SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
Quarterly Report Under Section 13 of the Securities Exchange Act of 1934
For quarter ended: September 30, 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 by check mark whether the Registrant is shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No (X)
--- ---
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of November 3, 2005:
----------------
Common Stock - Par Value $0.01 4,718,476 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
Item 5 Other Information 27
Item 6 Exhibits 27
Signature Page 28
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
(Unaudited)
September 30, December 31,
2005 2004
------------- ------------
(In thousands)
ASSETS:
Cash and due from banks $ 29,019 $ 21,585
Overnight investments 8,954 14,094
---------- ----------
Total cash and cash equivalents 37,973 35,679
Investment securities available for sale (amortized cost of
$141,363 and $103,953 at September 30, 2005 and December 31,
2004, respectively) 139,593 104,600
Mortgage-backed securities available for sale (amortized cost
of $237,791 and $159,581 at September 30, 2005 and December 31,
2004, respectively) 235,573 159,946
Stock in Federal Home Loan Bank of Boston 15,625 13,229
Loans and leases receivable:
Commercial loans and leases 439,293 402,770
Residential mortgage loans 302,323 316,135
Consumer and other loans 199,915 167,396
---------- ----------
Total loans and leases receivable 941,531 886,301
Less allowance for loan and lease losses (11,758) (11,906)
---------- ----------
Net loans and leases receivable 929,773 874,395
Premises and equipment, net 14,820 11,857
Goodwill 11,262 10,766
Accrued interest receivable 6,457 5,666
Investment in bank-owned life insurance 18,642 18,132
Prepaid expenses and other assets 7,533 4,799
---------- ----------
Total assets $1,417,251 $1,239,069
========== ==========
LIABILITIES:
Deposits:
Demand deposit accounts $ 175,682 $ 167,682
NOW accounts 90,635 108,159
Money market accounts 18,702 16,489
Savings accounts 349,388 339,836
Certificate of deposit accounts 327,092 248,508
---------- ----------
Total deposits 961,499 880,674
Overnight and short-term borrowings 24,436 18,050
Wholesale repurchase agreements 10,000 --
Federal Home Loan Bank of Boston borrowings 290,539 234,778
Subordinated deferrable interest debentures 18,558 18,558
Other liabilities 8,533 8,086
---------- ----------
Total liabilities 1,313,565 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 4,707,252 shares and 4,010,554 shares,
respectively 47 40
Additional paid-in capital 65,517 42,852
Retained earnings 40,714 35,373
Accumulated other comprehensive (loss) income, net (2,592) 658
---------- ----------
Total shareholders' equity 103,686 78,923
---------- ----------
Total liabilities and shareholders' equity $1,417,251 $1,239,069
========== ==========
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2005 2004 2005 2004
(In thousands, except per share data)
Interest and dividend income:
Commercial loans and leases $ 7,295 $ 5,891 $ 20,471 $ 16,770
Residential mortgage loans 3,772 4,081 11,767 13,018
Consumer and other loans 2,648 1,882 7,205 4,863
Mortgage-backed securities 2,541 1,714 6,632 4,046
Investment securities 1,386 1,240 3,996 3,355
Overnight investments 52 17 152 82
Federal Home Loan Bank of Boston stock dividends 168 85 452 197
---------- ---------- ---------- ----------
Total interest and dividend income 17,862 14,910 50,675 42,331
---------- ---------- ---------- ----------
Interest expense:
NOW accounts 138 272 469 961
Money market accounts 65 55 178 160
Savings accounts 1,287 1,088 3,371 2,826
Certificate of deposit accounts 2,388 1,411 6,187 4,176
Overnight and short-term borrowings 171 38 419 104
Wholesale repurchase agreements 51 -- 151 --
Federal Home Loan Bank of Boston borrowings 2,671 1,924 7,058 5,449
Subordinated deferrable interest debentures 324 276 934 756
---------- ---------- ---------- ----------
Total interest expense 7,095 5,064 18,767 14,432
---------- ---------- ---------- ----------
Net interest income 10,767 9,846 31,908 27,899
Provision for loan and lease losses 410 200 1,064 700
---------- ---------- ---------- ----------
Net interest income after provision for
loan and lease losses loan losses 10,357 9,646 30,844 27,199
---------- ---------- ---------- ----------
Noninterest income:
Service charges on deposit accounts 1,176 1,156 3,411 3,374
Commissions on nondeposit investment products 324 312 722 758
Income from bank-owned life insurance 169 159 509 478
Loan related fees 368 104 807 309
Commissions on loans originated for others 45 12 131 52
Gain (loss) on sale of investment securities -- (9) -- 332
Gain on sale of mortgage-backed securities 85 -- 181 --
Other income 414 303 1,340 938
---------- ---------- ---------- ----------
Total noninterest income 2,581 2,037 7,101 6,241
---------- ---------- ---------- ----------
Noninterest expense:
Salaries and employee benefits 5,013 4,566 14,484 12,588
Occupancy 795 675 2,298 2,007
Equipment 386 409 1,195 1,197
Data processing 616 664 2,113 2,056
Marketing 397 270 1,187 1,045
Professional services 474 512 1,485 1,154
Loan servicing 243 239 709 770
Loan workout and other real estate owned expense 64 8 98 78
Other expenses 1,173 1,038 3,229 3,041
---------- ---------- ---------- ----------
Total noninterest expense 9,161 8,381 26,798 23,936
---------- ---------- ---------- ----------
Income before income taxes 3,777 3,302 11,147 9,504
Income tax expense 1,310 1,124 3,813 3,167
---------- ---------- ---------- ----------
Net income $ 2,467 $ 2,178 $ 7,334 $ 6,337
========== ========== ========== ==========
Per share data:
Basic earnings per common share $ 0.53 $ 0.55 $ 1.67 $ 1.60
Diluted earnings per common share $ 0.50 $ 0.52 $ 1.58 $ 1.50
Average common shares outstanding - basic 4,682,357 3,988,311 4,399,995 3,967,168
Average common shares outstanding - diluted 4,892,262 4,228,666 4,628,975 4,212,009
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
Nine months ended September 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 -- -- 6,337 -- 6,337
Other comprehensive income,
net of tax:
Unrealized holding losses on
securities available for sale,
net of taxes of $127 (246) (246)
Reclassification adjustment,
net of taxes of $113 (219) (219)
--------
Comprehensive income 5,872
Exercise of stock options -- 478 -- -- 478
Exercise of stock warrants 1 699 -- -- 700
Common stock issued for incentive
stock award, net -- 26 -- -- 26
Dividends on common stock ($ 0.44
per common share) -- -- (1,713) -- (1,713)
--- ------- ------- ------- --------
Balance at September 30, 2004 $40 $42,642 $33,698 $ 1,090 $ 77,470
=== ======= ======= ======= ========
2005
----
Balance at December 31, 2004 $40 $42,852 $35,373 $ 658 $ 78,923
Net income -- -- 7,334 -- 7,334
Other comprehensive income,
net of tax:
Unrealized holding losses on
securities available for sale,
net of taxes of $1,624 (3,132) (3,132)
Reclassification adjustment,
net of taxes of $63 (118) (118)
--------
Comprehensive loss 4,084
Proceeds from stock offering 7 21,450 -- -- 21,457
Acquisition of Macrolease -- 250 -- -- 250
Exercise of stock options -- 941 -- -- 941
Common stock issued for incentive
stock award, net -- 24 -- -- 24
Dividends on common stock ($ 0.45
per common share) -- -- (1,993) -- (1,993)
--- ------- ------- ------- --------
Balance at September 30, 2005 $47 $65,517 $40,714 $(2,592) $103,686
=== ======= ======= ======= ========
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
September 30,
-----------------------
2005 2004
---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 7,334 $ 6,337
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation and amortization 2,169 2,840
Provision for loan and lease losses 1,064 700
Gain on sale of investment securities -- (332)
Gain on sale of mortgage-backed securities (181) --
Income from bank-owned life insurance (509) (478)
Compensation expense from restricted stock grant 24 26
(Increase) decrease in:
Accrued interest receivable (791) (90)
Prepaid expenses and other assets (737) (533)
Increase (decrease) in:
Other liabilities 447 (132)
Other, net (192) 21
--------- ---------
Net cash provided by operating activities 8,628 8,359
--------- ---------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (3,252) (7,429)
Commercial loans and leases (80,215) (82,835)
Consumer loans (64,017) (75,437)
Purchase of:
Investment securities available for sale (51,520) (48,993)
Mortgage-backed securities available for sale (128,341) (88,660)
Residential mortgage loans (36,981) (37,494)
Federal Home Loan Bank of Boston stock (2,396) (2,311)
Principal payments on:
Investment securities available for sale 13,999 31,000
Mortgage-backed securities available for sale 36,410 37,509
Residential mortgage loans 53,483 93,898
Commercial loans and leases 42,863 23,138
Consumer loans 31,237 30,623
Proceeds from sale of investment securities -- 8,428
Proceeds from sale of mortgage-backed securities 13,754 --
Capital expenditures for premises and equipment (4,735) (1,861)
--------- ---------
Net cash used by investing activities (179,711) (120,424)
--------- ---------
Cash flows from financing activities:
Net increase in deposits 80,825 74,765
Net increase (decrease) in overnight and short-term borrowings 6,386 (2,221)
Proceeds from long-term borrowings 258,908 119,155
Repayment of long-term borrowings (193,147) (79,970)
Proceeds from issuance of common stock 22,398 1,178
Dividends on common stock (1,993) (1,713)
--------- ---------
Net cash provided by financing activities 173,377 111,194
--------- ---------
Net increase (decrease) in cash and cash equivalents 2,294 (871)
Cash and cash equivalents at beginning of period 35,679 27,817
--------- ---------
Cash and cash equivalents at end of period $ 37,973 $ 26,946
========= =========
Supplementary Disclosures:
Cash paid for interest $ 18,427 $ 14,074
Cash paid for income taxes 4,577 3,777
Non-cash transactions:
Acquisition of Macrolease 250 --
Transfer to OREO 247 --
Change in other comprehensive income, net of taxes (3,250) (465)
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 Nine Months Ended
September 30, September 30,
------------------ -----------------
2005 2004 2005 2004
---- ---- ---- ----
Net income (in thousands):
As reported $2,467 $2,178 $7,334 $6,337
Compensation cost, net of taxes (1) (101) (142) (267) (383)
------ ------ ------ ------
Pro forma $2,366 $2,036 $7,067 $5,954
====== ====== ====== ======
Earnings per common share:
Basic:
As reported $ 0.53 $ 0.55 $ 1.67 $ 1.60
Compensation cost, net of taxes (1) (0.02) (0.04) (0.06) (0.10)
------ ------ ------ ------
Pro forma $ 0.51 $ 0.51 $ 1.61 $ 1.50
====== ====== ====== ======
Diluted:
As reported $ 0.50 $ 0.52 $ 1.58 $ 1.50
Compensation cost, net of taxes (1) (0.02) (0.03) (0.06) (0.09)
------ ------ ------ ------
Pro forma $ 0.48 $ 0.49 $ 1.52 $ 1.41
====== ====== ====== ======
The stock-based employee compensation cost, net of related tax
effects, that would have been included in the determination of net
income if the fair value based method had been applied to all awards
granted since 1995. The fair value of each option granted was
estimated as of the date of the grant using the Black-Scholes option-
pricing model.
8
(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 $466,000 and $330,000 for the nine months
ending September 30, 2005 and 2004, respectively. Accrued liabilities
associated with the SERPs were $1.7 million and $1.2 million for September
30, 2005 and December 31, 2004, respectively.
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 on a number of factors
including 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 probable losses
inherent in the portfolio; these additions, which are charged against
earnings, are necessarily greater when greater probable 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. The Company 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 85% (based upon June
2005 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. Institutions in the market have increased their advertising and
promotional product offerings, spurred on by the various new entrants into
the market.
For the nine months ended September 30, 2005, approximately 81.8% 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 emphasizing
core deposit growth which generates increased
11
service charges, and by introducing additional financial services, such as
nondeposit investment products. Recently, the Company has seen growth in the
area of commissions on loans and leases originated for third parties.
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, and controlling the growth of its noninterest or operating expenses.
Total assets increased $178.2 million, or 14.4%, to $1.4 billion at
September 30, 2005 from December 31, 2004. This increase was centered in the
Company's investment portfolio and commercial and consumer loans, with the
growth primarily funded by deposits and borrowings. Total deposits increased
$80.8 million or 9.2%. The increase was largely centered in certificates of
deposit (up $78.6 million, or 31.6%), as consumers have indicated a
preference for higher yielding term deposit products in this rate
environment. Core deposit accounts remained relatively constant with prior
year-end levels, growing by $2.2 million, or 0.35%. Meanwhile, total
borrowings (including wholesale repurchase agreements) increased $72.1
million, or 26.6%, as additional funding was required to support asset
growth. Shareholders' equity increased from $78.9 million at December 31,
2004 to $103.7 million at September 30, 2005, and represented 7.3% 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
12
the loans. Provisions for losses on the remaining commercial, commercial
real estate, small business, residential mortgage and consumer loans and
leases are based on pools of similar loans or leases using a combination of
payment status, historical loss experience, industry loss experience, market
economic factors, delinquency rates and qualitative adjustments. Management
uses available information to establish the allowance for loan and lease
losses at the level it believes is appropriate. However, future 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 $399.7 million, or 28.2% of total assets, at
September 30, 2005, compared to $291.9 million, or 23.6% of total assets, at
December 31, 2004. Total investments increased by $107.8 million or 36.9%.
All $375.2 million of investment securities and MBSs at September 30, 2005
were classified as available for sale and carried a total of $4.0 million in
net unrealized losses at the end of the quarter. The increase in total
investments reflects the leverage transactions entered into during the
second and third quarters of 2005. These transactions were undertaken to
partially offset the dilution in earnings per share resulting from the
issuance of additional common stock during the second quarter of 2005. The
increase in total investments also reflects cash flows being held in
investments before being redeployed in the Bank's loan portfolio and the
fact that market conditions made purchases of MBSs generally more attractive
than purchases of residential whole mortgage loans.
13
-- Loans and Leases. Total loans and leases were $941.5 million, or
66.4% of total assets, at September 30, 2005, compared to $886.3 million, or
71.5% of total assets, at December 31, 2004. The Company attempts to
concentrate its asset growth in its loan and lease portfolios to maximize
the yield on new assets and to take advantage of demand for both commercial
and home equity loan products in its market area.
The commercial loan and lease portfolio (consisting of commercial real
estate, commercial & industrial, equipment leases, multi-family real estate,
construction and small business loans) increased $36.5 million, or 9.1%,
during the first nine months of 2005. The primary drivers of this growth
were in the commercial real estate and construction lending areas. (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 $32.5 million, or 19.4%, during
the first nine months 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 $13.8 million, or
4.4%, during the first nine months of 2005, as originations ($39.6 million)
of residential mortgage loans were less than repayments ($53.4 million). At
September 30, 2005, the Bank had commitments to purchase residential
mortgage loans of $10 million within the next 60 days.
14
The following is a breakdown of loans and leases receivable:
(In thousands)
September 30, 2005 December 31, 2004
------------------ -----------------
Commercial loans:
Commercial real estate - nonowner occupied $ 99,666 $ 90,716
Commercial real estate - owner occupied 108,398 93,027
Commercial and industrial 78,561 78,918
Construction 40,833 32,319
Small business 36,226 37,820
Multi-family real estate 34,501 32,415
Leases and other 41,321 37,890
-------- --------
Subtotal 439,506 403,105
Net deferred loan origination fees (213) (335)
-------- --------
Total commercial loans $439,293 $402,770
======== ========
Residential mortgage loans:
One- to four-family adjustable rate $198,962 $199,031
One- to four-family fixed rate 101,472 115,350
-------- --------
Subtotal 300,434 314,381
Premium on loans acquired 1,952 1,826
Net deferred loan origination fees (63) (72)
-------- --------
Total residential mortgage loans $302,323 $316,135
======== ========
Consumer loans:
Home equity - term loans $129,783 $110,542
Home equity - lines of credit 67,086 53,551
Automobile 218 488
Installment 356 491
Savings secured 368 439
Unsecured and other 722 801
-------- --------
Subtotal 198,533 166,312
Premium on loans acquired 4 15
Net deferred loan origination costs 1,378 1,069
-------- --------
Total consumer loans $199,915 $167,396
======== ========
Total loans receivable $941,531 $886,301
======== ========
-- Deposits and Borrowings. Total deposits increased by $80.8 million,
or 9.2%, during the first nine months of 2005, from $880.7 million, or 71.1%
of total assets, at December 31, 2004, to $961.5 million, or 67.8% of total
assets, at September 30, 2005. In addition, the composition of total
deposits changed during the quarter. Although the Bank continues its
strategy of emphasizing core deposits over certificates of deposit, consumer
demand for certificates of deposit outpaced growth in core deposits during
the first nine months of 2005. As a result, the Bank experienced growth in
certificates of deposit, up $78.6 million, or 31.6%, whereas demand
deposits accounts increased $8.0 million or 4.8%, from December 31, 2004
levels. Additionally, in the aggregate, NOW, money market and savings
accounts showed a decrease of $5.8 million, or 1.2%, from December 31, 2004
levels. At September 30, 2005, core deposit accounts comprised 66.0% of
total deposits, compared to 71.8% of total deposits at December 31, 2004.
15
The following table sets forth certain information regarding deposits:
September 30, 2005 December 31, 2004
------------------------------- -------------------------------
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
------ ------- -------- ------ ------- --------
(Dollars in thousands)
NOW accounts $ 90,635 9.4% 0.56% $108,159 12.3% 0.76%
Money market accounts 18,702 2.0% 1.36% 16,489 1.9% 1.22%
Savings accounts 349,388 36.3% 1.55% 339,836 38.6% 1.25%
Certificate of deposit accounts 327,092 34.0% 3.10% 248,508 28.2% 2.55%
-------- ----- -------- -----
Total interest bearing deposits 785,817 81.7% 2.08% 712,992 81.0% 1.63%
Noninterest bearing accounts 175,682 18.3% -- 167,682 19.0% --
-------- ----- -------- -----
Total deposits $961,499 100.0% 1.70% $880,674 100.0% 1.32%
======== ===== ======== =====
FHLB borrowings and wholesale repurchase agreements increased $65.8
million, or 28.0%, during the first nine months of 2005. The increases were
the result of the Company utilizing borrowings to fund asset growth. The
Company, through the Bank's membership in the FHLB, has access to a number
of different funding structures. During the first nine months 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
cash flows 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 September 30, 2005, the Company had
nonperforming assets of $1.2 million, which represented 0.09% of total
assets. This compares to nonperforming assets of $733,000, or 0.06% of total
assets, at December 31, 2004. Total nonperforming assets at September 30,
2005, consisted of nonaccrual commercial loans aggregating $958,000 and
nonaccrual residential mortgage loans aggregating $24,000, and OREO of
$247,000. Included in nonaccrual loans were $838,000, at September 30, 2005,
and $671,000, at December 31, 2004, of impaired loans. Specific reserves
against these impaired loans were $99,000 and $170,000 at September 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 September 30, 2005, $800,000 of loan balances
were 60 to 89 days past due, an increase of $800,000 from December 31, 2004.
16
The following table sets forth information regarding nonperforming
assets and loans 60-89 days past due as to interest at the dates indicated.
September 30, December 31,
2005 2004
------------- ------------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $ 982 $733
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
------ ----
Total nonperforming loans 982 733
Other real estate owned 247 --
------ ----
Total nonperforming assets $1,229 $733
====== ====
Delinquent loans 60-89 days past due $ 800 $ --
Nonperforming loans as a percent of total loans 0.10% 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 0.08% 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 September 30, 2005, the Company had $4.4 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 September 30, 2005,
included in the assets that were classified as substandard, were $3.4
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 nine months of 2005, the Company made provisions to
the allowance for loan and lease losses totaling $1.1 million and had $1.2
million of net charge-offs, bringing the balance in the allowance to $11.8
million, compared to $11.9 million at December 31, 2004. The net charge-offs
occurred largely during the second quarter and were primarily due to 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 1.25% as of September 30,
2005, compared to 1.34% at the prior year end and stood at 1197% of
nonperforming loans at September 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
September 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 September 30, 2005,
compared to $2.0 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 September 30, 2005 and 2004
------------------------------------------------------------
-- General. The Company reported net income for the third quarter of
2005 of $2.5 million, up $289,000, or 13.3%, from the third quarter of 2004.
Diluted earnings per common share were $0.50 or down 3.8% for the third
quarter of 2005, compared to $0.52 for the third quarter of 2004. The
difference between the increase in earnings and the decrease in diluted
earnings per share for the third quarter of 2005 was due to the additional
common shares issued during the second quarter of 2005.
The Company reported a return on average assets of 0.71% and a return
on average equity of 9.44% for the 2005 period, as compared to a return on
average assets of 0.72% and a return on average equity of 11.63% for the
2004 period. The decrease in the return on average equity was due to the
additional equity raised during the second quarter of 2005.
-- Net Interest Income. For the quarter ended September 30, 2005, net
interest income was $10.8 million, compared to $9.8 million for the 2004
period. The net interest margin for the third quarter of 2005 at 3.25% was
down from the net interest margin for the 2004 period of 3.45%. The increase
in net interest income of $921,000, or 9.4%, was attributable to the
continued growth of the
18
Company, while the decrease in the net interest margin of 20 basis points
was due to the compression of the yield curve and current interest rate
environment. Average earning assets were $177.0 million, or 15.6%, higher,
and average interest-bearing liabilities were $153.2 million, or 16.3%,
higher, than the comparable period a year earlier.
-- Interest Income. Investments. Total investment income was $4.1
million for the quarter ended September 30, 2005, compared to $3.1 million
for the 2004 period. The increase in total investment income was $1.0
million, or 35.7%, and was attributable to an increase in the average
balance of total investments. The average balance increased $99.9 million,
or 34.9%, from the third quarter of 2004 to the third 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 continued a leverage program during the
third quarter of 2005, to partially offset the dilution of earnings per
share caused by the issuance of additional common stock during the second
quarter of 2005. The majority of the Company's investments are comprised of
U.S. Agency securities and MBSs with repricing periods or expected duration
of less than five years.
-- Interest Income. Loans and Leases. Interest from loans and leases
was $13.7 million for the three months ended September 30, 2005, and
represented a yield on total loans and leases of 5.88%. This compares to
$11.9 million of interest, and a yield of 5.56%, for the third quarter of
2004. Interest from commercial loans and leases increased $1.4 million, or
23.8%, and interest from consumer and other loans increased $766,000, or
40.7%, 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 third quarter of 2004 as follows: commercial loans and
leases increased $58.2 million, or 15.5%, and consumer and other loans
increased $39.7 million, or 26.1%, while residential mortgage loans
decreased $20.7 million, or 6.5%. Rising short-term interest rates, along
with a flattening of the yield curve, affected yields on the various loan
portfolios. Changes in the average yields from the third quarter of 2004
were as follows: commercial loans and leases increased 43 basis points, to
6.66%, and consumer and other loans increased 56 basis points, to 5.48%,
while residential mortgage loans decreased 6 basis points, to 5.02%.
-- Interest Expense. Interest paid on deposits and borrowings
increased $2.0 million, or 40.1%, to $7.1 million for the three months ended
September 30, 2005, from $5.1 million for the same period during 2004. The
average balance of total interest-bearing liabilities increased $153.2
million, from $942.9 million in the third quarter of 2004 to $1.1 billion in
the third quarter of 2005, as certificate of deposit ("CD") accounts
increased $86.7 million, or 38.3%, and FHLB borrowings and wholesale
repurchase agreements increased $85.8 million, or 43.2%. The overall average
cost for interest-bearing liabilities increased 41 basis points to 2.55% for
the third quarter of 2005, compared to 2.14% for the third 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 $410,000 for the quarter ended September 30, 2005 as
compared to $200,000 for the third 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 third
quarter of 2005 were primarily in response to changes in the mix of loans
and concern for general
19
economic conditions. During the quarter, there were $16,000 of loan
recoveries and $62,000 of charge-offs. The allowance expressed as a
percentage of total loans was 1.25% at September 30, 2005, compared to 1.34%
at December 31, 2004. As the loan portfolio continues to grow and mature, or
if economic conditions worsen, management believes it possible that the
level of nonperforming assets will increase, which in turn may lead to
increases in the provision for loan and lease losses in future periods. Also
see discussion under "Allowance for Loan and Lease Losses."
-- Noninterest Income. Total noninterest income increased $544,000, or
26.7%, to $2.6 million for the third quarter of 2005, from $2.0 million for
the third quarter of 2004. The Company experienced increases in loan related
fees, up $264,000 or 253.8%. Additionally, Other Income increased $111,000,
or 36.6%, largely driven by commissions on leases originated for third
parties. Service charges on deposit accounts continue to represent the
largest source of noninterest income for the Company, showing modest growth
of $20,000, or 1.7%, to $1.2 million for three months ended September 30,
2005 from $1.2 million for the same period in 2004. Commissions on
nondeposit investment products also increased $12,000, or 3.8%. While, the
Company did experience an increase in gross nondeposit investment product
sales, the related fee income was partially offset by the continuing decline
in the level of commissions being paid on such products.
-- Noninterest Expense. Noninterest expenses for the third quarter of
2005 increased a total of $780,000, or 9.3%, to $9.2 million from $8.4
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 $447,000, or 9.8%),
Marketing expense (up $127,000, or 47.0%), and Occupancy costs (up $120,000,
or 17.8%). These increased costs resulted largely from the Company's growth
in its branch network, with two new locations opened in 2005. Additionally,
the Company plans to further expand its branch network, with two additional
branches planned for 2006. Meanwhile, the Company's overall efficiency ratio
improved 190 basis points to 68.63% in 2005, from 70.53% in the 2004 period.
-- Income Tax Expense. Income tax expense of $1.3 million was recorded
for the three months ended September 30, 2005, compared to $1.1 million for
the same period during 2004. This represented total effective tax rates of
34.7% and 34.0%, 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
39.9% combined statutory federal and state tax rates.
Comparison of Nine Months Ended September 30, 2005 and 2004
-----------------------------------------------------------
-- General. Net income for the first nine months of 2005, increased
$997,000, or 15.7%, to $7.3 million, or $1.58 per diluted common share, from
$6.3 million, or $1.50 per diluted common share, for the first nine months
of 2004.
This performance represented a return on average assets of 0.74% and a
return on average equity of 10.24% for the 2005 period, as compared to a
return on average assets of 0.73% and a return on average equity of 11.45%
for the 2004 period. The decrease in return on equity represents the full
impact of the issuance of additional shares of common stock during the
second quarter of 2005.
-- Net Interest Income. For the nine months ended September 30, 2005,
net interest income was $31.9 million, compared to $27.9 million for the
first nine months of 2004. The net interest margin for the first nine months
of 2005 was 3.36% compared to a net interest margin of 3.43% for the 2004
20
period. The increase in net interest income of $4.0 million, or 14.4%, was
attributable to the overall growth of the Company. Average earning assets
increased $182.3 million, or 16.8%, and average interest-bearing liabilities
increased $151.3 million, or 16.8%, over the comparable period a year
earlier. The decrease of 7 basis points in the net interest margin primarily
resulted from increases in asset yields being 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 $11.2
million for the nine months ended September 30, 2005, compared to $7.7
million for the first nine months of 2004. This increase in total investment
income of $3.5 million, or 46.3%, was primarily attributable to a $99.5
million, or 39.7%, increase in the average balances coupled with a 19 basis
point increase in the overall yield on investments, from 4.09% in 2004, to
4.28% in 2005.
-- Interest Income. Loans and Leases. Interest from loans and leases
was $39.4 million for the nine months ended September 30, 2005, and
represented a yield on total loans and leases of 5.73%. This compares to
$34.7 million of interest, and a yield of 5.53%, for the first nine months
of 2004. Interest income increased resulting from both the growth in the
average balance of $82.8 million, or 9.9%, and the increase in yield of 20
basis points. The average balance of the various components of the loan
portfolio changed as follows: commercial loans increased $58.1 million, or
16.2%; consumer and other loans increased $58.1 million, or 43.4%; and
residential mortgage loans decreased $33.3 million, or 9.7%. The average
yield on the various components of the loan portfolio changed as follows:
commercial loans increased 32 basis points, to 6.55%; and consumer and other
loans increased 17 basis points, to 5.02%; and residential mortgage loans
increased 1 basis point, to 5.06%. 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 $4.3 million, or 30.0%, to $18.8 million for the nine months ended
September 30, 2005, compared to $14.4 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 25 basis points from
2.14% for the first nine months of 2004, to 2.39% for the first nine months
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 $151.3 million, or 16.8%,
from $899.7 million in 2004, to $1.1 billion in 2005. The Company
experienced growth in CD balances, which were up $68.9 million or 30.9%. The
growth in Savings account balances of $19.5 million or 6.2% was offset by
the decline in NOW account balances of $29.5 million or 23.2%. In addition,
the Company increased its utilization of FHLB borrowings (balances up $76.7
million, or 42.1%) and wholesale repurchase agreements (up $7.8 million, or
100.0%) compared to the first nine months of 2004.
-- Provision for Loan Losses. The provision for loan losses was $1.1
million for the nine months ended September 30, 2005, compared to $700,000
for the same period last year. The allowance, expressed as a percentage of
total loans, was 1.25% as of September 30, 2005, compared to 1.34% at the
prior year-end and stood at 1197% of nonperforming loans at September 30,
2005, compared to
21
1624% of nonperforming loans at December 31, 2004. Total nonperforming loans
increased from $733,000 at the end of last year, to $982,000 on September
30, 2005. Net charge-offs for the nine month period ending September 30,
2005 were $1.2 million, compared to $105,000 for the nine month period ended
September 30, 2004. The increase in the 2005 charge-offs reflects the asset-
based credit referenced earlier. 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 $860,000, or
13.8%, from $6.2 million for the first nine months of 2004, to $7.1 million
for the first nine months of 2005. The increase in noninterest income was
led by Loan fees increasing $498,000, or 161.2%. Commissions on loans
originated for others increased $79,000, or 151.9%. Additionally, Other
income increased $402,000, or 42.9%, primarily from commissions generated
from sales of historic tax credits and commissions from third party lease
originations. Service charges on deposit accounts continued to represent the
largest source of noninterest income for the Company and experienced an
increase of $37,000, or 1.1%. Commissions on nondeposit investment products
decreased $36,000, or 4.7%, as the level of commissions being paid on such
products declined. BOLI income increased by $31,000, or 6.5%. The Company
realized $151,000, or 45.5%, less in Gain on sale of investment securities
and MBSs.
-- Noninterest Expense. Noninterest expenses for the first nine months
of 2005 increased by $2.9 million, or 12.0%, to $26.8 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 $1.9 million, or 15.1%), Professional services (up $331,000, or
28.7%), and Occupancy costs (up $291,000, or 14.5%). The increases in Salary
and employee benefits and Occupancy costs resulted primarily from the
aforementioned branch openings in 2005. 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. The Company's
efficiency ratio improved 141 basis points to 68.70% for the 2005 period,
from 70.11% for the 2004 period.
-- Income Tax Expense. The Company recorded income tax expense of $3.8
million for the first nine months of 2005, compared to $3.2 million for the
same period during 2004. This represented total effective tax rates of 34.2%
and 33.3%, 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.
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
22
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. 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 September 30, 2005, overnight
investments, investment securities and MBSs available for sale amounted to
$384.1 million, or 27.1% 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
September 30, 2005 was $103.7 million, as compared to $78.9 million at
December 31, 2004. This increase of $24.8 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 nine months of
2005 of $7.3 million, partially offset by a decrease in accumulated other
comprehensive income of $3.3 million (attributable to increases in
unrealized losses on investments and MBSs) and dividends of $2.0 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 September 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 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 of the offering 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
23
regulatory capital to support asset growth and continued expansion of the
Bank's business, including the addition of branches. The proceeds from this
offering should enable the Company and the Bank to maintain their status as
well-capitalized institutions as they execute their growth strategies.
The Company's and the Bank's actual and required capital amounts and ratios
are as follows:
Minimum Required Minimum Required
For Capital To Be Considered
Actual Adequacy Purposes "Well Capitalized"
------------------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
At September 30, 2005:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $113,016 8.22% $41,240 3.00% $68,733 5.00%
Tier I capital (to risk weighted assets) 113,016 12.82% 35,253 4.00% 52,880 6.00%
Total capital (to risk weighted assets) 123,553 14.02% 70,506 8.00% 88,133 10.00%
Bank Rhode Island
Tier I capital (to average assets) $ 91,847 6.68% $41,220 3.00% $68,699 5.00%
Tier I capital (to risk weighted assets) 91,847 10.43% 35,236 4.00% 52,854 6.00%
Total capital (to risk weighted assets) 102,384 11.62% 70,472 8.00% 88,089 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 September 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 October 1, 2005:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 basis points $ 690 1.6%
Down 200 basis points (982) (2.3)%
Subsequent Twelve Month Period:
Up 200 basis points $ (508) (1.2)%
Down 200 basis points (1,983) (4.5)%
The Company also uses interest rate sensitivity gap analysis to
provide a more general overview of its interest rate risk profile. The
interest rate sensitivity gap is defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing within
a given time period. At September 30, 2005, the Company's one year
cumulative gap was a negative $142.8 million, or 10.1% 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
No information to report.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
No defaults upon senior securities have taken place.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
No information to report.
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
27
BANCORP RHODE ISLAND, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Bancorp Rhode Island, Inc.
November 3, 2005 /s/ Merrill W. Sherman
---------------- ----------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
November 3, 2005 /s/ Linda H. Simmons
---------------- --------------------
(Date) Linda H. Simmons
Chief Financial Officer
and Treasurer
28