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, 2005
Commission File No. 001-16101
BANCORP RHODE ISLAND, INC.
--------------------------
(Exact Name of Registrant as Specified in Its Charter)
RHODE ISLAND 05-0509802
------------ ----------
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
-------------------------------------------
(Address of Principal Executive Offices)
(401) 456-5000
--------------
(Issuer's Telephone Number, Including Area Code)
Not Applicable
--------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes (X) No ( )
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of August 5, 2005:
Common Stock - Par Value $0.01 4,653,702 shares
------------------------------ ----------------
(class) (outstanding)
BANCORP RHODE ISLAND, INC.
FORM 10-Q
INDEX
PAGE NUMBER
-----------
Cover Page 1
Index 2
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Changes in
Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7 - 9
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 10 - 24
Item 3 Quantitative and Qualitative Disclosures About
Market Risk 25 - 26
Item 4 Controls and Procedures 26
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 27
Item 2 Unregistered Sales of Equity Securities
and Use of Proceeds 27
Item 3 Default upon Senior Securities 27
Item 4 Submission of Matters to a Vote of Security Holders 27 - 28
Item 5 Other Information 28
Item 6 Exhibits 28
Signature Page 29
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
(Unaudited)
June 30, December 31,
2005 2004
-------- ------------
(In thousands)
ASSETS:
Cash and due from banks $ 29,523 $ 21,585
Overnight investments 867 14,094
---------- ----------
Total cash and cash equivalents 30,390 35,679
Investment securities available for sale (amortized cost of
$131,816 and $103,953 at June 30, 2005 and December 31, 2004,
respectively) 131,407 104,600
Mortgage-backed securities available for sale (amortized cost
of $229,880 and $159,581 at June 30, 2005 and December 31,
2004, respectively) 229,523 159,946
Stock in Federal Home Loan Bank of Boston 15,526 13,229
Loans and leases receivable:
Commercial loans and leases 433,267 402,770
Residential mortgage loans 306,657 316,135
Consumer and other loans 185,729 167,396
---------- ----------
Total loans and leases receivable 925,653 886,301
Less allowance for loan and lease losses (11,394) (11,906)
---------- ----------
Net loans and leases receivable 914,259 874,395
Premises and equipment, net 14,535 11,857
Goodwill 11,234 10,766
Accrued interest receivable 6,167 5,666
Investment in bank-owned life insurance 18,473 18,132
Prepaid expenses and other assets 6,459 4,799
---------- ----------
Total assets $1,377,973 $1,239,069
========== ==========
LIABILITIES:
Deposits:
Demand deposit accounts $ 187,554 $ 167,682
NOW accounts 94,826 108,159
Money market accounts 16,038 16,489
Savings accounts 332,450 339,836
Certificate of deposit accounts 303,095 248,508
---------- ----------
Total deposits 933,963 880,674
Overnight and short-term borrowings 16,594 18,050
Wholesale repurchase agreements 10,000 --
Federal Home Loan Bank of Boston borrowings 286,289 234,778
Subordinated deferrable interest debentures 18,558 18,558
Other liabilities 9,383 8,086
---------- ----------
Total liabilities 1,274,787 1,160,146
---------- ----------
SHAREHOLDERS' EQUITY:
Preferred stock, par value $0.01 per share, authorized
1,000,000 shares:
Issued and outstanding: none -- --
Common stock, par value $0.01 per share, authorized
11,000,000 shares:
Issued and outstanding 4,655,977 shares and 4,010,554 shares,
respectively 47 40
Additional paid-in capital 64,685 42,852
Retained earnings 38,953 35,373
Accumulated other comprehensive (loss) income, net (499) 658
---------- ----------
Total shareholders' equity 103,186 78,923
---------- ----------
Total liabilities and shareholders' equity $1,377,973 $1,239,069
========== ==========
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- -------------------------
2005 2004 2005 2004
---- ---- ---- ----
(In thousands, except per share data)
Interest and dividend income:
Commercial loans and leases $ 6,806 $ 5,670 $ 13,176 $ 10,879
Residential mortgage loans 4,026 4,242 7,995 8,937
Consumer and other loans 2,371 1,552 4,557 2,981
Mortgage-backed securities 2,294 1,211 4,091 2,332
Investment securities 1,373 1,019 2,610 2,115
Overnight investments 44 42 100 65
Federal Home Loan Bank of Boston stock dividends 154 61 284 112
---------- ---------- ---------- ---------
Total interest and dividend income 17,068 13,797 32,813 27,421
---------- ---------- ---------- ---------
Interest expense:
NOW accounts 154 312 331 689
Money market accounts 58 50 113 105
Savings accounts 1,072 889 2,084 1,738
Certificate of deposit accounts 2,077 1,371 3,799 2,765
Overnight and short-term borrowings 133 31 248 66
Wholesale repurchase agreements 92 -- 100 --
Federal Home Loan Bank of Boston borrowings 2,399 1,772 4,387 3,525
Subordinated deferrable interest debentures 313 261 610 480
---------- ---------- ---------- ---------
Total interest expense 6,298 4,686 11,672 9,368
---------- ---------- ---------- ---------
Net interest income 10,770 9,111 21,141 18,053
Provision for loan and lease losses 354 200 654 500
---------- ---------- ---------- ---------
Net interest income after provision for
loan and lease losses loan losses 10,416 8,911 20,487 17,553
---------- ---------- ---------- ---------
Noninterest income:
Service charges on deposit accounts 1,152 1,206 2,235 2,218
Commissions on nondeposit investment products 198 268 398 446
Income from bank-owned life insurance 168 154 340 319
Loan related fees 156 96 439 205
Commissions on loans originated for others 62 23 86 40
Gain on sale of investment securities -- 144 -- 341
Gain on sale of mortgage-backed securities 104 -- 96 --
Other income 605 315 926 635
---------- ---------- ---------- ---------
Total noninterest income 2,445 2,206 4,520 4,204
---------- ---------- ---------- ---------
Noninterest expense:
Salaries and employee benefits 4,848 4,129 9,471 8,022
Occupancy 771 652 1,503 1,332
Equipment 410 402 809 788
Data processing 745 722 1,497 1,392
Marketing 469 420 790 775
Professional services 523 357 1,011 642
Loan servicing 239 253 466 531
Loan workout and other real estate owned expense 23 48 34 70
Other expenses 1,097 997 2,056 2,003
---------- ---------- ---------- ---------
Total noninterest expense 9,125 7,980 17,637 15,555
---------- ---------- ---------- ---------
Income before income taxes 3,736 3,137 7,370 6,202
Income tax expense 1,276 1,042 2,503 2,043
---------- ---------- ---------- ---------
Net income $ 2,460 $ 2,095 $ 4,867 $ 4,159
========== ========== ========== ==========
Per share data:
Basic earnings per common share $ 0.55 $ 0.53 $ 1.14 $ 1.05
Diluted earnings per common share $ 0.52 $ 0.50 $ 1.08 $ 0.99
Average common shares outstanding - basic 4,508,165 3,966,526 4,258,815 3,956,597
Average common shares outstanding - diluted 4,737,503 4,214,017 4,497,435 4,203,771
See accompanying notes to consolidated financial statements
4
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity
(Unaudited)
Accumulated
Other
Compre-
Additional hensive
Common Paid-in Retained Income
Six months ended June 30, Stock Capital Earnings (Loss), Net Total
------------------------- ------ ---------- -------- ----------- -----
(In thousands)
2004
Balance at December 31, 2003 $39 $41,439 $29,074 $ 1,555 $ 72,107
Net income -- -- 4,159 -- 4,159
Other comprehensive income, net of tax:
Unrealized holding losses on securities
available for sale, net of taxes of $1,690 (3,280) (3,280)
Reclassification adjustment, net of taxes
of $116 (225) (225)
--------
Comprehensive income 654
Exercise of stock options -- 294 -- -- 294
Exercise of stock warrants 1 699 -- -- 700
Common stock issued for incentive
stock award, net -- 18 -- -- 18
Dividends on common stock ($ 0.28 per
common share) -- -- (1,113) -- (1,113)
--- ------- ------- ------- --------
Balance at June 30, 2004 $40 $42,450 $32,120 $(1,950) $ 72,660
=== ======= ======= ======= ========
2005
Balance at December 31, 2004 $40 $42,852 $35,373 $ 658 $ 78,923
Net income -- -- 4,867 -- 4,867
Other comprehensive income, net of tax:
Unrealized holding losses on securities
available for sale, net of taxes of $590 (1,095) (1,095)
Reclassification adjustment, net of taxes
of $34 (62) (62)
--------
Comprehensive loss 3,710
Proceeds from stock offering 7 21,450 -- -- 21,457
Acquisition of Macrolease -- 250 -- -- 250
Exercise of stock options -- 116 -- -- 116
Common stock issued for incentive
stock award, net -- 17 -- -- 17
Dividends on common stock ($ 0.30 per
common share) -- -- (1,287) -- (1,287)
--- ------- ------- ------- --------
Balance at June 30, 2005 $47 $64,685 $38,953 $ (499) $103,186
=== ======= ======= ======= ========
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended
June 30,
------------------------
2005 2004
---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 4,867 $ 4,159
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation and amortization 1,437 1,982
Provision for loan and lease losses 654 500
Gain on sale of investment securities -- (341)
Gain on sale of mortgage-backed securities (96) --
Income from bank-owned life insurance (340) (319)
Compensation expense from restricted stock grant 17 18
(Increase) decrease in:
Accrued interest receivable (501) (40)
Prepaid expenses and other assets (1,040) (551)
Increase (decrease) in:
Other liabilities 1,297 (1,218)
Other, net (180) 10
--------- ---------
Net cash provided by operating activities 6,115 4,200
--------- ---------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (3,026) (5,039)
Commercial loans and leases (43,900) (50,361)
Consumer loans (39,061) (49,080)
Purchase of:
Investment securities available for sale (37,932) (43,993)
Mortgage-backed securities available for sale (100,334) (74,545)
Residential mortgage loans (22,230) (27,445)
Federal Home Loan Bank of Boston stock (2,297) (1,591)
Principal payments on:
Investment securities available for sale 9,999 21,000
Mortgage-backed securities available for sale 20,692 26,923
Residential mortgage loans 34,558 69,167
Commercial loans and leases 12,406 12,423
Consumer loans 20,568 24,051
Proceeds from sale of investment securities -- 4,372
Proceeds from sale of mortgage-backed securities 9,359 --
Capital expenditures for premises and equipment (3,836) (1,706)
--------- ---------
Net cash used by investing activities (145,034) (95,824)
--------- ---------
Cash flows from financing activities:
Net increase in deposits 53,289 76,540
Net increase (decrease) in overnight and short-term borrowings (1,456) 2,920
Proceeds from long-term borrowings 202,750 55,155
Repayment of long-term borrowings (141,239) (27,971)
Proceeds from issuance of common stock 21,573 994
Dividends on common stock (1,287) (1,113)
--------- ---------
Net cash provided by financing activities 133,630 106,525
--------- ---------
Net (decrease) increase in cash and cash equivalents (5,289) 14,901
Cash and cash equivalents at beginning of period 35,679 27,817
--------- ---------
Cash and cash equivalents at end of period $ 30,390 $ 42,718
========= =========
Supplementary Disclosures:
Cash paid for interest $ 11,453 $ 8,887
Cash paid for income taxes 3,337 2,840
Non-cash transactions:
Change in other comprehensive income, net of taxes (1,157) (3,505)
See accompanying notes to consolidated financial statements
6
BANCORP RHODE ISLAND, INC.
Notes to Consolidated Financial Statements
(1) Basis of Presentation
Bancorp Rhode Island, Inc. (the "Company"), a Rhode Island
corporation, is the holding company for Bank Rhode Island (the "Bank"). The
Company has no significant assets other than the common stock of the Bank.
For that reason, substantially all of the discussion in this Quarterly
Report on Form 10-Q relates to the operations of the Bank and its
subsidiaries.
The audited consolidated financial statements include the accounts of
the Company and its wholly-owned direct subsidiary, the Bank, and its
indirect subsidiaries, BRI Investment Corp. (a Rhode Island passive
investment company), BRI Realty Corp. (a real estate holding company),
Macrolease Corporation (an equipment leasing company) and Acorn Insurance
Agency, Inc. (a licensed insurance agency). The Company adopted Financial
Accounting Standards Board ("FASB") Interpretation 46-R, "Consolidation of
Variable Interest Entities - Revised" on December 31, 2003, and therefore
deconsolidated its statutory trust subsidiaries as of that date. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
The unaudited interim results of consolidated operations are not
necessarily indicative of the results for any future interim period or for
the entire year. These interim consolidated financial statements do not
include all disclosures associated with annual financial statements and,
accordingly, should be read in conjunction with the annual consolidated
financial statements and accompanying notes included in the Company's Annual
Report on Form 10-K filed with the Securities and Exchange Commission
("SEC").
In preparing the unaudited consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance
sheet and revenues and expenses for the period. Actual results could differ
from those estimates. Material estimates that are particularly susceptible
to change relate to the determination of the allowance for loan losses and
goodwill valuation.
The unaudited interim consolidated financial statements of the Company
have been prepared in accordance with U.S. Generally Accepted Accounting
Principles ("GAAP") and prevailing practices within the banking industry and
include all necessary adjustments (consisting of only normal recurring
adjustments), that, in the opinion of management, are required for a fair
presentation of the results and financial condition of the Company.
(2) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and resulted in the issuance of additional
common stock that then shared in the earnings of the Company.
7
(3) Stock Based Compensation
The Company has adopted Statement of Financial Accounting Standards
("SFAS") 123, "Accounting for Stock-Based Compensation." This Statement
establishes a fair value based method of accounting for stock-based
compensation plans under which compensation cost is measured at the grant
date based on the value of the award and is recognized over the service
period. However, the Statement allows a company to continue to measure
compensation cost for such plans using the intrinsic value method under
which no compensation cost is recorded if, at the grant date, the exercise
price of the option is equal to the fair market value of the company's
stock. The Company has elected to continue to follow the intrinsic value
method; accordingly, the Company must disclose in the notes to its financial
statements various information as if the fair value based method of
accounting had been applied.
In December 2004, the FASB issued SFAS 123-R, "Share-Based Payment",
which requires companies to recognize an expense in the income statement for
the grant-date fair value of stock options and other equity-based
compensation issued to employees using the fair value method. This expense
will be recognized over the period during which an employee is required to
provide service in exchange for the award. This Statement carries forward
prior guidance on accounting for awards to non-employees. If an equity
award is modified after grant date, incremental compensation cost will be
recognized in an amount equal to the excess of the fair value of the
modified award over the fair value of the original award immediately prior
to the modification.
On April 14, 2005, the SEC announced the adoption of a new rule that
amends the compliance dates for SFAS 123-R, which requires registrants to
implement SFAS 123-R at the beginning of their next fiscal year, instead of
the next reporting period, that begins after June 15, 2005, which for the
Company is January 1, 2006.
The following table summarizes the differences between the fair value
and intrinsic value methods of accounting for stock-based compensation:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2005 2004 2005 2004
---- ---- ---- ----
Net income (in thousands):
As reported $2,460 $2,095 $4,867 $4,159
Compensation cost, net of taxes (1) (128) (187) (166) (241)
------ ------ ------ ------
Pro forma $2,332 $1,908 $4,701 $3,918
====== ====== ====== ======
Earnings per common share:
Basic:
As reported $ 0.55 $ 0.53 $ 1.14 $ 1.05
Compensation cost, net of taxes (1) (0.03) (0.05) (0.04) (0.06)
------ ------ ------ ------
Pro forma $ 0.52 $ 0.48 $ 1.10 $ .99
====== ====== ====== ======
Diluted:
As reported $ 0.52 $ 0.50 $ 1.08 $ .99
Compensation cost, net of taxes (1) (0.03) (0.04) (0.03) (0.06)
------ ------ ------ ------
Pro forma $ 0.49 $ 0.46 $ 1.05 $ .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
(4) Supplemental Executive Retirement Plans
The Bank maintains Supplemental Executive Retirement Plans ("SERPs")
for certain of its executives under which participants designated by the
Board of Directors are entitled to an annual retirement benefit. Expenses
associated with the SERPs were $302,000 and $218,000 for the six months
ending June 30, 2005 and 2004, respectively. Accrued liabilities associated
with the SERPs were $1.5 million and $1.2 million for June 30, 2005 and
December 31, 2004, respectively.
(5) Recent Developments
During the second quarter, the Company consummated an offering of
628,418 shares of its common stock, realizing net proceeds of approximately
$21.5 million. The Company also consummated its first acquisition with the
purchase of substantially all of the operating assets of Macrolease
International Corporation, a privately held equipment leasing company
located in Long Island, New York. The Company intends to use the Macrolease
platform to increase its portfolio of equipment leases and expand its
product offerings to existing Bank customers. In addition, the Bank opened
two new branches, one in Lincoln, next to its Operations Center and one in
East Greenwich, and now has sixteen full service branches in Rhode Island.
9
BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis
ITEM 2. Management's Discussion and Analysis
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
-------------------------------------------------
We make certain forward looking statements in this Quarterly Report on
Form 10-Q and in other documents that we incorporate by reference into this
report that are based upon our current expectations and projections about
current events. We intend these forward looking statements to be covered by
the safe harbor provisions for "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended and Section
21E of the Securities Exchange Act of 1934, as amended, and we are including
this statement for purposes of these safe harbor provisions. You can
identify these statements by reference to a future period or periods by our
use of the words "estimate," "project," "may," "believe," "intend,"
"anticipate," "plan," "seek," "expect" and similar terms or variations of
these terms.
Actual results may differ materially from those set forth in forward
looking statements as a result of risks and uncertainties, including those
detailed from time to time in our filings with the Securities and Exchange
Commission. Our forward looking statements do not reflect the potential
impact of any future acquisition, mergers, dispositions, joint ventures or
investments we may make. We do not assume any obligation to update any
forward looking statements.
GENERAL
-------
The Company's principal subsidiary, Bank Rhode Island, is a commercial
bank chartered as a financial institution in the State of Rhode Island. The
Bank pursues a community banking mission and is principally engaged in
providing banking products and services to individuals and businesses in
Rhode Island and nearby areas of Massachusetts. The Bank is subject to
competition from a variety of traditional and nontraditional financial
service providers both within and outside of Rhode Island. The Bank offers
its customers a wide range of commercial real estate, business, residential
and consumer loans, deposit products, nondeposit investment products, cash
management, and other banking products and services designed to meet the
financial needs of individuals and small- to mid-sized businesses. The Bank
also offers both commercial and consumer on-line banking products and
maintains a web site at http://www.bankri.com. The Company and Bank are
subject to regulation by a number of federal and state agencies and undergo
periodic examinations by certain of those regulatory authorities. The
Bank's deposits are insured by the Federal Deposit Insurance Corporation
("FDIC"), subject to regulatory limits. The Bank is also a member of the
Federal Home Loan Bank of Boston ("FHLB").
OVERVIEW
--------
The Company's operating results depend primarily on two factors: its
"net interest income" and the quality of its assets.
The Company's net interest income is the difference between its
interest income and its cost of money. Interest income depends on the
amount of interest-earning assets outstanding during the period and the
interest rates earned thereon. Cost of money is a function of the average
amount of
10
deposits and borrowed money outstanding during the period and the interest
rates paid thereon. See discussion under "Results of Operations." Because
the Company's assets are not identical in duration and in repricing dates to
its liabilities, the spread between the two is vulnerable to changes in
market interest rates as well as the overall shape of the yield curve.
These vulnerabilities are inherent to the business of banking and are
commonly referred to as "interest rate risk." How to measure interest rate
risk and, once measured, how much risk to take are based on numerous
assumptions and other subjective judgments. See discussion under "Interest
Rate Risk."
The quality of the Company's assets also influences its earnings.
Loans and leases that are not being paid on a timely basis and exhibit other
weaknesses can result in the loss of principal and/or interest income.
Additionally, the Company must make timely provisions to its allowance for
loan and lease losses as a result of its estimates as to potential future
losses; these additions, which are charged against earnings, are necessarily
greater when greater potential losses are expected. Finally, the Company
will incur expenses as a result of resolving troubled assets. All of these
form the "credit risk" that the Company takes on in the ordinary course of
its business and is further discussed under "Financial Condition - Asset
Quality."
The Company's business strategy has been to concentrate its asset
generation efforts on commercial and consumer loans and its deposit
generation efforts on checking and savings accounts. These deposit accounts
are commonly referred to as "core deposit accounts." This strategy is based
on the Company's belief that it can distinguish itself from its larger
competitors, and indeed attract customers from them, through a higher level
of service and through its ability to set policies and procedures, as well
as make decisions, locally. The loan and deposit products referenced also
tend to be geared more toward customers who are relationship oriented than
those who are seeking stand-alone or single transaction products. The
Company believes that its service-oriented approach enables it to compete
successfully for relationship-oriented customers. Additionally, the Company
is predominantly an urban franchise with a high concentration of businesses
making deployment of funds in the commercial lending area practicable.
Commercial loans are attractive, among other reasons, because of their
higher yields. Similarly, core deposits are attractive because of their
generally lower interest cost and potential for fee income.
In recent years, the Company also has sought to leverage business
opportunities presented by its customer base, franchise footprint and
resources. It has increased efforts in the area of consumer lending and to
a lesser degree, residential mortgage originations, and recently acquired
the capacity to originate equipment leases.
The deposit market in Rhode Island is highly concentrated. The
State's three largest banks have an aggregate market share of 84% (based
upon June 2004 FDIC statistics, excluding one bank that draws its deposits
primarily from the internet) in Providence and Kent Counties, the Bank's
primary marketplace. Competition for loans and deposits has intensified
during the past year. With Bank of America entering New England for the
first time during 2004, numerous institutions in the market have heightened
their advertising and promotional product offerings.
Currently, approximately 82% of the Company's revenues (defined as net
interest income plus noninterest income) are derived from its level of net
interest income. In an effort to diversify its sources of revenue, the
Company has attempted to expand its sources of noninterest income, primarily
fees and charges for products and services it offers. The Company has
increased its percentage of noninterest income to total revenue from 12.0%
in 2000, to 18.4% in 2004, by
11
emphasizing core deposit growth which generates increased service charges,
and by introducing additional financial services, such as nondeposit
investment products.
The future operating results of the Company will depend on its ability
to maintain and expand its net interest margin, while minimizing its
exposure to credit risk, along with increasing its sources of noninterest
income, while controlling the growth of its noninterest or operating
expenses.
Total assets increased $138.9 million, or 11.2%, to $ 1.4 billion at
June 30, 2005 from December 31, 2004. This increase was centered in the
Company's investment mortgage-backed securities and growth in commercial and
consumer loans and was funded by borrowings and deposits. Total deposits
increased $53.3 million, or 6.1%, and was centered in certificates of
deposit (up $54.6 million, or 22.0%) and demand deposits (up $19.9 million,
or 11.9%) . Meanwhile, total borrowings (including wholesale repurchase
agreements) increased $60.1 million, or 23.8%, as additional funding was
required to support asset growth. Shareholders' equity increased from $78.9
million at December 31, 2004 to $103.2 million at June 30, 2005, and
represented 7.5% of total assets. The increase in shareholders' equity
reflects the issuance of common stock during the second quarter of 2005, as
described under "Liquidity and Capital Resources".
CRITICAL ACCOUNTING POLICIES
----------------------------
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying
value of certain assets or net income, are considered critical accounting
policies. The Company considers the following to be its critical accounting
policies: allowance for loan and lease losses and review of goodwill for
impairment. There have been no significant changes in the methods or
assumptions used in accounting policies that require material estimates or
assumptions.
Allowance for loan and lease losses
Arriving at an appropriate level of allowance for loan and lease
losses necessarily involves a significant degree of judgment. First and
foremost in arriving at an appropriate allowance is the creation and
maintenance of a risk rating system that accurately classifies all loans and
leases into varying categories by degree of credit risk. Such a system also
establishes a level of allowance associated with each category of loans and
leases and requires early identification and reclassification of
deteriorating credits. Besides numerous subjective judgments as to the
number of categories, appropriate level of allowance with respect to each
category and judgments as to categorization of any individual loan or lease,
additional subjective judgments are involved when ascertaining the
probability as well as the extent of any potential losses. The Company's
ongoing evaluation process includes a formal analysis of the allowance each
quarter, which considers, among other factors, the character and size of the
loan and lease portfolio, business and economic conditions, loan growth,
delinquency trends, nonperforming loan trends, charge-off experience and
other asset quality factors. These factors are based on observable
information, as well as subjective assessment and interpretation.
Nonperforming commercial, commercial real estate and small business loans in
excess of a specified dollar amount are deemed to be "impaired." The
estimated reserves necessary for each of these credits is determined by
reviewing the fair value of the collateral, the present value of expected
future cash flows, and where available, the observable market price of the
loans. Provisions for losses on the remaining commercial, commercial real
estate, small business, residential mortgage and consumer loans and leases
are based on pools of similar loans or
12
leases using a combination of payment status, historical loss experience,
industry loss experience, market economic factors, delinquency rates and
qualitative adjustments. Management uses available information to establish
the allowance for loan and lease losses at the level it believes is
appropriate. However, future additions to the allowance may be necessary
based on changes in estimates or assumptions resulting from changes in
economic conditions and other factors. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review the Company's allowance for loan and lease losses. Such agencies may
require the Company to recognize adjustments to the allowance based on their
judgments about information available to them at the time of their
examination.
Review of goodwill for impairment
In March 1996, the Bank acquired certain assets and assumed certain
liabilities from Fleet Financial Group, Inc. and related entities. This
acquisition was accounted for utilizing the purchase method of accounting
and generated $17.5 million of goodwill. This goodwill was amortized in the
years prior to 2002, resulting in a net balance of $10.8 million on the
Company's balance sheet as of December 31, 2001. Effective January 1, 2002,
and in accordance with new accounting rules, the Company ceased amortizing
this goodwill and began to review it at least annually for impairment.
Goodwill is evaluated for impairment using market value comparisons for
similar institutions, such as price to earnings multiples, price to deposit
multiples and price to equity multiples. This valuation technique utilizes
verifiable market multiples, as well as subjective assessment and
interpretation. The application of different market multiples, or changes
in judgment as to which market transactions are reflective of the Company's
specific characteristics, could affect the conclusions reached regarding
possible impairment. In the event that the Company were to determine that
its goodwill were impaired, the recognition of an impairment charge could
have an adverse impact on its results of operations in the period that the
impairment occurred or on its financial position.
On May 1, 2005, the Bank acquired certain operating assets from
Macrolease International Corporation. This acquisition was accounted for
utilizing the purchase method of accounting and generated $468,000 of
additional goodwill. This goodwill will not be amortized and will be tested
separately on an annual basis in accordance with the accounting rules
described above.
FINANCIAL CONDITION
-------------------
-- Investments. Total investments (consisting of overnight
investments, investment securities, mortgage-backed securities ("MBSs") and
stock in the FHLB) totaled $377.3 million, or 27.4% of total assets, at June
30, 2005, compared to $291.9 million, or 23.6% of total assets, at December
31, 2004. All $360.9 million of investment securities and MBSs at June 30,
2005 were classified as available for sale and carried a total of $766,000
in net unrealized losses at the end of the quarter. The increase in total
investments of $85.4 million, or 29.3%, was the result of cash inflows being
held temporarily in investments before being redeployed in the Bank's loan
portfolios, as commercial and consumer loan growth was more modest during
the first quarter of 2005 and spreads between residential mortgage loans and
MBSs tightened. The increase in total investments also reflects leverage
transactions entered into during the second quarter of 2005. These
transactions will partially offset the dilution of earnings per share that
will result from the issuance of additional common stock during the second
quarter of 2005.
-- Loans and Leases. Total loans and leases were $925.7 million, or
67.2% of total assets, at June 30, 2005, compared to $886.3 million, or
71.5% of total assets, at December 31, 2004. The
13
Company attempts to concentrate its asset growth in its loan and lease
portfolios to maximize the yield on new assets and to take advantage of
demand for both commercial and home equity loan products in its market area.
The commercial loan and lease portfolio (consisting of commercial real
estate, commercial & industrial, equipment leases, multi-family real estate,
construction and small business loans) increased $30.5 million, or 7.6%,
during the first half of 2005. (The Company utilizes the term "small
business loans" to describe business lending relationships of approximately
$250,000 or less.) The Company believes it is well positioned for continued
commercial growth. Particular emphasis is placed on generation of small- to
medium-sized commercial relationships (those relationships with $7.0 million
or less in total loan commitments). Unlike many community banks, the Bank
is able to offer asset-based commercial loan facilities that monitor
advances against receivables and inventories on a formula basis. The Bank
is also active in small business lending in which it utilizes credit
scoring, in conjunction with traditional review standards, and employs
streamlined documentation. The Bank is a participant in the U.S. Small
Business Administration ("SBA") Preferred Lender Program in both Rhode
Island and Massachusetts. From time to time, the Company has purchased
equipment leases from third party originators. These leases generally have
maturities of five years or less and are not dependent on residual
collateral values. Historically, the U.S. Government and its agencies were
the principal lessees on the vast majority of these leases. The remaining
lessees are generally not-for-profits or small businesses. Through its new
subsidiary, Macrolease Corporation ("Macrolease"), the Bank expects to
increase its portfolio of equipment leases and to expand its product
offerings to existing Bank customers.
The consumer loan portfolio increased $18.3 million, or 11.0%, during
the first half of 2005. This growth was centered in home equity term loans
and home equity lines of credit with maximum loan-to-values of 85%. The
Company believes that these ten- and fifteen-year fixed-rate products, along
with the floating lines of credit, possess attractive cash flow
characteristics in the current interest rate environment and the Company
anticipates that growth in these products will continue.
While origination efforts continue to be concentrated on commercial
and consumer loan opportunities, the Company also originates residential
mortgage loans for its own portfolio, as well as for others, on a limited
basis. The Bank does not employ any outside mortgage originators, but from
time to time, purchases residential mortgage loans from third-party
originators. Until such time as the Bank can generate sufficient commercial
and consumer loans to utilize available cash flow, or to otherwise meet
investment objectives, it also intends to continue purchasing residential
mortgage loans as opportunities develop.
The residential mortgage loan portfolio decreased $9.5 million, or
3.0%, during the first half of 2005, as originations ($25.1 million) of
residential mortgage loans were less than repayments ($34.6 million). At
June 30, 2005, the Bank did not have any commitments to purchase residential
mortgage loans within the next 60 days.
14
The following is a breakdown of loans and leases receivable:
(In thousands)
June 30, 2005 Dec 31, 2004
------------- ------------
Commercial loans:
Commercial real estate - nonowner occupied $100,724 $ 90,716
Commercial real estate - owner occupied 103,364 93,027
Commercial and industrial 84,361 78,918
Construction 34,244 32,319
Small business 36,543 37,820
Multi-family real estate 35,107 32,415
Leases and other 39,186 37,890
-------- --------
Subtotal 433,529 403,105
Net deferred loan origination fees (262) (335)
-------- --------
Total commercial loans $433,267 $402,770
======== ========
Residential mortgage loans:
One- to four-family adjustable rate $198,522 $199,031
One- to four-family fixed rate 106,427 115,350
-------- --------
Subtotal 304,949 314,381
Premium on loans acquired 1,772 1,826
Net deferred loan origination fees (64) (72)
-------- --------
Total residential mortgage loans $306,657 $316,135
======== ========
Consumer loans:
Home equity - term loans $120,163 $110,542
Home equity - lines of credit 61,726 53,551
Automobile 280 488
Installment 350 491
Savings secured 358 439
Unsecured and other 1,592 801
-------- --------
Subtotal 184,469 166,312
Premium on loans acquired 6 15
Net deferred loan origination costs 1,254 1,069
-------- --------
Total consumer loans $185,729 $167,396
======== ========
Total loans receivable $925,653 $886,301
======== ========
-- Deposits and Borrowings. Total deposits increased by $53.3
million, or 6.1%, during the first half of 2005, from $880.7 million, or
71.1% of total assets, at December 31, 2004, to $934.0 million, or 67.8% of
total assets, at June 30, 2005. In addition, the composition of total
deposits changed during the quarter. While demand deposits (DDAs) finished
the first half of 2005 up $19.9 million, or 11.9%, NOW and savings accounts
experienced softness as they decreased a combined $21.2 million, or 4.6%, as
consumers shifted balances to higher yielding certificates of deposit, which
increased $54.6 million, or 22.0%. The Bank continues its strategy of
emphasizing core deposit growth over certificate of deposit growth, but from
time-to-time will promote certificates of deposit. At June 30, 2005, core
deposit accounts comprised 67.5% of total deposits, compared to 71.8% of
total deposits at December 31, 2004.
15
The following table sets forth certain information regarding deposits:
June 30, 2005 December 31, 2004
-------------------------------- --------------------------------
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
------ ------- -------- ------ ------- --------
(Dollars in thousands)
NOW accounts $ 94,826 10.2% 0.60% $108,159 12.3% .76%
Money market accounts 16,038 1.7% 1.31% 16,489 1.9% 1.22%
Savings accounts 332,450 35.6% 1.36% 339,836 38.6% 1.25%
Certificate of deposit accounts 303,095 32.4% 2.94% 248,508 28.2% 2.55%
-------- ----- -------- -----
Total interest bearing deposits 746,409 79.9% 1.90% 712,992 81.0% 1.63%
Noninterest bearing accounts 187,554 20.1% -- 167,682 19.0% --
-------- ----- -------- -----
Total deposits $933,963 100.0% 1.52% $880,674 100.0% 1.32%
======== ===== ==== ======== ===== ====
FHLB borrowings and wholesale repurchase agreements increased $51.5
million, or 21.9%, during the first half of 2005. The increases were the
result of the Company utilizing borrowings to partially fund asset growth.
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 2005 the Bank also utilized wholesale repurchase agreements
because of favorable spreads compared to FHLB borrowings. On a long-term
basis, the Company intends to continue concentrating on increasing its core
deposits, but will continue to utilize FHLB borrowings or wholesale
repurchase agreements as cashflows dictate and opportunities present
themselves.
Asset Quality
-------------
The definition of nonperforming assets includes nonperforming loans
and other real estate owned ("OREO"). OREO consists of real estate acquired
through foreclosure proceedings and real estate acquired through acceptance
of a deed in lieu of foreclosure. Nonperforming loans are defined as
nonaccrual loans, loans past due 90 days or more, but still accruing and
impaired loans. Under certain circumstances the Company may restructure the
terms of a loan as a concession to a borrower. These restructured loans are
generally considered impaired loans.
-- Nonperforming Assets. At June 30, 2005, the Company had
nonperforming assets of $1.3 million, which represented .09% of total
assets. This compares to nonperforming assets of $733,000, or .06% of total
assets, at December 31, 2004. Total nonperforming assets at June 30, 2005,
consisted of nonaccrual commercial loans aggregating $1.2 million and
nonaccrual residential mortgage loans aggregating $89,000. Included in
nonaccrual loans were $978,000, at June 30, 2005, and $671,000, at December
31, 2004, of impaired loans. Specific reserves against these impaired loans
were $28,000 and $170,000 at June 30, 2005 and December 31, 2004,
respectively. The Company evaluates the underlying collateral of each
nonperforming loan and continues to pursue the collection of interest and
principal. Management believes that the current level of nonperforming
assets remains low relative to the size of the Company's loan portfolio. As
the loan portfolio continues to grow and mature, or if economic conditions
worsen, management believes it possible that the level of nonperforming
assets will increase, as will its level of charged-off loans.
-- Delinquencies. At June 30, 2005, loans with an aggregate balance
of $311,000 were 60 to 89 days past due, an increase of $311,000 from
December 31, 2004. The majority of these loans are commercial loans.
16
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,
2005 2004
-------- ------------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $1,281 $ 733
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
------ ------
Total nonperforming loans 1,281 733
Other real estate owned -- --
------ ------
Total nonperforming assets $1,281 $ 733
====== ======
Delinquent loans 60-89 days past due $ 311 $ --
Nonperforming loans as a percent of total loans 0.14% 0.08%
Nonperforming assets as a percent of total assets 0.09% 0.06%
Delinquent loans 60-89 days past due as a percent
of total loans 0.03% 0.00%
-- Adversely Classified Assets. The Company's management adversely
classifies certain assets as "substandard," "doubtful" or "loss" based on
criteria established under banking regulations. An asset is considered
substandard if inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Substandard
assets include those characterized by the "distinct possibility" that the
insured institution will sustain "some loss" if existing deficiencies are
not corrected. Assets classified as doubtful have all of the weaknesses
inherent in those classified substandard with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the
basis of currently existing facts, conditions and values, "highly
questionable and improbable." Assets classified as loss are those
considered "uncollectible" and of such little value that their continuance
as assets without the establishment of a specific loss reserve is not
warranted.
At June 30, 2005, the Company had $5.3 million of assets that were
classified as substandard. This compares to $5.8 million of assets that
were classified as substandard at December 31, 2004. The Company had no
assets that were classified as doubtful or loss at either date. Performing
loans may or may not be adversely classified depending upon management's
judgment with respect to each individual loan. At June, 2005, included in
the assets that were classified as substandard, were $4.0 million of
performing loans. This compares to $5.1 million of adversely classified
performing loans as of December 31, 2004. These amounts constitute assets
that, in the opinion of management, could potentially migrate to
nonperforming or doubtful status. Any downturn in the New England economy
may lead to future deteriorations in commercial credit quality and increases
in nonaccrual loans. This in turn may necessitate an increase to the
provision for loan losses in future periods.
Allowance for Loan and Lease Losses
-----------------------------------
During the first half of 2005, the Company made provisions to the
allowance for loan and lease losses totaling $654,000 and had $1.2 million
of net charge-offs, bringing the balance in the allowance to $11.4 million,
compared to $11.9 million at December 31, 2004. The net charge-offs occurred
during the second quarter and were caused by one asset-based credit. To
resolve the credit, the Bank sold the loan to a third party at a discount,
resulting in a $1.2 million charge-off. The allowance, expressed as a
percentage of total loans, was 1.23% as of June 30, 2005, compared to 1.34%
at the prior year end and stood at 890% of nonperforming loans at June 30,
2005, compared to 1624% of nonperforming loans at December 31, 2004.
17
Assessing the adequacy of the allowance for loan and lease losses
involves substantial uncertainties and is based upon management's evaluation
of the amounts required to meet estimated charge-offs in the loan portfolio
after weighing various factors. Management's methodology to estimate loss
exposure includes an analysis of individual loans deemed to be impaired,
reserve allocations for various loan types based on payments status or loss
experience and an unallocated allowance that is maintained based on
management's assessment of many factors including the growth, composition
and quality of the loan portfolio, historical loss experiences, general
economic conditions and other pertinent factors. Based on this evaluation,
management believes that the allowance for loan and lease losses, as of June
30, 2005, is adequate.
A portion of the allowance for loan and lease losses is not allocated
to any specific segment of the loan portfolio. This non-specific allowance
is maintained for two primary reasons: (i) there exists an inherent
subjectivity and imprecision to the analytical processes employed, and (ii)
the prevailing business environment, as it is affected by changing economic
conditions and various external factors, may impact the portfolio in ways
currently unforeseen. Management, therefore, has established and maintains
a non-specific allowance for loan and lease losses. The amount of this
measurement imprecision allocation was $1.1 million at June 30, 2005,
compared to $2.5 million at December 31, 2004. The decline was caused
primarily by the $1.2 million charge-off referenced earlier, which was taken
against this non-specific allowance for loan loss.
While management evaluates currently available information in
establishing the allowance for loan and lease losses, future adjustments to
the allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review a financial institution's allowance for loan and lease losses and
carrying amounts of other real estate owned. Such agencies may require the
financial institution to recognize additions to the allowance based on their
judgments about information available to them at the time of their
examination.
RESULTS OF OPERATIONS
---------------------
Comparison of Three Months Ended June 30, 2005 and 2004
-------------------------------------------------------
-- General. The Company reported net income for the second quarter of
2005 of $2.5 million, up $365,000, or 17.4%, from the second quarter of
2004. Diluted earnings per common share were $0.52 or up 4% for the second
quarter of 2005, compared to $0.50 for the second quarter of 2004. The
difference between the increase in earnings and the increase in diluted
earnings per share in the second quarter of 2005 is due primarily to the
additional common shares issued during the quarter.
The Company reported a return on average assets of .74% and a return
on average equity of 10.09% for the 2005 period, as compared to a return on
average assets of .74% and a return on average equity of 11.45% for the 2004
period.
-- Net Interest Income. For the quarter ended June 30, 2005, net
interest income was $10.8 million, compared to $9.1 million for the 2004
period. The net interest margin for the second quarter of 2005 at 3.40% was
unchanged from the net interest margin for the 2004 period. The increase in
net interest income of $1.7 million, or 18.2%, was primarily attributable to
the continued growth of the Company. Average earning assets were $192.0
million, or 17.8%, higher, and average interest-bearing liabilities were
$167.3 million, or 18.8%, higher, than the comparable period a year earlier.
18
-- Interest Income. Investments. Total investment income was $3.9
million for the quarter ended June 30, 2005, compared to $2.3 million for
the 2004 period. The increase in total investment income was $1.5 million,
or 65.7%, and was primarily attributable to an increase in the average
balance of total investments. The average balance increased $114.7 million,
or 47.5%, from the second quarter of 2004 to the second quarter of 2005.
The Company's investments act as a counterbalance to loan and deposits
flows, and in times such as this past quarter, increase to absorb available
cash flows. In addition, the Company embarked on a leverage program
during the second quarter of 2005, to partially offset the dilution of
earnings per share caused by the issuance of additional common stock during
that quarter. The majority of the Company's investments are comprised of
U.S. Agency securities and MBSs with repricing periods or expected remaining
maturities of less than five years.
-- Interest Income. Loans and Leases. Interest from loans was $13.2
million for the three months ended June 30, 2005, and represented a yield on
total loans of 5.80%. This compares to $11.5 million of interest, and a
yield of 5.51%, for the second quarter of 2004. Interest from commercial
loans and leases increased $1.1 million, or 20.0%, and interest from
consumer and other loans increased $819,000, or 52.8%, as average balances
and average yields increased during the past year. The average balance of
the various components of the loan portfolio changed from the second quarter
of 2004 as follows: commercial loans and leases increased $56.2 million, or
15.6%, and consumer and other loans increased $48.7 million, or 37.4%, while
residential mortgage loans decreased $27.5 million, or 7.9%. Rising short-
term interest rates, along with a flattening of the yield curve, affected
yields on the various loan portfolios. Changes from the second quarter of
2004 are as follows: commercial loans and leases increased 22 basis points,
to 6.57%, and consumer and other loans increased 52 basis points, to 5.31%,
while residential mortgage loans increased 15 basis points, to 5.06%.
-- Interest Expense. Interest paid on deposits and borrowings
increased $1.6 million, or 34.4%, to $6.3 million for the three months ended
June 30, 2005, from $4.7 million for the same period during 2004. The
average balance of total interest-bearing liabilities increased $167.3
million, from $888.4 million in the second quarter of 2004 to $1.1 billion
in the second quarter of 2005, as savings account average balances increased
$18.6 million, or 6.0%, certificate of deposit ("CD") accounts increased
$73.4 million, or 33.1%, and FHLB borrowings and wholesale repurchase
agreements increased $101.6 million, or 58.2%. The overall average cost for
interest-bearing liabilities increased 24 basis points to 2.36% for the
second quarter of 2005, compared to 2.12% for the second quarter of 2004.
Customer demand for higher cost CDs and the longer-term funding required for
the leverage program were the main drivers of this increase. Liability
costs are dependent on a number of factors including general economic
conditions, national and local interest rates, competition in the local
deposit marketplace, interest rate tiers offered and the Company's cash flow
needs.
-- Provision for Loan and Lease Losses. The provision for loan and
lease losses was $354,000 for the quarter ended June 30, 2005 as compared to
$200,000 for the second quarter of 2004. Management evaluates several
factors including new loan originations, actual and estimated charge-offs,
the risk characteristics of the loan portfolio and general economic
conditions when determining the provision for each quarter. Additions to
the allowance for loan and lease losses during the second quarter of 2005
were primarily in response to changes in the mix of loans and concern for
general economic conditions. During the quarter, there were $31,000 of loan
recoveries and $1.2 million of charge-offs. The charge-off was related to a
single asset-based credit as referenced earlier. The allowance expressed as
a percentage of total loans was 1.23% at June 30, 2005, compared to 1.34%
19
at December 31, 2004. As the loan portfolio continues to grow and mature,
or if economic conditions worsen, management believes it possible that the
level of nonperforming assets will increase, which in turn may lead to
increases in the provision for loan and lease losses in future periods.
Also see discussion under "Allowance for Loan and Lease Losses."
-- Noninterest Income. Total noninterest income increased $239,000,
or 10.8%, to $2.4 million for the second quarter of 2005, from $2.2 million
for the second quarter of 2004. Service charges on deposit accounts, which
continue to represent the largest source of noninterest income for the
Company, decreased $54,000 or 4.5% to $1.2 million for three months ended
June 30, 2005 from $1.2 million for the same period in 2004. Commissions
on nondeposit investment products also declined $70,000, or 26.1%, as the
level of commissions being paid on such products declined. On the positive
side, Loan related fees were up $60,000 or 62.5% and Other Income was up
$290,000 or 92.1% primarily from commissions generated from the sales of
historic tax credits.
-- Noninterest Expense. Noninterest expenses for the second quarter of
2005 increased a total of $1.1 million, or 14.3%, to $9.1 million from $8.0
million in 2004. This increase occurred primarily from higher operating
costs resulting from the continued growth of the Company and was centered in
the following areas: Salaries and employee benefits (up $719,000, or 17.4%)
and Professional services (up $166,000, or 46.5%). In addition to incurring
increased operating costs as a result of the continuing growth in loans,
deposits and branches, the 2005 period includes the cost of partially
outsourcing internal audit activity, continuing outside accounting fees in
connection with ongoing compliance with Sarbanes-Oxley Section 404 and
consulting and legal costs. Meanwhile, the Company's overall efficiency
ratio improved to 69.05% in 2005, from 70.51% in the 2004 period.
-- Income Tax Expense. Income tax expense of $1.3 million was
recorded for the three months ended June 30, 2005, compared to $1.0 million
for the same period during 2004. This represented total effective tax rates
of 34.2% and 33.2%, respectively. Tax-favored income from Bank-owned life
insurance (BOLI), along with the Company's utilization of a Rhode Island
passive investment company, has reduced the effective tax rate from the
40.9% combined statutory federal and state tax rates.
Comparison of Six Months Ended June 30, 2005 and 2004
-----------------------------------------------------
-- General. Net income for the first half of 2005, increased
$708,000, or 17.0%, to $4.9 million, or $1.08 per diluted common share, from
$4.2 million, or $0.99 per diluted common share, for the first half of 2004.
This performance represented a return on average assets of 0.76% and a
return on average equity of 11.09% for the 2005 period, as compared to a
return on average assets of 0.74% and a return on average equity of 11.36%
for the 2004 period.
-- Net Interest Income. For the six months ended June 30, 2005, net
interest income was $21.1 million, compared to $18.1 million for the first
half of 2004. The net interest margin for the first six months of 2005 was
3.46% compared to a net interest margin of 3.41% for the 2004 period. The
increase in net interest income of $3.1 million, or 17.1%, was primarily
attributable to the overall growth of the Company. Average earning assets
increased $168.9 million, or 15.9%, and average interest-bearing liabilities
increased $150.2 million, or 17.1%, over the comparable period a year
earlier. The increase of 5 basis points in the net interest margin
primarily resulted from earning asset yields increasing in response to
rising short-term rates in the investment and loan portfolios.
20
Increases in asset yields were largely offset by the increase in deposit and
borrowing expenses resulting from rising short-term rates and customer
migration from lower cost core deposits to higher cost CDs.
-- Interest Income. Investments. Total investment income was $7.1
million for the six months ended June 30, 2005, compared to $4.6 million
for the first half of 2004. This increase in total investment income of
$2.5 million, or 53.2%, was primarily attributable to a $99.7 million, or
42.8%, increase in the average balances coupled with a 29 basis point
increase in the overall yield on investments, from 3.97% in 2004, to 4.26%
in 2005.
-- Interest Income. Loans and Leases. Interest from loans was $25.7
million for the six months ended June 30, 2005, and represented a yield on
total loans of 5.75%. This compares to $22.8 million of interest, and a
yield of 5.51%, for the first half of 2004. Increased interest income
resulting from growth in the average balance of loans of $69.3 million, or
8.3%. The average balance of the various components of the loan portfolio
changed as follows: commercial loans increased $50.8 million, or 16.5%;
residential mortgage loans decreased $39.7 million, or 11.2%; and consumer
and other loans increased $51.0 million, or 41.0%. The average yield on the
various components of the loan portfolio changed as follows: commercial
loans increased 28 basis points, to 6.50%; residential mortgage loans
increased 4 basis points, to 5.08%; and consumer and other loans increased
43 basis points, to 5.24%. 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
increased $2.3 million, or 24.6%, to $11.7 million for the six months ended
June 30, 2005, compared to $9.4 million for the same period during 2004.
The increase in total interest expense was attributable to both higher rates
and growth in average deposit and borrowing balances. The overall average
cost for interest-bearing liabilities increased 14 basis points from 2.15%
for the first half of 2004, to 2.29% for the first half of 2005. Increases
in short-term rates and the consumers' preference for higher yielding CDs
impacted the overall cost of deposits. 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. The average balance of
interest-bearing liabilities increased $150.2 million, or 17.1%, from $877.9
million in 2004, to $1.0 billion in 2005. The Company experienced growth
in Savings account balances which were up $29.8 million or 9.9%. This growth
was off set by the decline in NOW account balances of $29.9 million or 22.9%.
In addition, the Company increased its utilization of FHLB borrowings
(balance up $77.0 million, or 44.3%) and wholesale repurchase agreements (up
$6.6 million, or 16.6%) compared to the first half of 2004.
-- Provision for Loan Losses. The provision for loan losses was
$654,000 for the six months ended June 30, 2005, compared to $500,000 for
the same period last year. The allowance, expressed as a percentage of
total loans, was 1.23% as of June 30, 2005, compared to 1.34% at the prior
year-end and stood at 890% of nonperforming loans at June 30, 2005, compared
to 1624% of nonperforming loans at December 31, 2004. Total nonperforming
loans increased from $733,000 at the end of last year, to $1.3 million on
June 30, 2005. Net charge-offs for the six month period ending June 30,
2005 were $1.2 million, compared to $103,000 for the six month period ended
June 30, 2004. The increase in the 2005 charge-offs reflects the asset-
based credit referenced earlier.
21
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 and Lease Losses."
-- Noninterest Income. Total noninterest income increased $316,000,
or 7.5%, from $4.2 million for the first half of 2004, to $4.5 million for
the first six months of 2005. Service charges on deposit accounts, which
continue to represent the largest source of noninterest income for the
Company, increased $17,000, or 0.8%. Commissions on nondeposit investment
products decreased $48,000, or 10.8%, as the level of commissions being paid
on such products declined. BOLI income increased by $21,000, or 6.6%. and
Loan fees increase $234,000, or 214%. Commissions on loans originated by
others increased $46,000, or 215%, as the Company experienced an increase in
residential loan and lease sales. Other income increased $291,000, or
45.8%, primarily from commissions generated from sales of historic tax
credits. The Company realized $245,000, or 71.8%, less in Gain on sale of
investment securities and MBSs.
-- Noninterest Expense. Noninterest expenses for the first half of
2005 increased by $2.1 million, or 13.4%, to $17.6 million. This increase
occurred primarily as a result of the continued overall growth of the
Company and was centered in the following areas: Salaries and employee
benefits (up $1.4 million, or 18.1%), Occupancy and Equipment (up $192,000,
or 9.1%), Professional services (up $369,000, or 57.5%) and Other expenses
(up $137,000, or 3.2%). The increase in Professional services was related
to consulting fees paid in connection with sales of Rhode Island historic
tax credits, increased legal expenses and expenses related to the
outsourcing of residential loan processing. These increases were partially
offset by a decline in Loan servicing (down $65,000, or 12.2%). The
Company's efficiency ratio improved to 68.73% for the 2005 period, from
69.89% for the 2004 period.
-- Income Tax Expense. The Company recorded income tax expense of
$2.5 million for the first half of 2005, compared to $2.0 million for the
same period during 2004. This represented total effective tax rates of
34.0% and 32.9%, 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
40.9% combined statutory federal and state tax rates.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
-- Liquidity. Liquidity is defined as the ability to meet current and
future financial obligations of a short-term nature. The Company further
defines liquidity as the ability to respond to the needs of depositors and
borrowers, as well as to earnings enhancement opportunities, in a changing
marketplace.
The primary source of funds for the payment of dividends and expenses
by the Company is dividends paid to it by the Bank. Bank regulatory
authorities generally restrict the amounts available for payment of
dividends if the effect thereof would cause the capital of the Bank to be
reduced below applicable capital requirements. These restrictions
indirectly affect the Company's ability to pay dividends. The primary
sources of liquidity for the Bank consist of deposit inflows, loan
repayments, borrowed funds, maturity of investment securities and sales of
securities from the available for sale portfolio. Management believes that
these sources are sufficient to fund the Bank's
22
lending and investment activities. In June 2005, the Company contributed
$5 million of capital to the Bank to support continued asset growth.
Management is responsible for establishing and monitoring liquidity
targets as well as strategies and tactics to meet these targets. In
general, the Company seeks to maintain a high degree of flexibility with a
liquidity target of 10% to 25% of total assets. At June 30, 2005, overnight
investments, investment securities and MBSs available for sale amounted to
$361.8 million, or 26.3% of total assets. This compares to $278.6 million,
or 22.5% of total assets at December 31, 2004. The Bank is a member of the
FHLB and, as such, has access to both short- and long-term borrowings. In
addition, the Bank maintains a line of credit at the FHLB as well as a line
of credit with a correspondent bank. There have been no adverse trends in
the Company's liquidity or capital reserves. Management believes that the
Company has adequate liquidity to meet its commitments.
-- Capital Resources. Total shareholders' equity of the Company at
June 30, 2005 was $103.2 million, as compared to $78.9 million at December
31, 2004. This increase of $24.3 million was primarily attributable to
$21.5 million of net proceeds from the common stock offering consummated in
the second quarter of 2005 and net income for the first half of 2005 of $4.9
million, partially offset by a decrease in accumulated other comprehensive
income of $1.2 million (attributable to increases in unrealized losses on
investments and MBSs) and dividends of $1.3 million.
All FDIC-insured institutions must meet specified minimal capital
requirements. These regulations require banks to maintain a minimum
leverage capital ratio. In addition, the FDIC has adopted capital
guidelines based upon ratios of a bank's capital to total assets adjusted
for risk. The risk-based capital guidelines include both a definition of
capital and a framework for calculating risk-weighted assets by assigning
balance sheet assets and off-balance sheet items to broad risk categories.
These regulations require banks to maintain minimum capital levels for
capital adequacy purposes and higher capital levels to be considered "well
capitalized."
The Federal Reserve Board ("FRB") has also issued capital guidelines
for bank holding companies. These guidelines require the Company to
maintain minimum capital levels for capital adequacy purposes. In general,
the FRB has adopted substantially identical capital adequacy guidelines as
the FDIC. Such standards are applicable to bank holding companies and their
bank subsidiaries on a consolidated basis.
As of June 30, 2005, the Company and the Bank met all applicable
minimum capital requirements and were considered "well capitalized" by both
the FRB and the FDIC.
On February 23, 2005, the Company filed a registration statement on
Form S-3 with the SEC with respect to a proposed offering of 550,000 shares
of common stock. The underwriters of the offering were also granted a 30-
day option to purchase up to an additional 82,500 shares of common stock to
cover any over-allotments. On April 12, 2005, the SEC declared the
Company's registration statement effective and on April 18, 2005 the Company
issued 550,000 shares of common stock for net proceeds (after underwriting
discounts and commissions and expenses) of approximately $18.7 million. The
underwriters exercised their over-allotment option to purchase an additional
78,418 shares and on May 16, 2005, the Company issued 78,418 shares of
common stock for net proceeds (after underwriting discounts and commissions)
of approximately $2.7 million. The Company intends to retain the net
proceeds from this offering at the Company level for general business
purposes and working capital and to downstream such proceeds to the Bank as
necessary to provide regulatory capital to support asset growth and
continued expansion of the Bank's business, including
23
the addition of branches. The proceeds from this offering should enable the
Company and the Bank to maintain their status as well-capitalized
institutions as they execute their growth strategies.
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, 2005:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $110,450 8.29% $39,970 3.00% $66,616 5.00%
Tier I capital (to risk weighted assets) 110,450 12.80% 34,516 4.00% 51,773 6.00%
Total capital (to risk weighted assets) 121,236 14.05% 69,031 8.00% 86,289 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $ 90,188 6.80% $39,789 3.00% $66,315 5.00%
Tier I capital (to risk weighted assets) 90,188 10.46% 34,489 4.00% 51,733 6.00%
Total capital (to risk weighted assets) 100,974 11.71% 68,983 8.00% 86,229 10.00%
At December 31, 2004:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $ 85,386 7.06% $36,280 3.00% $60,466 5.00%
Tier I capital (to risk weighted assets) 85,386 10.01% 34,112 4.00% 51,168 6.00%
Total capital (to risk weighted assets) 96,055 11.26% 68,225 8.00% 85,281 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $ 81,928 6.78% $36,263 3.00% $60,438 5.00%
Tier I capital (to risk weighted assets) 81,928 9.61% 34,091 4.00% 51,137 6.00%
Total capital (to risk weighted assets) 92,597 10.86% 68,182 8.00% 85,228 10.00%
24
BANCORP RHODE ISLAND, INC.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK
------------------
The principal market risk facing the Company is interest rate risk.
The Company's objective regarding interest rate risk is to manage its assets
and funding sources to produce results which are consistent with its
liquidity, capital adequacy, growth and profitability goals, while
minimizing any adverse effect from changes in interest rates. The primary
tools for managing interest rate risk are the securities portfolio,
purchased mortgages, wholesale repurchase agreements and borrowings from the
FHLB.
The Company's actions in this regard are taken under the guidance of
the Bank's Asset/Liability Committee ("ALCO"). The ALCO manages the
Company's interest rate risk position using both income simulation and
interest rate sensitivity "gap" analysis. The ALCO has established internal
parameters for monitoring the Company's interest rate risk. These
guidelines serve as benchmarks for evaluating actions to balance the current
position against overall strategic goals. The ALCO monitors current
exposures and reports these to the Board of Directors.
Simulation is used as the primary tool for measuring the interest rate
risk inherent in the Company's balance sheet at a given point in time by
showing the effect on net interest income, over a 24-month period, of
interest rate ramps of up to 200 basis points. These simulations take into
account repricing, maturity and prepayment characteristics of individual
products. The ALCO reviews simulation results to determine whether the
downside exposure resulting from changes in market interest rates remains
within established tolerance levels over both a 12-month and 24-month
horizon, and develops appropriate strategies to manage this exposure. The
Company's guidelines for interest rate risk specify that if interest rates
were to shift up or down 200 basis points over a 12-month period, estimated
net interest income for those 12 months and the subsequent 12 months, should
decline by no more than 5.0% or 10.0%, respectively. As of June 30, 2005,
net interest income simulation indicated that the Company's exposure to
changing interest rates was within these tolerances. The ALCO reviews the
methodology utilized for calculating interest rate risk exposure and may,
from time to time, adopt modifications to this methodology.
25
The following table presents the estimated impact of interest rate
ramps on the Company's estimated net interest income over a twenty-four
month period beginning July 1, 2005:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 basis points $ 94 0.22%
Down 200 basis points 96 0.22%
Subsequent Twelve Month Period:
Up 200 basis points $(1,058) (2.52%)
Down 200 basis points (801) (1.91%)
The Company also uses interest rate sensitivity gap analysis to
provide a more general overview of its interest rate risk profile. The
interest rate sensitivity gap is defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing within
a given time period. At June 30, 2005, the Company's one year cumulative
gap was a negative $18.0 million, or 1.3% of total assets.
For additional discussion on interest rate risk see the section titled
"Asset and Liability Management" on pages 43 to 45 of the Company's 2004
Annual Report on Form 10-K.
ITEM 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), the Company carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures as of the end of the period covered by this report.
This evaluation was carried out under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer. Based upon
that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.
There was no significant 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. The Company continues
to enhance its internal controls over financial reporting, primarily by
evaluating and enhancing process and control documentation and increasing
system security, in connection with the Company's ongoing efforts to meet
the requirements of Sarbanes-Oxley Section 404 . Management discusses with
and discloses these matters to the Audit Committee of the Board of Directors
and the Company's auditors. The Company's is currently expanding its
controls over financial reporting to its new subsidiary, Macrolease, to meet
Sarbanes-Oxley Section 404 requirements.
26
BANCORP RHODE ISLAND, INC.
Other Information
PART II. Other Information
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Company or its subsidiaries are a party, or to which any of
their property is subject, other than ordinary routine
litigation incidental to the business of banking.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On May 13, 2005, Macrolease, a newly-formed, wholly-owned
subsidiary of the Bank, purchased substantially all of the
operating assets of Macrolease International Corporation, a New
York corporation (the "Seller"), pursuant to the terms of an
Asset Purchase Agreement dated April 29, 2005 among the Company,
the Bank, Macrolease, the Seller and certain shareholders of the
Seller (the "Agreement"). Concurrent with the closing of the
transaction, the Seller changed its name to DWW Leasing Corp.
Under the terms of the Agreement, the maximum aggregate purchase
price for the assets acquired is $1.9 million to be paid in
shares of the Company's common stock, $.01 par value. At the
closing on May 13, 2005, the Company issued 6,780 shares of its
common stock to the Seller, which shares were issued in a
private placement pursuant to Section 4(2) of the Securities Act
of 1933. In addition, the Company has reserved up to 44,572
shares of its common stock for issuance to the Seller in the
event Macrolease achieves certain performance goals over a
three-year period and pursuant to an earn-out over five years.
On June 27, 2005, the Company filed a registration statement on
Form S-3 covering up to 51,532 shares of its common stock issued
or reserved for issuance to the Seller pursuant to the
agreement, which registration statement was declared effective
on July 12, 2005.
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 18, 2005, holders
of common stock elected the Board's nominees to the Board of
Directors and ratified the appointment of independent auditors.
The vote for Class III director nominees with terms expiring in
2008 was:
FOR WITHHELD
--- --------
CLASS III DIRECTORS:
Anthony F. Andrade 3,565,568 12,101
Malcolm G. Chace 3,567,768 9,901
Ernest J. Chornyei, Jr. 3,565,568 12,101
Edward J. Mack II 3,430,853 146,816
Merrill W. Sherman 3,568,129 9,540
27
The vote for ratifying the appointment of KPMG LLP as
independent auditors for the Company was:
FOR AGAINST ABSTAIN
3,571,132 6,424 113
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
28
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, 2005 /s/ Merrill W. Sherman
-------------- -----------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
August 5, 2005 /s/ Linda H. Simmons
-------------- ---------------------
(Date) Linda H. Simmons
Chief Financial Officer
and Treasurer
29