SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------
F O R M 10 - KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the Fiscal Year Ended December 31, 2002.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to ____________________
Commission file number 333-59824
SOUTHERN CONNECTICUT BANCORP, INC.
(Name of Small Business Issuer in Its Charter)
Connecticut 06-1594123
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
215 Church Street
New Haven, Connecticut 06510
(Address of Principal Executive Offices) (Zip Code)
Issuer's telephone number (203) 782-1100
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $.01 per share
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 _____
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
State issuer's revenue for its most recent fiscal year. $1,211,484
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Aggregate market value of the voting stock held by nonaffiliates (assumes
directors and executive officers are non affiliates) of the registrant as of
February 28, 2003: $5,844,468
1
Number of shares of the registrant's Common Stock, par value $.01 per share,
outstanding as of February 28, 2003: 966,667
Transitional Small Business Disclosure Format (check one):
Yes _____; No__X__
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for 2003 Annual Meeting of Incorporated into Part III
Shareholders to be held on May 6, 2003. (A of this Form 10-KSB
definitive proxy statement will be filed
with the Securities and Exchange Commission
within 120 days after the close of the
fiscal year covered by this Form 10-KSB.)
2
Table of Contents
Part I Page
Item 1. Description of Business 4
Item 2. Description of Property 13
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Part II
Item 5. Market for Common Equity and Related Shareholder Matters 14
Item 6. Management's Discussion and Analysis or Plan of Operation 16-24
Item 7. Financial Statements 24
Item 8. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 24
Part III
Item 9. Directors and Executive Officers of the Registrant 24
Item 10. Executive Compensation 24
Item 11. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 24
Item 12. Certain Relationships and Related Transactions 24
Item 13. Exhibits, Lists, and Reports on Form 8 - K 24
Item 14. Controls and Procedures 25
Signatures 26
Section 302 Certification by Chief Executive Officer 27
Section 302 Certification by Interim Controller 28
Section 906 Certification by Chief Executive Officer 29
Section 906 Certification by Chief Executive Officer 30
Exhibit Index 31
3
PART I
Item 1. Description of Business.
Southern Connecticut Bancorp, Inc. ("Bancorp"), a Connecticut
corporation, was incorporated on November 8, 2000 to serve as a bank holding
company. Bancorp owns one hundred percent of the capital stock of The Bank of
Southern Connecticut ("Bank"), a state chartered bank in New Haven, Connecticut,
which commenced operations on October 1, 2001 after receiving its Final
Certificate of Authority from the Connecticut Banking Commissioner and its
deposit insurance from the Federal Deposit Insurance Corporation ("FDIC").
Bancorp invested $10,000,000 of the net proceeds of its July 26, 2001 stock
offering to purchase the capital stock of the Bank and an additional $360,000 to
cover the Bank's pre-opening deficit. The $10,000,000 of initial equity capital
for the Bank required under the Bank's Temporary Certificate of Authority
substantially exceeded the statutory minimum equity capital for a new
Connecticut bank of $5,000,000. Bancorp chose a holding company structure
because it provides flexibility that would not otherwise be available. For
example, Bancorp could acquire additional banks, establish de novo banks and
other businesses, including mortgage companies, leasing companies, insurance
agencies and small business investment companies. Bancorp may in the future
decide to engage in additional businesses permitted to bank holding companies or
financial holding companies. Before Bancorp could acquire interests in other
banks, establish de novo banks or expand into other businesses, it may need to
obtain regulatory approvals and might need additional capital.
Bancorp has leased a free-standing building located at 215 Church
Street, New Haven, Connecticut, located in the central business and financial
district of New Haven. It has assigned this lease to the Bank, and the Bank has
assumed all rights and obligations under this lease. Both Bancorp and the Bank
operate from this facility. On October 7, 2002 the Bank opened a new branch
office in Branford, Connecticut at West Main Street and Summit Place. On August
15, 2002 the Bank also purchased a building at 1475 Whalley Avenue in the
Westville section of New Haven for a branch office site to be opened in the
first quarter of 2003.
The following table sets forth the location of the Bank's branch
offices and other related information:
Office Location Status
------ -------- ------
Main Office 215 Church Street, New Haven, Connecticut Leased
Branford Office 445 West Main Street, Branford, Connecticut Leased
Amity Office* 1475 Whalley Avenue, New Haven, Connecticut Owned
* Office scheduled to open in March 2003
Management believes that Bancorp's short-term assets have sufficient
liquidity to cover potential fluctuations in deposit accounts and loan demand
and to meet other anticipated operating cash requirements. For a more detailed
discussion of Bancorp's liquidity, see Liquidity on page 22 of this Form 10-KSB.
Currently, there are no plans involving the significant purchase or sale of
property or equipment in the next twelve months. Outside of staffing the new
branches, Bancorp does not anticipate a significant change in the number of its
employees.
The Bank does not expect to compete with large institutions for the
primary banking relationships of large corporations, but it competes for niches
in this business segment and for the consumer business of employees of such
entities. The Bank focuses on small to medium-sized businesses, professionals
and individuals and their employees. This focus includes retail, service,
wholesale distribution, manufacturing and international businesses. The Bank
attracts these customers based on relationships and contacts which the Bank's
directors and management have within and beyond the Bank's primary service area.
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Greater New Haven is currently served by approximately 70 offices of
commercial banks, none of which is headquartered in New Haven. In addition, New
Haven Savings Bank, a mutual savings bank, has 16 branches in the New Haven
market. All of these banks are substantially larger than the Bank expects to be
in the near future and are able to offer products and services which may be
impracticable for the Bank to provide at this time.
There are numerous banks and other financial institutions serving the
communities surrounding New Haven which also draw customers from New Haven,
posing significant competition for the Bank to attract deposits and loans. The
Bank also experiences competition from out-of-state financial institutions.
Bancorp will have to obtain customers from the customer base of such existing
banks and financial institutions and from growth in New Haven and the
surrounding area. Many of such banks and financial institutions are well
established and well capitalized, allowing them to provide a greater range of
services (including trust services) than the Bank will be able to offer in the
near future.
Intense market demands, economic pressures and significant legislative
and regulatory actions have eroded banking industry classifications which were
once clearly defined and have increased competition among banks and other
financial institutions. Market dynamics and legislative and regulatory changes
impacting banks and other financial institutions have resulted in a number of
new competitors offering services historically offered only by commercial banks;
non-bank corporations offering services traditionally offered only by banks;
increased customer awareness of product and service differences among
competitors; and increased merger activity.
Additional legislative and regulatory changes may affect the bank in
the future; however, the nature of such changes and the effect of their
implementation cannot be assessed. New rules and regulations may, among other
things, revise limits on interest rates on various categories of deposits and
may limit or influence interest rates on loans. Monetary and fiscal policies of
the United States government and its instrumentalities, including the Federal
Reserve, significantly influence the growth of loans, investments and deposits.
The present bank regulatory scheme is undergoing significant change both as it
affects the banking industry itself and as it affects competition between banks
and non-bank financial institutions.
The Bank currently offers products and services described as "core"
products and services which are more completely described below. Through
correspondent and other relationships, it is expected that the Bank will be able
to help our customers meet all of their banking needs, including obtaining
services which the Bank may not offer directly.
The Bank is seeking to establish a sound base of core deposits,
including checking accounts, money market accounts, savings accounts, sweep
accounts, NOW accounts and a variety of certificates of deposits and IRA
accounts. To attract deposits, the Bank is employing an aggressive marketing
plan in its service area and features a broad product line and rates and
services competitive with those offered in the New Haven market. The primary
sources of deposits have been and are expected to be, residents of, and
businesses and their employees located in, New Haven and the surrounding
communities. The Bank is obtaining these deposits through personal solicitation
by its officers and directors, outside programs and advertisements published and
/ or broadcasted in the local media.
Deposits and the Bank's equity capital are the sources of funds for
lending and investment activities. Repayments on loans, investment income and
proceeds from the sale and maturity of investment securities will also provide
additional funds for these purposes. While scheduled principal repayments on
loans and investment securities are a relatively predictable source of funds,
deposit flows and loan prepayments are greatly influenced by general interest
rates, economic conditions and competition. We expect to manage the pricing of
deposits to maintain a desired deposit balance. We offer drive-in teller
services, wire transfers and safe deposit services.
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The Bank's loan strategy is to offer a broad range of loans to
businesses and individuals in its service area, including commercial and
business loans, personal loans, mortgage loans, home equity loans, automobile
loans and education loans. The Bank has received lending approval status from
the Small Business Administration ("SBA") to enable it to make SBA loans to both
the Greater New Haven business community and companies throughout the State of
Connecticut. Our marketing focus on small to medium-size businesses and
professionals may result in an assumption of certain lending risks that are
different from or greater than those which would apply to loans made to larger
companies or consumers. Commercial loans generally entail certain additional
risks because repayment is usually dependent on the success of the enterprise.
The Bank seeks to manage the credit risk inherent in its loan portfolio through
credit controls and loan diversification. Prior to approving a loan the Bank
evaluates: the credit histories of potential borrowers; the value and liquidity
of available collateral; the purpose of the loan; the source and reliability of
funds for repayment and other factors considered relevant in the circumstances.
Loans are made on a variable or fixed rate basis with fixed rate loans
limited to five year terms. All loans are approved by the Bank's management and
the Loan Committee of the Bank's Board of Directors. At the present time, the
Bank is not purchasing participation in loans nor is it syndicating or
securitizing loans. The Bank may consider participation in multi-bank loans for
companies in its service area. Commercial loans and commercial real estate loans
may be written for terms of up to twenty years. Loans to purchase or refinance
commercial real estate are collateralized by the subject real estate. Loans to
local businesses are generally supported by the personal guarantees of the
principal owners and are carefully underwritten to determine appropriate
collateral and covenant requirements.
Other services provided currently or to be provided include, cashier's
checks, money orders, travelers checks, bank by mail, direct deposit and U. S.
Savings Bonds. The Bank is associated with a shared network of automated teller
machines that its customers are able to use throughout Connecticut and other
regions. The Bank does not currently expect to offer trust services but may
offer trust services through a joint venture with a larger institution. To offer
such services in the future, the Bank would need the approval of the Connecticut
Banking Commissioner.
Another significant activity for the Bank is maintaining an investment
portfolio. Although granting a variety of loans to generate interest income and
loan fees is an important aspect of the Bank's business plan, the aggregate
amount of loans will be subject to maintaining a satisfactory loan-to-deposit
ratio. The Bank's overall portfolio objective is to maximize the long-term total
rate of return through active management of portfolio holdings taking into
consideration estimated asset/liability and liquidity needs, tax equivalent
yields and maturities. Permissible investments include debt securities such as
U. S. Government securities, government sponsored agency securities, municipal
bonds, domestic certificates of deposit that are insured by the FDIC,
mortgage-backed securities and collateralized mortgage obligations. The Bank
expects that investments in equity securities will be very limited. The Bank's
current investment portfolio is limited to U. S. government obligations which
have been classified as available for sale. Accordingly, the principal risk
associated with the Banks current investing activities is market risk
(variations in value resulting from general changes in interest rates) rather
than credit risk.
Overall, the Bank's plan of operation is focused on responsible growth
and pricing of deposits and loans, and investment in high quality U. S.
government securities to achieve a net interest margin sufficient to cover
operating expenses, achieve profitable operations and maintain liquidity.
Currently, the Bank has 21 full-time and no part-time employees. Most
routine day-to-day banking transactions are performed at the Bank by its
employees. However, the Bank has entered into a number of arrangements for
banking services such as correspondent banking, data processing and armored
carriers.
6
Supervision and Regulation
Banks and bank holding companies are extensively regulated under both
federal and state law. The Bank has set forth below brief summaries of various
aspects of supervision and regulation which do not purport to be complete and
which are qualified in their entirety by reference to applicable laws, rules and
regulations.
Regulations to which Bancorp is subject
As a bank holding company, Bancorp is regulated by and subject to the
supervision of the Board of Governors of the Federal Reserve System (the "FRB")
and is required to file with the FRB an annual report and such other information
as may be required. The FRB has the authority to conduct examinations of Bancorp
as well.
The Bank Holding Company Act of 1956 (the "BHC Act") limits the types
of companies which Bancorp may acquire or organize and the activities in which
they may engage. In general, a bank holding company and its subsidiaries are
prohibited from engaging in or acquiring control of any company engaged in
non-banking activities unless such activities are so closely related to banking
or managing and controlling banks as to be a proper incident thereto. Activities
determined by the FRB to be so closely related to banking within the meaning of
the BHC Act include operating a mortgage company, finance company, credit card
company, factoring company, trust company or savings association; performing
certain data processing operations; providing limited securities brokerage
services; acting as an investment or financial advisor; acting as an insurance
agent for certain types of credit-related insurance; leasing personal property
on a full-payout, non-operating basis; providing tax planning and preparation
service; operating a collection agency; and providing certain courier services.
The FRB also had determined that certain other activities, including real estate
brokerage and syndication, land development, property management and
underwriting of life insurance unrelated to credit transactions, are not closely
related to banking and therefore are not a proper activity for a bank holding
company.
In November 1999, Congress amended certain provisions of the BHC Act
through passage of the Gramm-Leach-Bliley Act. Under this new legislation, a
bank holding company may elect to become a "financial holding company" and
thereby engage in a broader range of activities than would be permissible for
traditional bank holding companies. In order to qualify for the election, all of
the depository institution subsidiaries of the bank holding company must be well
capitalized and well managed, as defined under FRB regulations, and all such
subsidiaries must have achieved a rating of "satisfactory" or better with
respect to meeting community credit needs. Pursuant to the Gramm-Leach-Bliley
Act, financial holding companies are permitted to engage in activities that are
"financial in nature" or incidental or complementary thereto, as determined by
the FRB. The Gramm-Leach-Bliley Act identifies several activities as "financial
in nature", including, among others, insurance underwriting and agency
activities, investment advisory services, merchant bank and underwriting, and
dealing in or making a market in securities.
The Gramm-Leach-Bliley Act also makes it possible for entities engaged
in providing various other financial services to form financial holding
companies and form or acquire banks. Accordingly, the Gramm-Leach-Bliley Act
makes it possible for a variety of financial services firms to offer products
and services comparable to the products and services offered by the Bank.
There are various statutory and regulatory limitations regarding the
extent to which present and future banking subsidiaries of Bancorp can finance
or otherwise transfer funds to Bancorp or its non-banking subsidiaries, whether
in the form of loans, extensions of credit, investments or asset purchases,
including regulatory limitation on the payment of dividends directly or
indirectly to Bancorp from the Bank. Federal and state bank regulatory agencies
also have the authority to limit further the Bank's payment of dividends based
on such factors as the maintenance of adequate capital for such subsidiary bank,
7
which could reduce the amount of dividends otherwise payable. Under the policy
of the FRB, Bancorp is expected to act as a source of financial strength to the
Bank and to commit resources to support the Bank in circumstances where we might
not do such absent such policy.
The FRB has established capital adequacy guidelines for bank holding
companies that are similar to the Federal Deposit Insurance Corporation ("FDIC")
capital requirements for the Bank described below.
Regulations to which the Bank is subject
The Bank is organized under the Banking Law of the State of
Connecticut. Its operations are subject to federal and state laws applicable to
commercial banks and to extensive regulation, supervision and examination by the
Connecticut Banking Commissioner, as well as by the FDIC, as its primary federal
regulatory and insurer of deposits. While the Bank is not a member of the
Federal Reserve System, it is subject to certain regulations of the FRB. In
addition to banking laws, regulations and regulatory agencies, the Bank is
subject to various other laws, regulations and regulatory agencies, all of which
directly or indirectly affect the Bank's operations. The Connecticut Banking
Commissioner and the FDIC examine the affairs of the Bank for the purpose of
determining its financial condition and compliance with laws and regulations.
The Connecticut Banking Commissioner and the FDIC have significant
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such policies whether by the FDIC, Congress, the
Connecticut Banking Commissioner or the Connecticut General Assembly could have
a material adverse impact on the Bank.
Federal laws and regulations also limit, with certain exceptions, the
ability of state banks to engage in activities or make equity investments that
are not permissible for national banks. Bancorp does not expect such provisions
to have a material adverse effect on Bancorp or the Bank.
Capital Standards
The FDIC has adopted risk-based capital guidelines to which
FDIC-insured, state-chartered banks that are not members of the Federal Reserve
System, such as the Bank, are subject. The guidelines establish a systematic
analytical framework that makes regulatory capital requirements more sensitive
to the differences in risk profiles among banking organizations. Banks are
required to maintain minimum levels of capital based upon their total assets and
total "risk-weighted assets." For purposes of these requirements, capital is
comprised of both Tier 1 and Tier 2 capital. Tier 1 capital consists primarily
of common stock and retained earnings. Tier 2 capital consists primarily of loan
loss reserves, subordinated debt, and convertible securities. In determining
total capital, the amount of Tier 2 capital may not exceed the amount of Tier 1
capital. A bank's total "risk-based assets" are determined by assigning the
bank's assets and off-balance sheet items (e.g., letters of credit) to one of
four risk categories based upon their relative credit risks. The greater the
risk associated with an asset, the greater the amount of such asset that will be
subject to capital requirements.
Safety and Soundness Standards
Federal law requires each federal banking agency to prescribe for
depository institutions under its jurisdiction standards relating to, among
other things: internal controls; information systems and audit systems; loan
documentation; credit underwriting; interest rate risk exposure; asset growth;
compensation; fees and benefits; and such other operational and managerial
standards as the agency deems appropriate. The federal banking agencies adopted
final regulations and Interagency Guidelines Establishing Standards for Safety
and Soundness (the "Guidelines") to implement these safety and soundness
standards. The Guidelines set forth the safety and soundness standards that the
federal banking agencies use to identify and address problems at insured
8
depository institutions before capital becomes impaired. The Guidelines address
internal controls and information systems; internal audit system; credit
underwriting; loan documentation; interest rate risk exposure; asset quality;
earnings and compensation; fees and benefits. If the appropriate federal banking
agency determines that an institution fails to meet any standards prescribed by
the Guidelines, the agency may require the institution to submit to the agency
an acceptable plan to achieve compliance with the standard set by the Federal
Deposit Insurance Act. The final regulations establish deadlines for submission
and review of such safety and soundness compliance plans.
The federal banking agencies also have adopted final regulations for
real estate lending prescribing uniform guidelines for real estate lending. The
regulations require insured depository institutions to adopt written policies
establishing standards, consistent with such guidelines, for extensions of
credit secured by real estate. The policies must address loan portfolio
management, underwriting standards and loan to value limits that do not exceed
the supervisory limits prescribed by the regulations.
Prompt Corrective Action and Other Enforcement Mechanisms
Federal law requires each federal banking agency to take prompt
corrective action to resolve the problems of insured depository institutions,
including but not limited to those that fall below one or more prescribed
minimum capital ratios. The law requires each federal banking agency to
promulgate regulations defining the following five categories in which an
insured depository institution will be placed, based on the level of its capital
ratios: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. In September
1992, the federal banking agencies issued uniform final regulations implementing
the prompt corrective action provisions of federal law.
An institution that, based upon its capital levels, is classified as
"well capitalized," "adequately capitalized" or "undercapitalized" may be
treated as though it were in the next lower capital category if the appropriate
federal banking agency, after notice and opportunity for hearing, determines
that an unsafe or unsound condition or an unsafe or unsound practice warrants
such treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. The federal banking agencies,
however, may not treat an institution as "critically undercapitalized" unless
its capital ratio actually warrants such treatment.
In addition to restrictions and sanctions imposed under the prompt
corrective action provisions, commercial banking organizations may be subject to
potential enforcement actions by the federal regulators for unsafe or unsound
practices in conducting their businesses or for violations of any law, rule,
regulation or any condition imposed in writing by the agency or any written
agreement with the agency. Enforcement actions may include the imposition of a
conservator or receiver, the issuance of a cease and desist order that can be
judicially enforced, the termination of insurance of deposits (in the case of a
depository institution), the imposition of civil money penalties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the issuance of removal and prohibition orders against
institution-affiliated parties and the enforcement of such actions through
injunctions or restraining orders based upon a judicial determination that the
agency would be harmed if such equitable relief was not granted.
Premiums for Deposit Insurance
The FDIC has implemented a risk-based assessment system, under which an
institution's deposit insurance premium assessment is based on the probability
that the deposit insurance fund will incur a loss with respect to the
institution, the likely amount of any such loss, and the revenue needs of the
deposit insurance fund.
9
Under this risk-based assessment system, banks are categorized into one
of three capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three categories based on supervisory evaluations
by its primary federal regulatory. The three supervisory categories are:
financially sound with only a few minor weaknesses (Group A), demonstrates
weaknesses that could result in significant deterioration (Group B), and poses a
substantial probability of loss (Group C). The capital ratios used by the FDIC
to define well-capitalized, adequately capitalized and undercapitalized are the
same in the FDIC's prompt corrective action regulations. As of December 31,
2002, the most recent notification from the Federal Deposit Insurance
Corporation and the State of Connecticut Department of Banking categorized the
Bank as welll capitalized under the regulatory framework for prompt corrective
action. There are no conditions or events then, that management believes have
changed the Bank's category.
FDIC insurance of deposits may be terminated by the FDIC, after notice
and hearing, upon finding by the FDIC that the insured institution has engaged
in unsafe or unsound practices, or is in an unsafe or unsound condition to
continue operations, or has violated any applicable law, regulation, rule or
order of, or conditions imposed by, the FDIC.
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), as implemented by FDIC
regulations, the Bank has a continuing and affirmative obligation consistent
with its safe and sound operation to help meet the credit needs of its entire
community, including law and moderate income neighborhoods. The CRA does not
prescribe specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the FDIC, in connection with its
examination of a savings institution, to assess the institution's record of
meeting the credit needs of its community and to take such record into account
in its evaluation of certain applications by such institution. The Financial
Institutions Reform, Recovery and Enforcement Act (FIRREA) amended the CRA to
require public disclosure of an institution's CRA rating and require the FDIC to
provide a written evaluation of an institution's CRA performance utilizing a
four-tiered descriptive rating system. Institutions are evaluated and rated by
the FDIC as "Outstanding", "Satisfactory", "Needs to Improve", or "Substantial
Non Compliance." Failure to receive at least a "Satisfactory" rating may inhibit
an institution from undertaking certain activities, including acquisitions or
other financial institutions, which require regulatory approval based, in part,
on CRA Compliance considerations.
Interstate Banking and Branching
Under the Riegel-Neal Interstate Banking and Branching Efficiency Act
of 1994, as amended (the "Interstate Act, a bank holding company that is
adequately capitalized and managed may obtain approval under the BHCA to acquire
an existing bank located in another state generally without regard to state law
prohibitions on such acquisitions. A bank holding company, however, can not be
permitted to make such an acquisition if, upon consummation, it would control
(a) more than 10% of the total amount of deposits of insured depository
institutions in the United States or (b) 30% or more of the deposits in the
state in which the bank is located. A state may limit the percentage of total
deposits that may be held in that state by any one bank or bank holding company
if application of such limitation does not discriminate against out of state
banks. An out of state bank holding company may not acquire a state bank in
existence for less than a minimum length of time that may be prescribed by state
law except that a state may not impose more than a five year existence
requirement. Since June 1, 1997 (and prior to that date in some instances),
banks have been able to expand across state lines where qualifying legislation
adopted by certain states prior to that date prohibits such interstate
expansion. Banks may also expand across state lines through the acquisition of
an individual branch of a bank located in another state or through the
establishment of a de novo branch in another state where the law of the state in
which the branch is to be acquired or established specifically authorizes such
acquisition or de novo branch establishment.
10
The USA PATRIOT Act
In response to the events of September 11, 2001, the Uniting and
Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, was signed into law on
October 26, 2001. The USA PATRIOT Act gives the federal government new powers to
address terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing and broadened anti-money
laundering requirements. By way of amendments to the Bank Secrecy Act, Title III
of the USA PATRIOT Act takes measures intended to encourage information sharing
among bank regulatory agencies and law enforcement bodies. Further, certain
provisions of Title III impose affirmative obligations on a broad range of
financial institutions, including banks, thrifts, brokers, dealers, credit
unions, money transfer agents and parties registered under the Commodity
Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the following
requirements with respect to financial institutions:
o Pursuant to Section 352, all financial institutions must
establish anti-money laundering programs that include, at
minimum: (i) internal policies, procedures, and controls; (ii)
specific designation of an anti-money laundering compliance
officer; (iii) ongoing employee training programs; and (iv) an
independent audit function to test the anti-money laundering
program.
o Section 326 authorizes the Secretary of the Department of
Treasury, in conjunction with other bank regulators, to issue
regulations by October 26, 2002 that provide for minimum
standards with respect to customer identification at the time
new accounts are opened.
o Section 312 requires financial institutions that establish,
maintain, administer, or manage private banking accounts or
correspondence accounts in the United States for non-United
States persons or their representatives (including foreign
individuals visiting the United States) to establish
appropriate, specific, and, where necessary, enhanced due
diligence policies, procedures, and controls designed to
detect and report money laundering.
o Financial institutions are prohibited from establishing,
maintaining, administering or managing correspondent accounts
for foreign shell banks (foreign banks that do not have a
physical presence in any country), and will be subject to
certain record keeping obligations with respect to
correspondent accounts of foreign banks.
o Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on
Federal Reserve Act and Bank Merger Act applications.
The federal banking agencies have begun to propose and implement
regulations pursuant to the USA PATRIOT Act. These proposed and interim
regulations would require financial institutions to adopt the policies and
procedures contemplated by the USA PATRIOT Act.
Sarbanes-Oxley Act of 2002
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act
of 2002 ("Sarbanes-Oxley"), which implemented legislative reforms intended to
address corporate and accounting fraud. In addition to the establishment of a
new accounting oversight board that will enforce auditing, quality control and
11
independence standards and will be funded by fees from all publicly traded
companies, Sarbanes-Oxley places certain restrictions on the scope of services
that may be provided by accounting firms to their public company audit clients.
Any non-audit services being provided to a public company audit client will
require preapproval by the company's audit committee. In addition,
Sarbanes-Oxley makes certain changes to the requirements for audit partner
rotation after a period of time. Sarbanes-Oxley requires chief executive
officers and chief financial officers, or their equivalent, to certify to the
accuracy of periodic reports filed with the Securities and Exchange Commission,
subject to civil and criminal penalties if they knowingly or willingly violate
this certification requirement. The Company's Chief Executive Officer and Chief
Financial Officer have signed certifications to this Form 10-KSB as required by
Sarbanes-Oxley. In addition, under Sarbanes-Oxley, counsel will be required to
report evidence of a material violation of the securities laws or a breach of
fiduciary duty by a company to its chief executive officer or its chief legal
officer, and, if such officer does not appropriately respond, to report such
evidence to the audit committee or other similar committee of the board of
directors or the board itself.
Under Sarbanes-Oxley, longer prison terms will apply to corporate
executives who violate federal securities laws; the period during which certain
types of suits can be brought against a company or its officers is extended; and
bonuses issued to top executives prior to restatement of a company's financial
statements are now subject to disgorgement if such restatement was due to
corporate misconduct. Executives are also prohibited from trading the company's
securities during retirement plan "blackout" periods, and loans to company
executives (other than loans by financial institutions permitted by federal
rules and regulations) are restricted. In addition, a provision directs that
civil penalties levied by the Securities and Exchange Commission as a result of
any judicial or administrative action under Sarbanes-Oxley be deposited to a
fund for the benefit of harmed investors. The Federal Accounts for Investor
Restitution provision also requires the Securities and Exchange Commission to
develop methods of improving collection rates. The legislation accelerates the
time frame for disclosures by public companies, as they must immediately
disclose any material changes in their financial condition or operations.
Directors and executive officers must also provide information for most changes
in ownership in a company's securities within two business days of the change.
Sarbanes-Oxley also increases the oversight of, and codifies certain
requirements relating to audit committees of public companies and how they
interact with the company's "registered public accounting firm." Audit Committee
members must be independent and are absolutely barred from accepting consulting,
advisory or other compensatory fees from the issuer. In addition, companies must
disclose whether at least one member of the committee is a "financial expert"
(as such term is defined by the Securities and Exchange Commission) and if not,
why not. Under Sarbanes-Oxley, a company's registered public accounting firm is
prohibited from performing statutorily mandated audit services for a company if
such company's chief executive officer, chief financial officer, comptroller,
chief accounting officer or any person serving in equivalent positions had been
employed by such firm and participated in the audit of such company during the
one-year period preceding the audit initiation date. Sarbanes-Oxley also
prohibits any officer or director of a company or any other person acting under
their direction from taking any action to fraudulently influence, coerce,
manipulate or mislead any independent accountant engaged in the audit of the
company's financial statements for the purpose of rendering the financial
statements materially misleading. Sarbanes-Oxley also requires the Securities
and Exchange Commission to prescribe rules requiring inclusion of any internal
control report and assessment by management in the annual report to
shareholders. Sarbanes-Oxley requires the company's registered public accounting
firm that issues the audit report to attest to and report on management's
assessment of the company's internal controls.
Although we anticipate that we will incur additional expense in
complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, management does not expect that such compliance will have a
material impact on our results of operations or financial condition.
12
Factors Affecting Future Results
In addition to historical information, this Form 10-KSB includes
certain forward looking statements that involve risks and uncertainties such as
statements of Bancorp's plans, expectations and unknown outcomes. Bancorp's
actual results could differ materially from management expectations. Factors
that could contribute to those differences include, but are not limited to,
general economic conditions, legislative and regulatory changes, monetary and
fiscal policies of the federal government, changes in tax policies, rates and
regulations of federal and local tax authorities, changes in interest rates,
deposit flows, the cost of funds, demand for loan products, demand for financial
services, competition, changes in the quality or composition of the Bank's loan
and investment portfolios, changes in ownership status resulting in, among other
things, change in accounting principles, policies or guidelines, and other
economic, competitive, governmental and technological factors affecting the
Company's operations, markets, products, services and prices.
Item 2. Description of Property.
Bancorp executed a lease for a free-standing building located at 215
Church Street, New Haven, Connecticut, in the central business and financial
district of New Haven. The lease was assigned to the Bank, and the Bank assumed,
all obligations there under. The location is a former bank branch, which has
been renovated for use as the headquarters of the Bank and Bancorp. The building
has a drive-up teller, an automated teller machine, two vaults and a night
deposit drop.
The lease is for an initial term of five years and three months, with
an option to extend the lease for up to three additional terms of five years.
There was no base rent payable for the first three months of the initial term
and monthly rent was $4,117 until August 1, 2001. The annual base rent during
the balance of the initial term will be $107,400 for the first year and
increases each year to $125,500 for the fifth year. The base rent for the option
periods is also fixed in the lease. The Bank is responsible for all costs to
maintain the building, other than structural repairs, and for all real estate
taxes. The Bank, as Bancorp's assignee, will have a right of first refusal to
purchase the building.
To the extent that the building contains space not needed for our
operations, the Bank expects to sublease such excess to the extent practicable.
The Bank had subleased approximately 160 square feet of office space to Michael
M. Ciaburri d/b/a Ciaburri Bank Strategies, Joseph V. Ciaburri's son. Such lease
was terminated in February 2003 when Michael Ciaburri was appointed President
and Chief Operating Officer of the Bank. In addition, the Bank had subleased
approximately 1,045 square feet to Laydon and Company, LLC, an entity owned by
Elmer A. Laydon, the son of Elmer F. Laydon, one of our directors.
The Bank entered into a lease agreement on August 7, 2002 to lease the
facility at 445 West Main Street, Branford, Connecticut, the site of the
Branford branch which opened for business on October 7, 2002.
The Branford branch lease is for an initial term of five years, with an
option to extend the lease for up to three additional terms of five years. The
base rent payable for the initial term and monthly rent is $3,095 until
September 30, 2007. The base rent for the option periods increases and is fixed
in the lease. The Bank is responsible for all costs to maintain the building,
other than structural repairs, and for all real estate taxes.
On August 15, 2002 the Bank also purchased an additional branch
facility at 1475 Whalley Avenue, New Haven, Connecticut, the site of the Amity
branch location which is scheduled to be opened in by the end of the first
quarter of 2003. The cost of this facility including improvements through
December 31, 2002, was approximately $640,000. Additional costs of $492,000 are
anticipated to renovate, furnish and equip this branch for operation.
13
Item 3. Legal Proceedings.
There are no legal proceedings currently pending or threatened against
Bancorp or the Bank or their property. Bancorp is not aware of any proceeding
contemplated by a governmental entity involving Bancorp or the Bank.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of shareholders of Bancorp
during the fourth quarter of the fiscal year covered by this Form 10-KSB.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
Bancorp's Common Stock is quoted on the Over the Counter Market System
under the symbol "SCNO."
The following table sets forth the high and low sales price per share
of Bancorp's Common Stock, as reported on the Over the Counter Market as quoted
on www.bigcharts.marketwatch.com, on and after July 26, 2001, the date of stock
issuance:
(The prices listed may not reflect actual transactions.)
Quarter Ended High Low
-------------
March 31, 2002 $ 12.00 $ 8.50
June 30,2002 $ 11.00 $ 8.50
September 30, 2002 $ 10.00 $ 7.85
December 31, 2002 $ 9.50 $ 8.05
September 30, 2001 $ 12.10 $ 7.00
December 31, 2001 $ 10.25 $ 7.00
Holders
There were approximately 96 registered shareholders of record of
Bancorp's Common Stock as of February 28, 2003.
Dividends
No dividends have been declared to date. Management expects that
earnings, if any, will be retained and that no cash dividends will be paid in
the near future. Bancorp may, however, declare stock dividends at the discretion
of its Board of Directors.
The policy of the Connecticut Banking Commissioner is to not permit
payment of any cash dividends prior to recapture of organization and
pre-operating expenses from operating profits. In addition, the Bank is
prohibited by Connecticut law from declaring a cash dividend on its Common Stock
without prior approval of the Connecticut Banking Commissioner except from its
net profits for that year and any retained net profits of the preceding two
years. "Net profits" is defined as the remainder of all earnings from current
operations. In some instances, further restrictions on dividends may be imposed
by the FDIC. However, during 2002, the Bank requested, and was granted,
14
permission from the State of Connecticut Department of Banking, to pay a special
dividend to Bancorp in the amount of $200,000. At December 31, 2002 and 2001, no
dividends may be declared by the Bank without regulatory approval.
The payment of dividends by the Bank may also be affected by other
factors, such as the requirement to maintain capital in accordance with
regulatory guidelines. If, in the opinion of the Connecticut Banking
Commissioner, the Bank were engaged in or was about to engage in an unsafe or
unsound practice, the Commissioner could require, after notice and a hearing,
the Bank to cease and desist from the practice. The federal banking agencies
have indicated that paying dividends that deplete a depository institution's
capital base to an inadequate level would be an unsafe and unsound banking
practice. Under the Federal Deposit Insurance Corporation Improvements Act of
1991, a depository institution may not pay any dividend if payment would cause
it to become undercapitalized or if it already is undercapitalized. Moreover,
the federal banking agencies have issued policy statements that provide that
bank holding companies and insured banks should generally only pay dividends out
of current operating earnings.
Equity Compensation Plan Information
The following schedule provides information with respect to the
compensation plans (including individual compensation arrangements) under which
equity securities of Bancorp are authorized for issuance as of December 31,
2002:
------------------------------- ---------------------------- ---------------------------- ----------------------------
Plan Category Number of securities to be Weighted-average exercise Number of securities
issued upon exercise of price of outstanding remaining available for
outstanding options, options, warrants future issuance under
warrants and rights and rights equity compensation plans
(a) (excluding securities
(b) reflected in column (a))
------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plan 2,500 $12.00 247,500
approved by security holders
------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans not 64,900 $12.00 0 (1)
approved by security holders
------------------------------- ---------------------------- ---------------------------- ----------------------------
Total 67,400 $12.00 247,500
------------------------------- ---------------------------- ---------------------------- ----------------------------
The equity compensation plan approved by security holders referenced in
the chart, above, is the 2002 Plan. The plans not approved by security holders
are the Option Plan and the Warrant Plans.
(1) The Option Plan was terminated on May 14, 2002.
recent Sales of Unregistered Securities
Bancorp has not sold unregistered securities.
15
Item 6. Management's Discussion and Analysis or Plan of Operation.
(a) Plan of Operation
Bancorp currently has no business operations other than owning and
managing the Bank. The Bank's plan of operation for the next twelve months
contemplates the continuation of the business currently being conducted, with
the possibility of offering certain additional banking services, and the further
development of its customer base in the Bank's target market, which includes the
City of New Haven, Connecticut and the surrounding areas. For a description of
business currently being conducted, see Part I. Item 1. Description of Business.
De Novo banks in Connecticut have reached profitability on average
within three to four years after commencement of operations. The Company
anticipates that the Bank will reach profitability within that tine frame.
(b) Management's Discussion and Analysis of Financial Condition and Results of
Operations
Southern Connecticut Bancorp, Inc.
Financial Highlights
As of and for the years ended December 31, 2002 and 2001:
2002 2001
---- ----
Operating Data
Interest and dividend income $ 1,135,723 $ 131,916
Interest expense 441,813 52,774
Net interest income 693,910 79,142
Provision for loan losses 220,000 12,000
Noninterest income 75,761 581
Noninterest expenses 1,933,684 951,940
Net loss (1,384,013) (884,217)
Basic and diluted loss per share (1.43) (2.10)
Balance Sheet Data
Cash and due from banks $ 1,245,010 $ 686,467
Federal funds sold 1,144,000 3,670,000
Short-term investments 662,419 6,079,864
Investment securities 9,501,492 4,085,428
Loans, net 19,049,212 1,195,344
Assets 35,500,115 17,412,399
Total deposits 24,992,931 6,784,031
Securities sold under
agreements to repurchase 822,259 --
Total shareholders equity 8,274,679 9,596,147
Assets
Bancorp's total assets were $35.5 million as of December 31, 2002.
Earning assets comprise $30.6 million of the total asset volume. Bancorp has
maintained liquidity by maintaining balances in overnight Federal Funds and
Money Market Mutual Funds, to provide funding for higher yielding loans as they
16
are approved. In addition, during 2002, investment securities of $7.5 million
were transferred from held to maturity classification to available for sale
classification to provide additional liquidity. As of December 31, 2002, Federal
Funds Sold were $1.1 million and Money Market Mutual Fund balances were
$662,000. In addition, the Bank has invested $9.5 million in U.S Government
Agency securities classified as available for sale. The loan portfolio was $19.3
million as of December 31, 2002.
The earning asset growth has been funded partially by the initial
investment by Bancorp into the Bank and partly by deposit growth within the
Bank's market area. Deposits were $25.0 million as of December 31, 2002. The mix
of deposits includes non-interest bearing checking accounts of $6.4 million, low
cost funds including interest- bearing checking deposits of $2.4 million,
savings deposits of $1.0 million, money market deposit balances of $8.9 million,
as well as time certificates of deposit of $6.3 million. The Bank does not have
any brokered deposits.
The following table presents the maturity distribution of investment
securities at December 31, 2002 and the weighted average yield of such
securities. The weighted average yields were calculated based on the amortized
cost and effective yields to maturity of each security.
One Year After One
One Year Through but Within Over No
Available for sale or Less Five Years Ten Years Ten Years Maturity Total
------------------- ----------- ---------- ---------- --------- -------- -----
U. S. Government
agency obligations $ 2,008,973 $ 5,008,709 $ 1,300,000 $ 585,000 $ 496,360 $ 9,399,042
Weighted average yield 2.54% 3.83% 3.63% 4.50% 4.59% 3.61%
The following table presents a summary of investments for any issuer that
exceeds 10% of shareholders' equity at December 31, 2002.
Amortized Fair
Cost Value
U. S. Government agencies:
Federal Farm Credit Bank $1,007,225 $1,015,000
Federal Home Loan Mortgage 3,797,343 3,846,810
Federal Home Loan Bank 3,104,935 3,131,955
Federal National Mortgage Association 993,179 1,018,170
Loans
The Bank's net loan portfolio was $19.0 million at December 31, 2002.
Loan demand has been strong throughout the year. The loan to deposit ratio as of
December 31, 2002 was 77.1%. As this ratio increases toward the targeted 80% to
83% range, it is expected that the higher yielding loans versus Federal Funds
Sold, money market funds and investments will produce a positive impact on net
interest spread - see the table depicting the Distribution of Assets,
Liabilities and Shareholders' Equity; Interest Rates and Interest Differential
on Page 21 of this Form 10-KSB. There are no significant loan concentrations in
the loan portfolio.
17
The following table presents the maturities of loans in Bancorp's
portfolio at December 31, 2002 by type of loan, and the sensitivities of loans
to changes in interest rates:
Due after
Due in one year
one year through Due After
(Thousands of dollars) or less five years five years Total
-------------------------------------------------------------------------------------------
Commercial real estate $ 432 $ 140 $ 8,236 $ 8,808
Residential real estate 520 164 847 1,531
Construction loans 500 69 -- 569
Commercial loans 2,270 1,336 3,798 7,404
Consumer installment 303 320 88 711
Consumer home equity -- -- 314 314
------- ------- ------- -------
Total $ 4,025 $ 2,029 $13,283 $19,337
======= ======= ======= =======
Fixed rate loans $ 759 $ 1,692 $ 3,901 $ 6,352
Variable rate loans 3,266 337 9,382 12,985
------- ------- ------- -------
Total $ 4,025 $ 2,029 $13,283 $19,337
======= ======= ======= =======
Critical Accounting Policy
In the ordinary course of business, Bancorp has made a number of
estimates and assumptions relating to the reporting results of operations and
financial condition in preparing its financial statements in conformity with
accounting principals generally accepted in the United States of America. Actual
results could differ significantly from those estimates under different
assumptions and conditions. Bancorp believes the following discussion addresses
Bancorp's only critical accounting policy, which is the policy that is most
important to the portrayal of Bancorp's financial condition and results and
requires management's most difficult, subjective and complex judgments, often as
a result of the need to make estimates about the effect of matters that are
inherently uncertain.
Allowance for Loan Losses
The allowance for loan losses, a material estimate susceptible to
significant change in the near-term, is established as losses are estimated to
have occurred through a provision for losses charged against operations, and is
maintained at a level that management considers adequate to absorb losses in the
loan portfolio. Management's judgment in determining the adequacy of the
allowance is inherently subjective and is based on the evaluation of individual
loans, pools of homogeneous loans, the known and inherent risk characteristics
and size of the loan portfolios, the assessment of current economic and real
estate market conditions, estimates of the current value of underlying
collateral, past loan loss experience, review of regulatory authority
examination reports and evaluations of specific loans and other relevant
factors. Loans, including impaired loans, are charged against the allowance for
loan losses when management believes that the uncollectibility of principal is
confirmed. Any subsequent recoveries are credited to the allowance for loan
losses when received. In connection with the determination of the allowance for
loan losses, management obtains appraisals for significant properties, when
considered necessary.
Based upon this evaluation, management believes the allowance for loan
losses of $232,000 or 1.2% of gross loans at December 31, 2002 is adequate,
under prevailing economic conditions, to absorb losses on existing loans.
18
The accrual of interest income on loans is discontinued whenever
reasonable doubt exists as to its collectibility and generally is discontinued
when loans are past due 90 days as to either principal or interest, or are
otherwise considered impaired. When the accrual of interest income is
discontinued, all previously accrued and uncollected interest is reversed
against interest income. The accrual of interest on loans past due 90 days or
more may be continued if the loan is well secured, and it is believed all
principal and accrued interest income due on the loan will be realized, and the
loan is in the process of collection. A non-accrual loan is restored to an
accrual status when it is no longer delinquent and collectibility of interest
and principal is no longer in doubt.
Management considers all non-accrual loans, other loans past due 90
days or more, based on contractual terms, and restructured loans to be impaired.
In most cases, loan payments that are past due less than 90 days are considered
minor collection delays, and the related loans are not considered to be
impaired. Bancorp considers consumer installment loans to be pools of smaller
balance homogeneous loans, which are collectively evaluated for impairment.
Analysis of Allowance for Loan Losses
2002 2001
-------- --------
Balance at beginning of period $ 12,000 $ --
Charge-offs -- --
Recoveries -- --
-------- --------
Net (charge-offs) recoveries -- --
Additions charged to operations 220,000 12,000
-------- --------
Balance at end of period $232,000 $ 12,000
======== ========
There were no charge-offs or recoveries during 2002.
Allocation of the Allowance for Loan Losses at December 31:
2002 2001
---------------------------------- -----------------------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Balance Total Loans Balance Total Loans
------- ------------ ------- ---------------
Real Estate:
Commercial $ 88,083 45.56% $ 3,485 28.95%
Construction 8,538 2.94% -- --
Residential 3,828 7.92% -- --
Commercial 74,041 38.29% 6,990 61.45%
Consumer Installment 3,550 3.67% 1,525 6.29%
Consumer Home Equity 785 1.62% -- 3.31%
Unallocated 53,175 -- --
-------- ------ -------- ------
$232,000 100.00% $ 12,000 100.0%
======== ====== ======== ======
Non-Accrual, Past Due and Restructured Loans
There were no non-accrual or restructured loans at December 31, 2002.
There were no loans in 2002 considered as "troubled debt restructurings."
Potential Problem Loans
At December 31, 2002, the Bank had no loans as to which management has
significant doubts as to the ability of the borrower to comply with the present
repayment terms.
19
Deposits
Total deposits were $25.0 million at December 31, 2002. The deposit
total at December 31, 2002 consists of non-interest bearing checking at $6.4
million (25.6%), interest bearing checking and money market deposits at $11.2
million (44.8%), savings at $1.0 million (4.0%) and certificates of deposit at
$6.4 million (25.6%). The Bank does not have any brokered deposits.
The Bank continues to offer competitive interest rates in the very
competitive New Haven County marketplace in order to fund expected loan growth.
As of December 31, 2002, the Bank's maturities of time deposits were:
$100,000 Less than
or greater $100,000 Totals
-------- --------- --------
(Thousands of dollars)
Three months or less $ 1,671 $ 544 $ 2,215
Over three months to one year 1,514 1,006 2,520
Over one year 555 1,061 1,616
-------- --------- --------
$ 3,740 $ 2,611 $ 6,351
======== ========= ========
Other
The increase in accrued interest receivable is due to the interest
purchased on investments and accrued on earning assets.
The increase in other assets primarily reflects the purchase of the
cash surrender value amount of $521,000 of a previously issued whole life
insurance policy on the Chairman of the Company. The Bank is the beneficiary.
The increase in premises and equipment is due to the acquisition of the
building to be used for the Amity branch, and the capital lease incurred for,
and improvements made to, the Branford office.
The increase in Capital lease obligations from $850,000 to $1,191,000
is the result of the capital lease obligation incurred for the Branford office.
In September, 2002, the Bank began offering securities sold under
agreements to repurchase, which are classified as secured borrowings, and
generally mature within one to three days from the transaction date. Securities
sold under agreements to repurchase are recorded at the amount of cash received
in connection with the transaction. The Bank may be required to provide
additional collateral based on the changes in fair value of the underlying
securities.
20
The following table presents average balance sheets (daily
averages), interest income, interest expense, and the corresponding annualized
rates on earning assets and rates paid on interest bearing liabilities for the
years ended December 31, 2002 and 2001.
Distribution of Assets, Liabilities and Shareholders'
Equity; Interest Rates and Interest Differential
2002 2001
-------------------------------------- ---------------------------------------- Fluctuations in
interest
Interest Interest Annualized Income/
Average Income/ Average Average Income/ Average Expense
(Dollars in Thousands) Balance Expense Rate Balance Expense Rate (b) Total (c)
---------------------- --------- ----------- ---------- ------------------------- ----------- ------------
Interest earning assets
Loans $ 9,095 $ 754 8.29% $ 322 $ 7 8.70% $ 747
Short term investments 3,642 59 1.62% 2,938 16 2.18% 43
Investments 7,649 264 3.45% 357 2 2.24% 262
Federal funds sold 3,692 59 1.60% 8,677 45 2.07% 14
--------- ----------- ------------ ----------- ------------
Total interest earning assets 24,078 1,136 4.72% 12,294 70(a) 2.28% 1,066
----------- ----------- ------------
Cash and due from banks 902 356
Premises and equipment, net 1,915 1,475
Allowance for loan losses (70) -
Other 756 107
--------- ------------
Total assets $27,581 $ 14,232
========= ============
Interest bearing liabilities
Time certificates $ 5,106 156 3.06% $ 1,559 $ 12 3.08% 144
Savings deposits 625 10 1.60% 222 1 1.80% 9
Money market / checking deposits 7,514 135 1.80% 1,340 8 2.39% 127
Capital lease obligations 936 137 14.64% 850 32 15.06% 105
Repurchase agreements 388 4 1.03% - - - 4
--------- ----------- ------------ ----------- ------------
Total interest bearing liabilities 14,569 442 3.03% 3,971 53 5.34% 389
--------- ----------- ------------ ----------- ------------
Non-interest bearing deposits 3,686 243
Accrued expenses and
other liabilities 210 135
Shareholder's equity 9,116 9,883
--------- ------------
Total liabilities and equity $27,581 $ 14,232
========= ============
Net interest income $ 694 $ 17 $ 677
=========== ============= ==============
Interest margin 2.88% .60%
========== ===========
Interest spread 1.69% (3.06)%
========== ===========
(a) For the year ended December 31, 2001, interest income was $132,000 or
$62,000 greater than the fourth quarter amount of $70,000 in the table above.
The $62,000 represents interest earned primarily on the net proceeds of the
stock issuance from July 26, 2001 through September 30, 2001. The average
annualized yield for that period was 3.35 % on an average balance of $10.2
million
(b) Because the Bank only had operations in the fourth quarter of 2001, the
actual calculated rates for 2001 have been multiplied by four to reflect an
estimate of the annual yields on the interest earning assets and interest
bearing liabilities.
21
(c) The fluctuations in interest income and interest expense due to changes in
rate and volume are not presented herein. Because the Bank only had operations
in the fourth quarter of 2001, calculations of such changes are not practicable
and are not meaningful. The increases in interest income and expense are due
mainly to increases in the average balances of the related assets and
liabilities and the fact that such assets and liabilities existed for a full
year in 2002 versus only one quarter in 2001.
The Bank's operations began October 1, 2001. A quality loan portfolio
takes time to develop, but with the existing backlog in loan requests, it is
anticipated that the interest spread will improve as loan volume increases. The
liquidity in the lower yielding short-term investments and Federal Funds sold is
available for investment into higher yielding loans. Also, the deposit
liabilities have been gathered to support the anticipated loan growth.
The following are measurements of Bancorp's earnings (loss) in relation
to assets and equity, and average equity to average assets for the year ended
December 31, 2002 (first full year of operations) and 2001.
2002 2001
---- ----
Return on average assets ( 5.02) % (13.83) %
Return on average equity (15.18) % (19.92) %
Average equity to average assets 33.05 % 69.44 %
Bancorp's net loss for the quarter ended December 31, 2001 was
$492,167.
Results of Operations
Since there were no operations during the first nine months of 2001,
comparisons of results of operations to the corresponding period in the prior
year is not meaningful. The income and expenses from operations during the year
ended December 31, 2002 are typical of a new bank and bank holding company, and
there were no unusual financial matters during the year ended December 31, 2002.
Liquidity
Bancorp's liquidity position as of December 31, 2002 and December 31,
2001 consisted of liquid assets totaling $12.6 million and $11.4 million,
respectively. This represents 35.5% and 65.6% of total assets at December 31,
2002 and 2001, respectively. The liquidity ratio is defined as the percentage of
liquid assets to total assets. The following categories of assets as described
in the accompanying balance sheet are considered liquid assets: Cash and due
from banks, federal funds sold, short-term investments, held to maturity
securities maturing in one year or less and securities available for sale.
Liquidity is a measure of Bancorp's ability to generate adequate cash to meet
financial obligations. The principal cash requirements of a financial
institution are to cover downward fluctuations in deposits and increases in its
loan portfolio.
Management believes Bancorp's short-term assets have sufficient
liquidity to cover potential fluctuations in deposit accounts and loan demand
and to meet other anticipated operating cash requirements.
Capital
The following table illustrates the Bank's regulatory capital ratios at
December 31:
2002 2001
---- ----
Leverage Capital 23.76% 67.40 %
Tier 1 Risk - Based Capital 31.52% 90.54 %
Total Risk - Based Capital 32.43% 90.66 %
22
Capital adequacy is one of the most important factors used to determine
the safety and soundness of individual banks and the banking system. Based on
the above ratios, the Bank is considered to be "well capitalized" under
applicable regulations. To be considered "well capitalized" an institution must
generally have a leverage capital ratio of at least 5%, a Tier 1 risk-based
capital ratio of at least 6% and a total risk-based capital ratio of at least
10%.
Bancorp is also considered to be well capitalized under the regulatory
framework specified by the Federal Reserve Bank ("FRB"). Bancorp's actual and
required ratios are not substantially different from those shown above.
Market Risk
Market risk is defined as the sensitivity of income to fluctuations in
interest rates, foreign exchange rates, equity prices, commodity prices and
other market-driven rates or prices. Based upon on the nature of the Company's
business, market risk is primarily limited to interest rate risk, which is the
impact that changing interest rates have on current and future earnings.
Bancorp's goal is to maximize long-term profitability, while minimizing
its exposure to interest rate fluctuations. The first priority is to structure
and price Bancorp's assets and liabilities to maintain an acceptable interest
rate spread, while reducing the net effect of changes in interest rates. In
order to reach an acceptable interest rate spread, Bancorp must generate loans
and seek acceptable long-term investments to replace the lower yielding balances
in Federal Funds sold and short-term investments. The focus also must be on
maintaining a proper balance between the timing and volume of assets and
liabilities re-pricing within the balance sheet. One method of achieving this
balance is to originate variable loans for the portfolio to offset the
short-term re-pricing of the liabilities. In fact, a number of the interest
bearing deposit products have no contractual maturity. Customers may withdraw
funds from their accounts at any time and deposits balances may therefore run
off unexpectedly due to changing market conditions.
The exposure to interest rate risk is monitored by the Asset and
Liability Management Committee ("ALCO") consisting of senior management
personnel and selected members of the Board of Directors. ALCO reviews the
interrelationships within the balance sheet to maximize net interest income
within acceptable levels of risk. ALCO reports to the Board of Directors on a
quarterly basis regarding the status of ALCO activities within the Company.
Impact of Inflation and Changing Prices
Bancorp's financial statements have been prepared in terms of
historical dollars, without considering changes in relative purchasing power of
money over time due to inflation. Unlike most industrial companies, virtually
all of the assets and liabilities of a financial institution are monetary in
nature. As a result, interest rates have a more significant impact on a
financial institution's performance than the effect of general levels of
inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as the prices of goods and services. Notwithstanding this
fact, inflation can directly affect the value of loan collateral, in particular,
real estate. Inflation, or disinflation, could significantly affect Bancorp's
earnings in future periods. "Safe Harbor" Statement Under Private Securities
Litigation Reform Act of 1995
Certain statements contained in Bancorp's public reports, including
this report, and in particular in this "Management's Discussion and Analysis or
Plan of Operation", may be forward looking and subject to a variety of risks and
uncertainties. These factors include, but are not limited to, (1) changes in
prevailing interest rates which would affect the interest earned on Bancorp's
interest earning assets and the interest paid on its bearing liabilities, (2)
the timing of re-pricing of Bancorp's interest earning assets and interest
bearing liabilities, (3) the effect of changes in governmental monetary policy,
(4) the effect of changes in regulations applicable to Bancorp and the conduct
23
of its business, (5) changes in competition among financial service companies,
including possible further encroachment of non-banks on services traditionally
provided by banks and the impact of recently enacted federal legislation, (6)
the ability of competitors which are larger than Bancorp to provide products and
services which it is impracticable for Bancorp to provide, (7) the effect of
Bancorp's opening of branches, (8) the effect of any decision by Bancorp to
engage in any business not historically permitted to it. Other such factors may
be described in Bancorp's filings with the SEC.
Although Bancorp believes that it offers the loan and deposit products
and has the resources needed for success, future revenues and interest spreads
and yields cannot be reliably predicted. These trends may cause Bancorp to
adjust its operations in the future. Because of the foregoing and other factors,
recent trends should not be considered reliable indicators of future financial
results or stock prices.
Item 7. Financial Statements
The consolidated balance sheets of Bancorp as of December 31, 2002 and
2001, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years then ended, together with the report thereon
of McGladrey & Pullen, LLP dated March 11, 2003 are included as part of this
Form 10-KSB in the "Financial Report" following page 31 hereof.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 9. Directors and Executive Officers of the Registrant
The information required by this Item 9 is incorporated into this Form
10-KSB by reference to Bancorp's definitive proxy statement for its 2003 Annual
Meeting of Shareholders (the "Definitive Proxy Statement").
Item 10. Executive Compensation
The information required by this Item 10 is incorporated into this Form
10-KSB by reference to the Definitive Proxy Statement.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item 11 is incorporated into this Form
10-KSB by reference to the Definitive Proxy Statement.
Item 12. Certain Relationships and Related Transactions and Related Stockholder
Matters
The information required by this Item 12 is incorporated into this Form
10-KSB by reference to the Definitive Proxy Statement.
Item 13. Exhibits, List and Reports on Form 8-K
(a) Exhibits
24
3(i) Amended and Restated Certificate of Incorporation of the Issuer
(incorporated by reference to Exhibit 3(i) to the Issuer's Registration
Statement on Form SB-2 (No. 333-59824))
3(ii) By-Laws of the Issuer (incorporated by reference to Exhibit 3(ii) to
the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
21. Subsidiaries (See Exhibit 21 attached hereto)
(b) Reports on Form 8-K
The issuer filed one report on Form 8-K during the fourth quarter of
2002.
Resignation, effective November 26, 2002, of Paul V. Erwin, the Chief
Financial Officer of Bancorp.
The 8-K report was filed on November 27, 2002.
Item 14. Controls and Procedures
(a) Evaluation of disclosure controls and procedures
Under the supervision and with the participation of our management,
including our Chairman and Chief Executive Officer and Interim Controller, we
evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rule
13a-14(c) under the Exchange Act) as of a date (the "Evaluation Date") within 90
days prior to the filing date of this report. Based upon that evaluation, the
Chairman and Chief Executive Officer and Interim Controller concluded that, as
of the Evaluation Date, our disclosure controls and procedures were effective in
timely alerting him to the material information relating to us required to be
included in our periodic SEC filings.
(b) Changes in Internal Controls
There have not been any significant changes in Bancorp's internal
controls or in other factors that could significantly affect these controls
subsequent to the evaluation referenced in paragraph (a) above.
25
SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly
SOUTHERN CONNECTICUT BANCORP, INC.
(Registrant)
By: /S/ Joseph V. Ciaburri
-----------------------
Name: Joseph V. Ciaburri
Title: Chairman and
Chief Executive Officer
Date: March 31, 2003
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in capacities and
on the dates indicated.
/S/ Joseph V. Ciaburri March 31, 2003
-------------------------------------- --------------
Joseph V. Ciaburri Date
Chief Executive Officer and Director
/S/ Elmer F. Laydon March 31, 2003
-------------------------------------- --------------
Elmer F. Laydon Date
Vice Chairman and Director
/S/ Juan Jose Alvarez de Lugo March 31, 2003
-------------------------------------- --------------
Juan Jose Alvarez de Lugo Date
Director
/S/ G. Leon Jacobs March 31, 2003
-------------------------------------- --------------
G. Leon Jacobs Date
Director
/S/ Joshua H. Sandman March 31, 2003
-------------------------------------- --------------
Joshua H. Sandman Date
Director
/S/ Alphonse F. Spadaro, Jr. March 31, 2003
-------------------------------------- --------------
Alphonse F. Spadaro, Jr. Date
Director
/S/ Carl R. Borrelli March 31, 2003
-------------------------------------- --------------
Carl R. Borrelli Date
Director
/S/ Anthony M. Avellani March 31, 2003
-------------------------------------- --------------
Anthony M. Avellani Date
Interim Controller
26
CERTIFICATION
I, Joseph V. Ciaburri, Chairman and Chief Executive Officer of Southern
Connecticut Bancorp, Inc., certify that:
1. I have reviewed this annual report on Form 10-KSB of Southern
Connecticut Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
By: /S/ Joseph V. Ciaburri
Joseph V. Ciaburri
Chairman and Chief Executive Officer
27
CERTIFICATION
I, Anthony M. Avellani, Interim Controller of Southern Connecticut
Bancorp, Inc., certify that:
1. I have reviewed this annual report on Form 10-KSB of Southern
Connecticut Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
By: /S/ Anthony M. Avellani
Anthony M. Avellani
Interim Controller
28
CERTIFICATION
I, Joseph V. Ciaburri, the Chairman and Chief Executive Officer of
Southern Connecticut Bancorp, Inc. (the "Company") certify, pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that:
(i) the annual report on Form 10-KSB of the Company for the period
ended December 31, 2002 fully complies with the requirements of Section 13(a) of
the Securities Exchange Act of 1934; and
(ii) the information contained in such annual report fairly presents,
in all material respects, the financial condition and results of operations of
the Company.
Date: March 31, 2003
By: /S/ JOSEPH V. CIABURRI
-----------------------
Joseph V. Ciaburri
Chairman & Chief Executive Officer
29
CERTIFICATION
I, Anthony M. Avellani, Interim Controller of Southern Connecticut
Bancorp, Inc. (the "Company") certify, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
(i) the annual report on Form 10-KSB of the Company for the period
ended December 31, 2002 fully complies with the requirements of Section 13(a) of
the Securities Exchange Act of 1934; and
(ii) the information contained in such annual report fairly presents,
in all material respects, the financial condition and results of operations of
the Company.
Date: March 31, 2003
By: /S/ Anthony M. Avellani
Anthony M. Avellani
Interim Controller
30
Exhibit and Index
No. Description Referral
--- ----------- --------
3(i) --- ---
3(ii) --- ---
21 Subsidiaries Attached hereto
31
CONTENTS
--------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT 1
--------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets 2
Consolidated Statements of Operations 3
Consolidated Statements of Shareholders' Equity 4
Consolidated Statements of Cash Flows 5-6
Notes to Consolidated Financial Statements 7-29
--------------------------------------------------------------------
SOUTHERN CONNECTICUT BANCORP, INC.
FINANCIAL REPORT
December 31, 2002 and 2001
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Southern Connecticut Bancorp, Inc.
New Haven, Connecticut
We have audited the accompanying consolidated balance sheets of Southern
Connecticut Bancorp, Inc. and Subsidiary (the "Company") as of December 31, 2002
and 2001, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Southern Connecticut
Bancorp, Inc. and Subsidiary as of December 31, 2002 and 2001, and the results
of their operations and their cash flows for the years then ended, in conformity
with accounting principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
New Haven, Connecticut
March 11, 2003
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
------------------------------------------------------------------------------------------------------------------
2002 2001
-------------------------------
ASSETS
Cash and due from banks (Note 3) $ 1,245,010 $ 686,467
Federal funds sold 1,144,000 3,670,000
Short-term investments (Note 3) 662,419 6,079,864
-------------------------------
Cash and cash equivalents 3,051,429 10,436,331
-------------------------------
Available for sale securities (at fair value) (Note 4) 9,501,492 -
Held to maturity securities (fair value: 2001 $4,081,373) (Note 5) - 4,085,428
Federal Home Loan Bank stock (Note 9) 500 -
Loans receivable (net of allowance for loan losses: 2002 $232,000;
2001 $12,000) (Note 6) 19,049,212 1,195,344
Accrued interest receivable 187,672 77,892
Premises and equipment, net (Note 7) 3,052,921 1,479,620
Other assets 656,889 137,784
-------------------------------
Total assets $ 35,500,115 $ 17,412,399
===============================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits (Note 8)
Noninterest bearing deposits $ 6,401,759 $ 662,366
Interest bearing deposits 18,591,172 6,121,665
-------------------------------
Total deposits 24,992,931 6,784,031
Securities sold under agreements to repurchase 822,259 -
Accrued expenses and other liabilities 178,489 182,221
Capital lease obligations (Note 10) 1,191,852 850,000
Deferred tax liability (Note 11) 39,905 -
-------------------------------
Total liabilities 27,225,436 7,816,252
-------------------------------
Commitments and Contingencies (Notes 9, 10, 12, 14, 15 and 18)
Shareholders' Equity (Notes 2, 12 and 15)
Preferred stock, no par value; 500,000 shares authorized;
none issued - -
Common stock, par value $.01; shares authorized: 2002 - 5,000,000;
2001 - 2,500,000; shares issued and outstanding: 966,667 in 2002 and 2001 9,667 9,667
Additional paid-in capital 10,705,382 10,705,382
Accumulated deficit (2,502,915) (1,118,902)
Accumulated other comprehensive income - net unrealized gain on
available for sale securities 62,545 -
-------------------------------
Total shareholders' equity 8,274,679 9,596,147
-------------------------------
Total liabilities and shareholders' equity $ 35,500,115 $ 17,412,399
===============================
See Notes to Consolidated Financial Statements.
2
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2002 and 2001
-------------------------------------------------------------------------------------------------------------------
2002 2001
------------------------------
Interest Income:
Interest and fees on loans $ 753,903 $ 7,361
Interest on securities 263,529 1,950
Interest on Federal funds sold and short-term investments 118,291 122,605
------------------------------
Total interest income 1,135,723 131,916
------------------------------
Interest Expense:
Interest expense on deposits (Note 8) 300,694 21,148
Interest expense on capital lease obligations 137,402 31,626
Interest expense on repurchase agreements 3,717 -
------------------------------
Total interest expense 441,813 52,774
------------------------------
Net interest income 693,910 79,142
------------------------------
Provision for Loan Losses (Note 6) 220,000 12,000
------------------------------
Net interest income after
provision for loan losses 473,910 67,142
------------------------------
Noninterest Income - service charges and fees 75,761 581
------------------------------
Noninterest Expenses:
Salaries and benefits (Note 9) 913,853 371,038
Professional services 368,131 213,664
Occupancy and equipment expense 183,550 86,210
Advertising and promotional expenses 97,732 40,824
Data processing and other outside services 124,841 20,179
Forms, printing and supplies 39,036 19,886
Organizer warrant expense (Note 12) - 70,000
Other operating expenses 206,541 130,139
------------------------------
Total noninterest expenses 1,933,684 951,940
------------------------------
Net loss $(1,384,013) $ (884,217)
==============================
Basic and Diluted Loss per Share $ (1.43) $ (2.10)
==============================
Dividends per Share $ - $ -
==============================
See Notes to Consolidated Financial Statements.
3
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2002 and 2001
---------------------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Other
Number Common Paid-In Accumulated Comprehensive
of Shares Stock Capital Deficit Income Total
------------------------------------------------------------------------------------
Balance, December 31, 2000 - $ - $ - $ (234,685) $ - $ (234,685)
Net loss - - - (884,217) - (884,217)
Issuance of common stock (Note 2) 966,667 9,667 10,635,382 - - 10,645,049
Issuance of common stock warrants (Note 12) - - 70,000 - - 70,000
------------------------------------------------------------------------------------
Balance, December 31, 2001 966,667 9,667 10,705,382 (1,118,902) - 9,596,147
---------------
Comprehensive income:
Net loss - - - (1,384,013) - (1,384,013)
Unrealized holding gain on available for
sale securities (Note 17) - - - - 62,545 62,545
---------------
Total comprehensive income (loss) (1,321,468)
------------------------------------------------------------------------------------
Balance December 31, 2002 966,667 $ 9,667 $ 10,705,382 $ (2,502,915) $ 62,545 $ 8,274,679
==================================================================== ===============
See Notes to Consolidated Financial Statements.
4
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2002 and 2001
------------------------------------------------------------------------------------------------------------------
2002 2001
-----------------------------------
Cash Flows From Operations
Net loss $ (1,384,013) $ (884,217)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization and accretion of premiums and discounts
on investments, net 47,441 765
Provision for loan losses 220,000 12,000
Depreciation and amortization 117,498 24,605
Issuance of stock warrants to organizers - 70,000
Changes in assets and liabilities:
Increase in deferred loan fees 54,091 1,494
Increase in accrued interest receivable (109,780) (77,892)
Decrease (increase) in other assets 1,895 (127,942)
(Decrease) increase in accrued expenses and other liabilities (3,732) 71,635
-----------------------------------
Net cash used in operating activities (1,056,600) (909,552)
-----------------------------------
Cash Flows From Investing Activities
Purchases of available for sale securities (1,890,699) -
Principal repayments on available for sale securities 7,173 -
Purchases of held to maturity securities (6,277,529) (4,086,193)
Maturities of held to maturity securities 2,800,000 -
Purchase of FHLB stock (500) -
Net increase in loans receivable (18,127,959) (1,208,838)
Purchase of life insurance policy (521,000) -
Purchases of premises and equipment (1,348,763) (654,225)
-----------------------------------
Net cash used in investing activities (25,359,277) (5,949,256)
-----------------------------------
Cash Flows From Financing Activities
Net increase in demand, savings and money market deposits 15,295,349 3,437,756
Net increase in time certificates of deposit 2,913,551 3,346,275
Net increase in securities sold under agreements to repurchase 822,259 -
Principal repayments on capital lease obligations (184) -
Decrease in deferred stock issuance costs - 76,192
Decrease in advances from organizers and other individuals - (260,000)
Net proceeds from sale of common stock - 10,645,049
-----------------------------------
Net cash provided by financing activities 19,030,975 17,245,272
-----------------------------------
Net (decrease) increase in cash and cash equivalents (7,384,902) 10,386,464
Cash and cash equivalents
Beginning 10,436,331 49,867
-----------------------------------
Ending $ 3,051,429 $ 10,436,331
===================================
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
For the Years Ended December 31, 2002 and 2001
------------------------------------------------------------------------------------------------------------------
2002 2001
-----------------------------------
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
Transfer of held to maturity securities to available for sale securities (Note 5) $ 7,517,682 $ -
===================================
Unrealized holding gains on available for sale securities arising during the period $ 102,450 $ -
===================================
Capital lease incurred for acquisition of building $ 342,036 $ 850,000
===================================
Supplemental Disclosures of Cash Flow Information:
Cash paid for:
Interest $ 417,344 $ 42,080
===================================
Income taxes $ - $ -
===================================
See Notes to Consolidated Financial Statements.
6
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
--------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies
Southern Connecticut Bancorp, Inc. (the "Company"), a Connecticut corporation,
is a bank holding company incorporated on November 8, 2000 for the purpose of
forming, and becoming the sole shareholder of, the Bank of Southern Connecticut
(the "Bank"). The Bank provides a full range of banking services to commercial
and consumer customers, primarily concentrated in the New Haven County area of
Connecticut, through its main office in New Haven, Connecticut and one branch
office in Branford, Connecticut.
Formation of the Bank and development stage activities
------------------------------------------------------
On September 7, 2000, the Bank received preliminary approval to operate as a
commercial bank from the Connecticut State Banking Commissioner, the Connecticut
State Treasurer and the Connecticut State Comptroller (the "Connecticut
Chartering Authority"). From December 1999 to September 2001, the Company was
primarily involved with raising capital and satisfying other conditions
precedent to receiving final regulatory approval to commence operations.
On July 26, 2001 the Company sold 966,667 shares of the Company's common stock
at $12.00 per share and, on October 1, 2001, invested $10,360,000 of the common
stock proceeds and certain net assets into the Bank to meet the capital required
under the Temporary Certificate of Authority granted to the Bank by the
Connecticut Chartering Authority as a condition of the Bank's receiving a Final
Certificate of Authority.
On October 1, 2001 the Bank received its Final Certificate of Authority,
received its deposit insurance from the Federal Deposit Insurance Corporation
and commenced operations.
Prior to October 1, 2001, the Company was a development stage enterprise.
Significant group concentrations of credit risk
-----------------------------------------------
Most of the Company's activities are with customers located within the New Haven
County region of Connecticut. Notes 4 and 5 discuss the types of securities that
the Company invests in and Note 6 discusses the types of lending that the
Company engages in. The Company does not have any significant concentrations in
any one industry or customer.
Principles of consolidation and basis of financial statement presentation
-------------------------------------------------------------------------
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, the Bank, and have been prepared in accordance with
accounting principles generally accepted in the United States of America and
general practices within the banking industry. All significant intercompany
balances and transactions have been eliminated. In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities, and disclosures of
7
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
contingent assets and liabilities as of the date of the balance sheet and the
reported amounts of income and expenses for the reporting period. Actual results
could differ from those estimates.
The following is a summary of the Company's significant accounting policies.
Cash and cash equivalents and statement of cash flows
-----------------------------------------------------
Cash and due from banks, Federal funds sold, and short-term investments are
recognized as cash equivalents in the statements of cash flows. Federal funds
sold generally mature in one day. For purposes of reporting cash flows, the
Company considers all highly liquid debt instruments purchased with an original
maturity of three months or less to be cash equivalents. Cash flows from
deposits are reported net. The Company maintains amounts due from banks and
Federal funds sold which, at times, may exceed Federally insured limits. The
Company has not experienced any losses from such concentrations.
Investments in debt and marketable equity securities
----------------------------------------------------
Management determines the appropriate classification of securities at the date
individual investment securities are acquired, and the appropriateness of such
classification is reassessed at each balance sheet date.
Debt securities that management has the positive intent and ability to hold to
maturity are classified as "held to maturity" and recorded at amortized cost.
"Trading" securities, if any, are carried at fair value with unrealized gains
and losses recognized in earnings. Securities not classified as held to maturity
or trading, including equity securities with readily determinable fair values,
are classified as "available for sale" and recorded at fair value, with
unrealized gains and losses excluded from earnings and reported in other
comprehensive income.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the fair value of
held to maturity and available for sale securities below their cost that are
deemed to be other than temporary are reflected in earnings as realized losses.
Gains and losses on the sale of securities are recorded on the trade date and
are determined using the specific identification method.
The sale of a held to maturity security within three months of its maturity date
or after collection of at least 85% of the principal outstanding at the time the
security was acquired is considered a maturity for purposes of classification
and disclosure.
Transfers of debt securities into the held to maturity classification from the
available for sale classification are made at fair value on the date of
transfer. The unrealized holding gain or loss on the date of transfer is
retained in accumulated other comprehensive income and in the carrying value of
the held to maturity securities. Such amounts are amortized over the remaining
contractual lives of the securities by the interest method.
8
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Loans receivable
----------------
Loans receivable are stated at their current unpaid principal balances, net of
the allowance for loan losses and net deferred loan origination fees and costs.
The Company has the ability and intent to hold its loans receivable for the
foreseeable future or until maturity or payoff.
A loan is classified as a restructured loan when certain concessions have been
made to the original contractual terms, such as a reduction in interest rate or
deferral of interest or principal payments, due to the borrower's financial
condition.
Impaired loans, if any, are measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or, as a
practical expedient, at the loan's observable market price or the fair value of
the collateral, if the loan is collateral dependent. The amount of impairment,
if any, and any subsequent changes are recorded as adjustments to the allowance
for loan losses. A loan is impaired when it is probable the Company will be
unable to collect all contractual principal and interest payments due in
accordance with the terms of the loan agreement.
Management considers all nonaccrual loans, other loans past due 90 days or more,
and restructured loans to be impaired. In most cases, loan payments that are
past due less than 90 days, based on contractual terms, are considered minor
collection delays, and the related loans are not considered to be impaired. The
Company considers consumer installment loans to be pools of small balance
homogeneous loans, which are collectively evaluated for impairment.
Allowance for loan losses
-------------------------
The allowance for loan losses, a material estimate susceptible to significant
change in the near-term, is established as losses are estimated to have occurred
through a provision for losses charged against operations, and is maintained at
a level that management considers adequate to absorb losses in the loan
portfolio. Management's judgment in determining the adequacy of the allowance is
inherently subjective and is based on the evaluation of individual loans, pools
of homogeneous loans, the known and inherent risk characteristics and size of
the loan portfolios, the assessment of current economic and real estate market
conditions, estimates of the current value of underlying collateral, past loan
loss experience, review of regulatory authority examination reports and
evaluations of specific loans and other relevant factors. Loans, including
impaired loans, are charged against the allowance for loan losses when
management believes that the uncollectibility of principal is confirmed. Any
subsequent recoveries are credited to the allowance for loan losses when
received. In connection with the determination of the allowance for loan losses,
management obtains appraisals for significant properties, when considered
necessary.
Management believes the allowance for loan losses is adequate. While management
uses available information to recognize losses on loans, future additions to the
allowance may be necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process,
9
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
periodically review the Company's allowance for loan losses. Such agencies have
the authority to require the Company to recognize additions to the allowance or
charge-offs based on the agencies' judgments about information available to them
at the time of their examination.
Interest and fees on loans
--------------------------
Interest on loans is accrued and included in operating income based on
contractual rates applied to principal amounts outstanding. The accrual of
interest income is discontinued whenever reasonable doubt exists as to its
collectibility and generally is discontinued when loans are past due 90 days as
to either principal or interest, or are otherwise considered impaired. When the
accrual of interest income is discontinued, all previously accrued and
uncollected interest is reversed against interest income. The accrual of
interest on loans past due 90 days or more may be continued if the loan is well
secured, and it is believed all principal and accrued interest income due on the
loan will be realized, and the loan is in the process of collection. A
nonaccrual loan is restored to an accrual status when it is no longer delinquent
and collectibility of interest and principal is no longer in doubt.
Loan origination fees, net of direct loan origination costs, are deferred and
amortized as an adjustment to the loan's yield generally over the contractual
life of the loan, utilizing the interest method.
Transfers of financial assets
-----------------------------
Transfers of financial assets are accounted for as sales when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right to pledge or exchange the transferred assets and no
condition both constrains the transferee from taking advantage of that right and
provides more than a trivial benefit for the transferor, and (3) the transferor
does not maintain effective control over the transferred assets through either
(a) an agreement that both entitles and obligates the transferor to repurchase
or redeem the assets before maturity or (b) the ability to unilaterally cause
the holder to return specific assets, other than through a cleanup call.
Premises and equipment
----------------------
Premises and equipment are stated at cost for purchased assets, and for assets
under capital lease, at the lower of fair value or the net present value of the
minimum lease payments required over the term of the lease, net of accumulated
depreciation and amortization. Leasehold improvements are capitalized and
amortized over the shorter of the terms of the related leases or the estimated
economic lives of the improvements. Depreciation is charged to operations using
the straight-line method over the estimated useful lives of the related assets
which range from 3 to 20 years. Gains and losses on dispositions are recognized
upon realization. Maintenance and repairs are expensed as incurred and
improvements are capitalized.
10
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Securities sold under agreements to repurchase
----------------------------------------------
Securities sold under agreements to repurchase, which are classified as secured
borrowings, generally mature within one to three days from the transaction date.
Securities sold under agreements to repurchase are reflected at the amount of
cash received in connection with the transaction. The Company may be required to
provide additional collateral based on the fair value of the underlying
securities.
Income taxes
------------
The Company recognizes income taxes under the asset and liability method. Under
this method, deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and loss carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized.
Stock compensation plans
------------------------
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation", encourages all entities to adopt a fair value based
method of accounting for employee stock compensation plans, whereby compensation
cost is measured at the grant date based on the value of the award and is
recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date (or other measurement date) over the
amount an employee must pay to acquire the stock. Stock options issued to
employees and directors under the Company's stock option and warrant plans have
no intrinsic value at the grant date, and under Opinion No. 25 no compensation
cost is recognized for them. During 2002, the Company adopted SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure, an
Amendment of FASB Statement No. 123." The Company has elected to continue with
the accounting methodology in Opinion No. 25 and, as a result, has provided pro
forma disclosures of net loss and earnings per share and other disclosures, as
if the fair value based method of accounting had been applied.
Had compensation cost for issuance of such options and warrants been recognized
based on the fair values of awards on the grant dates, in accordance with the
method described in SFAS No. 123, reported net loss and per share amounts for
2002 and 2001 would have been increased to the pro forma amounts shown below:
11
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
2002 2001
--------------------------------------
Net loss, as reported $ (1,384,013) $ (884,217)
Deduct: total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects (138,009) (81,167)
---------------------------------------
Pro forma net loss $ (1,522,022) $ (965,384)
=======================================
Basic and diluted loss per share:
As reported $ (1.43) $ (2.10)
=======================================
Pro forma $ (1.57) $ (2.29)
=======================================
Related party transactions
--------------------------
Directors and officers of the Company and the Bank and their affiliates have
been customers of and have had transactions with the Bank, and it is expected
that such persons will continue to have such transactions in the future.
Management believes that all deposit accounts, loans, services and commitments
comprising such transactions were made in the ordinary course of business, and
on substantially the same terms, including interest rates, as those prevailing
at the time for comparable transactions with other customers who are not
directors or officers. In the opinion of management, the transactions with
related parties did not involve more than normal risks of collectibility or
favored treatment or terms, or present other unfavorable features. Notes 3, 10
and 16 contain details regarding related party transactions.
Comprehensive income
--------------------
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available for sale
securities, are reported as a separate component of the shareholders' equity
section of the balance sheets, such items, along with net income or loss, are
components of comprehensive income.
Fair value of financial instruments
-----------------------------------
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments.
Cash and due from banks, Federal funds sold, short-term investments,
accrued interest receivable and securities sold under agreements to
repurchase
The carrying amount is a reasonable estimate of fair value.
12
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Securities
Fair values are based on quoted market prices or dealer quotes, if
available. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loans receivable
For variable rate loans which reprice frequently, and have no significant
changes in credit risk, fair value is based on the loan's carrying value.
The fair value of fixed rate loans is estimated by discounting the future
cash flows using the year-end rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining
maturities.
Deposits
The fair value of demand deposits, regular savings and certain money
market deposits is the amount payable on demand at the reporting date. The
fair value of certificates of deposit and other time deposits is estimated
using a discounted cash flow calculation that applies interest rates
currently being offered for deposits of similar remaining maturities to a
schedule of aggregated expected maturities on such deposits.
Off-balance-sheet instruments
Fair values for the Company's off-balance-sheet instruments (lending
commitments) are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and
the counterparties' credit standing.
Note 2. Common Stock Offering
On July 26, 2001, the Company completed the initial public offering of its
common stock through the sale of 966,667 shares of its $0.01 par value common
stock at an offering price of $12.00 per share. The net proceeds of the offering
and conversion of $554,000 of advances from the Bank's organizers and other
individuals amounted to $10,645,049, net of stock issuance costs of $954,951.
The par value of the shares issued, $9,667, was credited to common stock and the
excess of the net proceeds and conversion of advances over the par value of the
shares, $10,635,382, was credited to additional paid-in capital.
Note 3. Restrictions on Cash and Cash Equivalents
At December 31, 2002, the Company was required to maintain $25,000 in the
Federal Reserve Bank for clearing purposes. In addition, approximately $100,000
of short-term investments are maintained at another financial institution to
secure available customer letters of credit with that institution, and
approximately $10,000 of short-term investments are maintained with that
institution to secure an available credit card line of credit for a Company
director.
13
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Note 4. Available for Sale Securities
The amortized cost, gross unrealized gains, gross unrealized losses and
approximate fair values of available for sale securities at December 31, 2002
are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
2002 Cost Gains Losses Value
-------------------------------------------------------------------
U.S. Government Agency obligations $ 8,902,682 $ 110,252 $ (1,000) $ 9,011,934
Mortgage-backed securities 496,360 - (6,802) 489,558
-------------------------------------------------------------------
$ 9,399,042 $ 110,252 $ (7,802) $ 9,501,492
===================================================================
The amortized cost and fair value of available for sale debt securities at
December 31, 2002 by contractual maturity are presented below. Actual maturities
of mortgage-backed securities may differ from contractual maturities because the
mortgages underlying the securities may be called or repaid without any
penalties. Because mortgage-backed securities are not due at a single maturity
date, they are not included in the maturity categories in the following summary:
Amortized Fair
Cost Value
---------------------------------
Maturity:
Within one year $ 2,008,973 $ 2,017,189
After 1 but within 5 years 5,008,709 5,095,975
After 5 but within 10 years 1,300,000 1,313,220
Over 10 years 585,000 585,550
Mortgage-backed securities 496,360 489,558
---------------------------------
$ 9,399,042 $ 9,501,492
=================================
At December 31, 2002, available for sale securities with a carrying value of
$2,568,750 were pledged as collateral under repurchase agreements with Bank
customers and to secure public deposits.
During 2002, there were no sales of available for sale securities.
14
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Note 5. Held to Maturity Securities
The amortized cost, gross unrealized gains, gross unrealized losses and
approximate fair values of held to maturity securities at December 31, 2001 are
as follows:
2001 Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------------------
U.S. Government Agency obligations $ 4,085,428 $ -- $ 4,055 $ 4,081,373
=====================================================================
In December 2002, the Company transferred all of its held to maturity
securities, which had a carrying value of $7,517,682, to the available for sale
category. At the time of the transfer, the Company recognized an unrealized gain
of $66,973, net of taxes, as an adjustment to other comprehensive income. The
transfer of these securities resulted from a change in the Company's overall
investment strategies and for liquidity purposes.
There were no sales of held to maturity securities during 2002 and 2001.
Note 6. Loans Receivable and Allowance for Loan Losses
A summary of the Company's loan portfolio at December 31, 2002 and 2001 is as
follows:
2002 2001
--------------------------------------
Commercial mortgages $ 8,808,320 $ 350,000
Commercial loans 7,404,050 742,633
Construction and land loans, net of undisbursed
portion of $19,830 in 2002 569,229 -
Residential mortgages 1,531,186 -
Consumer home equity loans 314,082 40,000
Consumer installment loans 709,930 76,205
--------------------------------------
Total loans 19,336,797 1,208,838
Net deferred loan fees (55,585) (1,494)
Allowance for loan losses (232,000) (12,000)
--------------------------------------
Loans receivable, net $ 19,049,212 $ 1,195,344
======================================
15
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
The changes in the allowance for loan losses for the years ended December 31,
2002 and 2001 are as follows:
2002 2001
-------------------------------------
Balance, beginning of year $ 12,000 $ -
Provision for loan losses 220,000 12,000
Recoveries of loans previously charged-off - -
Loans charged-off - -
-------------------------------------
Balance, end of year $ 232,000 $ 12,000
=====================================
At December 31, 2002 and 2001, there were no loans delinquent 90 days or more
and no other loans placed on nonaccrual status. As of and for the year ended
December 31, 2002 and 2001, no loans were considered impaired by the Company.
The Company's lending activities are conducted principally in the New Haven
County section of Connecticut. The Company grants commercial real estate loans,
commercial business loans and a variety of consumer loans. In addition, the
Company may grant loans for the construction of residential homes, residential
developments and for land development projects. All residential and commercial
mortgage loans are collateralized by first or second mortgages on real estate.
The ability and willingness of borrowers to satisfy their loan obligations is
dependent in large part upon the status of the regional economy and regional
real estate market. Accordingly, the ultimate collectibility of a substantial
portion of any resulting real estate acquired is susceptible to changes in
market conditions.
The Company has established credit policies applicable to each type of lending
activity in which it engages, evaluates the creditworthiness of each customer on
an individual basis and, when deemed appropriate, obtains collateral. Collateral
varies by each borrower and loan type. The market value of collateral is
monitored on an ongoing basis and additional collateral is obtained when
warranted. Important types of collateral include business assets, real estate,
automobiles, marketable securities and time deposits. While collateral provides
assurance as a secondary source of repayment, the Company ordinarily requires
the primary source of repayment to be based on the borrower's ability to
generate continuing cash flows.
16
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Note 7. Premises and Equipment
At December 31, 2002 and 2001, premises and equipment consisted of the
following:
2002 2001
-------------------------------------
Premises under capital lease $ 1,192,036 $ 850,000
Leasehold improvements 816,268 353,934
Furniture and fixtures 201,134 117,889
Equipment 376,798 182,402
Construction in progress 608,788 -
-------------------------------------
3,195,024 1,504,225
Less accumulated depreciation and amortization (142,103) (24,605)
-------------------------------------
$ 3,052,921 $ 1,479,620
=====================================
For the year ended December 31, 2002 and 2001, depreciation and amortization
expense related to premises and equipment totaled $117,498 and $24,605,
respectively.
Premises under capital lease of $1,192,036 and $850,000, and related accumulated
amortization of $57,489 and $10,714, as of December 31, 2002 and 2001,
respectively, are included in premises and equipment.
Note 8. Deposits
At December 31, 2002 and 2001, deposits consisted of the following:
2002 2001
-------------------------------------
Noninterest bearing $ 6,401,759 $ 662,366
-------------------------------------
Interest bearing:
Time certificates, less than $100,000 2,610,756 1,243,088
Time certificates, $100,000 or more 3,740,551 2,194,668
Savings 1,029,433 396,712
Money market 8,858,585 1,315,208
Checking 2,351,847 971,989
-------------------------------------
Total interest bearing 18,591,172 6,121,665
-------------------------------------
Total deposits $ 24,992,931 $ 6,784,031
=====================================
17
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Contractual maturities of time certificates of deposit as of December 31, 2002
are summarized below:
Due within:
1 year $ 4,735,139
1-2 years 486,451
2-3 years 541,343
3-4 years 140,000
4-5 years 448,374
------------------
$ 6,351,307
==================
Interest expense on certificates of deposit in denominations of $100,000 or more
was $87,538 and $5,305 for the years ended December 31, 2002 and 2001,
respectively.
Note 9. Commitments
Federal Home Loan Bank borrowings and stock
-------------------------------------------
The Bank is a member of the Federal Home Loan Bank of Boston ("FHLB"). At
December 31, 2002, the Bank has the ability to borrow from the FHLB based on a
certain percentage of the value of the Bank's qualified collateral, as defined
in the FHLB Statement of Products Policy, at the time of the borrowing. In
accordance with an agreement with the FHLB, the qualified collateral must be
free and clear of liens, pledges and encumbrances.
The Bank is required to maintain an investment in capital stock of the FHLB in
an amount equal to a percentage of its outstanding mortgage loans and contracts
secured by residential properties, including mortgage-backed securities. No
ready market exists for FHLB stock and it has no quoted market value. For
disclosure purposes, such stock is assumed to have a market value which is equal
to cost since the Bank can redeem the stock with FHLB at cost.
Employment agreements
---------------------
The Company and the Bank have entered into an employment agreement (the
"Chairman Agreement") with the Chairman and Chief Executive Officer of the
Company and the Bank with an initial term of five years beginning October 1,
2001, which may be extended for additional one-year terms at the end of the
initial term. The Chairman Agreement provides for a base salary with annual
adjustments, and an annual bonus, as determined by the Board of Directors. The
Chairman Agreement also provides for vacation and various insurance benefits and
reimbursement for travel, entertainment and bank-related education and
convention expenses.
During the organization period through the date the Company completed its
initial public offering, the Directors agreed to adopt the terms of the Chairman
Agreement, except that compensation for the Chairman was provided at two-thirds
of the salary stipulated in the Chairman Agreement.
18
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Also, under the Chairman Agreement, the Company issued to the Chairman options
to purchase 50,000 shares of the Company's stock under the terms of the
Company's 2001 Stock Option Plan (see Note 12).
In the event of the early termination of the Chairman Agreement for any reason
other than cause, the Company would be obligated to compensate the Chairman, in
accordance with the terms of the Chairman Agreement, through the full term of
the Chairman Agreement. Also upon termination of the Chairman Agreement for
reasons other than cause, the Chairman Agreement provides that the Chairman will
serve as a consultant to the Company, on a year to year basis, and will be
compensated at the rate of $60,000 per year plus the employee benefits
previously described. Further, in the event the Chairman's position shall end or
his responsibilities be significantly reduced as a result of a business
combination (as defined), the Chairman will be entitled to a lump sum payment
equal to three times his then current annual compensation.
Also, the Company entered into a three year employment agreement (the "President
Agreement") with the President of the Bank beginning on October 1, 2001. The
President Agreement provided for a base salary and an annual bonus as determined
by the Board of Directors. The President Agreement also provided for vacation
and various insurance benefits and reimbursement for travel, entertainment and
Bank-related education and convention expenses. Also, under the President
Agreement, the Company issued to the President options to purchase 20,000 shares
of the Company's stock under the terms of the Company's 2001 Stock Option Plan
(see Note 12). During the organization period through the date the Company
completed its initial public offering, the Directors agreed to adopt the terms
of the President Agreement, except that compensation for the President was
provided at two-thirds of the salary stipulated in the President Agreement. As
of December 31, 2002, the Company terminated the President's employment.
Other
-----
The Company expects to open its second bank branch office in New Haven,
Connecticut in the first quarter of 2003. The Company expects to incur
approximately $492,000 of additional improvements in 2003 to its new branch
office building which it owns.
Note 10. Lease and Subleases
The Company leases the Bank's main office under a twenty year capital lease that
expires in 2021. In addition, the Company leases its Branford branch office
under a twenty year capital lease that expires in 2022. Under the terms of the
leases, the Bank will pay all executory costs including property taxes,
utilities and insurance. The Company also leases the driveway to its main office
and certain equipment under noncancelable operating leases.
The Company has also entered into a five-year sublease agreement for excess
office space in its premises with a tenant, the principal of which is related to
the Company's Vice Chairman. During 2001 and 2002, the Company also had a
sublease with another related party, which lease was terminated in early 2003
when such related party became an officer of the Bank.
19
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
At December 31, 2002, future minimum lease payments to be made and received
under these leases by year and in the aggregate, are as follows:
Year Capital Leases Operating Leases Sublease Income
--------------------------------------------------------------------------------------------------------
2003 $ 152,461 $ 6,598 $ 13,272
2004 156,984 6,598 13,690
2005 161,506 6,598 14,107
2006 166,028 5,108 3,552
2007 171,424 3,618 -
2008 and thereafter 2,988,931 47,937 -
-------------------- --------------------------------------
3,797,334 $ 76,457 $ 44,621
======================================
Less amount representing interest (2,605,482)
--------------------
Present value of future minimum lease
payments - capital lease obligation $ 1,191,852
====================
Prior to August 1, 2001, the Company leased its premises under an operating
lease arrangement and paid $4,117 per month for the period April 1, 2001 through
July 31, 2001, at which time rent of $8,950 per month commenced. Upon
commencement of operations, the long-term commitment under the lease was
classified as a capital lease. Total rent expense charged to operations under
the operating leases approximated $3,000 and $36,800 for the years ended
December 31, 2002 and 2001, respectively. Rental income under the subleases
approximated $17,800 and $7,200 for the years ended December 31, 2002 and 2001,
respectively.
Note 11. Income Taxes
A reconciliation of the anticipated income tax benefit (computed by applying the
statutory Federal income tax rate to the loss before income taxes) to the amount
reported in the statement of operations for the years ended December 31, 2002
and 2001 is as follows:
2002 2001
-------------------------------------
Benefit for income taxes at statutory Federal rate $ 470,564 $ 300,634
State taxes, net of Federal benefit 68,179 43,769
Increase in valuation allowance (526,329) (316,236)
Other (12,414) (28,167)
-------------------------------------
$ - $ -
=====================================
20
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
At December 31, 2002 and 2001, the components of gross deferred tax assets are
as follows:
2002 2001
-------------------------------------
Deferred tax assets:
Allowance for loan losses $ 90,364 $ 4,674
Net operating loss carryforwards 672,862 156,180
Start-up costs 194,183 245,048
Other 36,681 6,804
-------------------------------------
Gross deferred tax assets 994,090 412,706
Less valuation allowance (933,975) (407,646)
-------------------------------------
Deferred tax assets - net of valuation allowance 60,115 5,060
-------------------------------------
Deferred tax liabilities:
Tax bad debt reserve 15,162 5,060
Depreciation 44,953 -
Unrealized gain on available for sale securities 39,905 -
-------------------------------------
Gross deferred tax liabilities 100,020 5,060
-------------------------------------
Net deferred tax liability $ (39,905) $ -
=====================================
As of December 31, 2002, the Company had tax net operating loss carryforwards of
approximately $1,727,000 available to reduce future Federal and state taxable
income, which expire in 2021 and 2022.
The net changes in the valuation allowance for 2002 and 2001 were increases of
$526,329 and $316,236, respectively, to adjust deferred tax assets to amounts
considered by management more likely than not to be realized.
Note 12. Shareholders' Equity
Income (loss) per share
-----------------------
The Company is required to present basic income (loss) per share and diluted
income (loss) per share in its statements of operations. Basic and fully diluted
income (loss) per share are computed by dividing net income (loss) by the
weighted average number of common shares outstanding. Diluted per share amounts
assume exercise of all potential common stock instruments unless the effect is
to reduce the loss or increase the income per share. For the periods presented,
the common stock equivalents described below have been excluded from the
computation of the net loss per share because the inclusion of such equivalents
is anti-dilutive. Weighted average shares outstanding were 966,667 and 421,096
for the years ended December 31, 2002 and 2001, respectively.
21
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Stock options
-------------
The Company has adopted two stock option plans, the 2001 Stock Option Plan (the
"2001 Option Plan") and the 2002 Stock Option Plan (the "2002 Option Plan"),
under which an aggregate of 340,000 shares of the Company's common stock are
reserved for issuance upon the exercise of both incentive options and
nonqualified options granted under both option plans.
Under both option plans, the exercise price for each share covered by an option
may not be less than the fair market value of a share of the Company's common
stock on the date of grant. For incentive options granted to a person who owns
more than 10% of the combined voting power of the Company or any subsidiary
("ten percent shareholder"), the exercise price cannot be less than 110% of the
fair market value on the date of grant.
Options under both options plans have a term of ten years unless otherwise
determined at the time of grant, except that incentive options granted to any
ten percent shareholder will have a term of five years unless a shorter term is
fixed. Under both option plans, unless otherwise fixed at the time of grant, 40%
of the options become exercisable one year from the date of grant, and 30% of
the options become exercisable at each of the second and third anniversaries
from the date of grant.
Upon adoption of the 2002 Option Plan in May 2002, the Company determined that
no additional options will be granted under the 2001 Option Plan.
A summary of the status of the stock options at December 31, 2002 and 2001, and
changes during the year then ended, is as follows:
2002 2001
----------------------------------------------------------------
Weighted- Weighted-
Number Average Number Average
of Exercise of Exercise
Shares Price Shares Price
----------------------------------------------------------------
Outstanding at beginning of year 78,000 $ 12.00 - $ -
Granted 14,800 12.00 78,000 12.00
Terminated (25,400) 12.00 - -
----------------------------------------------------------------
Outstanding at end of year 67,400 $ 12.00 78,000 $ 12.00
================================================================
Exercisable at end of year 21,200 -
============= ============
Weighted-average fair value per option
of options granted during the year $2.09 $4.55
============= ============
The weighted-average remaining contractual life for the options outstanding at
December 31, 2002 and 2001 is 8.7 and 9.6 years, respectively.
22
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Stock warrants
--------------
The Company adopted the 2001 Warrant Plan and the 2001 Supplemental Warrant Plan
(the "Warrant Plans"), under which an aggregate of 100,000 shares of the
Company's common stock were reserved for issuance upon the exercise of warrants
granted to non-employee directors of the Company and the Bank, and certain other
individuals involved in the organization of the Bank.
The exercise price for each share covered by a warrant under the Warrant Plans
is $12.00, the initial public offering price of the Company's common stock.
Warrants under the Warrant Plans will have a term of ten years. Forty percent of
the warrants become exercisable one year from the date of grant, 30% of the
warrants become exercisable at each of the second and third anniversaries from
the date of grant.
During 2001, the Company granted warrants to acquire 72,681 shares of the
Company's common stock for $12.00 per share. With respect to the 72,681 warrants
issued, warrants to purchase 40,993 shares of common stock were issued to
directors of the Company and the Bank, and warrants to purchase 31,688 shares of
common stock were issued to other individuals. The cost of the 31,688 warrants
issued to non-directors was $70,000, which was recorded as a charge to
operations and a credit to additional paid-in capital.
A summary of the status of the warrants at December 31, 2002 and 2001, and
changes during the years then ended, is as follows:
2002 2001
-------------------------------------------------------------------
Weighted- Weighted-
Number Average Number Average
of Exercise of Exercise
Shares Price Shares Price
-------------------------------------------------------------------
Outstanding at beginning of year 72,681 $ 12.00 - $ -
Granted - - 72,681 12.00
Exercised - - - -
-----------------------------------------------------------------
Outstanding at end of year 72,681 $ 12.00 72,681 $ 12.00
=================================================================
Exercisable at end of year 29,072 -
=========== ==========
Weighted-average fair value per
warrant of warrants granted during
the year N/A $3.22
=========== ==========
The weighted-average remaining contractual life for the warrants outstanding at
December 31, 2002 and 2001 is 8.7 and 9.7 years, respectively.
23
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
The fair value of options and warrants issued in 2002 and 2001 was estimated at
the grant date using the Black-Scholes option-pricing model with the following
assumptions:
2002 2001
----------------------------------
Dividend rate - -
Risk free interest rate 2.28% 4.65% - 4.73%
Weighted-average expected lives 8 years 7-8 years
Volatility 20% 20%
Note 13. 401(k) Profit Sharing Plan
The Bank's employees are eligible to participate in the Bank of Southern
Connecticut 401(k) Profit Sharing Plan (the "Plan") under Section 401(k) of the
Internal Revenue Code. The Plan covers substantially all employees of the Bank.
Under the terms of the Plan, participants can contribute a discretionary
percentage of compensation, with total annual contributions subject to Federal
limitations. The Bank may make discretionary contributions to the Plan.
Participants are immediately vested in their contributions and become fully
vested in employer contributions after three years of service. There were no
discretionary contributions made by the Bank during 2002 and 2001.
Note 14. Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amounts recognized in the financial statements. The contractual amounts
of these instruments reflect the extent of involvement the Company has in
particular classes of financial instruments.
The contractual amounts of commitments to extend credit represents the amounts
of potential accounting loss should: the contract be fully drawn upon; the
customer default; and the value of any existing collateral become worthless. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments and evaluates each
customer's creditworthiness on a case-by-case basis. Management believes that
the Company controls the credit risk of these financial instruments through
credit approvals, credit limits, monitoring procedures and the receipt of
collateral as deemed necessary.
24
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Financial instruments whose contract amounts represent credit risk are as
follows at December 31, 2002:
2002 2001
------------------------------------
Commitments to extend credit:
Future loan commitments $ 2,890,000 $ 1,073,000
Unused lines of credit 5,518,023 541,967
Undisbursed construction loans 19,830 -
Letters of credit 338,059 -
-----------------------------------
$ 8,765,912 $ 1,614,967
===================================
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
to extend credit generally have fixed expiration dates or other termination
clauses and may require payment of a fee by the borrower. Since these
commitments could expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based
on management's credit evaluation of the counter party. Collateral held varies,
but may include residential and commercial property, deposits and securities.
Note 15. Regulatory Matters
The Company (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory -
and possibly additional discretionary - actions by regulators that, if
undertaken, could have a direct material effect on the Company's and the Bank's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and the Bank must meet
specific capital guidelines that involve quantitative measures of the assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2002, that the Company and the Bank meet all capital adequacy requirements to
which they are subject.
As of December 31, 2002, the most recent notification from the Federal Deposit
Insurance Corporation and the State of Connecticut Department of Banking
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the table. There are no conditions or events since then, that
management believes have changed the Bank's category.
25
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
The Bank's actual capital amounts and ratios at December 31, 2002 and 2001 were
(dollars in thousands):
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
2002 Actual Purposes Action Provisions
-----------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------
Total Capital to Risk-Weighted Assets $ 8,309 32.43% $ 2,050 8.00% $ 2,562 10.00%
Tier I Capital to Risk-Weighted Assets 8,077 31.52% 1,025 4.00% 1,537 6.00%
Tier I Capital to Average Assets 8,077 23.76% 1,360 4.00% 1,700 5.00%
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
2001 Actual Purposes Action Provisions
----
-----------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------
Total Capital to Risk-Weighted Assets $ 9,605 90.66% $ 848 8.00% $ 1,059 10.00%
Tier I Capital to Risk-Weighted Assets 9,593 90.54% 424 4.00% 636 6.00%
Tier I Capital to Average Assets 9,593 67.40% 569 4.00% 712 5.00%
The Company is also considered to be well capitalized under the regulatory
framework specified by the Federal Reserve Bank ("FRB"). The Company's actual
and required ratios are not substantially different from those shown above.
Restrictions on dividends, loans or advances
--------------------------------------------
The Company's ability to pay dividends is dependent on the Bank's ability to pay
dividends to the Company. However, certain restrictions exist regarding the
ability of the Bank to transfer funds to the Company in the form of cash
dividends, loans or advances. Regulatory approval is required to pay dividends
in excess of the Bank's net earnings retained in the current year plus retained
net earnings for the preceding two years. The Bank is also prohibited from
paying dividends that would reduce its capital ratios below minimum regulatory
requirements, and the FRB may impose further dividend restrictions on the
Company. During 2002, the Bank requested, and was granted, permission from the
State of Connecticut Department of Banking, to pay a special dividend to the
Company in the amount of $200,000. At December 31, 2002 and 2001, no dividends
may be declared by the Bank without regulatory approval.
Under Federal Reserve regulation, the Bank is also limited to the amount it may
loan to the Company, unless such loans are collateralized by specified
obligations. Loans or advances to the Company by the Bank are limited to 10% of
the Bank's capital stock and surplus on a secured basis.
26
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Note 16. Related Party Transactions
In the normal course of business, the Company may grant loans to executive
officers, directors and members of their immediate families, as defined, and to
entities in which these individuals have more than a 10% equity ownership. Such
loans are transacted at terms including interest rates, similar to those
available to unrelated customers.
Changes in loans outstanding to such related parties during 2002 are as follows:
Balance, beginning of year $ -
Additional loans 726,139
Repayments (201,501)
--------------------
Balance, end of year $ 524,638
====================
There were no loans to related parties outstanding at December 31, 2001.
Related party deposits aggregated approximately $3,999,000 and $2,014,000 as of
December 31, 2002 and 2001, respectively.
Included in professional services for the years ended December 31, 2002 and 2001
are approximately $7,900 and $46,500, respectively, in legal fees incurred for
services provided by law firms, principals of which are directors of the
Company. Included in consulting fees for the years ended December 31, 2002 and
2001 are $127,400 and $31,900, respectively, in consulting fees and expenses
paid to entities, the principals of which are related to Company directors.
In addition, during 2002 and 2001, the Company paid approximately $46,900 and
$52,000 for capital expenditures and maintenance to certain companies,
principals of which are directors of the Company.
Also, the Company purchased investment securities, including accrued interest
and fees, of approximately $8,176,000 through an investment brokerage firm, an
employee of which is related to the Company's Chairman and Chief Executive
Officer.
Lastly, as described in Note 10, rental income of approximately $14,800 and
$7,200 was received in 2002 and 2001, respectively, from tenants, the principals
of which are related to the Company's Chairman and Chief Executive Officer, and
the Company's Vice Chairman.
27
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
Note 17. Other Comprehensive Income
Other comprehensive income, which is comprised solely of the change in
unrealized gains and losses on available for sale securities, is as follows:
2002
---------------------------------------------------
Before-Tax Taxes Net-of-Tax
Amount Amount
----------------------------------------------------
Unrealized holding losses arising during period $ (7,252) $ 2,824 $ (4,428)
Add: adjustment for unrealized gains of held to
maturity securities transferred to available for
sale securities 109,702 (42,729) 66,973
---------------------------------------------------
Unrealized holding gain on available for sale
securities, net of taxes $ 102,450 $ (39,905) $ 62,545
===================================================
Note 18. Fair Value of Financial Instruments and Interest Rate Risk
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments"
("Statement No. 107"), requires disclosure of fair value information about
financial instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rates and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparisons to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. Statement No. 107 excludes certain
financial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Company.
Management uses its best judgment in estimating the fair value of the Company's
financial instruments; however, there are inherent weaknesses in any estimation
technique. Therefore, for substantially all financial instruments, the fair
value estimates presented herein are not necessarily indicative of the amounts
the Company could have realized in a sales transaction at December 31, 2002 and
2001. The estimated fair value amounts for 2002 and 2001 have been measured as
of their respective year-ends, and have not been reevaluated or updated for
purposes of these consolidated financial statements subsequent to those
respective dates. As such, the fair values of these financial instruments
subsequent to the respective reporting dates may be different from the amounts
reported at each year-end.
The information presented should not be interpreted as an estimate of the fair
value of the entire Company since a fair value calculation is only required for
a limited portion of the Company's assets and liabilities. Due to the wide range
of valuation techniques and the degree of subjectivity used in making the
28
SOUTHERN CONNECTICUT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2002 and 2001
-------------------------------------------------------------------------------
estimate, comparisons between the Company's disclosures and those of other bank
holding companies may not be meaningful.
As of December 31, 2002 and 2001, the recorded book balances and estimated fair
values of the Company's financial instruments were (in thousands):
2002 2001
--------------------------------------------------------------
Recorded Recorded
Book Book
Balance Fair Value Balance Fair Value
--------------------------------------------------------------
Financial Assets:
Cash and due from banks $ 1,245,010 $ 1,245,010 $ 686,467 $ 686,467
Federal funds sold 1,144,000 1,144,000 3,670,000 3,670,000
Short-term investments 662,419 662,419 6,079,864 6,079,864
Available for sale securities 9,501,492 9,501,492 - -
Held to maturity securities - - 4,085,428 4,081,373
Federal Home Loan Bank stock 500 500 - -
Loans receivable, net 19,049,212 19,029,150 1,195,344 1,195,344
Accrued interest receivable 187,672 187,672 77,892 77,892
Financial Liabilities:
Noninterest-bearing deposits 6,401,759 6,401,759 662,366 662,366
Time certificates of deposits 6,351,307 6,383,715 3,437,756 3,437,756
Savings deposits 1,029,433 1,029,433 396,712 396,712
Money market deposits 8,858,585 8,858,585 1,315,208 1,315,208
Interest bearing checking accounts 2,351,847 2,351,847 971,989 971,989
Repurchase agreements 822,259 822,259 - -
Unrecognized financial instruments
----------------------------------
Loan commitments on which the committed interest rate is less than the current
market rate are insignificant at December 31, 2002 and 2001.
The Company assumes interest rate risk (the risk that general interest rate
levels will change) as a result of its normal operations. As a result, the fair
values of the Company's financial instruments will change when interest rate
levels change and that change may be either favorable or unfavorable to the
Company. Management attempts to match maturities of assets and liabilities to
the extent believed necessary to minimize interest rate risk. However, borrowers
with fixed rate obligations are less likely to prepay in a rising rate
environment and more likely to prepay in a falling rate environment. Conversely,
depositors who are receiving fixed rates are more likely to withdraw funds
before maturity in a rising rate environment and less likely to do so in a
falling rate environment. Management monitors rates and maturities of assets and
liabilities and attempts to minimize interest rate risk by adjusting terms of
new loans and deposits and by investing in securities with terms that mitigate
the Company's overall interest rate risk.
29