UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
----- EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
Commission file number 000-23904
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SLADE'S FERRY BANCORP.
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(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-3061936
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(State or other jurisdiction of (I.R.S. Employer
in Company or organization) Identification Number)
100 Slade's Ferry Avenue
Somerset, Massachusetts 02726
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 675-2121
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.01 par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark 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 preceding 12 months and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in rule 12b-2 of the
Exchange Act. (Check one):
Large Accelerated Filer [ ] Accelerated Filer [ ] Non Accelerated Filer
[X]
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Act).
Yes [ ] No [X]
The aggregate market value of the voting stock of Slade's Ferry Bancorp.,
held by nonaffiliates of the registrant as of June 30, 2005 was
approximately $66,016,000.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Proxy Statement for the 2006 Annual Meeting of Shareholders
to be held on May 17, 2006 is incorporated by reference into Part III of
this Form 10-K.
TABLE OF CONTENTS
Part I
Forward-Looking Statements 2
ITEM 1 - Business 3
ITEM 1A - Risk Factors 18
ITEM 1B - Unresolved Staff Comments 20
ITEM 2 - Properties 21
ITEM 3 - Legal Proceedings 22
ITEM 4 - Submission of Matters to a Vote of Security Holders 22
Part II
ITEM 5 - Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 23
ITEM 6 - Selected Financial Data 25
ITEM 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 26
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk 44
ITEM 8 - Financial Statements and Supplementary Data 46
ITEM 9 - Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 46
ITEM 9A - Controls and Procedures 46
ITEM 9B - Other Information 46
Part III
ITEM 10 - Directors and Executive Officers of the Registrant 47
ITEM 11 - Executive Compensation 47
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 47
ITEM 13 - Certain Relationships and Related Transactions 47
ITEM 14 - Principal Accounting Fees and Services 47
Part IV
ITEM 15 - Exhibits, Financial Statement Schedules 48
Signatures 49
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PART I
FORWARD-LOOKING STATEMENTS
This Form 10-K 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. Such statements may be identified by words such as "believes,"
"will," "expects," "project," "may," "could," "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 our 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.
As used throughout this report, the terms "we," "our," "us," or the "Bank"
or the "Company" refer to Slade's Ferry Bancorp. and its consolidated
subsidiaries, unless context otherwise requires.
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ITEM 1
BUSINESS
GENERAL
Slade's Ferry Bancorp., a Massachusetts corporation, is a bank holding
company headquartered in Somerset, Massachusetts with consolidated assets of
$585.9 million, consolidated net loans and leases of $409.6 million,
consolidated deposits of $415.8 million and consolidated shareholders'
equity of $48.9 million as of December 31, 2005. We conduct our business
principally through our wholly-owned subsidiary, Slade's Ferry Trust Company
(referred to herein as the "Bank"), a Massachusetts-chartered trust company.
As a bank holding company, we are subject to the Bank Holding Company Act of
1956, as amended (the "BHCA"), and the rules and regulations of the Federal
Reserve Board (the "FRB") under the BHCA. We are additionally subject to the
provisions of the Massachusetts General Laws applicable to commercial bank
and trust companies and other depository institutions and their holding
companies and applicable regulations of the Massachusetts Division of Banks
(the "Division"). We are also subject to the rules and regulations of the
Securities and Exchange Commission (the "SEC") as our common stock is
registered with the SEC and is quoted on the Nasdaq Capital Market. The
Bank's deposit accounts are insured up to applicable limits by the Bank
Insurance Fund of the Federal Deposit Insurance Company (the "FDIC"). The
Bank is subject to extensive regulation, examination and supervision by the
Division as its primary corporate regulator, and by the FDIC as its deposit
insurer and primary federal regulator. Any change in such laws and
regulations, whether by the Division, the FDIC, the FRB or the SEC or
through legislation, could have a material adverse impact on our operation.
Our main office is located at 100 Slade's Ferry Avenue, Somerset,
Massachusetts, 02726, and our telephone number is (508) 675-2121. Slade's
Ferry Bancorp. was organized for the purpose of becoming the holding company
of the Bank. Slade's Ferry Bancorp.'s acquisition of the Bank was completed
on April 1, 1990.
We had consolidated asset growth of $36.5 million or 6.6% and our level of
deposits increased by $15.9 million, or by 4.0%, during 2005. Aside from
deposits, we increased borrowings from the Federal Home Loan Bank of Boston
(the "FHLB") by $17.6 million. This activity funded an increase in loans
totaling $47.3 million or 13.1%, and an increase in investments totaling
$1.9 million or 1.6%.
While we evaluate opportunities to acquire other banks or bank facilities as
they arise and may in the future acquire other banks, financial
institutions, or bank facilities, we are not currently engaged in any such
acquisition.
We are committed to the philosophy of serving the needs of customers within
our market area. We believe that our comprehensive retail, small business,
and commercial real estate products enable us to compete effectively. We do
not have any major target accounts, nor do we derive a material portion of
our deposits from any single depositor. We concentrate our operations in the
area of retail banking and we service the needs of the local communities.
Our loans are not concentrated within any single industry or group of
related industries that would have any possible adverse effect on our
business.
We currently have nine full service banking facilities plus a drive up
complex extending east from Seekonk, Massachusetts to Fairhaven,
Massachusetts. These facilities service numerous communities in Southeastern
Massachusetts and contiguous areas of Rhode Island. We also provide limited
banking services at the Somerset High School in Somerset, Massachusetts. We
opened our newest facility, located in Assonet, Massachusetts in early 2005.
This branch is a state-of-the-art, full-service banking office, designed to
provide superior customer convenience and service. We own and operate eight
full service automated teller machines ("ATM") and one ATM dispenser.
The Bank maintains three wholly-owned subsidiaries. Two of these, Slade's
Ferry Securities Corporation ("SFSC"), and Slade's Ferry Securities
Corporation II ("SFSCII") are Massachusetts securities corporations on
which, under current Massachusetts law, income is taxed at 1.32%, as
compared to the Massachusetts bank taxation rate of 10.5%. In exchange for
this lower tax rate, the assets of any Massachusetts security Corporation
are limited to certain investment securities, including United States
Treasury and agency securities, obligations of government-sponsored
entities, mortgage-backed investments, corporate debt securities and
marketable equity securities. Investment securities with book values
totaling $15.8 million and $32.9 million were held at SFSC and SFSC II,
respectively, at December 31, 2005.
Slade's Ferry Realty Trust ("SFRT") owns and manages our land and buildings.
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Slade's Ferry Loan Company ("SFLC") was a Rhode Island Company founded for
the purpose of generating loans in the State of Rhode Island. As the Bank
has received authorization to generate loans in Rhode Island directly, SFLC
was dissolved in early 2005.
Slade's Ferry Statutory Trust I, a Connecticut statutory trust was formed on
March 17, 2004 by the Company.
Our major customer accounts as of December 31, 2005 consist of approximately
29,940 personal savings, checking and money market accounts, and
approximately 6,800 personal and commercial certificates of deposit and
individual retirement accounts. Our commercial base consists of
approximately 3,240 checking, money market, and corporate accounts.
As we grew in 2005, we remained committed to customer service. We continue
to upgrade the systems utilized on the teller platform and in customer
service areas to allow employees to serve customers more efficiently.
SERVICES
We engage in a broad range of banking activities, including demand, savings
and time deposits, related personal and commercial checking account
services, real estate mortgages, commercial and installment lending, payroll
services, money orders, travelers checks, Visa, MasterCard, debit card, safe
deposit rentals and automatic teller machines. We also offer certain non-
traditional banking services including investments, life insurance,
annuities, and cash management services and we also provide a range of
internet-based services for both consumer and commercial customers.
LENDING ACTIVITIES
Our loan portfolio consists primarily of residential and commercial real
estate, construction and land development, commercial, home equity lines of
credit and consumer loans originated primarily in our market area. There are
no foreign loans outstanding. Interest rates charged by the Bank on loans
are affected principally by the demand for such loans, the supply of money
available for lending purposes and the rates offered by its competitors.
These factors are affected by general and economic conditions, monetary
policies of the federal government, including the FRB, legislative tax
policies and governmental budgetary matters. We originate residential
mortgage loans, equity lines of credit, fixed-rate equity loans, commercial
business loans, consumer loans and commercial real estate loans. Total net
loans were 69.9% of total assets at December 31, 2005, as compared to 65.9%
of total assets at December 31, 2004. See Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operation", for detailed
portfolio information.
Multi-Family and Commercial Real Estate Lending
We originate multi-family and commercial real estate loans that are
generally secured by five or more unit apartment buildings and properties
used for business purposes such as small office buildings, restaurants or
retail facilities primarily located in our primary market area. Our multi-
family and commercial real estate underwriting policies provide that such
real estate loans may be made in amounts of up to 80% of the appraised value
of the property, subject to our current loans-to-one-borrower limit of $9.5
million at December 31, 2005. Our multi-family and commercial real estate
loans are generally made with terms of up to 20 years and are offered with
interest rates that adjust periodically. In reaching a decision on whether
to make a multi-family or commercial real estate loan, we consider the net
operating income of the property, the borrower's expertise, credit history
and profitability and the value of the underlying property. We have
generally required that the properties securing these real estate loans have
debt service coverage ratios (earnings before debt service to debt service
requirements) of at least 1.20 times. Environmental impact surveys are
generally required for all commercial real estate loans. Generally, all
multi-family and commercial real estate loans made to companies,
partnerships and other business entities require personal guarantees by the
principals. We may choose not to require a personal guarantee on such loans
depending on the creditworthiness of the borrower and the amount of the down
payment and other mitigating circumstances.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one-to-four family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties are often
dependent on successful operation or management of the
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properties, repayment of such loans may be subject to adverse conditions in
the real estate market or the economy. We seek to minimize these risks
through our underwriting standards.
Multi-family and commercial real estate loans totaled $213.8 million and
comprised 51.6% of the total gross loan portfolio at December 31, 2005. At
December 31, 2004, the multi-family and commercial real estate loan
portfolio totaled $192.8 million, or 52.6% of total gross loans.
Residential Lending
We currently offer fixed-rate, one-to-four family mortgage loans with terms
from 10 to 30 years and a number of adjustable-rate mortgage ("ARM") loans
with terms of up to 30 years and interest rates which adjust every one or
three years from the outset of the loan. The interest rates for the ARM
loans are generally indexed to the applicable Constant Maturity Treasury
("CMT") Index, or other comparable indices. Our ARM loans generally provide
for periodic (not more than 2%) and overall (not more than 6%) caps on the
increase or decrease in the interest rate at any adjustment date and over
the life of the loan.
The origination of adjustable-rate residential mortgage loans and short-term
fixed-rate mortgage loans, as opposed to 30-year, fixed-rate residential
mortgage loans, generally helps reduce our exposure to increases in interest
rates. However, adjustable-rate loans generally pose credit risks not
inherent in fixed-rate loans, primarily because as interest rates rise, the
underlying payments of the borrower rise, thereby increasing the potential
for default. Periodic and lifetime caps on interest rate increases help to
reduce the risks associated with adjustable-rate loans but also limit the
interest rate sensitivity of such loans. The continued period of low market
interest rates has been the impetus for the Bank's customers to continue to
finance home purchases with fixed-rate loans or to refinance ARM loans into
fixed-rate loans.
Generally, we originate one-to-four family residential mortgage loans in
amounts of up to 95% of the appraised value or selling price of the property
securing the loan, whichever is lower. Certain loans in our "First-Time Home
Buyer" program allow for a 97% loan-to-value ("LTV") ratio. Private mortgage
insurance ("PMI") is required for loans with a LTV ratio of greater than
80%. Mortgage loans we originate generally include due-on-sale clauses,
which provide us with the contractual right to deem the loan immediately due
and payable in the event the borrower transfers ownership of the property
without our consent. Due-on-sale clauses are an important means of adjusting
the yields on our fixed-rate mortgage loan portfolio and we have generally
exercised our rights under these clauses. We require fire, casualty, title,
and, in certain cases, flood insurance on all properties securing real
estate loans we make.
In an effort to provide financing for moderate income and first-time
homebuyers, we offer Federal Housing Authority ("FHA") and Veterans
Administration ("VA") loans and we have our own First-Time Home Buyer loan
program. These programs offer residential mortgage loans to qualified
individuals. These loans are offered with adjustable and fixed rates of
interest and terms of up to 30 years. Such loans may be secured by a one-
to-four family residential property, in the case of FHA and VA loans, and
must be secured by a single-family, owner-occupied unit in the case of
First-Time Home Buyer loans. These loans are originated using modified
underwriting guidelines, in the case of FHA and VA loans, and the same
underwriting guidelines as our other one-to-four family mortgage loans in
the case of First-Time Home Buyer loans. Such loans may be originated in
amounts of up to 97% of the lower of the property's appraised value or the
sale price. Private mortgage insurance is required on all such loans with
loan to values in excess of 80%.
We generally underwrite our residential real estate loans to comply with
secondary market standards established by the Federal National Mortgage
Association. Although loans are underwritten to standards that make them
readily salable, we have not chosen to sell these loans, rather to maintain
them in portfolio, consistent with our income and interest rate risk
management targets.
Residential real estate loans totaled $120.3 million and comprised 29.1% of
the total gross loan portfolio at December 31, 2005. At December 31, 2004,
the residential real estate loan portfolio totaled $97.5 million, or 26.6%
of total gross loans.
Commercial Loans
Our commercial business loan portfolio consists of loans and lines of credit
predominantly collateralized by inventory, furniture and fixtures, and
accounts receivable. In assessing the collateral for these loans, 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. Like commercial real estate loans, the successful repayment of these
loans is dependent on the
5
operations of the business to which the loan is made. Accordingly, these
loans carry a higher level of credit risk than loans secured by real estate.
To alleviate some of this risk, credit enhancements, such as personal
guarantees or additional collateral are often taken.
Commercial loans totaled $38.1 million and comprised 9.2% of the total gross
loan portfolio at December 31, 2005. At December 31, 2004, the commercial
loan portfolio totaled $26.6 million, or 7.3% of total gross loans.
Construction Lending
We originate fixed-rate construction loans for the development of one-to-
four family residential properties, primarily located in our primary market
area. Although we do not generally make loans secured by raw land, our
policies permit the origination of such loans. Construction loans are
generally offered to experienced local developers operating in our primary
market area and to individuals for the construction of their primary
residence. Construction loans are generally offered with terms of up to 24
months and may be made in amounts of up to 70% of the appraised value of the
property, as improved. In the case of construction loans to individuals for
the construction of their primary residence, loans up to 90% of the
appraisal value may be made. Loans made to individuals are generally written
on a construction-to-permanent basis. Land loans of up to 80% of the
appraised value may be made. Construction loan proceeds are disbursed
periodically in increments as construction progresses and as inspections by
an independent construction specialist warrant. Generally, if the borrower
is a company, partnership or other business entity, personal guarantees by
the principals are required for all construction loans.
Construction financing is generally considered to involve a higher degree of
credit risk than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction compared to the estimated cost (including interest) of
construction and other assumptions, including the estimated time to sell
residential properties. If the estimate of value proves to be inaccurate, we
may be confronted with a project, when completed, having a value which is
insufficient to assure full repayment.
Construction and land development loans totaled $21.5 million and comprised
5.2% of the total gross loan portfolio at December 31, 2005. At December 31,
2004, the construction and land development loan portfolio totaled $24.2
million, or 6.6% of total gross loans.
Home Equity Lines of Credit
Substantially all of our home equity lines of credit are secured by second
mortgages on owner-occupied, one-to-four family residences located in our
primary market area. Our home equity lines of credit generally have interest
rates, indexed to the Wall Street Journal Prime Rate, that adjust on a
monthly basis. Home equity lines of credit generally have an 18% lifetime
limit on interest rates. Generally, the maximum combined loan-to-value ratio
on home equity lines of credit is 80%. The underwriting standards we employ
for home equity lines of credit include a determination of the applicant's
credit history and an assessment of the applicant's ability to meet existing
obligations and payments on the proposed loan and the value of the
collateral securing the loan. The stability of the applicant's monthly
income may be determined by verification of gross monthly income from
primary employment and, additionally, from any verifiable secondary income.
Creditworthiness of the applicant is a primary consideration.
Home equity lines of credit totaled $17.9 million and comprised 4.3% of the
total gross loan portfolio at December 31, 2005. At December 31, 2004, the
home equity line of credit portfolio totaled $23.1 million, or 6.3% of total
gross loans.
Consumer Lending
Loans secured by rapidly depreciable assets such as recreational vehicles
and automobiles entail greater risks than one-to-four family, residential
mortgage loans. In such cases, repossessed collateral for a defaulted loan
may not provide an adequate source of repayment of the outstanding loan
balance, since there is a greater likelihood of damage, loss or depreciation
of the underlying collateral. Further, consumer loan collections on these
loans are dependent on the borrower's continuing financial stability and,
therefore, are more likely to be adversely affected by job loss, divorce,
illness or personal bankruptcy. Finally, the application of various federal
and state laws, including federal and state bankruptcy and insolvency laws,
may limit the amount which can be recovered on such loans in the event of a
default. Accordingly, we originate consumer loans typically based on the
borrower's ability to repay the loan through continued financial stability.
We endeavor to minimize risk by reviewing the borrower's repayment history
on past debts, and
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assessing the borrower's ability to meet existing obligations on the
proposed loans. Because of the proliferation of manufacturers' discount
financing and automobile leasing, origination of automobile loans has
diminished significantly in the last five years, accounting for the
continued decrease in consumer loans as a percentage of our loan portfolio.
Consumer loans totaled $2.6 million and comprised 0.6% of the total gross
loan portfolio at December 31, 2005. At December 31, 2004, the consumer loan
portfolio totaled $2.5 million, or 0.7% of total gross loans.
Loan Approval Procedures and Authority
The Bank's Board of Directors establishes the Bank's lending policies and
loan approval limits. The Bank's Board of Directors has established a Loan
Committee that considers and approves all loans within its designated
authority as established by the Board. In addition, the Bank's Board of
Directors has authorized certain officers to consider and approve all loans
within their designated authority as established by the Board. The President
and Chief Executive Officer and Senior Vice President have authority to
approve loans to $250,000, and the Loan Committee has authority to approve
loans to $500,000. For loans above $500,000, Executive Committee or full
Board approval is necessary.
INVESTING ACTIVITIES
We utilize our investment portfolio as a temporary means of warehousing
liquidity until the funds can be lent. The investment portfolio also serves
to secure certain deposits and borrowings. We manage the investment
portfolio to optimize earnings, while using the portfolio as a tool in
managing interest rate risk. We use an independent investment advisor to
assist us in our portfolio management function.
We utilize both a "held-to-maturity" category and an "available-for-sale"
category, as defined in Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", to
manage the investment portfolio. Our investment policy requires Board
approval before a trading account can be established. The held-to-maturity
category was originally established for holding high-yielding municipal
securities. Beginning in the third quarter of 2004, certain mortgage-backed
securities designated as collateral for FHLB advances were also designated
as held-to-maturity. Management has the ability and intent to hold these
securities to their contractual maturity. Held-to-maturity securities
totaled $29.3 million at December 31, 2005, while available-for-sale
securities totaled $94.3 million as compared to $37.8 million and $83.9
million, respectively, at December 31, 2004.
We primarily utilize obligations of U.S. Government-sponsored enterprises
and mortgage-backed securities as investment vehicles. High-quality
corporate bonds and municipal securities are purchased when an exceptional
opportunity to enhance investment yields arises. Purchases of these
investments are limited to securities that carry a rating of "Baa1"
(Moody's) or "BBB+" (Standard and Poor's), in order to control credit risk
within the investment portfolio. Among other investment criteria, it is
management's goal to maintain a total portfolio duration of less than 5
years. At December 31, 2005, the portfolio duration was estimated at 2.80
years, which is within the established portfolio duration limit.
Excess cash is sold on an overnight basis into federal funds or overnight
deposits at the FHLB. At December 31, 2005 federal funds sold totaled $2.2
million or 0.4% of total assets, as compared to $18.8 million, or 3.4% of
total assets at December 31, 2004.
Under Massachusetts Law, the Bank is permitted to invest in marketable
equity securities. Management views equity securities as a source of current
income with tax advantages, as well as a source of capital gain income,
given appreciation in the portfolio. Limits on asset quality, holding size,
overall portfolio size and composition are in place to protect us from undue
market risk. All equity securities are classified as available-for-sale.
DEPOSIT ACTIVITIES
We seek to develop relationships with our customers in order to become the
customer's primary bank. We have developed programs that stress multiple
account relationships in order to increase the level of "core deposits" in
our portfolio. Management views a customer's checking account as the primary
relationship account and, accordingly, emphasizes the growth of checking
accounts in its strategic plans. Aside from checking accounts being a
consistent, low-cost source of funds, they provide a source of non-interest
income in the form of service charges and insufficient funds fees.
7
Deposits are obtained from individuals and from small and medium-sized
businesses in the local market area. Our customer base is diverse, and
accordingly different product suites are offered to different groups of
customers. The suites range from accounts that serve the basic service needs
of any customer, such as free checking and statement savings accounts, to
our "Coastal" product suite, which addresses the particular needs of high-
balance customers. Additionally, small and medium-sized businesses have
suites of products that address their particular needs. We also attract
deposits from municipalities and other government agencies. We do not
solicit or accept brokered deposits. We offer a full line of deposit
products including checking and NOW accounts, savings accounts, money market
accounts, and certificates of deposit. We offer debit cards for our checking
and savings accounts.
Customers have access to deposit funds at any of our ten office locations,
all of which are equipped with Automated Teller Machines. Additionally, the
Bank is a member of the NYCE Network, enabling customers to have access to
their funds worldwide. We also provide balance inquiry and funds transfer
telephonically. Our website, www.sladesferry.com, provides customers with
the ability to manage their accounts and pay bills online. Business
customers who utilize our cash management program have the ability to
transfer funds and originate wire transfers or ACH transactions through the
website as well.
As a general rule, management systematically reviews the deposit accounts it
offers to determine if the products meet both the customers' needs and our
asset/liability management goals. This review is the responsibility of the
Pricing Committee, which meets weekly to determine products and pricing
practices consistent with overall earnings and growth goals. The Pricing
Committee establishes deposit interest rates based on a variety of factors,
including local economy, market interest rates, competitors' interest rates,
and the need to fund loan demand. We set rates to be competitive, but not
necessarily the highest rates in our market area. As competition for
deposits has intensified with the larger financial institutions in our
market area, we introduced the use of off-maturity "special" certificate
accounts. We actively market our other products to new depositors garnered
through the use of promotions, in order to cross-sell additional products
and services, and thereby establish a continued banking relationship.
In order to offset the potentially adverse effects of early withdrawal, we
generally charge an early withdrawal penalty on certificates of deposit in
an amount equal to three months' interest on accounts with original
maturities of one year or less, and six months' interest on accounts with an
original maturity of greater than one year. Interest credited to a
certificate account during any term may be withdrawn without penalty at any
time during the term. Upon renewal of a certificate account, only interest
credited during the renewal term may be withdrawn without penalty.
NON-DEPOSIT INVESTMENT PRODUCTS
We offer a variety of mutual funds, annuities, and insurance products
offered through third-party sales arrangements with Linsco Private Ledger,
Inc. and the Savings Bank Life Insurance Company of Massachusetts ("SBLI").
BORROWING ACTIVITIES
In order to fund additional asset growth, we have the ability to borrow at
the FHLB of Boston. The FHLB limits borrowings to 30% of assets, and limits
FHLB stock purchases to 4.5% of total borrowings. These borrowings are
collateralized by our residential loan portfolio, certain commercial real
estate loans, and certain obligations and mortgage-backed securities of
government-sponsored enterprises. Management views borrowing as not only a
funding mechanism, but as a tool to manage the levels of interest rate risk
inherent in the balance sheet. In addition, we maintain borrowing lines of
credit with correspondent banks to meet short-term liquidity needs.
During this period we have utilized FHLB advances to enhance our interest
rate risk position. In prior years, we had used amortizing advances to
"match-fund" certain commercial loans. As management has taken a whole-
balance sheet approach to interest rate risk management, the use of matched
funding strategies has decreased, in favor of the use of bullet and
community development advances, deployed in a laddered approach. Because the
FHLB attaches significant prepayment penalties to long-term advances,
management does not anticipate prepayment of the amortizing advances.
COMPETITION
The banking business in our market area is highly competitive. We actively
compete for both loans and deposits with local branches of nationwide and
regional banks, as well as local banks and credit unions. We also compete
with consumer mortgage and finance companies, financing subsidiaries of
durable goods manufacturers, and insurance
8
companies. Many of the major commercial banks or other affiliates in our
service areas offer services such as international banking and trust
services that we do not currently offer directly.
In order to expand our market area, we opened our newest facility located in
Assonet, Massachusetts in early 2005. This branch is a state-of-the-art,
full-service banking office, designed to provide superior customer
convenience and service. We believe that the addition of this branch will
add to the diversity in our loan portfolio and add a new pool of potential
depositors.
EMPLOYEES
At December 31, 2005, we had 116 full-time and 33 part-time employees. We
believe that employee relations are good, and there are no known disputes
between management and employees.
All employees are eligible to participate in our Retirement Savings 401(k)
Plan and Profit Sharing Plan. Additionally, certain officers may participate
in the Slade's Ferry Bancorp. Stock Option Plan, and certain executive
officers may participate in a supplemental executive retirement program.
Our performance-based incentive programs for officers and employees have
supported, and will continue to support our growth, by giving employees a
stake in our overall performance and for balancing profit, growth and
productivity.
HOLDING COMPANY REGULATION
FEDERAL REGULATION
Capital Requirements
The FRB has adopted capital adequacy guidelines pursuant to which it
assesses the adequacy of capital in examining and supervising a bank holding
company and in analyzing applications to it under the BHCA. The FRB capital
adequacy guidelines generally require bank holding companies to maintain
total capital equal to 8% of total risk-adjusted assets, with at least one-
half of that amount consisting of Tier I, or core capital, and up to one-
half of that amount consisting of Tier II, or supplementary capital. Tier I
capital for bank holding companies generally consists of the sum of common
shareholders' equity and perpetual preferred stock (subject in the case of
the latter to limitations on the kind and amount of such stocks which may be
included as Tier I capital), less goodwill and, with certain exceptions,
intangibles. Tier II capital generally consists of hybrid capital
instruments; perpetual preferred stock which is not eligible to be included
as Tier I capital; term subordinated debt and intermediate-term preferred
stock; and, subject to limitations, general allowances for loan losses.
Assets are adjusted under the risk-based guidelines to take into account
different risk characteristics, with the categories ranging from 0%
(requiring no additional capital) for assets such as cash to 100% for the
bulk of assets which are typically held by a bank holding company, including
multi-family residential and commercial real estate loans, commercial
business loans and consumer loans. Single-family residential first mortgage
loans which are not past-due (90 days or more) or non-performing and which
have been made in accordance with prudent underwriting standards are
assigned a 50% level in the risk-weighing system, as are certain privately-
issued mortgage-backed securities representing indirect ownership of such
loans. Off-balance sheet items also are adjusted to take into account
certain risk characteristics.
In addition to the risk-based capital requirements, the FRB requires bank
holding companies to maintain a minimum leverage capital ratio of Tier I
capital to total assets of 3.0%. Total assets for this purpose does not
include goodwill and any other intangible assets and investments that the
FRB determines should be deducted from Tier I capital. The FRB has announced
that the 3.0% Tier I leverage capital ratio requirement is the minimum for
the top-rated bank holding companies without any supervisory, financial or
operational weaknesses or deficiencies or those that are not experiencing or
anticipating significant growth. Other bank holding companies are expected
to maintain Tier I leverage capital ratios of at least 4.0% to 5.0% or more,
depending on their overall condition.
The Company is in compliance with the above-described FRB regulatory capital
requirements.
9
Activities
The BHCA prohibits a bank holding company from acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any bank, or
increasing such ownership or control of any bank, without prior approval of
the FRB. No approval under the BHCA is required, however, for a bank holding
company already owning or controlling 50% of the voting shares of a bank to
acquire additional shares of such bank.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring more than 5% of the voting shares of any company that is not
a bank and from engaging in any business other than banking or managing or
controlling banks. Under the BHCA, the FRB is authorized to approve the
ownership of shares by a bank holding company in any company, the activities
of which the FRB has determined to be so closely related to banking or to
managing or controlling banks as to be a proper incident thereto. In making
such determinations, the FRB is required to weigh the expected benefit to
the public, such as greater convenience, increased competition or gains in
efficiency, against the possible adverse effects, such as undue
concentration of resources, decreased or unfair competition, conflicts of
interest or unsound banking practices.
In addition, a bank holding company that does not qualify and elect to be
treated as a financial holding company under the Gramm-Leach-Bliley
Financial Services Modernization Act is generally prohibited from engaging
in, or acquiring, direct or indirect control of any company engaged in non-
banking activities. One of the principal exceptions to this prohibition is
for activities found by the FRB to be so closely related to banking or
managing or controlling banks as to be permissible. Bank holding companies
that do qualify as a financial holding company may engage in activities that
are financial in nature or incident to activities which are financial in
nature. Bank holding companies may qualify to become a financial holding
company if it meets certain criteria set forth by the FRB.
Beginning June 1, 1997, the Interstate Banking Act permitted federal banking
agencies to approve merger transactions between banks located in different
states, regardless of whether the merger would be prohibited under the law
of the two states. The Interstate Banking Act also permitted a state to "opt
in" to the provisions of the Interstate Banking Act before June 1, 1997, and
permitted a state to "opt out" of the provisions of the Interstate Banking
Act by adopting appropriate legislation before that date. Accordingly,
beginning June 1, 1997, the Interstate Banking Act permitted a bank, such as
the Bank, to acquire an institution by merger in a state other than
Massachusetts unless the other state had opted out of the Interstate Banking
Act. The Interstate Banking Act also authorizes de novo branching into
another state if the host state enacts a law expressly permitting out of
state banks to establish such branches within its borders.
MASSACHUSETTS REGULATION
The Company as a Massachusetts-chartered corporation is governed by the
Massachusetts Business Company Law and the Company's Articles of
Organization and Bylaws. Under the Massachusetts banking laws, a company
owning or controlling two or more banking institutions, including a savings
bank, is regulated as a bank holding company. The Company or the Bank would
become a Massachusetts bank holding company if the Company acquired a second
banking institution and operated it separately from the Bank or the Bank
acquired a banking institution.
ACQUISITION OF THE COMPANY OR THE BANK
Federal Restrictions
Under the federal Change in Bank Control Act, any person (including a
company), or group acting in concert, seeking to acquire control of the
Company or the Bank will be required to submit prior notice to the FRB.
Under the Change in Bank Control Act, the FRB has 60 days within which to
act on such notices, taking into consideration factors, including the
financial and managerial resources of the acquirer, the convenience and
needs of the communities served by the Company and the Bank, and the anti-
trust effects of the acquisition. The term "control" is defined generally
under the BHCA to mean the ownership or power to vote 25% or more of any
class of voting securities of an institution or the ability to control in
any manner the election of a majority of the institution's directors.
Additionally under the Bank Merger Act sections of the Federal Deposit
Insurance Act, the prior approval of an insured institution's primary
federal regulator is required for an insured institution to merge with or
transfer assets to another insured institution or an uninsured institution.
10
BANK REGULATION
MASSACHUSETTS BANKING REGULATION
General
The Bank is subject to Massachusetts statute and the rules and regulations
of the Division establishing the powers of the Bank, investment limitations
and minimum standards relative to the security and protection of the Bank
for the benefit of Bank employees and the general public.
Loans-to-One-Borrower Limitations
With specified exceptions, the total obligations of a single borrower to a
Massachusetts-chartered commercial bank and trust company may not exceed 20%
of shareholders' equity. A commercial bank and trust company may lend
additional amounts up to 100% of its retained earnings account if secured by
collateral meeting the requirements of the Massachusetts banking laws. The
Bank currently complies with applicable loans-to-one-borrower limitations.
Dividends
Under the Massachusetts banking laws, a commercial bank and trust company
may, subject to several limitations, declare and pay a dividend on its
capital stock out of the Bank's net profits. A dividend may not be declared,
credited or paid by a stock trust company so long as there is any impairment
of capital stock. No dividend may be declared on the Bank's common stock for
any period other than for which dividends are declared upon preferred stock,
except as authorized by the Commissioner of the Division. The approval of
the Commissioner is also required for a commercial bank and trust company to
declare a dividend, if the total of all dividends declared by the commercial
bank and trust company in any calendar year shall exceed the total of its
net profits for that year combined with its retained net profits of the
preceding two years, less any required transfer to surplus or a fund for the
retirement of any preferred stock.
In addition, federal law may also limit the amount of dividends that may be
paid by the Bank. See "- Federal Banking Regulation - Prompt Corrective
Action."
Examination and Enforcement
The Division is required to periodically examine commercial bank and trust
companies at least once every calendar year or at least once each 18-month
period if the commercial bank and trust company qualifies as well
capitalized under the prompt corrective action provisions of the Federal
Deposit Insurance Act. See "- Federal Banking Regulation - Prompt Corrective
Action."
Community Reinvestment Act
The Bank is subject to provisions of the Massachusetts Community
Reinvestment Act, which are similar to those imposed by the federal
Community Reinvestment Act with the exception of the assigned exam ratings.
Massachusetts banking law provides for an additional exam rating of "high
satisfactory" in addition to the federal Community Reinvestment Act ratings
of "outstanding," "satisfactory," "needs to improve" and "substantial
noncompliance." The Division is required to consider a bank's Massachusetts
Community Reinvestment Act rating when reviewing the Bank's application to
engage in certain transactions, including mergers, asset purchases and the
establishment of branch offices or automated teller machines, and provides
that such assessment may serve as a basis for the denial of any such
application. The Massachusetts Community Reinvestment Act requires the
Division to assess a bank's compliance and to make such assessment available
to the public. The Bank's latest Massachusetts Community Reinvestment Act
rating, from an exam dated July 18, 2005, was a rating of "Satisfactory."
FEDERAL BANKING REGULATION
Capital Requirements
FDIC regulations require Bank Insurance Fund-insured banks, such as the
Bank, to maintain minimum levels of capital. The FDIC regulations define two
classes of capital known as Tier 1 and Tier 2 capital.
11
The FDIC regulations establish a minimum leverage capital requirement for
banks in the strongest financial and managerial condition, with a rating of
1 (the highest examination rating of the FDIC for banks) under the Uniform
Financial Institutions Rating System, of not less than a ratio of 3.0% of
Tier 1 capital to total assets. For all other banks, the minimum leverage
capital requirement is 4.0%, unless a higher leverage capital ratio is
warranted by the particular circumstances or risk profile of the depository
institution.
The FDIC regulations also require that banks meet a risk-based capital
standard. The risk-based capital standard requires the maintenance of a
ratio of total capital (which is defined as the sum of Tier 1 capital and
Tier 2 capital) to risk-weighted assets of at least 8% and a ratio of Tier 1
capital to risk-weighted assets of at least 4%. In determining the amount of
risk-weighted assets, all assets, plus certain off balance sheet items, are
multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC
believes are inherent in the type of asset or item.
The federal banking agencies, including the FDIC, have also adopted
regulations to require an assessment of an institution's exposure to
declines in the economic value of a bank's capital due to changes in
interest rates when assessing the Bank's capital adequacy. Under such a risk
assessment, examiners will evaluate a bank's capital for interest rate risk
on a case-by-case basis, with consideration of both quantitative and
qualitative factors.
Institutions with significant interest rate risk may be required to hold
additional capital. The agencies also issued a joint policy statement
providing guidance on interest rate risk management, including a discussion
of the critical factors affecting the agencies' evaluation of interest rate
risk in connection with capital adequacy. The Bank was considered "well-
capitalized" under FDIC guidelines at December 31, 2005.
Activity Restrictions on State-Chartered Banks
Section 24 of the Federal Deposit Insurance Act ("FDIA"), as amended, which
was added by the Federal Deposit Insurance Company Improvement Act of 1991
("FDICIA"), generally limits the activities and investments of state-
chartered FDIC insured banks and their subsidiaries to those permissible for
national banks and their subsidiaries, unless such activities and
investments are specifically exempted by Section 24 or consented to by the
FDIC.
Section 24 provides an exception for investments by a bank in common and
preferred stocks listed on a national securities exchange or the shares of
registered investment companies if:
(1) The Bank held such types of investments during the 14-month
period from September 30, 1990 through November 26, 1991;
(2) The state in which the Bank is chartered permitted such
investments as of September 30, 1991; and
(3) The Bank notifies the FDIC and obtains approval from the FDIC to
make or retain such investments. Upon receiving such FDIC
approval, an institution's investment in such equity securities
will be subject to an aggregate limit up to the amount of its
Tier 1 capital.
The Bank received approval from the FDIC to retain and acquire such equity
investments subject to a maximum permissible investment equal to the lesser
of 100% of the Bank's Tier 1 capital or the maximum permissible amount
specified by the FDIA. Section 24 also provides an exception for majority
owned subsidiaries of a bank, but Section 24 limits the activities of such
subsidiaries to those permissible for a national bank, permissible under
Section 24 of the FDIA and the FDIC regulations issued pursuant thereto, or
as approved by the FDIC.
Before making a new investment or engaging in a new activity not permissible
for a national bank or not otherwise permissible under Section 24 of the
FDIC regulations thereunder, an insured bank must seek approval from the
FDIC to make such investment or engage in such activity. The FDIC will not
approve the activity unless the Bank meets its minimum capital requirements
and the FDIC determines that the activity does not present a significant
risk to the FDIC insurance funds.
12
Enforcement
The FDIC has extensive enforcement authority over insured state-chartered
commercial bank and trust companies, including the Bank. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist orders and to remove directors and
officers. In general, these enforcement actions may be initiated in response
to violations of laws and regulations and to unsafe or unsound practices.
The FDIC is required, with certain exceptions, to appoint a receiver or
conservator for an insured state bank if that bank is "critically
undercapitalized." For this purpose, "critically undercapitalized" means
having a ratio of tangible capital to total assets of less than 2%. The FDIC
may also appoint a conservator or receiver for a state bank on the basis of
the institution's financial condition or upon the occurrence of certain
events.
Deposit Insurance
Pursuant to FDICIA, the FDIC established a system for setting deposit
insurance premiums based upon the risks a particular institution poses to
its deposit insurance fund. Under the risk-based deposit insurance
assessment system, the FDIC assigns an institution to one of three capital
categories based on the institution's financial information, as of the most
recent quarterly report filed with the applicable bank regulatory agency
prior to the assessment period. The three capital categories are: (1) well
capitalized, (2) adequately capitalized and (3) undercapitalized, using
capital ratios that are substantially similar to the prompt corrective
action capital ratios discussed below. See "-Federal Banking Regulation -
Prompt Corrective Action" below. The FDIC also assigns an institution to a
supervisory subgroup based on a supervisory evaluation provided to the FDIC
by the institution's primary federal regulator and information that the FDIC
determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds (which may include, if applicable,
information provided by the institution's state supervisor). An
institution's assessment rate depends on the capital category and
supervisory category to which it is assigned. Any increase in insurance
assessments could have an adverse effect on the earnings of insured
institutions, including the Bank.
Under the FDIA, the FDIC may terminate the insurance of an institution's
deposits upon a finding that the institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC. The management of the Bank does not know of
any practice, condition or violation that might lead to termination of
deposit insurance.
Transactions with Affiliates of the Bank
Transactions between an insured bank, such as the Bank, and any of its
affiliates are governed by Sections 23A and 23B of the Federal Reserve Act
(the "FRA"). An affiliate of a bank is any company or entity that controls,
is controlled by or is under common control with the Bank. A subsidiary of a
bank that is not also a depository institution is not treated as an
affiliate of the Bank for purposes of Sections 23A and 23B.
Section 23A:
* limits the extent to which the Bank or its subsidiaries may
engage in "covered transactions" with any one affiliate to an
amount equal to 10% of such bank's capital stock and retained
earnings, and limit on all such transactions with all affiliates
to an amount equal to 20% of such capital stock and retained
earnings; and
* requires that all such transactions be on terms that are
consistent with safe and sound banking practices.
The term "covered transaction" includes the making of loans, purchase of
assets, issuance of guarantees and other similar types of transactions.
Further, most loans by a bank to any of its affiliates must be secured by
collateral in amounts ranging from 100 to 130 percent of the loan amounts.
In addition, any covered transaction by a bank with an affiliate and any
purchase of assets or services by a bank from an affiliate must be on terms
that are substantially the same, or at least as favorable to the Bank, as
those that would be provided to a non-affiliate.
Effective April 1, 2003, the Federal Reserve Board, or FRB, rescinded its
interpretations of Sections 23A and 23B of the FRA and replaced these
interpretations with Regulation W. In addition, Regulation W makes various
changes to existing
13
law regarding Sections 23A and 23B, including expanding the definition of
what constitutes an affiliate subject to Sections 23A and 23B and exempting
certain subsidiaries of state-chartered banks from the restrictions of
Sections 23A and 23B. We do not expect that the changes made by Regulation W
will have a material adverse effect on our business.
The Bank's authority to extend credit to its directors, executive officers
and 10% shareholders, as well as to entities controlled by such persons, is
currently governed by the requirements of Sections 22(g) and 22(h) of the
FRA and Regulation O of the Federal Reserve Board. Among other things, these
provisions require that extensions of credit to insiders (a) be made on
terms that are substantially the same as, and follow credit underwriting
procedures that are not less stringent than, those prevailing for comparable
transactions with unaffiliated persons and that do not involve more than the
normal risk of repayment or present other unfavorable features and (b) not
exceed certain limitations on the amount of credit extended to such persons,
individually and in the aggregate, which limits are based, in part, on the
amount of the Bank's capital. The regulations allow small discounts on fees
on residential mortgages for directors, officers and employees. In addition,
extensions for credit in excess of certain limits must be approved by the
Bank's Board of Directors.
Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension of
personal loans to directors and executive officers of issuers (as defined in
Sarbanes-Oxley). The prohibition, however, does not apply to mortgages
advanced by an insured depository institution, such as the Bank, that are
subject to the insider lending restrictions of Section 22(h) of the Federal
Reserve Act.
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), any insured depository
institution, including the Bank has a continuing and affirmative obligation
consistent with its safe and sound operation to help meet the credit needs
of its entire community, including low and moderate income neighborhoods.
The CRA does not establish specific lending requirements or programs for
financial institutions nor does it limit an institution's discretion to
develop the types of products and services that it believes are best suited
to its particular community. The CRA requires the FDIC, in connection with
its examination of a commercial bank and trust company, to assess the
depository institution's record of meeting the credit needs of its community
and to take such record into account in its evaluation of certain
applications by such institution, including applications for additional
branches and acquisitions.
The CRA requires the FDIC to provide a written evaluation of an
institution's CRA performance utilizing a four-tiered descriptive rating
system and requires public disclosure of an institution's CRA rating. The
Bank received a "Satisfactory" rating on its last CRA exam on July 18, 2005.
Safety and Soundness Standards
Pursuant to the requirements of the FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994, each federal
banking agency, including the FDIC, has adopted guidelines establishing
general standards relating to internal controls, information and internal
audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, asset quality, earnings and compensation, fees and
benefits. In general, the guidelines require, among other things,
appropriate systems and practices to identify and manage the risks and
exposures specified in the guidelines. The guidelines prohibit excessive
compensation as an unsafe and unsound practice and describe compensation as
excessive when the amounts paid are unreasonable or disproportionate to the
services performed by an executive officer, employee, director, or principal
stockholder.
In addition, the FDIC adopted regulations to require a bank that is given
notice by the FDIC that it is not satisfying any of such safety and
soundness standards to submit a compliance plan to the FDIC. If, after being
so notified, a bank fails to submit an acceptable compliance plan or fails
in any material respect to implement an accepted compliance plan, the FDIC
may issue an order directing corrective and other actions of the types to
which a significantly undercapitalized institution is subject under the
"prompt corrective action" provisions of the FDICIA. If a bank fails to
comply with such an order, the FDIC may seek to enforce such an order in
judicial proceedings and to impose civil monetary penalties.
Prompt Corrective Action
The FDICIA also established a system of prompt corrective action to resolve
the problems of undercapitalized institutions. The FDIC, as well as the
other federal banking regulators, adopted regulations governing the
supervisory
14
actions that may be taken against undercapitalized institutions. The
regulations establish five categories, consisting of "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." The severity of the
action authorized or required to be taken under the prompt corrective action
regulations increases as a bank's capital decreases within the three
undercapitalized categories. All banks are prohibited from paying dividends
or other capital distributions or paying management fees to any controlling
person if, following such distribution, the Bank would be undercapitalized.
FEDERAL RESERVE SYSTEM
Under Federal Reserve Board regulations, the Bank is required to maintain
noninterest-earning reserves against its transaction accounts. Current
Federal Reserve Board regulations generally require that reserves of 3% must
be maintained against aggregate transaction accounts of $47.6 million or
less, subject to adjustment by the Federal Reserve Board. Total transaction
accounts in excess of $47.6 million are required to have a reserve of 10%
held against them, which are also subject to adjustment by the Federal
Reserve Board. The first $7.0 million of otherwise reservable balances,
subject to adjustments by the Federal Reserve Board, are exempted from the
reserve requirements. The Bank is in compliance with these requirements.
Because required reserves must be maintained in the form of vault cash, a
noninterest-bearing account at a Federal Reserve Bank or a pass-through
account as defined by the Federal Reserve Board, the effect of this reserve
requirement is to reduce the Bank's interest-earning assets.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the Federal Home Loan Bank system, which consists of
12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a
central credit facility primarily for member institutions. The Bank, as a
member of the Federal Home Loan Bank of Boston (the "FHLB"), is required to
acquire and hold shares of capital stock in the FHLB in an amount equal to
at least 1% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or
1/20 of its advances (borrowings) from the FHLB, whichever is greater. The
Bank was in compliance with this requirement with an investment in FHLB
stock at December 31, 2005 of $6.3 million. The Federal Home Loan Banks are
required to provide funds for certain purposes including contributing funds
for affordable housing programs. These requirements could reduce the amount
of dividends that the Federal Home Loan Banks pay to their members and
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members.
THE U.S.A. PATRIOT ACT
The Bank is subject to the USA PATRIOT Act, which gives the federal
government new powers to address money laundering and terrorist threats
through enhanced domestic security measures, expanded surveillance powers,
increased information sharing, and amendments to the Bank Secrecy Act. Title
III of the USA PATRIOT Act takes measures intended to encourage information
sharing among financial institutions, bank regulatory agencies and law
enforcement bodies. Further, certain provisions of Title III impose
affirmative obligations on a broad range of financial institutions,
including banks, thrifts, brokers, dealers, credit unions, money transfer
agents, and parties registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the
following obligations on financial institutions:
* Pursuant to Section 352, all financial institutions must
establish anti-money laundering programs that include, at
minimum: (i) internal policies, procedures, and controls; (ii)
specific designation of an anti-money laundering compliance
officer; (iii) ongoing employee training programs; and (iv) an
independent audit function to test the anti-money laundering
program.
* Pursuant to Section 326, rules establishing minimum standards
for customer due diligence, identification and verification
became effective on October 1, 2003.
15
* Section 312 requires financial institutions that establish,
maintain, administer, or manage private banking accounts or
correspondent accounts in the United States for non-United
States persons or their representatives (including foreign
individuals visiting the United States) to establish
appropriate, specific, and, where necessary, enhanced due
diligence policies, procedures, and controls designed to detect
and report instances of money laundering through those accounts.
* Section 318, which became effective December 25, 2001, prohibits
financial institutions from establishing, maintaining,
administering, or managing correspondent accounts for foreign
shell banks (foreign banks that do not have a physical presence
in any country), and requires financial institutions to take
reasonable steps to ensure that correspondent accounted provided
to foreign banks are not being used to indirectly provide
banking services to foreign shell banks.
* Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Bank
Holding Company Act and Bank Merger Act applications.
THE SARBANES-OXLEY ACT
The Sarbanes-Oxley Act of 2002 implements a broad range of corporate
governance and accounting measures for public companies designed to promote
honesty and transparency in corporate America and protect investors from
corporate wrongdoing. The Sarbanes-Oxley Act's principal legislation and
derivative regulation and rulemaking promulgated by the SEC includes:
* the creation of an independent accounting oversight board;
* auditor independence provisions which restrict non-audit
services that accountants may provide to their audit clients;
* additional corporate governance and responsibility measures,
including the requirement that the chief executive officer and
chief financial officer certify financial statements;
* a requirement that companies establish and maintain a system of
internal control over financial reporting and that management
provide an annual report regarding its assessment of the
effectiveness of such internal control over financial reporting
to its independent accountants and that such accountants provide
an attestation report with respect to management's assessment of
the effectiveness of the company's internal control over
financial reporting.
* the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by directors
and senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
* an increase in the oversight of, and enhancement of, certain
requirements relating to audit committees of public companies
and how they interact with the Company's independent auditors;
* requirement that audit committee members must be independent and
are absolutely barred from accepting consulting, advisory or
other compensatory fees from the issuer;
* requirement that companies disclose whether at least one member
of the committee is an "audit committee financial expert" (as
such term is defined by the Securities and Exchange Commission)
and if not, why not;
* expanded disclosure requirements for corporate insiders,
including accelerated reporting of stock transactions by
insiders and a prohibition on insider trading during pension
blackout periods;
16
* a prohibition on personal loans to directors and officers,
except certain loans made by insured financial institutions;
* disclosure of a code of ethics and filing a Form 8-K for a
change or waiver of such code;
* mandatory disclosure by analysts of potential conflicts of
interest; and
* a range of enhanced penalties for fraud and other violations.
Although the Company has and will continue to incur additional expense in
complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, such compliance will not have a material impact on its results
of operations or financial condition.
FEDERAL SECURITIES LAW
The Company's common stock is registered with the SEC under Section 12(g) of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Thus,
the Company is subject to information, proxy solicitation, insider trading
restrictions, and other requirements under the Exchange Act.
RECENT REGULATORY EXAMINATIONS
As the result of a 2004 joint examination, on March 14, 2005, the Bank
entered into an informal agreement with the FDIC and Massachusetts
Commissioner of Banks under which the Bank agreed to certain recommendations
designed to strengthen its policies and procedures for compliance with
certain provisions of the Bank Secrecy Act.
The FDIC, with concurrence from the Massachusetts Commissioner of
Banks, terminated the aforementioned agreement in January 2006.
17
ITEM 1A
RISK FACTORS
Our loan portfolio includes loans with a higher risk of loss. We originate
multi-family and commercial real estate loans, commercial business loans,
consumer loans, and residential mortgage loans primarily within our market
area. Commercial mortgage, commercial business, and consumer loans may
expose a lender to greater credit risk than loans secured by residential
real estate because the collateral securing these loans may not be sold as
easily as residential real estate. In addition, commercial real estate and
commercial business loans may also involve relatively large loan balances to
individual borrowers or groups of borrowers. These loans also have greater
credit risk than residential real estate for the following reasons:
* Commercial Real Estate Loans. Repayment is dependent upon income
being generated in amounts sufficient to cover operating
expenses and debt service. Commercial mortgage loans represented
51.6% of total gross loans as of December 31, 2005.
* Commercial Loans. Repayment is generally dependent upon the
successful operation of the borrower's business. Commercial
loans represented 9.2% of total gross loans as of December 31,
2005.
* Construction Loans. Construction financing is generally
considered to involve a higher degree of credit risk than long-
term financing on improved, owner-occupied real estate. Risk of
loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at
completion of construction compared to the estimated cost
(including interest) of construction and other assumptions,
including the estimated time to sell residential properties.
Construction loans represented 5.2% of total gross loans as of
December 31, 2005.
* Consumer Loans. Consumer loans (such as personal lines of
credit) may or may not be collateralized with assets that
provide an adequate source of payment of the loan due to
depreciation, damage, or loss. Consumer loans represented 0.6%
of total gross loans as of December 31, 2005.
Any downturn in the real estate market or local economy could adversely
affect the value of the properties securing the loans or revenues from the
borrower's business thereby increasing the risk of non-performing loans.
If our allowance for loan losses is not sufficient to cover actual loan
losses, our earnings could decrease. Our loan customers may not repay their
loans according to their terms and the collateral securing the payment of
these loans may be insufficient to pay any remaining loan balance. We
therefore may experience significant loan losses, which could have a
material adverse effect on our operating results.
Material additions to our allowance for loan losses also would materially
decrease our net income, and the charge-off of loans may cause us to
increase the allowance. We make various assumptions and judgments about the
collectibility of our loan portfolio, including the creditworthiness of our
borrowers and the value of the real estate and other assets serving as
collateral for the repayment of many of our loans. We rely on our loan
quality reviews, our historical loss experience and our evaluation of
economic conditions, among other factors, in determining the amount of the
allowance for loan losses. If our assumptions prove to be incorrect, our
allowance for loan losses may not be sufficient to cover losses inherent in
our loan portfolio, resulting in additions to our allowance. As of December
31, 2005, the allowance for loan loss as a percent of year-end loans was
1.05%.
Changes in interest rates could adversely affect our results of operations
and financial condition. Our profitability, like that of most financial
institutions, depends substantially on our net interest income, which is the
difference between the interest income earned on our interest-earning assets
and the interest expense paid on our interest-bearing liabilities. Increases
in interest rates may decrease loan demand and make it more difficult for
borrowers to repay adjustable rate loans. In addition, as market interest
rates rise, we will have competitive pressures to increase the rates we pay
on deposits, which will result in a decrease of our net interest income.
We also are subject to reinvestment risk associated with changes in interest
rates. Changes in interest rates may affect the average life of loans and
mortgage-related securities. Decreases in interest rates can result in
increased prepayments of
18
loans and mortgage-related securities as borrowers refinance to reduce
borrowing costs. Under these circumstances, we are subject to reinvestment
risk to the extent that we are unable to reinvest the cash received from
such prepayments at rates that are comparable to the rates on existing loans
and securities.
Our earnings may be adversely impacted by an increase in interest rates
because a significant portion of our interest-earning assets are long-term,
fixed rate mortgage-related assets that will not reprice as long-term
interest rates increase while a majority of our interest-bearing liabilities
are expected to reprice as interest rates increase. Therefore, in an
increasing interest rate environment, our cost of funds is expected to
increase more rapidly than the yields earned on our loan portfolio and
securities portfolio. An increasing rate environment is expected to cause a
narrowing of our net interest rate spread and a decrease in our net interest
income. The rising interest rate environment has compressed our net interest
margin from 3.44% for the year ended December 31, 2004 to 3.39% for the year
ended December 31, 2005.
Our local economy may affect our future growth possibilities. Our current
market area is principally located in southeastern Massachusetts and
contiguous areas of Rhode Island. Our future growth opportunities depend on
the growth and stability of our regional economy and our ability to expand
our market area. A downturn in our local economy may limit funds available
for deposit and may negatively affect our borrowers' ability to repay their
loans on a timely basis, both of which could have an impact on our
profitability.
Competition in our primary market area may reduce our ability to attract and
retain deposits and originate loans. We operate in a competitive market for
both attracting deposits, which is our primary source of funds, and
originating loans. Historically, our most direct competition for savings
deposits has come from credit unions, community banks, large commercial
banks and thrift institutions in our primary market area. Particularly in
times of extremely low or extremely high interest rates, we have faced
additional significant competition for investors' funds from brokerage firms
and other firms' short-term money market securities and corporate and
government securities. Our competition for loans comes principally from
mortgage brokers, commercial banks, other thrift institutions, and insurance
companies. Competition for loan originations and deposits may limit our
future growth and earnings prospects.
We operate in a highly regulated environment, and changes in laws and
regulations to which we are subject may adversely affect our results of
operations. We are subject to extensive regulation, supervision and
examination by the state of Massachusetts, as the Bank's chartering
authority, and by the Federal Deposit Insurance Corporation (the "FDIC") as
the insurer of our deposits up to certain limits. We also belong to the
Federal Home Loan Bank System and, as a member of such system, we are
subject to certain limited regulations promulgated by the Federal Home Loan
Bank of Boston. This regulation and supervision limits the activities in
which we may engage. The purpose of regulation and supervision is primarily
to protect our depositors and borrowers and, in the case of FDIC regulation,
the FDIC's insurance fund. Regulatory authorities have extensive discretion
in the exercise of their supervisory and enforcement powers. They may, among
other things, impose restrictions on the operation of a banking institution,
the classification of assets by such institution and such institution's
allowance for loan losses. Regulatory and law enforcement authorities also
have wide discretion and extensive enforcement powers under various consumer
protection and civil rights laws, including the Truth-in-Lending Act, the
Equal Credit Opportunity Act, the Fair Housing Act, and the Real Estate
Settlement Procedures Act. Any change in the laws or regulations applicable
to us, or in banking regulators' supervisory policies or examination
procedures, whether by the Massachusetts Commissioner of Banks, the FDIC,
other state or federal regulators, the United States Congress or the
Massachusetts legislature could have a material adverse effect on our
business, financial condition, results of operations and cash flows.
We depend on our executive officers and key personnel to continue the
implementation of our long-term business strategy and could be harmed by the
loss of their services. We believe that our continued growth and future
success will depend in large part upon the skills of our management team.
The competition for qualified personnel in the financial services industry
is intense, and the loss of our key personnel or an inability to continue to
attract, retain and motivate key personnel could adversely affect our
business. We cannot assure you that we will be able to retain our existing
key personnel or attract additional qualified personnel. Although we have
employment agreements with our president and chief executive officer, our
executive vice president and chief financial officer/chief operations
officer, and our senior vice president that contain non-compete provisions,
the loss of the services of one or more of our executive officers and key
personnel could impair our ability to continue to develop our business
strategy.
If we fail to maintain an effective system of internal control over
financial reporting, we may not be able to accurately report our financial
results or prevent fraud, and, as a result, investors and depositors could
lose confidence in our financial reporting, which could adversely affect our
business, the trading price of our stock and our ability to attract
additional deposits. In the future, we will be required to include in our
annual reports filed with the Securities and
19
Exchange Commission (the "SEC") a report of our management regarding
internal control over financial reporting beginning with our annual report
for the fiscal year ended December 31, 2007. We expect this requirement to
be in effect beginning with our annual report for the fiscal year ended
December 31, 2007. However, if we become an "accelerated filer," as defined
by SEC regulations, we will have to comply with this requirement beginning
with our annual report for the fiscal year ended December 31, 2006. In
anticipation of this new obligation, we have begun to document and evaluate
our internal control over financial reporting in order to satisfy the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and SEC rules
and regulations, which require an annual management report on our internal
control over financial reporting, including, among other matters,
management's assessment of the effectiveness of internal control over
financial reporting and an attestation report by our independent auditors
addressing these assessments. Accordingly, management has retained outside
consultants to assist us in (i) assessing and documenting the adequacy of
our internal control over financial reporting, (ii) improving control
processes, where appropriate, and (iii) verifying through testing that
controls are functioning as documented. If we fail to identify and correct
any significant deficiencies in the design or operating effectiveness of our
internal control over financial reporting or fail to prevent fraud, current
and potential stockholders and depositors could lose confidence in our
financial reporting, which could adversely affect our business, financial
condition and results of operations, the trading price of our stock and our
ability to attract additional deposits.
ITEM 1B
UNRESOLVED STAFF COMMENTS
There were no unresolved staff comments as of December 31, 2005.
20
ITEM 2
PROPERTIES
Our main office is located at 100 Slade's Ferry Avenue, Somerset,
Massachusetts at the junctions of U.S. Routes 6, 138, and 103. We operate
our business from ten office locations in Assonet, Fairhaven, Fall River,
New Bedford, Seekonk, Somerset and Swansea, Massachusetts. As of December
31, 2005, the following properties were owned through the Bank's wholly-
owned subsidiary, Slade's Ferry Realty Trust:
Location Sq. Footage
-------- -----------
Main Office 100 Slade's Ferry Avenue Somerset, MA 42,000
North Somerset 2722 County Street Somerset, MA 3,025
Linden Street 244-253 Linden Street Fall River, MA 1,750
Brayton Avenue 855 Brayton Avenue Fall River, MA 3,325
North Swansea 2388 G.A.R. Highway Swansea, MA 2,960
Seekonk 1400 Fall River Avenue Seekonk, MA 2,300
Fairhaven 75 Huttleston Avenue Fairhaven, MA 13,000
Ashley Boulevard 833 Ashley Boulevard New Bedford, MA 2,655
The office listed below is leased by the Bank with the indicated lease
expiration date.
Assonet 58B South Main Street Assonet, MA 2,000
(expires February 2010 with two options to extend term of lease for five year periods)
The facility listed below is owned by the Bank, however, the land is leased
with the indicated lease expiration date.
Brayton Avenue
Drive-Up Complex 16 Stevens Street Fall River, MA 549
(expires October 2015)
The main office building contains approximately 42,000 square feet of usable
space which we occupy. We also operate a school banking facility located in
the Somerset High School, Grandview Avenue, Somerset, Massachusetts that
consists of 200 square feet. This facility provides basic banking services
to students and school staff. The Seekonk office is an 8,800 square foot
building of which we utilize 2,300 square feet and lease out the remainder.
We own an ATM dispenser, located at 58A South Main Street, Assonet,
Massachusetts. We sublease the space on which the ATM dispenser is located.
The original term of lease expires October 2009.
21
ITEM 3
LEGAL PROCEEDINGS
We are not involved in any pending legal proceedings that would have a
material impact on our consolidated financial condition and results of
operations.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2005, no matters were submitted to a vote of
our stockholders.
22
PART II
ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is listed in the Nasdaq Capital Market under the symbol
SFBC. The following table sets forth the range of high and low bid price for
our common stock as reported for the Nasdaq Capital Market by quarter for
the two-year period ended:
December 31,
--------------------------------------------------
2005 2004
----------------------- -----------------------
High Price Low Price High Price Low Price
---------- --------- ---------- ---------
First Quarter $20.80 $18.01 $24.00 $21.75
Second Quarter $19.00 $18.01 $22.00 $17.35
Third Quarter $20.25 $17.75 $22.94 $18.65
Fourth Quarter $21.68 $18.00 $20.90 $19.01
During 2005, there were no shares repurchased.
Holders
As of March 17, 2006, there were 1,275 holders of an aggregate of 4,156,712
shares of common stock issued and outstanding.
Dividends - History and Policy
Slade's Ferry Bancorp., since its inception in 1990 and prior thereto the
Bank, has consistently paid dividends to shareholders since 1961. We paid
four quarterly cash dividends of $.09 per share for a total of $.36 per
share during each of 2004 and 2005.
The declaration of cash dividends is dependent on a number of factors,
including regulatory limitations, and the Bank's operating results and
financial condition. Our shareholders will be entitled to dividends only
when, and if, declared by the Board of Directors out of funds legally
available. Under the Massachusetts Business Company Law, a dividend may not
be declared if the Company is insolvent or if the declaration of the
dividend would render the Company insolvent.
Chapter 172 Section 28 of the Massachusetts Statutes on Banks and Banking
provides that a bank's Board of Directors may, subject to the restriction
contained in the section, declare and pay dividends on capital stock out of
net profits from time to time and to such extent as they deem advisable.
However, under this provision, no cash dividend shall be paid unless,
following the payment of such dividend, the capital stock and retained
earnings account will be unimpaired.
23
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth information pertaining to our equity
compensation plans in effect as of December 31, 2005.
Equity Compensation Plan Information
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation
of outstanding options, outstanding options, plans (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
-----------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans 254,945 $17.35 152,394
approved by security
holders
Equity compensation plans - - -
not approved by security
holders
-----------------------------------------------------------------------------------------------------------
Total 254,945 $17.35 152,394
===========================================================================================================
24
ITEM 6
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data for the last five
years from the consolidated financial statements of Slade's Ferry Bancorp.
The following information is only a summary and should be read in
conjunction with our consolidated financial statements and notes.
At or for the Years Ended December 31,
-----------------------------------------------------------------
2005 2004 2003 2002 2001
-----------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
EARNINGS DATA
Interest and dividend income $ 28,919 $ 24,106 $ 20,617 $ 22,037 $ 27,324
Interest expense 10,995 7,946 6,073 7,928 12,327
Net interest income 17,924 16,160 14,544 14,109 14,997
Provision (credit) for loan losses 167 376 (602) (310) 750
Noninterest income 2,320 2,505 2,214 2,533 1,770
Noninterest expense 13,896 12,785 12,669 12,877 11,501
Income before income taxes 6,181 5,504 4,691 4,075 4,516
Provision for income taxes 2,161 1,887 2,007 1,124 1,360
Net income 4,020 3,617 2,684 2,951 3,156
Return on average assets 0.70% 0.70% 0.64% 0.74% 0.80%
Return on average equity 8.36% 8.28% 6.47% 7.52% 9.03%
Net interest margin 3.39% 3.44% 3.91% 3.89% 4.18%
Net interest spread 2.96% 3.07% 3.48% 3.31% 3.34%
Basic earnings per share $ 0.98 $ 0.89 $ 0.68 $ 0.75 $ 0.82
Diluted earnings per share $ 0.97 $ 0.88 $ 0.67 $ 0.75 $ 0.82
Cash dividends declared per share $ 0.36 $ 0.36 $ 0.36 $ 0.36 $ 0.44
Dividend payout ratio 36.84% 40.31% 53.32% 47.50% 52.63%
BALANCE SHEET DATA
Assets $ 585,914 $ 549,398 $ 439,234 $ 398,347 $ 394,719
Loans, net of deferred loan fees 413,943 366,366 335,651 264,670 253,503
Allowance for loan losses 4,333 4,101 4,154 4,854 5,485
Loans, net 409,610 362,265 331,497 259,816 248,018
Goodwill 2,173 2,173 2,173 2,173 2,173
Securities and FHLB Stock 129,908 126,305 61,487 80,618 96,401
Deposits 415,846 399,905 333,145 335,633 337,043
Borrowings 118,175 100,596 60,475 19,185 17,448
Stockholders' equity 48,855 46,601 42,537 40,623 37,881
Average equity as a percentage of average assets 8.40% 8.49% 9.97% 9.80% 8.86%
Shares outstanding at end of period 4,132,200 4,068,423 3,995,857 3,937,763 3,869,924
Book value per share at end of period $ 11.82 $ 11.45 $ 10.65 $ 10.32 $ 9.79
25
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The purpose of Management's Discussion and Analysis is to focus on certain
significant factors which have affected our operating results and financial
condition, and to provide shareholders a more comprehensive review of the
financial data contained in this report. The following discussion should be
read in conjunction with our audited financial statements and notes thereto,
included as pages F-1 through F-42 of this report.
2005 ITEMS OF SIGNIFICANCE
* In 2005, we recorded net income of $4.0 million or $0.97 per
share on a diluted basis compared to $3.6 million or $0.88 per
share on a diluted basis in 2004. This represents an increase of
$403,000 or 11.1% in net income and $0.09 or 10.2% per share on
a diluted basis between 2005 and 2004. This increase is due to
an increase in net interest income of $1.8 million arising from
our growth. Our return on average equity for the year ended
December 31, 2005 was 8.36%, as compared to 8.28% for the year
ended December 31, 2004.
* 2005 experienced a rising rate environment with prime interest
rate increasing 200 basis points, combined with intense
competition for deposits in our market area. As a result, our
net interest margin has compressed from 3.44% for the year ended
December 31, 2004 to 3.39% for the year ended December 31, 2005.
* The book value of our common stock increased from $11.45 per
share at December 31, 2004 to $11.82 at December 31, 2005.
* Total assets increased by $36.5 million, or 6.6% from the fiscal
year ended December 31, 2004.
* Total gross loans increased by $47.5 million, or 12.9% from the
fiscal year ended December 31, 2004.
* Capital adequacy ratios continue to meet the criteria of "well
capitalized" under regulatory guidelines.
* As we remain committed to customer service, our technology
improvement plan calls for the continued upgrading of the
systems utilized on the teller platform and in customer service
areas to allow employees to serve customers more efficiently.
* In April 2005, we opened our newest facility, located in
Assonet, Massachusetts. This branch is a state-of-the-art full-
service banking office, designed to provide superior customer
convenience and service.
FINANCIAL CONDITION
Total assets increased by $36.5 million, or 6.6%, from $549.4 million at
December 31, 2004 to $585.9 million at December 31, 2005. The increase in
total assets during 2005 is the result of planned growth across the balance
sheet. Total net loans increased from $362.3 million at December 31, 2004 to
$409.6 million, an increase of $47.3 million or 13.1%, while the investment
portfolio increased from $126.3 million at December 31, 2004 to $129.9
million at December 31, 2005, an increase of 2.9%. The combination of growth
in deposits and FHLB advances funded the increase in loans and investments.
Total deposits increased from $399.9 million at December 31, 2004 to $415.8
million at December 31, 2005, an increase of $15.9 million or 4.0%. Total
FHLB advances increased by $17.6 million or 19.5%, to $107.9 million at
December 31, 2005 from $90.3 million at December 31, 2004.
26
INVESTMENT PORTFOLIO
The main objectives of our investment portfolio are to achieve a competitive
rate of return over a reasonable time period and to provide liquidity.
Our total investment portfolio increased from $126.3 million at December 31,
2004 to $129.9 million at December 31, 2005, an increase of 2.9%. The
increase is the result of the investment of excess funds from both deposits
and borrowings into obligations of government-sponsored entities and
mortgage-backed securities, which were raised in accordance with our
strategic plans. Certain mortgage-backed securities totaling $28.0 million
were purchased during 2005 as a direct replacement of loans, as loan pay-
offs exceeded management's expectations.
The current investment strategy has concentrated on the purchase of state
and municipal obligations generally maturing or callable within five to
seven years. The investment policy also permits investments in mortgage-
backed securities, usually having a longer weighted average life. The
investment policy, however, limits the duration of the aggregate investment
portfolio to 5 years. At December 31, 2005, the portfolio duration was 2.8
years. We do not purchase investments with imbedded derivative
characteristics, or free-standing derivative instruments such as swaps,
options, or futures.
Securities Held to Maturity
The held-to-maturity portfolio consists of mortgage-backed securities and
securities issued by states and municipalities. Held-to-maturity securities
decreased from $37.8 million at December 31, 2004 to $29.3 million at
December 31, 2005. The decrease is the result of the maturity, calls and
paydowns of certain state and municipal obligations and mortgage-backed
securities. Those funds were used to increase the available for sale
portfolio to provide liquidity for future loan growth. Management has
designated these mortgage-backed securities to secure advances from the
FHLB. We have the positive intent and ability to hold these securities to
maturity.
The following table shows the amortized cost basis and fair value of the
major categories of investment securities held to maturity for the years
indicated:
December 31,
--------------------------------------------------------------------------------
2005 2004 2003
Amortized Amortized Amortized
Cost Basis Fair Value Cost Basis Fair Value Cost Basis Fair Value
--------------------------------------------------------------------------------
(In thousands)
State and municipal obligations $ 6,766 $ 6,892 $ 8,588 $ 8,928 $11,299 $11,851
Mortgage-backed securities 22,540 21,966 29,185 29,184 1 1
---------------------- --------------------- ---------------------
Total securities held to maturity $29,306 $28,858 $37,773 $38,112 $11,300 $11,852
====================== ===================== =====================
27
The following table shows the amortized cost basis of securities held to
maturity with the weighted average interest yield for each maturity range.
December 31, 2005
-------------------------------------------------
State and Municipal Mortgage-Backed
Obligations (2) Securities (1) Total
-------------------------------------------------
(Dollars in thousands)
Maturity
--------
Within 1 year $1,761 $ - $ 1,761
Yield 6.04% 0.00% 6.04%
After 1 year through 5 years 2,793 - 2,793
Yield 5.86% 0.00% 5.86%
After 5 year through 10 years 1,014 - 1,014
Yield 6.48% 0.00% 6.48%
Over 10 years 1,198 22,540 23,738
Yield 6.90% 5.42% 5.49%
-----------------------------------------
Amount $6,766 $22,540 $29,306
=========================================
Yield 6.18% 5.42% 5.60%
=========================================
--------------------
Mortgage-backed securities stated using contractual maturity.
On fully taxable equivalent basis based on tax rate of 35.0%.
Securities Available for Sale
Securities not designated as held-to-maturity are designated as available
for sale. Although we do not anticipate the sale of these securities, the
designation as available for sale allows us the flexibility to alter our
investment strategies and sell these securities when conditions warrant.
Additionally, marketable equity securities that have no maturity date must
be designated as available-for-sale. These securities are carried at fair
value. The available-for-sale securities portfolio includes obligations and
mortgage-backed securities of government-sponsored enterprises, corporate
debt and equity securities.
The following table shows the amortized cost basis and fair value of the
major categories of securities available for sale at the dates indicated:
December 31,
--------------------------------------------------------------------------------
2005 2004 2003
--------------------------------------------------------------------------------
Amortized Amortized Amortized
Cost Basis Fair Value Cost Basis Fair Value Cost Basis Fair Value
--------------------------------------------------------------------------------
(In thousands)
Debt Securities:
Government-sponsored enterprises $50,443 $49,581 $41,419 $41,206 $27,932 $27,654
Corporate 9,564 9,014 9,364 9,485 1,658 1,728
Mortgage-backed securities 31,574 31,232 27,805 28,207 14,034 14,480
Marketable equity securities 3,426 3,271 3,859 3,751 3,511 3,364
Mutual funds 1,205 1,200 1,216 1,233 - -
------- ------- ------- ------- ------- -------
$96,212 $94,298 $83,663 $83,882 $47,135 $47,226
======= ======= ======= ======= ======= =======
28
The following table shows the amortized cost basis of debt securities
available for sale with the weighted average interest yield for each
maturity range.
December 31, 2005
------------------------------------------------------
Government-
Sponsored Mortgage-Backed
Enterprises Securities (1) Corporate Total
------------------------------------------------------
(Dollars in thousands)
Within 1 year $ 8,987 $ - $ 250 $ 9,237
Yield 2.84% 0.00% 5.62% 2.92%
After 1 year through 5 years 41,456 921 9,314 51,691
Yield 3.77% 4.54% 5.06% 4.02%
After 5 year through 10 years - 5,717 - 5,717
Yield 0.00% 4.63% 0.00% 4.63%
Over 10 years - 24,936 - 24,936
Yield 0.00% 4.43% 0.00% 4.43%
------- ------- ------ -------
Amount $50,443 $31,556 $9,564 $91,563
======= ======= ====== =======
Yield 3.60% 4.89% 5.05% 4.20%
======= ======= ====== =======
Mortgage-backed securities stated using contractual maturity.
LOANS
Our total loan portfolio increased from $362.3 million at December 31, 2004
to $409.6 million at December 31, 2005, an increase of $47.3 million or
13.1%. The increase is the result of continued loan growth initiatives,
designed to invest the deposits and borrowings that were raised in
accordance with our strategic plans.
Although commercial real estate loans and commercial business loans have
traditionally been our leading loan products, management has made
considerable effort to diversify the loan portfolio over the past three
years, adding significant levels of residential real estate loan products to
the balance sheet. Management believes these loans will enhance our overall
credit risk profile. At December 31, 2005, our one-to-four family mortgage
loans totaled $120.3 million or 29.1% of total gross loans, compared with
$97.5 million, or 26.6% of total gross loans outstanding at December 31,
2004, while home equity lines of credit totaled $17.9 million, or 4.3% of
our total gross loans, compared to $23.1 million or 6.3% of total gross
loans at December 31, 2004. Originations of residential real estate loans
for the year ended December 31, 2005 totaled $27.0 million as compared to
$20.6 million for the year ended December 31, 2004. Gross home equity lines
of credit totaled $17.9 million and unadvanced funds committed under home
equity lines of credit totaled $17.7 million at December 31, 2005.
The commercial real estate loan portfolio was $213.8 million or 51.6% of
total loans at December 31, 2005. At December 31, 2004, commercial real
estate loans totaled $192.8 million or 52.6% of total gross loans.
Commercial real estate loan originations totaled $62.6 million for the year
ended December 31, 2005. At December 31, 2005, we had $21.5 million of
advanced construction loans that amounted to 5.2% of our total gross loans,
compared to $24.2 million or 6.6% of total gross loans at December 31, 2004.
Construction loan originations totaled $38.1 million for the year ended
December 31, 2005. Unfunded portions of construction loans totaled $14.9
million at December 31, 2005. Other commercial loans totaled $38.1 million
or 9.2% of the total gross loan portfolio at December 31, 2005, compared to
$26.6 million or 7.3% at December 31, 2004.
Consumer loans at December 31, 2005 amounted to $2.6 million, or 0.6% of
total gross loans, as compared to $2.5 million or 0.7% of total gross loans
at December 31, 2004.
29
The following table summarizes loans by category at the end of each of the
last five years.
December 31,
------------------------------------------------------------
2005 2004 2003 2002 2001
------------------------------------------------------------
(In thousands)
Real estate mortgage loans:
Commercial $213,815 $192,822 $181,401 $154,161 $148,415
Residential 120,345 97,496 88,019 50,495 39,032
Construction and land development 21,490 24,240 10,346 14,078 7,600
Home equity lines of credit 17,915 23,131 18,330 8,606 2,377
Commercial, financial and agricultural 38,111 26,606 33,980 30,455 45,238
Consumer loans 2,623 2,510 4,018 7,217 11,222
------------------------------------------------------------
Total loans 414,299 366,805 336,094 265,012 253,884
Less: Allowance for loan losses (4,333) (4,101) (4,154) (4,854) (5,485)
Net deferred loan fees (356) (439) (443) (342) (381)
------------------------------------------------------------
Loans, net $409,610 $362,265 $331,497 $259,816 $248,018
============================================================
We have no foreign loans nor do we have any reportable concentrations of
loans.
Loan portfolio rate sensitivity
In our demographic market and relatively low interest rate environment, the
origination of adjustable-rate loans at our Bank has been minimum.
Additionally, our customer base tends to prefer fixed-rate mortgage loans to
adjustable-rate loans. Accordingly, the portfolio of adjustable-rate loans
has declined significantly during the past three years. Adjustable-rate
mortgage loans totaled $5.8 million, or 4.9% of residential real estate
loans at December 31, 2005. Substantially all of our equity lines of credit
have interest rates that adjust monthly with the Wall Street Journal prime
rate.
Additionally, the market for commercial and commercial real estate loans in
our market area is intense. In response to the competition, we offer
commercial real estate loans that adjust every five years, based on either
the Wall Street Journal prime rate or the Treasury rate matching the
adjustment period. Of the total commercial real estate loan portfolio,
$192.7 million, or 90.1% have adjustable interest rates at December 31,
2005.
The following table shows the contractual maturity distributions of all loan
categories at December 31, 2005:
Within One to
Year Five Years After Five Years Total
------ ---------- ---------------- -----
(In thousands)
Real estate mortgage loans:
Commercial $ 2,224 $11,189 $200,402 $213,815
Residential 13 2,258 118,074 120,345
Construction and land development 17,820 3,670 - 21,490
Home equity lines of credit 269 570 17,076 17,915
Commercial, financial and agricultural 10,941 11,764 15,406 38,111
Consumer 1,539 1,014 70 2,623
------- ------- -------- --------
$32,806 $30,465 $351,028 $414,299
======= ======= ======== ========
30
The following table shows the amounts, included in the preceding table,
which are due after one year and which have fixed interest rates and
adjustable interest rates:
Total Due After One Year
-----------------------------------------
Fixed Rate Adjustable Rate Total
---------- --------------- --------
(In thousands)
Real estate mortgage loans:
Commercial $ 18,888 $192,703 $211,591
Residential 114,479 5,853 120,332
Construction and land development 6,671 14,677 21,348
Home equity lines of credit - 17,646 17,646
Commercial, financial and agricultural 11,117 16,053 27,170
Consumer 685 399 1,084
-------- -------- --------
$151,840 $247,331 $399,171
======== ======== ========
Loan Delinquencies
It is our policy to manage our loan portfolio in order to recognize problem
loans at an early stage and thereby minimize loan losses. Loans are
considered delinquent when any payment of principal or interest is one month
or more past due. We generally commence collection procedures when accounts
are 15 days past due. Generally, when a loan becomes past due 90 days or
more, management discontinues the accrual of interest and reverses
previously accrued interest, unless the credit is well-secured and in
process of collection. Loans are returned to accrual status when all the
principal and interest amounts contractually due are brought current and
future payments are reasonably assured. When a loan is determined to be
uncollectible, it is charged off to the Allowance for Loan Losses or, if
applicable, any real estate that is securing the loan is acquired through
foreclosure, and recorded on our books as Other Real Estate Owned.
Management defines non-performing loans to include non-accrual loans, loans
past due 90 days or more and still accruing, and restructured loans not
performing in accordance with amended terms.
The following table presents information regarding non-performing loans in
the portfolio:
December 31,
------------------------------------------------
2005 2004 2003 2002 2001
------------------------------------------------
(Dollars in thousands)
Non-accrual loans $ 906 $ 506 $ 407 $ 635 $1,138
Loans 90 days or more past due and still accruing - - - 8 444
------------------------------------------------
Total non-performing loans $ 906 $ 506 $ 407 $ 643 $1,582
================================================
Restructured debt performing in accordance
with amended terms, not included above $ - $ - $ 198 $ 166 $ 186
================================================
Percentage of non-accrual loans to total loans 0.22% 0.14% 0.12% 0.24% 0.45%
Percentage of allowance for loan losses to non-accrual loans 478.3% 810.5% 1,020.6% 764.4% 481.9%
For the year ended December 31, 2005, interest income that would have been
recorded if non-accrual loans at December 31, 2005 had been current in
accordance with their original terms amounted to $54,000. The actual
interest recorded on these loans amounted to $40,000 for the year ended
December 31, 2005.
31
Allowance for Loan Losses
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower
than the carrying value of that loan. The general component covers non-
classified loans and is based on historical loss experience adjusted for
qualitative factors. An unallocated component is maintained to cover
uncertainties that could affect management's estimate of probable losses.
The unallocated component of the allowance reflects the margin of
imprecision inherent in the underlying assumptions used in the methodologies
for estimating specific and general losses in the portfolio.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review our allowance for loan losses.
As the composition of the loan portfolio gradually changes and diversifies
from higher credit risk weighted loans, such as commercial real estate and
commercial, to residential and home equity loans, a lower overall reserve
allowance rate will be required. During 2005, stronger underwriting
guidelines and overall improvement in credit quality of existing loans
resulted in a decrease in the degree of credit risk embedded in the loan
portfolio. Consequently, the allowance for loan losses as a percentage of
total loans outstanding declined from 1.12% at December 31, 2004 to 1.05% at
December 31, 2005. After thorough review and analysis of the adequacy of the
loan loss allowance during 2005, we recorded a provision for loan losses of
$167,000, compared to $376,000 recorded for the year ended December 31,
2004. There were no loans charged off in 2005 compared with $525,000 for the
year ended December 31, 2004. We realized recoveries of previously charged-
off loans totaling $65,000 for the year ended December 31, 2005 compared
with recoveries totaling $96,000 for the year ended December 31, 2004.
Management believes that the Allowance for Loan Losses of $4.3 million as of
December 31, 2005 is adequate to cover potential losses in the loan
portfolio, based on current information available to management.
32
The table below illustrates the changes in the Allowance for Loan Losses for
the periods indicated.
December 31,
--------------------------------------------------
2005 2004 2003 2002 2001
--------------------------------------------------
(Dollars in thousands)
Balance at beginning of year $4,101 $4,154 $4,854 $5,485 $4,776
Charge-offs:
Real estate mortgage loans:
Commercial - (446) (169) - -
Residential - - - - -
Home equity lines of credit - - - (20) -
Commercial, financial and agricultural loans - (62) (10) (337) (73)
Consumer - (17) (32) (26) (28)
--------------------------------------------------
- (525) (211) (383) (101)
Recoveries:
Real estate mortgage loans:
Commercial 39 8 43 18 15
Residential - - - - 2
Home equity lines of credit 16 17 1 20 12
Commercial, financial and agricultural loans - 60 55 17 15
Consumer 10 11 14 7 16
--------------------------------------------------
65 96 113 62 60
Net loan recoveries (charge-offs) 65 (429) (98) (320) (42)
Provision (credit) for loan losses 167 376 (602) (310) 750
--------------------------------------------------
Balance at end of year $4,333 $4,101 $4,154 $4,854 $5,485
==================================================
Allowance for loan losses as a percent of year-end loans 1.05% 1.12% 1.24% 1.83% 2.16%
--------------------------------------------------
Ratio of net charge-offs to average loans outstanding 0.00% (0.12%) (0.03%) (0.13%) (0.02%)
--------------------------------------------------
33
Thee table below shows an allocation of the allowance for loan losses at the
dates indicated:
December 31, 2005 December 31, 2004 December 31, 2003 December 31, 2002 December 31, 2001
--------------------------------------------------------------------------------------------------------------------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category to Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
----------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Commercial (5) $ 905(1) 9.2% $ 743(1) 7.3% $ 943(1) 10.1% $1,155(1) 11.6% $1,629(1) 17.9%
Real estate
construction 248 5.2% 236 6.6% 52 3.1% 70 5.3% 41 3.0%
Real estate
mortgage 3,056(2) 85.0% 2,989(2) 85.4% 3,071(2) 85.6% 3,465(2) 80.5% 3,586(2) 74.8%
Consumer 124(3) 0.6% 133(3) 0.7% 88(3) 1.2% 164(3) 2.6% 229(3) 4.3%
----------------- ----------------- ----------------- ----------------- -----------------
$4,333 100.0% $4,101 100.0% $4,154 100.0% $4,854 100.0% $5,485 100.0%
================= ================= ================= ================= =================
--------------------
Includes amounts specifically reserved for impaired loans of $84,434
at December 31, 2005, $270,722 at December 31, 2004, $251,280 at
December 31, 2003, $412,761 at December 31, 2002, and $780,029 at
December 31, 2001, as required by Financial Accounting Standard No.
114, "Accounting for Impairment of Loans."
Includes amounts specifically reserved for impaired loans of $2,215 at
December 31, 2005, $0 at December 31, 2004, $23,621 at December 31,
2003, $34,757 at December 31, 2002, and $413,663 at December 31, 2001,
as required by Financial Accounting Standard No. 114, "Accounting for
Impairment of Loans."
Includes amounts specifically reserved for impaired loans of $21 at
December 31, 2005, $76,194 at December 31, 2004, $170 at December 31,
2003, $29,606 at December 31, 2002, and $1,632 at December 31, 2001,
as required by Financial Accounting Standard No. 114, "Accounting for
Impairment of Loans."
34
DEPOSITS AND BORROWED FUNDS
We solicit depositors from our primary market area using rates and services
designed to appeal to customers across a broad spectrum of ages and income
levels. We compete for deposit customers with community banks and credit
unions, as well as local branches of regional and national banks. Despite
this level of competition, our total deposits increased from $399.9 million
at December 31, 2004 to $415.8 million at December 31, 2005, an increase of
$15.9 million or 4.0%. Implementation of our "Coastal" product line was
designed to attract high-balance customers with whom we have multiple-
product relationships.
The following table sets forth the average amount and the average rate paid
on deposits for the periods indicated:
December 31,
-----------------------------------------------------------------
2005 2004 2003
------------------- ------------------- -------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
-----------------------------------------------------------------
(Dollars in thousands)
Noninterest-bearing deposits $ 80,048 0.00% $ 76,815 0.00% $ 72,602 0.00%
NOW deposits 49,787 1.06 42,533 0.74 42,908 0.52
Savings deposits 92,578 1.14 87,983 1.00 67,487 0.52
Money market deposits 33,543 1.28 36,929 1.35 19,838 1.18
Time deposits 147,360 2.77 150,839 2.18 140,939 2.62
-------- -------- --------
$403,316 1.51% $395,099 1.26% $343,774 1.66%
======== ======== ========
As of December 31, 2005, the aggregate amount of time deposits in
denominations of $100,000 or more had the following maturities:
Amount
--------------
(In thousands)
Within three months $11,147
After three months through six months 13,166
After six months through twelve months 13,469
Over twelve months 8,024
-------
$45,806
=======
As of December 31, 2005, the aggregate amount of time deposits in
denominations of less than $100,000 had the following maturities:
Amount
--------------
(In thousands)
Within three months $ 28,321
After three months through six months 35,189
After six months through twelve months 34,314
Over twelve months 19,037
--------
$116,861
========
35
As a member of the FHLB, the Bank is entitled to participate in the FHLB's
advance programs. The advance programs allow the Bank to borrow up to 30% of
total assets, but limited, based on the amount of qualified collateral (as
defined by the FHLB) pledged, and the amount of FHLB preferred stock held.
FHLB advances are utilized as an additional funding source for loans and
investments as well as a tool for controlling the levels of interest rate
risk on the balance sheet. FHLB advances are secured by a blanket lien on
qualified collateral, consisting primarily of loans with first mortgages
secured by one-to-four family properties and certain unencumbered investment
securities. In addition qualified commercial real estate loans are used as
collateral to obtain additional FHLB advances.
Short-term borrowings include funds drawn under lines of credit with the
FHLB and FHLB advances with an original maturity of less than one year.
Total short-term borrowings increased from zero at December 31, 2004 to $7.0
million at December 31, 2005. At no time did the average balance of short-
term borrowings exceed 30% of stockholders' equity.
Long-term FHLB advances increased from $90.3 million at December 31, 2004 to
$100.9 million at December 31, 2005, an increase of $10.6 million or 11.7%.
The proceeds were utilized to fund loan and investment growth in excess of
deposit growth, as well as to hedge the effects of rising short-term
interest rates on net interest income. At December 31, 2005, outstanding
long-term FHLB advances had the following scheduled maturities and weighted
average interest rates:
Weighted
Final Maturity Amount Average Rate
-------------- ------ ------------
(In thousands)
2006 $ 8,000 2.69%
2007 27,000 3.42
2008 15,239 3.86
2009 21,000 3.22
2010 7,000 4.49
Thereafter 22,626 6.32
-------- ----
$100,865 4.11%
======== ====
Although most advances are payable at maturity, advances totaling $16.9
million are payable on an amortizing basis, in terms ranging from 120 to 240
months. Amortizing advances are being repaid in equal monthly payments and
are being amortized from the date of the advance to the maturity date on a
direct reduction basis. Also, certain advances are redeemable at the option
of the FHLB, at par value on the call date and quarterly thereafter.
In March 2004, we issued $10.3 million in subordinated debentures. The
debentures mature in 2034, and carry an adjustable interest rate equivalent
to the three-month LIBOR plus 279 basis points. The rate adjusts every three
months based on the change in the LIBOR. At December 31, 2005 the interest
rate on the subordinated debentures was 7.29%. Current bank and bank holding
company regulations view these debentures as "tier 1 capital." As such, we
may leverage this regulatory capital in order to expand our franchise or
otherwise enhance our earnings.
STOCKHOLDERS' EQUITY
Total stockholders' equity increased from $46.6 million at December 31, 2004
to $48.9 million at December 31, 2005, primarily the result of net income of
$4.0 million. Net income was reduced by cash dividends declared totaling
$1.5 million. Other factors affecting total stockholders' equity include the
other comprehensive loss of $1.3 million pertaining to net unrealized losses
on securities available for sale, and the issuance of common stock through
option and dividend reinvestment plans, totaling $1.0 million.
RESULTS OF OPERATIONS
Our operating performance is dependent on net interest 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 impacted by several factors such as economic
conditions, interest rates, asset/liability management, and corporate tax
and strategic planning.
36
The following table sets forth our average assets, liabilities, and
stockholders' equity, interest income earned and interest paid, average
rates earned and paid, net interest spread and the net interest margin.
Average balances reported are daily averages.
Years Ended December 31,
---------------------------------------------------------------------------------------------
2005 2004 2003
---------------------------------------------------------------------------------------------
Interest Interest Interest
Average Income/ Average Average Income/ Average Average Income/ Average
Balance Exmpense Rate Balance Expense Rate Balance Expense Rate
--------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Assets:
------
Interest earning assets (2)
Loans:
Commercial loan $ 32,560 $ 2,160 6.63% $ 31,536 $ 1,717 5.44% $ 32,044 $ 1,739 5.43%
Commercial real estate 223,355 13,613 6.09% 207,937 12,499 6.01% 172,299 10,955 6.36%
Residential real estate 135,714 7,267 5.35% 114,832 5,867 5.11% 85,648 4,604 5.38%
Consumer 2,405 144 5.99% 3,233 180 5.57% 5,043 305 6.05%
------------------- ------------------- -------------------
Total loans 394,034 23,184 5.88% 357,538 20,263 5.67% 295,034 17,603 5.97%
Federal funds sold 8,754 247 2.82% 19,351 185 0.96% 10,504 101 0.96%
Taxable debt securities 112,637 4,708 4.18% 71,657 2,962 4.13% 53,807 2,210 4.11%
Tax-exempt debt securities (1) 7,837 520 6.64% 9,666 633 6.55% 12,659 895 7.07%
Marketable equity securities 4,612 160 3.47% 3,730 93 2.49% 3,112 94 3.02%
FHLB stock 5,868 257 4.38% 3,422 98 2.86% 1,512 45 2.98%
Other investments 650 25 3.85% 10,401 89 0.86% 5,418 52 0.96%
------------------- ------------------- -------------------
Total interest earning assets 534,392 29,101 5.45% 475,765 24,323 5.11% 382,046 21,000 5.50%
------- ------- -------
Allowance for loan losses (4,212) (4,324) (4,607)
Deferred loan fees (415) (473) (388)
Cash and due from banks 16,249 18,411 17,091
Other assets 26,311 25,058 22,140
-------- -------- --------
$572,325 $514,437 $416,282
======== ======== ========
Liabilities and Stockholders' Equity:
-------------------------------------
Savings accounts $ 92,578 $ 1,051 1.14% $ 87,983 $ 882 1.00% $ 67,487 $ 349 0.52%
NOW accounts 49,787 529 1.06% 42,533 314 0.74% 42,908 222 0.52%
Money market accounts 33,543 428 1.28% 36,929 497 1.35% 19,838 235 1.18%
Time deposits 147,360 4,076 2.77% 150,839 3,289 2.18% 140,939 3,699 2.62%
FHLB advances 108,450 4,274 3.94% 63,390 2,594 4.09% 28,824 1,568 5.44%
Subordinated debt 10,282 637 6.20% 8,248 370 4.49% - -
------------------- ------------------- -------------------
Total interest-bearing
liabilities 442,000 10,995 2.49% 389,922 7,946 2.04% 299,996 6,073 2.02%
------- -------
Demand deposits 78,960 76,815 72,602
Other liabilities 3,304 4,001 2,200
-------- -------- --------
Total liabilities 524,264 470,738 374,798
Total stockholders' equity 48,061 43,699 41,484
-------- -------- --------
$572,325 $514,437 $416,282
======== ======== ========
Net interest income $18,106 $16,377 $14,927
======= ======= =======
Net interest spread 2.96% 3.07% 3.48%
==== ==== ====
Net interest margin 3.39% 3.44% 3.91%
==== ==== ====
--------------------
On a fully taxable equivalent basis based on tax rate of 35.0% for
2005, 34.3% for 2004 and 42.8% for 2003. Interest income on
investments and net interest income includes a fully taxable
equivalent adjustment of $182,000 in 2005, $217,000 in 2004 and
$383,000 in 2003.
Average balance includes non-accruing loans. The effect of including
such loans, although not material, is to reduce the average rate
earned on the Company's loans.
37
RATE - VOLUME ANALYSIS
----------------------
The following table presents the changes in components of net interest
income for the years ended December 31, which are the result of changes in
interest rates and the changes that are the result of changes in volume of
the underlying asset or liability. Changes that are attributable to changes
in both rate and volume have been allocated equally to rate and volume.
NET INTEREST INCOME - CHANGES DUE TO VOLUME AND RATE
2005 vs. 2004 Increase (Decrease) 2004 vs. 2003 Increase (Decrease)
--------------------------------- ---------------------------------
Total Due to Due to Total Due to Due to
Change Volume Rate Change Volume Rate
----------------------------------------------------------------------
(In thousands)
Commercial loans $ 443 $ 62 $ 381 $ (22) $ (28) $ 6
Commercial real estate 1,114 933 181 1,544 2,204 (660)
Residential real estate 1,400 1,093 307 1,263 1,530 (267)
Consumer loans (36) (48) 12 (125) (105) (20)
Federal funds sold 62 (200) 262 84 85 (1)
Taxable debt securities 1,746 1,703 43 752 735 17
Tax-exempt debt securities (1) (113) (121) 8 (262) (204) (58)
Marketable equity securities 67 26 41 (1) 17 (18)
FHLB Stock 159 89 70 53 56 (3)
Other investments (64) (229) 165 37 45 (8)
----------------------------- -----------------------------
Total interest income 4,778 3,308 1,470 3,323 4,335 (1,012)
----------------------------- -----------------------------
Savings accounts 169 49 120 533 156 377
NOW accounts 215 65 150 92 (2) 94
Money market accounts (69) (45) (24) 262 216 46
Time deposits 787 (86) 873 (410) 238 (648)
FHLB advances 1,680 1,810 (130) 1,026 1,647 (621)
Subordinated debt 267 109 158 370 370 -
----------------------------- -----------------------------
Total interest expense 3,049 1,902 1,147 1,873 2,625 (752)
----------------------------- -----------------------------
Net interest income $1,729 $1,406 $ 323 $1,450 $1,710 $ (260)
============================= =============================
The change in interest income on investments and net interest income
includes interest on a fully tax equivalent basis based on a tax rate
of 35.0% for 2005, 34.3% for 2004 and 42.8% for 2003.
38
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
We realized net income totaling $4.0 million for the year ended December 31,
2005, equivalent to basic earnings per share of $0.98 and diluted earnings
per share of $0.97. This represents a 11.1% increase in net income from the
year ended December 31, 2004, where net income totaled $3.6 million, or
$0.89 per share (basic) and $0.88 per share (diluted). Net interest income
increased from $16.2 million for the year ended December 31, 2004 to $17.9
million for the year ended December 31, 2005, the direct result of our
growth over the year. We recognized a provision for loan losses of $167,000
and $376,000 for the years ended December 31, 2005 and 2004, respectively.
During the past three years, we have made concerted efforts to enhance the
credit quality of our loan portfolio. Continuing the dedication to loan
quality that management has taken has resulted in a loan loss provision that
management believes is in line with its growing loan portfolio. Non-interest
income decreased from $2.5 million for the year ended December 31, 2004 to
$2.3 million for the year ended December 31, 2005. During the same period,
non-interest expense increased from $12.8 million for the year ended
December 31, 2004 to $13.9 million for the year ended December 31, 2005.
Income before taxes was $6.2 million and $5.5 million, for the years ended
December 31, 2005 and 2004, respectively. Income taxes increased from $1.9
million for the year ended December 31, 2004, to $2.2 million for the year
ended December 31, 2005.
Interest income increased from $24.1 million for the year ended December 31,
2004, to $28.9 million for the year ended December 31, 2005, an increase of
20.0%. This increase can be attributed to the growth in the loan portfolio,
as the average balance of loans increased by $36.5 million or 10.21%. The
yield on the loan portfolio increased from 5.67% for the year ended December
31, 2004, to 5.88% for the year ended December 31, 2005. Interest and
dividends on investments increased by $1.8 million, on a fully taxable
equivalent basis, from $3.9 million for the year ended December 31, 2004 to
$5.7 million for the year ended December 31, 2005, the result of the growth
in the investment portfolio. The portfolio grew from an average balance of
$98.9 million to $131.6 million. Income from federal funds sold increased
from $185,000 to $247,000, the result of increased volume of overnight
money.
Interest expense increased from $7.9 million for the year ended December 31,
2004 to $11.0 million for the year ended December 31, 2005, resulting
primarily from the increased use of borrowings in 2005. The average balance
of FHLB advances increased from $63.4 million for the year ended December
31, 2004 to $108.5 million for the year ended December 31, 2005. Management
used borrowings to fund a substantial portion of our loan growth in 2005.
During the period of low interest rates, we utilized longer-term advances to
fund loan originations in order to control interest rate risk. As a result
of the timing of borrowings, the average rate paid on FHLB advances
decreased from 4.09% for the year ended December 31, 2004 to 3.94% for the
year ended December 31, 2005. Interest on deposits increased from $5.0
million for the year ended December 31, 2004 to $6.1 million for the year
ended December 31, 2005. We have increased certain interest rates in
response to increases in market interest rates and corresponding increases
in deposit interest rates offered by our competitors, in order to continue
to fund loan growth. This increase was the result of the deposit campaigns,
both for certificates of deposit and core accounts. A marketing strategy was
employed whereby certificates of deposit were offered at premium rates, and
the customer was cross-sold basic banking products to establish a long-term
relationship with the customer. At the same time, a suite of products was
offered to high-balance customers. These campaigns served to increase the
levels of all deposit types, including non-interest bearing demand deposits.
We also issued $10.3 million of subordinated debentures in March 2004. The
debentures carry an interest rate equal to the three-month LIBOR plus 279
basis points. The effect of the issue was to increase interest expense by
$267,000. The cost of interest-bearing liabilities increased from 2.04% to
2.49%.
Net interest income increased from $16.2 million for the year ended December
31, 2004 to $17.9 million for the year ended December 31, 2005, an increase
of 10.9%. This increase was the result of our growth, offset by a
compression of our net interest margin from 3.44% for the year ended
December 31, 2004 to 3.39% for the year ended December 31, 2005, and the
continued period of low market interest rates, combined with intense
competition for deposits in our market area.
The provision for loan losses is a charge against earnings and funds the
allowance for loan losses. We maintain the allowance for loan losses at a
level that we believe is adequate to absorb inherent 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, the nature of the
39
portfolio mix and the balance of non-performing and classified loans. We
assess the allowance for loan losses on a monthly basis. After thorough
review and analysis of the adequacy of the allowance and the continued
improvement in asset quality in the loan portfolio, management deemed it
prudent to provide $167,000 and $376,000 for possible loan losses for the
year ended December 31, 2005 and 2004, respectively.
Non-interest income decreased from $2.5 million for the year ended December
31, 2004 to $2.3 million for the year ended December 31, 2005, a decrease of
7.4%. The decrease can be attributed to a one-time sale of impaired loans,
which resulted in a gain of $196,000 for the year ended December 31, 2004,
as compared to $49,000 for the year ended December 31, 2005, a decrease of
75%. Also, contributing to the decrease is the result of the introduction of
free checking account products. In response to competitive pressure, we
offered and promoted free checking accounts and realized a significant shift
of accounts into this product, resulting in decreased fee income. Service
charges on deposit accounts declined $124,000 from $1.0 million for the year
ended December 31, 2004 to $914,000 for the year ended December 31, 2005.
Other income increased from $844,000 for the year ended December 31, 2004 to
$860,000 for the year ended December 31, 2005, an increase of 1.9%. This
increase was the result of official check fees, ATM and debit card income
offset by the decrease of commissions on sales of non-deposit investment
products.
Non-interest expense increased from $12.8 million for the year ended
December 31, 2004 to $13.9 million for the year ended December 31, 2005, an
increase of 8.7%. Salaries and employee benefits increased by $423,000, or
5.5%, from $7.6 million for the year ended December 31, 2004, to $8.0
million for the year ended December 31, 2005. Salary increases in 2005 were
offset by increased levels of deferred loan origination costs. Occupancy and
equipment expense increased from $1.3 million for the year ended December
31, 2004 to $1.7 million for the year ended December 31, 2005. The increase
is a result of cost savings realized from closing branches in 2004 that have
been offset by costs associated with opening the new Assonet branch in April
2005. Equipment expense increased due to modernization of and investments in
teller and platform systems initiatives that we believe will ultimately
result in a more efficient customer service. Professional fees increased by
$320,000 when comparing the years ended December 31, 2005 and 2004. The
increase is the result of accounting and consulting costs associated with
our restatement of certain financial statements and related information
totaling $211,000. Also professional fees increased by $25,000 in 2005 due
to costs associated with the anticipated implementation of Section 404 of
the Sarbanes-Oxley Act of 2002 and implementing section 305 for the FDIC
Improvement Act of 1991. Marketing costs increased from $510,000 for the
year ended December 31, 2004 to $549,000 for the year ended December 31,
2005. This is the result of increased advertising and promotional costs
associated with our "Coastal" product line and other deposit gathering
initiatives. As we continue to launch new deposit products and services,
such as the Coastal Savings account and the Bank at Work Program, we expect
marketing costs to rise. Other expenses decreased from $2.3 million for the
year ended December 31, 2004 to $2.2 million for the year ended December 31,
2005, a decrease of $6,000.
Income before income taxes was $6.2 million for the year ended December 31,
2005, compared to $5.5 million for the year ended December 31, 2004.
Provision for income taxes totaled $2.2 million and $1.9 million for the
years ended December 31, 2005 and 2004, respectively, representing overall
effective tax rates of 35.0% and 34.3%, respectively.
40
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
We realized net income totaling $3.6 million for the year ended December 31,
2004, equivalent to basic earnings per share of $0.89 and diluted earnings
per share of $0.88. This represents a 34.8% increase in net income from the
year ended December 31, 2003, where net income totaled $2.7 million, or
$0.68 per share (basic) and $0.67 per share (diluted). Net interest income
increased from $14.5 million for the year ended December 31, 2003 to $16.2
million for the year ended December 31, 2004, the direct result of our
growth over the year. Commensurate with loan growth, we recognized a
provision for loan losses of $376,000 in 2004, compared with a credit for
loan losses of $602,000 in 2003. During the past two years, we have made
concerted efforts to enhance the credit quality of our loan portfolio, and
the credit recorded in 2003 was the direct result of that effort. Continuing
the dedication to loan quality that management has taken has resulted in a
loan loss provision that management believes is in line with its growing
loan portfolio. Non-interest income increased from $2.2 million for the year
ended December 31, 2003 to $2.5 million for the year ended December 31,
2004. During the same period, non-interest expenses remained relatively
constant, increasing from $12.7 million for the year ended December 31, 2003
to $12.8 million for the year ended December 31, 2004. Income before taxes
was $5.5 million and $4.7 million, for the years ended December 31, 2004 and
2003, respectively. Income taxes decreased from $2.0 million for the year
ended December 31, 2003, to $1.9 million for the year ended December 31,
2004.
Interest income increased from $20.6 million for the year ended December 31,
2003, to $24.1 million for the year ended December 31, 2004, an increase of
17.0%. This increase can be attributed to the growth in the loan portfolio,
as the average balance of loans increased by $62.5 million or 21.2%. The
effect of the growth in the portfolio was somewhat offset by lower interest
rates on these loans, due to the unprecedented low interest rates that were
present in our market area during 2004. The yield on the loan portfolio
decreased from 5.97% for the year ended December 31, 2003, to 5.67% for the
year ended December 31, 2004. Interest and dividends on investments
increased by $579,000, on a fully taxable equivalent basis, from $3.3
million for the year ended December 31, 2003 to $3.9 million for the year
ended December 31, 2004, also the result of the growth in the investment
portfolio. The portfolio grew from an average balance of $76.5 million to
$98.9 million. Income from federal funds sold increased from $101,000 to
$185,000, the result of increased volume of overnight money, particularly
when the campaigns for deposit growth were active.
Interest expense increased from $6.1 million for the year ended December 31,
2003 to $7.9 million for the year ended December 31, 2004, resulting
primarily from the increased use of borrowings in 2004. The average balance
of FHLB advances increased from $28.8 million for the year ended December
31, 2003 to $63.4 million for the year ended December 31, 2004. Management
took advantage of low interest rates to further grow by funding loan
originations or growth in the investment portfolio. Indicative of these low
rates, the average rate paid on FHLB advances decreased from 5.44% for the
year ended December 31, 2003 to 4.09% for the year ended December 31, 2004.
Interest on deposits increased from $4.5 million for the year ended December
31, 2003 to $5.0 million for the year ended December 31, 2004. This increase
was the result of the deposit campaigns, both for certificates of deposit
and core accounts. A marketing strategy was employed whereby certificates of
deposit were offered at premium rates, then the customer was cross-sold
basic banking products to establish a long-term relationship with the
customer. At the same time a suite of products was offered to high-balance
customers. These campaigns served to increase the levels of all deposit
types, including non-interest bearing demand deposits. We also issued $10.3
million of subordinated debentures in March 2004. The debentures carry an
interest rate equal to the three-month LIBOR plus 279 basis points. The
effect of the issue was to increase interest expense by $370,000. The cost
of all interest-bearing liabilities rose from 2.02% to 2.04%.
Net interest income increased from $14.5 million for the year ended December
31, 2003 to $16.2 million for the year ended December 31, 2004, an increase
of 11.7%. This increase was the result of our growth, as the continued
period of low market interest rates, combined with intense competition for
deposits in our market area, has compressed our net interest margin from
3.91% for the year ended December 31, 2003 to 3.44% for the year ended
December 31, 2004.
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 inherent
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
41
the loan portfolio and the balance of non-performing and classified loans.
We assess 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 provide
$376,000 for loan losses for the year ended December 31, 2004. Our credit
for loan losses for 2003 was $602,000.
Non-interest income increased from $2.2 million for the year ended December
31, 2003 to $2.5 million for the year ended December 31, 2004, an increase
of 13.2%. Service charges on deposit accounts decreased by $81,000, or 7.24%
from $1.1 million for the year ended December 31, 2003 to $1.0 million for
the year ended December 31, 2004. This decrease of $81,000 consists of
migration of customers into free checking accounts, a decline in the total
number of deposit accounts and a decline in the number of low-balance
accounts. Cash surrender value of life insurance policies decreased by
$79,000 from $511,000 for the year ended December 31, 2003 to $432,000 for
the year ended December 31, 2004 due to the redemption of certain life
insurance policies. The increase in non-interest income is attributed to a
one-time gain on the sale of impaired loans, of $196,000. Other income
increased from $582,000 for the year ended December 31, 2003 to $844,000 for
the year ended December 31, 2004, an increase of $262,000, or 45.0%. This
increase consisted of an increase on commission sales of non-deposit
investment products of $62,000. In 2003, we changed the third party through
whom investment products are sold and in early 2004, added a line of life
insurance products to our non-deposit investment products. Additionally,
electronic banking fees increased by $36,000 when comparing the years ended
December 31, 2004 and 2003, and a $20,000 gain on the sale of fixed assets.
Non-interest expense remained relatively constant when comparing the years
ended December 31, 2004 and 2003, increasing by only $116,000, or 0.9%. The
small magnitude of the change is indicative of management's commitment to
expense control. In 2003 and 2004, three branches were closed, and the
deposits housed therein were transferred to another branch. As a result,
salaries and employee benefits decreased from $7.8 million for the year
ended December 31, 2003 to $7.6 million for the year ended December 31,
2004. Of this decrease, $61,000 was attributed to a decrease in pension
expenses, as the expected return on assets increased. Occupancy and
equipment expense decreased from $1.4 million to $1.3 million over the same
period. Professional fees increased by $11,000 when comparing the years
ended December 31, 2004 and 2003. Marketing costs increased from $375,000
for the year ended December 31, 2003 to $510,000 for the year ended December
31, 2004. This is the result of increased advertising and promotional costs
associated with our "Coastal" product line and other deposit gathering
initiatives. Other expenses increased from $2.1 million for the year ended
December 31, 2003 to $2.3 million for the year ended December 31, 2004, an
increase of $199,000. The increase is primarily the result of a one-time
expense related to the Directors' retirement plan, resulting in an increase
in the expense of $172,000. Additionally, computer service fees increased by
$69,000 because of implementing the cash management and Internet banking
products. Costs other than those mentioned above typically rose due to
increases in general price levels of inflation.
Income before income taxes was $5.5 million for the year ended December 31,
2004, compared to $4.7 million for the year ended December 31, 2003. Income
taxes totaled $1.9 million and $2.0 million for the years ended December 31,
2004 and 2003, representing overall tax rates of 34.3% and 42.8%,
respectively. The income tax rate decreased primarily because of the
settlement of a dispute with the Massachusetts Department of Revenue
concerning the dividends received deduction claimed by the Bank from its
REIT subsidiary. Refer to Note 10 to the consolidated financial statements
and Item 1 of this report for more details.
IMPACT OF INFLATION
The consolidated financial statements and related consolidated financial
data presented herein have been prepared in accordance with generally
accepted accounting principles, which require the measurement of financial
position and results of operations in terms of historical dollars without
considering changes in the relative purchasing power of money over time due
to inflation. The primary effect of inflation on our operations is reflected
in increased operating costs. Unlike most industrial companies, virtually
all assets of a financial institution are monetary in nature. As a result,
interest rates have a more significant effect on a financial institution's
performance than the effect of general levels of inflation. Interest rates
do not necessarily move in the same direction or in the same magnitude as
the prices of goods and services.
42
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
Our principal sources of funds are customer deposits, amortization and
payoff of existing loan principal, and sales or maturities of various
investment securities. The Bank is a voluntary member of the Federal Home
Loan Bank of Boston (the "FHLB") and as such, may take advantage of the
FHLB's borrowing programs to enhance liquidity and leverage its favorable
capital position. The Bank also may draw on lines of credit at the FHLB or
the Federal Reserve Board (the "FRB"), and enter into repurchase or reverse
repurchase agreements with authorized brokers. These various sources of
liquidity are used to fund withdrawals, new loans, and investments.
Management seeks to promote deposit growth while controlling cost of funds.
Sales-oriented programs to attract new depositors and the cross-selling of
various products to its existing customer base are currently in place.
Management reviews, on an ongoing basis, possible new products, with
particular attention to products and services, which will aid in retaining
our base of lower-costing deposits.
Maturities and sales of investment securities provide us with significant
liquidity. Our policy of purchasing shorter-term debt securities reduces
market risk in the bond portfolio while providing significant cash flow. For
the year ended December 31, 2005, cash flow from maturities of securities
was $21.1 million, proceeds from sales of securities totaled $2.6 million,
compared to maturities of securities of $23.1 million, and proceeds from
sales of securities of $1.6 million for the year ended December 31, 2004.
Purchases of securities during 2005 and 2004 totaled $28.0 million and $88.1
million, respectively.
Amortization and pay-offs of the loan portfolio also provide us with
significant liquidity. Traditionally, amortization and pay-offs are
reinvested into loans. Excess liquidity is invested in federal funds sold
and overnight investments at the FHLB.
We have also used borrowed funds as a source of liquidity. At December 31,
2005, the Bank's outstanding borrowings from the FHLB were $107.9 million.
The Bank has the capacity to borrow in excess of $48 million additional at
the FHLB.
Loan originations for the year ended December 31, 2005 totaled $146.8
million. Commitments to originate loans at December 31, 2005 were $6.4
million, excluding unadvanced construction funds totaling $14.9 million,
unadvanced commercial lines of credit totaling $18.9 million and unadvanced
home equity lines totaling $17.7 million. Management believes that adequate
liquidity is available to fund loan commitments utilizing deposits, loan
amortization, maturities of securities, or borrowings.
CAPITAL RESOURCES
At December 31, 2005, our total shareholders' equity was $48.9 million, an
increase of $2.3 million from $46.6 million reported on December 31, 2004.
The increase in capital was a combination of several factors. Additions
consisted primarily of net income of $4.0 million for the year ended
December 31, 2005. There were 33,777 shares issued at a value of $627,000,
pursuant to the Dividend Reinvestment Program, in lieu of cash dividends or
for optional cash contributions and exercised stock options resulted in the
issuance of 30,000 shares common stock at a value of $411,000, including a
tax benefit. These additions were offset by dividends paid of $1.5 million
and accumulated other comprehensive loss of $1.3 million.
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.
In addition to meeting the required levels, Slade's Ferry Bancorp.'s and the
Bank's capital ratios meet the criteria of the
43
"well capitalized" category established by the federal banking agencies as
of December 31, 2005 and 2004; refer to Note 13 to the consolidated
Financial Statements included herein for additional information.
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We consider interest rate risk to be a significant market risk as it could
potentially have an effect on our financial condition and results of
operation. The definition of interest rate risk is the exposure of our
earnings to adverse movements in interest rates, arising from the
differences in the timing of repricing of assets and liabilities; the
differences in the various pricing indices inherent in our assets and
liabilities; and the effects of overt and embedded options in our assets and
liabilities. Our Asset/Liability Committee, comprised of executive
management, is responsible for managing and monitoring interest rate risk,
and reviewing with the Board of Directors, at least quarterly, the interest
rate risk positions, the impact changes in interest rates would have on net
interest income, and the maintenance of interest rate risk exposure within
approved guidelines.
The potentially volatile nature of market interest rates requires us to
manage interest rate risk on an active and dynamic basis. Our objective is
to reduce and control the volatility of net interest income to within
tolerance levels established by the Board of Directors, by managing the
relationship of interest-earning assets and interest-bearing liabilities. In
order to manage this relationship, the Asset/Liability Committee utilizes an
income simulation model to measure the net interest income at risk under
differing interest rate scenarios. Additionally, the Committee use Economic
Value of Equity ("EVE") analysis to measure the effects of changing interest
rates on the market values of rate-sensitive assets and liabilities, taken
as a whole. The Board of Directors and management believe that static
measures of timing differences, such as "gap analysis", do not accurately
assess the levels of interest rate risk inherent in our balance sheet. Gap
analysis does not reflect the effects of overt and embedded options on net
interest income, given a shift in interest rates; nor does it take into
account basis risk, the risk arising from using various different indices on
which to base pricing decisions.
The income simulation model currently utilizes a 300 basis point increase in
interest rates and a 200 basis point decrease in rates. The interest rate
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 rates. Prepayment speeds for loans are based on median dealer forecasts
for each interest rate scenario.
The Board of Directors has established a risk limit of a 5.00% change in net
interest income for each 100 basis point shift in market interest rates. The
limit established by the Board provides an internal tolerance level to
control interest rate risk. We are within our policy-mandated risk limit for
net interest income at risk.
The following table reflects our estimated exposure as a percentage of net
interest income and the change in basis points for the next twelve months,
assuming an immediate change in interest rates set forth below:
Rate Change Estimated Exposure as a Percentage Change
(Basis Points) of Net Interest Income (Basis Points)
----------------------------------------------------------------------
+300 -10.23% -20
-200 -2.44% -6
Additionally we use the model to estimate the effects of changes in interest
rates on our EVE. EVE represents our theoretical market value, given the
rate shocks applied in the model. The Board of Directors has established a
risk limit for EVE which provides that the EVE will not fall below 6.00%,
the FDIC's minimum capital level to be classified as "well capitalized". We
are within our risk limit for EVE.
44
The following table presents the changes in EVE given rate shocks.
Rate Change Change from
(Basis Points) Economic Value of Equity Flat Rates
---------------------------------------------------------
Flat 13.17% N/A
+300 11.43% -1.74%
-200 11.81% -1.35%
45
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, together with the reports of
independent registered public accounting firms, appear beginning on page F-1
of the Annual Report on Form 10-K.
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Effective March 14, 2005, the Audit Committee of our Board of Directors
dismissed Shatswell, MacLeod & Company, P.C. and engaged Wolf & Company,
P.C. as our independent registered public accounting firm for the fiscal
year ended December 31, 2005. We had no disagreements with Shatswell,
MacLeod & Company on accounting and financial disclosure matters.
ITEM 9A
CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934, within
the 90 days prior to the date of this report, the Company carried out an
evaluation under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief
Financial Officer of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based upon that evaluation,
the Chief Executive Officer and 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 the reports it files
or submits under the Exchange Act is (i) recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms and (ii) accumulated and communicated to the
Company's management, including its principal executive officer and
principal accounting officer, as appropriate to allow timely decisions
regarding disclosure. In connection with the rules regarding disclosure and
control procedures, we intend to continue to review and document our
disclosure controls and procedures, including our internal controls and
procedures for financial reporting, and may from time to time make changes
aimed at enhancing their effectiveness and to ensure that our systems evolve
with our business.
ITEM 9B
OTHER INFORMATION
None.
46
PART III
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is hereby made to our definitive Proxy Statement for the 2006
Annual Meeting of Shareholders. The information set forth under the heading
"Directors and Executive Officers" and under the heading "Section 16(a)
Beneficial Ownership Reporting Compliance" of such Proxy Statement is
incorporated herein by reference.
ITEM 11
EXECUTIVE COMPENSATION
Reference is hereby made to our definitive Proxy Statement for the 2006
Annual Meeting of Shareholders. The information set forth under the heading
"Executive Compensation Tables and Information" of such Proxy Statement is
incorporated herein by reference.
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
Reference is hereby made to our definitive Proxy Statement for the 2006
Annual Meeting of Shareholders. The information set forth under this heading
of such Proxy Statement is incorporated herein by reference.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is hereby made to our definitive Proxy Statement for the 2006
Annual Meeting of Shareholders. The information set forth under this heading
of such Proxy Statement is incorporated herein by reference.
ITEM 14
PRINCIPAL ACCOUNTING FEES AND SERVICES
Reference is hereby made to our definitive Proxy Statement for the 2006
Annual Meeting of Shareholders. The information set forth under this heading
of such Proxy Statement is incorporated herein by reference.
47
PART IV
ITEM 15
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) Financial Statement Schedules
All financial statement schedules required by Item 15(a)(2) have
been omitted because they are inapplicable or because the
required information has been included in the Consolidated
Financial Statements or Notes thereto.
(2) Exhibits: see attached Exhibit Index Page 50
48
SIGNATURES
----------
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized on March 30, 2006.
Slade's Ferry Bancorp.
By /s/ Mary Lynn D. Lenz
---------------------------------
Mary Lynn D. Lenz, President/
Chief Executive Officer and Interim
Chairperson
In accordance with the requirements of the Exchange Act, this report has
been signed by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Peter G. Collias 03/31/06 /s/ Anthony F. Cordeiro 03/31/06
---------------------------------- ------------------------------------------
Peter G. Collias Anthony F. Cordeiro
Director Director
/s/ Scott W. Costa 03/31/06 /s/ Paul C. Downey 03/31/06
---------------------------------- ------------------------------------------
Scott W. Costa Paul C. Downey
Director Director
/s/ Melvyn A. Holland 03/31/06 /s/ Mary Lynn D. Lenz 03/31/06
---------------------------------- ------------------------------------------
Melvyn A. Holland Mary Lynn D. Lenz
Director President/CEO and Interim Chairperson
/s/ Jean F. MacCormack 03/31/06 /s/ Francis A. Macomber 03/31/06
---------------------------------- ------------------------------------------
Jean F. MacCormack Francis A. Macomber
Director Director
/s/ Joan Parkos Moran 03/31/06 /s/ Majed Mouded, MD 03/31/06
---------------------------------- ------------------------------------------
Joan Parkos Moran Majed Mouded, MD
Director Director
/s/ Shaun O'Hearn Sr. 03/31/06 /s/ Lawrence J. Oliveira, DDS 03/31/06
---------------------------------- ------------------------------------------
Shaun O'Hearn Sr. Lawrence J. Oliveira, DDS
Director Director
/s/ Carlos Ribeiro 03/31/06 /s/ William J. Sullivan 03/31/06
---------------------------------- ------------------------------------------
Carlos Ribeiro William J. Sullivan
Director Director
/s/ David F. Westgate 03/31/06 /s/ Deborah A. McLaughlin 03/31/06
---------------------------------- ------------------------------------------
David F. Westgate Deborah A. McLaughlin
Vice Chairman and Director Executive Vice President
Chief Financial Officer/Chief Operations
Officer
49
EXHIBIT INDEX
-------------
Exhibit No. Description Item
----------- ----------- ----
3.1 Amended and Restated Articles of Incorporation of Slade's Ferry Bancorp. (1)
3.2 Amended and Restated Bylaws of Slade's Ferry Bancorp. (2)
3.3 Articles of Amendment to the Amended and Restated Articles of Incorporation (3)
of Slade's Ferry Bancorp.
10.1 Slade's Ferry Bancorp. 1996 Stock Option Plan, as amended (4)
10.2 Supplemental Executive Retirement Agreement between Slade's Ferry Bancorp. (5)
and Manuel J. Tavares
10.3 Form of Director Supplemental Retirement Program Director Agreement, (6)
Exhibit 1 thereto (Slade's Ferry Trust Company Director Supplemental
Retirement Program Plan) and Endorsement Method Split Dollar Plan
Agreement thereunder.
10.4 Form of Directors' Paid-up Insurance Policy (part of the Director Supplemental (7)
Retirement Program).
10.5 Supplemental Executive Retirement Agreement between Slade's Ferry Bancorp. (8)
and Mary Lynn D. Lenz
10.6 Employment Agreement between Slade's Ferry Bancorp. and Mary Lynn D. Lenz (9)
10.7 Employment Agreement between Slade's Ferry Bancorp. and Deborah A. McLaughlin (10)
10.8 Employment Agreement between Slade's Ferry Bancorp. and Manuel J. Tavares (11)
10.9 Form Change of Control Agreement (12)
10.10 Severance Pay Plan (13)
10.11 Slade's Ferry Bancorp. 2004 Equity Incentive Plan (14)
14.1 Code of Ethics (15)
21.1 List of Subsidiaries (16)
23.1 Consent of Wolf & Company, P.C.
23.2 Consent of Shatswell, MacLeod & Company, P.C.
31.1 Rule 13a-14(a)/15d-14(a) Certification of the CEO
31.2 Rule 13a-14(a)/15d-14(a) Certification of the CFO
32.1 Section 1350 Certification of the CEO
32.2 Section 1350 Certification of the CFO
--------------------
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-Q filed with the
Commission on May 12, 2005.
Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on December 21, 2004.
Incorporated by reference to the Registrant's Form 10-Q for the
quarter ended June 30, 1999.
Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1996.
Incorporated by reference to Exhibit 10 to the Registrant's Form 10-Q
for the quarter ended March 31, 1999.
Incorporated by reference to Exhibit 10 to the Registrant's Form
10-QSB for the quarter ended June 30, 1998.
50
Incorporated by reference to Exhibit 10.10 to the Registrant's Form
10-Q for the quarter ended March 31, 2003.
Incorporated by reference to Exhibit 10.11 to the Registrant's Form
10-Q for the quarter ended June 30, 2004.
Incorporated by reference to Exhibit 10.7 to the Registrant's Form
10-Q for the quarter ended September 30, 2004.
Incorporated by reference to Exhibit 10.8 to the Registrant's Form
10-Q for the quarter ended September 30, 2004.
Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on January 13, 2005.
Incorporated by reference to the Registrant's Form 8-K filed with the
Commission on January 14, 2005.
Incorporated by reference to Appendix C to the Registrant's Proxy
Statement filed on April 9, 2004.
Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended December 31, 2003.
Incorporated by reference to Part I, Item 1 - "General."
51
INDEX TO FINANCIAL STATEMENTS
Slade's Ferry Bancorp. and Subsidiary Page
----
Report of Independent Registered Public Accounting Firm -
Wolf & Company, P.C. F-2
Report of Independent Registered Public Accounting Firm -
Shatswell, MacLeod & Company, P.C. F-3
Consolidated Balance Sheets as of December 31, 2005 and
December 31, 2004 F-4
Consolidated Statements of Income for the years ended
December 31, 2005, 2004 and 2003 F-5
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 2005, 2004 and 2003 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2005, 2004 and 2003 F-7
Notes to Consolidated Financial Statements F-9
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Slade's Ferry Bancorp.
We have audited the accompanying consolidated balance sheet of Slade's
Ferry Bancorp. and subsidiary (the "Company") as of December 31, 2005, and
the related consolidated statements of income, changes in stockholders'
equity and cash flows for the year then ended. These financial statements
are the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Slade's
Ferry Bancorp. and subsidiary as of December 31, 2005, and the results of
their operations and their cash flows for the year then ended in conformity
with accounting principles generally accepted in the United States of
America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
January 20, 2006
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Slade's Ferry Bancorp.
We have audited the accompanying consolidated balance sheet of Slade's
Ferry Bancorp. and Subsidiary as of December 31, 2004 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the years ended December 31, 2004 and 2003. These consolidated
financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of Slade's Ferry Bancorp. and Subsidiary as of December 31, 2004,
and the consolidated results of their operations and their cash flows for
the years ended December 31, 2004 and 2003, in conformity with accounting
principles generally accepted in the United States of America.
/s/ Shatswell, Macleod & Company, P.C.
West Peabody, Massachusetts
January 13, 2005
F-3
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------
2005 2004
---- ----
Assets (In thousands)
------
Cash and due from banks $ 17,782 $ 15,984
Interest-bearing demand deposits with other banks 36 410
Federal funds sold 2,200 18,800
-------- --------
Cash and cash equivalents 20,018 35,194
Interest-bearing certificates of deposit with other banks 100 100
Securities available for sale 94,298 83,882
Securities held to maturity (fair value approximates of $28,858
at December 31, 2005 and $38,112 at December 31, 2004) 29,306 37,773
Federal Home Loan Bank stock, at cost 6,304 4,650
Loans, net of allowance for loan losses of $4,333
at December 31, 2005 and $4,101 at December 31, 2004 409,610 362,265
Premises and equipment, net 5,917 5,527
Goodwill 2,173 2,173
Accrued interest receivable 2,298 1,969
Bank-owned life insurance 11,884 11,548
Deferred tax assets, net 2,089 1,180
Other assets 1,917 3,137
-------- --------
$585,914 $549,398
======== ========
Liabilities and Stockholders' Equity
------------------------------------
Deposits:
Noninterest-bearing $ 80,705 $ 80,232
Interest-bearing 335,141 319,673
-------- --------
Total deposits 415,846 399,905
Short-term borrowings 7,000 -
Long-term borrowings 100,865 90,286
Subordinated debentures 10,310 10,310
Accrued expenses and other liabilities 3,038 2,296
-------- --------
Total liabilities 537,059 502,797
Commitments and contingencies (Notes 5, 11 and 12) - -
Stockholders' equity:
Common stock, par value $0.01 per share; authorized
10,000,000 shares; issued and outstanding 4,132,200
shares in 2005 and 4,068,423 shares in 2004 41 41
Additional paid-in capital 31,014 29,976
Retained earnings 18,998 16,459
Accumulated other comprehensive income (loss) (1,198) 125
-------- --------
Total stockholders' equity 48,855 46,601
-------- --------
$585,914 $549,398
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
-------------------------------------
2005 2004 2003
---- ---- ----
(In thousands, except per share data)
Interest and dividend income:
Interest and fees on loans $23,184 $20,263 $17,603
Interest and dividends on securities:
Taxable 5,125 3,153 2,349
Tax-exempt 338 416 512
Interest on federal funds sold 247 185 101
Other interest 25 89 52
------- ------- -------
Total interest and dividend income 28,919 24,106 20,617
------- ------- -------
Interest expense:
Interest on deposits 6,084 4,982 4,505
Interest on Federal Home Loan Bank advances 4,274 2,594 1,568
Interest on subordinated debentures 637 370 -
------- ------- -------
Total interest expense 10,995 7,946 6,073
------- ------- -------
Net interest and dividend income 17,924 16,160 14,544
Provision (credit) for loan losses 167 376 (602)
------- ------- -------
Net interest income, after provision (credit)
for loan losses 17,757 15,784 15,146
------- ------- -------
Noninterest income:
Service charges on deposit accounts 914 1,038 1,119
Gain (loss) on sales and calls of available-for-sale
securities, net 29 (5) 2
Gain on sales of loans, net 49 196 -
Increase in cash surrender value of life insurance policies 468 432 511
Other income 860 844 582
------- ------- -------
Total noninterest income 2,320 2,505 2,214
------- ------- -------
Noninterest expense:
Salaries and employee benefits 8,063 7,640 7,786
Occupancy and equipment expense 1,680 1,345 1,428
Professional fees 1,360 1,040 1,029
Marketing expense 549 510 375
Other expense 2,244 2,250 2,051
------- ------- -------
Total noninterest expense 13,896 12,785 12,669
------- ------- -------
Income before income taxes 6,181 5,504 4,691
Provision for income taxes 2,161 1,887 2,007
------- ------- -------
Net income $ 4,020 $ 3,617 $ 2,684
======= ======= =======
Earnings per share:
Basic $ 0.98 $ 0.89 $ 0.68
Diluted $ 0.97 $ 0.88 $ 0.67
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2005, 2004 and 2003
Accumulated
Shares of Additional Other
Common Common Paid-in Retained Comprehensive
Stock Stock Capital Earnings Income (Loss) Total
--------- ------ ---------- -------- -------------- -----
(In thousands, except per share data)
Balance at December 31, 2002 3,937,763 $39 $27,693 $13,051 $ (160) $40,623
Comprehensive income:
Net income - - 2,684 - 2,684
Other comprehensive loss - - - (252) (252)
-------
Comprehensive income 2,432
-------
Issuance of common stock 49,739 1 795 - - 796
Stock options exercised 8,355 - 94 - - 94
Tax benefit of stock options exercised - 27 - - 27
Dividends on minority interest preferred
stock ($40.00 per share) - - (4) - (4)
Dividends declared ($.36 per share) - - (1,431) - (1,431)
--------- --- ------- ------- ------- -------
Balance at December 31, 2003 3,995,857 40 28,609 14,300 (412) 42,537
Comprehensive income:
Net income - - 3,617 - 3,617
Other comprehensive income - - - 537 537
-------
Comprehensive income 4,154
-------
Issuance of common stock 33,588 - 710 - - 710
Stock options exercised 42,390 1 532 - - 533
Tax benefit of stock options exercised - 157 - - 157
Common stock retired (3,412) - (32) - - (32)
Dividends declared ($.36 per share) - - (1,458) - (1,458)
--------- --- ------- ------- ------- -------
Balance at December 31, 2004 4,068,423 41 29,976 16,459 125 46,601
Comprehensive income:
Net income - - 4,020 - 4,020
Other comprehensive loss - - - (1,323) (1,323)
-------
Comprehensive income 2,697
-------
Issuance of common stock 33,777 - 627 - - 627
Stock options exercised 30,000 - 316 - - 316
Tax benefit of stock options exercised - 95 - - 95
Dividends declared ($.36 per share) - - (1,481) - (1,481)
--------- --- ------- ------- ------- -------
Balance at December 31, 2005 4,132,200 $41 $31,014 $18,998 $(1,198) $48,855
========= === ======= ======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
------------------------------------
2005 2004 2003
---- ---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 4,020 $ 3,617 $ 2,684
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization, net of accretion of securities 294 247 184
(Gain) loss on sales and calls of available-for-sale
securities, net (29) 5 (2)
Change in net deferred loan fees (83) (4) 102
Provision (credit) for loan losses 167 376 (602)
Deferred tax provision (benefit) (195) 686 312
Depreciation and amortization 813 659 639
Gain on sale of loans, net (49) (196) -
Increase in cash surrender value of life insurance (468) (432) (511)
Net change in:
Other assets 572 (1,397) 715
Accrued interest receivable (329) (331) 42
Other liabilities 933 13 78
-------- -------- --------
Net cash provided by operating activities 5,646 3,243 3,641
-------- -------- --------
Cash flows from investing activities:
Decrease in interest-bearing certificates of deposit with
other banks - 100 -
Activity in available-for-sale securities:
Purchases (28,027) (57,976) (33,726)
Sales 2,590 1,646 864
Maturities, calls and pay-downs 12,837 19,536 50,994
Activity in held-to-maturity securities:
Purchases - (30,109) (4,926)
Maturities, calls and pay-downs 8,253 3,586 7,309
Purchases of Federal Home Loan Bank stock (1,654) (1,626) (2,010)
Investment in unconsolidated subsidiary - (310) -
Loan principal originations, net (47,494) (39,528) (73,778)
Recoveries of loans previously charged off 65 96 113
Capital expenditures (1,221) (886) (460)
Proceeds from sale of property and equipment 13 - 1
Proceeds from sale of investment real estate 653 - -
Proceeds from sales of loans 49 8,487 2,484
Investment in life insurance policies - (135) (1,050)
Redemption of life insurance policy 132 - 331
Investment in limited partnership - (119) -
-------- -------- --------
Net cash used in investing activities (53,804) (97,238) (53,854)
-------- -------- --------
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31,
------------------------------------
2005 2004 2003
---- ---- ----
(In thousands)
Cash flows from financing activities:
Net increase in noninterest-bearing deposits 473 6,979 975
Net increase (decrease) in interest-bearing deposits 15,468 59,780 (3,464)
Short-term advances from Federal Home Loan Bank 15,500 - 4,300
Long-term advances from Federal Home Loan Bank 29,500 35,476 37,279
Payments on Federal Home Loan Bank short-term advances (8,500) (4,300) -
Payments on Federal Home Loan Bank long-term advances (18,921) (1,364) (289)
Proceeds from issuance of common stock 627 710 796
Stock options exercised 316 532 94
Retirement of shares of common stock - (32) -
Dividends paid (1,481) (1,458) (1,435)
Proceeds from issuance of subordinated debentures - 10,160 -
Repurchase of minority interest preferred stock - - (56)
Issuance of minority interest preferred stock - - 2
-------- -------- --------
Net cash provided by financing activities 32,982 106,483 38,202
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (15,176) 12,488 (12,011)
Cash and cash equivalents at beginning of year 35,194 22,706 34,717
-------- -------- --------
Cash and cash equivalents at end of year $ 20,018 $ 35,194 $ 22,706
======== ======== ========
Supplemental disclosures:
Interest paid $ 10,576 $ 7,804 $ 6,026
Income taxes paid $ 1,749 $ 1,106 $ 1,087
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Slade's Ferry
Bancorp. (the "Company"), its wholly-owned subsidiary, Slade's Ferry Trust
Company (the "Bank") and the Bank's wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation. The Company accounts for its wholly-owned subsidiary,
Slade's Ferry Statutory Trust I, using the equity method. (See Note 9.)
Nature of Operations
The Company is a Massachusetts company that was organized in 1990 to become
the holding company of the Bank. The Bank is a state chartered bank, which
was incorporated in 1959 and is headquartered in Somerset, Massachusetts.
The Bank operates its business from nine banking offices located in
southeastern Massachusetts. The Bank is engaged principally in the business
of attracting deposits from the general public and investing those deposits
in commercial and residential real estate loans, and in commercial,
consumer and small business loans.
Use of Estimates
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America,
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 reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant change in the
near term relate to the determination of the allowance for loan losses and
other-than-temporary impairment losses.
Significant Group Concentrations of Credit Risk
Most of the Company's activities are with customers located within
southeastern Massachusetts and Rhode Island. Note 3 discusses the types of
securities that the Company invests in. Note 4 discusses the types of
lending that the Company engages in. The Company does not have any
significant concentrations to any one industry or customer.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash and balances due from banks, interest-bearing
demand deposits with other banks and federal funds sold, all of which
mature within ninety days.
Interest-bearing Deposits in Banks
Interest-bearing deposits in banks mature within one year and are carried
at cost.
Reclassification
Certain amounts in the 2004 and 2003 consolidated financial statements have
been reclassified to conform to the 2005 presentation.
F-9
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Securities
Debt securities that management has the positive intent and ability to hold
to maturity are classified as "held to maturity" and recorded at amortized
cost. Securities not classified as held to maturity, including equity
securities with readily determinable fair values, are classified as
"available for sale" and recorded at fair value, with unrealized gains and
losses excluded from earnings and reported in other comprehensive income.
Purchase premiums and discounts are recognized in interest income using the
interest method over terms of the securities. Declines in the fair value of
held-to-maturity and available-for-sale securities below their cost that
are deemed to be other than temporary are reflected in earnings as realized
losses. In estimating other-than-temporary-impairment losses, management
considers (1) the length of time and the extent to which the fair value has
been less than cost, (2) the financial condition and near-term prospects of
the issuer, and (3) the intent and ability of the Company to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. Gains and losses on the sale of
securities are recorded on the trade date and are determined using the
specific identification method.
Loans
The Company grants mortgage, commercial and consumer loans to customers. A
substantial portion of the loan portfolio is represented by mortgage loans
throughout southeastern Massachusetts and Rhode Island. The ability of the
Company's debtors to honor their contracts is dependent upon the real
estate and general economic conditions in this area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off generally are reported at
their outstanding unpaid principal balances adjusted for charge-offs, the
allowance for loan losses, and any deferred fees or costs on originated
loans. Interest income is accrued on the unpaid principal balance. Loan
origination fees, net of certain direct origination costs, are deferred and
recognized as an adjustment of the related loan yield using the interest
method.
The accrual of interest on mortgage and commercial loans is discontinued at
the time the loan is 90 days past due unless the credit is well-secured and
in process of collection. Other personal loans are typically charged off no
later than 180 days past due. Past due status is based on contractual terms
of the loan. In all cases, loans are placed on nonaccrual or charged-off at
an earlier date if collection of principal or interest is considered
doubtful.
All interest accrued but not collected for loans that are placed on
nonacccrual or charged off is reversed against interest income. The
interest on these loans is accounted for on the cash-basis or cost-recovery
method until qualifying for return to accrual. Loans are returned to
accrual status when all the principal and interest amounts contractually
due are brought current and future payments are reasonably assured.
F-10
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loan
losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower
than the carrying value of that loan. The general component covers non-
classified loans and is based on historical loss experience adjusted for
qualitative factors. An unallocated component is maintained to cover
uncertainties that could affect management's estimate of probable losses.
The unallocated component of the allowance reflects the margin of
imprecision inherent in the underlying assumptions used in the
methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management
in determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when
due. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Management determines
the significance of payment delays and payment shortfalls on a case-by-case
basis, taking into consideration all of the circumstances surrounding the
loan and the borrower, including the length of the delay, the reasons for
the delay, the borrower's prior payment record, the amount of the shortfall
in relation to the principal and interest owed. Impairment is measured on a
loan by loan basis by either the present value of expected future cash flows
discounted at the loan's effective rate, the loan's obtainable market price,
or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. The Company does not separately identify consumer
loans for impairment disclosures. Prior to 2005, the Company did not
separately identify residential loans for impairment disclosures.
Commencing in 2005, residential loans are separately identified and
included in impairment disclosures.
Premises and Equipment
Land is carried at cost. Buildings and equipment are carried at cost, less
accumulated depreciation and amortization computed on the straight-line
method over the estimated useful lives of the assets or the expected terms
of the leases, if shorter. Expected terms include lease option periods to
the extent that the exercise of such options is reasonably assured.
Goodwill
Goodwill is evaluated for impairment on an annual basis using the
consolidated Company as the reporting unit for measurement purposes.
F-11
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over
the assets has been surrendered. Control over transferred assets is deemed
to be surrendered when (1) the assets have been isolated from the Company,
(2) the transferee obtains the right to pledge or exchange the transferred
assets, and (3) the Company does not maintain effective control over the
transferred assets through an agreement to repurchase them before their
maturity.
Advertising Costs
Advertising costs are expensed as incurred.
Retirement Plan
The compensation cost of an employee's pension benefit is recognized on the
projected unit credit method over the employee's approximate service
period. The unit credit cost method is utilized for funding purposes.
Stock Compensation Plans
Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting
for Stock-Based Compensation, encouraged all entities to adopt a fair value
based method of accounting for employee stock compensation plans, whereby
compensation cost is measured at the grant date based on the value of the
award and is recognized over the service period, which is usually the
vesting period. However, it also allowed an entity to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No.
25, Accounting for Stock Issued to Employees, whereby compensation cost is
the excess, if any, of the quoted market price of the stock at the grant
date (or other measurement date) over the amount an employee must pay to
acquire the stock. Stock options issued under the Company's stock option
plan have no intrinsic value at the grant date, and under APB Opinion No.
25 no compensation cost is recognized for them.
The Company has applied APB Opinion No. 25 and related interpretations in
accounting for the stock option plan. Accordingly, no compensation cost has
been recognized. Had compensation cost for the Company's stock option plan
been determined based on the fair value at the grant dates for awards under
the plan consistent with the method prescribed by SFAS No. 123, the
Company's net income and earnings per share would have been adjusted to the
pro forma amounts indicated below:
Years Ended December 31,
------------------------------
2005 2004 2003
---- ---- ----
(In thousands, except per share data)
Net income, as reported $4,020 $3,617 $2,684
Deduct: stock-based employee compensation
expense determined under the fair
value method, net of related tax
effects (99) (153) (132)
------ ------ ------
Net income, pro forma $3,921 $3,464 $2,552
====== ====== ======
Earnings per share - basic As reported $ 0.98 $ 0.89 $ 0.68
Pro forma $ 0.95 $ 0.86 $ 0.64
Earnings per share - assuming
dilution As reported $ 0.97 $ 0.88 $ 0.67
Pro forma $ 0.95 $ 0.85 $ 0.64
F-12
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock Compensation Plans (Concluded)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:
Years Ended December 31,
----------------------------------
2005 2004 2003
---- ---- ----
Dividend yield 1.9% 1.9% 2.3%
Expected life 10 years 9 years 5 years
Expected volatility 28% 27% 28%
Risk-free interest rate 4.2% 4.1% 2.9%
Effective January 1, 2006, the Company will adopt SFAS 123(R). See Note 1 -
Recent Accounting Pronouncement.
Income Taxes
Deferred income tax assets and liabilities are determined using the
liability (or balance sheet) method. Under this method, the net deferred
tax asset or liability is determined based on the tax effects of the
temporary differences between the book and tax bases of the various balance
sheet assets and liabilities and gives current recognition to changes in
tax rates and laws.
Earnings Per Common Share
Basic earnings per share represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during
the period. Diluted earnings per share reflects additional common shares
that would have been outstanding if dilutive potential common shares had
been issued, as well as any adjustment to income that would result from the
assumed issuance. Potential common shares that may be issued by the Company
relate solely to outstanding stock options, and are determined using the
treasury stock method.
Earnings per common share have been computed based on the following:
Years Ended December 31,
------------------------------
2005 2004 2003
---- ---- ----
(Dollars in thousands)
Net income $4,020 $3,617 $2,684
====== ====== ======
Average number of common shares outstanding 4,111 4,046 3,970
Effect of dilutive options 27 49 39
------ ------ ------
Average number of common shares outstanding used
to calculate diluted earnings per common share 4,138 4,095 4,009
====== ====== ======
F-13
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses,
gains and losses be included in net income. Although certain changes in
assets and liabilities, such as unrealized gains and losses on available-
for-sale securities and certain pension liability adjustments, are reported
as a separate component of the equity section of the balance sheet, such
items, along with net income, are components of comprehensive income.
The components of other comprehensive income (loss) and related tax effects
are as follows:
Years Ended December 31,
------------------------------
2005 2004 2003
---- ---- ----
(In thousands)
Unrealized gains (losses) on securities
available for sale $(2,104) $ 122 $(443)
Reclassification adjustment for losses (gains)
realized in income (29) 5 (2)
------- ----- -----
Net unrealized gains (losses) (2,133) 127 (445)
Tax effect 810 7 211
------- ----- -----
Net-of-tax amount (1,323) 134 (233)
------- ----- -----
Minimum pension liability adjustment - 682 (31)
Tax effect - (279) 13
------- ----- -----
Net-of-tax amount - 403 (18)
------- ----- -----
$(1,323) $ 537 $(252)
======= ===== =====
The components of accumulated other comprehensive income (loss), included
in stockholders' equity, are as follows:
December 31,
------------------
2005 2004
---- ----
(In thousands)
Net unrealized gain (loss) on securities
available for sale $(1,914) $219
Tax effect 716 (94)
------- ----
Net-of-tax amount $(1,198) $125
======= ====
F-14
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recent Accounting Pronouncement
In December 2004, the Financial Accounting Standards Board ("FASB")
published Statement No. 123 (revised 2004), Share-Based Payment ("SFAS
123(R)" or the "Statement"). SFAS 123(R) requires that the compensation
cost relating to share-based payment transactions be recognized in
financial statements. That cost will be measured based on the fair value of
the equity or liability instruments issued. SFAS 123(R) covers a wide range
of share-based compensation arrangements including stock options,
restricted share plans, performance-based awards, share appreciation
rights, and employee share purchase plans. SFAS 123(R) is a replacement of
SFAS No. 123, Accounting for Stock- Based Compensation, and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees, and its related
interpretive guidance. The effect of the Statement will be to require
entities to measure the cost of employee services received in exchange for
stock options based on the grant-date fair value of the award, and to
recognize the cost over the period the employee is required to provide
services for the award. SFAS 123(R) permits entities to use any option-
pricing model that meets the fair value objective in the Statement.
For public entities, SFAS 123(R) is effective for fiscal years beginning on
or after June 15, 2005, and is applicable to all employee awards vested,
granted, modified, or settled after the effective date. As of the effective
date, compensation cost related to the non-vested portion of awards
outstanding as of that date would be based on the grant-date fair value of
those awards as calculated under the original provisions of Statement No.
123; that is, an entity would not re-measure the grant-date fair value
estimate of the unvested portion of awards granted prior to the effective
date of SFAS 123(R). This Statement is not expected to have a material
impact on the Company's consolidated financial statements.
2. RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS
The Bank is required to maintain average balances on hand or with the
Federal Reserve Bank. At December 31, 2005 and 2004, these reserve balances
amounted to $3,920,000 and $2,417,000, respectively.
F-15
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. SECURITIES
The amortized cost and fair value of securities, with gross unrealized
gains and losses, follows:
December 31, 2005
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In thousands)
Securities Available for Sale
-----------------------------
Debt Securities:
Government-sponsored enterprises $50,443 $ - $ 862 $49,581
Corporate 9,564 5 555 9,014
Mortgage-backed 31,574 75 417 31,232
------- ---- ------ -------
Total debt securities 91,581 80 1,834 89,827
Marketable equity securities 3,426 116 271 3,271
Mutual funds 1,205 - 5 1,200
------- ---- ------ -------
Total securities available for sale $96,212 $196 $2,110 $94,298
======= ==== ====== =======
Securities Held to Maturity
---------------------------
State and municipal obligations $ 6,766 $138 $ 12 $ 6,892
Mortgage-backed securities 22,540 - 574 21,966
------- ---- ------ -------
Total securities held to maturity $29,306 $138 $ 586 $28,858
======= ==== ====== =======
F-16
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (Continued)
December 31, 2004
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In thousands)
Securities Available for Sale
-----------------------------
Debt Securities:
Government-sponsored enterprises $41,419 $ 73 $286 $41,206
Corporate 9,364 150 29 9,485
Mortgage-backed 27,805 468 66 28,207
------- ---- ---- -------
Total debt securities 78,588 691 381 78,898
------- ---- ---- -------
Marketable equity securities 3,859 203 311 3,751
Mutual funds 1,216 17 - 1,233
------- ---- ---- -------
Total securities available for sale $83,663 $911 $692 $83,882
======= ==== ==== =======
Securities Held to Maturity
---------------------------
State and municipal obligations $ 8,588 $340 $ - $ 8,928
Mortgage-backed securities 29,185 15 16 29,184
------- ---- ---- -------
Total securities held to maturity $37,773 $355 $ 16 $38,112
======= ==== ==== =======
At December 31, 2005 and 2004, obligations of government-sponsored
enterprises with a carrying value of $3,860,000 and $2,371,000,
respectively, were pledged to secure public deposits and for other purposes
required or permitted by law. Also, obligations of government-sponsored
enterprises with a carrying value of $54,464,000 and $63,957,000 were
pledged to secure Federal Home Loan Bank advances at December 31, 2005 and
2004, respectively.
F-17
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (Continued)
The amortized cost and fair value of debt securities by contractual
maturity at December 31, 2005 follows:
Available for Sale Held to Maturity
--------------------- ---------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ----- --------- -----
(In thousands)
Within 1 year $ 9,237 $ 9,119 $ 1,761 $ 1,769
After 1 year through 5 years 50,770 49,476 2,793 2,831
After 5 years through 10 years - - 1,014 1,041
Over 10 years - - 1,198 1,251
------- ------- ------- -------
60,007 58,595 6,766 6,892
Mortgage-backed securities 31,574 31,232 22,540 21,966
------- ------- ------- -------
$91,581 $89,827 $29,306 $28,858
======= ======= ======= =======
For the years ended December 31, 2005, 2004 and 2003, proceeds from sales
of securities available for sale amounted to $2,590,000, $1,646,000 and
$864,000, respectively. Gross realized gains amounted to $244,000, $176,000
and $13,000, respectively. Gross realized losses amounted to $215,000,
$65,000 and $11,000, respectively. The tax provision applicable
to these net realized gains and losses amounted to $10,000, $39,000 and
$2,000, respectively.
F-18
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (Continued)
Information pertaining to securities with gross unrealized losses at
December 31, 2005 and 2004, aggregated by investment category and length of
time that individual securities have been in a continuous loss position,
follows:
Less Than Twelve Months Over Twelve Months
----------------------- -------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ----- ---------- -----
December 31, 2005: (In thousands)
Securities Available for Sale
-----------------------------
Debt securities:
Government-sponsored enterprises $284 $24,170 $ 578 $25,411
Corporate 319 5,868 236 1,812
Mortgage-backed 313 20,913 104 4,063
---- ------- ------ -------
Total debt securities 916 50,951 918 31,286
Marketable equity securities 61 650 210 1,134
Mutual funds 5 1,200 - -
---- ------- ------ -------
$982 $52,801 $1,128 $32,420
==== ======= ====== =======
Securities Held to Maturity
---------------------------
State and municipal obligations $ 12 $ 783 $ - $ -
Mortgage-backed securities 472 16,542 102 5,424
---- ------- ------ -------
$484 $17,325 $ 102 $ 5,424
==== ======= ====== =======
December 31, 2004:
Securities available for sale
-----------------------------
Debt securities:
Government-sponsored enterprises $ 59 $15,445 $ 227 $10,770
Corporate 29 2,035 - -
Mortgage-backed 81 24,304 - -
---- ------- ------ -------
Total debt securities 169 41,784 227 10,770
Marketable equity securities 55 614 256 1,229
---- ------- ------ -------
$224 $42,398 $ 483 $11,999
==== ======= ====== =======
Securities Held to Maturity
---------------------------
Mortgage-backed securities $ 16 $19,365 $ - $ -
==== ======= ====== =======
F-19
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (Continued)
Management evaluates securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market
concerns warrant such evaluation.
At December 31, 2005, six debt securities have unrealized losses with
aggregate depreciation of less than 10% from the Company's amortized cost
basis. These unrealized losses relate to the financing, automotive, and
chemical industries during 2005 as these industries continue to struggle
with profitability. In analyzing an issuer's financial condition,
management considers whether the debt securities are issued by government-
sponsored enterprises and mortgage-backed securities, whether downgrades by
bond rating agencies have occurred, and industry analysts' reports. As
management has the ability to hold debt securities until maturity, or for
the foreseeable future if classified as available for sale, no declines are
deemed to be other than temporary.
At December 31, 2005, there were no marketable equity securities that had
unrealized losses with aggregate depreciation of 30% from the Company's
cost basis, which is management's guideline for evaluating other-than-
temporary impairment. Evaluation will also occur at an earlier stage if
conditions warrant. Equity securities are reviewed for impairment by
examining several factors, such as financial condition and near-term
prospects of the issuer, credit deterioration of the issuer, rating
downgrades, business segment dynamics, extent to which the market value is
less than cost, length of time held, and buy/hold/sell recommendations of
investment advisors or market analyst. At December 31, 2005, no unrealized
losses were deemed to be other than temporary.
F-20
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. LOANS
A summary of the balances of loans follows:
December 31,
----------------------
2005 2004
---- ----
(In thousands)
Real estate mortgage loans:
Commercial $213,815 $192,822
Residential 120,345 97,496
Construction and land development 21,490 24,240
Home equity lines of credit 17,915 23,131
Commercial, financial and agricultural loans 38,111 26,606
Consumer loans 2,623 2,510
-------- --------
Total loans 414,299 366,805
Less: Allowance for loan losses (4,333) (4,101)
Net deferred loan fees (356) (439)
-------- --------
Loans, net $409,610 $362,265
======== ========
An analysis of the allowance for loan losses follows:
December 31,
------------------------------
2005 2004 2003
---- ---- ----
(In thousands)
Balance at beginning of year $4,101 $4,154 $4,854
Provision (credit) for loan losses 167 376 (602)
Loans charged-off - (525) (211)
Recoveries of loans previously charged-off 65 96 113
------ ------ ------
Balance at end of year $4,333 $4,101 $4,154
====== ====== ======
F-21
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
LOANS (Concluded)
The following is a summary of information pertaining to impaired and non-
accrual loans:
December 31,
--------------
2005 2004
---- ----
(In thousands)
Impaired loans without a valuation allowance $ 49 $ 49
Impaired loans with a valuation allowance 906 67
---- ----
Total impaired loans $955 $116
==== ====
Valuation allowance related to impaired loans $ 87 $ 3
==== ====
Total non-accrual loans $906 $506
==== ====
Total loans past-due ninety days or more and still accruing $ - $ -
==== ====
Years ended December 31,
--------------------------
2005 2004 2003
---- ---- ----
(In thousands)
Average investment in impaired loans $485 $933 $2,193
==== ==== ======
Interest income recognized on impaired loans $ 26 $111 $ 124
==== ==== ======
Interest income recognized on a cash basis
on impaired loans $ 26 $ 17 $ 30
==== ==== ======
No additional funds are committed to be advanced in connection with
impaired loans.
F-22
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation and amortization of
premises and equipment follows:
December 31,
--------------------
2005 2004
---- ----
(In thousands)
Premises:
Land $ 1,600 $ 1,600
Buildings 6,407 6,355
Leasehold improvements 436 22
Furniture and equipment 4,812 5,578
Assets in process - 151
------- -------
13,255 13,706
Accumulated depreciation and amortization (7,338) (8,179)
------- -------
$ 5,917 $ 5,527
======= =======
Depreciation and amortization expense for the years ended December 31,
2005, 2004 and 2003 amounted to $813,000, $659,000 and $639,000,
respectively.
Pursuant to the terms of noncancelable lease agreements in effect at
December 31, 2005, pertaining to premises and equipment, future
minimum rent commitments under various operating leases are as follows:
Year Ending
December 31, Amount
------------ ------
(In thousands)
2006 $ 97
2007 97
2008 83
2009 83
2010 87
Thereafter 842
------
$1,289
======
Certain leases contain provisions for escalation of minimum lease payments
contingent upon increases in real estate taxes and percentage increases in
the consumer price index. In addition, the leases contain options to extend
for periods from five to ten years. The cost of such rentals is not
included above. Total rent expense for the years ended December 31, 2005,
2004 and 2003 amounted to $127,000, $85,000 and $124,000, respectively.
F-23
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. DEPOSITS
A summary of deposits by type is as follows:
December 31,
----------------------
2005 2004
---- ----
(In thousands)
Demand deposits $ 80,705 $ 80,232
NOW 55,493 42,880
Regular and other savings 87,146 89,957
Money market deposits 29,835 38,518
-------- --------
Total non-certificate accounts 253,179 251,587
-------- --------
Term certificates less than $100,000 116,861 112,912
Term certificates of $100,000 or more 45,806 35,406
-------- --------
Total certificate accounts 162,667 148,318
-------- --------
Total deposits $415,846 $399,905
======== ========
At December 31, 2005, the scheduled maturities of time deposits are as
follows:
Amount
------
(In thousands)
2006 $135,606
2007 22,182
2008 2,341
2009 1,372
2010 1,166
--------
$162,667
========
7. SHORT-TERM BORROWINGS
Short-term borrowings consist of Federal Home Loan Bank advances amounting
to $7,000,000 at December 31, 2005, with an original maturity of less than
one year at a weighted average rate of 4.07%. There were no short-term
borrowings at December 31, 2004.
The Bank also has an available line of credit in the amount of $500,000
with the Federal Home Loan Bank of Boston ("FHLB") at an interest rate that
adjusts daily. Borrowings under the line are limited to 2% of the Bank's
total assets. All borrowings from the Federal Home Loan Bank of Boston are
secured by a blanket lien on qualified collateral, defined principally as
75% of the carrying value of first mortgage loans on owner-occupied
residential property and 90% of the market value of U.S. Government and
federal agency securities.
F-24
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. LONG-TERM BORROWINGS
Long-term borrowings at December 31, 2005 and 2004 consists of the
following FHLB advances:
Amount Weighted Average Rate
--------------------- ---------------------
2005 2004 2005 2004
---- ---- ---- ----
(In thousands)
Fixed-rate advances maturing:
2005 $ - $ 8,000 - 2.1%
2006 8,000 8,000 2.7% 2.7%
2007 27,000 20,500 3.4% 3.3%
2008 14,500 16,000 3.8% 2.6%
2009* 21,000 17,000 3.2% 2.9%
2010 7,000 - 4.5% -
Thereafter** 6,430 3,430 5.2% 5.9%
-------- -------
83,930 72,930 3.6% 3.0%
-------- -------
Fixed-rate amortizing advances
maturing:
2008 739 834 6.0% 6.0%
After 2010 16,196 16,522 6.8% 6.8%
-------- -------
16,935 17,356 6.7% 6.7%
-------- -------
Total FHLB advances $100,865 $90,286 4.1% 3.7%
======== =======
* Includes $4,000,000 callable if and when the three-month LIBOR is
greater than or equal to 4.50%, and $10,000,000 callable in September
2006 and thereafter.
** Includes $3,000,000 maturing in 2015 and callable hereafter.
9. SUBORDINATED DEBENTURES
On March 17, 2004, Slade's Ferry Statutory Trust I (the "Trust") , a
Connecticut Statutory trust formed by the Company, completed the sale of
$10,000,000 of floating rate trust preferred securities (liquidation amount
of $1,000 per security) in a private placement as part of a pooled trust
preferred securities transaction. The Trust also issued common securities
in the amount of $310,000 to the Company and used the net proceeds from the
preferred and common securities to purchase subordinated debentures of the
Company. The subordinated debentures are the sole assets of the Trust. The
Company contributed $10,000,000 of the proceeds from the sale of the
subordinated debentures to the Bank as Tier I Capital to support the Bank's
growth. Total expenses associated with the offering approximating $150,000
are included in other assets and are being amortized on a straight-line
basis over the life of the subordinated debentures.
The subordinated debentures and the trust preferred securities accrue and
pay distributions quarterly at a floating rate of 3-Month LIBOR plus 2.79%.
At December 31, 2005 and 2004, this rate was 7.29% and 5.29%, respectively.
The Company has the option to defer interest payments on the subordinated
debentures for up to
F-25
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUBORDINATED DEBENTURES (Concluded)
five years and, accordingly, the trust may defer dividend distributions for
up to five years. The Company has fully and unconditionally guaranteed all
of the obligations of the Trust, including the semi-annual distributions
and payments on liquidation or redemption of the trust preferred
securities.
The Company has the right to redeem the subordinated debentures, in whole
or in part, on or after March 17, 2009 at par value, plus any accrued but
unpaid interest to the redemption date. Redemption may occur prior to March
17, 2009 under certain conditions, at a premium to par value. The trust
preferred securities are mandatorily redeemable upon the maturing of the
subordinated debentures on March 17, 2034, or upon earlier redemption of
the subordinated debentures.
F-26
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. INCOME TAXES
Allocation of federal and state income taxes between current and deferred
portions is as follows:
Years Ended December 31,
------------------------------
2005 2004 2003
---- ---- ----
(In thousands)
Current tax provision:
Federal $1,854 $ 878 $ 499
State 502 323 1,196
------ ------ ------
2,356 1,201 1,695
------ ------ ------
Deferred tax provision (benefit):
Federal (153) 540 307
State (42) 161 93
Change in valuation allowance for
deferred tax assets - (15) (88)
------ ------ ------
(195) 686 312
------ ------ ------
Total provision for income taxes $2,161 $1,887 $2,007
====== ====== ======
The reasons for the differences between the statutory federal income tax
rate and effective tax rates are summarized as follows:
Years Ended December 31,
---------------------------
2005 2004 2003
---- ---- ----
Statutory federal tax rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
Tax-exempt income (1.7) (2.5) (3.7)
Dividends received deduction (0.4) (0.4) (0.4)
State tax, net of federal tax benefit 4.9 5.8 5.7
Additional state tax, net of federal benefit,
due to REIT dividend deduction settlement - - 12.4
Change in valuation allowance - (0.3) (1.9)
Officers' life insurance (2.4) (2.7) (3.7)
Other, net 0.6 0.4 0.4
---- ---- ----
Effective tax rates 35.0% 34.3% 42.8%
==== ==== ====
F-27
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (Concluded)
The components of the net deferred tax asset, included in other assets, are
as follows:
December 31,
------------------
2005 2004
---- ----
(In thousands)
Deferred tax assets:
Allowance for loan losses $1,568 $1,545
Deferred loan fees 118 186
Interest on non-performing loans 48 48
Accrued employee benefits 117 133
Deferred compensation 145 114
Write-down of securities 18 53
Net unrealized holding loss on available for
sale equity securities 718 55
------ ------
2,732 2,134
------ ------
Deferred tax liabilities:
Accelerated depreciation (283) (343)
Prepaid pension contributions (356) (458)
Discount accretion (2) (2)
Deferred gain on stock conversion - (2)
Net unrealized holding gain on
available-for-sale debt securities (2) (149)
------ ------
(643) (954)
------ ------
Net deferred tax asset $2,089 $1,180
====== ======
Deferred tax assets as of December 31, 2005 and 2004 have not been reduced
by a valuation allowance because management believes that it is more likely
than not that the full amount of deferred taxes will be realized.
REIT Dividend Deduction Settlement
Slade's Ferry Preferred Capital Corporation ("SFPCC"), a subsidiary of the
Bank, was dissolved in 2003 as a Massachusetts-chartered real estate
investment trust ("REIT"). The Bank received dividends from SFPCC.
On March 5, 2003, the Commonwealth of Massachusetts enacted tax legislation
which denied the dividends received deduction for dividends received from
real estate investment trusts retroactively to 1999. The additional state
tax liability created by the new law for the Bank would have been
$1,764,000 plus previously assessed interest of $258,000 for the calendar
years 1999 through 2002.
On June 20, 2003, the Bank and SFPCC entered into an agreement with the
Massachusetts Department of Revenue (the "DOR") settling the dispute
concerning the dividends received deduction through calendar year 2002
claimed or to be claimed by the Bank. Under the agreement, the Bank agreed
to pay, and the DOR agreed to abate, 50% of all tax and interest assessed
or unassessed relating to the REIT dividend deduction. Therefore, the
previously unrecorded tax liability of $882,000, interest of $129,000 and
federal and state tax benefits of $353,000 were recognized during the year
ended December 31, 2003.
F-28
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. OFF-BALANCE SHEET ACTIVITIES
The Company is a party to credit related financial instruments with
off-balance-sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments include
commitments to extend credit, standby letters of credit and commercial
letters of credit. Such commitments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheets. The Company's exposure to credit loss is
represented by the contractual amount of these commitments. The Company
follows the same credit policies in making commitments as it does for
on-balance-sheet instruments.
At December 31, 2005 and 2004, the following financial instruments were
outstanding for which the contract amounts represent credit risk:
Contract Amount
--------------------
2005 2004
---- ----
(In thousands)
Commitments to grant loans $ 6,375 $10,798
Unfunded commitments under lines of credit 25,041 15,795
Unfunded commitments under construction loans 14,863 11,412
Equity lines of credit 17,711 18,182
Standby letters of credit 3,188 739
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. The commitments for equity lines
of credit may expire without being drawn upon. Therefore, the total
commitment amounts do not necessarily represent future cash requirements.
The amount of collateral obtained, if it is deemed necessary by the
Company, is based on management's credit evaluation of the customer.
Unfunded commitments under commercial lines-of-credit, revolving credit
lines and overdraft protection agreements are commitments for possible
future extensions of credit to existing customers. These lines-of-credit
are uncollateralized and usually do not contain a specified maturity date
and may not be drawn upon to the total extent to which the Company is
committed.
Standby letters-of-credit are conditional commitments issued by the Company
to guarantee the performance of a customer to a third party. Those letters-
of-credit are primarily issued to support public and private borrowing
arrangements. Essentially all letters of credit issued have expiration
dates within one year. The credit risk involved in issuing letters-of-
credit is essentially the same as that involved in extending loan
facilities to customers. The Company generally holds collateral supporting
those commitments, and at December 31, 2005 and 2004 such collateral
amounted to $3,128,000 and $677,000 respectively.
Guarantees that are not derivative contracts have been recorded on the
Company's consolidated balance sheet at their fair value at inception. The
Company considers standby letters of credit to be guarantees, and the
amount of the recorded liability related to such guarantees at December 31,
2005 and 2004 was $65,000, and $87,000 respectively.
F-29
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12. LEGAL CONTINGENCIES
Various claims also arise from time to time in the normal course of
business which, in the opinion of management, will have no material effect
on the Company's consolidated financial statements.
13. MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could
have a direct material effect on the Company's and the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Company and the Bank must meet specific
capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. Their capital amounts and classification
are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the following table) of total and Tier 1 capital (as defined
in the regulations) to risk-weighted assets (as defined) and of Tier 1
capital (as defined) to average assets (as defined). Management believes,
as of December 31, 2005 and 2004, that the Company and the Bank meet all
capital adequacy requirements to which they are subject.
F-30
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
MINIMUM REGULATORY CAPITAL REQUIREMENTS (Concluded)
As of December 31, 2005, the most recent notification from the Federal
Deposit Insurance Company categorized the Bank as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as
well capitalized, an institution must maintain minimum total risk-based,
Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following
tables. There are no conditions or events since the notification that
management believes have changed the Bank's category. The Company's and the
Bank's actual capital amounts and ratios as of December 31, 2005 and 2004
are also presented in the table.
To Be Well Capitalized
Minimum Capital Under Prompt Corrective
Actual Requirement Action Provisions
----------------- ---------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
December 31, 2005:
Total Capital to Risk Weighted
Assets:
Consolidated $62,240 15.72% $31,668 8.0% N/A N/A
Bank 53,555 13.58 31,540 8.0 $39,425 10.0%
Tier 1 Capital to Risk Weighted
Assets:
Consolidated 58,014 14.66 15,834 4.0 N/A N/A
Bank 49,329 12.51 15,770 4.0 23,655 6.0
Tier 1 Capital to Average Assets:
Consolidated 58,014 10.07 23,038 4.0 N/A N/A
Bank 49,329 8.56 23,038 4.0 28,797 5.0
December 31, 2004:
Total Capital to Risk Weighted
Assets:
Consolidated $58,639 15.82% $29,647 8.0% N/A N/A
Bank 50,381 13.68 29,468 8.0 $36,835 10.0%
Tier 1 Capital to Risk Weighted
Assets:
Consolidated 54,538 14.72 14,824 4.0 N/A N/A
Bank 46,280 12.56 14,734 4.0 22,101 6.0
Tier 1 Capital to Average Assets:
Consolidated 54,538 10.22 21,348 4.0 N/A N/A
Bank 46,280 8.67 21,348 4.0 26,685 5.0
F-31
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. EMPLOYEE BENEFIT PLANS
Pension Plan
The Company has a defined benefit plan that up to January 1, 1998 covered
substantially all of its full time employees who met certain eligibility
requirements. On January 1, 1998, the Bank suspended the plan so that
employees no longer earn additional defined benefits for future service.
The benefits paid are based on 1.5% of total salary plus .5% of
compensation in excess of the integration level per year of service. The
integration level was the first $750 of monthly compensation. The accrued
benefit is based on years of service. Information pertaining to the
activity in the plan is as follows:
Years Ended December 31,
-----------------------------
2005 2004 2003
---- ---- ----
(In thousands)
Change in benefit obligation:
Benefit obligation at beginning of year $ 1,663 $ 1,747 $ 1,706
Interest cost 86 105 107
Assumption changes 140 - 252
Actuarial loss (gain) 49 8 (95)
Settlement (41) 66 75
Benefits paid (610) (263) (298)
------- ------- -------
Benefit obligation at end of year 1,287 1,663 1,747
------- ------- -------
Change in plan assets:
Fair value of plan assets at beginning of year 2,094 622 673
Actual return on plan assets 89 25 97
Employer contribution - 1,710 150
Benefits paid (610) (263) (298)
------- ------- -------
Fair value of plan assets at end of year 1,573 2,094 622
------- ------- -------
Funded status 286 431 (1,125)
Unrecognized net actuarial loss 583 687 682
------- ------- -------
Prepaid (accrued) pension cost $ 869 $ 1,118 $ (443)
======= ======= =======
Amounts recognized in the balance sheet consist of:
Prepaid (accrued) benefit cost $ 869 $ 1,118 $ (443)
Additional minimum liability - - (682)
Accumulated other comprehensive loss before
income tax benefit - - 682
------- ------- -------
Net amount recognized $ 869 $ 1,118 $ (443)
======= ======= =======
F-32
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (Continued)
Pension Plan (Continued)
The assumptions used to determine the benefit obligation are as follows:
December 31,
----------------
2005 2004
---- ----
Discount rate 5.75% 6.25%
Rate of compensation increase - -
The components of net periodic pension cost are as follows:
Years Ended December 31,
----------------------------
2005 2004 2003
---- ---- ----
(In thousands)
Interest cost $ 86 $ 105 $ 107
Expected return on plan assets (148) (107) (48)
Amortization of prior service cost - - -
Settlements 276 109 117
Recognized net actuarial loss 35 42 34
----- ----- -----
$ 249 $ 149 $ 210
===== ===== =====
The assumptions used to determine net periodic pension cost are as follows:
Years Ended December 31,
------------------------
2005 2004 2003
---- ---- ----
Discount rate 6.25% 6.25% 7.00%
Expected long term rate of return on assets 8.00 8.00 8.00
The expected long-term rate of return on plan assets reflects management's
expectations of long-term average rates of returns on funds invested to
provide benefits included in the projected benefit obligations. The
expected rate of return is based on the outlook for inflation, fixed income
returns, and equity returns, which in turn is based upon historical returns
and asset allocation. Applying the actual allocation percentages to the
anticipated rate of return results in an overall rate of compensation
assumption of 8.00%.
The Company's pension plan weighted average asset allocations are as
follows:
Percentage of Plan Assets at
December 31,
----------------------------
2005 2004
---- ----
Asset Category
--------------
Equity securities 65.50% 14.03%
Debt securities 32.70 6.62
Money market funds 1.80 79.35
------ ------
Total 100.00% 100.00%
====== ======
F-33
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (Continued)
Pension Plan (Concluded)
Equity securities include the Company's common stock in the amounts of $0
and $75,000 (3.6% of total plan assets) at December 31, 2005 and 2004,
respectively.
The investment portfolio serves as the primary source of earnings for the
defined benefit pension plan and provides the plan with a source of
liquidity. As funds are available to invest, the Company obtains the
recommendation from investment advisors regarding the best and most
suitable type of security to purchase. Debt securities are purchased with
the ability and intent to hold the security to its stated maturity, or in
the case of equity securities, viewed as a long-term hold. Securities may
be sold from time to time prior to maturity should liquidity requirements
necessitate the sale.
No contribution is expected for the plan year beginning January 1, 2006.
Estimated future benefit payments are as follows:
Year Ending December 31, Amount
------------------------ ------
(In thousands)
2006 $248
2007 12
2008 15
2009 62
2010 161
Years 2011 - 2015 308
401(k) Plan
The Company has a 401(k) Plan whereby substantially all employees who
attain the age of 21 and complete three months of service are eligible to
participate in the Plan. Employees may contribute up to 100 percent of
their compensation subject to certain limits based on federal tax laws. The
Company makes matching contributions equal to 3 percent of the first 6
percent of an employee's compensation contributed to the Plan. Matching
contributions vest to the employee after a one-year period. For the years
ended December 31, 2005, 2004 and 2003, expense attributable to the Plan
amounted to $97,000, $104,000 and $20,000, respectively.
Employees who attain age 21 and complete one year of service (1,000 hours)
are also eligible to receive profit sharing contributions under the 401(k)
plan. The Company contributes amounts at the Company's discretion. Costs
recognized by the Company for profit-sharing amounted to $114,000, $101,000
and $300,000 for the years ended December 31, 2005, 2004 and 2003,
respectively.
Employment Agreements
In May of 2004, the Company entered into an Employment Agreement with the
President of the Company. In August of 2004, the Company entered into
Employment Agreements with two additional Executive Officers. Under the
agreements, the President and Executive Officers are entitled to severance
benefits upon a change-in-control as defined in the agreements. The
severance benefits include, among other things, the value of the cash
compensation, value of employer contributions to employer-provided benefit
plans and continued fringe benefits that the President would have received
had she worked an additional three years and the Executive Officers would
have received had they worked an additional two years. In addition, the
President and Executive Officers would be entitled to accelerated vesting
in other benefit plans upon a change of control or termination without
cause. The President would also be indemnified for any impact from excise
taxes due under
F-34
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (Concluded)
Employment Agreements (Concluded)
Section 4999 of the Code while the Executive Officers would have any
benefits limited to avoid excise taxes under Section 4999 of the Code.
In May of 2005, the Company entered into Change of Control Agreements with
two additional executive officers of the Bank. These agreements provide for
a one-year severance payment upon a change of control that results in a
termination of the executives' employment.
Supplemental Retirement Plans
The Bank has entered into supplemental retirement plans with certain
executive officers and trustees that provide for supplemental benefits
commencing with retirement. The present value of estimated future benefits
payable is accrued over the required service periods. For the years ended
December 31, 2005, 2004 and 2003, expense attributable to the supplemental
retirement plans amounted to $40,000, $30,000, and $29,000, respectively.
In connection with the supplemental retirement plans, the Bank has
purchased life insurance policies applicable to the executive officers and
directors included in the plans. The policies are reflected on the
consolidated balance sheet at cash surrender value. Increases in cash
surrender value are reflected in other income in the consolidated
statements of income.
15. STOCK COMPENSATION PLANS
Slade's Ferry Bancorp. Stock Option Plan (Stock Option Plan)
The Stock Option Plan includes a Discretionary Grant Program and an
Automatic Grant Program. The maximum number of shares of common stock
issuable over the term of the Stock Option Plan may not exceed 275,625
shares and the maximum aggregate number of shares issuable under both
programs in any plan year may not exceed 55,125 shares. Unless sooner
terminated by the Board, the Stock Option Plan will in all events terminate
on March 11, 2006.
Under the Discretionary Grant Program, key employees, including officers,
may be granted incentive stock options to purchase shares of common stock
of the Company. The exercise price per share may not be less than one
hundred percent of the fair market value of common stock at the grant date
and options become exercisable upon grant. The maximum term of each option
is ten years.
The Automatic Grant Program is limited to non-employee directors of the
Company or its subsidiary. A non-statutory option for 2,000 shares of
common stock is granted each plan year to eligible directors. The exercise
price per share is equal to one hundred percent of the fair market value of
common stock at the grant date and options become exercisable upon grant.
The maximum term of each option is five years.
F-35
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK COMPENSATION PLANS (Continued)
Slade's Ferry Bancorp. 2004 Equity Incentive Plan (2004 Plan)
The maximum number of shares of stock reserved and available for issuance
under the 2004 Plan is 300,000 shares, subject to adjustment as provided in
the Plan (through the application of certain anti-dilution provisions);
provided that not more than 100,000 shares shall be issued in the form of
Unrestricted Stock Awards, Restricted Stock Awards or Deferred Stock
Awards.
Stock options granted under the 2004 Plan may be either incentive stock
options or non-qualified stock options. The exercise price for incentive
stock options granted to employees shall not be less than 100 percent of
the fair market value at grant date. No stock option shall be exercisable
more than 10 years after the date the stock option is granted.
Each non-employee director who is serving as director of the Company on the
day after each annual meeting of shareholders or any special meeting in
lieu thereof, beginning with the 2004 annual meeting, shall automatically
be granted on such day a non-qualified stock option to acquire 2,000 shares
of stock, exercise price to be fair market value on date of grant. No stock
option shall be exercisable more than 10 years after the grant date.
Unrestricted Stock Awards may be granted in respect of past services or
other valid consideration. Restricted Stock Awards entitle the recipient to
acquire, at such purchase price as determined by the Company, shares of
stock subject to such restrictions and conditions as the Company may
determine at time of grant. A Deferred Stock Award is an award of
restricted unit to a grantee, subject to restrictions and conditions as the
Company may determine at time of grant. If any Restricted Stock Award or
Deferred Stock Award granted is intended to qualify as "Performance-based
Compensation", such Award shall comply with provisions as set forth in the
2004 Plan.
The Company applies APB Opinion 25 and related Interpretations in
accounting for its plans. (See Note 1.)
A summary of the status (shares in thousands) of the Company's stock option
plans are presented below:
2005 2004 2003
---------------------- ---------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
------ -------------- ------ -------------- ------ --------------
Outstanding at beginning
of year 215 $15.92 161 $12.90 164 $12.12
Granted 78 18.74 99 19.46 48 15.91
Exercised (30) 10.55 (42) 12.55 (8) 11.23
Forfeited (8) 19.14 (3) 18.55 (24) 16.19
Surrendered for stock appreciation value - - (19) 10.11
----- ----- -----
Outstanding at end of year 255 $17.35 215 $15.92 161 $12.90
===== ===== =====
Options exercisable at year-end 211 $17.03 173 $15.04 161 $12.90
Weighted-average fair value
of options granted during the year $6.46 $6.08 $3.56
F-36
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK COMPENSATION PLANS (Concluded)
Slade's Ferry Bancorp. 2004 Equity Incentive Plan (2004 Plan) (Concluded)
Information pertaining to options (in thousands) outstanding at December
31, 2005 is as follows:
Options Outstanding Options Exercisable
-------------------------------------------------- ------------------------------
Weighted Average
Weighted Average Number Remaining Number Weighted Average
Exercise Price Outstanding Contractual Life Outstanding Exercise Price
---------------- ----------- ---------------- ----------- ----------------
$ 9.50 22 .36 years 22 $ 9.50
14.15 24 1.36 years 24 14.15
14.59 28 2.36 years 28 14.59
18.55 9 2.75 years 9 18.55
18.85 66 4.42 years 22 18.85
18.85 12 4.42 years 12 18.85
19.25 30 3.36 years 30 19.25
19.55 64 8.85 years 64 19.55
--- ---
17.35 255 4.49 years 211 17.03
=== ===
16. RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to principal
officers and directors and their affiliates amounting to $11,455,000 at
December 31, 2005 and $6,955,000 at December 31, 2004. During the year
ended December 31, 2005, total principal additions were $13,544,000 and
total principal payments were $7,811,000. Included in the December 31,
2004 balance are loans amounting to $1,233,000 for principal officers
and directors who have retired or are no longer affiliated with the Company.
Deposits from related parties held by the Bank at December 31, 2005 and
2004 amounted to $3,867,000 and $3,599,000, respectively.
17. RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES
Federal and state banking regulations place certain restrictions on
dividends paid and loans or advances made by the Bank to the Company. The
total amount of dividends which may be paid at any date is generally
limited to the retained earnings of the Bank, and loans or advances are
limited to 10 percent of the Bank's capital stock and surplus on a secured
basis.
In addition, dividends paid by the Bank to the Company would be prohibited
if the effect thereof would cause the Bank's capital to be reduced below
applicable minimum capital requirements.
At December 31, 2005, the Bank's retained earnings available for the
payment of dividends was $5,048,000. Accordingly, $45,432,000 of the
Company's equity in the net assets of the Bank was restricted at December
31, 2005. Funds available for loans or advances by the Bank to the Company
amounted to $10,096,000.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that would
be exchanged between willing parties, other than in a forced liquidation.
Fair value is best determined based upon quoted market prices. However, in
many instances, there are no quoted market prices for the Company's various
financial instruments. In cases
F-37
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including
the discount rate and estimates of future cash flows. Accordingly, the fair
value estimates may not be realized in an immediate settlement of the
instrument. SFAS 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented may not necessarily represent the
underlying fair value of the Company.
The following methods and assumptions were used by the Company in
estimating fair value disclosures for financial instruments:
Cash and cash equivalents - The carrying amounts of cash and cash
equivalents approximate fair values.
Interest-bearing deposits in banks -The carrying amounts of interest-
bearing deposits maturing within ninety days approximate their fair values.
Fair values of other interest-bearing deposits are estimated using
discounted cash flow analyses based on current rates for similar types of
deposits.
Securities - Fair values for securities, excluding Federal Home Loan Bank
stock, are based on quoted market prices. The carrying value of Federal
Home Loan Bank stock approximates fair value based on the redemption
provisions of the Federal Home Loan Bank.
Loans receivable - For variable-rate loans that reprice frequently and with
no significant change in credit risk, fair values are based on carrying
values. Fair values for other loans are estimated using discounted cash
flow analyses, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. Fair values for non-
performing loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable.
Deposit liabilities - The fair values disclosed for demand deposits (e.g.,
interest and noninterest checking, passbook savings, and certain types of
money market accounts) are, by definition, equal to the amount payable on
demand at the reporting date (i.e., their carrying amounts). The carrying
amounts of variable-rate, fixed-term money market accounts and certificates
of deposit approximate their fair values at the reporting date. Fair values
for fixed-rate certificates of deposit are estimated using a discounted
cash flow calculation that applies interest rates currently being offered
on certificates to a schedule of aggregated expected monthly maturities on
time deposits.
Short-term borrowings - For short-term borrowings maturing within ninety
days, carrying values approximate fair values. Fair values of other short-
term borrowings are estimated using discounted cash flow analyses based on
the Company's current incremental borrowing rates for similar types of
borrowing arrangements.
Long-term borrowings and subordinated debt - The fair values of the
Company's long-term borrowings and subordinated debt are estimated using
discounted cash flow analyses based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
Accrued interest - The carrying amounts of accrued interest approximate
fair value.
Off-balance sheet credit-related instruments - Fair values for off-balance-
sheet, credit related financial instruments are based on fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreements and the counterparties' credit standing and are not
material.
F-38
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (Concluded)
The estimated fair values, and related carrying or notional amounts, of the
Company's financial instruments are as follows:
December 31,
----------------------------------------------
2005 2004
-------------------- --------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ----- -------- -----
(In thousands)
Financial assets:
Cash and cash equivalents $ 20,018 $ 20,018 $ 35,194 $ 35,194
Interest-bearing certificates of
deposit with other banks 100 100 100 100
Securities available for sale 94,298 94,298 83,882 83,882
Securities held to maturity 29,306 28,858 37,773 38,112
Federal Home Loan Bank stock 6,304 6,304 4,650 4,650
Loans, net 409,610 403,712 362,265 359,600
Accrued interest receivable 2,298 2,298 1,969 1,969
Financial liabilities:
Deposits 415,846 415,728 399,905 400,095
Short-term borrowings 7,000 7,000 - -
Long-term borrowings 100,865 101,035 90,286 91,656
Subordinated debt 10,310 10,310 10,310 10,310
19. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial information pertaining only to Slade's Ferry Bancorp. is as
follows:
December 31,
--------------------
BALANCE SHEETS 2005 2004
-------------- ---- ----
(In thousands)
Assets
------
Cash and due from banks $ 2,621 $ 1,671
Securities available for sale (at fair value) 5,868 6,457
Investment in Bank subsidiary 50,480 48,652
Investment in Trust subsidiary 310 310
Other assets 266 615
------- -------
Total assets $59,545 $57,705
======= =======
Liabilities and Stockholders' Equity
------------------------------------
Subordinated debentures $10,310 $10,310
Other liabilities 380 794
------- -------
Total liabilities 10,690 11,104
------- -------
Stockholders' equity 48,855 46,601
------- -------
Total liabilities and stockholders' equity $59,545 $57,705
======= =======
F-39
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (Continued)
Years Ended December 31,
---------------------------------
STATEMENTS OF INCOME 2005 2004 2003
-------------------- ---- ---- ----
(In thousands)
Income:
Dividends from Bank subsidiary $ 1,470 $ 1,440 $ 1,400
Dividends from Trust subsidiary 19 10 -
Interest on investments 240 193 130
Management fee income from subsidiary 316 412 318
Gain on sale of securities available for sale, net - 3 -
------- ------- -------
Total income 2,045 2,058 1,848
Operating expenses (1,256) (1,143) (446)
------- ------- -------
Income before income taxes and equity in
undistributed net income of subsidiaries 789 915 1,402
Applicable income tax provision (benefit) (231) (175) 8
------- ------- -------
1,020 1,090 1,394
Equity in undistributed net income of Bank
subsidiary 3,000 2,527 1,290
------- ------- -------
Net income $ 4,020 $ 3,617 $ 2,684
======= ======= =======
F-40
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (Concluded)
Years Ended December 31,
---------------------------------
STATEMENTS OF CASH FLOWS 2005 2004 2003
------------------------ ---- ---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 4,020 $ 3,617 $ 2,684
Adjustments to reconcile net income to net cash
used by operating activities:
Equity in undistributed net income of Bank
subsidiary (3,000) (2,527) (1,290)
Increase in other assets 532 44 95
Increase (decrease) in accrued expenses (18) 10 (124)
Increase (decrease) in other liabilities (546) 36 (11)
------- ------- -------
Net cash provided by operating activities 988 1,180 1,354
------- ------- -------
Cash flows from investing activities:
Purchases of securities available for sale - (3,183) (4,297)
Proceeds from maturities of securities available
for sale 500 - 5,500
Investment in Bank subsidiary - (10,000) -
Investment in Trust subsidiary - (310) -
Capital expenditures - (48) -
------- ------- -------
Net cash provided (used) by investing activities 500 (13,541) 1,203
------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock 627 710 796
Proceeds from exercise of stock options 316 532 94
Cash dividends paid on common stock (1,481) (1,451) (1,425)
Retirement of shares of common stock - (32) -
Net proceeds from issuance of subordinated
debentures - 10,160 -
------- ------- -------
Net cash provided (used) by financing activities (538) 9,919 (535)
------- ------- -------
Net increase (decrease) in cash and cash equivalents 950 (2,442) 2,022
Cash and cash equivalents at beginning of year 1,671 4,113 2,091
------- ------- -------
Cash and cash equivalents at end of year $ 2,621 $ 1,671 $ 4,113
======= ======= =======
F-41
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
20. QUARTERLY DATA (UNAUDITED)
Years Ended December 31,
-----------------------------------------------------------------------------
2005 2004
------------------------------------- -------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
(In thousands, except per share data)
Interest and dividend income $ 7,691 $ 7,462 $ 7,109 $ 6,657 $ 6,619 $ 6,250 $ 5,757 $ 5,480
Interest expense (3,123) (2,980) (2,686) (2,206) (2,183) (2,025) (2,005) (1,733)
------------------------------------- -------------------------------------
Net interest income 4,568 4,482 4,423 4,451 4,436 4,225 3,752 3,747
Provision for loan losses (58) (44) (15) (50) - - (130) (246)
------------------------------------- -------------------------------------
Net interest income, after
provision for loan losses 4,510 4,438 4,408 4,401 4,436 4,225 3,622 3,501
Noninterest income 609 602 540 569 529 813 600 563
Noninterest expense (3,277) (3,682) (3,622) (3,315) (2,890) (3,462) (3,220) (3,213)
------------------------------------- -------------------------------------
Income before income taxes 1,842 1,358 1,326 1,655 2,075 1,576 1,002 851
Provision for income taxes (670) (458) (478) (555) (744) (500) (377) (266)
------------------------------------- -------------------------------------
Net Income $ 1,172 $ 900 $ 848 $ 1,100 $ 1,331 $ 1,076 $ 625 $ 585
===================================== =====================================
Earnings per common share:
Basic $ 0.28 $ 0.22 $ 0.21 $ 0.27 $ 0.32 $ 0.27 $ 0.15 $ 0.15
===================================== =====================================
Diluted $ 0.28 $ 0.22 $ 0.21 $ 0.27 $ 0.32 $ 0.26 $ 0.15 $ 0.14
===================================== =====================================
F-42