SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
Quarterly Report Under Section 13 of the Securities Exchange Act of 1934
For quarter ended: September 30, 2004
Commission File No. 001-16101
BANCORP RHODE ISLAND, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
RHODE ISLAND 05-0509802
--------------------------------- -------------------
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
------------------------------------------
(Address of Principal Executive Offices)
(401) 456-5000
------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Not Applicable
----------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes (X) No
--- ---
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of November 8, 2004:
----------------
Common Stock - Par Value $0.01 4,008,254 shares
------------------------------ ----------------
(class) (outstanding)
BANCORP RHODE ISLAND, INC.
FORM 10-Q
INDEX
PAGE NUMBER
-----------
Cover Page 1
Index 2
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Changes in
Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7 - 9
Item 2 Management's Discussion and Analysis 10 - 25
Item 3 Quantitative and Qualitative Disclosures About Market Risk 26 - 27
Item 4 Controls and Procedures 27
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 28
Item 2 Changes in Securities 28
Item 3 Defaults upon Senior Securities 28
Item 4 Submission of Matters to a Vote of Security Holders 28
Item 5 Other Information 28
Item 6 Exhibits and Reports on Form 8-K 28
Signature Page 29
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
September 30, December 31,
2004 2003
------------- ------------
(In thousands)
(Unaudited)
ASSETS:
Cash and due from banks $ 22,981 $ 27,084
Overnight investments 3,965 733
---------- ----------
Total cash and cash equivalents 26,946 27,817
Investment securities available for sale
(amortized cost of $106,508 and $96,828,
respectively) 107,971 98,595
Mortgage-backed securities available for sale
(amortized cost of $156,879 and $106,028,
respectively) 157,069 106,618
Stock in Federal Home Loan Bank of Boston 11,865 9,554
Loans receivable:
Commercial loans 392,016 332,266
Residential mortgage loans 316,726 366,230
Consumer and other loans 160,348 115,786
---------- ----------
Total loans 869,090 814,282
Less allowance for loan losses (11,673) (11,078)
---------- ----------
Net loans 857,417 803,204
Premises and equipment, net 12,597 12,457
Goodwill 10,766 10,766
Accrued interest receivable 5,687 5,597
Investment in bank-owned life insurance 15,969 15,491
Prepaid expenses and other assets 4,644 3,872
---------- ----------
Total assets $1,210,931 $1,093,971
========== ==========
LIABILITIES:
Deposits:
Demand deposit accounts $ 177,953 $ 159,916
NOW accounts 116,082 129,398
Money market accounts 16,096 16,937
Savings accounts 357,092 292,277
Certificate of deposit accounts 218,825 212,755
---------- ----------
Total deposits 886,048 811,283
Overnight and short-term borrowings 11,239 13,460
Federal Home Loan Bank of Boston borrowings 210,789 176,759
Subordinated deferrable interest debentures 18,558 13,403
Other liabilities 6,827 6,959
---------- ----------
Total liabilities 1,133,461 1,021,864
---------- ----------
SHAREHOLDERS' EQUITY:
Preferred stock, par value $0.01 per share,
authorized 1,000,000 shares:
Issued and outstanding: none -- --
Common stock, par value $0.01 per share,
authorized 11,000,000 shares:
Issued and outstanding 4,006,254 shares and
3,891,190 shares, respectively 40 39
Additional paid-in capital 42,642 41,439
Retained earnings 33,698 29,074
Accumulated other comprehensive income, net 1,090 1,555
---------- ----------
Total shareholders' equity 77,470 72,107
---------- ----------
Total liabilities and shareholders'
equity $1,210,931 $1,093,971
========== ==========
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(In thousands, except per share data)
(Unaudited)
Interest and dividend income:
Commercial loans $ 5,891 $ 4,975 $ 16,770 $ 14,488
Residential mortgage loans 4,081 4,444 13,018 12,941
Consumer and other loans 1,882 1,284 4,863 3,909
Mortgage-backed securities 1,714 973 4,046 3,785
Investment securities 1,240 854 3,355 2,985
Overnight investments 17 59 82 143
Federal Home Loan Bank of Boston stock dividends 85 69 197 198
--------- --------- --------- ---------
Total interest and dividend income 14,910 12,658 42,331 38,449
--------- --------- --------- ---------
Interest expense:
NOW accounts 272 333 961 1,003
Money market accounts 55 27 160 79
Savings accounts 1,088 922 2,826 3,136
Certificate of deposit accounts 1,411 1,458 4,176 4,578
Overnight and short-term borrowings 38 20 104 109
Federal Home Loan Bank of Boston borrowings 1,924 1,803 5,449 5,364
Subordinated deferrable interest debentures 276 -- 756 --
Company-obligated mandatorily redeemable capital securities -- 203 -- 480
--------- --------- --------- ---------
Total interest expense 5,064 4,766 14,432 14,749
--------- --------- --------- ---------
Net interest income 9,846 7,892 27,899 23,700
Provision for loan losses 200 400 700 1,200
--------- --------- --------- ---------
Net interest income after provision for loan losses 9,646 7,492 27,199 22,500
--------- --------- --------- ---------
Noninterest income:
Service charges on deposit accounts 1,156 957 3,374 2,952
Commissions on nondeposit investment products 312 220 758 626
Income from bank-owned life insurance 159 171 478 579
Loan related fees 104 127 309 570
Commissions on loans originated for others 12 128 52 331
Gain (loss) on sale of investment securities (9) 348 332 681
Gain (loss) on sale of mortgage-backed securities -- -- -- 104
Other income 303 283 938 701
--------- --------- --------- ---------
Total noninterest income 2,037 2,234 6,241 6,544
--------- --------- --------- ---------
Noninterest expense:
Salaries and employee benefits 4,566 3,697 12,588 10,741
Occupancy 675 595 2,007 1,785
Equipment 409 389 1,197 1,102
Data processing 664 599 2,056 2,245
Marketing 270 235 1,045 830
Professional services 512 289 1,154 951
Loan servicing 239 270 770 708
Loan workout and other real estate owned expense 8 33 78 34
Other expenses 1,038 930 3,041 2,859
--------- --------- --------- ---------
Total noninterest expense 8,381 7,037 23,936 21,255
--------- --------- --------- ---------
Income before income taxes 3,302 2,689 9,504 7,789
Income tax expense 1,124 904 3,167 2,570
--------- --------- --------- ---------
Net income $ 2,178 $ 1,785 $ 6,337 $ 5,219
========= ========= ========= =========
Per share data:
Basic earnings per common share $ 0.55 $ 0.47 $ 1.60 $ 1.37
Diluted earnings per common share $ 0.52 $ 0.44 $ 1.50 $ 1.29
Average common shares outstanding - basic 3,988,311 3,830,461 3,967,168 3,799,116
Average common shares outstanding - diluted 4,228,666 4,084,174 4,212,009 4,052,699
See accompanying notes to consolidated financial statements
4
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity
Accumulated
Other
Compre-
Additional hensive
Common Paid-in Retained Income,
Nine months ended September 30, Stock Capital Earnings Net Total
------ ---------- -------- ----------- -----
(In thousands)
(Unaudited)
2003
----
Balance at December 31, 2002 $38 $40,134 $24,002 $ 2,253 $66,427
Net income -- -- 5,219 -- 5,219
Other comprehensive income,
net of tax:
Unrealized holding gain on
securities available for sale,
net of taxes of $315 (612) (612)
Reclassification adjustment,
net of taxes of $267 (518) (518)
-------
Comprehensive income 4,089
Exercise of stock options -- 415 -- -- 415
Exercise of stock warrants 1 662 -- -- 663
Common stock issued for incentive
stock award, net -- 26 -- -- 26
Dividends on common stock -- -- (1,598) -- (1,598)
--- ------- ------- ------- -------
Balance at September 30, 2003 $39 $41,237 $27,623 $ 1,123 $70,022
=== ======= ======= ======= =======
2004
----
Balance at December 31, 2003 $39 $41,439 $29,074 $ 1,555 $72,107
Net income -- -- 6,337 -- 6,337
Other comprehensive income,
net of tax:
Unrealized holding losses on
securities available for sale,
net of taxes of $127 (246) (246)
Reclassification adjustment,
net of taxes of $113 (219) (219)
-------
Comprehensive income 5,872
Exercise of stock options -- 478 -- -- 478
Exercise of stock warrants 1 699 -- -- 700
Common stock issued for incentive
stock award, net -- 26 -- -- 26
Dividends on common stock -- -- (1,713) -- (1,713)
--- ------- ------- ------- -------
Balance at September 30, 2004 $40 $42,642 $33,698 $ 1,090 $77,470
=== ======= ======= ======= =======
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
Nine Months Ended
September 30,
-----------------------
2004 2003
---- ----
(In thousands)
(Unaudited)
Cash flows from operating activities:
Net income $ 6,337 $ 5,219
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization 2,840 3,512
Provision for loan losses 700 1,200
Gain on sale of investment securities (332) (681)
Gain on sale of mortgage-backed securities -- (104)
Gain on sale of other real estate owned -- (15)
Income from bank-owned life insurance (478) (579)
Compensation expense from restricted stock grant 26 26
(Increase) decrease in:
Accrued interest receivable (90) 557
Prepaid expenses and other assets (533) (447)
Increase (decrease) in:
Other liabilities (132) (329)
Other, net 21 75
--------- ---------
Net cash provided by operating activities 8,359 8,434
--------- ---------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (7,429) (22,645)
Commercial loans (82,835) (72,065)
Consumer loans (75,437) (41,719)
Purchase of:
Investment securities available for sale (48,993) (53,844)
Mortgage-backed securities available for sale (88,660) (62,812)
Residential mortgage loans (37,494) (217,473)
Federal Home Loan Bank of Boston stock (2,311) (1,251)
Principal payments on:
Investment securities available for sale 31,000 54,085
Mortgage-backed securities available for sale 37,509 88,269
Residential mortgage loans 93,898 170,479
Commercial loans 23,138 34,507
Consumer loans 30,623 28,618
Proceeds from sale of investment securities 8,428 22,788
Proceeds from sale of mortgage-backed securities -- 25,164
Proceeds from sale of other real estate owned -- 56
Capital expenditures for premises and equipment (1,861) (3,890)
--------- ---------
Net cash used by investing activities (120,424) (51,733)
--------- ---------
Cash flows from financing activities:
Net increase in deposits 74,765 38,501
Net increase (decrease) in overnight and short-term borrowings (2,221) (14,671)
Proceeds from long-term borrowings 119,155 99,750
Repayment of long-term borrowings (79,970) (61,959)
Proceeds from issuance of common stock 1,178 1,078
Dividends on common stock (1,713) (1,598)
--------- ---------
Net cash provided by financing activities 111,194 61,101
--------- ---------
Net (decrease) increase in cash and cash equivalents (871) 17,802
Cash and cash equivalents at beginning of period 27,817 42,959
--------- ---------
Cash and cash equivalents at end of period $ 26,946 $ 60,761
========= =========
Supplementary Disclosures:
Cash paid for interest $ 14,074 $ 15,026
Cash paid for income taxes 3,777 2,367
Non-cash transactions:
Change in other comprehensive income, net of taxes (465) (1,130)
See accompanying notes to consolidated financial statements
6
BANCORP RHODE ISLAND, INC.
Notes to Consolidated Financial Statements
(1) Basis of Presentation
Bancorp Rhode Island, Inc. (the "Company"), a Rhode Island
corporation, was organized by Bank Rhode Island (the "Bank") to be a bank
holding company and to acquire all of the capital stock of the Bank. The
reorganization of the Bank into the holding company form of ownership was
completed on September 1, 2000. The Company has no significant operating
entities other than the Bank. For that reason, substantially all of the
discussion in this Quarterly Report on Form 10-Q relates to the operations
of the Bank and its subsidiaries.
Beginning December 31, 2003, the consolidated financial statements
include the accounts of the Company and its wholly-owned direct subsidiary,
the Bank, and its indirect subsidiaries, BRI Investment Corp. (a Rhode
Island passive investment company), BRI Realty Corp. (a real estate holding
company) and Acorn Insurance Agency, Inc. (a licensed insurance agency). The
Company adopted Financial Accounting Standards Board ("FASB") Interpretation
46-R, "Consolidation of Variable Interest Entities - Revised" on December
31, 2003, and therefore has deconsolidated its statutory trust subsidiaries
as of that date. The Consolidated Statement of Operations for the 2003
periods also includes the results of BRI Statutory Trusts I, II and III
(issuers of trust preferred securities). All significant intercompany
accounts and transactions have been eliminated in consolidation.
The interim results of consolidated operations are not necessarily
indicative of the results for any future interim period or for the entire
year. These interim consolidated financial statements do not include all
disclosures associated with annual financial statements and, accordingly,
should be read in conjunction with the annual consolidated financial
statements and accompanying notes included in the Company's Annual Report to
Shareholders filed with the Securities and Exchange Commission.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts
of assets and liabilities as of the date of the balance sheet and revenues
and expenses for the period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to change
relate to the determination of the allowance for loan losses and goodwill
valuation.
The unaudited interim consolidated financial statements of the Company
have been prepared in accordance with Accounting Principles Generally
Accepted in the United States of America ("GAAP") and prevailing practices
within the banking industry and include all necessary adjustments
(consisting of only normal recurring adjustments), that, in the opinion of
management, are required for a fair presentation of the results and
financial condition of the Company.
(2) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and resulted in the issuance of additional
common stock that then shared in the earnings of the entity.
7
(3) Stock Based Compensation
In December 2002, the FASB issued Statement of Financial Accounting
Standards ("SFAS") 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure". SFAS 148 amends SFAS 123, "Accounting for Stock-
Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-
based employee compensation. Companies are able to eliminate a "ramp-up"
effect that the SFAS 123 transition rule creates in the year of adoption.
Companies can choose to elect a method that will provide for comparability
amongst years reported. In addition, this Statement amends the disclosure
requirement of SFAS 123 to require prominent disclosures in both annual and
interim financial statements about the fair value based method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. The adoption of this Statement did not have a material
impact on the Company's financial position or results of operations at
adoption, but may have a material impact sometime in the future if the
Company were to elect the alternative method for accounting for stock-based
employee compensation.
On March 31, 2004, the FASB issued Exposure Draft "Share-Based Payment
- An Amendment to FASB Statement No. 123 and 95." The Exposure Draft
concluded that all companies should expense the fair value of employee stock
options using either the modified prospective grant-date measurement
approach, or the modified retrospective grant-date measurement approach, as
defined in SFAS 123. Compensation cost would be recognized in the financial
statements prospectively over the requisite service period for interim
periods beginning after June 15, 2005, as if all share-based compensation
awards granted, modified or settled after December 15, 1994 had been
accounted for using the fair value method of accounting. A final Statement
is expected in the fourth quarter of 2004. We are still assessing the impact
of the proposed Statement on our financial statements. Until the new
Statement is issued, the provisions of SFAS 123 and SFAS 148 remain in
effect.
The following table summarizes the differences between the fair value
and intrinsic value methods of accounting for stock-based compensation:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income (in thousands):
As reported $2,178 $1,785 $6,337 $5,219
Compensation cost, net of taxes (1) (142) (47) (383) (142)
------ ------ ------ ------
Pro forma $2,036 $1,738 $5,954 $5,077
====== ====== ====== ======
Earnings per common share:
Basic:
As reported $ 0.55 $ 0.47 $ 1.60 $ 1.37
Compensation cost, net of taxes (1) (0.04) (0.01) (0.10) (0.04)
------ ------ ------ ------
Pro forma $ 0.51 $ 0.46 $ 1.50 $ 1.33
====== ====== ====== ======
Diluted:
As reported $ 0.52 $ 0.44 $ 1.50 $ 1.29
Compensation cost, net of taxes (1) (0.03) (0.01) (0.09) (0.04)
------ ------ ------ ------
Pro forma $ 0.49 $ 0.43 $ 1.41 $ 1.25
====== ====== ====== ======
The stock-based employee compensation cost, net of related tax
effects, that would have been included in the determination of net
income if the fair value based method had been applied to all awards
granted since 1995. The fair value of each option granted was
estimated as of the date of the grant using the Black-Scholes option-
pricing model.
8
(4) Supplemental Executive Retirement Plans
The Bank maintains Supplemental Executive Retirement Plans ("SERPs")
for certain of its senior executives under which participants designated by
the Board of Directors are entitled to an annual retirement benefit.
Expenses associated with the SERPs were $330,000 and $282,000 for the nine
months ending September 30, 2004 and 2003, respectively. Accrued liabilities
associated with the SERPs were $1.2 million and $834,000 for September 30,
2004 and December 31, 2003, respectively.
(5) Recent Accounting Developments
At the November 2003 meeting of FASB's Emerging Issues Task Force
("EITF"), the EITF reached consensus on EITF Issue 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
The consensus requires new disclosure requirements for holders of debt or
marketable equity securities that are accounted for under SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities." The new
disclosure requirements relate to temporarily impaired investments and are
effective for fiscal years ending after December 15, 2003. The requirements
apply only to annual financial statements and comparative disclosures for
prior periods are not required. The Company adopted the EITF's
recommendations on December 31, 2003, and has provided additional
disclosures regarding any possible other-than-temporarily impaired
investments in the footnotes to its 2003 Annual Report to Shareholders.
Adoption of these recommendations did not have a material impact on the
Company's financial position or results of operations. The guidance also
dictates when impairment is deemed to exist, provides guidance on
determining if impairment is other than temporary, and directs how to
calculate impairment loss.
In September 2004, the EITF issued EITF 03-1-1, "Effective Date of
Paragraphs 10-20 of EITF Issue 03-1, 'The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments'", which delays the
effective date of those paragraphs to be concurrent with the final issuance
of EITF 03-1-a, "Implementation Guidance for the Application of Paragraph 16
of EITF 03-1, 'The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments'." EITF 03-1-a is currently being debated
by the FASB in regards to final guidance and effective date with a comment
period that ended October 29, 2004. EITF 03-1, as issued, was originally
effective for periods beginning after June 15, 2004. The Company anticipates
that the adoption of EITF 03-1-1 or EITF 03-1-a will not have a material
impact on the Company's financial position or results of operations.
In December 2003, the FASB issued FASB Interpretation ("FIN") 46-R,
"Consolidation of Variable Interest Entities - Revised." FIN 46-R revises
FIN 46, "Consolidation of Variable Interest Entities" which is an
interpretation of Accounting Research Bulletin 51, "Consolidated Financial
Statements." FIN 46-R provides guidance regarding the consolidation of
special purpose entities, and removed uncertainty over whether FIN 46
required consolidation or deconsolidation of special purpose entities that
issue trust preferred securities. FIN 46-R clarified that even those
entities that issue trust preferred securities with call options must be
deconsolidated. FIN 46-R is effective for financial statements for periods
ending after December 15, 2003, with no requirement for restatement of
previous periods. The Company adopted FIN 46-R on December 31, 2003, and
therefore has deconsolidated its statutory trust subsidiaries as of that
date. Adoption of this Interpretation did not have a material impact on the
Company's financial position or results of operations.
9
BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis
ITEM 2. Management's Discussion and Analysis
Certain statements contained herein are "Forward Looking Statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Forward
Looking Statements may be identified by reference to a future period or
periods or by the use of forward looking terminology such as "may,"
"believes," "intends," "expects," and "anticipates" or similar terms or
variations of these terms. Actual results may differ materially from those
set forth in Forward Looking Statements as a result of certain risks and
uncertainties, including but not limited to, changes in political and
economic conditions, interest rate fluctuations, competitive product and
pricing pressures, equity and bond market fluctuations, credit risk,
inflation, as well as other risks and uncertainties detailed from time to
time in filings with the Securities and Exchange Commission ("SEC").
GENERAL
-------
The Company's principal subsidiary, Bank Rhode Island, is a commercial
bank chartered as a financial institution in the State of Rhode Island. The
Bank pursues a community banking mission and is principally engaged in
providing banking products and services to individuals and businesses in
Rhode Island and nearby areas of Massachusetts. The Bank is subject to
competition from a variety of traditional and nontraditional financial
service providers both within and outside of Rhode Island. The Bank offers
its customers a wide range of deposit products, nondeposit investment
products, commercial, residential and consumer loans, and other traditional
banking products and services designed to meet the needs of individuals and
small- to mid-sized businesses. The Bank also offers both commercial and
consumer on-line banking products and maintains a web site at
http://www.bankri.com. The Company and Bank are subject to regulation by a
number of federal and state agencies and undergo periodic examinations by
certain of those regulatory authorities. The Bank's deposits are insured by
the Federal Deposit Insurance Corporation ("FDIC"), subject to regulatory
limits. The Bank is also a member of the Federal Home Loan Bank of Boston
("FHLB").
OVERVIEW
--------
The Company's operating results depend primarily on two factors: its
"net interest income" and the quality of its assets.
The Company's net interest income is the difference between its
interest income and its cost of money. Interest income depends on the amount
of interest-earning assets outstanding during the year and the interest
rates earned thereon. Cost of money is a function of the average amount of
deposits and borrowed money outstanding during the year and the interest
rates paid thereon. See discussion under "Results of Operations." Because
the Company's assets are not identical in duration and in repricing dates to
its liabilities, the spread between the two is vulnerable to changes in
market interest rates. This vulnerability is inherent to the business of
banking and is commonly referred to as "interest rate risk." How to measure
such risk and, once measured, how much risk to take are based on numerous
assumptions and other subjective judgments. See discussion under "Interest
Rate Risk."
10
The quality of the Company's assets also influences its earnings.
Loans that are not being paid on a timely basis and exhibit other weaknesses
can result in the loss of principal and/or interest income. Additionally,
the Company must make timely provisions to its allowance for loan losses as
a result of its estimates as to probable future losses; these additions,
which are charged against earnings, are necessarily greater when greater
potential losses are expected. Finally, the Company will incur expenses as a
result of resolving troubled assets. All of these form the "credit risk"
that the Company assumes in the ordinary course of its business and is
further discussed under "Financial Condition - Asset Quality."
The Company's business strategy has been to concentrate its asset
generation efforts on commercial loans and its deposit generation efforts on
checking and savings accounts. These deposit accounts are commonly referred
to as "core accounts." This strategy is based on the Company's belief that
it can distinguish itself from its larger competitors, and indeed attract
customers from them, through a higher level of service and its ability to
set policies and procedures, as well as make decisions, locally. The loan
and deposit products referenced also tend to be geared more toward customers
who are relationship oriented than those who are seeking stand-alone or
single transaction products. The Company believes that its service-oriented
approach enables it to compete successfully for relationship-oriented
customers. Additionally, the Company is predominantly an urban franchise
with a high concentration of businesses, making deployment of funds in the
commercial lending area practicable. Commercial loans are attractive, among
other reasons, because of their higher yields. Similarly, core deposits are
attractive because of their generally lower interest cost.
In recent years, the Company also has sought to promote business
opportunities presented by its customer base, franchise footprint and system
resources through increased efforts in both the areas of consumer lending
and residential mortgage originations.
The deposit market in Rhode Island is highly concentrated. The State's
three largest banks have an aggregate market share of 84% (based upon June
2004 FDIC statistics, excluding one bank that draws its deposits primarily
from the internet) in Providence and Kent Counties, Bank Rhode Island's
primary marketplace.
Competition for loans and deposits has intensified in recent months.
With Bank of America entering New England for the first time earlier this
year, numerous institutions in the market have heightened their advertising
and promotional product offerings.
Currently, approximately 80% of the Company's revenues are dependent
on its level of net interest income. In an effort to diversify its sources
of revenue, the Company has attempted to expand its sources of noninterest
income, primarily fees and charges for products and services it offers. The
Company has increased its percentage of noninterest income to total revenue
from 13% in 1999, to 20% in 2004, by emphasizing core deposit growth which
generates increased service charges, and by introducing additional financial
services, such as nondeposit investment products.
Future operating results will depend on the Company's ability to
maintain and expand its net interest margin, while minimizing its exposure
to credit risk, along with increasing its sources of noninterest income,
while controlling the growth of its noninterest or operating expenses.
Total assets increased $117.0 million, or 10.7%, to $1.2 billion at
September 30, 2004 from December 31, 2003. This increase was centered in the
Company's commercial and consumer loan
11
portfolios, along with its mortgage-backed security portfolio, and was
funded primarily by a combination of deposit and borrowings growth. Since
the end of 2003, commercial loans increased $59.8 million, or 18.0%,
consumer loans increased $44.6 million, or 38.5%, mortgage-backed securities
increased $50.5 million, or 47.3%, total deposits increased $74.8 million,
or 9.2%, and total borrowings increased $37.0 million, or 18.2%.
Shareholders' equity was $77.5 million at September 30, 2004, and
represented 6.4% of total assets, compared to $72.1 million, or 6.6% of
total assets, at December 31, 2003.
CRITICAL ACCOUNTING POLICIES
----------------------------
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying
value of certain assets or net income, are considered critical accounting
policies. The Company considers the following to be its critical accounting
policies: allowance for loan losses and review of goodwill for impairment.
There have been no significant changes in the methods or assumptions used in
accounting policies that require material estimates or assumptions.
Allowance for loan losses
Arriving at an appropriate level of allowance for loan losses
necessarily involves a significant degree of judgment. First and foremost in
arriving at an appropriate allowance is the creation and maintenance of a
risk rating system that accurately classifies all loans into varying
categories by degree of credit risk. Such a system also establishes a level
of allowance associated with each category of loans and requires early
identification and reclassification of deteriorating credits. Besides
numerous subjective judgments as to the number of categories, appropriate
level of allowance with respect to each category and judgments as to
categorization of any individual loan, additional subjective judgments are
involved when ascertaining the probability as well as the extent of any
potential losses. The Company's ongoing evaluation process includes a formal
analysis of the allowance each quarter, which considers, among other
factors, the character and size of the loan portfolio, business and economic
conditions, loan growth, delinquency trends, nonperforming loan trends,
charge-off experience and other asset quality factors. These factors are
based on observable information, as well as subjective assessment and
interpretation. Nonperforming commercial, commercial real estate and small
business loans in excess of a specified dollar amount are deemed to be
"impaired." The estimated reserves necessary for each of these credits is
determined by reviewing the fair value of the collateral, the present value
of expected future cash flows, and where available, the observable market
price of the loans. Provisions for losses on the remaining commercial,
commercial real estate, small business, residential mortgage and consumer
loans are based on pools of similar loans using a combination of payment
status, historical loss experience, industry loss experience, market
economic factors, delinquency rates and qualitative adjustments. Management
uses available information to establish the allowance for loan losses at the
level it believes is appropriate. However, future additions to the allowance
may be necessary based on changes in estimates or assumptions resulting from
changes in economic conditions and other factors. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies
may require the Company to recognize adjustments to the allowance based on
their judgments about information available to them at the time of their
examination.
Review of goodwill for impairment
12
In March 1996, the Bank acquired certain assets and assumed certain
liabilities from Fleet National Bank of Connecticut and related entities.
This acquisition was accounted for utilizing the purchase method of
accounting and generated $17.5 million of goodwill. This goodwill was
amortized in the years prior to 2002, resulting in a net balance of
$10.8 million on the Company's balance sheet as of December 31, 2001.
Effective January 1, 2002, in accordance with SFAS 142 "Goodwill and Other
Intangible Assets" and SFAS 147 "Acquisitions of Certain Financial
Institutions", the Company was required to cease amortizing this goodwill
and to review it at least annually for impairment. Goodwill is evaluated for
impairment using market value comparisons for similar institutions, such as
price to earnings multiples, price to deposit multiples and price to equity
multiples. This valuation technique utilizes verifiable market multiples, as
well as subjective assessment and interpretation. The application of
different market multiples, or changes in judgment as to which market
transactions are reflective of the Company's specific characteristics, could
affect the conclusions reached regarding possible impairment. In the event
that the Company were to determine that its goodwill were impaired, the
recognition of an impairment charge could have an adverse impact on its
results of operations in the period that the impairment occurred or on its
financial position.
13
FINANCIAL CONDITION
-------------------
-- Investments. Total investments (consisting of overnight
investments, investment securities, mortgage-backed securities ("MBSs") and
stock in the FHLB) totaled $280.9 million, or 23.2% of total assets, at
September 30, 2004, compared to $215.5 million, or 19.7% of total assets, at
December 31, 2003. All $265.0 million of investment securities and MBSs at
September 30, 2004 were classified as available for sale and carried a total
of $1.7 million in net unrealized gains at the end of September. The
increase in total investments of $65.4 million, or 30.3%, since the end of
last year was the result of cash inflows from deposit growth, residential
loan prepayments and borrowings being partially deployed in MBSs.
-- Loans. Total loans were $869.1 million, or 71.8% of total assets,
at September 30, 2004, compared to $814.3 million, or 74.4% of total assets,
at December 31, 2003. The Company attempts to concentrate its asset growth
in its loan portfolios to maximize the yield on new assets and to take
advantage of continued strong demand for both commercial and home equity
loan products in its market area.
The commercial loan portfolio (consisting of commercial & industrial,
small business, leases, commercial real estate, multi-family real estate,
and construction loans) increased $59.8 million, or 18.0%, during the first
nine months of 2004. The Company believes it is well positioned for
continued commercial loan growth. Particular emphasis is placed on
generation of small- to medium-sized commercial relationships (those
relationships with $7.0 million or less in loan commitments). The Company is
also active in small business lending (loans of $250,000 or less) in which
it utilizes credit scoring, in conjunction with traditional review
standards, and employs streamlined documentation. The Bank is a participant
in the U.S. Small Business Administration ("SBA") Preferred Lender Program
in Rhode Island and the 7a Guarantee Loan Program in Massachusetts. From
time to time, the Company also invests in short-term leases. During the
first nine months of 2004, the Company purchased $21.1 million of leases
from a third party with the U.S. Government and its agencies as the
principal lessees. All of these leases are structured to achieve payment in
full over the term of the lease and, absent default, are not dependent on
residual collateral values.
The consumer loan portfolio increased $44.6 million, or 38.5%, during
the first nine months of 2004. This growth has been centered in ten- to
twenty-year fixed-rate home equity loans with maximum loan-to-values of 85%.
In the current interest rate environment, these fixed-rate products provide
an attractive alternative to first-mortgage refinances and the Company
anticipates that growth in this product will continue. The remaining
consumer loan growth has been in home equity lines of credit, which provide
the Company with a floating rate asset for interest rate risk management
purposes.
While origination efforts continue to be concentrated on commercial
and consumer loan opportunities, the Company also originates residential
mortgage loans on a limited basis. Additionally, until such time as the
Company can generate sufficient commercial and consumer loans to utilize
available cash flow, or to otherwise meet investment objectives, it also
intends to continue purchasing residential mortgage loans as opportunities
develop.
The residential mortgage loan portfolio decreased $49.5 million, or
13.5%, since the beginning of the year as repayments ($90.9 million) were
greater than originations ($7.4 million) and purchases ($34.5 million).
Before purchasing residential mortgage loans, the Company performs a risk-
14
adjusted analysis of whole loans compared to MBSs and purchases the
residential whole loans if there is sufficient spread versus the securitized
product. During much of 2004, spreads on residential whole loans tightened
and the Company believed that MBSs were a more attractive investment. As a
result, the Company reduced its purchasing of residential mortgage loans and
increased its purchasing of MBSs. At September 30, 2004, the Company did not
have any commitments to purchase residential mortgage loans in the next 60
days.
The following is a breakdown of loans receivable:
September 30, December 31,
2004 2003
------------- ------------
(In thousands)
Commercial loans:
Commercial real estate - nonowner occupied $ 88,011 $ 78,083
Commercial real estate - owner occupied 90,113 77,317
Commercial and industrial 81,249 67,925
Construction 33,212 30,632
Small business 33,184 30,429
Multi-family real estate 33,029 28,730
Leases and other 33,569 19,548
-------- --------
Subtotal 392,367 332,664
Net deferred loan origination fees (351) (398)
-------- --------
Total commercial loans $392,016 $332,266
======== ========
Residential mortgage loans:
One- to four-family adjustable rate $192,836 $232,543
One- to four-family fixed rate 122,180 131,743
-------- --------
Subtotal 315,016 364,286
Premium on loans acquired 1,780 2,026
Net deferred loan origination fees (70) (82)
-------- --------
Total residential mortgage loans $316,726 $366,230
======== ========
Consumer loans:
Home equity - term loans $106,261 $ 68,523
Home equity - lines of credit 50,527 42,067
Automobile 664 1,455
Installment 396 662
Savings secured 344 631
Unsecured and other 1,134 1,787
-------- --------
Subtotal 159,326 115,125
Premium on loans acquired 20 44
Net deferred loan origination costs 1,002 617
-------- --------
Total consumer loans $160,348 $115,786
======== ========
Total loans receivable $869,090 $814,282
======== ========
15
-- Deposits and Borrowings. Total deposits increased by $74.8 million,
or 9.2%, during the first nine months of 2004, from $811.3 million, or 74.2%
of total assets, at December 31, 2003, to $886.0 million, or 73.2% of total
assets, at September 30, 2004. The decrease in the relative percentage of
total assets resulted from a portion of the Company's asset growth being
funded by FHLB borrowings and subordinated deferrable interest debentures.
In addition, the composition of total deposits changed during 2004. Core
deposit accounts (checking and savings) increased $68.7 million, or 11.5%,
in the first nine months of 2004, while certificates of deposit increased
$6.1 million, or 2.9%, during this time period. The Bank continues its
strategy of emphasizing core deposit growth over certificate of deposit
growth, but from time-to-time will promote certificates of deposit. At
September 30, 2004, core deposit accounts comprised 75.3% of total deposits,
compared to 73.8% of total deposits at December 31, 2003.
The following table sets forth certain information regarding deposits:
September 30, 2004 December 31, 2003
--------------------------------- ---------------------------------
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
------ ------- -------- ------ ------- --------
(Dollars in thousands)
NOW accounts $116,082 13.1% 0.86% $129,398 16.0% 1.13%
Money market accounts 16,096 1.8% 1.36% 16,937 2.1% 1.29%
Savings accounts 357,092 40.3% 1.26% 292,277 36.0% 1.18%
Certificate of deposit accounts 218,825 24.7% 2.46% 212,755 26.2% 2.55%
-------- ----- -------- -----
Total interest bearing deposits 708,095 79.9% 1.57% 651,367 80.3% 1.62%
Noninterest bearing accounts 177,953 20.1% -- 159,916 19.7% --
-------- ----- -------- -----
Total deposits $886,048 100.0% 1.25% $811,283 100.0% 1.30%
======== ===== ==== ======== ===== ====
The Company, through the Bank's membership in the FHLB, has access to
a variety of borrowing alternatives, and management will from time-to-time
take advantage of these opportunities to fund asset growth. During the first
nine months of 2004, FHLB borrowings increased $34.0 million, or 19.3%, as
the Company sought to take advantage of lower borrowing rates to fund a
portion of its asset growth. The proceeds from these new borrowings were
primarily reinvested in the purchase of MBSs and allowed the Company to
continue to grow its balance sheet. However, on a long-term basis, the
Company intends to continue concentrating on increasing its core deposits.
In March 2004, the Company issued $5.2 million of subordinated
deferrable interest debentures to a related entity, which in turn issued
trust preferred securities. This transaction generated $5.0 million of Tier
I capital for regulatory purposes that can be used to support continued
growth of the Company.
Asset Quality
-------------
The definition of nonperforming assets includes nonperforming loans
and other real estate owned ("OREO"). OREO consists of real estate acquired
through foreclosure proceedings and real estate acquired through acceptance
of a deed in lieu of foreclosure. Nonperforming loans are defined as
nonaccrual loans, loans past due 90 days or more, but still accruing and
impaired loans. Under certain circumstances the Company may restructure the
terms of a loan as a concession to a borrower. These restructured loans are
considered impaired loans.
16
-- Nonperforming Assets. At September 30, 2004, the Company had
nonperforming assets of $790,000, which represented 0.07% of total assets.
This compares to nonperforming assets of $2.5 million, or 0.23% of total
assets, at December 31, 2003. The decline in nonperforming assets was
primarily the result of the successful resolution of a commercial
relationship aggregating $2.1 million. Total nonperforming assets at
September 30, 2004, consisted of nonaccrual residential mortgage loans
aggregating $25,000, nonaccrual consumer loans aggregating $5,000 and
nonaccrual commercial loans aggregating $760,000. Included in nonaccrual
loans were $701,000, at September 30, 2004, and $2.1 million, at December
31, 2003, of impaired loans. Specific reserves against these impaired loans
were $170,000 and $-0- at September 30, 2004 and December 31, 2003,
respectively. The Company evaluates the underlying collateral of each
nonperforming loan and continues to pursue the collection of interest and
principal. Management believes that the current level of nonperforming
assets is very low relative to the size of the Company's loan portfolio. As
the loan portfolio continues to grow and mature, or if economic conditions
worsen, management believes it possible that the level of nonperforming
assets will increase, as will its level of charged-off loans.
Delinquencies. At September 30, 2004, there were no loans 60 to 89
days past due, a decrease of $597,000, or 100.0%, from the $597,000 reported
at December 31, 2003. The majority of these loans at December 31, 2003 were
residential mortgage loans and were secured. As with the level of
nonperforming assets, management believes the level of delinquent loans is
unusually low and that as the loan portfolio continues to grow and mature,
or if economic conditions worsen, delinquencies could increase.
The following table sets forth information regarding nonperforming
assets and loans 60-89 days past due as to interest at the dates indicated.
September 30, December 31,
2004 2003
------------- ------------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $ 790 $2,462
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
----- ------
Total nonperforming loans 790 2,462
Other real estate owned -- --
----- ------
Total nonperforming assets $ 790 $2,462
===== ======
Delinquent loans 60-89 days past due $ -- $ 597
Nonperforming loans as a percent of total loans 0.09% 0.30%
Nonperforming assets as a percent of total assets 0.07% 0.23%
Delinquent loans 60-89 days past due as a percent of total loans 0.00% 0.07%
Adversely Classified Assets. The Company's management adversely
classifies certain assets as "substandard," "doubtful" or "loss" based on
criteria established under banking regulations. An asset is considered
substandard if inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Substandard
assets include those characterized by the "distinct possibility" that the
insured institution will sustain "some loss" if existing deficiencies are
not corrected. Assets classified as doubtful have all of the weaknesses
inherent in those classified substandard with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the
basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as loss are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted.
17
At September 30, 2004, the Company had $3.2 million of assets that
were classified as substandard. This compares to $5.5 million of assets that
were classified as substandard at December 31, 2003. The Company had no
assets that were classified as doubtful or loss at either date. Performing
loans may or may not be adversely classified depending upon management's
judgment with respect to each individual loan. At September 30, 2004,
included in the assets that were classified as substandard, were $2.4
million of performing loans. This compares to $3.1 million of adversely
classified performing loans as of December 31, 2003. These amounts
constitute assets that, in the opinion of management, could potentially
migrate to nonperforming status. Any downturn in the New England economy may
lead to future deteriorations in commercial credit quality and increases in
nonaccrual loans. This in turn may necessitate an increase to the provision
for loan losses in future periods.
Allowance for Loan Losses
-------------------------
During the first nine months of 2004, the Company made provisions to
the allowance for loan losses totaling $700,000 and had $105,000 of net
charge-offs, bringing the balance in the allowance to $11.7 million,
compared to $11.1 million at December 31, 2003. The allowance, expressed as
a percentage of total loans, was 1.34% as of September 30, 2004, compared to
1.36% at the prior year end and stood at 1477.6% of nonperforming loans at
September 30, 2004, compared to 450.0% of nonperforming loans at December
31, 2003.
Assessing the adequacy of the allowance for loan losses involves
substantial uncertainties and is based upon management's evaluation of the
amounts required to meet estimated charge-offs in the loan portfolio after
weighing various factors. Management's methodology to estimate loss exposure
includes an analysis of individual loans deemed to be impaired, reserve
allocations for various loan types based on payments status or loss
experience and an unallocated allowance that is maintained based on
management's assessment of many factors including the growth, composition
and quality of the loan portfolio, historical loss experiences, general
economic conditions and other pertinent factors. Based on this evaluation,
management believes that the allowance for loan losses, as of September 30,
2004, is adequate.
A portion of the allowance for loan losses is not allocated to any
specific segment of the loan portfolio. This non-specific allowance is
maintained for two primary reasons: (i) there exists an inherent
subjectivity and imprecision to the analytical processes employed, and (ii)
the prevailing business environment, as it is affected by changing economic
conditions and various external factors, may impact the portfolio in ways
currently unforeseen. Management, therefore, has established and maintains a
non-specific allowance for loan losses. The amount of this measurement
imprecision allocation was $2.5 million at September 30, 2004, compared to
$3.1 million at December 31, 2003. This decrease was due to improvement in
general economic conditions and improving performance of the loan portfolio.
While management evaluates currently available information in
establishing the allowance for loan losses, future adjustments to the
allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review a financial institution's allowance for loan losses and carrying
amounts of other real estate owned. Such agencies may require the financial
institution to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
18
RESULTS OF OPERATIONS
---------------------
Comparison of Three Months Ended September 30, 2004 and 2003
------------------------------------------------------------
-- General. The Company reported net income for the third quarter of
2004 of $2.2 million, up $393,000, or 22.0%, from the third quarter of 2003.
Diluted earnings per common share were $0.52 for the third quarter of 2004,
compared to $0.44 for the third quarter of 2003.
The Company reported a return on average assets of 0.72% and a return
on average equity of 11.63% for the 2004 period, as compared to a return on
average assets of 0.67% and a return on average equity of 10.17% for the
2003 period.
-- Net Interest Income. For the quarter ended September 30, 2004, net
interest income was $9.8 million, compared to the $7.9 million reported for
the 2003 period. The net interest margin for the third quarter of 2004 was
3.45% compared to a net interest margin of 3.13% for the 2003 period. The
increase in net interest income of $2.0 million, or 24.8%, was primarily
attributable to the continued growth of the Company. Average earnings assets
were $134.0 million, or 13.4%, higher and average interest-bearing
liabilities were $101.1 million, or 12.0%, higher, than the comparable
period a year earlier. The increase of 32 basis points in the net interest
margin resulted from the Company benefiting from increases in the Prime Rate
during 2004 on the asset side of its balance sheet, while managing to reduce
the overall cost of its interest-bearing liabilities. Additionally,
prepayment activity on mortgage-related assets slowed considerably from the
same period in 2003.
-- Interest Income. Investments. Total investment income was $3.1
million for the quarter ended September 30, 2004, compared to $2.0 million
for the third quarter of 2003. The increase in total investment income of
$1.1 million, or 56.3%, was primarily attributable to an increase of $56.6
million, or 24.7%, in the overall average balance of investments between the
two periods, coupled with a slowdown in prepayment activity on MBSs. The
overall average yield on investments increased 87 basis points, from the
third quarter of 2003 to the third quarter of 2004, as prepayment activity
slowed significantly and overnight investments were redeployed in higher
yielding securities. The majority of the Company's investments are comprised
of US Agency securities and MBSs with repricing periods or expected
remaining maturities of less than five years.
-- Interest Income. Loans. Interest from loans was $11.9 million for
the three months ended September 30, 2004, and represented a yield on total
loans of 5.56%. This compares to $10.7 million of interest, and a yield of
5.52%, for the third quarter of 2003. Interest from commercial loans
increased $916,000, or 18.4%, and consumer and other loan income increased
$598,000, or 46.6%, as average balances increased and average yields
remained relatively stable. Declining average balances resulted in
residential mortgage loan interest decreasing $363,000, or 8.2%, from the
third quarter of 2003. The average balance of the various components of the
loan portfolio changed from the second quarter of 2003 as follows:
commercial loans increased $58.5 million, or 18.4%, and consumer and other
loans increased $49.5 million, or 48.2%, while residential mortgage loans
decreased $30.6 million, or 8.7%. The yields on the various loan portfolio
components changed as follows: commercial loans increased 2 basis points, to
6.23%; consumer and other loans decreased 4 basis points, to 4.92%; and
residential mortgage loans increased 3 basis points, to 5.08%. Since its
inception, the Company has concentrated its origination efforts on
commercial and consumer loan opportunities, while purchasing residential
mortgage loans, and to a limited degree, leases and automobile loans, as
cash flows dictated. More recently, the Company has increased its home
equity loan origination capacity in response to strong demand for this
product.
19
-- Interest Expense. Interest paid on deposits and borrowings
increased $298,000, or 6.3%, to $5.1 million for the three months ended
September 30, 2004, from $4.8 million paid during the same period in 2003.
The increase in total interest expense was primarily attributable to an
increase in the average balance of deposits and borrowings, partially offset
by a decrease in market interest rates. The average balance of interest-
bearing liabilities increased $101.1 million, or 12.0%, from $841.7 million
in the third quarter of 2003 to $942.9 million in the third quarter of 2004,
as deposit growth, along with additional borrowings, were utilized to fund
the Company's asset growth. Meanwhile, the overall average cost for
interest-bearing liabilities decreased 11 basis points from 2.25% for the
third quarter of 2003, to 2.14% for the third quarter of 2004. Liability
costs are dependent on a number of factors including general economic
conditions, national and local interest rates, competition in the local
deposit marketplace, interest rate tiers offered and the Company's cash flow
needs. Average costs for the various components of interest-bearing
liabilities changed from the third quarter of 2003 as follows: NOW accounts
decreased 21 basis points, to 0.89%, certificate of deposit accounts
decreased 31 basis points, to 2.48%, and borrowings decreased 21 basis
points to 3.89%, while savings accounts increased 5 basis points, to 1.24%,
and money market accounts increased 32 basis points, to 1.30% (primarily the
result of increased balances in higher rate tiers).
-- Provision for Loan Losses. The provision for loan losses was
$200,000 for the quarter ended September 30, 2004, down $200,000, or 50.0%,
from the same quarter last year. Management evaluates several factors
including new loan originations, actual and estimated charge-offs, the risk
characteristics of the loan portfolio and general economic conditions when
determining the provision for each quarter. Also see discussion under
"Allowance for Loan Losses." While nonperforming loans and loan charge-offs
were minimal, additions to the allowance for loan losses were made during
the quarter in response to growth in total loans outstanding and general
economic conditions. The allowance expressed as a percentage of total loans
was 1.34% at September 30, 2004, compared to 1.36% at December 31, 2003. As
the loan portfolio continues to grow and mature, or if economic conditions
worsen, management believes it possible that the level of nonperforming
assets will increase, which in turn may lead to increases in the provision
for loan losses in future periods.
-- Noninterest Income. Total noninterest income decreased $197,000, or
8.8%, to $2.0 million for the third quarter of 2004, from $2.2 million for
the 2003 quarter. While the Company experienced growth in a number of its
noninterest income categories, two categories experienced significant
declines primarily as a result of changes in market interest rates between
the two periods. On the positive side, Service charges on deposit accounts,
which continues to represent the largest source of noninterest income for
the Company, increased $199,000, or 20.8%, in response to continued growth
in checking accounts and changes in how the Bank assesses NSF fees.
Commissions on nondeposit investment products increased $92,000, or 41.8%,
compared to the third quarter of 2003, as consumer interest in investment
products rebounded. However, more than offsetting these increases, the
Company realized $357,000 less in Gains on sale of investment securities and
$116,000 less in Commissions on loans originated for others.
-- Noninterest Expense. Total noninterest expense for the third
quarter of 2004 increased $1.3 million, or 19.1%, to $8.4 million from $7.0
million in 2003. This increase occurred primarily as a result of the
continued overall growth of the Company, coupled with increased costs for
auditing and management training, and was centered in the following areas:
Salaries and employee benefits (up $869,000, or 23.5%), Occupancy and
Equipment (up $100,000, or 10.2%), Data processing (up $65,000, or 10.9%)
and Professional services (up $223,000, or 77.2%). In addition to incurring
increased operating costs as a result of continuing growth in both loans and
core deposits, the 2004
20
period includes incentive bonus accruals which the 2003 period did not.
Partially offsetting these increases were decreases in Loan servicing (down
$31,000, or 11.5%) and Loan workout (down $25,000, or 75.8%), as the level
of purchased loans and problem loans decreased from the 2003 period. The
Company's efficiency ratio increased 104 basis points, from 69.49% for the
third quarter of 2003, to 70.53% for the third quarter of 2004.
-- Income Tax Expense. Income tax expense of $1.1 million was recorded
for the quarter ended September 30, 2004, compared to $904,000 for the 2003
period. This represented total effective tax rates of 34.0% and 33.6%,
respectively. Tax-favored income from U.S. Agency securities and BOLI, along
with the utilization of a Rhode Island passive investment company, has
reduced the Company's effective tax rate from the 39.9% combined statutory
federal and state tax rates.
Comparison of Nine Months Ended September 30, 2004 and 2003
-----------------------------------------------------------
-- General. Net income for the first nine months of 2004, increased
$1.1 million, or 21.4%, to $6.3 million, or $1.50 per diluted common share,
from $5.2 million, or $1.29 per diluted common share, for the first nine
months of 2003.
This performance represented a return on average assets of 0.73% and a
return on average equity of 11.45% for the 2004 period, as compared to a
return on average assets of 0.68% and a return on average equity of 10.24%
for the 2003 period.
During the 2003 period, the Company made some significant investments
in the future of the Bank, including converting to a new core data
processing system in May, as well as opening a new Operations Center in
January. These investments included start-up charges of approximately
$600,000 during the 2003 period which were not present during the 2004
period.
-- Net Interest Income. For the nine months ended September 30, 2004,
net interest income was $27.9 million, compared to $23.7 million for the
2003 period. The net interest margin for the first nine months of 2004 was
3.43% compared to a net interest margin of 3.26% for the 2003 period. The
increase in net interest income of $4.2 million, or 17.7%, was primarily
attributable to the overall growth of the Company. Average earning assets
increased $114.2 million, or 11.7%, and average interest-bearing liabilities
increased $77.2 million, or 9.4%, over the comparable period a year earlier.
The increase of 17 basis points in the net interest margin resulted from the
Company's assets benefiting from increases in the Prime Rate during 2004,
while the Company also was able to reduce the overall cost of its interest-
bearing liabilities. Additionally, prepayment activity on mortgage-related
assets slowed considerably from the 2003 period.
-- Interest Income. Investments. Total investment income was $7.7
million for the nine months ended September 30, 2004, compared to $7.1
million for the 2003 period. This increase in total investment income of
$569,000, or 8.0%, was attributable to a 22 basis point increase in the
overall yield on investments, from 3.87% in 2003, to 4.09% in 2004, in
response to slower prepayment activity in MBSs, coupled with a $5.5 million,
or 2.3%, increase in the average balance of investments.
-- Interest Income. Loans. Interest from loans was $34.7 million for
the nine months ended September 30, 2004, and represented a yield on total
loans of 5.53%. This compares to $31.3 million of interest, and a yield of
5.75%, for the first nine months of 2003. Increased interest income
resulting from growth in the average balance of loans of $108.6 million, or
14.9%, was partially
21
offset by a decrease in the average yield of loans of 22 basis points. The
decrease in the average yield on loans resulted from a drop in market
interest rates that has occurred over the past year. The average balance of
the various components of the loan portfolio changed as follows: commercial
loans increased $55.0 million, or 18.1%; consumer and other loans increased
$32.9 million, or 32.6%; and residential mortgage loans increased $20.7
million, or 6.4%. The average yield on the various components of the loan
portfolio changed as follows: commercial loans decreased 15 basis points, to
6.23%; consumer and other loans decreased 34 basis points, to 4.86%; and
residential mortgage loans decreased 29 basis points, to 5.06%. The Company
has continued to concentrate its origination efforts on commercial and
consumer loan opportunities, but also originates residential mortgage loans
for its portfolio on a limited basis. Until such time as the Company can
originate sufficient commercial, consumer and residential loans to utilize
available cash flow, it intends to continue purchasing residential mortgage
loans as opportunities develop.
-- Interest Expense. Interest paid on deposits and borrowings
decreased $317,000, or 2.1%, to $14.4 million for the nine months ended
September 30, 2004, compared to $14.7 million for the same period during
2003. The decrease in total interest was primarily attributable to the drop
in market interest rates over the past year and was partially offset by
growth in deposit and borrowing balances. The overall average cost for
interest-bearing liabilities decreased 26 basis points from 2.40% for the
2003 period, to 2.14% for the 2004 period. Deposit costs are dependent on a
number of factors including general economic conditions, national and local
interest rates, competition in the local marketplace, interest rate tiers
offered, and the Company's cash flow needs. Offsetting the effect of the
decline in market interest rates, the average balance of interest-bearing
liabilities increased $77.2 million, or 9.4%, from $822.4 million in 2003,
to $899.7 million in 2004. The Company experienced strong average balance
growth in core deposit accounts, specifically NOW accounts (up $16.5
million, or 14.9%) and savings accounts (up $16.7 million, or 5.6%). In
addition, the Company increased its utilization of FHLB borrowings (up $23.8
million, or 15.0%) and subordinated deferrable interest debentures (up $6.8
million, or 69.9%).
-- Provision for Loan Losses. The provision for loan losses was
$700,000 for the nine months ended September 30, 2004, compared to $1.2
million for the same period last year. The allowance, expressed as a
percentage of total loans, was 1.34% as of September 30, 2004, compared to
1.36% at the prior year-end and stood at 1477.6% of nonperforming loans at
September 30, 2004, compared to 450.0% of nonperforming loans at December
31, 2003. Net charge-offs for the nine month period ending September 30,
2004 were $105,000, compared to $488,000 for the period ending September 30,
2003. Management evaluates several factors including new loan originations,
actual and estimated charge-offs, the risk characteristics of the loan
portfolio and general economic conditions when determining the provision for
loan losses. Also see discussion under "Allowance for Loan Losses."
-- Noninterest Income. Total noninterest income decreased $303,000, or
4.6%, from $6.5 million for the first nine months of 2003, to $6.2 million
for the first nine months of 2004. While the Company experienced growth in a
number of its noninterest income categories, a few of the categories
declined between the two periods. On the positive side, Service charges on
deposit accounts, which continues to represent the largest source of
noninterest income for the Company, increased $422,000, or 14.3%, in
response to continued growth in checking accounts and NSF fee enhancements.
Commissions on nondeposit investment products increased $132,000, or 21.1%,
as consumer interest in investment products rebounded. Other income
increased $237,000, or 33.8%, primarily from commissions generated from
sales of tax credits, along with increased credit card and tuition payment
activity. However, more than offsetting these increases, the Company
realized
22
$453,000, or 57.7%, less in Gains on sale of investment securities and MBSs;
$279,000, or 84.3%, less in Commissions on loans originated for others; and
$101,000, or 17.4%, less in Income from BOLI. Lastly, the 2003 period
contained loan prepayment penalties aggregating $286,000, which were not
present in the 2004 period.
-- Noninterest Expense. Noninterest expenses for the first nine months
of 2004 increased a total of $2.7 million, or 12.6%, to $23.9 million. This
increase occurred primarily as a result of the continued overall growth of
the Company and was centered in the following areas: Salaries and employee
benefits (up $1.8 million, or 17.2%), Occupancy and Equipment (up $317,000,
or 11.0%), Marketing (up $215,000, or 25.9%), Professional services (up
$203,000, or 21.3%), Loan servicing (up $62,000, or 8.8%) and Other expenses
(up $182,000, or 6.4%). In addition to incurring increased operating costs
as a result of continuing growth in both loans and core deposits, the 2004
period includes incentive bonus accruals which the 2003 period did not.
Partially offsetting these increases was a decrease in Data processing (down
$189,000, or 8.4%) as the 2003 period contained expenses associated with the
Bank's data processing conversion that were not present in the 2004 period.
The Company's efficiency ratio improved slightly to 70.11% for the 2004
period, from 70.28% for the 2003 period.
-- Income Tax Expense. The Company recorded income tax expense of $3.2
million for the first nine months of 2004, compared to $2.6 million for the
same period during 2003. This represented total effective tax rates of 33.3%
and 33.0%, respectively. Tax-favored income from U.S. Agency securities and
BOLI, along with its utilization of a Rhode Island passive investment
company, has reduced the Company's effective tax rate from the 39.9%
combined statutory federal and state tax rates.
23
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
-- Liquidity. Liquidity is defined as the ability to meet current and
future financial obligations of a short-term nature. The Company further
defines liquidity as the ability to respond to the needs of depositors and
borrowers, as well as to earnings enhancement opportunities, in a changing
marketplace.
The primary source of funds for the payment of dividends and expenses
by the Company is dividends paid to it by the Bank. Bank regulatory
authorities generally restrict the amounts available for payment of
dividends if the effect thereof would cause the capital of the Bank to be
reduced below applicable capital requirements. These restrictions indirectly
affect the Company's ability to pay dividends. The primary sources of
liquidity for the Bank consist of deposit inflows, loan repayments, borrowed
funds, maturity of investment securities and sales of securities from the
available for sale portfolio. Management believes that these sources are
sufficient to fund the Bank's lending and investment activities.
Management is responsible for establishing and monitoring liquidity
targets as well as strategies and tactics to meet these targets. In general,
the Company seeks to maintain a high degree of flexibility. At September 30,
2004, overnight investments, investment securities and MBSs available for
sale amounted to $269.0 million, or 22.2% of total assets. This compares to
$205.9 million, or 18.8% of total assets at December 31, 2003. The Bank is a
member of the FHLB and, as such, has access to both short- and long-term
borrowings. In addition, the Bank maintains a line of credit at the FHLB as
well as a line of credit with a correspondent bank. There have been no
adverse trends in the Company's liquidity or capital reserves. Management
believes that the Company has adequate liquidity to meet its commitments.
-- Capital Resources. Total shareholders' equity of the Company at
September 30, 2004 was $77.5 million, as compared to $72.1 million at
December 31, 2003. This increase of $5.4 million was primarily the result of
net income for the nine months of $6.3 million, plus proceeds from issuance
of stock of $1.2 million, less dividends of $1.7 million and reductions in
other comprehensive income of $465,000.
All FDIC-insured institutions must meet specified minimal capital
requirements. These regulations require banks to maintain a minimum leverage
capital ratio. In addition, the FDIC has adopted capital guidelines based
upon ratios of a bank's capital to total assets adjusted for risk. The risk-
based capital guidelines include both a definition of capital and a
framework for calculating risk-weighted assets by assigning balance sheet
assets and off-balance sheet items to broad risk categories. These
regulations require banks to maintain minimum capital levels for capital
adequacy purposes and higher capital levels to be considered "well
capitalized."
Capital guidelines have also been issued by the Federal Reserve Board
("FRB") for bank holding companies. These guidelines require the Company to
maintain minimum capital levels for capital adequacy purposes. In general,
the FRB has adopted substantially identical capital adequacy guidelines as
the FDIC. Such standards are applicable to bank holding companies and their
bank subsidiaries on a consolidated basis.
As of September 30, 2004, the Company and the Bank met all applicable
minimum capital requirements and were considered "well capitalized" by both
the FRB and the FDIC.
24
The recent decision by the SEC to require the deconsolidation of
"special purpose entities" under the Financial Accounting Standards Board's
Interpretation 46-R, "Consolidation of Variable Interest Entities -
Revised," has lead to some uncertainty regarding whether the FRB would
disallow, or further limit, the inclusion of trust preferred securities in
future Tier I capital calculations. To date, the Company has issued a total
of $18.0 million of trust preferred securities and utilized their proceeds
as Tier I capital to help support the Company's growth. If trust preferred
securities are no longer available as a source of Tier I capital, the
Company expects to use other forms of capital (e.g., common or preferred
equity) to support its future growth, which, because of less favorable tax
treatment, may be a somewhat more expensive source of capital than trust
preferred securities.
The Company's and the Bank's actual and required capital amounts and
ratios are as follows:
Minimum Required Minimum Required
For Capital To Be Considered
Actual Adequacy Purposes "Well Capitalized"
------------------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
At September 30, 2004:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $83,614 7.03% $35,666 3.00% $59,443 5.00%
Tier I capital (to risk weighted assets) 83,614 10.10% 33,112 4.00% 49,669 6.00%
Total capital (to risk weighted assets) 93,972 11.35% 66,225 8.00% 82,781 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $80,276 6.76% $35,650 3.00% $59,417 5.00%
Tier I capital (to risk weighted assets) 80,276 9.70% 33,092 4.00% 49,638 6.00%
Total capital (to risk weighted assets) 90,634 10.96% 66,184 8.00% 82,730 10.00%
At December 31, 2003:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $72,690 6.76% $32,255 3.00% $53,759 5.00%
Tier I capital (to risk weighted assets) 72,690 9.71% 29,954 4.00% 44,931 6.00%
Total capital (to risk weighted assets) 81,784 10.92% 59,908 8.00% 74,885 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $70,835 6.59% $32,570 3.00% $54,283 5.00%
Tier I capital (to risk weighted assets) 70,835 9.46% 29,938 4.00% 44,907 6.00%
Total capital (to risk weighted assets) 79,929 10.68% 59,876 8.00% 74,845 10.00%
25
BANCORP RHODE ISLAND, INC.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK
------------------
The principal market risk facing the Company is interest rate risk.
The Company's objective regarding interest rate risk is to manage its assets
and funding sources to produce results which are consistent with its
liquidity, capital adequacy, growth and profitability goals, while
minimizing any adverse effect from changes in interest rates. The primary
tools for managing interest rate risk are the securities portfolio,
purchased mortgages and borrowings form the FHLB.
The Company's actions in this regard are taken under the guidance of
the Bank's Asset/Liability Committee ("ALCO"). The ALCO manages the
Company's interest rate risk position using both income simulation and
interest rate sensitivity "gap" analysis. The ALCO has established internal
parameters for monitoring the Company's interest rate risk. These guidelines
serve as benchmarks for evaluating actions to balance the current position
against overall strategic goals. The ALCO monitors current exposures and
reports these to the Board of Directors.
Simulation is used as the primary tool for measuring the interest rate
risk inherent in the Company's balance sheet at a given point in time by
showing the effect on net interest income, over a 24-month period, of
interest rate ramps of up to 200 basis points. These simulations take into
account repricing, maturity and prepayment characteristics of individual
products. The ALCO reviews simulation results to determine whether the
downside exposure resulting from changes in market interest rates remains
within established tolerance levels over both a 12-month and 24-month
horizon, and develops appropriate strategies to manage this exposure. The
Company's guidelines for interest rate risk specify that if interest rates
were to shift up or down 200 basis points over a 12-month period, estimated
net interest income for those 12-months and the subsequent 12 months, should
decline by no more than 5.0% or 10.0%, respectively. As of September 30,
2004, net interest income simulation indicated that the Company's exposure
to changing interest rates was within these tolerances. The ALCO reviews the
methodology utilized for calculating interest rate risk exposure and will
adopt changes based on changing market conditions or industry standards.
26
The following table presents the estimated impact of changes in market
interest rates on the Company's estimated net interest income over a twenty-
four month period beginning October 1, 2004:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 basis points $ (132) (0.33%)
Down 200 basis points 299 0.74%
Subsequent Twelve Month Period:
Up 200 basis points $(2,798) (7.02%)
Down 200 basis points 291 0.73%
The Company also uses interest rate sensitivity gap analysis to
provide a more general overview of its interest rate risk profile. The
interest rate sensitivity gap is defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing within
a given time period. At September 30, 2004, the Company's one year
cumulative gap was a positive $53.1 million, or 4.39% of total assets.
For additional discussion on interest rate risk see the section titled
"Asset and Liability Management" on pages 38 to 40 of the Company's 2003
Annual Report to Shareholders.
ITEM 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), the Company carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures as of the end of the period covered by this report.
This evaluation was carried out under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer. Based upon that
evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.
There was no significant change in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter that has materially affected, or is reasonably likely to affect, the
Company's internal control over financial reporting.
27
BANCORP RHODE ISLAND, INC.
Other Information
PART II. Other Information
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company
or its subsidiaries are a party, or to which any of their property is
subject, other than ordinary routine litigation incidental to the
business of banking.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
No information to report.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
No defaults upon senior securities have taken place.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
No information to report.
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.14 Employment Agreement of Linda H. Simmons dated
September 8, 2004
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Current Report on Form 8-K dated July 20, 2004, announcing the
Company's second quarter consolidated earnings.
28
BANCORP RHODE ISLAND, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Bancorp Rhode Island, Inc.
November 8, 2004 /s/ Merrill W. Sherman
---------------- ----------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
November 8, 2004 /s/ Albert R. Rietheimer
---------------- ------------------------
(Date) Albert R. Rietheimer
Chief Financial Officer
and Treasurer
29