UNITED STATES
SECURITIES AND EXCHANGE COMMISION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For quarter ended September 30, 2003
----------------------
Commission file number 000-23904
-------------
SLADE'S FERRY BANCORP
--------------------------------------------------------
(Exact name of registrant as specified in its character)
Massachusetts 04-3061936
------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
100 Slade's Ferry Avenue
Somerset, Massachusetts 02726
---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
(508)-675-2121
----------------------------------------------------
(Registrant's telephone number, including area code)
Check whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 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
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date:
Common stock ($0.01 par value) 3,979,534.14 shares as of September 30, 2003.
----------------------------------------------------------------------------
PART I
ITEM 1
Financial Statements
--------------------
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2003 December 31, 2002
----------------------------------------
(Unaudited)
ASSETS:
Cash, due from banks and interest-bearing
demand deposits with other banks $ 18,887,821 $ 14,993,969
Money market mutual funds 41,851 222,567
Federal Home Loan Bank overnight deposit 7,000,000 10,000,000
Federal funds sold 4,000,000 9,500,000
----------------------------------
Cash and Cash Equivalents 29,929,672 34,716,536
Interest-bearing time deposits with other banks 200,000 200,000
Investment securities held-to-maturity(1) 12,148,328 13,696,254
Investment securities available-for-sale(2) 52,502,490 65,907,926
Federal Home Loan Bank stock 2,105,400 1,013,400
Loans, net 311,724,282 259,816,056
Premises and equipment 5,991,270 6,067,879
Goodwill 2,173,368 2,173,368
Accrued interest receivable 1,511,498 1,492,591
Cash surrender value of life insurance 11,019,566 9,750,661
Deferred income tax asset, net 2,114,099 1,849,723
Other assets 1,472,230 1,690,589
----------------------------------
TOTAL ASSETS $432,892,203 $398,374,983
==================================
LIABILITIES & STOCKHOLDERS' EQUITY:
Deposits $346,229,006 $335,632,532
Federal Home Loan Bank advances 42,106,161 19,185,338
Other liabilities 2,477,628 2,336,109
----------------------------------
Total Liabilities 390,812,795 357,153,979
----------------------------------
Preferred stockholders' equity in a
subsidiary company 50,500 54,000
----------------------------------
STOCKHOLDERS' EQUITY:
Common stock 39,796 39,378
Paid-in-capital 28,316,556 27,693,199
Retained earnings 13,991,179 13,445,335
Accumulated other comprehensive income (loss) (318,623) (10,908)
----------------------------------
Total Stockholders' Equity 42,028,908 41,167,004
----------------------------------
TOTAL LIABILITIES &
STOCKHOLDERS' EQUITY $432,892,203 $398,374,983
==================================
--------------------
Investment securities held-to-maturity have a fair market value of
$12,719,647 as of September 30, 2003 and $14,262,405 as of December
31, 2002.
Securities classified as available-for-sale are stated at a fair
value with any unrealized gains or losses reflected as an adjustment
in Stockholders' Equity, net of tax effect.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND EXPENSE
(UNAUDITED)
9 MONTHS ENDING SEPTEMBER 30,
2003 2002
---------------------------
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans $12,928,787 $13,088,783
Interest and dividends on investments 2,258,138 3,461,700
Other interest 135,253 258,593
---------------------------
Total interest and dividend income 15,322,178 16,809,076
---------------------------
INTEREST EXPENSE:
Interest on deposits 3,538,854 5,307,036
Interest on Federal Home Loan Bank and other borrowed funds 1,059,978 892,868
---------------------------
Total interest expense 4,598,832 6,199,904
---------------------------
Net interest and dividend income 10,723,346 10,609,172
Provision (benefit) for loan losses (539,357) 375,000
---------------------------
Net interest and dividend income
after provision (benefit) for loan losses 11,262,703 10,234,172
---------------------------
OTHER INCOME:
Service charges on deposit accounts 429,266 415,297
Overdraft service charges 410,788 226,387
Gain on sales of available-for-sale securities, net 1,944 582,540
Increase in cash surrender value of life insurance policies 318,405 305,914
Other income 430,816 435,475
---------------------------
Total other income 1,591,219 1,965,613
---------------------------
OTHER EXPENSE:
Salaries and employee benefits 5,743,711 5,367,058
Occupancy expense 710,580 637,618
Equipment expense 398,971 369,307
Stationary and supplies 164,337 216,010
Professional fees 780,640 323,860
Marketing expense 310,058 269,416
Writedown on securities 0 1,085,158
Loss on sale of loans 115,792 0
Other expense 1,262,251 1,273,675
---------------------------
Total other expense 9,486,340 9,542,102
---------------------------
Income before income taxes and extraordinary item 3,367,582 2,657,683
Income taxes 1,092,553 568,010
---------------------------
Net income before extraordinary item 2,275,029 2,089,673
Extraordinary item, net of income taxes (658,168) 0
---------------------------
NET INCOME $ 1,616,861 $ 2,089,673
===========================
Basic earnings (loss) per share:
Income before extraordinary item $ 0.57 $ 0.54
Extraordinary item, net of income taxes (0.17) 0.00
---------------------------
Net income $ 0.40 $ 0.54
===========================
Diluted earnings (loss) per share:
Income before extraordinary item $ 0 .57 $ 0.53
Extraordinary item, net of income taxes (0.16) 0.00
---------------------------
Net income $ 0.41 $ 0.53
===========================
Basic averages shares outstanding 3,963,167 3,900,580
===========================
Diluted average shares outstanding 3,994,511 3,929,760
===========================
Dividends per share $ 0.27 $ 0.27
===========================
Comprehensive Income(1) $ 1,309,146 $ 1,952,432
===========================
--------------------
Calculated using the change in accumulated other comprehensive income
(loss) for the period and net income (loss) for the period.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND EXPENSE
(UNAUDITED)
3 MONTHS ENDING SEPTEMBER 30,
2003 2002
--------------------------
INTEREST AND DIVIDEND INCOME:
Interest and fees on loans $4,419,503 $4,274,244
Interest and dividends on investments 671,857 1,102,826
Other interest 26,873 107,836
--------------------------
Total interest and dividend income 5,118,233 5,484,906
--------------------------
INTEREST EXPENSE:
Interest on deposits 1,090,910 1,640,563
Interest on Federal Home Loan Bank and other borrowed funds 408,772 333,679
--------------------------
Total interest expense 1,499,682 1,974,242
--------------------------
Net interest and dividend income 3,618,551 3,510,664
Provision (benefit) for loan losses 0 0
--------------------------
Net interest and dividend income
after provision (benefit) for loan losses 3,618,551 3,510,664
--------------------------
OTHER INCOME:
Service charges on deposit accounts 151,072 133,668
Overdraft service charges 147,662 95,982
Gain on sale of available-for-sale securities, net 42,862 585,358
Increase in cash surrender value of life insurance policies 102,065 95,639
Other income 137,763 138,731
--------------------------
Total other income 581,424 1,049,378
--------------------------
OTHER EXPENSE:
Salaries and employee benefits 2,005,682 1,807,639
Occupancy expense 225,567 219,173
Equipment expense 143,949 118,594
Stationery and supplies 50,055 63,451
Professional fees 238,964 137,099
Marketing expense 80,441 78,757
Writedown on securities 0 138,263
Loss on sale of loans 12,258 0
Other expense 424,376 409,036
--------------------------
Total other expense 3,181,292 2,972,012
--------------------------
Income before income taxes and extraordinary item 1,018,683 1,588,030
Income taxes 319,338 337,033
--------------------------
Net income before extraordinary item 699,345 1,250,997
Extraordinary item, net of income taxes 0 0
--------------------------
NET INCOME $ 699,345 $1,250,997
==========================
Basic earnings per share:
Income before extraordinary item $ 0.18 $ 0.32
Extraordinary item, net of income taxes 0.00 0.00
--------------------------
Net income $ 0.18 $ 0.32
==========================
Diluted earnings per share:
Income before extraordinary item $ 0.17 $ 0.32
Extraordinary item, net of income taxes 0.00 0.00
--------------------------
Net income $ 0.17 $ 0.32
==========================
Basic average shares outstanding 3,976,557 3,917,902
==========================
Diluted average shares outstanding 4,022,804 3,944,581
==========================
Dividends per share $ 0.09 $ 0.09
==========================
Comprehensive Income (1) $ 189,219 $ 978,350
==========================
--------------------
Calculated using the change in accumulated other comprehensive income
(loss) for the period and net income (loss) for the period.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
-------------------------------
(Unaudited)
2003 2002
-----------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,616,861 $ 2,089,673
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization, net of accretion of securities 156,662 120,436
Loss on sales of available-for-sale securities, net (1,944) (582,540)
Loss on sale of loans 115,792 0
Change in unearned income 35,935 (42,540)
Provision (benefit) for loan losses (539,357) 375,000
Depreciation and amortization 473,251 476,321
Increase in cash surrender value of life insurance policies (318,405) (305,914)
Writedown on securities 0 1,085,158
(Increase) decrease in taxes receivable 215,024 (232,946)
Deferred tax expense 52,941 0
(Increase) decrease in other assets 47,739 (35,621)
(Increase) decrease in prepaid expenses (39,605) 57,030
(Increase) decrease in interest receivable (18,907) 327,311
Increase (decrease) in other liabilities (13,265) 94,596
Increase in accrued expenses 135,115 94,558
Increase (decrease) in interest payable 11,111 (15,884)
Decrease in minority interest in subsidiary (3,500) (1,500)
-----------------------------
Net cash provided by operating activities 1,925,448 3,503,138
-----------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of interest-bearing time deposit with other bank 0 (100,000)
Purchases of available-for-sale securities (29,246,394) (22,166,456)
Proceeds from maturities and calls of available-for-sale securities 41,882,767 35,949,210
Purchases of held-to-maturity securities (4,926,305) (2,786,923)
Proceeds from maturities of held-to-maturity securities 6,463,543 4,581,409
Purchase of Federal Home Loan Bank stock (1,092,000) 0
Loan originations and principal collections, net (53,473,842) 47,671
Recoveries of loans previously charged off 90,927 27,326
Proceeds from sales of loans 1,862,319 0
Capital expenditures (396,642) (181,171)
Proceeds from sale of asset 0 10,600
Investment in life insurance policies (950,500) (1,000,000)
-----------------------------
Net cash used in investing activities (39,786,127) 14,381,666
-----------------------------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
SLADE'S FERRY BANCORP AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
-------------------------------
(Unaudited)
(Continued)
2003 2002
-----------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, NOW, money market
and savings accounts 18,164,159 16,549,104
Net decrease in time deposits (7,567,685) (12,548,609)
Advances in Federal Home Loan Bank borrowings, net of payments 22,920,823 2,272,808
Net increase (decrease) in other borrowed funds 0 (454,101)
Proceeds from issuance of common stock 623,775 692,313
Dividends paid (1,067,257) (1,048,485)
-----------------------------
Net cash provided by financing activities 33,073,815 5,463,030
-----------------------------
Net increase (decrease) in cash and cash equivalents (4,786,864) 23,347,834
Cash and cash equivalents at beginning of year 34,716,536 28,692,310
-----------------------------
Cash and cash equivalents at the end of period $ 29,929,672 $ 52,040,144
=============================
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 4,587,721 $ 6,215,788
Income taxes paid $ 824,588 $ 800,956
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
SLADE'S FERRY BANCORP AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2003
Note A - Basis of Presentation
------------------------------
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in
the United States of America (GAAP) for interim financial information and
the instructions to Form 10-Q and, accordingly, do not include all of the
information and footnotes required by GAAP for complete financial
statements. In the opinion of the management of Slade's Ferry Bancorp (the
"Company"), all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the nine months ended September 30, 2003 are not necessarily
indicative of the results that may be expected for the year ending December
31, 2003.
The year-end condensed consolidated balance sheet data was derived from
audited financial statements, but does not include all disclosures required
by GAAP.
Note B - Accounting Policies
----------------------------
The accounting principles followed by Slade's Ferry Bancorp and subsidiary
and the methods of applying these principles which materially affect the
determination of financial position, results of operations, or changes in
financial position are consistent with those used for the year ended
December 31, 2002.
The consolidated financial statements of Slade's Ferry Bancorp include its
wholly-owned subsidiary, Slade's Ferry Trust Company, and its subsidiaries,
Slade's Ferry Realty Trust, Slade's Ferry Securities Corporation, Slade's
Ferry Preferred Capital Corporation, and Slade's Ferry Loan Company. All
significant intercompany balances have been eliminated.
Note C - Stock Based Compensation
---------------------------------
At September 30, 2003, the Company has a stock-based employee compensation
plan. The Company accounts for the plan under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued
to Employees," and related Interpretations. No stock-based employee
compensation cost is reflected in net income (except for appreciation from
options surrendered), as all options granted under this plan had an exercise
price equal to the market value of the underlying common stock on the date
of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS Statement No. 123, "Accounting for Stock-Based
Compensation", to stock-based employee compensation.
7
3 Months Ending September 30, 9 Months Ending September 30,
2003 2002 2003 2002
---------------------------------------------------------------
Net income, as reported $699,345 $1,250,997 $1,616,861 $2,089,673
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects 0 0 55,967 59,377
----------------------------------------------------------
Pro forma net income (loss) $699,345 $1,250,997 $1,560,894 $2,030,296
Earnings per share:
Basic - as reported $ 0.18 $ 0.32 $ 0.41 $ 0.54
Basic - pro forma $ 0.00 $ 0.00 $ 0.39 $ 0.52
Diluted - as reported $ 0.17 $ 0.32 $ 0.40 $ 0.53
Diluted - pro forma $ 0.00 $ 0.00 $ 0.39 $ 0.52
Note D - Impact of New Accounting Standards
-------------------------------------------
In June 2001, the FASB issued SFAS No. 141, "Business Combinations". This
Statement addresses financial accounting and reporting for business
combinations and supercedes APB Opinion No. 16, "Business Combinations", and
SFAS No. 38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises". Under Opinion 16, business combinations were accounted for
using one of two methods, the pooling-of-interests method or the purchase
method. All business combinations in the scope of SFAS No. 141 are to be
accounted for using one method - the purchase method. The provisions of
SFAS No. 141 apply to all business combinations initiated after June 30,
2001 and to all business combinations accounted for using the purchase
method for which the date of acquisition is July 1, 2001, or later.
The adoption of SFAS No. 141 had no immediate effect on the Company's
consolidated financial statements since it had no pending business
combinations as of June 30, 2001 or as of the date of the issuance of these
consolidated financial statements. If the Company consummates business
combinations in the future, any such combinations that would have been
accounted for by the pooling-of-interests method under Opinion 16 will be
accounted for under the purchase method and the difference in accounting
could have a substantial impact on the Company's consolidated financial
statements.
In June 2001, the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets", which is effective for fiscal years beginning after
December 15, 2001. Under prior accounting standards, goodwill resulting
from a business combination was amortized on a straight-line basis over 15
years. As a result of SFAS No. 142, goodwill is generally no longer
amortized as an expense after 2001, but instead will be reviewed and tested
for impairment using a fair value methodology and assessment. Goodwill will
be tested at least annually for impairment. Management does not anticipate
an impairment adjustment to the goodwill reflected in the accompanying
condensed consolidated balance sheet. In accordance with SFAS No. 142, the
Company, as of January 1, 2002, ceased the amortization of the goodwill
balance of $2.2 Million.
SFAS No. 142 provides that goodwill shall not be amortized. Goodwill is
defined as the excess of the cost of an acquired entity over the net of the
amounts assigned to assets acquired and liabilities assumed. SFAS No. 142
further provides that goodwill shall be tested for impairment at a level of
reporting referred to as a reporting unit. Impairment is the condition that
exists when the carrying amount of goodwill exceeds its implied fair value.
SFAS No. 142 was effective as follows:
All of the provisions of SFAS No. 142 were applied in fiscal years
beginning after December 15, 2001, to all goodwill and intangible
assets recognized in the Company's statement of financial
8
position at the beginning of that fiscal year, regardless of when
those previously recognized assets were initially recognized.
The Company's assets as of December 31, 2001 included goodwill of $2,173,368
recognized in the acquisition of Fairbank, Inc., in 1997. This goodwill was
being amortized at the rate of $226,800 per year. Under SFAS No. 142 this
amortization was discontinued after December 31, 2001 but is subject to the
impairment review requirements of SFAS No. 142.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived
assets. SFAS No. 144 supercedes SFAS No. 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," but
retains the basic recognition and measurement model for assets held for use
and held for sale. The provisions of SFAS No. 144 are required to be
adopted starting with fiscal years beginning after December 15, 2001. This
Statement did not have a material impact on the Company's consolidated
financial statements.
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities." This Statement requires that a liability
for a cost associated with an exit or disposal activity be recognized and
measured initially at fair value only when the liability is incurred. SFAS
No. 146 is effective for exit or disposal activities that are initiated
after December 31, 2002. This Statement did not have a material impact on
the Company's consolidated financial statements.
In October 2002, the FASB issued SFAS No. 147 "Acquisitions of Certain
Financial Institutions" an Amendment of SFAS Nos. 72 and 144 and FASB
Interpretation No. 9, SFAS No. 72 "Accounting for Certain Acquisitions of
Banking or Thrift Institutions" and FASB Interpretation No. 9 "Applying APB
Opinions No. 16 and 17 When a Savings and Loan Association or a Similar
Institution is Acquired in a Business Combination Accounted for by the
Purchase Method" provided interpretive guidance on the application of the
purchase method to acquisitions of financial institutions. Except for
transactions between two or more mutual enterprises, SFAS No. 147 removes
acquisitions of financial institutions from the scope of both Statement 72
and Interpretation 9 and requires that those transactions be accounted for
in accordance with SFAS No. 141 "Business Combinations" and SFAS No. 142
"Goodwill and Other Intangible Assets". Thus, the requirement in paragraph 5
of Statement 72 to recognize (and subsequently amortize) any excess of the
fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired as an unidentifiable intangible
asset no longer applies to acquisitions within the scope of SFAS No. 147.
In addition, SFAS No. 147 amends SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets" to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets and credit cardholder
intangible assets. Consequently, those intangible assets are subject to the
same undiscounted cash flow recoverability test and impairment loss
recognition and measurement provisions that SFAS No. 144 requires for other
long-lived assets that are held and used.
Paragraph 5 of SFAS No. 147, which relates to the application of the
purchase method of accounting, is effective for acquisitions for which the
date of acquisition is on or after October 1, 2002. The provisions in
paragraph 6 related to accounting for the impairment or disposal of certain
long-term customer-relationship intangible assets were effective on October
1, 2002. Transition provisions for previously recognized unidentifiable
intangible assets were effective on October 1, 2002. Transition provisions
for previously recognized unidentifiable intangible assets in paragraphs 8-
14 were effective on October 1, 2002, with earlier application permitted.
9
ITEM 2
Management's Discussion and Analysis of Financial Condition and Results of
--------------------------------------------------------------------------
Operation
---------
Forward-looking Statements
--------------------------
This Form 10-Q contains certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements regarding the strength of the company's capital and asset
quality. Other such statements may be identified by words such as
"believes," "will," "expects," "project," "may," "developments,"
"strategic," "launching," "opportunities," "anticipates," "estimates,"
"intends," "plans," "targets" and similar expressions. These statements are
based upon the current beliefs and expectations of Slade's Ferry Bancorp's
management and are subject to significant risks and uncertainties. Actual
results may differ materially from those set forth in the forward-looking
statements as a result of numerous factors.
The following factors, among others, could cause actual results to differ
materially from the anticipated results or other expectations expressed in
our forward-looking statements: (1) enactment of adverse government
regulation; (2) competitive pressures among depository and other financial
institutions may increase significantly and have an effect on pricing,
spending, third-party relationships and revenues; (3) the strength of the
United States economy in general and specifically the strength of the New
England economies may be different than expected, resulting in, among other
things, a deterioration in overall credit quality and borrowers' ability to
service and repay loans, or a reduced demand for credit, including the
resultant effect on the Bank's loan portfolio, levels of charge-offs and
non-performing loans and allowance for loan losses; (4) changes in the
interest rate environment may reduce interest margins and adversely impact
net interest income; and (5) changes in assumptions used in making such
forward-looking statements. Should one or more of these risks materialize
or should underlying beliefs or assumptions prove incorrect, Slade's Ferry
Bancorp's actual results could differ materially from those discussed. All
subsequent written and oral forward-looking statements attributable to
Slade's Ferry Bancorp or any person acting on its behalf are expressly
qualified in their entirety by the cautionary statements set forth above.
Slade's Ferry Bancorp does not intend or undertake any obligation to update
any forward-looking statement to reflect circumstances or events that occur
after the date the forward-looking statements are made.
Financial Condition
-------------------
Total assets increased by $34.5 Million, or 8.7%, from $398.4 Million at
December 31, 2002 to $432.9 Million at September 30, 2003. The increase in
total assets during the first nine months of 2003 was most significant in
the loan portfolio experiencing a 20.0% increase. This increase in total
assets was generated by deposit growth of $10.6 Million, additional advances
from the Federal Home Loan Bank of $22.9 Million, and an increase in
Stockholders' Equity of $0.9 Million.
Cash and cash equivalents decreased by $4.8 Million, from $34.7 Million
reported as of year-end 2002 to $29.9 Million at September 30, 2003. Cash
and cash equivalents, for purpose of reporting cash flows, include cash,
amounts due from banks, federal funds sold, overnight deposits with the
Federal Home Loan Bank, and other short-term investments, i.e. money market
mutual funds.
The investment portfolio represents the second largest component of the
Company's total assets, and consists of securities available-for-sale and
securities held-to-maturity. The designation of which category a security
is to be classified is determined at the time of the purchase of the
investment instrument.
Total investments, excluding Federal Home Loan Bank stock, decreased by
$15.0
10
Million from $79.6 Million reported at December 31, 2002 to $64.6 Million at
September 30, 2003. The decrease in investments of $15.0 Million combined
with the $10.6 Million increase in deposits, and $22.9 Million increase in
advances from the Federal Home Loan Bank provided the liquidity to fund
gross loan growth of approximately $51.4 Million.
The Held-to-Maturity category consists predominately of securities issued by
states of the United States and political subdivisions of states and short-
term debt securities issued by the U. S. Treasury. The Company has the
positive intent and ability to hold these securities to maturity. In
managing the Held-to-Maturity portfolio, the Company seeks to maximize its
return and maintain consistency to meet short and long term liquidity
forecasts by purchasing securities with maturities laddered within a short-
term period of 1-3 years, a mid-term period of 3-5 years, and some
securities extending out to 10 years. The Company does not purchase
investments with off-balance sheet characteristics, such as swaps, options,
futures, and other hedging activities that are called derivatives. The main
objective of the investment policy is to provide adequate liquidity to meet
reasonable declines in deposits and any anticipated increases in the loan
portfolio, to provide safety of principal and interest, to generate earnings
adequate to provide a stable income, and to fit within the overall
asset/liability management objectives of the Company.
Investment Securities Held-to-Maturity are securities that the Company will
hold to maturity and are carried at amortized cost on the balance sheet, and
are summarized as follows as of September 30, 2003:
Amortized Gross Unrealized Gross Unrealized
(Dollars in Thousands) Cost Basis Holding Gains Holding Losses Fair Value
-------------------------------------------------------------------------------------------------------------------
Debt securities issued by the U.S.
Treasury and other U.S. Government
Corporations and Agencies $ 0 $ 0 $0 $ 0
Debt securities issued by states of the
United States and political
subdivisions of the states 12,147 572 0 $12,719
Mortgage-backed securities 1 0 0 1
Other debt securities 0 0 0 0
-----------------------------------------------------------------------------------------------------------------
Total $12,148 $572 $0 $12,720
=================================================================================================================
Securities in the Available-for-Sale category are securities that the
Company intends to hold for an indefinite period of time, but not
necessarily to maturity. These securities may be sold in response to
interest rate changes, liquidity needs or other factors. Any unrealized
gains or losses, net of taxes, are excluded from earnings and reflected in
Stockholders' Equity as a separate component in accumulated other
comprehensive income (loss).
Investments in Available-for-Sale securities are carried at fair value on
the balance sheet and are summarized as follows as of September 30, 2003:
Gains in Losses in
Accumulated Accumulated
Other Other
Amortized Comprehensive Comprehensive
(Dollars in Thousands) Cost Basis Income Income Fair Value
------------------------------------------------------------------------------------------------------
Debt securities issued by the U. S.
Treasury and other U. S. Government
Corporations and Agencies $30,052 $ 94 $315 $29,831
Marketable Equities 3,447 95 543 2,999
Mortgage-backed securities 16,932 491 0 17,423
Corporate Bonds 2,161 89 0 2,250
----------------------------------------------------------------------------------------------------
Total $52,592 $769 $858 $52,503
====================================================================================================
11
Effect on Stockholders' Equity as of September 30, 2003:
(In Whole Dollars)
Net unrealized loss on Available-for-Sale Securities $(89,179)
Less tax effect 4,736
--------
Net unrealized loss on Available-for-Sale Securities after tax effect $(84,443)
========
The Available-for-Sale category at September 30, 2003 had net unrealized
losses, net of taxes, of $84,443 of which $211,598 are net unrealized gains
(net of tax) attributed to securities of the U.S. Treasury, other U.S.
Government corporations and agencies, corporate bonds, and mortgage-backed
securities, and $296,041 are net unrealized losses (net of tax) attributable
to marketable equity securities.
Securities of the U.S. Treasury, U.S. Government corporations and agencies,
and mortgage-backed securities have little or no credit risk, other than
being sensitive to changes in interest rates; and if held-to-maturity, these
securities will mature at par. The Company amortizes premiums and accretes
discounts over the life of the securities.
Marketable equity securities, however, have a greater risk as they are
subject to rapid market fluctuations. These securities are constantly
monitored and evaluated to determine their suitability for sale, retention
in the portfolio, or possible writedowns due to impairment issues.
Management minimizes its risk by limiting the total amount invested into
marketable equity securities. At September 30, 2003, the amount invested in
marketable equity securities was 4.6% of the total market value of the
investment portfolio distributed over various industry sectors.
Total net loans increased by $51.9 Million or 20.0% from $259.8 Million
reported at December 31, 2002 to $311.7 Million at September 30, 2003.
Residential mortgage and home equity loans increased by approximately $40.0
Million during the nine months ending September 30, 2003 as new and existing
customers took advantage of the lower interest rate environment. In the
third quarter of 2003, due to continued marketing to promote the historical
low mortgage and home equity interest rates, the Bank originated more than
$15.0 Million in these loan types. In addition, the Bank also maintains an
active commercial loan portfolio increasing commercial real estate and
commercial and industrial loans by approximately $14.0 Million during the
nine months ending September 30, 2003. In the third quarter of 2003, these
loans increased by $7.5 Million. These increases in loans were partially
offset by a decrease in indirect auto loans, regular loan amortization and
prepayments, due to a high level of refinancing activities. Additionally,
during the nine months ending September 30, 2003, aggressive plans to
improve the asset quality of loans resulted in the sale of approximately
$1.9 Million of loans deemed impaired, recognizing a pre-tax loss of
$115,792.
The composition of our loan portfolio continues to change and diversify.
Loan demand for residential real estate and home equity loans continues to
be strong, and commercial loan borrowers, due to the uncertainty of the
economy, focus on refinancing existing debt to lower borrowing costs.
12
INFORMATION WITH RESPECT TO NONACCRUAL AND PAST DUE LOANS
AT SEPTEMBER 30, 2003 AND 2002 AND DECEMBER 31, 2002 AND 2001
At September 30, At December 31,
---------------------------------------------------------------------------------------------------
(Dollars in Thousands) 2003 2002 2002 2001
---------------------------------------------------------------------------------------------------
Nonaccrual Loans $ 637 $ 887 $ 635 $ 1,138
Loans 90 days or more past due and still accruing 13 0 8 444
Real estate acquired by foreclosure
or substantively repossessed 0 0 0 0
Percentage of nonaccrual loans to total gross loans 0.20% 0.35% 0.24% 0.45%
Percentage of nonaccrual loans, restructured loans,
and real estate acquired by foreclosure or
substantively repossessed to total assets 0.15% 0.22% 0.16% 0.34%
Percentage of allowance for loan losses
to nonaccrual loans 687.28% 625.93% 764.41% 481.90%
The $637,000 in nonaccrual loans as of September 30, 2003 consists of
$500,000 of real estate mortgages and $100,000 attributed to commercial
loans. Nonaccrual loans include restructured loans of $152,100 at September
30, 2003.
The Company's nonperforming assets as a total increased slightly by $7,000,
from $643,000 reported on December 31, 2002 to $650,000 as of September 30,
2003. The Company considers nonaccrual loans, loans past due 90 days or
more but still accruing, and real estate acquired by foreclosure or
substantively repossessed as nonperforming assets. Although the loan
portfolio increased by $51.9 Million, nonaccrual loans, which is the largest
component of nonperforming assets, increased by only $2,000 during the nine
months ending September 30, 2003. Loans 90 day or more but still accruing
increased by $5,000 during the first nine months of 2003. As of September
30, 2003, there was no real estate acquired by foreclosure.
The percentage of nonaccrual loans to total gross loans decreased from 0.24%
reported at the year end 2002 to 0.20% at September 30, 2003 due to a
decrease in the nonaccrual category and the increase in the total loan
portfolio. The percentage of nonaccrual loans and real estate acquired by
foreclosure or substantively repossessed to total assets also decreased due
to the decrease in nonaccrual loans and increase in the loan portfolio total
assets.
INFORMATION WITH RESPECT TO INTEREST ON NONACCRUAL AND PAST DUE LOANS
AT SEPTEMBER 30, 2003 AND 2002 AND DECEMBER 31, 2002 AND 2001
At September 30, At December 31,
--------------------------------------------------------------------------------------
(Dollars in Thousands) 2003 2002 2002 2001
--------------------------------------------------------------------------------------
Nonaccrual Loans $637 $887 $635 $1,138
Interest income that would have been recorded
under original terms 30 78 303 109
Interest income recorded during the period 18 64 121 6
The Company stops accruing interest on a loan once it becomes past due 90
days or more unless there is adequate collateral and the financial condition
of the borrower is sufficient. When a loan is placed on nonaccrual status,
all previously accrued but unpaid interest is reversed and charged against
current income. Interest is thereafter recognized in that category only when
payments are received and the loan becomes current.
13
Loans in the nonaccrual category will remain in that category until the
possibility of collection no longer exists, the loan is paid off, or the
loan becomes current. When a loan is determined to be uncollectible, it is
then charged off against the Allowance for Loan Losses.
Statement of Financial Accounting Standards No. 114 "Accounting by Creditors
for Impairment of a Loan" applies to all loans except large groups of
smaller-balance homogeneous loans that are collectively evaluated for
impairment, loans measured at fair value or at a lower of cost or fair
value, leases, and debt securities as defined in Statement 115. Statement
114 requires that impaired loans be valued at 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 value of the collateral
if the loan is collateral dependent. Smaller balance homogeneous loans are
considered by the Company to include consumer installment loans and credit
card loans.
At September 30, 2003, there were $2,000,861 of loans which the Company has
determined to be impaired, with a related allowance for credit losses of
$319,176. In addition, principal reductions, loan payoffs, charged off
balances, loan upgrades, and a change in our impairment identification
methodology are other factors resulting in a decrease of impaired loans.
There were no other loans classified for regulatory purposes at September
30, 2003 that management reasonably expects will materially impact future
operating results, liquidity or capital resources.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
Balance at January 1 $4,854 $5,484 $5,484 $4,776
----------------------------------------------------------------------------
Charge-offs:
Commercial (0) (288) (336) (73)
Real Estate-construction (0) (0) (0) (0)
Real Estate-mortgage (10) (20) (20) (0)
Installment/consumer (18) (26) (26) (28)
----------------------------------------------------------------------------
Total charge-offs (28) (334) (382) (101)
----------------------------------------------------------------------------
Recoveries:
Commercial 51 11 17 14
Real Estate-construction 0 0 0 0
Real Estate-mortgage 29 13 38 29
Installment/consumer 11 3 7 16
----------------------------------------------------------------------------
Total Recoveries 91 27 62 59
----------------------------------------------------------------------------
Net (charge-offs) recoveries 63 (307) (320) (42)
----------------------------------------------------------------------------
Provision (benefit) charged to
(increasing) operations (539) 375 (310) 750
----------------------------------------------------------------------------
Balance at end of period $4,378 $5,552 $4,854 $5,484
============================================================================
Ratio of net charge-offs to
Average loans outstanding (0.01%) (0.12%) (0.13%) (0.02%)
The Allowance for Loan Losses at September 30, 2003 was $4,377,797, compared
to $4,854,388 at year-end 2002. The Allowance for Loan Losses as a
percentage of outstanding loans was 1.39% at September 30, 2003, and 1.83%
at December 31, 2002.
The Company provides for loan losses to maintain the Allowance for Loan
Losses at a level that management believes to be adequate to absorb
potential losses in the loan portfolio.
14
As the composition of our loan portfolio gradually changes and diversifies
from higher credit risk weighted loans, such as commercial real estate and
commercial and industrial, to residential and home equity loans, less
reserve allowance will be required. Due to the continued changes in the
loan portfolio, stronger underwriting guidelines, the sale of loans
previously deemed substandard, and overall improvement in credit quality of
existing loans, the overall credit risk embedded in the loan portfolio
decreased. After thorough review and analysis of the adequacy of the loan
loss reserve during the second quarter, the Bank recovered $680,357 of
previously provided loan loss provisions, and for the nine months ending
September 30, 2003, the Bank recorded a provision benefit to earnings of
$539,357, compared to a provision expense of $375,000 recorded for the same
period in the previous year. Loans charged off were $382,000 in 2002,
$101,000 in 2001, $28,000 in the nine months ended September 30, 2003, and
$334,000 for the same period in 2002. Recoveries of loans previously
charged off were $62,000 in 2002, $59,000 in 2001, $91,000 in the nine
months ended September 30, 2003, and $27,000 for the same period in 2002.
Management believes that the Allowance for Loan Losses of $4,378,000 as of
September 30, 2003 is adequate to cover potential losses in the loan
portfolio, based on current information available to management.
The level of the Allowance for Loan Losses is evaluated monthly by
management and encompasses several factors. These factors include but are
not limited to recent trends in the nonperforming loans, the adequacy of the
assets that collateralize the nonperforming loans, the level of nonaccrual
loans, current economic conditions in the market area, and various other
external and internal factors. Management's assessment of the adequacy of
the Allowance for Loan Losses is reviewed by regulators, the Company's
independent accountants, and outside loan review consultants.
This table shows an allocation of the allowance for loan losses as of the
end of each of the periods indicated.
September 30, 2003 December 31, 2002 December 31, 2001
----------------------------------------------------------------------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Each Each Each
Category Category Category
to Total to Total to Total
Amount Loans Amount Loans Amount Loans
----------------------------------------------------------------------------------
(Dollars in Thousands)
Domestic:
Commercial (5) $1,078(1) 10.85% $1,155(1) 11.60% $1,629(1) 17.91%
Real estate - Construction 77 4.48% 70 5.31% 41 2.99%
Real estate - mortgage 3,098(2) 83.20% 3,465(2) 80.48% 3,585(2) 74.77%
Consumer(3) 125(4) 1.47% 164(4) 2.61% 229(4) 4.33%
-------------------------------------------------------------------------------
$4,378 100.00% $4,854 100.00% $5,484 100.00%
===============================================================================
--------------------
Includes amounts specifically reserved for impaired loans of $270,423
as of September 30, 2003, $412,761 as of December 31, 2002, and
$780,029 as of December 31, 2001 as required by Financial Accounting
Standard No. 114, Accounting for Impairment of Loans.
Includes amounts specifically reserved for impaired loans of $38,081
as of September 30, 2003, $34,757 as of December 31, 2002, and
$413,663 as of December 31, 2001 as required by Financial Accounting
Standard No. 114, Accounting for Impairment of Loans.
Includes consumer, obligations of states and political subdivisions
and other.
Includes amounts specifically reserved for impaired loans of $10,672
as of September 30, 2003, $29,606 as of December 31, 2002, and $1,632
as of December 31, 2001 as required by Financial Accounting Standard
No. 114, Accounting for Impairment of Loans.
Includes commercial, financial, agricultural and nonprofit loans.
15
The loan portfolio's largest segment of loans is commercial real estate
loans, which represent 55.2% of gross loans. Residential real estate,
including home equity loans, represents 32.6% of gross loans. The Company
requires a loan to value ratio of 80% in both commercial and residential
mortgages. These mortgages are secured by real properties which have a
readily ascertainable appraised value.
Real estate residential loans are both loans secured by one-to-four family
property and home equity loans. Home equity loans are generally revolving
lines of credit and are typically secured by second mortgages on one-to-four
family owner-occupied properties.
Generally, commercial real estate loans have a higher degree of credit risk
than residential real estate loans because they depend primarily on unit
supply and demand and various conditions. When granting these loans, the
Company evaluates the financial statements of the borrower(s), the location
of the real estate, the quality of management, profitability, and general
economic and competitive conditions. When granting a residential mortgage,
the Company reviews the borrower(s) repayment history on past debts, and
assesses the borrower(s) ability to meet existing obligations and payments
on the proposed loans. Real estate construction loans comprise both
residential and commercial construction loans throughout our market area.
Commercial loans consist of loans predominantly collateralized by inventory,
furniture and fixtures, and accounts receivable. In assessing the
collateral for this type of loan, management applies a 50% liquidation value
to inventories; 25% to furniture, fixtures and equipment; and 70% to
accounts receivable less than 90 days of invoice date. Commercial loans
represent 10.7% of the loan portfolio as of September 30, 2003,
approximately the same level as of September 30, 2002.
Consumer loans are both secured and unsecured borrowings and represent only
1.5% of the total loan portfolio as of September 30, 2003. These loans have
a higher degree of risk than residential mortgage loans. The underlying
collateral of a secured consumer loan tends to depreciate in value.
Consumer loans are typically made based on the borrower's ability to repay
the loan through continued financial stability. The Company endeavors to
minimize risk by reviewing the borrower's repayment history on past debts,
and assessing the borrower's ability to meet existing obligations on the
proposed loans.
The allocation of the Allowance for Loan Losses is based on management's
judgement of potential losses in the respective portfolios. While
management has allocated reserves to various portfolio segments, the
allowance is general in nature and is available for the portfolio in its
entirety.
Total deposits at September 30, 2003 were $346.2 Million, an increase of
$10.6 Million or 3.2%, compared to $335.6 Million at December 31, 2002.
Savings deposit balances and money market accounts increased by $19.3
Million, offset by a net decrease in demand deposits and NOW accounts of
$1.5 Million. Term certificates of deposit as of September 30, 2003
decreased by $7.2 Million when compared to December 31, 2002. This decrease
was primarily the result of declining interest rates for these products and
depositors electing to maintain a more liquid position. The Bank's
marketing campaign to promote new money market account products during the
first nine months of 2003 had been very successful, generating more than
$10.0 Million in new core deposits.
Total borrowed funds were $42.6 Million at September 30, 2003, as compared
to $19.2 Million at December 31, 2002, for an increase of $23.4 Million.
The Bank took advantage of the low interest rate environment to obtain
advances from the Federal Home Loan Bank to augment its funding sources, and
also as a tool to hedge against interest rate risk.
16
Total stockholders' equity was $42.0 Million at September 30, 2003, as
compared to $41.2 Million at December 31, 2002, for an increase of $862,000.
The increase during the first nine months of 2003 resulted from net income
of $1.6 Million, and dividend reinvestments of $0.6 Million, partially
offset by dividends declared of $1.1 Million.
Results of Operations
---------------------
The Company's operating performance is dependent on net interest and
dividend income, which is the difference between interest income earned on
loans and investments and interest expense paid on deposits and borrowed
funds. The level of net interest income achieved is significantly impacted
by several factors such as economic conditions, interest rates,
asset/liability management, and corporate tax and strategic planning. Net
interest and dividend income for September 30, 2003 increased by $114,174 to
$10,723,346 when compared to $10,609,172 recorded during the same period in
2002. Total interest and dividend income decreased by $1,486,898 offset by
a decrease in total interest expense of $1,601,072. The Company's net
interest margin decreased by 7 basis points from 3.87% reported at September
30, 2002 to 3.80% as of September 30, 2003.
The Provision for Loan Losses is a charge against earnings and funds the
Allowance for Loan Losses. It is management's desire to maintain the
Allowance for Loan Losses at a level that is adequate to absorb potential
losses within the loan portfolio. In determining the appropriate level of
the allowance for loan losses, management takes into consideration past and
anticipated loss experience, prevailing economic conditions, evaluations of
underlying collateral, and the volume of the loan portfolio and balance of
nonperforming and classified loans. Management assesses the allowance for
loan losses on a monthly basis. After thorough review and analysis of the
adequacy of the loan loss reserve, the continued improvement in asset
quality in the loan portfolio, and the reduction and sale of loans deemed
substandard, management deemed it prudent to recover $680,357 of previously
provided loan loss provisions during the second quarter of 2003. As of
September 30, 2003 the allowance for loan losses remains adequate to absorb
any credit risk remaining in the portfolio, therefore no provisions were
recorded during the third quarter of 2003. The Bank's provision for the
first nine months of 2003 was a benefit to earnings of $539,357 compared to
an expense provision of $375,000 recorded for the same period 2002.
Total noninterest income decreased by $374,394 for the first nine months in
2003, when compared to the same period in 2002. This decrease is associated
with a decrease in net gains on sales of available-for-sale securities from
$582,540 recognized during 2002, compared to only $1,944 in 2003. The gains
recognized during 2002 resulted from sales of various securities to
partially offset the writedown charge of $1,085,158 due to the recognition
of various impairment adjustments within the equity securities of the
investment portfolio that were deemed to be other than temporary. No
securities writedown charges were necessary during the nine months ending
September 30, 2003. Partially offsetting the $580,596 decrease in security
gains was an increase in overdraft service charges by $184,401, from
$226,387 recorded during 2002 to $410,788 for the same period in 2003. This
increase was due to a new overdraft fee pricing schedule and procedure
implemented during the second quarter of 2003. Service charges on deposit
accounts increased slightly by $13,969 from 2002 to 2003. The cash surrender
value of bank owned life insurance policies associated with both the
directors' and executive officers' life insurance programs increased by
$12,491 due to the purchase of additional policies for newly hired executive
officers during 2003. The line item Other Income decreased slightly by
$4,659 when compared to the first nine months of 2002. These income items
represent earnings derived from fees associated with safe deposit box
rentals, checkbook printing, ATM/debit card usage, customer investment
commissions, and other miscellaneous income.
The category Total Other Expense, made up of various noninterest expenses
decreased by $55,762, to $9,486,340 recorded during the first nine months
ending September 30, 2003, compared to $9,542,102 reported for the same
period in 2002. Salaries and employee benefits increased by $376,653, or
7.0% from
17
$5,367,058 reported for the first nine months of 2002, to $5,743,711
expensed for the same period in 2003. The increase was attributable to
additions to staff to support consumer lending activities, sales incentive
commissions paid for achieving sales production targets, and general salary
increases due to performance reviews. A Chief Operating Officer/Chief
Financial Officer was also hired in May 2003 and, in the third quarter of
2003, a director of retail and an investment executive were hired. In
addition employee benefits expense also increased as the Company increased
its defined benefit plan contribution for 2003.
Occupancy and equipment expenses combined totaled $1,109,551 during the
first nine months of 2003, compared to $1,006,925 in 2002, an increase of
$102,626, primarily due to increased snow removal cost resulting from a
cold, severe winter, and higher energy cost, during the first quarter of
2003. In addition, real estate taxes on bank owned properties increased
during 2003, and costs associated with closing a branch in Swansea were
recorded during the third quarter of 2003.
The expenses for stationery and supplies decreased by $51,673 from $216,010
reported as of year-to-date September 30, 2002 to $164,337 reported for the
same period in 2003.
Professional fees increased by $456,780 from the first nine months of 2002
compared to 2003. This increase reflects costs associated with consultants
for marketing, advertising, investment advisory, strategic planning, pension
actuaries, and information technology. In addition legal expenses for both
corporate matters and loan related matters increased.
Marketing expenses attributed to production and media costs for radio
commercials, print advertising, and other direct marketing increased by
$40,642. These marketing costs were associated with campaigns for consumer
loan products, and new money market accounts.
Included in total other expenses in 2002 was a writedown on securities of
$1,085,158 due to the recognition of various impairment adjustments within
the equity securities of the investment portfolio that were deemed to be
other than temporary. During the first nine months of 2003, no writedowns
were necessary. The investment portfolio is reviewed at least quarterly
with the Investment Committee to determine if there are any possible
impairment issues within the portfolio.
As previously mentioned, during the first nine months of 2003, management
implemented new policies and procedures, and instituted aggressive plans to
reduce problem loan relationships. As a result, in the second quarter of
2003, a portion of these loans were sold at a discount recognizing a pre-tax
loss of $103,534, a loss of $12,258 recorded in the third quarter, and
allowed the Bank to recover previously provided loan loss provisions
directly allocated to these loans. During the first nine months of 2002, no
loans were sold.
The following table sets forth the components of the line item Other
Expense. This table reflects an increase of $15,340 to $424,376 from
$409,036 for the three month period ending September 30, 2003 and a decrease
of $11,424 to $1,262,251 from $1,273,675 for the nine month period ending
September 30, 2003 when compared to September 30, 2002.
Three Months Nine Months
-----------------------------------------------------------------------------
2003 2002 Variance 2003 2002 Variance
-----------------------------------------------------------------------------
Communications/Postage $ 83,383 $ 76,488 $ 6,895 $ 251,341 $ 240,252 $ 11,089
Committee Fees 40,750 56,150 (15,400) 123,650 149,500 (25,850)
Other Expenses 300,243 276,398 23,845 887,260 883,923 3,337
-----------------------------------------------------------------------------
$424,376 $409,036 $ 15,340 $1,262,251 $1,273,675 $(11,424)
=============================================================================
18
For the nine months ended September 30, 2003, Other Expense decreased by
$11,424. Communications/Postage Expense increased by $11,089 due to the
increase in postage cost effective June 2002. Committee Fees decreased by
$25,850, from $149,500 reported for the nine months ending September 30,
2002 to $123,650 for the same period in 2003. Additional committee meetings
were necessary during 2002 to review the candidates for the Chief Executive
Officer/President, and Other Miscellaneous Expense increased slightly by
$3,337.
Income before income taxes and extraordinary item was $3,367,582 for the
nine month period ending September 30, 2003, compared to $2,657,683 reported
for the same period in 2002. Income taxes before extraordinary item totaled
$1,092,553, an increase of $524,543 when compared to $568,010 reported for
the same period in 2002 as a result of higher taxable income in 2003 and the
higher income tax rate due to the disallowance of the dividend deduction
pertaining to the "REIT" settlement in 2003. The increase in taxable income
of $709,899 is attributable to a combination of the writedown expense of
securities recorded during the first nine months of 2002 of $1,085,158, and
the recovery of previously provided loan loss provisions resulting in a
benefit to earnings of $539,357 in 2003. Year-to-date net income as of
September 30, 2003 decreased by 22.6%, or $472,812 from $2,089,673 or $0.53
diluted earnings per share reported during the first nine months of 2002 to
$1,616,861 or $0.41 diluted earnings per share for the same period this
year.
As announced in the Company's July 15, 2003 press release, the Bank entered
into a settlement with the Massachusetts Department of Revenue ("DOR") and
paid $855,967 in retroactive state taxes to resolve a dispute involving the
DOR's disallowance of the deduction taken by the Bank for dividends received
from its REIT subsidiary for the tax years 1999, 2000, 2001 and 2002.
During the first quarter of 2003, the Bank accrued a liability of
approximately $1.3 Million, net of taxes, due to new legislation enacted in
Massachusetts in March 2003, expressly disallowing the deduction for
dividends received from a REIT. The Bank has ceased recording the tax
benefits associated with the dividend received deduction in 2003. As a
result of the settlement, the Company recognized income, net of taxes, of
approximately $627,000 or $0.16 per share in the second quarter of 2003,
representing the unused portion of the accrual and therefore reduced the
extraordinary expense item, net of tax benefits, from $1,285,066 recorded in
the first quarter of 2003 to $658,168 as of June 30, 2003.
The results of operation for the third quarter in 2003 indicates that net
interest and dividend income increased slightly by $107,887 to $3,618,551
from $3,510,664 reported for the same period in 2002. Total interest and
dividend income decreased by $366,673 from 2002 to 2003, offset by a
decrease in total interest expense of $474,560. Interest margin
compression, the interest rate environment, and the future direction of the
economy are still concerns although we have been effective in maintaining a
flat net interest margin for the last nine months. During this low interest
rate environment, the Bank has lowered interest rates on deposit accounts to
offset the impact of historical lower loan rates, but there is very little
room for further reductions in deposit rates causing pressure on our net
interest margins.
During 2003, the Bank implemented procedures to improve asset quality within
the loan portfolio. Due to continued diversification in the composition of
the loan portfolio, stronger underwriting guidelines, and the sale of $1.9
Million of loans carrying higher credit risk and reserve allocations, the
aggregate credit risk embedded in the loan portfolio decreased
substantially. After review and analysis of the adequacy of the loan loss
reserve, management with the approval of the Board of Directors, deemed it
prudent to recover $680,357 of previously provided loan loss provisions in
the second quarter of 2003. No provision for loan losses was recorded in
the three months ending September 30, 2002 or 2003. The allowance for loan
losses is maintained at a level that management believes is adequate to
cover potential losses in the loan portfolio which are deemed probable and
based on information available to management. Management assesses the
allowance for loan losses on a monthly basis, and believes that it has been
reasonable in the analysis of the allowance for loan losses.
Total Other Income decreased by $467,954 for the three months ending
September 30, 2003, when compared to the same period in 2002. This decrease
is associated with the gains on sale of securities during the third quarter
2002 of $585,358 compared to only $42,862 recorded in 2003. Service charges
on both deposit accounts
19
and overdrafts combined increased by $69,084. An increase in the Bank's
deposit base and new procedures on overdrawn deposit accounts are directly
responsible for the increase in service charge income. There was also an
increase of $6,426 in the cash surrender value of life insurance policies
associated with purchases of additional policies for new executive officers.
The line item Other Income decreased slightly by $968 when compared to the
second quarter of 2002. These income items represent earnings derived from
rental fees on safe deposit boxes, checkbook order fees, ATM/debit card
usage fees, and customer investment commission fees.
Total Other Expenses, made up of various noninterest expenses, increased by
$209,280 from $2,972,012 reported as of quarter end September 30, 2002 to
$3,181,292 as of September 30, 2003. Included in the three months ending
September 30, 2002 was the writedown of securities totaling $138,263. No
writedowns were necessary during 2003. Salaries and employee benefits
increased by $198,043 related to staff additions, sales incentive
commissions, and general wage increases due to annual performance
evaluations. Occupancy and equipment expenses combined increased by $31,749
due primarily to an increase in real estate taxes paid on bank owned
properties and additional depreciation expense on equipment and software
purchases and branch closing costs. Stationery and supplies expense
decreased by $13,396. Professional fees increased by $101,865 from the
three months ending September 30, 2002 compared to the same period in 2003.
This increase reflects costs associated with marketing, investment advisory,
pension actuaries, and information technology consulting services to promote
the Bank and improve the efficiencies in the operation of the Bank.
Marketing expenses increased by $1,684 attributed to print advertising and
other direct marketing and business development promotion costs. During the
three months ending September 30, 2002, the Bank recorded a writedown charge
of $138,263 on equity securities with no similar charge in 2003. The Bank
sold $280,000 of higher credit risk loans during the third quarter of 2003
recognizing a loss of $12,258. There were no loan sales during the same
quarter in 2002. The item Other Expenses increased by $15,340 due to the
expense of stock appreciation rights recorded during the second quarter of
2002 of approximately $40,000, with no similar expense recorded in 2003.
Income before taxes and extraordinary item for the third quarter in 2003
decreased by $569,347 from earnings reported in 2002, to $1,018,683 this
year. This decrease in quarterly earnings from 2002 to 2003 is due
primarily to the $585,358 gain recognized in 2002 on sale of securities,
offset partially by a loss of $138,263 on the writedown of securities.
Associated applicable income taxes decreased by $17,695 from 2002 to 2003.
Net income for the three month period ending September 30, 2003 was
$699,345, or a decrease of $551,652, when compared to $1,250,997 reported in
the third quarter of 2002.
Liquidity
---------
Liquidity represents the ability of the Bank to meet its funding
requirements. In assessing the appropriate level of liquidity, the Bank
considers deposit levels, lending funding requirements and investment
maturities in light of prevailing economic conditions. Through this
assessment, the Bank manages its liquidity level to optimize earnings and
respond to fluctuations in customer borrowing and deposit needs.
The Company's principle sources of funds are customer deposits, loan
amortization, loan payoffs, and the maturities of investment securities.
Through these sources, funds are provided for customer withdrawals from
deposit accounts, loan origination, drawdowns on loan commitments,
acquisitions of investment securities, and other normal business activities.
Investors' capital also provides a source of funding.
The largest source of funds is provided by depositors. The largest
component of the Company's deposit base is term certificates which extend
out to a maximum of five years. The Company does not participate in
brokered deposits. Deposits are obtained from consumers and commercial
customers within the Bank's community reinvestment area, being Bristol
County, Massachusetts and several abutting towns in Rhode Island.
20
The Company also has the ability to borrow funds for liquidity purposes from
correspondent banks, the Federal Home Loan Bank, as well as the Federal
Reserve Bank of Boston, by pledging various investment securities as
collateral. Borrowings from the Federal Home Loan Bank increased by
approximately $22.9 Million from December 31, 2002 to September 30, 2003, as
the Bank took advantage of the favorable low interest rate environment to
draw down some longer term structured funding opportunities, and to hedge
against any possible interest rate risk as a result of the increase in long
term, fixed rate residential mortgages. As of September 30, 2003, there was
$42.1 Million in advances outstanding from the Federal Home Loan Bank.
Excess available funds are invested on a daily basis into Federal Funds
Sold. An appropriate level of Federal Funds Sold is maintained to meet loan
commitments, anticipated loan growth and deposit forecasts. Funds exceeding
this level are then used to purchase investment securities that are suitable
in yields and maturities for the investment portfolio.
Liquidity during the first nine months of 2003 was primarily provided by a
net increase in deposits of $10.6 Million, advances in Federal Home Loan
Bank borrowings of $22.9 Million, and proceeds from maturities and calls of
securities totaling $48.3 Million. These were offset by purchases of
securities of $34.2 Million and Federal Home Loan stock of $1.1 Million,
loan originations, principal collections, and purchased loans of $53.5
Million, and purchases of life insurance policies for executive officers of
$1.0 Million. Other factors affecting liquidity included cash provided by
other operating activities and cash used in financing activities as
indicated in the consolidated statements of cash flows.
Capital
-------
As of September 30, 2003, the Company had total capital of $42,028,908.
This represents an increase of $861,904 from $41,167,004 reported on
December 31, 2002. The increase in capital was a combination of several
factors. Nine months earnings resulted in net income of $1,616,861.
Transactions originating through the Dividend Reinvestment Program resulted
in 6,949.543 shares being issued for cash contributions of $104,586 and
33,871.680 shares being issued for $509,689 in lieu of cash dividend
payments. These additions were offset by dividends declared of $1,071,017.
Also, affecting capital is accumulated other comprehensive income (loss)
which reflects net unrealized gains or losses, net of taxes, on securities
classified as Available-for-Sale and the minimum pension liability
adjustment. On December 31, 2002 the Available-for-Sale portfolio had
unrealized gains, net of taxes, of $223,272, and on September 30, 2003, as a
result of current market values, the portfolio reflects unrealized losses,
net of taxes, of $84,443. There was no change in the minimum pension
liability adjustment of $234,180, net of taxes, recorded December 31, 2002.
Under the requirements for Risk Based and Leverage Capital of the federal
banking agencies, a minimum level of capital will vary among banks based on
safety and soundness of operations. Risk Based Capital ratios are
calculated with reference to risk-weighted assets, which include both on and
off balance sheet exposure.
21
At September 30, 2003 the actual total Risk Based Capital of the Bank was
$32,789,000 for Tier 1 Capital, exceeding the minimum requirements of
$12,460,520 by $20,328,480. Total Capital of $36,689,000 exceeded the
minimum requirements of $24,921,040 by $11,767,960 and Leverage Capital of
$32,789,000 exceeded the minimum requirements of $16,748,200 by $16,040,800.
In addition to the "minimum" capital requirements, "well capitalized"
standards have also been established by the Federal Banking Regulators.
The table below illustrates the capital ratios of the Company and the Bank
on September 30, 2003 and at December 31, 2002.
Well September 30, 2003 December 31, 2002
Capitalized ------------------ -----------------
Requirement Bancorp Bank Bancorp Bank
----------- ------- ---- ------- ----
Total Capital (to Risk
Weighted Assets) > or =10% 13.90% 11.78% 14.84% 12.63%
------------------------------------------------------------------------------------
Tier 1 Capital (to Risk
Weighted Assets) > or =6% 12.65% 10.53% 13.59% 11.38%
------------------------------------------------------------------------------------
Leverage Capital (to
Average Assets) > or =5% 9.31% 7.83% 9.48% 8.00%
------------------------------------------------------------------------------------
Under the revised informal agreement entered into with the Massachusetts
Commissioner of Banks and the Federal Deposit Insurance Corporation,
effective January 17, 2002, the Bank is required to maintain a seven (7)
percent Tier I Leverage Capital ratio. As of September 30, 2003, this ratio
was 7.83% compared to 8.0% at year-end 2002.
In addition to meeting the required levels, the Company and the Bank's
capital ratios meet the criteria of the "well capitalized" category
established by the federal bank regulatory agencies as of September 30,
2003.
22
ITEM 3
Quantitative and Qualitative Disclosure About Market Risk
---------------------------------------------------------
Interest Rate Risk
------------------
Volatility in interest rates requires the Company to manage interest rate
risk that arises from the differences in the timing of repricing of assets
and liabilities. The Company considers interest rate risk, the exposure of
earnings to adverse movements in interest rates, to be a significant market
risk as it could potentially have an affect on the Company's financial
condition and results of operation.
Management's objective is to reduce risk and control the vulnerability of
its net interest margin to changes in interest rates by managing the
relationship of interest-earning assets and interest-bearing liabilities.
The interest rate risk is managed by periodic review and evaluation of the
risk potential in certain balance sheet accounts, and determining the level
of risk considered appropriate for our level of capital. This, in
conjunction with certain assumptions and other related factors, such as
anticipated changes in interest rates, liquidity requirements, performance
objectives and strategic plans, provides management a means of evaluating
interest rate risk.
The Company's Asset/Liability Committee, comprised of the executive
management and designated Board of Directors are responsible for managing
and monitoring interest rate risk, and reviewing with the Board of
Directors, at least quarterly, the Bank's interest rate risk positions, the
impact changes in interest rates would have on net interest income, and the
maintenance of interest rate risks within approved guidelines.
The Company quantifies its interest rate risk exposure using a simulation
model. This simulation analysis is used to measure the exposure to net
interest income to changes in interest rates over a specified time frame.
The simulation analysis projects future interest income and interest expense
under different rate scenarios. Internal guidelines on limitations on
interest rate risk specify that for every 100 basis points of immediate
change in interest rates, projected net interest income over the next twelve
months should not decline by more than 5%.
The simulation model currently utilizes a 300 basis point increase in
interest rates and a 50 basis point decrease in rates. Due to the existing
low interest rate environment in effect with the average Federal Funds
overnight rate trading below 1.50%, the simulation model only reduces rates
downward by 50 basis points. The rate interest movements used assume an
instant and parallel change in interest rates, and no implementation of any
strategic plans are made in response to the change in interest rates.
Prepayment speeds for loans are based on median dealer forecasts for each
interest rate scenario.
The following table reflects the Company's estimated exposure as a
percentage of estimated net interest income for the next twelve months,
assuming an immediate change in interest rates as set forth below:
Estimated Exposure as a Percentage
Rate Change of Net Interest Income
(Basis Points) September 30, 2003
-----------------------------------------------------
+300 (6.28)%
-50 (0.21)%
The model used to monitor earnings-at-risk provides management a measurement
tool to assess the effect of changes in interest rates on the Company's
current and future earnings. The limit established by the Company provides
an internal tolerance level to control interest rate risk exposure.
23
ITEM 4 CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
As required by new Rule 13a-15 under the Securities Exchange Act of 1934, we
carried out an evaluation under the supervision and with the participation
of our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that they believe that,
as of September 30, 2003, our disclosure controls and procedures were
effective to ensure that information required to be disclosed by us in the
reports we file or submit under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities
and Exchange Commission's rules and forms. In connection with the new
rules, we will continue to review and document our disclosure controls and
procedures, including our internal controls and procedures for financial
reporting, on an ongoing basis, and may from time to time make changes aimed
at enhancing their effectiveness and to ensure that our systems evolve with
our business.
(b) Changes in internal controls.
None.
24
PART II
Other Information
ITEM 5
Other Information
-----------------
The Company was saddened to report the passing of Donald T. Corrigan on
September 22, 2003. Mr. Corrigan was a founder of the Bank and served as a
member of its Board of Directors since its inception. In 1969 he was
elected President and Chief Executive Officer. In 1983, he was appointed
Chairman of the Board and Chief Executive Officer. Mr. Corrigan served as
President of the Company from its inception from 1989 to 1996. Mr. Corrigan
retired as CEO in 1995 but remained Chairman of the Board of both the Bank
and the Bank holding company.
The Board of Directors of Slade's Ferry Bancorp on October 20, 2003
unanimously elected Kenneth R. Rezendes to the post of Chairman and David F.
Westgate as Vice Chairman. Mr. Rezendes has served on the board since 1978,
and as Vice Chairman since September 22, 2002. Mr. Westgate has been a
board member for six years.
ITEM 6
Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits: See exhibit index.
(b) A report on Form 8-K dated July 15, 2003 was filed with the Securities
and Exchange Commission reporting under Items 9 and 12 the release of
information concerning the second quarter 2003 results of operations
and financial condition.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SLADE'S FERRY BANCORP
----------------------------------------
(Registrant)
November 12, 2003 /s/ Mary Lynn D. Lenz
------------------------- ----------------------------------------
(Date) (Signature) Mary Lynn D. Lenz
President/Chief Executive Officer
November 12, 2003 /s/ Deborah A. McLaughlin
------------------------- ----------------------------------------
(Date) (Signature) Deborah A. McLaughlin
Chief Operating Officer/
Chief Financial Officer
26
EXHIBIT INDEX
Exhibit No. Description Note
----------- ----------- ----
3.1 Articles of Incorporation of Slade's Ferry Bancorp as amended (1)
3.2 By-laws of Slade's Ferry Bancorp as amended (2)
10.1 Slade's Ferry (formerly Weetamoe) Bancorp 1996 Stock Option Plan
(as amended) (3)
10.2 Noncompetition Agreement between Slade's Ferry Trust Company and
Edward S. Machado (A substantially identical contract exists with
Peter Paskowski) (4)
10.3 Supplemental Executive Retirement Agreement between Slade's
Ferry (formerly Weetamoe) Bancorp and Donald T. Corrigan (5)
10.4 Supplemental Executive Retirement Agreement between Slade's
Ferry (formerly Weetamoe) Bancorp and James D. Carey (2)
10.5 Supplemental Executive Retirement Agreement between Slade's
Ferry (formerly Weetamoe) Bancorp and Manuel J. Tavares (2)
10.6 Swansea Mall Lease (4)
10.7 Form of Director Supplemental Retirement Program Director Agreement,
Exhibit I thereto (Slade's Ferry Trust Company Director Supplemental
Retirement Program Plan) and Endorsement Method Split Dollar Plan
Agreement thereunder for Thomas B. Almy. (Similar forms of agreement
entered into between Slade's Ferry Trust Company and the other directors) (6)
10.8 Form of Directors' Paid-up Insurance Policy for Thomas B. Almy
(part of the Director Supplemental Retirement Program). (Similar
forms of policy entered into by Company for other directors). (7)
10.9 Form of Officers' Paid-up Endorsement Method Split Dollar Plan
Agreement and Insurance Policies for Janice Partridge (Similar
forms of policies entered into by Company for its President and
other Vice Presidents) (8)
10.10 Supplemental Executive Retirement Agreement between Slade's Ferry
Bancorp and Mary Lynn D. Lenz. (9)
10.11 Change-in-Control Severance Agreement between Slade's Ferry Bancorp,
Slade's Ferry Trust Company and Mary Lynn D. Lenz (9)
10.12 Confidentiality and Non-Solicitation Agreement between Slade's Ferry
Bancorp and Mary Lynn D. Lenz (9)
11.0 Computation of Per Share Earnings (Page 30)
31 Certifications of Chief Executive Officer and Chief Financial Officer
pursuant to Rule 13a-14(a)/15d-14(a) (Page 31 & 32)
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 1350 (Page 33)
--------------------
Incorporated by reference to the Registrant's Registration Statement
on Form SB-2 filed with the Commission on April 14, 1997.
Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1996.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended June 30, 1999.
Incorporated by reference to the Registrant's Registration Statement
on Form S-4 File No. 33-32131.
Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1994.
27
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended March 31, 1999.
Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended June 30, 1998.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended June 30, 2000.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended March 31, 2003.
28