SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
Quarterly Report Under Section 13 of the Securities Exchange Act of 1934
For quarter ended: September 30, 2002
Commission File No. 001-16101
BANCORP RHODE ISLAND, INC.
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(Exact Name of Registrant as Specified in Its Charter)
RHODE ISLAND 05-0509802
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(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903
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(Address of Principal Executive Offices)
(401) 456-5000
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(Issuer's Telephone Number, Including Area Code)
Not Applicable
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(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes ( X ) No
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of Nov. 7, 2002:
Common Stock - Par Value $0.01 3,776,250 shares
------------------------------ ----------------
(class) (outstanding)
BANCORP RHODE ISLAND, INC.
FORM 10-Q
INDEX
PAGE NUMBER
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Cover Page 1
Index 2
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Changes in
Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7 - 10
Item 2 Management's Discussion and Analysis 11 - 22
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 23 - 24
Item 4 Controls and Procedures 24
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 25
Item 2 Changes in Securities 25
Item 3 Default upon Senior Securities 25
Item 4 Submission of Matters to a Vote of Security Holders 25
Item 5 Other Information 25
Item 6 Exhibits and Reports on Form 8-K 25
Signature Page 26
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets
September 30, December 31,
2002 2001
------------- ------------
(Dollars in thousands)
ASSETS:
Cash and due from banks $ 24,960 $ 24,261
Overnight investments 30,886 4,913
Investment securities available for sale (amortized cost of $72,382 and
$49,193 at September 30, 2002 and December 31, 2001, respectively) 73,622 49,453
Mortgage-backed securities available for sale (amortized cost of $179,046
and $149,549 at September 30, 2002 and December 31, 2001, respectively) 181,056 150,650
Stock in Federal Home Loan Bank of Boston 7,683 5,668
Loans receivable:
Residential mortgage loans 285,714 310,212
Commercial loans 277,670 239,364
Consumer and other loans 75,328 61,388
-------------------------
Total loans 638,712 610,964
Less allowance for loan losses (9,548) (8,524)
-------------------------
Net loans 629,164 602,440
Premises and equipment, net 8,293 7,184
Other real estate owned -- 264
Goodwill, net 10,766 10,766
Accrued interest receivable 6,094 5,803
Investment in bank-owned life insurance 10,380 --
Prepaid expenses and other assets 2,879 848
-------------------------
Total assets $985,783 $862,250
=========================
LIABILITIES:
Deposits:
Demand deposit accounts $129,773 $112,925
NOW accounts 88,120 44,445
Money market accounts 9,708 9,914
Savings accounts 275,060 254,861
Certificate of deposit accounts 228,356 248,268
-------------------------
Total deposits 731,017 670,413
Overnight and short-term borrowings 33,035 13,033
Federal Home Loan Bank of Boston borrowings 144,878 113,365
Company-obligated mandatorily redeemable capital securities 8,000 3,000
Other liabilities 3,954 3,342
-------------------------
Total liabilities 920,884 803,153
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SHAREHOLDERS' EQUITY:
Common stock, par value $0.01 per share, authorized 11,000,000 shares:
Voting: Issued and outstanding 3,776,250 shares in 2002 and
3,753,550 in 2001 38 37
Additional paid-in capital 40,113 39,826
Retained earnings 22,603 18,336
Accumulated other comprehensive income, net 2,145 898
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Total shareholders' equity 64,899 59,097
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Total liabilities and shareholders' equity $985,783 $862,250
=========================
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations
Three Months Ended Nine Months Ended
September 30, September 30,
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2002 2001 2002(A) 2001
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(Dollars in thousands, except per share data)
Interest and dividend income:
Residential mortgage loans $ 4,555 $ 5,613 $ 14,327 $ 16,312
Commercial loans 4,833 4,470 13,564 13,751
Consumer and other loans 988 1,121 2,886 3,590
Mortgage-backed securities 2,188 1,850 6,636 5,807
Investment securities 863 856 2,392 2,303
Overnight investments 82 65 198 421
Federal Home Loan Bank of Boston stock dividends 68 72 210 223
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Total interest and dividend income 13,577 14,047 40,213 42,407
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Interest expense:
NOW accounts 240 57 368 165
Money market accounts 36 47 102 185
Savings accounts 1,286 1,568 3,785 5,222
Certificate of deposit accounts 1,975 3,321 6,365 10,595
Overnight and short-term borrowings 114 86 226 394
Federal Home Loan Bank of Boston borrowings 1,880 1,433 5,530 3,756
Other borrowings -- -- -- 138
Company-obligated mandatorily redeemable capital securities 145 73 302 186
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Total interest expense 5,676 6,585 16,678 20,641
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Net interest income 7,901 7,462 23,535 21,766
Provision for loan losses 575 566 1,425 1,406
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Net interest income after provision for loan losses 7,326 6,896 22,110 20,360
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Noninterest income:
Service charges on deposit accounts 993 869 2,760 2,529
Loan related fees 78 107 251 207
Commissions on loans originated for others 78 55 230 185
Commissions on nondeposit investment products 349 164 771 310
Gain on sale of mortgage-backed securities -- -- 23 4
Income from bank-owned life insurance 143 -- 380 --
Other income 155 161 465 529
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Total noninterest income 1,796 1,356 4,880 3,764
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Noninterest expense:
Salaries and employee benefits 3,376 2,826 9,630 8,141
Occupancy 485 458 1,448 1,326
Equipment 288 213 783 652
Data processing 500 466 1,425 1,348
Marketing 215 182 896 739
Professional services 330 210 1,128 610
Loan servicing 216 235 675 686
Other real estate owned expense (3) 106 4 170
Amortization of goodwill -- 291 -- 873
Other 827 840 2,348 2,319
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Total noninterest expense 6,234 5,827 18,337 16,864
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Income before income taxes 2,888 2,425 8,653 7,260
Income tax expense 957 849 2,919 2,552
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Net income $ 1,931 $ 1,576 $ 5,734 $ 4,708
================================================
Per share data:
Basic earnings per common share $ 0.51 $ 0.42 $ 1.53 $ 1.26
Diluted earnings per common share $ 0.48 $ 0.40 $ 1.44 $ 1.21
Average common shares outstanding - basic 3,765,585 3,730,550 3,754,604 3,729,793
Average common shares outstanding - diluted 3,988,321 3,922,503 3,993,256 3,892,485
(A) Restated to remove goodwill amortization, net of taxes, for the six
months ended June 30, 2002, in accordance with the adoption of
SFAS 147.
See accompanying notes to consolidated financial statements
4
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity
Accumulated
Other
Compre-
Additional hensive
Common Paid-in Retained Income
Nine months ended September 30, Stock Capital Earnings (Loss), Net Total
------ ---------- -------- ----------- -----
(In thousands)
2002
----
Balance at December 31, 2001 $37 $39,826 $18,336 $ 898 $59,097
Net income (A) -- -- 5,734 -- 5,734
Other comprehensive income, net of tax:
Unrealized holding gains on
securities available for sale,
net of taxes of $650 1,262 1,262
Realized gain on securities available
for sale, net of taxes of $8 (15) (15)
-------
Comprehensive income 6,981
Proceeds from exercise of options 1 263 -- -- 264
Common stock issued for incentive
stock award, net -- 24 -- -- 24
Dividends on common stock -- -- (1,467) -- (1,467)
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Balance at September 30, 2002 $38 $40,113 $22,603 $2,145 $64,899
=========================================================
2001
----
Balance at December 31, 2000 $37 $39,621 $13,815 $ (181) $53,292
Net income -- -- 4,708 -- 4,708
Other comprehensive income, net of tax:
Unrealized holding gains on
securities available for sale,
net of taxes of $910 1,767 1,767
Realized gain on securities available
for sale, net of taxes of $1 (3) (3)
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Comprehensive income 6,472
Proceeds from exercise of options -- 16 -- -- 16
Common stock issued for incentive
stock award, net -- 18 -- -- 18
Dividends on common stock -- -- (1,345) -- (1,345)
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Balance at September 30, 2001 $37 $39,655 $17,178 $1,583 $58,453
=========================================================
Restated to remove goodwill amortization, net of taxes, for the six
months ended June 30, 2002, in accordance with the adoption of
SFAS 147.
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows
Nine Months Ended
September 30,
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2002(A) 2001
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(In thousands)
Cash flows from operating activities:
Net income $ 5,734 $ 4,708
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation and amortization 1,943 2,269
Provision for loan losses 1,425 1,406
Gain on mortgage-backed securities (23) (4)
Gain on sale of other real estate owned (29) (14)
Income from bank-owned life insurance (380) --
Compensation expense from restricted stock grant 24 18
(Increase) decrease in:
Accrued interest receivable (291) (1,110)
Prepaid expenses and other assets (2,674) (508)
Increase (decrease) in:
Other liabilities 612 (213)
Other, net 79 13
-----------------------
Net cash provided (used) by operating activities 6,420 6,565
-----------------------
Cash flows from investing activities:
Origination of:
Residential mortgage loans (6,842) (13,270)
Commercial loans (70,467) (39,475)
Consumer loans (29,849) (14,816)
Purchase of:
Investment securities available for sale (54,210) (38,026)
Mortgage-backed securities available for sale (78,065) (50,851)
Residential mortgage loans (102,143) (146,154)
Consumer loans -- (5,045)
Federal Home Loan Bank of Boston stock (2,015) (1,960)
Principal payments on:
Investment securities available for sale 31,006 33,250
Mortgage-backed securities available for sale 44,480 29,681
Residential mortgage loans 132,958 87,329
Commercial loans 31,812 25,567
Consumer loans 15,640 17,559
Proceeds from sale of mortgage-backed securities 3,766 3,885
Proceeds from sale of other real estate owned 293 84
Proceeds from sale of premises and equipment -- 18
Capital expenditures for premises and equipment (2,028) (1,075)
Purchase of bank-owned life insurance (10,000) --
-----------------------
Net cash provided (used) by investing activities (95,664) (113,299)
-----------------------
Cash flows from financing activities:
Net increase in deposits 60,604 20,752
Net increase in overnight and short-term borrowings 20,002 2,589
Proceeds from long-term borrowings 45,351 86,000
Repayment of long-term borrowings (8,838) (7,757)
Proceeds from exercise of stock options 264 16
Dividends on common stock (1,467) (1,345)
-----------------------
Net cash provided (used) by financing activities 115,916 100,255
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Net increase (decrease) in cash and cash equivalents 26,672 (6,479)
Cash and cash equivalents at beginning of period 29,174 34,453
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Cash and cash equivalents at end of period $ 55,846 $ 27,974
=======================
Supplementary Disclosures:
Cash paid for interest $ 17,174 $ 20,321
Cash paid for income taxes 3,589 3,445
Non-cash transactions:
Additions to other real estate owned in settlement
of loans -- 62
Change in other comprehensive income, net of taxes 1,247 1,764
Restated to remove goodwill amortization, net of taxes, for the six
months ended June 30, 2002, in accordance with the adoption of
SFAS 147.
See accompanying notes to consolidated financial statements
6
BANCORP RHODE ISLAND, INC.
Notes to Consolidated Financial Statements
(1) Basis of Presentation
Bancorp Rhode Island, Inc. (the "Company"), a Rhode Island
corporation, was organized by Bank Rhode Island (the "Bank") to be a bank
holding company and to acquire all of the capital stock of the Bank. The
reorganization of the Bank into the holding company form of ownership was
completed on September 1, 2000. The Company has no significant assets other
than the common stock of the Bank. For that reason, substantially all of the
discussion in this Quarterly Report on Form 10-Q relates to the operations
of the Bank and its subsidiaries.
The consolidated financial statements include the accounts of the
Company and its wholly-owned direct subsidiaries, the Bank, BRI Statutory
Trust I and BRI Statutory Trust II (issuers of trust preferred securities),
and its indirect subsidiaries, BRI Investment Corp. (a Rhode Island passive
investment company), BRI Realty Corp. (a real estate holding company) and
Acorn Insurance Agency, Inc. (a licensed insurance agency). All significant
intercompany accounts and transactions have been eliminated in
consolidation.
The interim results of consolidated operations are not necessarily
indicative of the results for any future interim period or for the entire
year. These interim consolidated financial statements do not include all
disclosures associated with annual financial statements and, accordingly,
should be read in conjunction with the annual consolidated financial
statements and accompanying notes included in the Company's Annual Report to
Shareholders filed with the Securities and Exchange Commission.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts
of assets and liabilities as of the date of the balance sheet and revenues
and expenses for the period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to change
relate to the determination of the allowance for loan losses.
The unaudited interim consolidated financial statements of the Company
have been prepared in accordance with Accounting Principles Generally
Accepted in the United States of America ("GAAP") and prevailing practices
within the banking industry and include all necessary adjustments
(consisting of only normal recurring adjustments), that, in the opinion of
management, are required for a fair presentation of the results and
financial condition of the Company.
7
(2) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if options, warrants or other
contracts to issue common stock were exercised and resulted in the issuance
of additional common stock that then shared in the earnings of the entity.
(3) Recent Accounting Developments
On July 20, 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Account Standards ("SFAS") 142, "Goodwill and
Other Intangible Assets". SFAS 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets and supersedes
Accounting Principles Board ("APB") Opinion No. 17, "Intangible Assets".
Under SFAS 142, goodwill and intangible assets that have indefinite useful
lives will no longer be amortized, but rather will be tested at least
annually for impairment. The Statement applies to existing goodwill, as well
as goodwill arising subsequent to the effective date of the Statement.
Intangible assets that have finite useful lives will continue to be
amortized over their useful lives, but without the constraint of the 40-year
maximum life required by APB Opinion No. 17. The provisions of SFAS 142 must
be applied for fiscal years beginning after December 15, 2001 and may not be
adopted earlier.
On October 17, 2001, FASB issued Action Alert No. 01-37. That Action
Alert reported a conclusion reached by FASB at its October 10, 2001 meeting
regarding the application of SFAS 142 and SFAS 141, "Business Combinations"
with respect to goodwill accounting for bank branch acquisitions. The
conclusion set forth in the October 17th Action Alert states that paragraph
5 of SFAS 72, "Accounting for Certain Acquisitions of Banking or Thrift
Institutions" applies to all acquisitions of financial institutions (or
branches thereof) whether "troubled" or not, in which the fair value of the
liabilities assumed exceeds the fair value of tangible and intangible assets
acquired." SFAS 72 was originally issued in 1983, in the context of the
savings and loan crisis and the acquisition of so-called "troubled"
financial institutions. The acquisition associated with the formation of the
Company's banking subsidiary in March 1996 was such that the fair value of
the liabilities assumed exceeded the fair value of tangible and intangible
assets acquired. Based upon the conclusion set forth in the October 17th
Action Alert, the Company continued amortizing its intangible attributable
to its March 1996 acquisition from Fleet Financial Group, Inc.
On October 1, 2002, FASB issued SFAS 147, "Acquisitions of Certain
Financial Institutions". SFAS 147 states that the specialized accounting
guidance in paragraph 5 of SFAS 72 will not apply after September 30, 2002,
and if certain criteria are met, any unidentifiable intangible asset will be
reclassified to goodwill upon adoption of the Statement. Financial
institutions meeting conditions outlined in SFAS 147 will be required to
restate previously issued financial statements for fiscal periods beginning
after December 15, 2001. The objective of the restatement requirement is to
present the balance sheet and income statement as if the amount accounted
for under SFAS 72 as an unidentifiable intangible asset had been
reclassified to goodwill as of the date SFAS 142 was initially applied. The
transition provisions of SFAS 147 are effective on October 1, 2002, however
early application is permitted. The Company adopted SFAS 147 during the
third quarter of 2002, and therefore has restated the first and second
quarters to remove any amortization of goodwill, net of taxes. At January 1,
2002, the Company had $10.7 million of intangible assets that have now been
reclassified as goodwill and will no longer be amortized, but will be
reviewed periodically for impairment.
8
The following table summarizes the effect of the restatement on the
first two quarters of 2002.
For the Quarter Ended
------------------------------------------------
March 31, 2002 June 30, 2002
---------------------- ----------------------
As As
Originally As Originally As
Reported Restated Reported Restated
---------- -------- ---------- --------
Net income (in thousands) $1,705 $1,894 $1,714 $1,909
Basic earnings per share $ 0.46 $ 0.51 $ 0.46 $ 0.51
Diluted earnings per share $ 0.43 $ 0.48 $ 0.43 $ 0.48
The following table sets forth the reconcilement of net income and
earnings per share excluding goodwill amortization for the three and nine
months ended September 30, 2002 and 2001.
Three Months Ended Nine Months Ended
September 30, September 30,
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2002 2001 2002 2001
---- ---- ---- ----
Reported net income (in thousands) $1,931 $1,576 $5,734 $4,708
Add back:
Goodwill amortization, net of taxes -- 189 -- 566
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Adjusted net income $1,931 $1,765 $5,734 $5,274
======================================
Basic earnings per share $ 0.51 $ 0.42 $ 1.53 $ 1.26
Add back:
Goodwill amortization, net of taxes -- 0.05 -- 0.15
--------------------------------------
Adjusted basic earnings per share $ 0.51 $ 0.47 $ 1.53 $ 1.41
======================================
Diluted earnings per share $ 0.48 $ 0.40 $ 1.44 $ 1.21
Add back:
Goodwill amortization, net of taxes -- 0.05 -- 0.14
--------------------------------------
Adjusted diluted earnings per share $ 0.48 $ 0.45 $ 1.44 $ 1.35
======================================
In April 2002, the FASB issued SFAS 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections". SFAS 145 among other things addresses financial
accounting and reporting of gains and losses from extinguishment of debt.
SFAS 145 requires gains and losses resulting from the extinguishment of debt
to be classified as extraordinary items only if they meet the criteria in
APB Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions". This statement rescinds
SFAS 4, "Reporting Gains and Losses from Extinguishment of Debt", SFAS 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements" and
amends SFAS 13, "Accounting for Leases". SFAS 145 is effective for fiscal
years beginning after May 15, 2002, with early application encouraged. The
Company does not believe the adoption of this Statement will have a material
impact on the Company's financial position or results of operations.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal
activities. The statement supersedes Emerging Issues Task Force ("EITF")
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs
9
to Exit an Activity (Including Certain Costs Incurred in a Restructuring)".
SFAS 146 is effective for exit or disposal activities that are initiated
after December 31, 2002, with early application encouraged. The Company does
not believe the adoption of this Statement will have a material impact on
the Company's financial position or results of operations.
10
BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis
ITEM 2. Management's Discussion and Analysis
Certain statements contained herein are "Forward Looking Statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Forward
Looking Statements may be identified by reference to a future period or
periods or by the use of forward looking terminology such as "may,"
"believes," "intends," "expects," and "anticipates" or similar terms or
variations of these terms. Actual results could differ materially from those
set forth in Forward Looking Statements as a result of certain risks and
uncertainties, including but not limited to, changes in political and
economic conditions, interest rate fluctuations, competitive product and
pricing pressures, equity and bond market fluctuations, credit risk,
inflation, as well as other risks and uncertainties detailed from time to
time in filings with the Securities and Exchange Commission ("SEC").
GENERAL
-------
The Company's principal subsidiary, Bank Rhode Island, is a commercial
bank chartered as a financial institution in the State of Rhode Island. The
Bank pursues a community banking mission and is principally engaged in
providing banking products and services to individuals and businesses in
Providence and Kent counties. The Bank is subject to competition from a
variety of traditional and nontraditional financial service providers both
within and outside of Rhode Island. The Bank offers its customers a wide
range of deposit products, nondeposit investment products, commercial,
residential and consumer loans, and other traditional banking products and
services designed to meet the needs of individuals and small- to mid-sized
businesses. The Bank also offers both commercial and consumer on-line
banking products and maintains a web site at http://www.bankri.com. The
Company and Bank are subject to regulation by a number of federal and state
agencies and undergo periodic examinations by certain of those regulatory
authorities. The Bank's deposits are insured by the Federal Deposit
Insurance Corporation ("FDIC"), subject to regulatory limits. The Bank is
also a member of the Federal Home Loan Bank of Boston ("FHLB").
OVERVIEW
--------
Total assets increased $123.5 million, or 14.3%, to $985.8 million at
September 30, 2002 from $862.3 million at December 31, 2001. The increase
was predominantly in overnight investments, US Agency securities, mortgage-
backed securities ("MBSs"), commercial loans and consumer loans. Funding of
this growth was primarily from increases in checking and savings deposits,
borrowings from the FHLB, and repayments of residential mortgage loans.
Since the end of 2001, commercial loans increased $38.3 million, or 16.0%,
consumer loans increased $13.9 million, or 22.7%, checking and savings
deposits increased $80.5 million, or 19.1%, and FHLB borrowings increased
$31.5 million, or 27.8%. Shareholders' equity was $64.9 million at September
30, 2002, and represented 6.6% of total assets.
In June 2002, the Company, through its subsidiary, BRI Statutory Trust
II, issued $5.0 million of trust preferred securities. These securities
qualify as Tier I capital for regulatory purposes and can be used to support
continued growth of the Company.
11
FINANCIAL CONDITION
-------------------
-- Investments. Total investments (consisting of overnight
investments, investment securities, MBSs and stock in the FHLB) totaled
$293.2 million, or 29.7% of total assets, at September 30, 2002, compared to
$210.7 million, or 24.4% of total assets, at December 31, 2001. All $254.7
million of investment securities and MBSs at September 30, 2002 were
classified as available for sale and carried a total of $3.3 million in net
unrealized gains. The increase of $82.6 million, or 39.2%, in total
investments was associated with the growth in total deposits and FHLB
borrowings.
-- Loans. Total loans were $638.7 million, or 64.8% of total assets,
at September 30, 2002, compared to $611.0 million, or 70.9% of total assets,
at December 31, 2001. As a result of low market interest rates, the Company
has experienced a sharp increase in residential mortgage loan prepayments
during 2002. This has led to the residential mortgage loan portfolio
decreasing $24.5 million, or 7.9%, during the first nine months of 2002, as
prepayments exceeded new loan purchases.
The commercial loan portfolio (consisting of commercial & industrial,
small business, commercial real estate, multi-family real estate and
construction loans) increased $38.3 million, or 16.0%, during the first
three quarters of 2002. Particular emphasis is placed on the generation of
small- to medium-sized commercial relationships (those relationships with
$5.0 million or less in loan commitments). The Bank is also active in small
business lending (loans of $250,000 or less) in which it utilizes credit
scoring, in conjunction with traditional review standards, and employs
streamlined documentation. The Bank is a participant in the U.S. Small
Business Administration ("SBA") Preferred Lender Program in Rhode Island and
the 7a Guarantee Loan Program in Massachusetts.
The consumer loan portfolio increased $13.9 million, or 22.7%,
reaching $75.3 million at September 30, 2002. This increase was
predominantly in home equity related loans, which grew $16.1 million, or
31.2%, since December 31, 2001. While origination efforts continue to be
concentrated on commercial and consumer loan opportunities, the Bank also
originates residential mortgage loans on a limited basis for its customers.
Additionally, until such time as the Company can generate sufficient
commercial and consumer loans to utilize available cash flow, or to
otherwise meet investment objectives, it also intends to continue purchasing
residential mortgage and automobile loans as opportunities develop.
12
The following is a breakdown of loans receivable:
September 30, December 31,
2002 2001
------------- ------------
(In thousands)
Residential mortgage loans:
One- to four-family adjustable rate $267,800 $285,589
One- to four-family fixed rate 16,756 23,306
-------------------------
Subtotal 284,556 308,895
Premium on loans acquired 1,224 1,381
Net deferred loan origination fees (66) (64)
-------------------------
Total residential mortgage loans $285,714 $310,212
=========================
Commercial loans:
Commercial real estate - nonowner occupied $ 83,260 $ 73,369
Commercial and industrial 55,628 53,677
Commercial real estate - owner occupied 55,765 46,698
Small business 27,361 24,122
Multi-family real estate 17,744 14,927
Construction 17,190 14,027
Leases and other 20,971 12,715
-------------------------
Subtotal 277,919 239,535
Net deferred loan origination fees (249) (171)
-------------------------
Total commercial loans $277,670 $239,364
=========================
Consumer loans:
Home equity - lines of credit $ 35,294 $ 28,460
Home equity - term loans 32,153 22,930
Automobile 3,987 6,335
Installment 997 1,240
Savings secured 617 656
Unsecured and other 1,684 1,153
-------------------------
Subtotal 74,732 60,774
Premium on loans acquired 120 192
Net deferred loan origination costs 476 422
-------------------------
Total consumer loans $ 75,328 $ 61,388
=========================
-- Deposits and Borrowings. Total deposits increased by $60.6 million,
or 9.0%, during the first three quarters of 2002, from $670.4 million, or
77.8% of total assets, at December 31, 2001, to $731.0 million, or 74.2% of
total assets, at September 30, 2002. The decrease in the relative percentage
of total assets resulted from first quarter total asset growth being
primarily funded by FHLB borrowings. In addition, the composition of total
deposits has changed since the end of 2001. Core deposit accounts (checking
and savings accounts) increased $80.5 million, or 19.1%, while certificates
of deposit decreased $19.9 million, or 8.0%. The increase in NOW accounts
has primarily been in a newly-designed premium product positioned to compete
against short-term investments. The Company continues its strategy of
emphasizing core deposit growth over certificate of deposit growth. The
decline in certificates of deposits also reflects customer movement away
from extended term deposits in response to the current low interest rate
environment. At September 30, 2002, core deposit accounts comprised 68.8% of
total deposits, compared to 63.0% of total deposits at December 31, 2001.
13
The following table sets forth certain information regarding deposits:
September 30, 2002 December 31, 2001
------------------------------- -------------------------------
Percent Weighted Percent Weighted
of Average of Average
Amount Total Rate Amount Total Rate
------ ------- -------- ------ ------- --------
(Dollars in thousands)
NOW accounts $ 88,120 12.1% 1.45% $ 44,445 6.6% 0.40%
Money market accounts 9,708 1.3% 1.34% 9,914 1.5% 1.40%
Savings accounts 275,060 37.6% 1.87% 254,861 38.0% 1.90%
Certificate of deposit accounts 228,356 31.2% 3.24% 248,268 37.0% 4.15%
----------------- -----------------
Total interest bearing deposits 601,244 82.2% 2.32% 557,488 83.1% 2.77%
Noninterest bearing accounts 129,773 17.8% -- 112,925 16.9% --
----------------- -----------------
Total deposits $731,017 100.0% 1.91% $670,413 100.0% 2.31%
================================================================
The Company, through the Bank's membership in the FHLB, has access to
a variety of borrowing alternatives, and management will from time to time
take advantage of these opportunities to fund asset growth. During the first
nine months of 2002, FHLB borrowings increased $31.5 million, or 27.8%, as
the Company sought to take advantage of lower, long-term borrowing rates to
fund its asset growth. The proceeds from these new borrowings were primarily
reinvested in hybrid ARM MBSs and allowed the Company to control the
duration match of its balance sheet. However, on a long-term basis, the
Company intends to continue its efforts concentrated on increasing its core
deposits.
Asset Quality
-------------
The definition of nonperforming assets includes nonperforming loans
and other real estate owned ("OREO"). OREO consists of real estate acquired
through foreclosure proceedings and real estate acquired through acceptance
of a deed in lieu of foreclosure. Nonperforming loans are defined as
nonaccrual loans, loans past due 90 days or more, but still accruing, and
impaired loans. Under certain circumstances the Company may restructure the
terms of a loan as a concession to a borrower. These restructured loans are
considered impaired loans.
-- Nonperforming Assets. At September 30, 2002, the Company had
nonperforming assets of $538,000, which represented 0.05% of total assets.
This compares to nonperforming assets of $1.0 million, or 0.12% of total
assets, at December 31, 2001. The level of nonperforming assets remains at a
low level, but as the loan portfolio continues to grow and mature, or if
economic conditions worsen, management believes it highly likely that the
level of nonperforming assets will increase, as will its level of charged-
off loans. Nonperforming assets at September 30, 2002, consisted of
nonaccrual residential mortgage loans aggregating $454,000 and nonaccrual
commercial loans aggregating $84,000. There were no impaired loans at either
September 30, 2002 or December 31, 2001. The Company evaluates the
underlying collateral of each nonperforming loan and continues to pursue the
collection of interest and principal.
Delinquencies. At September 30, 2002, loans with an aggregate balance
of $326,000 were 60 to 89 days past due, an increase of $195,000, or 148.9%,
from $131,000 reported at December 31, 2001. The majority of these loans at
both dates were residential mortgage loans and are secured.
14
The following table sets forth information regarding nonperforming
assets and loans 60-89 days past due as to interest at the dates indicated.
September 30, December 31,
2002 2001
------------- ------------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $538 $ 753
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
----------------------
Total nonperforming loans 538 753
Other real estate owned -- 264
----------------------
Total nonperforming assets $538 $1,017
======================
Delinquent loans 60-89 days past due $326 $ 131
Nonperforming loans as a percent of total loans .08% .12%
Nonperforming assets as a percent of total assets .05% .12%
Delinquent loans 60-89 days past due as a percent
of total loans .05% .02%
Adversely Classified Assets. The Company's management adversely
classifies certain assets as "substandard," "doubtful" or "loss" based on
criteria established under banking regulations. An asset is considered
substandard if inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Substandard
assets include those characterized by the "distinct possibility" that the
insured institution will sustain "some loss" if existing deficiencies are
not corrected. Assets classified as doubtful have all of the weaknesses
inherent in those classified substandard with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the
basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as loss are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted.
At September 30, 2002, the Company had $8.4 million of assets that
were classified as substandard. This compares to $8.7 million of assets that
were classified as substandard at December 31, 2001. The Company had no
assets that were classified as doubtful or loss at either date. Performing
loans may or may not be adversely classified depending upon management's
judgment with respect to each individual loan. At September 30, 2002,
included in the $8.4 million of assets that were classified as substandard,
were $7.9 million of performing loans. This compares to $7.9 million of
adversely classified performing assets as of December 31, 2001. Adversely
classified assets are a reflection of commercial credit quality. An increase
in adversely classified assets may lead to an increase in nonperforming
assets and an increase in the provision for loan losses in future periods.
Allowance for Loan Losses
-------------------------
During the first nine months of 2002, the Company made provisions to
the allowance for loan losses totaling $1.4 million and had $401,000 of net
charge-offs, bringing the balance in the allowance to $9.5 million at
September 30, 2002, compared to $8.5 million at December 31, 2001. The
allowance, expressed as a percentage of total loans, was 1.49% as of
September 30, 2002, compared to 1.40% at the prior year-end and stood at
1774.7% of nonperforming loans at September 30, 2002, compared to 1132.0% of
nonperforming loans at December 31, 2001.
Assessing the adequacy of the allowance for loan losses involves
substantial uncertainties and is based upon management's evaluation of the
amounts required to meet estimated charge-offs in the
15
loan portfolio after weighing various factors. Among these factors are the
risk characteristics of the loan portfolio, the quality of specific loans,
the level of nonaccruing loans, current economic conditions, trends in
delinquencies and charge-offs, and the value of underlying collateral, all
of which can change frequently. Based on this evaluation, management
believes that the allowance for loan losses, as of September 30, 2002, is
adequate.
While management evaluates currently available information in
establishing the allowance for loan losses, future adjustments to the
allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review a financial institution's allowance for loan losses and carrying
amounts of other real estate owned. Such agencies may require the financial
institution to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
RESULTS OF OPERATIONS
---------------------
The Company's operating results depend primarily on its "net interest
income," or the difference between its interest income and its cost of
money, and on the quality of its assets. Interest income depends on the
average amount of interest-earning assets outstanding during the period and
the interest rates earned thereon. Cost of money is a function of the
average amount of deposits and borrowed money outstanding during the period
and the interest rates paid thereon. Earnings are further influenced by the
quality of assets, through the amount of interest income lost on nonaccrual
loans, the amount of additions to the allowance for loan losses and the
amount of expenses incurred as a result of resolving troubled assets.
The Bank's formation in 1996 resulted in the generation of $17.5
million of intangibles that prior to January 1, 2002 were being amortized
over a 15-year period. Pursuant to SFAS 147, the transaction in which those
intangibles arose was deemed to be a business combination, and as such, the
Company was required to stop amortization of these intangibles on January 1,
2002. The Company has restated its income for the first two quarters of 2002
to reflect the elimination of this goodwill amortization. The amortization
of these intangibles reduced the Bank's pre-tax income $1.2 million
annually.
Because of the impact of this amortization, certain measures of
financial performance for periods prior to January 1, 2002, have been
calculated excluding such amortization and any related income taxes. These
measures are identified as "cash" or "cash basis" and have been provided to
assist the reader in comparing the Company's 2002 operating results to its
2001 operating results. Information presented on a cash basis is not in
accordance with GAAP, but management believes it to be beneficial to gaining
an understanding of the core performance of the Company.
16
Three Months Ended September 30, 2002 and 2001
----------------------------------------------
-- Overview. The Company reported net income for the third quarter of
2002 of $1.9 million, up $355,000, or 22.5%, from the third quarter of 2001.
Diluted earnings per common share were $0.48 for the third quarter of 2002,
compared to $0.40 for the third quarter of 2001. Diluted cash earnings per
common share were $0.45 for the 2001 period.
The Company reported a return on average assets of 0.80% and a return
on average equity of 12.75% for the 2002 period, as compared to a return on
average assets of 0.75% and a return on average equity of 11.02% for the
2001 period. Cash basis return on average assets and cash basis return on
average equity were 0.85% and 12.34% for the 2001 period, respectively.
-- Net Interest Income. For the quarter ended September 30, 2002, net
interest income was $7.9 million, compared to $7.5 million for the 2001
period. The net interest margin for the third quarter of 2002 was 3.42%
compared to a net interest margin of 3.72% for the 2001 period. The increase
in net interest income of $439,000, or 5.9%, was primarily attributable to
the continued growth of the Company. Average earnings assets were $120.9
million, or 15.2%, higher and average interest-bearing liabilities were
$105.9 million, or 15.8%, higher than the comparable period a year earlier.
The decrease of 30 basis points in the net interest margin was primarily
attributable to a drop in market interest rates and an increase in
residential mortgage loan and MBS prepayments.
-- Interest Income. Investments. Total investment income was $3.2
million for the quarter ended September 30, 2002, compared to $2.8 million
for the third quarter of 2001. This increase in total investment income of
$358,000, or 12.6%, was primarily attributable to an increase of $87.7
million, or 44.0%, in the average balance of investments. The Company's
investments are primarily comprised of US Agency securities or MBSs with
remaining maturities or repricing periods of less than five years. In
addition to assisting in overall tax planning, management believes that this
composition, along with a structured maturity ladder, provides more stable
earnings and predictable cash flows from the portfolio.
-- Interest Income. Loans. Interest from loans was $10.4 million for
the three months ended September 30, 2002, and represented a yield on total
loans of 6.56%. This compares to $11.2 million of interest, and a yield of
7.49%, for the third quarter of 2001. Declining market interest rates,
coupled with residential mortgage loan prepayment activity, resulted in
lower interest from the loan portfolio. Interest from residential mortgage
loans decreased $1.1 million and consumer and other loan income decreased
$133,000, or 11.9%, between the two quarters. Partially offsetting these
decreases in interest income, interest from commercial loans increased
$363,000, or 8.1%, as a result of strong growth in commercial outstandings.
Since its inception, the Bank has concentrated its origination efforts on
commercial and consumer loan opportunities, while purchasing residential
mortgage loans, and more recently automobile loans, as cash flows dictated.
The average balance of the various components of the loan portfolio changed
from the third quarter of 2001 as follows: commercial loans increased $48.3
million, or 21.7%, and consumer and other loans increased $6.9 million, or
11.3%, while residential mortgage loans decreased $21.9 million, or 7.0%. As
a result of declining market interest rates, coupled with increased
prepayment activity, the yields on the various loan portfolio components
changed as follows: commercial loans decreased 89 basis points, to 7.07%;
consumer and other loans decreased 153 basis points, to 5.80%, and
residential mortgage loans decreased 91 basis points, to 6.27%.
17
-- Interest Expense. Interest paid on deposits and borrowings
decreased $909,000, or 13.8%, to $5.7 million for the three months ended
September 30, 2002, from $6.6 million paid during the third quarter of 2001.
The decrease in total interest expense was primarily attributable to a
decrease in market interest rates, partially offset by an increase in the
average balance of deposits and borrowings. The overall average cost for
interest-bearing liabilities decreased 100 basis points from 3.90% for the
third quarter of 2001 to 2.90% for the third quarter of 2002. Average costs
for the various components of interest-bearing liabilities changed from the
third quarter of 2001 as follows: money market accounts decreased 57 basis
points, to 1.35%, savings accounts decreased 69 basis points, to 1.87%,
certificate of deposit accounts decreased 179 basis points, to 3.33%, and
borrowings decreased 68 basis points to 4.61%, while NOW accounts increased
77 basis points, to 1.33%. The increase in the average cost of NOW accounts
was attributable to the introduction of a premium NOW account earlier in
2002. Meanwhile, the average balance of interest-bearing liabilities
increased $105.9 million, from $670.7 million in the third quarter of 2001
to $776.6 million in the third quarter of 2002, as NOW and savings account
growth, along with borrowings, were utilized to fund much of the asset
growth. Liability costs are dependent on a number of factors including
general economic conditions, national and local interest rates, competition
in the local deposit marketplace, interest rate tiers offered and the
Company's cash flow needs.
-- Provision for Loan Losses. The provision for loan losses was
$575,000 for the quarter ended September 30, 2002, up $9,000, or 1.6%, from
the same quarter last year. As the loan portfolio continues to grow and
mature, or if economic conditions worsen, management believes it highly
likely that the level of nonperforming assets will increase, which in turn
may lead to increases in the provision for loan losses in future periods.
Management evaluates several factors including new loan originations, actual
and estimated charge-offs, the risk characteristics of the loan portfolio
and general economic conditions when determining the provision for each
quarter. Also see discussion under "Allowance for Loan Losses."
-- Noninterest Income. Total noninterest income increased $440,000, or
32.4%, to $1.8 million for the third quarter of 2002, from $1.4 million for
the 2001 quarter. The Bank's purchase of $10.0 million of bank-owned life
insurance during the first quarter of 2002 resulted in $143,000 of
noninterest income during the third quarter. This income was not present
during the third quarter of 2001. Service charges on deposit accounts, which
represent the largest source of noninterest income for the Company,
increased $124,000, or 14.3%, from $869,000 for the quarter ended September
30, 2001, to $993,000 for the same period in 2002, as core deposit accounts
continued to grow. In addition, Commissions on nondeposit investment
products increased $185,000, or 112.8%, compared to the third quarter of
2001 as a result of efforts begun in 2001 to revitalize the program.
Partially offsetting these increases was a decrease of $29,000, or 27.1%, in
Loan related fees that resulted primarily from the timing of one-time
prepayment penalties on commercial loans.
-- Noninterest Expense. Total noninterest expense for the third
quarter of 2002 increased $407,000, or 7.0%, to $6.2 million from $5.8
million in 2001. After removing the effects of SFAS 147, total operating
noninterest expense increased $698,000, or 12.6%, as the 2002 period does
not contain any goodwill amortization, while the 2001 period included
$291,000 of goodwill amortization. The increase in operating noninterest
expenses occurred primarily in the following areas: Salaries and employee
benefits (up $550,000, or 19.5%), Occupancy and Equipment (up $102,000, or
15.2%), Data processing (up $34,000, or 7.3%) and Professional services (up
$120,000, or 57.1%). During 2001 and into 2002, the Company experienced
substantial growth in both loans and core deposits that resulted in the
increased operating costs evidenced in the third quarter of 2002. In
addition, the Company retained professional assistance to help in evaluating
its data processing
18
alternatives and to develop and test software being deployed in conjunction
with its CampusMate(TM) product. As a result, the Company's efficiency ratio
was 64.29% for the third quarter of 2002, compared to an efficiency ratio of
66.08%, and a cash basis efficiency ratio of 62.78%, for the third quarter
of 2001.
-- Income Tax Expense. Income tax expense of $957,000 was recorded for
the quarter ended September 30, 2002, compared to $849,000 for the 2001
period. This represented total effective tax rates of 33.1% and 35.0%,
respectively. Tax-favored income from U.S. Agency securities, along with the
utilization of a Rhode Island passive investment company, has reduced the
Company's effective tax rate from the 39.9% combined statutory federal and
state tax rates. The 2002 period also benefited from the tax-favored status
of the Company's investment in bank-owned life insurance.
Nine Months Ended September 30, 2002 and 2001
---------------------------------------------
-- Overview. Net income for the first nine months of 2002, increased
$1.0 million, or 21.8%, to $5.7 million, or $1.44 per diluted common share,
from $4.7 million, or $1.21 per diluted common share, for the first nine
months of 2001. Diluted cash earnings per common share were $1.35 for the
2001 period.
This performance represented a return on average assets of 0.83% and a
return on average equity of 12.77% for the 2002 period, as compared to a
return on average assets of 0.78% and a return on average equity of 11.39%
for the 2001 period. Cash basis return on average assets and cash basis
return on average equity were 0.89% and 12.75% for the 2001 period,
respectively.
-- Net Interest Income. For the nine months ended September 30, 2002,
net interest income was $23.5 million, compared to $21.8 million for the
first three quarters of 2001. The net interest margin for the 2002 period
was 3.57% compared to a net interest margin of 3.78% for the 2001 period.
The increase in net interest income of $1.8 million, or 8.1%, was primarily
attributable to the overall growth of the Company. Average earning assets
increased $112.6 million, or 14.6%, and average interest-bearing liabilities
increased $98.1 million, or 15.1%, over the comparable period a year
earlier. The decrease of 21 basis points in the net interest margin was
primarily caused by the dramatic drop in market interest rates occurring in
the second half of 2001, coupled with the asset-sensitive nature of the
Company's balance sheet.
-- Interest Income. Investments. Total investment income was $9.4
million for the nine months ended September 30, 2002, compared to $8.8
million for the first nine months of 2001. This increase in total investment
income of $682,000, or 7.8%, was primarily attributable to a $53.8 million,
or 42.4%, increase in the average balance of MBSs. Meanwhile, the overall
yield on investments decreased 139 basis points, from 6.05% in 2001, to
4.66% in 2002, in response to dramatically lower market interest rates and
accelerated prepayments on MBSs.
-- Interest Income. Loans. Interest from loans was $30.8 million for
the nine months ended September 30, 2002, and represented a yield on total
loans of 6.71%. This compares to $33.7 million of interest, and a yield of
7.79%, for the 2001 period. This decrease of $2.9 million, or 8.5%, in
interest on loans was due primarily to a decrease in the average yield on
loans resulting from the dramatic drop in market interest rates and faster
prepayments over the past year. The average yield on the various components
of the loan portfolio changed as follows: residential mortgage loans
19
decreased 84 basis points, to 6.49%; commercial loans decreased 123 basis
points, to 7.16%; and consumer and other loans decreased 193 basis points,
to 5.97%. The effect of the decreases in average yield was partially offset
by an increase in the average balance of the commercial loan portfolio. The
average balance of the various components of the loan portfolio changed as
follows: residential mortgage loans decreased $2.5 million, or 0.8%,
commercial loans increased $34.2 million, or 15.6%, and consumer and other
loans increased $3.9 million, or 6.4%. The Company has continued to
concentrate its origination efforts on commercial and consumer loan
opportunities, but also originates residential mortgage loans for its
portfolio on a limited basis.
-- Interest Expense. Interest paid on deposits and borrowings
decreased $4.0 million, or 19.2%, to $16.7 million for the nine months ended
September 30, 2002, compared to $20.6 million for the same period during
2001. The decrease in total interest expense was also primarily attributable
to the dramatic drop in market interest rates over the past year and was
partially offset by growth in checking and savings deposits, along with the
use of borrowings to fund the overall growth of the Company. The overall
average cost for interest-bearing liabilities decreased 126 basis points
from 4.24% for the first three quarters of 2001, to 2.98% for the first
three quarters of 2002. Deposit costs are dependent on a number of factors
including general economic conditions, national and local interest rates,
competition in the local marketplace, interest rate tiers offered, and the
Company's cash flow needs. Partially offsetting the effect of the decline in
market interest rates, the average balance of interest-bearing liabilities
increased $98.1 million, from $650.5 million in 2001, to $748.6 million in
2002. The Company continued to experience strong average balance growth in
core deposit accounts, specifically noninterest bearing demand deposit
accounts (up $17.1 million, or 17.5%), NOW accounts (up $17.0 million, or
43.6%) and savings accounts (up $40.7 million, or 17.7%). In addition, the
Company increased its utilization of FHLB borrowings (up $54.1 million, or
58.5%).
-- Provision for Loan Losses. The provision for loan losses was $1.4
million for the nine months ended September 30, 2002, compared to $1.4
million for the same period last year. The allowance, expressed as a
percentage of total loans, was 1.49% as of September 30, 2002, compared to
1.40% at the prior year-end and stood at 1774.7% of nonperforming loans at
September 30, 2002, compared to 1132.0% of nonperforming loans at December
31, 2001. Management evaluates several factors including new loan
originations, actual and estimated charge-offs, and the risk characteristics
of the loan portfolio when determining the provision for the quarter. Also
see discussion under "Allowance for Loan Losses."
-- Noninterest Income. Total noninterest income increased $1.1
million, or 29.6%, from the first three quarters of 2001, to $4.9 million
for the first three quarters of 2002. Service charges on deposit accounts,
which represents the largest source of noninterest income, rose $231,000, or
9.1%, from $2.5 million for the 2001 period, to $2.8 million for the 2002
period, primarily as a result of continued growth in core deposit accounts.
Commissions on nondeposit investment products increased $461,000, or 148.7%,
in response to efforts to revitalize this program begun in 2001.
Additionally, the Bank's purchase of $10.0 million of bank-owned life
insurance during the first quarter of 2002 resulted in $380,000 of
noninterest income for the nine month period.
-- Noninterest Expense. Noninterest expenses for the first nine months
of 2002 increased a total of $1.5 million, or 8.7%, to $18.3 million. After
removing the effects of SFAS 147, total operating noninterest expense
increased $2.3 million, or 14.7%, as the 2002 period does not contain any
goodwill amortization, while the 2001 period included $873,000 of goodwill
amortization. The increase in operating noninterest expenses occurred
primarily as a result of the overall growth of the
20
Company, along with development of new products, and was centered in the
following areas: Salaries and employee benefits (up $1.5 million, or 18.3%),
Occupancy and Equipment (up $253,000, or 12.8%), Data processing (up
$77,000, or 5.7%), Marketing (up $157,000, or 21.2%) and Professional
services (up $518,000, or 84.9%). Partially offsetting these increases was a
decrease in: Other real estate owned expense (down $166,000, or 97.6%). The
Company's efficiency ratio was 64.53% for the first three quarters of 2002,
compared to an efficiency ratio of 66.06%, and a cash basis efficiency ratio
of 62.64%, for the 2001 period.
-- Income Tax Expense. The Company recorded income tax expense of $2.9
million for the first nine months of 2002, compared to $2.6 million for the
same period during 2001. This represented total effective tax rates of 33.7%
and 35.2%, respectively. Tax-favored income from U.S. Agency securities and
bank-owned life insurance, along with its utilization of a Rhode Island
passive investment company, has reduced the Company's effective tax rate
from the 39.9% combined statutory federal and state tax rates.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
-- Liquidity. Liquidity is defined as the ability to meet current and
future financial obligations of a short-term nature. The Company further
defines liquidity as the ability to respond to the needs of depositors and
borrowers, as well as to earnings enhancement opportunities, in a changing
marketplace.
The primary source of funds for the payment of dividends and expenses
by the Company is dividends paid to it by the Bank. Bank regulatory
authorities generally restrict the amounts available for payment of
dividends if the effect thereof would cause the capital of the Bank to be
reduced below applicable capital requirements. These restrictions indirectly
affect the Company's ability to pay dividends. The primary sources of
liquidity for the Bank consist of deposit inflows, loan repayments, borrowed
funds, maturity of investment securities and sales of securities from the
available for sale portfolio. Management believes that these sources are
sufficient to fund the Bank's lending and investment activities.
Management is responsible for establishing and monitoring liquidity
targets as well as strategies and tactics to meet these targets. In general,
the Company maintains a high degree of flexibility. At September 30, 2002,
overnight investments, investment securities and MBSs available for sale
amounted to $285.6 million, or 29.0% of total assets. This compares to
$205.0 million, or 23.8% of total assets at December 31, 2001. The Bank is a
member of the FHLB and, as such, has access to both short- and long-term
borrowings. In addition, the Bank maintains a line of credit at the FHLB as
well as a line of credit with a correspondent bank. There have been no
adverse trends in the Company's liquidity or capital reserves. Management
believes that the Company has adequate liquidity to meet its commitments.
-- Capital Resources. Total shareholders' equity of the Company at
September 30, 2002 was $64.9 million, as compared to $59.1 million at
December 31, 2001. This increase of $5.8 million was primarily the result of
net income for the period of $5.7 million, plus changes in unrealized gains
on investment securities of $1.2 million, less dividends paid on common
stock of $1.5 million.
All FDIC-insured institutions must meet specified minimal capital
requirements. These regulations require banks to maintain a minimum leverage
capital ratio. In addition, the FDIC has
21
adopted capital guidelines based upon ratios of a bank's capital to total
assets adjusted for risk. The risk-based capital guidelines include both a
definition of capital and a framework for calculating risk-weighted assets
by assigning balance sheet assets and off-balance sheet items to broad risk
categories. These regulations require banks to maintain minimum capital
levels for capital adequacy purposes and higher capital levels to be
considered "well capitalized."
Capital guidelines have also been issued by the Federal Reserve Board
("FRB") for bank holding companies. These guidelines require the Company to
maintain minimum capital levels for capital adequacy purposes. In general,
the FRB has adopted substantially identical capital adequacy guidelines as
the FDIC. Such standards are applicable to bank holding companies and their
bank subsidiaries on a consolidated basis.
As of September 30, 2002, the Company and the Bank met all applicable
minimum capital requirements and were considered "well capitalized" by both
the FRB and the FDIC. The Company's and the Bank's actual and required
capital amounts and ratios are as follows:
Minimum Required Minimum Required
For Capital To Be Considered
Actual Adequacy Purposes "Well Capitalized"
----------------- ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
At September 30, 2002:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $59,988 6.31% $28,501 3.00% $47,502 5.00%
Tier I capital (to risk weighted assets) 59,988 10.26% 23,391 4.00% 35,087 6.00%
Total capital (to risk weighted assets) 67,322 11.51% 46,782 8.00% 58,478 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $53,780 5.61% $28,774 3.00% $47,957 5.00%
Tier I capital (to risk weighted assets) 53,780 9.20% 23,379 4.00% 35,069 6.00%
Total capital (to risk weighted assets) 61,114 10.46% 46,759 8.00% 58,449 10.00%
At December 31, 2001:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $50,433 5.93% $25,508 3.00% $42,513 5.00%
Tier I capital (to risk weighted assets) 50,433 9.86% 20,462 4.00% 30,694 6.00%
Total capital (to risk weighted assets) 56,803 11.10% 40,925 8.00% 51,156 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $49,702 5.84% $25,526 3.00% $42,544 5.00%
Tier I capital (to risk weighted assets) 49,702 9.72% 20,458 4.00% 30,687 6.00%
Total capital (to risk weighted assets) 56,121 10.97% 40,916 8.00% 51,145 10.00%
22
BANCORP RHODE ISLAND, INC.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
INTEREST RATE RISK
------------------
The principal market risk facing the Company is interest rate risk.
The Company's objective regarding interest rate risk is to manage its assets
and funding sources to produce results which are consistent with its
liquidity, capital adequacy, growth and profitability goals, while
minimizing the vulnerability of its operations to changes in market interest
rates. The Bank's Asset/Liability Committee ("ALCO") manages the Company's
interest rate risk position using both income simulation and interest rate
sensitivity "gap" analysis. The ALCO has established internal parameters for
monitoring the income simulation and gap analysis. These guidelines serve as
benchmarks for evaluating actions to balance the current position against
overall strategic goals. The ALCO monitors current exposures and reports
these to the Board of Directors.
Simulation is used as the primary tool for measuring the interest rate
risk inherent in the Company's balance sheet at a given point in time by
showing the effect on net interest income, over a 24-month period, of
interest rate ramps of up to 200 basis points. These simulations take into
account repricing, maturity and prepayment characteristics of individual
products. The ALCO reviews simulation results to determine whether the
downside exposure resulting from changes in market interest rates remains
within established tolerance levels over both a 12-month and 24-month
horizon, and develops appropriate strategies to manage this exposure. The
Company's limits on interest rate risk specify that if interest rates were
to shift up or down 200 basis points over a 12-month period, estimated net
interest income for those 12 months and the subsequent 12 months, should
decline by no more than 5.0% or 10.0%, respectively. As of June 30, 2002,
net interest income simulation indicated that the Company's exposure to
changing interest rates was outside of the 10% tolerance level established
for the second year of a 200 basis point decline. This exposure primarily
results from the unusually low current rates paid on deposit accounts and
the extremely high prepayment speeds anticipated for mortgage-related assets
if market rates declined 200 basis points. The current rates on many deposit
accounts are so low, that they cannot decline 200 basis points without
becoming negative. This results in a floor of zero percent for these deposit
accounts, and this floor causes compression of the net interest margin for
modeling purposes. The ALCO reviews the methodology utilized for calculating
interest rate risk exposure and may, from time to time, adopt modifications
to this methodology. While the ALCO reviews simulation assumptions and
methodology to ensure that they reflect historical experience, it should be
noted that income simulation may not always prove to be an accurate
indicator of interest rate risk because the actual repricing, maturity and
prepayment characteristics of individual products may differ from the
estimates used in the simulations.
23
The following table presents the estimated impact of interest rate
ramps on the Company's estimated net interest income over a 24-month period
beginning October 1, 2002:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
------ -------
(Dollars in thousands)
Initial 12-Month Period:
Up 200 basis points $ 872 2.88%
Up 100 basis points 514 1.70%
Down 100 basis points (684) (2.26%)
Down 200 basis points (1,333) (4.40%)
Subsequent 12-Month Period:
Up 200 basis points $ 1,532 5.48%
Up 100 basis points 1,154 4.12%
Down 100 basis points (1,912) (6.84%)
Down 200 basis points (4,108) (14.69%)
The Company also uses interest rate sensitivity gap analysis to
provide a more general overview of its interest rate risk profile. The
interest rate sensitivity gap is defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing within
a given time period. At September 30, 2002, the Company's one year
cumulative gap was a positive $98.2 million, or 9.96% of total assets.
For additional discussion on interest rate risk see the section titled
"Asset and Liability Management" contained on pages 39 to 41 of the
Company's 2001 Annual Report to Shareholders.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation of the effectiveness of the Company's
disclosure controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report, the undersigned officers of the
Company have concluded that such disclosure controls and procedures are
adequate. There were no significant changes in internal controls or in other
factors that could significantly affect internal controls, including any
corrective actions with regard to significant deficiencies and material
weaknesses, subsequent to the date of the most recent evaluation by the
undersigned officers of the Company of the design and operation of internal
controls which could adversely affect the Company's ability to record,
process, summarize and report financial data.
24
BANCORP RHODE ISLAND, INC.
Other Information
PART II. Other Information
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Company or its subsidiaries are a party, or to which any of their
property is subject, other than ordinary routine litigation
incidental to the business of banking.
ITEM 2. CHANGE IN SECURITIES
No information to report.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
No defaults upon senior securities have taken place.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
No information to report.
ITEM 5. OTHER INFORMATION
No information to report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350 as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350 as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Current Report on Form 8-K dated October 7, 2002, announcing
that as a result of the issuance of SFAS 147 on October 1,
2002, the Company is required to eliminate $1.2 million of
annual goodwill amortization beginning January 1, 2002. The
Company will restate its income for the first two quarters of
2002 to reflect the elimination of goodwill amortization and
will adopt the new FASB standard beginning in the third
quarter.
24
BANCORP RHODE ISLAND, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Bancorp Rhode Island, Inc.
November 12, 2002 By: /s/ Merrill W. Sherman
----------------- ---------------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
November 12, 2002 By: /s/ Albert R. Rietheimer
----------------- ---------------------------
(Date) Albert R. Rietheimer
Chief Financial Officer
and Treasurer
26
FORM 10-Q CERTIFICATIONS
I, Merrill W. Sherman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Bancorp Rhode
Island, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
e) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
f) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
c) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
/s/ Merrill W. Sherman
------------------------
Merrill W. Sherman
President and
Chief Executive Officer
FORM 10-Q CERTIFICATIONS
I, Albert R. Rietheimer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Bancorp Rhode
Island, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
g) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
h) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
d) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
/s/ Albert R. Rietheimer
------------------------
Albert R. Rietheimer
Chief Financial Officer
and Treasurer