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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
 
Commission file number 0-16455
NEWMIL BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware
06-1186389
(State or other jurisdiction
(I.R.S. Employer
of incorporation or organization)
Identification No.)
19 Main Street, P.O. Box 600, New Milford, CT
06776
(Address of principal executive offices)
(Zip code)
(860) 355-7600
(Registrant's telephone number, including area code)


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 (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 [ ]

 
The number of shares of Common Stock outstanding as of March 31, 2005, is 4,210,924.
 
1
TABLE OF CONTENTS
   
Page
     
PART I FINANCIAL INFORMATION
     
Item 1.
Financial Statements:
  
     
 
Consolidated Balance Sheets as of
 
 
March 31, 2005 and December 31, 2004
3
     
 
Consolidated Statements of Income
 
 
for the three month periods
  
 
ended March 31, 2005 and March 31, 2004
4
     
 
Consolidated Statements of Changes in
 
 
Shareholders' Equity for the three month
  
 
periods ended March 31, 2005 and March 31, 2004
5
     
 
Consolidated Statements of Cash Flows
 
 
for the three month periods ended
  
 
March 31, 2005 and March 31, 2004
6
     
 
Notes to Consolidated Financial Statements
7
     
Item 2.
Management's Discussion and Analysis of Financial Condition
  
 
and Results of Operations
15
     
Item 3.
Quantitative and Qualitative Disclosures
 
 
about Market Risk
25
     
Item 4.
Control and Procedures
25
     
PART II Other Information
     
Item 1.
Legal Proceedings
25
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
26
Item 3.
Defaults upon Senior Securities
26
Item 4.
Submission of matters to a vote of security holders
26
Item 5.
Other information
26
Item 6.
Exhibits
26
 
2
NewMil Bancorp, Inc. and Subsidiary
CONSOLIDATED BALANCE SHEETS
(unaudited)
   
March 31,
  
December 31,
  
(dollars in thousands)
  
2005
  
2004
 
ASSETS
              
Cash and due from bank
  
$
20,664
  
$
18,493
  
Federal funds sold
    
-
    
-
  
Total cash and cash equivalents
    
20,664
    
18,493
 
Securities
              
Available-for-sale at market
    
246,194
    
204,101
  
Held-to-maturity at amortized cost
             
(fair value: $12,123 and $12,800)
    
11,885
    
12,457
  
Loans (net of allowance for loan losses: $5,001 and $5,048)
    
476,772
    
476,660
  
Other real estate owned
   
73
    
-
  
Bank premises and equipment, net
    
7,171
    
7,339
  
Accrued interest income
    
3,228
    
3,343
 
Intangible assets (net of accumulated amortization: $1,501 and $1,464)
    
8,203
    
8,240
 
Other assets
    
15,610
    
13,966
  
Total Assets
  
$
789,800
  
$
744,599
  
               
LIABILITIES and SHAREHOLDERS' EQUITY
              
Deposits
              
Demand (non-interest bearing)
  
$
71,039
  
$
66,895
  
NOW accounts
    
84,766
    
85,889
  
Money market
    
151,220
    
147,375
  
Savings and other
    
87,130
    
85,829
  
Certificates of deposit
    
210,129
    
201,022
  
Total deposits
    
604,284
    
587,010
  
Federal Home Loan Bank advances
    
98,663
    
75,654
 
Repurchase agreements
    
14,186
    
13,147
 
Long-term debt
    
9,821
    
9,806
  
Accrued interest and other liabilities
    
8,264
    
3,369
  
Total Liabilities
    
735,218
    
688,986
  
Commitments and contingencies
    
-
    
-
 
Shareholders' Equity
              
Common stock - $.50 per share par value
              
Authorized: 20,000,000
             
Shares issued: 5,990,138
    
2,995
    
2,995
 
Paid-in capital
    
42,067
    
41,957
  
Retained earnings
    
34,908
    
33,514
  
Accumulated other comprehensive (loss) income, net
    
(1,609
)
  
703
  
Treasury stock, at cost: 1,779,214 and
             
1,793,614 shares
    
(23,779
)
  
(23,556
)
Total Shareholders' Equity
    
54,582
    
55,613
  
Total Liabilities and Shareholders' Equity
  
$
789,800
  
$
744,599
  

See accompanying notes to consolidated financial statements.
3
NewMil Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share amounts)
(unaudited)
   
Three months ended
  
   
March 31,
  
   
2005
  
2004
  
Interest and dividend income
              
Interest and fees on loans
  
$
6,737
  
$
6,441
  
Interest and dividends on securities
    
2,530
    
2,383
  
Interest on federal funds sold
    
12
    
7
  
Total interest and dividend income
    
9,279
    
8,831
  
Interest expense
              
Deposits
    
1,874
    
1,623
  
FHLB Advances
    
630
    
492
  
Repurchase agreements
    
40
   
31
  
Long term debt
    
175
    
175
  
Total interest expense
    
2,719
    
2,321
  
Net interest and dividend income
    
6,560
    
6,510
  
Provision for loan losses
    
-
    
-
  
Net interest and dividend income
              
after provision for loan losses
    
6,560
    
6,510
  
Non-interest income
              
Service charges on deposit accounts
    
702
    
684
  
Gains on sales of mortgage loans, net
    
52
    
40
  
Loan servicing fees
    
7
    
10
  
Other
    
186
    
183
  
Total non-interest income
    
947
    
917
  
Non-interest expense
              
Salaries and employee benefits
    
2,312
    
2,466
  
Occupancy
   
433
    
402
  
Equipment
   
354
    
328
  
Marketing
   
67
    
121
  
Postage and telecommunications
   
133
    
131
  
Printing and office supplies
   
104
    
101
  
Professional, collections and OREO
   
226
    
297
  
Service bureau
    
93
    
94
  
Amortization of intangibles
    
37
    
49
  
Other
    
496
    
476
  
Total non-interest expense
    
4,255
    
4,465
  
Income before income taxes 
    
3,252
    
2,962
  
Income tax provision
    
1,017
    
939
  
Net income
  
$
2,235
  
$
2,023
  
               
Per common share
              
Diluted earnings
  
$
0.52
  
$
0.47
  
Basic earnings
    
0.53
    
0.48
  
Cash dividends
    
0.20
    
0.15
  

See accompanying notes to consolidated financial statements.
4
NewMil Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited)
  
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
other comp-
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
rehensive
 
share-
 
 
 
CommonStock
 
Paid-in
 
Retained
 
Treasury
 
(loss)
 
holders'
 
(dollars in thousands)
 
Shares
 
Amount
 
capital
 
earnings
 
stock
 
income
 
equity
  
Balances at
                                           
December 31, 2003
    
5,990,138
  
$
2,995
  
$
42,142
  
$
27,844
  
$
(23,588
)
$
2,913
  
$
52,306
  
Net income for period
    
-
   
-
   
-
   
2,023
    
-
   
-
   
2,023
  
Net unrealized loss on
                                           
securities available-for-sale,
                                            
net of taxes
    
-
   
-
   
-
   
-
   
-
   
(8
)
  
(8
)
Total comprehensive income
                                        
2,015
  
Cash dividends paid
    
-
   
-
   
-
   
(631
)
  
-
   
-
   
(631
)
Exercise of stock options
    
-
   
-
   
(341
)
  
-
   
1,225
    
-
   
884
  
Common stock issued
    
-
   
-
   
-
    
-
   
-
    
-
   
-
  
Tax benefit from exercise of
                                           
non-qualified stock options
    
-
   
-
   
60
    
-
   
-
   
-
   
60
  
Common stock repurchased
    
-
   
-
   
-
   
-
   
(210
)
  
-
   
(210
)
Balances at March 31, 2004
    
5,990,138
  
$
2,995
  
$
41,861
  
$
29,236
  
$
(22,573
)
$
2,905
  
$
54,424
  
Balances at
                                           
December 31, 2004
    
5,990,138
  
$
2,995
  
$
41,957
  
$
33,514
  
$
(23,556
)
$
703
  
$
55,613
  
Net income for period
    
-
   
-
   
-
   
2,235
    
-
   
-
   
2,235
  
Net unrealized loss on
                                            
securities available-for-sale,
                                            
net of taxes
    
-
   
-
   
-
   
-
   
-
   
(2,312
)
  
(2,312
)
Total comprehensive (loss) income
                                        
( 77
)
Cash dividends paid
    
-
   
-
   
-
   
(841
)
  
-
   
-
   
(841
)
Exercise of stock options
    
-
   
-
   
55
    
-
   
212
    
-
   
267
  
Tax benefit from exercise of
                                           
non- qualified stock options
    
-
   
-
   
55
   
-
   
-
    
-
   
55
  
Common stock repurchased
    
-
   
-
   
-
    
-
   
(435
)
  
-
   
(435
)
Balances at March 31, 2005
    
5,990,138
  
$
2,995
  
$
42,067
  
$
34,908
  
$
(23,779
)
$
(1,609
)
$
54,582
  

See accompanying notes to consolidated financial statements.
5
NewMil Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
  
Three months ended
  
   
March 31,
  
(unaudited, in thousands)
  
2005
  
2004
  
Operating Activities
              
Net income
  
$
2,235
  
$
2,023
  
Adjustments to reconcile net income to
              
net cash provided by operating activities:
              
Provision for loan losses
    
-
   
-
  
Depreciation and amortization
    
208
   
207
  
Amortization of intangible assets
    
37
    
49
  
Amortization of issuance cost on long term debt
   
15
    
15
  
Amortization and accretion of securities
             
premiums and (discounts), net
    
40
    
81
  
Gains on sales of mortgage loans, net
    
(52
)
  
(40
)
Mortgage loans originated for sale
    
(2,691
)
  
(2,181
)
Proceeds from sales of mortgage loans
    
2,743
    
2,221
  
Tax benefit from exercise of non-qualified stock options
    
55
    
60
 
Deferred income tax provision
    
(89
)
  
(68
)
Increase in BOLI cash surrender value
    
(103
)
  
(98
)
Decrease in accrued interest income
    
115
    
332
  
Increase in other liabilities
    
593
    
546
  
Increase in other assets, net
    
(261
)
  
(103
)
Net cash provided by operating activities
    
2,845
    
3,044
  
Investing Activities
              
Purchases of securities available-for-sale
    
(23,164
)
  
(5,032
)
Purchases of mortgage backed securities available-for-sale
    
(42,784
)
  
(20,175
)
Proceeds from maturities and principal repayments of securities
    
18,520
    
19,494
  
Principal collected on mortgage-backed securities
    
6,668
    
5,635
  
Loan advances, net
    
(112
)
  
(2,650
)
Increase in OREO, net
    
(73
)
  
-
  
Purchases of Bank premises and equipment, net
    
(41
)
  
(144
)
Net cash used by investing activities
    
(40,986
)
  
(2,872
)
Financing Activities
              
Net increase in deposits
    
17,273
    
673
  
Net increase in repurchase agreements
    
1,039
    
1,749
  
FHLB borrowings, net
    
23,009
    
5,299
  
Common Stock repurchased
    
(435
)
  
(210
)
Cash dividends paid
    
(841
)
  
(631
)
Proceeds from exercise of stock options
    
267
    
884
  
Net cash provided by financing activities
    
40,312
    
7,764
  
Increase in cash and cash equivalents
    
2,171
    
7,936
  
Cash and cash equivalents, beginning of period
    
18,493
    
22,524
  
Cash and cash equivalents, end of period
  
$
20,664
  
$
30,460
  
Cash paid during period
              
Interest to depositors
  
$
1,877
  
$
1,633
  
Interest on borrowings
    
787
    
677
  
Income taxes paid
    
-
    
-
  
Non-Cash Transfers
              
From Loans to OREO
    
73
    
-
  

See accompanying notes to consolidated financial statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
NOTE 1 - BASIS OF PRESENTATION
 
The interim consolidated financial statements of NewMil Bancorp, Inc. ("NewMil") include those of NewMil and its wholly owned subsidiary, NewMil Bank (the "Bank"). NewMil does not consolidate its subsidiary, NewMil Statutory Trust I, as described in Note 9. Certain prior period amounts in the statement of income and balance sheets have been reclassified to conform with the current financial presentation. In the opinion of management, the interim unaudited consolidated financial statements include all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of NewMil and the statements of income and shareholder's equity and cash flows for the interim periods presented.
 
The financial statements have been prepared in accordance with generally accepted accounting principles. In preparing the financial statements, management is required to make extensive use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet, revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and valuation of real estate, management obtains independent appraisals for significant properties.
 
Certain financial information, which is normally included in financial statements prepared in accordance with generally accepted accounting principles, but which is not required for interim reporting purposes, has been condensed or omitted. Operating results for the three-month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. The accompanying condensed financial statements should be read in conjunction with the financial statements and notes thereto included in NewMil's Annual Report for the period ended December 31, 2004.
 
The allowance for loan losses is a significant accounting policy and is presented in the Notes to Consolidated Financial Statements and in Management’s Discussion and Analysis, which provide information on how significant assets are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for loan losses to be the accounting area that requires the most subjective judgments, and as such could be most subject to revision as new information becomes available.
 
Impact of New Accounting Pronouncements
 
In December 2004, the Financial Accounting Standards Board (“FASB”) issued revised Statement of Financial Accounting Standard (“SFAS”) No. 123(R), “Share-Based Payment”. The Statement requires entities to measure the cost of employees services received in exchange for an award of equity instruments based on the estimated grant-date fair value of the award. That cost will be recognized over the period during which the employee is required to provide service in exchange for the award (usually the vesting period). However, no compensation expense is recognized for equity instruments that do not vest. The estimated grant-date fair value of employee share options must be determined using option-pricing models adjusted for the unique characteristics of those instruments. The notes to the financial statements will include additional disclosures to assist users of the financial statements in understanding the nature of share-based payment transactions and the effects of those transactions on the financial statements.
7
The effective date of the Statement for NewMil is January 1, 2006. All public entities will be required to apply the Statement using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for either recognition or proforma disclosure purposes. Under the stock option plans currently in place at NewMil, and assuming similar amounts of options are granted to directors as in prior years and that no options are granted to employees, since no option grants are contemplated, and using the current valuation assumptions with respect to the dividend yield, expected volatility, risk-free interest rate and expected lives, NewMil expects the impact of this statement to reduce net income by approximately $50,000, or $0.01 per share, for 2006 and thereafter.
 
 
 
 
 
 
 
 

8
NOTE 2 - SECURITIES
 
Securities classified as available-for-sale (carried at fair value) were as follows:
   
 
  
Gross
  
Gross
  
 
  
 
  
Estimated
  
unrealized
  
unrealized
  
Amortized
  
(in thousands)
  
fair value
  
gains
  
losses
  
cost
  
March 31, 2005
                          
U.S. Government Agency notes
                          
Within 1 year
  
$
5,013
  
$
13
  
$
-
  
$
5,000
  
After 1 year but within 5 years
    
24,563
    
-
   
437
    
25,000
  
Corporate bonds
    
   
   
   
 
Within 1 year
    
8,056
    
53
    
-
   
8,003
  
Municipal bonds
    
   
   
   
 
After 5 years but within 10 years
    
580
    
-
    
15
   
595
  
After 10 years but within 15 years
    
18,888
    
-
    
545
   
19,433
  
After 15 years
    
6,149
    
1
    
163
   
6,311
  
Mortgage backed securities
    
172,168
    
899
    
2,255
    
173,524
  
Collateralized mortgage obligations
    
4,422
    
46
    
34
    
4,410
  
Total debt securities
    
239,839
    
1,012
    
3,449
    
242,276
  
FHLB capital stock and other
    
6,355
    
-
    
-
   
6,355
  
Total securities available-for-sale
  
$
246,194
  
$
1,012
  
$
3,449
  
$
248,631
  
 
 
  
 
  
Gross
  
Gross
  
 
  
 
  
Estimated
  
unrealized
  
unrealized
  
Amortized
  
(in thousands)
  
fair value
  
gains
  
losses
  
cost
  
December 31, 2004
    
   
   
   
 
U.S. Government Agency notes
    
   
   
   
 
Within 1 year
  
$
20,072
  
$
57
  
$
-
  
$
20,015
  
After 1 but within 5 years
    
24,828
    
-
    
170
   
24,998
  
Corporate Bonds
    
   
   
   
 
Within 1 year
    
11,166
    
162 -
    
   
11,004
  
Mortgage backed securities
    
138,146
    
1,515
    
581
   
137,212
  
Collateralized mortgage obligations
    
4,658
    
84
    
-
   
4,574
  
Total debt securities
    
198,870
    
1,818
    
751
   
197,803
  
FHLB capital stock and other
    
5,231
    
1
    
-
   
5,230
  
Total securities available-for-sale
  
$
204,101
  
$
1,819
  
$
751
  
$
203,033
  

Securities classified as held-to-maturity (carried at amortized cost) were as follows: 

   
 
 
Gross
 
Gross
 
 
 
 
 
Amortized
 
unrealized
 
unrealized
 
Estimated
 
(in thousands)
 
cost(a)
 
gains
 
losses
 
fair value
  
March 31, 2005
                          
Municipal bonds
                          
Within 1 year
 
$
500
  
$
2
  
$
3
  
$
499
  
After 5 but within 10 years
   
4,791
    
98
    
-
   
4,889
  
After 10 years
    
4,524
    
39
    
-
   
4,563
  
Mortgage backed securities
    
2,003
    
101
    
-
   
2,104
  
Collateralized mortgage obligations
    
67
    
1
    
-
   
68
  
Total securities held-to-maturity
  
$
11,885
  
$
241
  
$
3
  
$
12,123
  
 
9
 
   
 
  
Gross
  
Gross
  
 
  
 
  
Amortized
  
unrealized
  
unrealized
  
Estimated
  
(in thousands)
  
cost(a)
  
gains
  
losses
  
fair value
  
December 31, 2004
                          
Municipal bonds
                          
Within 1 year
 
$
500
  
$
4
  
$
4
  
$
500
  
After 5 but within 10 years
    
4,361
    
121
    
-
    
4,482
  
After 10 years within 15 years
    
5,232
    
71
    
-
   
5,303
  
Mortgage backed securities
    
2,220
    
148
    
-
   
2,368
  
Collateralized mortgage obligations
    
144
    
3
    
-
   
147
  
Total securities held-to-maturity
  
$
12,457
  
$
347
  
$
4
  
$
12,800
  

(a)
Securities transferred from available-for-sale are carried at estimated fair value as of the transfer date and adjusted for subsequent amortization.

At March 31, 2005 there was one fixed rate mortgage-backed security and one fixed rate municipal bond which had unrealized losses which have been in unrealized loss positions for over a twelve month period. The fixed rate mortgage-backed security had a loss of $216,000, or 2.7% of the carrying value. The fixed rate municipal bond had a loss of $4,000, or 1.4% of the carrying value. All other losses were in loss positions under a twelve-month period. Management does not believe any individual loss as of March 31, 2005 represented anything other than temporary impairment. These unrealized losses are primarily attributable to changes in interest rates.

At March 31, 2005 securities with a carrying value and market value of $5.5 million and $5.6 million, respectively, were pledged as collateral against public funds and securities with a carrying value and market value of $24.9 million and $24.9 million, respectively, were pledged as collateral against repurchase agreements. Also, securities with a carrying value and market value of $16.2 million and $16.3 million, respectively, were pledged as collateral for Treasury, tax and loan payments as well as possible Federal Reserve discount window borrowings.
 
NOTE 3 - LOANS
 
The composition of the loan portfolio is as follows:
   
March 31,
  
December 31,
  
(in thousands)
  
2005
  
2004
  
Real estate mortgages
              
1-to-4 family residential
  
$
287,792
  
$
296,252
  
5-or-more family residential
    
7,073
    
6,785
  
Commercial
   
124,742
    
117,915
  
Land & land development
    
3,656
    
3,197
  
Home equity credit
    
34,194
    
34,431
  
Commercial & industrial
    
21,791
    
20,471
  
Installment & other
    
1,893
    
1,949
  
Total loans, gross
    
481,141
    
481,000
  
Deferred loan origination fees, cost and purchase premium, net
    
632
    
708
  
Allowance for loan losses
    
(5,001
)
  
(5,048
)
Total loans, net
  
$
476,772
  
$
476,660
  
               
Impaired loans
              
 
    
March 31, 
    
December 31,
  
(in thousands)
    
2005
    
2004
  
With no valuation allowance
  
$
118
  
$
218
  
With valuation allowance
    
122
    
239
  
Total impaired loans
  
$
240
  
$
457
  
Valuation allowance
  
$
17
  
$
151
  

10
NewMil's loans consist primarily of residential and commercial real estate loans located principally in western Connecticut, NewMil's service area. NewMil offers a broad range of loan and credit facilities to borrowers in its service area, including residential mortgage loans, commercial real estate loans, construction loans, working capital loans, and a variety of consumer loans, including home equity lines of credit, and installment and collateral loans. All residential and commercial mortgage loans are collateralized by first or second mortgages on real estate. The ability and willingness of borrowers to satisfy their loan obligations are dependent in large part upon the status of the regional economy and regional real estate market. Accordingly, the ultimate collectability of a substantial portion of the NewMil's loan portfolio and the recovery of a substantial portion of OREO are susceptible to changes in market conditions.

Changes in the allowance for loan losses during the three-month periods ended March 31, are as follows:

   
March 31,
  
(in thousands)
  
2005
  
2004
  
Balance, beginning of period
  
$
5,048
  
$
5,198
  
Provision for losses
    
-
   
-
 
Charge-offs
    
(60
)
  
(29
)
Recoveries
    
13
    
9
  
Balance, end of period
  
$
5,001
  
$
5,178
  

NOTE 4 - NON-PERFORMING ASSETS
 
The components of non-performing assets are as follows:
 
   
March 31,
  
December 31,
  
(in thousands)
  
2005
  
2004
  
Non-accrual loans
  
$
207
  
$
393
  
Accruing loans past due 90 days or more
    
196
    
529
  
Accruing troubled debt restructured loans
    
-
   
-
  
Total non-performing loans
    
403
    
922
  
Real estate acquired in settlement of loans
    
73
    
-
 
Total non-performing assets
  
$
476
  
$
922
  

Real estate acquired in settlement of loans includes collateral acquired through foreclosure, forgiveness of debt or otherwise in lieu of debt.
 
NOTE 5 - EARNINGS PER SHARE
 
Basic earnings per share is computed using the weighted-average number of common shares outstanding during the year. The computation of diluted earnings per share is similar to the computation of basic earnings per share except the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. Shares used in the computations are as follows:
 
   
Three months ended
  
   
March 31,
  
(in thousands)
  
2005
  
2004
  
Basic
    
4,202
    
4,197
  
Effect of dilutive stock options
    
107
    
137
  
Diluted
    
4,309
    
4,334
  
 
11
NOTE 6 - COMPREHENSIVE (LOSS) INCOME
 
The components of comprehensive (loss) income are as follows:
 
   
Three months ended
  
   
March 31,
  
(in thousands)
 
2005
  
2004
  
Comprehensive (loss) income
              
Net income
  
$
2,235
  
$
2,023
  
Net unrealized losses on
             
securities available-for-sale during period
    
(2,312
)
  
(8
)
Comprehensive (loss) income
  
$
( 77
)
$
2,015
  

The components of other comprehensive (loss) income, and related tax effects are as follows:

(in thousands)
  
Before
 
Tax
 
Net of
 
 
 
tax
 
(expense)
 
tax
 
 
 
amount
 
benefit
 
amount
  
Three months ended March 31, 2005
                    
Net unrealized losses on securities
                   
available-for-sale arising during the period
  
$
(3,505
)
$
1,192
  
$
(2,313
)
Accretion of unrealized gain on securities transferred from
                    
available-for-sale to held-to-maturity
    
1
    
-
    
1
  
Net unrealized gains on
                    
securities during period
  
$
(3,504
)
$
1,192
  
$
(2,312
)

Three months ended March 31, 2004
                    
Net unrealized losses on securities
                   
available-for-sale arising during the period
  
$
(14
)
$
4
  
$
(10
)
Accretion of unrealized gain on securities transferred from
                    
available-for-sale to held-to-maturity
    
3
    
(1
)
  
2
  
Net unrealized losses on
                    
securities during period
  
$
(11
)
$
3
  
$
(8
)
 
NOTE 7 - INCOME TAXES 
 
The components of the income tax provision are as follows:
 
   
Three months ended
  
   
March 31,
 
(in thousands)
 
2005
 
2004
  
Current provision
              
Federal
  
$
1,106
  
$
1,007
  
State
    
-
    
-
  
Total
    
1,106
    
1,007
  
Deferred benefit
             
Federal
    
(89
)
  
(68
)
State
    
-
    
-
  
Total
    
(89
)
  
(68
)
Income tax provision
  
$
1,017
  
$
939
  

12
Connecticut tax legislation permits banks to shelter certain mortgage income from the Connecticut corporation business tax through the use of a special purpose entity called a passive investment company (“PIC”). In accordance with this legislation, in 1999 NewMil formed a PIC, NewMil Mortgage Company. NewMil's effective tax rates for the three month periods ended March 31, 2005 and 2004 are 31.3% and 31.7%, respectively, and reflect the full impact of the Connecticut legislation. NewMil does not expect to pay state income tax in the foreseeable future unless there is a change in the State of Connecticut corporate tax law.

NOTE 8 - SHAREHOLDERS' EQUITY
 
Capital Requirements
 
NewMil and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. The Bank was classified at its most recent notification as "well capitalized". NewMil and the Bank's regulatory capital ratios at March 31, 2005 are as follows:

   
NewMil
  
Bank
  
Leverage ratio
    
7.75
%
  
7.64
%
Tier I risk-based ratio
    
13.10
   
12.92
  
Total risk-based ratio
    
14.23
   
14.05
  

Restrictions on Subsidiary's Dividends and Payments
 
NewMil's ability to pay dividends is dependent on the Bank's ability to pay dividends to NewMil. There are certain restrictions on the payment of dividends and other payments by the Bank to NewMil. Under Connecticut law the Bank is prohibited from declaring a cash dividend on its common stock except from its net earnings for the current year and retained net profits for the preceding two years. In some instances, further restrictions on dividends may be imposed on NewMil by the Federal Reserve Bank.
 
NOTE 9 - LONG TERM DEBT
 
During March 2003, NewMil formed a subsidiary, NewMil Statutory Trust I, a trust formed under the laws of the state of Delaware, and issued $10 million of fixed/adjustable rate Trust Preferred Securities through a pooled trust-preferred securities offering. FTN Financial Capital Markets and Keefe Bruyette and Woods, Inc. acted as placement agents in the pooled offering. NewMil owns all of the common securities of the Trust and the Trust has no independent assets or operations, and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in an equivalent amount of junior subordinated debentures issued by NewMil. The junior subordinated debentures, which are the sole assets of the trust, are unsecured obligations of NewMil and generally are subordinate and junior in right of payment to all present and future senior and subordinated indebtedness and certain other financial obligations of NewMil. NewMil does not consolidate the trust, pursuant to FIN 46R, “Consolidation of Variable Interest Entities - an interpretation of ARB No. 51”.
 
The Trust Preferred Securities have an original term of 30 years and bear a fixed coupon of 6.40% for the first five years, and thereafter, a floating-rate coupon that will reset quarterly at three-month LIBOR plus 3.15%. Interest on the securities is payable quarterly. NewMil may redeem the trust-preferred securities, in whole or in part, on or after March 26, 2008, or earlier under certain conditions. The subordinated debentures bear the same terms and conditions as the trust preferred securities. NewMil paid $300,000 in connection with the issuance of the Trust Preferred Securities and this amount is being amortized over the estimated life of the underlying securities. The net proceeds qualify as Tier I capital for regulatory purposes.
 
NOTE 10 - STOCK BASED COMPENSATION
 
NewMil has stock-option plans, which are described more fully in Note 13 (Stock Options) to Financial Statements in the Company's 2004 Form 10-K. As permitted by Financial Accounting Standards Board (FASB) Statement No. 123 (FAS 123), Accounting for Stock-Based Compensation, NewMil uses the intrinsic value method of Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees, to account for its stock-based employee compensation plans. As required by FASB Statement No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment to FASB Statement 123, pro forma net income and earnings per common share information is provided, as if NewMil accounted for its employee stock option plans under the fair value method of FAS 123.
13
   
Three months ended
  
   
March 31,
  
(net income in thousands)
  
2005
  
2004
  
As reported
              
Net income
  
$
2,235
  
$
2,023
  
Earnings per share, diluted
    
0.52
    
0.47
  
Earnings per share, basic
    
0.53
    
0.48
  
Pro forma
              
Net income
    
1,857
    
1,948
  
Earnings per share, diluted
    
0.43
    
0.45
  
Earnings per share, basic
    
0.44
    
0.46
  
Stock-based employee compensation
              
cost, net of related taxes, included
              
in net income
              
As reported
    
-
    
-
  
Pro forma
    
378
    
75
  
 
NOTE 11 - RETIREMENT PLANS 
 
NewMil has retirement plans, which are described more fully in Note 9 (Retirement Plans) to the Financial Statements in the Company's 2004 Form 10-K. NewMil has a non-contributory defined benefit pension plan (the "Pension Plan") covering all eligible employees. NewMil also provides post-retirement health care and life insurance benefits (the “Other Benefits Plan”) for eligible current retirees and eligible employees. The following are components of net periodic benefit (income) cost:

Three Months Ended March 31,
  
Pension Plan
  
Other Benefits Plan
  
(in thousands)
  
2005
  
2004
  
2005
  
2004
  
Components of net periodic cost:
                          
Service cost
  
$
-
  
$
-
  
$
4
  
$
4
  
Interest cost
   
95
    
98
    
13
    
11
  
Expected return on plan assets
    
(122
)
  
(120
)
  
-
   
-
  
Amortization of prior service cost
    
3
    
-
    
-
   
-
  
Amortization of unrecognized net loss
    
1
    
3
    
2
   
-
  
Amortization of net transition obligation
    
-
    
-
    
4
    
4
  
Net periodic benefit (income) cost
  
$
(23
)
$
(19
)
$
23
  
$
19
  

 
14

NewMil Bancorp, Inc. and Subsidiary
 
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Management's discussion and analysis of financial condition and results of operations of NewMil and its subsidiary should be read in conjunction with NewMil's Annual Report on Form 10-K for the period ended December 31, 2004.
 
BUSINESS
 
NewMil Bancorp, Inc. ("NewMil"), a Delaware corporation, is a bank holding company for NewMil Bank ("Bank"), a Connecticut-chartered and Federal Deposit Insurance Corporation (the "FDIC") insured savings bank headquartered in New Milford, Connecticut. NewMil's principal business consists of the business of the Bank. The Bank is engaged in customary banking activities, including general deposit taking and lending activities to both retail and commercial markets, and conducts its business from nineteen full-service offices in Connecticut's Litchfield, Fairfield and New Haven Counties. NewMil and the Bank were formed in 1987 and 1858, respectively.
 
Cautionary Statement
 
This Quarterly Report on Form 10-Q contains and incorporates by reference statements relating to future results of NewMil that are considered “forward-looking” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to, among other things, expectations concerning loan demand, growth and performance, simulated changes in interest rates and the adequacy of the allowance for loan losses. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties, including, but not limited to, changes in political and economic conditions, interest rate fluctuations, competitive product and pricing pressures within NewMil’s markets, equity and fixed income market fluctuations, personal and corporate customers’ bankruptcies, inflation, technological changes, changes in law and regulations, changes in fiscal, monetary, regulatory and tax policies, monetary fluctuations, success in gaining regulatory approvals when required as well as other risks and uncertainties reported from time to time in NewMil’s filings with the Securities and Exchange Commission.
 
Application of Critical Accounting Policies
 
NewMil’s consolidated financial statements are prepared in accordance with US GAAP and follow general practices within the banking industry in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event.
 
NewMil’s significant accounting policies are presented in Note 1 of Notes to Consolidated Financial Statements. These policies, along with the disclosures presented in Notes to Consolidated Financial Statements and in Management’s Discussion and Analysis, provide information on how significant assets are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for loan losses to be the accounting area that requires the most subjective judgments, and as such could be most subject to revision as new information becomes available.
15
The allowance for loan losses represents management’s estimate of probable credit losses in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet. Note 1 describes the methodology used to determine the allowance for loan losses. A discussion of the factors driving changes in the amount of the allowance for loan losses is included in the “Provision and Allowance For Loan Losses” section of Management’s Discussion and Analysis.
 
RESULTS OF OPERATIONS
 
For the three month periods ended March 31, 2005 and 2004
 
Overview
 
NewMil earned net income of $2.2 million, or $0.52 cents per share (diluted), for the quarter ended March 31, 2005 as compared with $2.0 million, or $0.47 cents per share (diluted), for the quarter ended March 31, 2004. The increase was achieved through a variety of factors, the most important of which was a $58.7 million increase in average earning assets, which outpaced a 30 basis point decrease in the net interest margin to 3.71% from 4.01%. Net interest income increased $50,000 in the 2005 period. Non-interest expense decreased for the first quarter of 2005, primarily due to a lower bonus accrual, lower marketing and professional services expenses. Credit quality remained strong as nonperforming assets represented only 6 basis points of total assets at March 31, 2005. The return on average shareholders equity was 16.1% for the quarter.
 
Analysis of net interest and dividend income
 
Net interest and dividend income increased $50,000, for the quarter ended March 31, 2005 as compared with the prior year period. The increase in net interest income resulted primarily from the growth in average earning assets offset somewhat by a decrease in the net interest margin. Average earning assets increased $58.7 million, or 9.0%, over the prior year period. Average total borrowings and interest bearing deposits increased $32.4 million, or 5.4% over the prior year period. The net interest margin decreased 30 basis points to 3.71% from 4.01% over the prior period. The change in the net interest margin was due to the changes in the mix of earning assets and funding liabilities, asset and liability growth, changes in market interest rates and the impact of asset and liability re-pricing during 2005 as compared with 2004. The following table sets forth the components of NewMil's net interest income and yields on average interest-earning assets and interest-bearing funds.


16
 
Three months ended March 31,
  
Average
  
Income/
  
Average
  
   
Balance
  
Expense
  
Yield/Rate
  
(dollars in thousands)
  
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
Loans (a)
  
$
482,016
  
$
454,333
  
$
6,737
  
$
6,441
    
5.59
%
  
5.67
%
Mortgage backed securities (b)
    
152,423
    
79,315
    
1,786
    
1,011
    
4.69
    
5.10
  
Other securities (b)(c)
    
73,520
    
115,570
    
756
    
1,379
    
4.11
    
4.77
  
Total earning assets
    
707,959
    
649,218
    
9,279
    
8,831
    
5.24
    
5.44
  
Other assets
   
46,319
    
51,281
                          
Total assets
  
$
754,278
  
$
700,499
                          
                                       
NOW accounts
  
$
82,386
  
$
74,782
    
49
    
46
    
0.24
    
0.25
  
Money market accounts
    
149,116
    
156,344
    
389
    
392
    
1.04
    
1.00
  
Savings & other
    
84,952
    
83,331
    
137
    
138
    
0.65
    
0.66
  
Certificates of deposit
   
203,208
    
190,187
    
1,299
    
1,047
    
2.56
    
2.20
  
Total interest-bearing deposits
    
519,662
    
504,644
    
1,874
    
1,623
    
1.44
    
1.29
  
FHLB advances & other
    
98,385
    
81,118
    
670
    
523
    
2.72
    
2.58
  
Long term debt
    
9,819
    
9,753
    
175
    
175
    
7.13
    
7.18
  
Total interest-bearing funds
    
627,866
    
595,515
    
2,719
    
2,321
    
1.73
    
1.56
  
Demand deposits
    
67,202
    
47,100
                          
Other liabilities
    
3,617
    
4,511
                          
Shareholders' equity
    
55,593
    
53,373
                          
Total liabilities &
                                      
shareholders' equity
  
$
754,278
  
$
700,499
                          
Net interest income
              
$
6,560
  
$
6,510
              
Spread on interest-bearing funds
                            
3.51
    
3.88
  
Net interest margin (d)
                            
3.71
    
4.01
  

(a) Includes non-accrual loans.
(b) Average balances of investments are based on historical cost.
(c) Includes interest-bearing deposits in other banks and federal funds sold.
(d) Net interest income divided by average interest-earning assets.

The following table sets forth the changes in interest due to volume and rate.

Three months ended March 31,
 
 2005 versus 2004
  
(in thousands)
  
 Change in interest due to
  
 
    
Volume (1) 
    
Rate(1)
 
  
Net
  
Interest-earning assets:
                    
Loans
  
$
388
  
$
(92
)
$
296
  
Mortgage backed securities
    
863
    
(88
)
  
775
  
Other securities
    
(558
)
  
(65
)
  
(623
)
Total
    
693
    
(245
)
  
448
  
Interest-bearing liabilities:
                    
Deposits
    
64
    
187
    
251
  
FHLB advances & other
    
117
    
30
    
147
  
Long term debt
    
-
   
-
   
-
 
Total
    
181
    
217
    
398
  
Net change to interest income
  
$
512
  
$
(462
)
$
50
  
 
(1) Changes attributable to rate/volume are allocated proportionately to both rate and volume.
 
Interest income
 
Total interest and dividend income increased $448,000 for the quarter ended March 31, 2005 as compared with the same period a year ago. Loan income increased $0.3 million, or 4.6%, primarily as a result of higher volumes offset somewhat by a lower yield. Average loans increased $27.7 million, or 6.1%, due to loan originations during the period, offset in part by loan repayments. The decrease in the average loan yield, down 8 basis points, was caused by lower interest rates in 2005 and their effect on loan re-pricing and loan re-financing activity, which was partially offset by a change in portfolio mix resulting from growth in commercial loans.
17
Investment income increased $0.2 million, or 6.4%, as a result of higher average volume and offset somewhat by lower yields due to change in the mix of the portfolio over the prior year period. Average securities increased $31.1 million, or 15.9%.
 
Interest expense
 
Interest expense for the quarter ended March 31, 2005 increased $0.4 million, or 17.2%, as compared with the prior year period as a result of an increase in interest rates paid and higher average interest bearing deposits and average borrowings. Deposit expense increased $0.3 million, or 15.5%, as a result of higher deposit rates and by an increase in average deposit levels, and changes in deposit mix. Average interest bearing deposits increased $15.0 million. The average cost of interest-bearing deposits increased 15 basis points to 1.44%. Interest expense on FHLB advances and other borrowings increased $0.1 million, or 28.1%, primarily due to higher average borrowings, amounting to $17.3 million, in addition to an increase in the borrowing cost, up 14 basis points to 2.72% over the period, due to a change in mix and higher interest rates paid.
 
Provision and Allowance for loan losses
 
NewMil made no provision for loan losses during the quarters ending March 31, 2005 and 2004. During the past several years the Bank has experienced an improvement in loan quality and a decline in loan losses, which have averaged less than 1% on an annual basis, each of the past three years. These factors, offset by loan portfolio growth, have enabled the Bank to lower its allowance for loan losses as a percentage of total loans, and resulted in no provision for loan losses for the period. The following table sets forth key ratios for the periods presented.

   
March 31,
 
December 31,
 
March 31,
 
(in thousands)
 
2005
 
2004
 
2004
  
Ratio of allowance for loan losses:
                    
to non-performing loans
    
1241.15
%
  
547.51
%
  
341.17
%
to total gross loans
    
1.04
    
1.05
    
1.13
  
Ratio of non-performing loans
                   
to total loans
    
0.08
    
0.19
    
0.33
  
Ratio of past-due loans
                   
to total loans
    
0.38
    
0.61
    
0.74
  

As of March 31, 2005 the ratio of the allowance for loan losses to total gross loans decreased from 1.13% at March 31, 2004 and 1.05% at December 31, 2004, to 1.04% at March 31, 2005. The decline, as compared with March 31, 2004, was primarily due to the growth in residential one-to-four family residential mortgages, which exhibit lower reserve requirements. The ratio of non-performing loans to total loans continued to remain historically low, at 0.08% as of March 31, 2005, compared with 0.19% as of December 31, 2004 and 0.33% as of March 31, 2004. The ratio of past due loans (including non-performing loans) to total loans also remained at a historically low level of 0.38% as of March 31, 2005 compared with 0.61% as of December 31, 2004 and 0.74% as of March 31, 2004. During the three month period ended March 31, 2005, non-performing loans decreased $519,000, or 56.3%, while gross loans increased by $65,000. For additional discussion on loan quality see "Non-Performing Assets". 
 
NewMil determines its allowance and provisions for loan losses based upon a detailed evaluation of the loan portfolio through a process which considers numerous factors, including estimated credit losses based upon internal and external portfolio reviews, delinquency levels and trends, estimates of the current value of underlying collateral, concentrations, portfolio volume and mix, changes in lending policy, current economic conditions and historical loan loss experience over a 10-to-15 year economic cycle. Determining the level of the allowance at any given period is difficult, particularly during deteriorating or uncertain economic periods, and therefore management takes a relatively long view of loan loss asset quality measures. Management must make estimates using assumptions and information that are often subjective and changing rapidly. The review of the loan portfolio is a continuing event in the light of a changing economy and the dynamics of the banking and regulatory environment. In management's judgment NewMil remains adequately reserved both against total loans and non-performing loans at March 31, 2005.
18
Should the economic climate deteriorate, borrowers could experience difficulty and the level of non-performing loans, charge-offs and delinquencies could rise and require increased provisions. The allowance for loan losses is reviewed and approved by the Bank's Board of Directors on a quarterly basis. The allowance for loan losses is computed by segregating the portfolio into various risk rating and product categories. Some loans have been further segregated and carry specific reserve amounts. All other loans that do not have specific reserves assigned are reserved based on a loss percentage assigned to the outstanding balance. The percentage applied to the outstanding balance varies depending on the loan’s risk rating and product category, as well as present economic conditions, which have or may adversely affect the financial capacity and/or collateral values supporting the loan.
 
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies could require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination. The Bank was examined by the State of Connecticut’s Department of Banking in July 2004 and the FDIC in July 2003 and no additions to the allowance were requested as a result of these examinations.
 
Non-interest income
 
The following table details the principal categories of non-interest income.

   
March 31,
          
(in thousands)
  
2005
  
2004
  
Change
  
Service charges on deposit accounts
  
$
702
  
$
684
  
$
18
    
2.6
%
Gains on sales of mortgage loans, net
    
52
    
40
    
12
    
30.0
  
Loan servicing
    
7
    
10
    
(3
)
  
(30.0
)
Increase in cash surrender value of bank-owned
                          
life insurance
    
103
    
98
    
5
    
5.1
  
Other
    
83
    
85
    
(2
)
  
(2.4
)
Total non-interest income
  
$
947
  
$
917
  
$
30
    
3.3
%

The increase in non-interest income for the quarter ended March 31, 2005 as compared to the prior year period resulted primarily from an increase in retail banking fees earned due to an increase in the Bank’s fee schedule and the volume of accounts serviced. The increase in gains on sales of mortgage loans during the 2005 period was primarily due to higher volume originated. The Bank originated and sold $2.7 million in residential loans during the 2005 period versus $2.2 million during the 2004 period. Loans originated for sale are pre-sold with servicing rights released on an individual basis at commitment. The increase in the cash surrender value of bank-owned life insurance, when compared to the prior year period, was due to the higher level of the underlying insurance assets over the 2004 period. Loan servicing revenue decreased because of loan payoffs and the decline in serviced loan outstandings since the 2004 period.
19
Operating expenses
 
The following table details the principal categories of operating expenses.

   
March 31,
         
(in thousands)
  
2005
  
2004
  
Change
  
Salaries and employee benefits
  
$
2,312
  
$
2,466
  
$
(154
)
  
(6.2
)%
Occupancy
    
433
    
402
    
31
    
7.7
  
Equipment
    
354
    
328
    
26
    
7.9
  
Professional, collection and OREO
    
226
    
297
    
(71
)
  
(23.9
)
Postage and telecommunications
    
133
    
131
    
2
    
1.5
  
Printing and office supplies
    
104
    
101
    
3
    
3.0
  
Marketing
    
67
    
121
    
(54
)
  
(44.6
)
Service bureau
    
93
    
94
    
(1
)
  
(1.1
)
Amortization of intangibles
    
37
    
49
    
(12
)
  
(24.5
)
Other
    
496
    
476
    
20
    
4.2
  
Total operating expenses
  
$
4,255
  
$
4,465
  
$
(210
)
  
(4.7
)%

The net decrease in operating expenses was primarily due to decreases in salaries and employee benefits, marketing expense and professional fees for the quarter ended March 31,2005 as compared with the prior year period.  Compensation expense decreased primarily due to a lower bonus accrual, lower mortgage commissions and lower health benefits, offset somewhat by higher payroll taxes during the 2005 period. Occupancy expense increased during 2005 primarily due to higher building maintenance and repair expenses, higher utilities and higher rent expense. Equipment expense increased primarily due to increases in maintenance costs associated with equipment repairs and service contracts and higher depreciation on hardware/software and furniture. Professional, collection and OREO expense decreased primarily due to lower consulting costs and lower corporate and legal collection expense offset partially by higher internal and external auditing expense. The decrease in marketing expense was due to lower advertising and marketing campaigns during the period. Amortization of intangibles expense was reduced during the 2005 period as compared with the prior year period. The increase in other expenses was primarily related to increases in directors’ fees, ATM network and card activity and dues/memberships and filing fees.

Income taxes
 
Net income for the quarter included an income tax provision of $1.0 million representing a 31.3% effective rate, as compared with a provision of $939,000 a year ago, representing a 31.7% effective rate. The effective tax rate was less than the 34% federal statutory rate due to tax-exempt income and other related matters.
 
FINANCIAL CONDITION
 
Overview
 
For the three-month period ended March 31, 2005, total assets grew $45.2 million, or 6.1%, to $789.8 million. The increase resulted from a slight increase in net loans to $476.8 million and a $41.5 million increase in investment securities. Federal Home Loan Bank advances increased $23.0 million. Deposits and retail repurchase agreements increased by $17.3 million and $1.0 million, respectively. Non-performing assets continue to remain very low, measured as a percentage of total assets. As of March 31, 2005 non-performing assets were $0.5 million, or 0.06% of total assets, compared with $0.9 million, or 0.12% of total assets at December 31, 2004.
20
Securities & Overnight Fed Funds Sold
 
For the three-month period ended March 31, 2005 securities increased $41.5 million to $258.1 million. During the period securities purchases of $65.9 million were offset partially by repayments of mortgage-backed securities and other securities totaling $25.2 million, and a decrease in the mark-to-market adjustment for unrealized securities holding losses. Securities purchases for the period included $42.8 million of fixed and adjustable rate mortgage-backed securities, $22.0 million of fixed rate municipal bonds and $1.1 million of other investments.
 
NewMil's securities portfolio consists of U.S. Government Agency notes, mortgage backed securities (MBS), corporate bonds, bank qualified municipal bonds, collateralized mortgage obligations (CMOs) and Federal Home Loan Bank stock. At March 31, 2005, the portfolio had a projected weighted average duration and life of 4.7 years and 5.3 years, respectively, based on median projected prepayment speeds at current interest rates. At March 31, 2005, securities totaling $246.2 million, or 95.4%, were classified as available-for-sale and securities totaling $11.9 million, or 4.6%, were classified as held-to-maturity.
 
Loans
 
During the three-month period ended March 31, 2005 net loans increased $112,000. Loan originations, advances and loan purchases totaled $29.6 million, while loan repayments were $29.4 million. The ratio of loans to assets decreased slightly during the quarter to 60.4% at March 31, 2005, compared with 64.0% at December 31, 2004, and from 63.3% a year ago at March 31, 2004. NewMil originated and sold in the secondary market $2.7 million of residential mortgage loans during the three-month period ending March 31, 2005. Major loan classifications are as follows:

   
March 31,
  
December 31,
  
(in thousands)
  
2005
 
2004
  
Real Estate Mortgages:
              
Residential
              
1-to-4 family
  
$
287,792
  
$
296,252
  
5-or-more family
    
7,073
    
6,785
  
Commercial
    
124,742
    
117,915
  
Land & land development
    
3,656
    
3,197
  
Home equity credit
    
34,194
    
34,431
  
Total mortgage loans
    
457,457
    
458,580
  
Commercial and industrial
    
21,791
    
20,471
  
Installment and other
    
1,893
    
1,949
  
Total loans, gross
    
481,141
    
481,000
  
Deferred loan origination
              
fees and purchase premiums, net
    
632
    
708
  
Allowance for loan losses
    
(5,001
)
  
(5,048
)
Total loans, net
  
$
476,772
  
$
476,660
  

The Commercial Lending department specializes in lending to small and mid-size companies and professional practices and provides short-term and long-term financing, construction loans, commercial mortgages and property improvement loans. The department also works with several government-assisted lending programs. The Residential Mortgage Department, in addition to traditional portfolio lending, originates loans for sale to the secondary market on a service-released basis, which enables the Bank to offer a very comprehensive mortgage product line and earn gains from sales of such loans. The department also offers home equity loans and lines of credit and consumer installment loans.
21
Non-performing assets
 
The composition of non-performing assets is as follows:
 
   
March 31,
  
December 31,
  
(in thousands)
  
2005
  
2004
  
Non-accruing loans
  
$
207
  
$
393
  
Accruing loans past due
              
90 days or more
    
196
    
529
  
Accruing restructured loans
    
-
   
-
 
Total non-performing loans
    
403
    
922
  
OREO, net
    
73
   
-
 
Total non-performing assets
  
$
476
  
$
922
  
Percent of total assets
    
0.06
%
  
0.12
%

During the three-month period ended March 31, 2005 non-performing assets decreased $446,000, to $0.5 million. Non-performing assets continue to remain historically low at 0.06% of total assets at March 31, 2005, compared with 0.12% at December 31, 2004. The low level of non-performing assets reflects NewMil's rigorous ongoing credit management process and prudent credit policy.
 
In addition to non-performing assets, at March 31, 2005 NewMil had $0.6 million of performing classified loans that are considered potential problem loans. Although not impaired, performing classified loans, in the opinion of management, exhibit a higher than normal degree of risk and warrant monitoring due to various considerations, including (i) the degree of documentation supporting the borrower's current financial position, (ii) potential weaknesses in the borrowers' ability to service the loan, (iii) possible collateral value deficiency, and (iv) other risk factors such as geographic location, industry focus and negatively trending financial results. These deficiencies create some uncertainty, but not serious doubt, as to the borrowers' ability to comply with the loan repayment terms in the future. Management believes that reserves for these loans are adequate.
 
NewMil pursues the resolution of all non-performing assets through restructurings, credit enhancements or collections. When collection procedures do not bring a loan into performing or restructured status, NewMil generally initiates action to foreclose the property or to acquire it by deed in lieu of foreclosure. NewMil actively markets all OREO property.
 
Deposits and Borrowings
 
During the three-month period deposits grew $17.3 million, or 2.9% to $604.3 million. At March 31, 2005 retail repurchase agreements increased $1.0 million to $14.2 million from December 31, 2004. Additionally, NewMil increased its Federal Home Loan Bank advances by $23.0 million, or 30.4% to aid in funding its asset growth during the first quarter of 2005.
 
During March 2003, NewMil formed a subsidiary, NewMil Statutory Trust I, a trust formed under the laws of the state of Delaware, and issued $10 million of fixed/adjustable rate Trust Preferred Securities through a pooled trust-preferred securities offering. FTN Financial Capital Markets and Keefe Bruyette and Woods, Inc. acted as placement agents in the pooled offering. NewMil owns all of the common securities of the Trust and the Trust has no independent assets or operations, and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in an equivalent amount of junior subordinated debentures issued by NewMil. The junior subordinated debentures, which are the sole assets of the trust, are unsecured obligations of NewMil and generally are subordinate and junior in right of payment to all present and future senior and subordinated indebtedness and certain other financial obligations of NewMil.
22
LIQUIDITY
 
NewMil manages its liquidity position to ensure that there is sufficient funding availability at all times to meet both anticipated and unanticipated deposit withdrawals, loan originations and advances, securities purchases and other operating cash outflows. NewMil's primary sources of liquidity are principal payments and maturities of securities and loans, short-term borrowings through repurchase agreements and Federal Home Loan Bank advances, net deposit growth and funds provided by operations. Liquidity can also be provided through sales of loans and available-for-sale securities.
 
Operating activities for the three-month period ended March 31, 2005 provided net cash of $2.8 million. Investing activities utilized net cash of $41.0 million, principally for securities purchases and to a lesser degree, net loan advances, offset in part by security repayments and maturities. Financing activities provided net cash of $40.3 million, principally, $23.0 million from a net increase in FHLB advances, $18.3 million from an increase in deposits and repurchase agreements, as well as $0.2 million as a result of net proceeds from stock option exercises, offset by cash dividends paid and treasury stock purchases.
 
At March 31, 2005, NewMil's liquidity ratio, as represented by cash, short term available-for-sale securities, marketable assets and the ability to borrow against held-to-maturity securities and loans through unused FHLB and other short term borrowing capacity, of approximately $123.6 million, to net deposits and short term unsecured liabilities, was 46.6%, well in excess of NewMil's minimum guideline of 15%. 
 
At March 31, 2005, NewMil had outstanding commitments to fund new loan originations of $18.6 million, construction mortgage commitments of $21.0 million and unused lines of credit of $56.6 million. These commitments can be met in the normal course of business. NewMil believes that its liquidity sources will continue to provide funding sufficient to support operating activities, loan originations and commitments, and deposit withdrawals.
 
CAPITAL RESOURCES

During the period ended March 31, 2005 shareholders' equity decreased $1.0 million to $54.6 million and book value per share decreased $0.29 to $12.96. Primarily reducing shareholders’ equity were other comprehensive losses of $2.3 million (a net decrease in the unrealized holding losses on securities available-for-sale, net of taxes), dividend payments of $0.8 million and treasury stock purchases of $0.4 million. Increasing shareholders' equity was net income of $2.2 million, or $0.52 per share (diluted), stock option exercise proceeds of $0.3 million and a tax benefit from the exercise of non-qualified stock options of $55,000.
Capital requirements
 
NewMil and the Bank are subject to minimum capital requirements established, respectively, by the Federal Reserve Board (the "FRB") and the FDIC. At March 31, 2005 NewMil's Tier 1 Leverage Capital ratio was 7.75% and its Tier 1 and Total Risk-Based Capital ratios were 13.10% and 14.23%, respectively. At March 31, 2005 the Bank's Tier 1 Leverage Capital ratio was 7.64% and its Tier 1 and Total Risk-Based Capital ratios were 12.92% and 14.05%, respectively. NewMil and the Bank are categorized as "well capitalized". A well capitalized institution, which is the highest capital category for an institution as defined by the Prompt Corrective regulations issued by the FDIC and the FRB, is one which maintains a Total Risk-Based ratio of 10% or above, a Tier I Risk-Based ratio of 6% or above and a Leverage ratio of 5% or above, and is not subject to any written order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level.
 
Dividends
 
NewMil's ability to pay dividends is dependent on the Bank's ability to pay dividends to NewMil. There are certain restrictions on the payment of dividends and other payments by the Bank to NewMil. Under Connecticut law the Bank is prohibited from declaring a cash dividend on its common stock except from its net earnings for the current calendar year and retained net profits for the preceding two years. In some instances, further restrictions on dividends may be imposed on NewMil by the Federal Reserve Bank.
 
NewMil believes that the payment of cash dividends to its shareholders is appropriate, provided that such payment considers NewMil's capital needs, asset quality, and overall financial condition and does not adversely affect the financial stability of NewMil or the Bank. The continued payment of cash dividends by NewMil will be dependent on NewMil's future core earnings, financial condition and capital needs, regulatory restrictions, and other factors deemed relevant by the Board of Directors of NewMil.
23
Impact of New Accounting Pronouncements
 
In December 2004, the Financial Accounting Standards Board (“FASB”) issued revised Statement of Financial Accounting Standard (“SFAS”) No. 123(R), “Share-Based Payment”. The Statement requires entities to measure the cost of employees services received in exchange for an award of equity instruments based on the estimated grant-date fair value of the award. That cost will be recognized over the period during which the employee is required to provide service in exchange for the award (usually the vesting period). However, no compensation expense is recognized for equity instruments that do not vest. The estimated grant-date fair value of employee share options must be determined using option-pricing models adjusted for the unique characteristics of those instruments. The notes to the financial statements will include additional disclosures to assist users of the financial statements in understanding the nature of share-based payment transactions and the effects of those transactions on the financial statements.

The effective date of the Statement for NewMil is January 1, 2006. All public entities will be required to apply the Statement using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for either recognition or proforma disclosure purposes. Under the stock option plans currently in place at NewMil, and assuming similar amounts of options are granted to directors as in prior years and that no options are granted to employees, since no option grants are contemplated, and using the current valuation assumptions with respect to the dividend yield, expected volatility, risk-free interest rate and expected lives, NewMil expects the impact of this statement to reduce net income by approximately $50,000, or $0.01 per share, for 2006 and thereafter.

 
 

 
24
Item 3.
QUANTITATIVE and QUALITATIVE DISCLOSURE of MARKET RISK

Market risk is the exposure to losses resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which NewMil is exposed is interest rate risk. NewMil has no foreign currency or commodity price risk and equity price risk is considered limited due to the fact that NewMil has minimal investments in equities and investments in corporate bonds are in the highest credit grades.
 
NewMil manages interest rate risk through an Asset Liability Committee comprised of representatives from senior management and the Board of Directors. The objective of interest rate risk management is to achieve and maintain a high and stable net interest margin under changing interest rate environments. NewMil seeks to manage interest rate risk within limits approved by the Board of Directors. NewMil monitors exposure to interest rate risk on a quarterly basis using earnings simulation analysis and gap analysis. Earnings simulation analysis measures the amount of short-term earnings at risk under both rising and falling rate scenarios as compared with current interest rates. Balance sheet gap analysis identifies short-, medium- and long-term interest rate positions or exposure. NewMil's interest rate risk has not significantly changed from December 31, 2004. For additional information, refer to “Asset/Liability Management and Market Risk” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in NewMil's 2004 Annual Report.

Item 4.
CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures
 
NewMil maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in NewMil’s reports filed with, or furnished to, the SEC, pursuant to the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to NewMil’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934.  
 
Within 90 days prior to the date of this report, NewMil carried out an evaluation, under the supervision and with the participation of the NewMil’s management, including NewMil’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the NewMil’s disclosure controls and procedures. Based on the foregoing evaluation, NewMil’s Chief Executive Officer and Chief Financial Officer concluded that the NewMil’s disclosure controls and procedures were effective.
 
Changes in Internal Controls over Financial Reporting
 
There were no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date we carried out our evaluation.

PART II.
OTHER INFORMATION

Item 1.
LEGAL PROCEEDINGS

There are no material legal proceedings pending against NewMil or the Bank or any of their properties, other than ordinary routine litigation incidental to NewMil's business.
25
 
Item 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) -(b) None
 
(c)

   
Total # Shares
  
Average
  
   
Purchased
  
Price
  
               
January 2005
    
-
 
$
-
  
February 2005
    
11,800
    
29.60
  
March 2005
    
3,000
    
28.79
  
Total number of shares purchased during
              
period as part of a publicly announced
             
repurchase program
    
14,800
  
$
29.43
  
Maximum remaining shares available to
              
be purchased under the announced plan
    
76,216
        

On April 23, 2003, NewMil announced its intention to repurchase 203,690, or 5%, of its outstanding shares of common stock in the open market and unsolicited negotiated transactions, including block purchases. The purpose of NewMil’s repurchase plan is to offset the future dilution from shares issued upon the exercise of stock options under NewMil's stock option plans, and for general corporate purposes.

Item 3.
DEFAULTS UPON SENIOR SECURITIES

None

Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The annual shareholder’s meeting was held on April 27, 2005. The following matters were considered and voted on, as certified by the election officer at the annual meeting:


 
Votes For
Votes Against
Votes Withheld
Director Election
      
Joseph Carlson II, for 3 year term
3,513,581
67,153
-
       
Director Election
      
Betty F. Pacocha, for 3 year term
3,516,751
63,983
-
       
Director Election
      
Anthony M. Rizzo, for 3 year term
3,511,526
69,208
-
       
Director Election
      
Mary C. Williams, for 3 year term
3,512,981
67,753
-
       
Ratification of
     
PricewaterhouseCoopers, LLP
  
 
  
As auditors
3,519,283
58,115
3,336

Item 5.
OTHER INFORMATION

None

Item 6.
EXHIBITS

 
11.1
Statement regarding Computation of Net Income Per Common Share.
 
31.1
Chief Executive Officer Certification Pursuant to 17 CFR 240.13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
26
 
 
31.2
Chief Financial Officer Certification Pursuant to 17 CFR 240.13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
32.1
Chief Executive Officer Certification Pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
32.2
Chief Financial Officer Certification Pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
 
 
 
 
 

27

SIGNATURES 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


 
NEWMIL BANCORP, INC.
   
   
   
May 4, 2005
by /s/ Francis J. Wiatr
 
 Francis J. Wiatr,
 
 Chairman, President and CEO
   
   
   
May 4, 2005
by /s/ B. Ian McMahon
 
 B. Ian McMahon,
 
 Chief Financial Officer
 
 
 

 
28