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: September 30, 2003
Commission File No. 001-16101
BANCORP RHODE ISLAND, INC.
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(Exact Name of Registrant as Specified in Its Charter)
RHODE ISLAND 05-0509802
--------------------------------- -------------------
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
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(Address of Principal Executive Offices)
(401) 456-5000
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(Issuer's Telephone Number, Including Area Code)
Not Applicable
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(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 the number of shares outstanding of each of the Registrant's
classes of common stock, as of November 10, 2003:
-----------------
Common Stock - Par Value $0.01 3,885,190 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 - 8
Item 2 Management's Discussion and Analysis 9 - 21
Item 3 Quantitative and Qualitative Disclosures About Market Risk 22 - 23
Item 4 Controls and Procedures 23
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 24
Item 2 Changes in Securities 24
Item 3 Defaults upon Senior Securities 24
Item 4 Submission of Matters to a Vote of Security Holders 24
Item 5 Other Information 24
Item 6 Exhibits and Reports on Form 8-K 24
Signature Page 25
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
September 30, December 31,
2003 2002
------------- ------------
(Dollars in thousands)
ASSETS:
Cash and due from banks $ 22,919 $ 25,336
Overnight investments 37,842 17,623
---------- ----------
Total cash and cash equivalents 60,761 42,959
Investment securities available for sale (amortized cost of $77,103 and
$99,803 at September 30, 2003 and December 31, 2002, respectively) 78,658 101,329
Mortgage-backed securities available for sale (amortized cost of $102,728 and
$154,225 at September 30, 2003 and December 31, 2002, respectively) 102,875 156,114
Stock in Federal Home Loan Bank of Boston 8,934 7,683
Loans receivable:
Commercial loans 318,222 280,967
Residential mortgage loans 366,580 297,763
Consumer and other loans 104,734 91,928
---------- ----------
Total loans 789,536 670,658
Less allowance for loan losses (10,808) (10,096)
---------- ----------
Net loans 778,728 660,562
Premises and equipment, net 12,287 9,702
Other real estate owned -- 58
Goodwill 10,766 10,766
Accrued interest receivable 5,626 6,183
Investment in bank-owned life insurance 15,347 14,768
Prepaid expenses and other assets 3,782 2,753
---------- ----------
Total assets $1,077,764 $1,012,877
========== ==========
LIABILITIES:
Deposits:
Demand deposit accounts $ 153,329 $ 137,920
NOW accounts 123,519 100,476
Money market accounts 13,157 10,660
Savings accounts 309,274 290,981
Certificate of deposit accounts 201,133 221,874
---------- ----------
Total deposits 800,412 761,911
Overnight and short-term borrowings 12,693 27,364
Federal Home Loan Bank of Boston borrowings 176,732 143,941
Company-obligated mandatorily redeemable capital securities 13,000 8,000
Other liabilities 4,905 5,234
---------- ----------
Total liabilities 1,007,742 946,450
---------- ----------
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:
Voting: Issued and outstanding 3,885,080 shares in 2003 and
3,777,450 in 2002 39 38
Additional paid-in capital 41,237 40,134
Retained earnings 27,623 24,002
Accumulated other comprehensive income, net 1,123 2,253
---------- ----------
Total shareholders' equity 70,022 66,427
---------- ----------
Total liabilities and shareholders' equity $1,077,764 $1,012,877
========== ==========
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands, except per share data)
Interest and dividend income:
Commercial loans $ 4,975 $ 4,833 $ 14,488 $ 13,564
Residential mortgage loans 4,444 4,555 12,941 14,327
Consumer and other loans 1,284 988 3,909 2,886
Mortgage-backed securities 973 2,188 3,785 6,636
Investment securities 854 863 2,985 2,392
Overnight investments 59 82 143 198
Federal Home Loan Bank of Boston stock dividends 69 68 198 210
--------- --------- --------- ---------
Total interest and dividend income 12,658 13,577 38,449 40,213
--------- --------- --------- ---------
Interest expense:
NOW accounts 333 240 1,003 368
Money market accounts 27 36 79 102
Savings accounts 922 1,286 3,136 3,785
Certificate of deposit accounts 1,458 1,975 4,578 6,365
Overnight and short-term borrowings 20 114 109 226
Federal Home Loan Bank of Boston borrowings 1,803 1,880 5,364 5,530
Company-obligated mandatorily redeemable capital securities 203 145 480 302
--------- --------- --------- ---------
Total interest expense 4,766 5,676 14,749 16,678
--------- --------- --------- ---------
Net interest income 7,892 7,901 23,700 23,535
Provision for loan losses 400 575 1,200 1,425
--------- --------- --------- ---------
Net interest income after provision for loan losses 7,492 7,326 22,500 22,110
--------- --------- --------- ---------
Noninterest income:
Service charges on deposit accounts 957 993 2,952 2,760
Commissions on nondeposit investment products 220 349 626 771
Income from bank-owned life insurance 171 143 579 380
Loan related fees 127 78 570 251
Commissions on loans originated for others 128 78 331 230
Gain on sale of mortgage-backed securities -- -- 104 23
Gain on sale of investment securities 348 -- 681 --
Other income 283 155 701 465
--------- --------- --------- ---------
Total noninterest income 2,234 1,796 6,544 4,880
--------- --------- --------- ---------
Noninterest expense:
Salaries and employee benefits 3,697 3,376 10,741 9,630
Occupancy 595 485 1,785 1,448
Equipment 389 288 1,102 783
Data processing 599 500 2,245 1,425
Marketing 235 215 830 896
Professional services 289 330 951 1,128
Loan servicing 270 216 708 675
Other real estate owned expense 33 (3) 34 4
Other expenses 930 827 2,859 2,348
--------- --------- --------- ---------
Total noninterest expense 7,037 6,234 21,255 18,337
--------- --------- --------- ---------
Income before income taxes 2,689 2,888 7,789 8,653
Income tax expense 904 957 2,570 2,919
--------- --------- --------- ---------
Net income $ 1,785 $ 1,931 $ 5,219 $ 5,734
========= ========= ========= =========
Per share data:
Basic earnings per common share $ 0.47 $ 0.51 $ 1.37 $ 1.53
Diluted earnings per common share $ 0.44 $ 0.48 $ 1.29 $ 1.44
Average common shares outstanding - basic 3,830,461 3,765,585 3,799,116 3,754,604
Average common shares outstanding - diluted 4,084,174 3,988,321 4,052,699 3,993,256
See accompanying notes to consolidated financial statements
4
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity
Accumulated
Other
Compre-
Additional hensive
Common Paid-in Retained Income,
Nine months ended September 30, Stock Capital Earnings Net Total
------ ---------- -------- ----------- -----
(In thousands)
2003
----
Balance at December 31, 2002 $38 $40,134 $24,002 $2,253 $66,427
Net income -- -- 5,219 -- 5,219
Other comprehensive income,
net of tax:
Unrealized gains on
securities available for sale,
net of taxes of $315 (612) (612)
Realized gains on
securities available for sale,
net of taxes of $267 (518) (518)
-------
Comprehensive income 4,089
Exercise of stock options -- 415 -- -- 415
Exercise of stock warrants 1 662 -- -- 663
Common stock issued for incentive
stock award, net -- 26 -- -- 26
Dividends on common stock -- -- (1,598) -- (1,598)
--- ------- ------- ------ -------
Balance at September 30, 2003 $39 $41,237 $27,623 $1,123 $70,022
=== ======= ======= ====== =======
2002
----
Balance at December 31, 2001 $37 $39,826 $18,336 $ 898 $59,097
Net income -- -- 5,734 -- 5,734
Other comprehensive income,
net of tax:
Unrealized gains on
securities available for sale,
net of taxes of $650 1,262 1,262
Realized gains on securities available
for sale, net of taxes of $8 (15) (15)
-------
Comprehensive income 6,981
Proceeds from exercise of options 1 263 -- -- 264
Common stock issued for incentive
stock award, net -- 24 -- -- 24
Dividends on common stock -- -- (1,467) -- (1,467)
--- ------- ------- ------ -------
Balance at September 30, 2002 $38 $40,113 $22,603 $2,145 $64,899
=== ======= ======= ====== =======
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
Nine Months Ended
September 30,
-----------------------
2003 2002
---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 5,219 $ 5,734
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization 3,512 1,943
Provision for loan losses 1,200 1,425
Gain on investment securities (681) --
Gain on mortgage-backed securities (104) (23)
Gain on sale of other real estate owned (15) (29)
Income from bank-owned life insurance (579) (380)
Compensation expense from restricted stock grant 26 24
(Increase) decrease in:
Accrued interest receivable 557 (291)
Prepaid expenses and other assets (447) (2,674)
Increase (decrease) in:
Other liabilities (329) 612
Other, net 75 79
--------- ---------
Net cash provided (used) by operating activities 8,434 6,420
--------- ---------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (22,645) (6,842)
Commercial loans (72,065) (70,467)
Consumer loans (41,719) (29,849)
Purchase of:
Investment securities available for sale (53,844) (54,210)
Mortgage-backed securities available for sale (62,812) (78,065)
Residential mortgage loans (217,473) (102,143)
Federal Home Loan Bank of Boston stock (1,251) (2,015)
Principal payments on:
Investment securities available for sale 54,085 31,006
Mortgage-backed securities available for sale 88,269 44,480
Residential mortgage loans 170,479 132,958
Commercial loans 34,507 31,812
Consumer loans 28,618 15,640
Proceeds from sale of investment securities 22,788 --
Proceeds from sale of mortgage-backed securities 25,164 3,766
Proceeds from sale of other real estate owned 56 293
Capital expenditures for premises and equipment (3,890) (2,028)
Purchase of bank-owned life insurance -- (10,000)
--------- ---------
Net cash provided (used) by investing activities (51,733) (95,664)
--------- ---------
Cash flows from financing activities:
Net increase in deposits 38,501 60,604
Net increase (decrease) in overnight and short-term borrowings (14,671) 20,002
Proceeds from long-term borrowings 99,750 45,351
Repayment of long-term borrowings (61,959) (8,838)
Proceeds from exercise of stock options and warrants 1,078 264
Dividends on common stock (1,598) (1,467)
--------- ---------
Net cash provided (used) by financing activities 61,101 115,916
--------- ---------
Net increase (decrease) in cash and cash equivalents 17,802 26,672
Cash and cash equivalents at beginning of period 42,959 29,174
--------- ---------
Cash and cash equivalents at end of period $ 60,761 $ 55,846
========= =========
Supplementary Disclosures:
Cash paid for interest $ 15,026 $ 17,174
Cash paid for income taxes 2,367 3,589
Non-cash transactions:
Change in other comprehensive income, net of taxes (1,130) 1,247
See accompanying notes to consolidated financial statements
6
BANCORP RHODE ISLAND, INC.
Notes to Consolidated Financial Statements
(1) Basis of Presentation
Bancorp Rhode Island, Inc. (the "Company"), a Rhode Island
corporation, was organized by Bank Rhode Island (the "Bank") to be a bank
holding company and to acquire all of the capital stock of the Bank. The
reorganization of the Bank into the holding company form of ownership was
completed on September 1, 2000. The Company has no significant operating
entities other than the Bank. For that reason, substantially all of the
discussion in this Quarterly Report on Form 10-Q relates to the operations
of the Bank and its subsidiaries.
The consolidated financial statements include the accounts of the
Company and its wholly-owned direct subsidiaries, the Bank, BRI Statutory
Trusts I, II and III (issuers of trust preferred securities), and its
indirect subsidiaries, BRI Investment Corp. (a Rhode Island passive
investment company), BRI Realty Corp. (a real estate holding company), BRI
Community Investment Corp. (a community development entity) and Acorn
Insurance Agency, Inc. (a licensed insurance agency). All significant
intercompany accounts and transactions have been eliminated in
consolidation.
The interim results of consolidated operations are not necessarily
indicative of the results for any future interim period or for the entire
year. These interim consolidated financial statements do not include all
disclosures associated with annual financial statements and, accordingly,
should be read in conjunction with the annual consolidated financial
statements and accompanying notes included in the Company's Annual Report to
Shareholders filed with the Securities and Exchange Commission.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts
of assets and liabilities as of the date of the balance sheet and revenues
and expenses for the period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to change
relate to the determination of the allowance for loan losses and goodwill
valuation.
The unaudited interim consolidated financial statements of the Company
have been prepared in accordance with Accounting Principles Generally
Accepted in the United States of America ("GAAP") and prevailing practices
within the banking industry and include all necessary adjustments
(consisting of only normal recurring adjustments), that, in the opinion of
management, are required for a fair presentation of the results and
financial condition of the Company.
(2) Critical Accounting Policies
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions. Accounting policies
involving significant judgments and assumptions by management, which have,
or could have, a material impact on the carrying value of certain assets and
impact income, are considered critical accounting policies. Management has
discussed the development and the selection of critical accounting policies
with the Audit Committee of our Board of Directors. As discussed in our
2002 Annual Report on Form 10-K, we have identified the allowance for loan
losses and review of goodwill for impairment as critical accounting
policies. There have been no significant changes in the methods or
assumptions used in the accounting policies that require material estimates
and assumptions.
7
(3) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and resulted in the issuance of additional
common stock that then shared in the earnings of the entity.
(4) Recent Accounting Developments
In December 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure". SFAS 148 amends
SFAS 123, "Accounting for Stock-Based Compensation", to provide alternative
methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. Companies are able to
eliminate a "ramp-up" effect that the SFAS 123 transition rule creates in
the year of adoption. Companies can choose to elect a method that will
provide for comparability amongst years reported. In addition, this
Statement amends the disclosure requirement of SFAS 123 to require prominent
disclosures in both annual and interim financial statements about the fair
value based method of accounting for stock-based employee compensation and
the effect of the method used on reported results. The amendments to SFAS
123 are effective for financial statements for fiscal years ending after
December 15, 2002. The adoption of this Statement did not have a material
impact on the Company's financial position or results of operations.
The following table summarizes the differences between the fair value
and intrinsic value methods of accounting for stock-based compensation:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2003 2002 2003 2002
---- ---- ---- ----
Net income (in thousands):
As reported $1,785 $1,931 $5,219 $5,734
Compensation cost, net of taxes (1) (47) (40) (142) (119)
------ ------ ------ ------
Pro forma $1,738 $1,891 $5,077 $5,615
====== ====== ====== ======
Earnings per common share:
Basic:
As reported $ 0.47 $ 0.51 $ 1.37 $ 1.53
Compensation cost, net of taxes (1) (0.01) (0.01) (0.04) (0.03)
------ ------ ------ ------
Pro forma $ 0.46 $ 0.50 $ 1.33 $ 1.50
====== ====== ====== ======
Diluted:
As reported $ 0.44 $ 0.48 $ 1.29 $ 1.44
Compensation cost, net of taxes (1) (0.01) (0.01) (0.04) (0.03)
------ ------ ------ ------
Pro forma $ 0.43 $ 0.47 $ 1.25 $ 1.41
====== ====== ====== ======
The stock-based employee compensation cost, net of related tax
effects, that would have been included in the determination of net
income if the fair value based method had been applied to all awards
granted since 1995. The fair value of each option granted was
estimated as of the date of the grant using the Black-Scholes option-
pricing model.
8
BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis
ITEM 2. Management's Discussion and Analysis
Certain statements contained herein are "Forward Looking Statements" within
the meaning of the Private Securities Litigation Reform Act of 1995.
Forward Looking Statements may be identified by reference to a future period
or periods or by the use of forward looking terminology such as "may,"
"believes," "intends," "expects," and "anticipates" or similar terms or
variations of these terms. Actual results may differ materially from those
set forth in Forward Looking Statements as a result of certain risks and
uncertainties, including but not limited to, changes in political and
economic conditions, interest rate fluctuations, competitive product and
pricing pressures, equity and bond market fluctuations, credit risk,
inflation, as well as other risks and uncertainties detailed from time to
time in filings with the Securities and Exchange Commission ("SEC").
GENERAL
-------
The Company's principal subsidiary, Bank Rhode Island, is a commercial
bank chartered as a financial institution in the State of Rhode Island. The
Bank pursues a community banking mission and is principally engaged in
providing banking products and services to individuals and businesses in
Rhode Island. The Bank is subject to competition from a variety of
traditional and nontraditional financial service providers both within and
outside of Rhode Island. The Bank offers its customers a wide range of
deposit products, nondeposit investment products, commercial, residential
and consumer loans, and other traditional banking products and services
designed to meet the needs of individuals and small- to mid-sized
businesses. The Bank also offers both commercial and consumer on-line
banking products and maintains a web site at http://www.bankri.com. The
Company and Bank are subject to regulation by a number of federal and state
agencies and undergo periodic examinations by certain of those regulatory
authorities. The Bank's deposits are insured by the Federal Deposit
Insurance Corporation ("FDIC"), subject to regulatory limits. The Bank is
also a member of the Federal Home Loan Bank of Boston ("FHLB").
OVERVIEW
--------
Total assets increased $64.9 million, or 6.4%, to $1.1 billion at
September 30, 2003 from December 31, 2002. This increase was centered in
the Company's residential, commercial and consumer loan portfolios and was
funded by a combination of checking and savings deposit growth, and borrowings
from the FHLB. In addition, decreases in investment securities and
mortgage-backed securities ("MBSs") also funded some of the loan growth.
Since the end of 2002, residential mortgage loans increased $68.8 million,
or 23.1%, commercial loans increased $37.3 million, or 13.3%, consumer loans
increased $12.8 million, or 13.9%, checking and savings deposits increased
$59.2 million, or 11.0%, and FHLB borrowings increased $32.8 million, or
22.8%. Shareholders' equity was $70.0 million at September 30, 2003, and
represented 6.5% of total assets, compared to $66.4 million at December 31,
2002.
In June 2003, the Company through its subsidiary, BRI Statutory Trust
III, issued $5.0 million of trust preferred securities. These securities
qualify as Tier I capital for regulatory purposes and can be used to support
continued growth of the Company.
9
FINANCIAL CONDITION
-------------------
-- Investments. Total investments (consisting of overnight
investments, investment securities, MBSs, and stock in the FHLB) totaled
$228.3 million, or 21.2% of total assets, at September 30, 2003, compared to
$282.7 million, or 27.9% of total assets, at December 31, 2002. All $181.5
million of investment securities and MBSs at September 30, 2003 were
classified as available for sale and carried a total of $1.7 million in net
unrealized gains at the end of September. The decrease in total investments
of $54.4 million, or 19.2%, since the end of last year was utilized to
partially fund the growth in the loan portfolios.
-- Loans. Total loans were $789.5 million, or 73.3% of total assets,
at September 30, 2003, compared to $670.7 million, or 66.2% of total assets,
at December 31, 2002. The Company concentrated its asset growth during the
first nine months of 2003 in its loan portfolios to maximize the yield on
new assets and to take advantage of continued strong demand for both
commercial and home equity loan products in its market area.
The commercial loan portfolio (consisting of commercial & industrial,
small business, leases, commercial real estate, multi-family real estate,
and construction loans) increased $37.3 million, or 13.3%, during the first
nine months of 2003. The Company believes it is well positioned for
continued commercial loan growth. Particular emphasis is placed on
generation of small- to medium-sized commercial relationships (those
relationships with $6.0 million or less in loan commitments). The Bank is
also active in small business lending (loans of $250,000 or less) in which
it utilizes credit scoring, in conjunction with traditional review
standards, and employs streamlined documentation. The Bank is a participant
in the U.S. Small Business Administration ("SBA") Preferred Lender Program
in Rhode Island and the 7a Guarantee Loan Program in Massachusetts. From
time to time, the Bank also invests in short-term leases. These leases are
solely with the U.S. Government and its agencies. All leases are structured
to achieve payment in full over the term of the lease and, absent default,
are not dependent on residual collateral values.
The consumer loan portfolio increased $12.8 million, or 13.9%, during
the first three quarters of 2003. This growth has been centered in fifteen-
year fixed-rate home equity loans with maximum loan-to-values of 85%. In
the current interest rate environment, this fifteen-year fixed-rate product
provides an attractive alternative to first-mortgage refinances and the
Company anticipates that growth in this product will continue.
Despite the continuing low interest rate environment, and the
resulting higher level of prepayments, the residential mortgage loan
portfolio increased $68.8 million, or 23.1%, during the first three quarters
of 2003, as purchases of adjustable and fixed-rate loans ($217.5 million)
along with originations ($22.6 million) were greater than repayments ($170.5
million). As long as market interest rates remain low, the Company expects
prepayment activity to continue to be above average historical levels. At
September 30, 2003, the Bank had commitments to purchase approximately $7
million of hybrid ARMs and $30 million of 30 year fixed-rate loans in the
next 60 days.
10
While origination efforts continue to be concentrated on commercial
and consumer loan opportunities, the Company also originates residential
mortgage loans on a limited basis. Additionally, until such time as the
Company can generate sufficient commercial and consumer 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 following is a breakdown of loans receivable:
September 30, December 31,
2003 2002
------------- ------------
(In thousands)
Residential mortgage loans:
One- to four-family adjustable rate $260,716 $277,265
One- to four-family fixed rate 103,599 19,310
-------- --------
Subtotal 364,315 296,575
Premium on loans acquired 2,343 1,248
Net deferred loan origination fees (78) (60)
-------- --------
Total residential mortgage loans $366,580 $297,763
======== ========
Commercial loans:
Commercial real estate - nonowner occupied $ 77,914 $ 81,242
Commercial real estate - owner occupied 69,705 59,249
Commercial and industrial 62,129 57,389
Small business 29,757 28,750
Multi-family real estate 27,931 18,952
Construction 26,766 18,101
Leases and other 24,438 17,613
-------- --------
Subtotal 318,640 281,296
Net deferred loan origination fees (418) (329)
-------- --------
Total commercial loans $318,222 $280,967
======== ========
Consumer loans:
Home equity - term loans $ 61,521 $ 47,906
Home equity - lines of credit 38,191 37,381
Automobile 1,809 3,409
Installment 661 967
Savings secured 511 602
Unsecured and other 1,408 1,063
-------- --------
Subtotal 104,101 91,328
Premium on loans acquired 55 103
Net deferred loan origination costs 578 497
-------- --------
Total consumer loans $104,734 $ 91,928
======== ========
Total loans receivable $789,536 $670,658
======== ========
11
-- Deposits and Borrowings. Total deposits increased by $38.5
million, or 5.1%, during the first nine months of 2003, from $761.9 million,
or 75.2% of total assets, at December 31, 2002, to $800.4 million, or 74.3%
of total assets, at September 30, 2003. The slight decrease in the relative
percentage of total assets resulted from a portion of the purchased
residential mortgage loan packages being funded by FHLB borrowings. In
addition, the composition of total deposits changed during 2003. Core
deposit accounts (checking and savings) increased $59.2 million, or 11.0%,
in the first three quarters of 2003, while certificates of deposit decreased
$20.7 million, or 9.3%, during this time period. The Bank continues its
strategy of emphasizing core deposit growth over certificate of deposit
growth. The decline in certificates of deposits also reflects customer
movement away from extended term deposits in response to the current low
interest rate environment. At September 30, 2003, core deposit accounts
comprised 74.9% of total deposits, compared to 70.9% of total deposits at
December 31, 2002.
The following table sets forth certain information regarding deposits:
September 30, 2003 December 31, 2002
--------------------------------- ---------------------------------
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
------ ------- -------- ------ ------- --------
(Dollars in thousands)
NOW accounts $123,519 15.4% 1.10% $100,476 13.2% 1.37%
Money market accounts 13,157 1.7% 1.00% 10,660 1.4% 1.00%
Savings accounts 309,274 38.6% 1.18% 290,981 38.2% 1.70%
Certificate of deposit accounts 201,133 25.1% 2.71% 221,874 29.1% 3.07%
-------- ----- -------- -----
Total interest bearing deposits 647,083 80.8% 1.64% 623,991 81.9% 2.12%
Noninterest bearing accounts 153,329 19.2% -- 137,920 18.1% --
-------- ----- -------- -----
Total deposits $800,412 100.0% 1.32% $761,911 100.0% 1.74%
======== ===== ==== ======== ===== ====
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 nine months of 2003, FHLB borrowings increased $32.8 million, or
22.8%, as the Company sought to take advantage of lower borrowing rates to
fund a portion of its asset growth. The proceeds from these new borrowings
were primarily reinvested in the Company's residential loan portfolio and
allowed the Company to continue to grow its balance sheet. However, on a
long-term basis, the Company intends to continue concentrating on increasing
its core deposits.
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
considered impaired loans.
-- Nonperforming Assets. At September 30, 2003, the Company had
nonperforming assets of $3.6 million, which represented 0.34% of total
assets. This compares to nonperforming assets of $794,000, or 0.08% of
total assets, at December 31, 2002. The growth in nonperforming assets was
concentrated in two commercial relationships placed on nonaccrual status
earlier in 2003 aggregating
12
$3.2 million. Total nonperforming assets at September 30, 2003, consisted
of nonaccrual residential mortgage loans aggregating $319,000 and nonaccrual
commercial loans aggregating $3.3 million. The Company evaluates the
underlying collateral of each nonperforming loan and continues to pursue the
collection of interest and principal. The current level of nonperforming
assets remains below peer averages, but as the loan portfolio continues to
grow and mature, or if economic conditions worsen or do not improve,
management believes it possible that the level of nonperforming assets could
increase, as could its level of charged-off loans. Included in nonaccrual
loans were $3.2 million, at September 30, 2003, and $224,000, at December
31, 2002, of impaired loans. There were no specific reserves against
impaired loans at either September 30, 2003 and December 31, 2002.
Delinquencies. At September 30, 2003, loans with an aggregate balance
of $258,000 were 60 to 89 days past due, an increase of $231,000, or 855.6%,
from the $27,000 reported at December 31, 2002. The majority of these loans
at both dates were residential mortgage loans and are secured.
The following table sets forth information regarding nonperforming
assets and loans 60-89 days past due as to interest at the dates indicated.
September 30, December 31,
2003 2002
------------- ------------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $3,647 $ 736
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
------ -----
Total nonperforming loans 3,647 736
Other real estate owned -- 58
------ -----
Total nonperforming assets $3,647 $ 794
====== =====
Delinquent loans 60-89 days past due $ 258 $ 27
Nonperforming loans as a percent of total loans 0.46% 0.11%
Nonperforming assets as a percent of total assets 0.34% 0.08%
Delinquent loans 60-89 days past due as a percent of total loans 0.03% 0.01%
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 September 30, 2003, the Company had $8.2 million of assets that
were classified as substandard and $82,000 of assets that were classified as
doubtful. This compares to $8.4 million of assets that were classified as
substandard at December 31, 2002. The Company had no assets that were
classified as doubtful at December 31, 2002 and no assets classified as 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 September 30, 2003, included in the assets that were
13
classified as substandard, were $4.5 million of performing loans. This
compares to $7.6 million of adversely classified performing loans as of
December 31, 2002. These amounts constitute assets that, in the opinion of
management, could potentially migrate to nonperforming status. An increase
in nonperforming loans may also lead to an increase in the provision for
loan losses in future periods.
Allowance for Loan Losses
-------------------------
During the first nine months of 2003, the Company made provisions to
the allowance for loan losses totaling $1.2 million and had $488,000 of net
charge-offs, bringing the balance in the allowance to $10.8 million,
compared to $10.1 million at December 31, 2002. The allowance, expressed as
a percentage of total loans, was 1.37% as of September 30, 2003, compared to
1.51% at the prior year end and stood at 296.4% of nonperforming loans at
September 30, 2003, compared to 1371.7% of nonperforming loans at December
31, 2002.
Assessing the adequacy of the allowance for loan losses involves
substantial uncertainties and is based upon management's evaluation of the
amounts required to meet estimated charge-offs in the loan portfolio after
weighing various factors. Management's methodology to estimate loss
exposure includes an analysis of individual loans deemed to be impaired,
reserve allocations for various loan types based on payments status or loss
experience and an unallocated allowance that is maintained based on
management's assessment of many factors including the growth, composition
and quality of the loan portfolio, historical loss experiences, general
economic conditions and other pertinent factors. Based on this evaluation,
management believes that the allowance for loan losses, as of September 30,
2003, is adequate.
A portion of the allowance for loan losses is not allocated to any
specific segment of the loan portfolio. This non-specific allowance is
maintained for two primary reasons: (i) there exists an inherent
subjectivity and imprecision to the analytical processes employed, and (ii)
the prevailing business environment, as it is affected by changing economic
conditions and various external factors, may impact the portfolio in ways
currently unforeseen. Management, therefore, has established and maintains
a non-specific allowance for loan losses.
While management evaluates currently available information in
establishing the allowance for loan losses, future adjustments to the
allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review a financial institution's allowance for loan losses and carrying
amounts of other real estate owned. Such agencies may require the financial
institution to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
RESULTS OF OPERATIONS
---------------------
The Company's operating results depend primarily on its "net interest
income," or the difference between its interest income and its cost of
money, and on the quality of its assets. Interest income depends on the
average amount of interest-earning assets outstanding during the period and
the interest rates earned thereon. The Company's cost of money is a
function of the average amount of deposits and borrowed money outstanding
during the period and the interest rates paid thereon. Earnings are further
influenced by the quality of assets, through the amount of interest income
lost on nonaccrual loans, the amount of additions to the allowance for loan
losses and the amount of losses and other expenses incurred as a result of
resolving troubled assets.
14
Three Months Ended September 30, 2003 and 2002
----------------------------------------------
-- Overview. The Company reported net income for the third quarter of
2003 of $1.8 million, down $146,000, or 7.6%, from the third quarter of
2002. Diluted earnings per common share were $0.44 for the third quarter of
2003, compared to $0.48 for the third quarter of 2002.
The Company reported a return on average assets of 0.67% and a return
on average equity of 10.17% for the 2003 period, as compared to a return on
average assets of 0.80% and a return on average equity of 12.75% for the
2002 period.
During late 2002 and early 2003, the Company made significant
investments in the future of the Bank to support its continued growth.
These investments have caused an increase in operating expenses for the the
Company. Increased interest income from continued growth of the Company was
offset by pressure on its net interest margin from the current low rate
environment and high rates of loan prepayments. As a result, the increases
in noninterest expenses caused the Company's net income to decline from the
third quarter of last year.
-- Net Interest Income. For the quarter ended September 30, 2003, net
interest income was $7.9 million, relatively unchanged from the $7.9 million
reported for the 2002 period. The growth of the Company's earning assets
was entirely offset by a decrease in its net interest margin. Average
earnings assets were $85.3 million, or 9.3%, higher and average interest-
bearing liabilities were $65.1 million, or 8.4%, higher than the comparable
period a year earlier. The net interest margin for the third quarter of
2003 was 3.13% compared to a net interest margin of 3.42% for the 2002
period. The decrease of 29 basis points in the net interest margin was
primarily attributable to a significant drop in market interest rates and an
increase in prepayment activity of residential mortgage loans and mortgage
related investments.
-- Interest Income. Investments. Total investment income was $2.0
million for the quarter ended September 30, 2003, compared to $3.2 million
for the third quarter of 2002. This decrease in total investment income of
$1.2 million, or 38.9%, was primarily attributable to a decrease of $68.3
million, or 37.0%, in the average balance of MBSs, coupled with a decrease
of 140 basis points in the overall yield of MBSs, from the third quarter of
2002. The majority of the Company's investments are comprised of US Agency
securities or MBSs with remaining maturities or repricing periods of less
than five years. However, in an effort to diversify the portfolio and
increase yields, commencing in the fourth quarter of 2002, the Company began
investing in corporate debt securities and collateralized mortgage
obligations ("CMOs").
-- Interest Income. Loans. Interest from loans was $10.7 million for
the three months ended September 30, 2003, and represented a yield on total
loans of 5.52%. This compares to $10.4 million of interest, and a yield of
6.56%, for the third quarter of 2002. Declining market interest rates,
coupled with increased prepayment activity, resulted in residential mortgage
loan interest decreasing $111,000, or 2.4%, from the third quarter of 2002
despite the average balance of residential mortgage loans increasing $61.1
million, or 21.0%. Interest from commercial loans increased $142,000, or
2.9%, and consumer and other loan income increased $296,000, or 30.0%, as
increased average balances more than offset any decline in average yields.
In response to declining market interest rates, the yields on the various
loan portfolio components changed as follows: residential mortgage loans
decreased 121 basis points, to 5.05%; commercial loans decreased 86 basis
points, to 6.21%; and consumer and other loans decreased 84 basis points, to
4.96%. The average balance of the various components of the loan portfolio
changed from the third quarter of
15
2002 as follows: commercial loans increased $46.7 million, or 17.2%,
consumer and other loans increased $35.1 million, or 52.0%, and, as
previously mentioned, residential mortgage loans increased $61.1 million, or
21.0%. Since its inception, the Bank has concentrated its origination
efforts on commercial and consumer loan opportunities, while purchasing
residential mortgage loans, and to a limited degree, automobile loans, as
cash flows dictated. More recently, the Bank has increased its residential
mortgage loan origination capacity in response to strong demand for this
product.
-- Interest Expense. Interest paid on deposits and borrowings
decreased $910,000, or 16.0%, to $4.8 million for the three months ended
September 30, 2003, from $5.7 million paid during the same period in 2002.
The decrease in total interest expense was primarily attributable to a
decrease in market interest rates, partially offset by an increase in the
average balance of deposits and borrowings. The overall average cost for
interest-bearing liabilities decreased 65 basis points from 2.90% for the
third quarter of 2002 to 2.25% for the third quarter of 2003. Liability
costs are dependent on a number of factors including general economic
conditions, national and local interest rates, competition in the local
deposit marketplace, interest rate tiers offered and the Company's cash flow
needs. Average costs for the various components of interest-bearing
liabilities changed from the third quarter of 2002 as follows: NOW accounts
decreased 23 basis points, to 1.10%, money market accounts decreased 37
basis points, to 0.98%, savings accounts decreased 67 basis points, to
1.20%, certificate of deposit accounts decreased 54 basis points, to 2.79%,
and borrowings decreased 49 basis points to 4.07%. Meanwhile, the average
balance of interest-bearing liabilities increased $65.1 million, or 8.4%,
from $776.6 million in the third quarter of 2002 to $841.7 million in the
third quarter of 2003, as NOW and savings account growth, along with
additional borrowings, were utilized to fund much of the Company's asset
growth.
-- Provision for Loan Losses. The provision for loan losses was
$400,000 for the quarter ended September 30, 2003, down $175,000, or 30.4%,
from the same quarter last year. Management evaluates several factors
including new loan originations, actual and estimated charge-offs, the risk
characteristics of the loan portfolio and general economic conditions when
determining the provision for each quarter. Also see discussion under
"Allowance for Loan Losses." Nonperforming loans and adversely classified
loans each decreased $1.1 million during the third quarter. As the loan
portfolio continues to grow and mature, or if economic conditions worsen,
management believes it possible that the level of nonperforming assets will
increase, which in turn may lead to increases in the provision for loan
losses in future periods.
-- Noninterest Income. Total noninterest income increased $438,000,
or 24.4%, to $2.2 million for the third quarter of 2003, from $1.8 million
for the 2002 quarter. Continuing sources of noninterest income include
service charges, commissions and income from bank-owned life insurance
("BOLI"). Service charges on deposit accounts, which continues to represent
the largest source of noninterest income for the Company, decreased $36,000,
or 3.6%, in response to lower rates on debit card transactions. Commissions
on nondeposit investment products decreased $129,000, or 37.0%, compared to
the third quarter of 2002 as the number of nondeposit sales is closely tied
to periodic marketing campaigns which did not occur during the third quarter
of 2003. Income from BOLI increased $28,000, or 19.6%, as the amount
invested in BOLI increased since the 2002 period. Noninterest income during
the 2003 period included a net gain of $348,000 from the Company's
restructure of a portion of its investment portfolio, along with the receipt
of loan prepayment penalties aggregating approximately $40,000. The 2002
period did not contain either of these events.
16
-- Noninterest Expense. Total noninterest expense for the third
quarter of 2003 increased $803,000, or 12.9%, to $7.0 million from $6.2
million in 2002. This increase occurred primarily in the following areas:
Salaries and employee benefits (up $321,000, or 9.5%), Occupancy and
Equipment (up $211,000, or 27.3%), Data processing (up $99,000, or 19.8%),
Loan servicing (up $54,000, or 25.0%) and Other expenses (up $103,000, or
12.5%). In addition to incurring increased operating costs as a result of
continuing growth in both loans and core deposits, the Company made
significant investments during the first half of 2003 in the future of the
Bank which have resulted in additional operating expenses in the current
quarter. These investments included the opening of a new Operations Center
in January 2003 and converting to a new core data processing system in May
2003. Partially offsetting these increases was a decrease in Professional
services (down $41,000, or 12.4%), as the 2002 period included a higher
level of professional fees associated with reviewing alternative data
processing systems, which were not present in the 2003 period. As a result
of the increased noninterest expenses, the Company's efficiency ratio
increased 520 basis points, from 64.29% for the third quarter of 2002, to
69.49% for the third quarter of 2003.
-- Income Tax Expense. Income tax expense of $904,000 was recorded
for the quarter ended September 30, 2003, compared to $957,000 for the 2002
period. This represented total effective tax rates of 33.6% and 33.1%,
respectively. Tax-favored income from U.S. Agency securities and BOLI,
along with the utilization of a Rhode Island passive investment company, has
reduced the Company's effective tax rate from the 39.9% combined statutory
federal and state tax rates.
Nine Months Ended September 30, 2003 and 2002
---------------------------------------------
-- Overview. Net income for the first nine months of 2003, decreased
$515,000, or 9.0%, to $5.2 million, or $1.29 per diluted common share, from
$5.7 million, or $1.44 per diluted common share, for the first nine months
of 2002.
This performance represented a return on average assets of 0.68% and a
return on average equity of 10.24% for the 2003 period, as compared to a
return on average assets of 0.83% and a return on average equity of 12.77%
for the 2002 period.
During the 2003 period, the Company made some significant investments
in the future of the Bank, including opening a new Operations Center in
January, as well as converting to a new core data processing system in May.
These investments included start-up charges of approximately $600,000 during
the 2003 period.
-- Net Interest Income. For the nine months ended September 30, 2003,
net interest income was $23.7 million, compared to $23.5 million for the
first nine months of 2002. The net interest margin for the 2003 period was
3.26% compared to a net interest margin of 3.57% for the 2002 period. The
increase in net interest income of $165,000, or 0.7%, was attributable to
the overall growth of the Company offset by the decrease in the net interest
margin. Average earning assets increased $90.5 million, or 10.2%, and
average interest-bearing liabilities increased $73.8 million, or 9.9%, over
the comparable period a year earlier. The decrease of 31 basis points in
the net interest margin was primarily caused by a drop in market interest
rates, coupled with higher prepayment activity in residential mortgage loans
and MBSs.
-- Interest Income. Investments. Total investment income was $7.1
million for the nine months ended September 30, 2003, compared to $9.4
million for the 2002 period. This decrease in total investment income of
$2.3 million, or 24.6%, was primarily attributable to a $51.4 million, or
17
28.5%, decrease in the average balance of MBSs, coupled with a 78 basis
point decrease in the overall yield on investments, from 4.65% in 2002, to
3.87% in 2003, in response to dramatically lower market interest rates and
increased prepayment activity.
-- Interest Income. Loans. Interest from loans was $31.3 million for
the nine months ended September 30, 2003, and represented a yield on total
loans of 5.75%. This compares to $30.8 million of interest, and a yield of
6.71%, for the 2002 period. Increased interest income resulting from growth
in the average balance of loans of $115.8 million, or 18.9%, was almost
entirely offset by a decrease in the average yield of loans of 96 basis
points. The decrease in the average yield on loans resulted from the
dramatic drop in market interest rates and increased prepayment activity
that has occurred over the past year. The average yield on the various
components of the loan portfolio changed as follows: residential mortgage
loans (which experienced the fastest prepayment speeds) decreased 115 basis
points, to 5.35%; commercial loans and consumer and other loans, both
decreased 79 basis points, to 6.36% and 5.18%, respectively. The average
balance of the various components of the loan portfolio changed as follows:
commercial loans increased $51.1 million, or 20.2%, consumer and other loans
increased $36.2 million, or 56.1%, and residential mortgage loans increased
$28.5 million, or 9.7%. The Company has continued to concentrate its
origination efforts on commercial and consumer loan opportunities, but also
originates residential mortgage loans for its portfolio on a limited basis.
Until such time as the Bank can originate sufficient commercial, consumer
and residential loans to utilize available cash flow, it intends to continue
purchasing residential mortgage loans as opportunities develop.
-- Interest Expense. Interest paid on deposits and borrowings
decreased $1.9 million, or 11.6%, to $14.7 million for the nine months ended
September 30, 2003, compared to $16.7 million for the same period during
2002. The decrease in total interest was also primarily attributable to the
dramatic drop in market interest rates over the past year and was partially
offset by growth in checking and savings deposits, along with the use of
borrowings to fund the overall growth of the Company. The overall average
cost for interest-bearing liabilities decreased 58 basis points from 2.98%
for the 2002 period, to 2.40% for the 2003 period. Deposit costs are
dependent on a number of factors including general economic conditions,
national and local interest rates, competition in the local marketplace,
interest rate tiers offered, and the Company's cash flow needs. Partially
offsetting the effect of the decline in market interest rates, the average
balance of interest-bearing liabilities increased $73.8 million, or 9.9%,
from $748.6 million in 2002, to $822.4 million in 2003. The Company
continued to experience strong average balance growth in core deposit
accounts, specifically NOW accounts (up $54.9 million, or 98.2%), primarily
from growth in the Asset Manager product, and savings accounts (up $29.3
million, or 10.8%). In addition, the Company increased its utilization of
FHLB borrowings (up $11.9 million, or 8.1%) and capital trust securities (up
$5.0 million, or 104.7%).
-- Provision for Loan Losses. The provision for loan losses was $1.2
million for the nine months ended September 30, 2003, compared to $1.4
million for the same period last year. The allowance, expressed as a
percentage of total loans, was 1.37% as of September 30, 2003, compared to
1.51% at the prior year-end and stood at 296.4% of nonperforming loans at
September 30, 2003, compared to 1371.7% of nonperforming loans at December
31, 2002. While total nonperforming loans increased from the end of last
year, net charge-offs have only been $488,000 for the nine month period
ending September 30, 2003. In addition, total adversely classified loans
decreased $129,000 during the 2003 period. Management evaluates several
factors including new loan originations, actual and estimated charge-offs,
and the risk characteristics of the loan portfolio when determining the
provision for the quarter. Also see discussion under "Allowance for Loan
Losses."
18
-- Noninterest Income. Total noninterest income increased $1.7
million, or 34.1%, from the first nine months of 2002, to $6.5 million for
the first nine months of 2003. Service charges on deposit accounts, which
represents the largest source of noninterest income, rose $192,000, or 7.0%,
from $2.8 million for the 2002 period, to $3.0 million for the 2003 period,
primarily as a result of continued growth in core deposit accounts. During
the 2003 period, the Company also benefited from the receipt of loan
prepayment penalties aggregating $286,000 and gains from restructuring a
portion of investments aggregating $785,000. Similar events were not
present during the 2002 period. Additionally, Income from BOLI increased
$199,000, or 52.4%, as the Company's investment in BOLI increased from the
prior year.
-- Noninterest Expense. Noninterest expenses for the first nine
months of 2003 increased a total of $2.9 million, or 15.9%, to $21.3
million. This increase occurred primarily as a result of the overall growth
of the Company, along with investments in the Bank for a new Operations
Center and a new core data processing system, and was centered in the
following areas: Salaries and employee benefits (up $1.1 million, or
11.5%), Occupancy and Equipment (up $656,000, or 29.4%), Data processing (up
$820,000, or 57.5%) and Other expenses (up $511,000, or 21.8%). Included in
these increases were start-up expenses related to the data processing
conversion of approximately $600,000 for the 2003 period. Partially
offsetting these increases were decreases in: Marketing (down $66,000, or
7.4%) and Professional services (down $177,000, or 15.7%). The Company's
efficiency ratio increased to 70.28% for the 2003 period, from 64.53% for
the 2002 period.
-- Income Tax Expense. The Company recorded income tax expense of
$2.6 million for the first nine months of 2003, compared to $2.9 million for
the same period during 2002. This represented total effective tax rates of
33.0% and 33.7%, respectively. Tax-favored income from U.S. Agency
securities and BOLI, along with its utilization of a Rhode Island passive
investment company, has reduced the Company's effective tax rate from the
39.9% combined statutory federal and state tax rates.
19
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
-- Liquidity. Liquidity is defined as the ability to meet current and
future financial obligations of a short-term nature. The Company further
defines liquidity as the ability to respond to the needs of depositors and
borrowers, as well as to earnings enhancement opportunities, in a changing
marketplace.
The primary source of funds for the payment of dividends and expenses
by the Company is dividends paid to it by the Bank. Bank regulatory
authorities generally restrict the amounts available for payment of
dividends if the effect thereof would cause the capital of the Bank to be
reduced below applicable capital requirements. These restrictions
indirectly affect the Company's ability to pay dividends. The primary
sources of liquidity for the Bank consist of deposit inflows, loan
repayments, borrowed funds, maturity of investment securities and sales of
securities from the available for sale portfolio. Management believes that
these sources are sufficient to fund the Bank's lending and investment
activities.
Management is responsible for establishing and monitoring liquidity
targets as well as strategies and tactics to meet these targets. In
general, the Company seeks to maintain a high degree of flexibility. At
September 30, 2003, overnight investments, investment securities and MBSs
available for sale amounted to $219.4 million, or 20.4% of total assets.
This compares to $275.1 million, or 27.2% of total assets at December 31,
2002. 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
September 30, 2003 was $70.0 million, as compared to $66.4 million at
December 31, 2002. This increase of $3.6 million was primarily the result
of net income for the nine months of $5.2 million, plus proceeds from
issuance of stock of $1.1 million, less dividends of $1.6 million and
decreases in unrealized gains of $1.1 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."
Capital guidelines have also been issued by the Federal Reserve Board
("FRB") for bank holding companies. These guidelines require the Company to
maintain minimum capital levels for capital adequacy purposes. In general,
the FRB has adopted substantially identical capital adequacy guidelines as
the FDIC. Such standards are applicable to bank holding companies and their
bank subsidiaries on a consolidated basis.
In June 2003, the Company through its subsidiary, BRI Statutory Trust
III, issued $5.0 million of trust preferred securities. These securities
qualify as Tier I capital for regulatory purposes and can be used to support
continued growth of the Company.
20
As of September 30, 2003, the Company and the Bank met all applicable
minimum capital requirements and were considered "well capitalized" by both
the FRB and the FDIC. 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 September 30, 2003:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $71,132 6.76% $31,551 3.00% $52,585 5.00%
Tier I capital (to risk weighted assets) 71,132 9.73% 29,231 4.00% 43,846 6.00%
Total capital (to risk weighted assets) 80,281 10.99% 58,462 8.00% 73,077 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $68,495 6.52% $31,536 3.00% $52,559 5.00%
Tier I capital (to risk weighted assets) 68,495 9.38% 29,212 4.00% 43,818 6.00%
Total capital (to risk weighted assets) 77,644 10.63% 58,424 8.00% 73,030 10.00%
At December 31, 2002:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $61,408 6.19% $29,779 3.00% $49,631 5.00%
Tier I capital (to risk weighted assets) 61,408 9.63% 25,506 4.00% 38,260 6.00%
Total capital (to risk weighted assets) 69,401 10.88% 51,013 8.00% 63,766 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $60,097 6.06% $29,760 3.00% $49,599 5.00%
Tier I capital (to risk weighted assets) 60,097 9.43% 25,494 4.00% 38,240 6.00%
Total capital (to risk weighted assets) 68,090 10.68% 50,987 8.00% 63,734 10.00%
21
BANCORP RHODE ISLAND, INC.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK
------------------
The principal market risk facing the Company is interest rate risk.
The Company's objective regarding interest rate risk is to manage its assets
and funding sources to produce results which are consistent with its
liquidity, capital adequacy, growth and profitability goals, while
minimizing the vulnerability of its operations to changes in market interest
rates. The Company's actions in this regard are taken under the guidance of
the Bank's Asset/Liability Committee ("ALCO"). The ALCO manages the
Company's interest rate risk position using both income simulation and
interest rate sensitivity "gap" analysis. The ALCO has established internal
parameters for monitoring the 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
changes in market interest rates. 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 a 24-month horizon, and develops
appropriate strategies to manage this exposure. The Company's guidelines
for interest rate risk specify that for each 100 basis points that market
interest rates were to shift up or down, estimated net interest income for
each of the first two 12-month periods may have a maximum negative variance
of 5.0% when compared to a flat interest rate scenario. As of September 30,
2003, net interest income simulation indicated that the Company's exposure
to a 200 basis point decline in market interest rates was outside of the 10%
tolerance level established for the second 12-month period. This exposure
primarily results from the unusually low current rates paid on deposit
accounts and the extremely high prepayment speeds anticipated for mortgage-
related assets if market rates declined 200 basis points. The current rates
on many deposit accounts are so low, that they cannot decline 200 basis
points without becoming negative. This results in a floor of zero percent
for these deposit accounts, and this floor causes compression of the net
interest margin for modeling purposes. The ALCO reviews the methodology
utilized for calculating interest rate risk exposure and may, from time to
time, adopt modifications to this methodology. While the ALCO reviews
simulation assumptions and methodology to ensure that they reflect
historical experience, it should be noted that income simulation may not
always prove to be an accurate indicator of interest rate risk because the
actual repricing, maturity and prepayment characteristics of individual
products may differ from the estimates used in the simulations.
22
The following table presents the estimated impact of changes in market
interest rates on the Company's estimated net interest income over a twenty-
four month period beginning October 1, 2003:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 basis points $ 1,422 4.21%
Up 100 basis points 836 2.47%
Down 100 basis points (250) (0.74%)
Down 200 basis points (750) (2.22%)
Subsequent Twelve Month Period:
Up 200 basis points $ 1,836 5.31%
Up 100 basis points 1,854 5.36%
Down 100 basis points (478) (1.38%)
Down 200 basis points (3,365) (9.73%)
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 September 30, 2003, the Company's one year
cumulative gap was a positive $118.9 million, or 11.03% of total assets.
For additional discussion on interest rate risk see the section titled
"Asset and Liability Management" on pages 39 to 41 of the Company's 2002
Annual Report to Shareholders.
ITEM 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), the Company carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures as of the end of the period covered by this report.
This evaluation was carried out under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer. Based upon
that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.
There was no significant change 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.
23
BANCORP RHODE ISLAND, INC.
Other Information
PART II. Other Information
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company
or its subsidiaries are a party, or to which any of their property is
subject, other than ordinary routine litigation incidental to the
business of banking.
ITEM 2. CHANGE IN SECURITIES
No information to report.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
No defaults upon senior securities have taken place.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
No information to report.
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.2(a) Amendment to Bylaws.
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Current Report on Form 8-K dated July 16, 2003, announcing the
Company's second quarter consolidated earnings.
24
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.
November 10, 2003 /s/ Merrill W. Sherman
----------------- ---------------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
November 10, 2003 /s/ Albert R. Rietheimer
----------------- ---------------------------
(Date) Albert R. Rietheimer
Chief Financial Officer
and Treasurer
25