requirements. These restrictions indirectly
affect the Company's ability to pay dividends. The primary sources of
liquidity for the Bank consist of deposit inflows, loan repayments, borrowed
funds, maturity of investment securities and sales of securities from the
20
available for sale portfolio. Management believes that these sources are
sufficient to fund the Bank's lending and investment activities.
Management is responsible for establishing and monitoring liquidity
targets as well as strategies and tactics to meet these targets. In general,
the Company seeks to maintain a high degree of flexibility with a liquidity
target of 10% to 25% of total assets. At March 31, 2005, overnight
investments, investment securities and MBSs available for sale amounted to
$321.3 million, or 24.6% of total assets. This compares to $278.6 million,
or 22.5% of total assets at December 31, 2004. The Bank is a member of the
FHLB and, as such, has access to both short- and long-term borrowings. In
addition, the Bank maintains a line of credit at the FHLB as well as a line
of credit with a correspondent bank. There have been no adverse trends in
the Company's liquidity or capital reserves. Management believes that the
Company has adequate liquidity to meet its commitments.
-- Capital Resources. Total shareholders' equity of the Company at
March 31, 2005 was $77.8 million, as compared to $78.9 million at December
31, 2004. This decrease of $1.1 million was primarily the result of a
decrease in accumulated other comprehensive income of $3.0 million
(attributable to increases in unrealized losses on investment and MBS
securities) and dividends of $602,000 exceeding net income for the quarter
of $2.4 million.
All FDIC-insured institutions must meet specified minimal capital
requirements. These regulations require banks to maintain a minimum leverage
capital ratio. In addition, the FDIC has adopted capital guidelines based
upon ratios of a bank's capital to total assets adjusted for risk. The risk-
based capital guidelines include both a definition of capital and a
framework for calculating risk-weighted assets by assigning balance sheet
assets and off-balance sheet items to broad risk categories. These
regulations require banks to maintain minimum capital levels for capital
adequacy purposes and higher capital levels to be considered "well
capitalized."
The Federal Reserve Board ("FRB") has also issued capital guidelines
for bank holding companies. These guidelines require the Company to maintain
minimum capital levels for capital adequacy purposes. In general, the FRB
has adopted substantially identical capital adequacy guidelines as the FDIC.
Such standards are applicable to bank holding companies and their bank
subsidiaries on a consolidated basis.
As of March 31, 2005, the Company and the Bank met all applicable
minimum capital requirements and were considered "well capitalized" by both
the FRB and the FDIC.
On February 23, 2005, the Company filed a registration statement on
Form S-3 with the SEC with respect to a proposed offering of 550,000 shares
of common stock. The underwriters of the offering were also granted a 30-day
option to purchase up to an additional 82,500 shares of common stock to
cover any over-allotments. On April 12, 2005, the SEC declared the Company's
registration statement effective and on April 18, 2005 the Company issued
550,000 shares of common stock for net proceeds (after underwriting
discounts and commissions and expenses) of approximately $18.7 million. The
underwriters may exercise their option to purchase the additional 82,500
shares at any time on or before May 12, 2005. The Company intends to retain
the net proceeds from this offering at the Company level for general
business purposes and working capital and intends to downstream such
proceeds to the Bank as necessary to provide regulatory capital to support
asset growth and continued expansion of the Bank's business, including the
addition of branches. The proceeds from this offering should enable the
Company and the Bank to maintain their status as well-capitalized
institutions as they execute their growth strategies.
21
The Company's and the Bank's actual and required capital amounts and
ratios are as follows:
Minimum Required Minimum Required
For Capital To Be Considered
Actual Adequacy Purposes "Well Capitalized"
------------------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
At March 31, 2005:
Bancorp Rhode Island, Inc.
- --------------------------
Tier I capital (to average assets) $87,403 7.02% $37,349 3.00% $62,247 5.00%
Tier I capital (to risk weighted assets) 87,403 10.43% 33,536 4.00% 50,303 6.00%
Total capital (to risk weighted assets) 97,897 11.68% 67,071 8.00% 83,839 10.00%
Bank Rhode Island
- -----------------
Tier I capital (to average assets) $83,701 6.73% $37,339 3.00% $62,231 5.00%
Tier I capital (to risk weighted assets) 83,701 9.99% 33,511 4.00% 50,267 6.00%
Total capital (to risk weighted assets) 94,195 11.24% 67,023 8.00% 83,778 10.00%
At December 31, 2004:
Bancorp Rhode Island, Inc.
- --------------------------
Tier I capital (to average assets) $85,386 7.06% $36,280 3.00% $60,466 5.00%
Tier I capital (to risk weighted assets) 85,386 10.01% 34,112 4.00% 51,168 6.00%
Total capital (to risk weighted assets) 96,055 11.26% 68,225 8.00% 85,281 10.00%
Bank Rhode Island
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Tier I capital (to average assets) $81,928 6.78% $36,263 3.00% $60,438 5.00%
Tier I capital (to risk weighted assets) 81,928 9.61% 34,091 4.00% 51,137 6.00%
Total capital (to risk weighted assets) 92,597 10.86% 68,182 8.00% 85,228 10.00%
22
BANCORP RHODE ISLAND, INC.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK
- ------------------
The principal market risk facing the Company is interest rate risk.
The Company's objective regarding interest rate risk is to manage its assets
and funding sources to produce results which are consistent with its
liquidity, capital adequacy, growth and profitability goals, while
minimizing any adverse effect from changes in interest rates. The primary
tools for managing interest rate risk are the securities portfolio,
purchased mortgages, wholesale repurchase agreements and borrowings from the
FHLB.
The Company's actions in this regard are taken under the guidance of
the Bank's Asset/Liability Committee ("ALCO"). The ALCO manages the
Company's interest rate risk position using both income simulation and
interest rate sensitivity "gap" analysis. The ALCO has established internal
parameters for monitoring the Company's interest rate risk. These guidelines
serve as benchmarks for evaluating actions to balance the current position
against overall strategic goals. The ALCO monitors current exposures and
reports these to the Board of Directors.
Simulation is used as the primary tool for measuring the interest rate
risk inherent in the Company's balance sheet at a given point in time by
showing the effect on net interest income, over a 24-month period, of
interest rate ramps of up to 200 basis points. These simulations take into
account repricing, maturity and prepayment characteristics of individual
products. The ALCO reviews simulation results to determine whether the
downside exposure resulting from changes in market interest rates remains
within established tolerance levels over both a 12-month and 24-month
horizon, and develops appropriate strategies to manage this exposure. The
Company's guidelines for interest rate risk specify that if interest rates
were to shift up or down 200 basis points over a 12-month period, estimated
net interest income for those 12 months and the subsequent 12 months, should
decline by no more than 5.0% or 10.0%, respectively. As of March 31, 2005,
net interest income simulation indicated that the Company's exposure to
changing interest rates was within these tolerances. The ALCO reviews the
methodology utilized for calculating interest rate risk exposure and may,
from time to time, adopt modifications to this methodology.
23
The following table presents the estimated impact of interest rate
ramps on the Company's estimated net interest income over a twenty-four
month period beginning April 1, 2005:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 basis points $ (205) (0.48%)
Up 100 basis points 114 0.27%
Down 100 basis points (9) (0.02%)
Down 200 basis points (125) (0.29%)
Subsequent Twelve Month Period:
Up 200 basis points $(1,316) (3.28%)
Up 100 basis points 43 0.11%
Down 100 basis points (304) (0.76%)
Down 200 basis points (1,571) (3.91%)
The Company also uses interest rate sensitivity gap analysis to
provide a more general overview of its interest rate risk profile. The
interest rate sensitivity gap is defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing within
a given time period. At March 31, 2005, the Company's one year cumulative
gap was a negative $92.4 million, or 7.07% of total assets.
For additional discussion on interest rate risk see the section titled
"Asset and Liability Management" on pages 43 to 45 of the Company's 2004
Annual Report on Form 10-K.
ITEM 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), the Company carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures as of the end of the period covered by this report.
This evaluation was carried out under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer. Based upon that
evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.
There was no significant changes in the Company's internal control
over financial reporting that occurred during the Company's most recent
fiscal quarter that has materially affected, or is reasonably likely to
affect, the Company's internal control over financial reporting.
24
BANCORP RHODE ISLAND, INC.
Other Information
PART II. Other Information
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Company or its subsidiaries are a party, or to which any of their
property is subject, other than ordinary routine litigation
incidental to the business of banking.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES
No information to report.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
No defaults upon senior securities have taken place.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
No information to report.
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
25
BANCORP RHODE ISLAND, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Bancorp Rhode Island, Inc.
May 3, 2005 /s/ Merrill W. Sherman
- ----------- ----------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
May 3, 2005 /s/ Albert R. Rietheimer
- ----------- ------------------------
(Date) Albert R. Rietheimer
Chief Financial Officer
and Treasurer
26