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: June 30, 2003
Commission File No. 001-16101
BANCORP RHODE ISLAND, INC.
--------------------------
(Exact Name of Registrant as Specified in Its Charter)
RHODE ISLAND 05-0509802
------------ ----------
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
-------------------------------------------
(Address of Principal Executive Offices)
(401) 456-5000
--------------
(Issuer's Telephone Number, Including Area Code)
Not Applicable
--------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes (X) No ( )
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of August 5, 2003:
---------------
Common Stock - Par Value $0.01 3,836,965 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 25
Item 6 Exhibits and Reports on Form 8-K 25
Signature Page 26
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
June 30, December 31,
2003 2002
---------- ------------
(Dollars in thousands)
ASSETS:
Cash and due from banks $ 28,668 $ 25,336
Overnight investments 12,202 17,623
---------- ----------
Total cash and cash equivalents 40,870 42,959
Investment securities available for sale (amortized
cost of $81,207 and $99,803 at June 30, 2003 and
December 31, 2002, respectively) 83,811 101,329
Mortgage-backed securities available for sale (amortized
cost of $130,081 and $154,225 at June 30, 2003 and
December 31, 2002, respectively) 131,319 156,114
Stock in Federal Home Loan Bank of Boston 8,934 7,683
Loans receivable:
Residential mortgage loans 330,301 297,763
Commercial loans 314,017 280,967
Consumer and other loans 103,206 91,928
---------- ----------
Total loans 747,524 670,658
Less allowance for loan losses (10,831) (10,096)
---------- ----------
Net loans 736,693 660,562
Premises and equipment, net 11,991 9,702
Other real estate owned -- 58
Goodwill, net 10,766 10,766
Accrued interest receivable 5,686 6,183
Investment in bank-owned life insurance 15,176 14,768
Prepaid expenses and other assets 3,127 2,753
---------- ----------
Total assets $1,048,373 $1,012,877
========== ==========
LIABILITIES:
Deposits:
Demand deposit accounts $ 146,290 $ 137,920
NOW accounts 116,628 100,476
Money market accounts 10,546 10,660
Savings accounts 299,247 290,981
Certificate of deposit accounts 210,226 221,874
---------- ----------
Total deposits 782,937 761,911
Overnight and short-term borrowings 13,606 27,364
Federal Home Loan Bank of Boston borrowings 162,693 143,941
Company-obligated mandatorily redeemable capital securities 13,000 8,000
Other liabilities 6,803 5,234
---------- ----------
Total liabilities 979,039 946,450
---------- ----------
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 3,800,850 shares in 2003 and
3,777,450 in 2002 38 38
Additional paid-in capital 40,385 40,134
Retained earnings 26,375 24,002
Accumulated other comprehensive income, net 2,536 2,253
---------- ----------
Total shareholders' equity 69,334 66,427
---------- ----------
Total liabilities and shareholders' equity $1,048,373 $1,012,877
========== ==========
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
Interest and dividend income:
Residential mortgage loans $ 4,323 $ 4,845 $ 8,497 $ 9,772
Commercial loans 4,830 4,443 9,513 8,731
Consumer and other loans 1,336 959 2,625 1,898
Mortgage-backed securities 1,332 2,348 2,812 4,448
Investment securities 992 821 2,131 1,529
Overnight investments 45 43 84 116
Federal Home Loan Bank of Boston stock dividends 67 80 129 142
---------- ---------- ---------- ----------
Total interest and dividend income 12,925 13,539 25,791 26,636
---------- ---------- ---------- ----------
Interest expense:
NOW accounts 344 86 670 128
Money market accounts 24 31 52 66
Savings accounts 1,066 1,282 2,214 2,499
Certificate of deposit accounts 1,520 2,101 3,120 4,390
Overnight and short-term borrowings 38 53 89 112
Federal Home Loan Bank of Boston borrowings 1,799 1,888 3,561 3,650
Company-obligated mandatorily redeemable
capital securities 140 81 277 157
---------- ---------- ---------- ----------
Total interest expense 4,931 5,522 9,983 11,002
---------- ---------- ---------- ----------
Net interest income 7,994 8,017 15,808 15,634
Provision for loan losses 400 450 800 850
---------- ---------- ---------- ----------
Net interest income after provision for loan losses 7,594 7,567 15,008 14,784
---------- ---------- ---------- ----------
Noninterest income:
Service charges on deposit accounts 1,043 912 1,995 1,767
Commissions on nondeposit investment products 232 173 406 422
Income from bank-owned life insurance 205 142 408 237
Loan related fees 339 82 443 173
Commissions on loans originated for others 94 58 203 152
Gain on sale of mortgage-backed securities -- -- 104 23
Gain on sale of investment securities 279 -- 333 --
Other income 202 151 418 310
---------- ---------- ---------- ----------
Total noninterest income 2,394 1,518 4,310 3,084
---------- ---------- ---------- ----------
Noninterest expense:
Salaries and employee benefits 3,746 3,207 7,044 6,254
Occupancy 587 496 1,190 963
Equipment 377 246 713 495
Data processing 801 485 1,646 925
Marketing 298 385 595 681
Professional services 385 416 662 798
Loan servicing 210 236 438 459
Other real estate owned expense (14) 16 1 7
Other expenses 955 759 1,929 1,521
---------- ---------- ---------- ----------
Total noninterest expense 7,345 6,246 14,218 12,103
---------- ---------- ---------- ----------
Income before income taxes 2,643 2,839 5,100 5,765
Income tax expense 881 930 1,666 1,962
---------- ---------- ---------- ----------
Net income $ 1,762 $ 1,909 $ 3,434 $ 3,803
========== ========== ========== ==========
Per share data:
Basic earnings per common share $ 0.47 $ 0.51 $ 0.91 $ 1.01
Diluted earnings per common share $ 0.43 $ 0.48 $ 0.85 $ 0.95
Average common shares outstanding - basic 3,787,881 3,751,054 3,783,444 3,749,113
Average common shares outstanding - diluted 4,053,902 4,012,159 4,036,645 3,995,352
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,
Six months ended June 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 -- -- 3,434 -- 3,434
Other comprehensive income,
net of tax:
Unrealized gains on
securities available for sale,
net of taxes of $305 567 567
Realized gains on
securities available for sale,
net of taxes of $153 (284) (284)
-------
Comprehensive income 3,717
Exercise of stock options -- 134 -- -- 134
Exercise of stock warrants -- 100 -- -- 100
Common stock issued for incentive
stock award, net -- 17 -- -- 17
Dividends on common stock -- -- (1,061) -- (1,061)
------- ------- ------- ------- -------
Balance at June 30, 2003 $ 38 $40,385 $26,375 $ 2,536 $69,334
======= ======= ======= ======= =======
2002
----
Balance at December 31, 2001 $ 37 $39,826 $18,336 $ 898 $59,097
Net income -- -- 3,803 -- 3,803
Other comprehensive income,
net of tax:
Unrealized gains on
securities available for sale,
net of taxes of $132 257 257
Realized gains on securities available
for sale, net of taxes of $8 (15) (15)
-------
Comprehensive income 4,045
Proceeds from exercise of options 1 128 -- -- 129
Common stock issued for incentive
stock award, net -- 16 -- -- 16
Dividends on common stock -- -- (977) -- (977)
------- ------- ------- ------- -------
Balance at June 30, 2002 $ 38 $39,970 $21,162 $ 1,140 $62,310
======= ======= ======= ======= =======
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
Six Months Ended
June 30,
------------------
2003 2002
-------- --------
(In thousands)
Cash flows from operating activities:
Net income $ 3,434 $ 3,803
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation and amortization 2,063 1,210
Provision for loan losses 800 850
Gain on investment securities (333) --
Gain on mortgage-backed securities (104) (23)
Gain on sale of other real estate owned (15) (29)
Income from bank-owned life insurance (408) (237)
Compensation expense from restricted stock grant 17 16
(Increase) decrease in:
Accrued interest receivable 497 (256)
Prepaid expenses and other assets (519) (2,342)
Increase (decrease) in:
Other liabilities 1,569 930
Other, net 21 53
-------- --------
Net cash provided (used) by operating activities 7,022 3,975
-------- --------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (12,144) (4,915)
Commercial loans (50,002) (33,845)
Consumer loans (28,581) (12,313)
Purchase of:
Investment securities available for sale (27,826) (41,074)
Mortgage-backed securities available for sale (53,834) (73,017)
Residential mortgage loans (112,291) (62,318)
Federal Home Loan Bank of Boston stock (1,251) (2,015)
Principal payments on:
Investment securities available for sale 32,139 19,006
Mortgage-backed securities available for sale 52,325 30,359
Residential mortgage loans 91,519 85,614
Commercial loans 17,024 13,619
Consumer loans 17,102 8,949
Proceeds from sale of investment securities 14,394 --
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 (3,098) (1,122)
Purchase of bank-owned life insurance -- (10,000)
-------- --------
Net cash provided (used) by investing activities (39,304) (79,013)
-------- --------
Cash flows from financing activities:
Net increase in deposits 21,026 30,776
Net increase (decrease) in overnight and short-term borrowings (13,758) 4,970
Proceeds from long-term borrowings 79,750 45,351
Repayment of long-term borrowings (55,998) (2,914)
Proceeds from exercise of stock options and warrants 234 129
Dividends on common stock (1,061) (977)
-------- --------
Net cash provided (used) by financing activities 30,193 77,335
-------- --------
Net increase (decrease) in cash and cash equivalents (2,089) 2,297
Cash and cash equivalents at beginning of period 42,959 29,174
-------- --------
Cash and cash equivalents at end of period $ 40,870 $ 31,471
======== ========
Supplementary Disclosures:
Cash paid for interest $ 10,150 $ 10,901
Cash paid for income taxes 2,162 2,582
Non-cash transactions:
Change in other comprehensive income, net of taxes 283 242
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) 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) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and resulted in the issuance of additional
common stock that then shared in the earnings of the entity.
7
(3) 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 June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
------ ------ ------ ------
Net income (in thousands):
As reported $1,762 $1,909 $3,434 $3,803
Compensation cost, net of taxes (1) (72) (40) (95) (79)
------ ------ ------ ------
Pro forma $1,690 $1,869 $3,339 $3,724
------ ------ ------ ------
Earnings per common share:
Basic:
As reported $ 0.47 $ 0.51 $ 0.91 $ 1.01
Compensation cost, net of taxes (1) (0.02) (0.01) (0.03) (0.02)
------ ------ ------ ------
Pro forma $ 0.45 $ 0.50 $ 0.88 $ 0.99
------ ------ ------ ------
Diluted:
As reported $ 0.43 $ 0.48 $ 0.85 $ 0.95
Compensation cost, net of taxes (1) (0.01) (0.01) (0.02) (0.02)
------ ------ ------ ------
Pro forma $ 0.42 $ 0.47 $ 0.83 $ 0.93
------ ------ ------ ------
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 $35.5 million, or 3.5%, to $1.0 billion at June
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, borrowings
from the FHLB and decreases in overnight investments, investment securities
and mortgage-backed securities ("MBSs"). Since the end of 2002, residential
mortgage loans increased $32.5 million, or 10.9%, commercial loans increased
$33.1 million, or 11.8%, consumer loans increased $11.3 million, or 12.3%,
checking and savings deposits increased $32.7 million, or 6.1%, and FHLB
borrowings increased $18.8 million, or 13.0%. Shareholders' equity was
$69.3 million at June 30, 2003, and represented 6.6% of total assets.
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
$236.3 million, or 22.5% of total assets, at June 30, 2003, compared to
$282.7 million, or 27.9% of total assets, at December 31, 2002. All $215.1
million of investment securities and MBSs at June 30, 2003 were classified
as available for sale and carried a total of $3.8 million in net unrealized
gains at the end of June. The decrease in total investments of $46.5
million, or 16.4%, since the end of last year was utilized to partially fund
the growth in the loan portfolios.
-- Loans. Total loans were $747.5 million, or 71.3% of total assets,
at June 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 half 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 $33.1 million, or 11.8%, during the first
half 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 $11.3 million, or 12.3%, during
the first two 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 $32.5 million, or 10.9%, during the first half of 2003,
as purchases of hybrid ARMS and 15 to 30 year fixed-rate loans ($112.3
million) along with originations ($12.1 million) were greater than
repayments ($91.5 million). As long as market interest rates remain low,
the Company expects prepayment activity to continue to be above average
historical levels. At June 30, 2003, the Bank had commitments to purchase
approximately $40 million of hybrid ARMs and $35 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 and automobile loans as
opportunities develop.
The following is a breakdown of loans receivable:
June 30, December 31,
-------- ------------
2003 2002
---- ----
(In thousands)
Residential mortgage loans:
One- to four-family adjustable rate $254,153 $277,265
One- to four-family fixed rate 74,848 19,310
-------- --------
Subtotal 329,001 296,575
Premium on loans acquired 1,361 1,248
Net deferred loan origination fees (61) (60)
-------- --------
Total residential mortgage loans $330,301 $297,763
======== ========
Commercial loans:
Commercial real estate - nonowner occupied $ 77,122 $ 81,242
Commercial and industrial 65,847 57,389
Commercial real estate - owner occupied 68,888 59,249
Small business 28,824 28,750
Multi-family real estate 26,234 18,952
Construction 19,751 18,101
Leases and other 27,723 17,613
-------- --------
Subtotal 314,389 281,296
Net deferred loan origination fees (372) (329)
-------- --------
Total commercial loans $314,017 $280,967
======== ========
Consumer loans:
Home equity - term loans $ 57,625 $ 47,906
Home equity - lines of credit 38,517 37,381
Automobile 2,258 3,409
Installment 709 967
Savings secured 545 602
Unsecured and other 2,924 1,063
-------- --------
Subtotal 102,578 91,328
Premium on loans acquired 69 103
Net deferred loan origination costs 559 497
-------- --------
Total consumer loans $103,206 $ 91,928
======== ========
Total loans receivable $747,524 $670,658
======== ========
11
-- Deposits and Borrowings. Total deposits increased by $21.0
million, or 2.8%, during the first half of 2003, from $761.9 million, or
75.2% of total assets, at December 31, 2002, to $782.9 million, or 74.7% of
total assets, at June 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 $32.7 million, or 6.1%, in
the first half of 2003, while certificates of deposit decreased $11.6
million, or 5.2%, 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 June 30, 2003, core deposit accounts comprised 73.1% of
total deposits, compared to 70.9% of total deposits at December 31, 2002.
The following table sets forth certain information regarding deposits:
June 30, 2003 December 31, 2002
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
(Dollars in thousands)
NOW accounts $116,628 14.9% 1.14% $100,476 13.2% 1.37%
Money market accounts 10,546 1.3% 0.90% 10,660 1.4% 1.00%
Savings accounts 299,247 38.2% 1.36% 290,981 38.2% 1.70%
Certificate of deposit accounts 210,226 26.9% 2.87% 221,874 29.1% 3.07%
Total interest bearing deposits 636,647 81.3% 1.81% 623,991 81.9% 2.12%
Noninterest bearing accounts 146,290 18.7% -- 137,920 18.1% --
Total deposits $782,937 100.0% 1.47% $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 half of 2003, FHLB borrowings increased $18.8 million, or 13.0%, 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 June 30, 2003, the Company had
nonperforming assets of $4.7 million, which represented 0.45% 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
aggregating $4.1 million. Total nonperforming assets at June 30, 2003,
consisted of nonaccrual residential mortgage loans aggregating $250,000,
nonaccrual commercial loans aggregating $4.5 million and nonaccrual
12
consumer loans aggregating $2,000. 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
$4.2 million, at June 30, 2003, and $224,000, at December 31, 2002, of
impaired loans. Specific reserves against these impaired loans were
$426,000 and $-0- at June 30, 2003 and December 31, 2002, respectively.
Delinquencies. At June 30, 2003, loans with an aggregate balance of
$373,000 were 60 to 89 days past due, an increase of $346,000, or 1281.5%,
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.
June 30, December 31,
2003 2002
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $4,745 $ 736
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
Total nonperforming loans 4,745 736
Other real estate owned -- 58
Total nonperforming assets $4,745 $ 794
Delinquent loans 60-89 days past due $ 373 $ 27
Nonperforming loans as a percent of total loans 0.63% 0.11%
Nonperforming assets as a percent of total assets 0.45% 0.08%
Delinquent loans 60-89 days past due as a percent of total loans 0.05% 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 June 30, 2003, the Company had $9.3 million of assets that were
classified as substandard and $465,000 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 June 30, 2003, included in the assets that were classified as
substandard, were $6.8 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,
13
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 half of 2003, the Company made provisions to the
allowance for loan losses totaling $800,000 and had $65,000 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 1.45% as of June 30, 2003, compared to 1.51%
at the prior year end and stood at 228.3% of nonperforming loans at June 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 June 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 June 30, 2003 and 2002
-----------------------------------------
-- Overview. The Company reported net income for the second quarter
of 2003 of $1.8 million, down $147,000, or 7.7%, from the second quarter of
2002. Diluted earnings per common share were $0.43 for the second quarter
of 2003, compared to $0.48 for the second quarter of 2002.
The Company reported a return on average assets of 0.68% and a return
on average equity of 10.36% for the 2003 period, as compared to a return on
average assets of 0.83% and a return on average equity of 12.67% for the
2002 period.
During the second quarter of 2003, the Company completed a significant
investment in the future of the Bank by converting its core data processing
system to a new service provider. This conversion resulted in approximately
$300,000 of start-up charges for the quarter. Increased interest income
from continued growth of the Company was offset by pressure on its net
interest margin from the current low rate environment. As a result, the
increases in noninterest expenses caused the Company's net income to decline
from the second quarter of last year.
-- Net Interest Income. For the quarter ended June 30, 2003, net
interest income was $8.0 million, relatively unchanged from the $8.0 million
reported for the 2002 period. The growth of the Company's earning assets
was almost entirely offset by a decrease in its net interest margin.
Average earnings assets were $95.3 million, or 10.8%, higher and average
interest-bearing liabilities were $75.1 million, or 10.0%, higher than the
comparable period a year earlier. The net interest margin for the second
quarter of 2003 was 3.29% compared to a net interest margin of 3.66% for the
2002 period. The decrease of 37 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 $2.4
million for the quarter ended June 30, 2003, compared to $3.3 million for
the second quarter of 2002. This decrease in total investment income of
$856,000, or 26.0%, was primarily attributable to a decrease of $51.9
million, or 27.7%, in the average balance of MBSs, coupled with a decrease
of 89 basis points in the overall yield of investments, from the second
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 $10.5 million for
the three months ended June 30, 2003, and represented a yield on total loans
of 5.79%. This compares to $10.2 million of interest, and a yield of 6.78%,
for the second quarter of 2002. Declining market interest rates, coupled
with increased prepayment activity, resulted in residential mortgage loan
interest decreasing $522,000, or 10.8%, from the second quarter of 2002.
Interest from commercial loans increased $387,000, or 8.7%, and consumer and
other loan income increased $377,000, or 39.3%, 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 116
basis points, to 5.45%; commercial loans decreased 85 basis points, to
6.34%; and consumer and other loans decreased 75 basis points, to 5.23%.
The average balance of the various components of the loan portfolio changed
from the second quarter of 2002 as follows: commercial loans increased
$57.7 million, or 23.3%, consumer and other loans increased $38.2
15
million, or 59.4%, and residential mortgage loans increased $24.3 million,
or 8.3%,. 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.
-- Interest Expense. Interest paid on deposits and borrowings
decreased $591,000, or 10.7%, to $4.9 million for the three months ended
June 30, 2003, from $5.5 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 56 basis points from 2.96% for the second
quarter of 2002 to 2.40% for the second 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 second quarter of 2002 as follows: money market accounts
decreased 40 basis points, to 0.92%, savings accounts decreased 44 basis
points, to 1.43%, certificate of deposit accounts decreased 63 basis points,
to 2.88%, and borrowings decreased 57 basis points to 4.16%, while NOW
accounts increased 59 basis points, to 1.25% (as a result of the
introduction of the Asset Manager, a premium rate checking account).
Meanwhile, the average balance of interest-bearing liabilities increased
$75.2 million, from $747.8 million in the second quarter of 2002 to $823.0
million in the second 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 June 30, 2003, down $50,000, or 11.1%, 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 decreased slightly during
the quarter and actual loan charge-offs were minimal. 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 $876,000,
or 57.7%, to $2.4 million for the second quarter of 2003, from $1.5 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, rose $131,000, or
14.4%, in response to continued growth in checking and savings accounts.
Commissions on nondeposit investment products increased $59,000, or 34.1%,
compared to the second quarter of 2002 as consumer interest in investment
products rebounded. Income from BOLI increased $63,000, or 44.4%, as the
amount invested in BOLI increased since the 2002 period. Noninterest income
during the 2003 period included a net gain of $279,000 from the Company's
restructure of a portion of its investment portfolio, along with the receipt
of loan prepayment penalties aggregating $246,000. The 2002 period did not
contain either of these events.
-- Noninterest Expense. Total noninterest expense for the second
quarter of 2003 increased $1.1 million, or 17.6%, to $7.3 million from $6.2
million in 2002. This increase occurred primarily in the following areas:
Salaries and employee benefits (up $539,000, or 16.8%), Occupancy and
16
Equipment (up $222,000, or 29.9%), Data processing (up $316,000, or 65.2%)
and Other expenses (up $196,000, or 25.8%). 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. These investments included the
opening of a brand new Operations Center in January 2003 and converting to a
new core data processing system in May 2003. The investment in a new core
data processing system included approximately $300,000 of start-up costs,
such as for setup and training, which were incurred during the second
quarter of 2003. Partially offsetting these increases were decreases in
Marketing (down $87,000, or 22.6%) and Professional services (down $31,000,
or 7.5%), as the 2002 period included a higher level of marketing
initiatives and 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 65.51% for the second quarter of 2002, to
70.71% for the second quarter of 2003.
-- Income Tax Expense. Income tax expense of $881,000 was recorded
for the quarter ended June 30, 2003, compared to $930,000 for the 2002
period. This represented total effective tax rates of 33.3% and 32.8%,
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.
Six Months Ended June 30, 2003 and 2002
---------------------------------------
-- Overview. Net income for the first half of 2003, decreased
$369,000, or 9.7%, to $3.4 million, or $0.85 per diluted common share, from
$3.8 million, or $0.95 per diluted common share, for the first half of 2002.
This performance represented a return on average assets of 0.68% and a
return on average equity of 10.27% for the 2003 period, as compared to a
return on average assets of 0.85% and a return on average equity of 12.71%
for the 2002 period.
During the first half of 2003, 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 first half of 2003.
-- Net Interest Income. For the six months ended June 30, 2003, net
interest income was $15.8 million, compared to $15.6 million for the first
half of 2002. The net interest margin for the first six months of 2003 was
3.31% compared to a net interest margin of 3.64% for the 2002 period. The
increase in net interest income of $174,000, or 1.1%, was primarily
attributable to the overall growth of the Company. Average earning assets
increased $95.1 million, or 11.0%, and average interest-bearing liabilities
increased $78.1 million, or 10.6%, over the comparable period a year
earlier. The decrease of 33 basis points in the net interest margin was
primarily caused by the dramatic drop in market interest rates occurring in
2002, coupled with the asset-sensitive nature of the Company's balance
sheet.
-- Interest Income. Investments. Total investment income was $5.2
million for the six months ended June 30, 2003, compared to $6.2 million
for the first half of 2002. This decrease in total investment income of
$1.1 million, or 17.3%, was primarily attributable to a $42.8 million, or
24.0%, decrease in the average balance of MBSs, coupled with a 72 basis
point decrease in the
17
overall yield on investments, from 4.76% in 2002, to 4.04% in 2003, in
response to dramatically lower market interest rates and increased
prepayment activity.
-- Interest Income. Loans. Interest from loans was $20.6 million for
the six months ended June 30, 2003, and represented a yield on total loans
of 5.88%. This compares to $20.4 million of interest, and a yield of 6.79%,
for the first half of 2002. Increased interest income resulting from growth
in the average balance of loans of $102.1 million, or 16.9%, was almost
entirely offset by a decrease in the average yield of loans of 91 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 decreased 108 basis points, to 5.52%; commercial loans decreased 76
basis points, to 6.44%; and consumer and other loans decreased 77 basis
points, to 5.30%. The average balance of the various components of the
loan portfolio changed as follows: commercial loans increased $53.3
million, or 21.8%, consumer and other loans increased $36.8 million, or
58.4%, and residential mortgage loans increased $11.9 million, or 4.0%. 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 $1.0 million, or 9.3%, to $10.0 million for the six months ended
June 30, 2003, compared to $11.0 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 54 basis points from 3.02%
for the first half of 2002, to 2.48% for the first half of 2003. 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 $78.1 million, or
10.6%, from $734.4 million in 2002, to $812.5 million in 2003. The Company
continued to experience strong average balance growth in core deposit
accounts, specifically NOW accounts (up $58.1 million, or 121.3%), primarily
from growth in the Asset Manager product, and savings accounts (up $27.5
million, or 10.2%). In addition, the Company increased its utilization of
FHLB borrowings (up $6.7 million, or 4.6%) and capital trust securities (up
$4.9 million, or 154.9%).
-- Provision for Loan Losses. The provision for loan losses was
$800,000 for the six months ended June 30, 2003, compared to $850,000 for
the same period last year. The allowance, expressed as a percentage of
total loans, was 1.45% as of June 30, 2003, compared to 1.51% at the prior
year-end and stood at 228.3% of nonperforming loans at June 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 $65,000 for the six month period ending June 30, 2003.
This compares to net charge-offs of $108,000 for the same period last year.
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 $1.2
million, or 39.8%, from the first half of 2002, to $4.3 million for the
first six months of 2003. Service charges on deposit accounts, which
represents the largest source of noninterest income, rose $228,000, or
12.9%, from $1.8 million for the six months ended June 30, 2002, to $2.0
million for the same period in 2003, 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 $246,000
and gains from restructuring a portion of investments aggregating $437,000.
Similar events were not present during the first half of 2002.
Additionally, Income from BOLI increased $171,000, or 72.2%, as the
Company's investment in BOLI increased from the prior year.
-- Noninterest Expense. Noninterest expenses for the first half of
2003 increased a total of $2.1 million, or 17.5%, to $14.2 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 $790,000, or 12.6%), Occupancy and
Equipment (up $445,000, or 30.5%), Data processing (up $721,000, or 77.9%)
and Other expenses (up $408,000, or 26.8%). Included in these increases
were start-up expenses related to the data processing conversion of
approximately $600,000 for the six months ended June 30, 2003. Partially
offsetting these increases were decreases in: Marketing (down $86,000, or
12.6%) and Professional services (down $136,000, or 17.0%). The Company's
efficiency ratio increased to 70.67% for the 2003 period, from 64.66% for
the 2002 period.
-- Income Tax Expense. The Company recorded income tax expense of
$1.7 million for the first half of 2003, compared to $2.0 million for the
same period during 2002. This represented total effective tax rates of
32.7% and 34.0%, 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
June 30, 2003, overnight investments, investment securities and MBSs
available for sale amounted to $227.3 million, or 21.7% 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
June 30, 2003 was $69.3 million, as compared to $66.4 million at December
31, 2002. This increase of $2.9 million was primarily the result of net
income for the six months of $3.4 million, plus proceeds from issuance of
stock of $251,000, less dividends 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 June 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 June 30, 2003:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $69,031 6.76% $30,634 3.00% $51,057 5.00%
Tier I capital (to risk weighted assets) 69,031 9.91% 27,853 4.00% 41,780 6.00%
Total capital (to risk weighted assets) 77,756 11.17% 55,706 8.00% 69,633 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $65,358 6.41% $30,605 3.00% $51,009 5.00%
Tier I capital (to risk weighted assets) 65,358 9.39% 27,837 4.00% 41,755 6.00%
Total capital (to risk weighted assets) 74,083 10.65% 55,674 8.00% 69,592 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 June 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 July 1, 2003:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 basis points $1,439 4.55%
Up 100 basis points 855 2.70%
Down 100 basis points (382) (1.21%)
Down 200 basis points (1,044) (3.30%)
Subsequent Twelve Month Period:
Up 200 basis points $2,853 9.15%
Up 100 basis points 2,375 7.62%
Down 100 basis points (1,384) (4.44%)
Down 200 basis points (4,776) (15.32%)
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 June 30, 2003, the Company's one year cumulative
gap was a positive $187.7 million, or 17.90% 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
At the Annual Meeting of Shareholders, held May 21, 2003, holders of
Common Stock elected the Board's nominees to the Board of Directors
and ratified the appointment of independent public accountants.
The vote for Class I director nominees with terms expiring in 2006
was:
FOR WITHHELD
Karen Adams 3,554,130 31,551
Meredith A. Curren 3,576,330 9,351
Bogdan Nowak 3,578,530 7,151
Cheryl W. Snead 3,574,130 11,551
John A. Yena 3,559,030 26,651
The vote for Class II director nominee with a term expiring in 2004
was:
FOR WITHHELD
Pablo Rodriguez, M.D. 3,552,430 33,251
The vote for ratifying the appointment of KPMG LLP as independent
public accountants for the Company was:
FOR AGAINST ABSTAIN
3,524,830 8,200 2,860
24
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.10(a) Amendment No. 1 to Bank Rhode Island 2002
Supplemental Executive Retirement Plan.
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 April 15, 2003, announcing the
Company's first quarter consolidated earnings.
25
BANCORP RHODE ISLAND, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Bancorp Rhode Island, Inc.
August 5, 2003 /s/ Merrill W. Sherman
-------------- -----------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
August 5, 2003 /s/ Albert R. Rietheimer
-------------- -------------------------
(Date) Albert R. Rietheimer
Chief Financial Officer
and Treasurer
26