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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
(Quarterly Report Under Section 13 of the Securities Exchange Act of 1934)
For the quarter ended: March 31, 2006
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 of (IRS Employer
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 or 15(d) 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 by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer, as defined in
Section 12b-2 of the Exchange Act of 1934.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of May 1, 2006:
Common Stock - Par Value $0.01 4,760,171 shares
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(class) (outstanding)
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1
Bancorp Rhode Island, Inc.
Quarterly Report on Form 10-Q
Table of Contents
Description Page Number
----------- -----------
Cover Page 1
Table of Contents 2
Part I - Financial Information
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Changes in Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Condensed Notes to Consolidated Financial Statements 7-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-26
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27-28
Item 4. Controls and Procedures 28
Part II - Other Information
Item 1. Legal Proceedings 29
Item 1A. Risk Factors 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits 29
Signature Page 30
Special Note Regarding Forward Looking Statements
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We make certain forward looking statements in this Quarterly Report on
Form 10-Q and in other documents that we incorporate by reference into this
report that are based upon our current expectations and projections about
current events. We intend these forward looking statements to be covered by
the safe harbor provisions for "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended and Section
21E of the Securities Exchange Act of 1934, as amended, and we are including
this statement for purposes of these safe harbor provisions. You can
identify these statements by reference to a future period or periods by our
use of the words "estimate," "project," "may," "believe," "intend,"
"anticipate," "plan," "seek," "expect" and similar terms or variations of
these terms.
Actual results may differ materially from those set forth in forward
looking statements as a result of risks and uncertainties, including those
detailed from time to time in our filings with the Securities and Exchange
Commission. Our forward looking statements do not reflect the potential
impact of any future acquisition, mergers, dispositions, joint ventures or
investments we may make. We do not assume any obligation to update any
forward looking statements.
2
BANCORP RHODE ISLAND, INC.
Consolidated Balance Sheets (unaudited)
March 31, December 31,
2006 2005
--------- ------------
(In thousands)
ASSETS:
Cash and due from banks $ 22,857 $ 30,177
Overnight investments 3,723 10,370
Total cash and cash equivalents 26,580 40,547
Investment securities available for sale
(amortized cost of $161,290 and $153,328
at March 31, 2006 and December 31, 2005,
respectively) 158,369 150,959
Mortgage-backed securities available for sale
(amortized cost of $226,804 and $237,449 at
March 31, 2006 and December 31, 2005,
respectively) 221,225 234,858
Total securities available for sale 379,594 385,817
Stock in Federal Home Loan Bank of Boston 16,530 16,062
Loans and leases receivable:
Commercial loans and leases 441,521 438,309
Residential mortgage loans 302,344 306,016
Consumer and other loans 213,543 206,481
Total loans and leases receivable 957,408 950,806
Less allowance for loan and lease losses (12,282) (12,168)
Net loans and leases receivable 945,126 938,638
Premises and equipment, net 15,263 14,858
Goodwill 11,234 11,234
Accrued interest receivable 7,144 6,965
Investment in bank-owned life insurance 20,111 18,824
Prepaid expenses and other assets 9,258 9,334
Total assets $1,430,840 $1,442,279
LIABILITIES:
Deposits:
Demand deposit accounts $ 175,132 $ 185,089
NOW accounts 78,791 89,594
Money market accounts 9,737 12,122
Savings accounts 344,134 341,115
Certificate of deposit accounts 348,339 353,049
Total deposits 956,133 980,969
Overnight and short-term borrowings 28,383 26,238
Wholesale repurchase agreements 20,000 20,000
Federal Home Loan Bank of Boston borrowings 293,378 279,973
Subordinated deferrable interest debentures 18,558 18,558
Other liabilities 10,036 11,709
Total liabilities 1,326,488 1,337,447
SHAREHOLDERS' EQUITY:
Preferred stock, par value $0.01 per share,
authorized 1,000,000 shares:
Issued and outstanding: none -- --
Common stock, par value $0.01 per share,
authorized 11,000,000 shares:
Issued and outstanding 4,757,036 shares
and 4,719,126 shares, respectively 48 47
Additional paid-in capital 66,777 65,768
Retained earnings 43,052 42,241
Accumulated other comprehensive loss, net (5,525) (3,224)
Total shareholders' equity 104,352 104,832
Total liabilities and shareholders' equity $1,430,840 $1,442,279
See accompanying notes to consolidated financial statements
3
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations (unaudited)
Three Months Ended
March 31,
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2006 2005
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(Dollars and shares
in thousands, except per
share data)
Interest and dividend income:
Loans and leases $14,829 $12,525
Mortgage-backed securities 4,325 3,034
Overnight investments 30 56
Federal Home Loan Bank of Boston stock dividends 211 130
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Total interest and dividend income 19,395 15,745
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Interest expense:
Deposits 4,486 2,966
Overnight and short-term borrowings 315 115
Wholesale repurchase agreements 189 8
Federal Home Loan Bank of Boston borrowings 3,007 1,988
Subordinated deferrable interest debentures 348 297
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Total interest expense 8,345 5,374
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Net interest income 11,050 10,371
Provision for loan and lease losses 300 300
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Net interest income after provision for
loan and lease losses 10,750 10,071
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Noninterest income:
Service charges on deposit accounts 1,187 1,083
Commissions on nondeposit investment products 312 200
Income from bank-owned life insurance 179 172
Loan related fees 144 283
Commissions on loans originated for others 23 24
Other income 460 313
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Total noninterest income 2,305 2,075
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Noninterest expense:
Salaries and employee benefits 5,507 4,623
Occupancy 873 732
Equipment 379 399
Data processing 737 752
Marketing 340 321
Professional services 416 488
Loan servicing 198 227
Loan workout and other real estate owned expense 143 11
Loss on note receivable 868 --
Other expenses 1,330 959
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Total noninterest expense 10,791 8,512
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Income before income taxes 2,264 3,634
Income tax expense 739 1,227
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Net income $ 1,525 $ 2,407
======= =======
Average common shares outstanding - basic 4,746 4,009
Average common shares outstanding - diluted 4,906 4,257
Per share data:
Basic earnings per common share $ 0.32 $ 0.60
Diluted earnings per common share $ 0.31 $ 0.57
Cash dividends declared per common share $ 0.15 $ 0.15
See accompanying notes to consolidated financial statements
4
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity (unaudited)
Accumulated
Other
Compre-
Additional hensive
Common Paid-in Retained Income
Three months ended March 31, Stock Capital Earnings (Loss), Net Total
------ ---------- -------- ----------- -----
(In thousands)
2005
----
Balance at December 31, 2004 $40 $42,852 $35,373 $ 658 $ 78,923
Net income -- -- 2,407 -- 2,407
Other comprehensive loss,
net of tax:
Unrealized holding losses on
securities available for sale,
net of taxes of $1,631 (3,042) (3,042)
Reclassification adjustment,
net of taxes of $(3) 5 5
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Total comprehensive loss (630)
Exercise of stock options -- 90 -- -- 90
Share-based compensation -- 9 -- -- 9
Dividends on common stock ($ 0.15 per
common share) -- -- (602) -- (602)
--- ------- ------- ------- --------
Balance at March 31, 2005 $40 $42,951 $37,178 $(2,379) $ 77,790
=== ======= ======= ======= ========
2006
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Balance at December 31, 2005 $47 $65,768 $42,241 $(3,224) $104,832
Net income -- -- 1,525 -- 1,525
Other comprehensive loss,
net of tax:
Unrealized holding losses on
securities available for sale,
net of taxes of $1,239 (2,301) (2,301)
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Total comprehensive loss (776)
Exercise of stock options 1 1,003 -- -- 1,004
Share-based compensation -- 6 -- -- 6
Dividends on common stock ($ 0.15 per
common share) -- -- (714) -- (714)
--- ------- ------- ------- --------
Balance at March 31, 2006 $48 $66,777 $43,052 $(5,525) $104,352
=== ======= ======= ======= ========
See accompanying notes to consolidated financial statements
5
BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows (unaudited)
Three Months Ended
March 31,
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2006 2005
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(In thousands)
Cash flows from operating activities:
Net income $ 1,525 $ 2,407
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation and amortization 255 701
Provision for loan and lease losses 300 300
Gain on sale of investment securities -- --
Gain on sale of mortgage-backed securities -- 8
Income from bank-owned life insurance (179) (172)
Share-based compensation 6 9
(Increase) decrease in:
Accrued interest receivable (179) (580)
Prepaid expenses and other assets 1,315 (667)
Increase (decrease) in:
Other liabilities (1,673) (46)
Other, net 6 6
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Net cash provided by operating activities 1,376 1,966
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Cash flows from investing activities:
Investment securities available for sale:
Purchases (8,000) (27,933)
Mortgage-backed securities available for sale:
Purchases -- (38,929)
Maturities and principal repayments 10,617 8,686
Proceeds from sales -- 3,423
Net increase in loans and leases 1,100 2,045
Purchases of loans and leases, including purchased interest (7,502) (22,230)
Purchase of Federal Home Loan Bank of Boston stock (468) (614)
Purchases of premises and equipment (986) (817)
Purchase of bank-owned life insurance (1,108) --
-------- --------
Net cash used by investing activities (6,347) (76,369)
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Cash flows from financing activities:
Net increase (decrease) in deposits (24,836) 20,427
Net increase in overnight and short-term borrowings 2,145 6,205
Proceeds from long-term borrowings 100,000 79,880
Repayment of long-term borrowings (86,595) (36,021)
Exercise of stock options 1,004 90
Dividends on common stock (714) (602)
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Net cash (used) provided by financing activities (8,996) 69,979
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Net decrease in cash and cash equivalents (13,967) (4,424)
Cash and cash equivalents at beginning of period 40,547 35,679
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Cash and cash equivalents at end of period $ 26,580 $ 31,255
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Supplementary Disclosures:
Cash paid for interest $ 8,352 $ 5,203
Cash paid for income taxes 20 432
Non-cash transactions:
Change in accumulated other comprehensive loss, net (2,301) (3,037)
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, is the holding company for Bank Rhode Island (the "Bank"). 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.
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 and lease losses and
review of goodwill for impairment.
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, Bank Rhode Island, along with the
Bank's wholly-owned subsidiaries, BRI Investment Corp. (a Rhode Island
passive investment company), BRI Realty Corp. (a Rhode Island real estate
holding company), Acorn Insurance Agency, Inc. (a licensed insurance agency)
and Macrolease Corporation (an equipment leasing company). All significant
intercompany accounts and transactions have been eliminated in
consolidation.
The unaudited interim consolidated financial statements of the Company
have been prepared in accordance with U.S. generally accepted accounting
principles 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. Certain prior period
amounts have been reclassified to conform to the current year
classification. Such reclassifications have no effect on previously
reported net income or shareholders' equity.
The unaudited 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 2005
Annual Report on Form 10-K filed with the Securities and Exchange Commission
("SEC").
(2) Earnings Per Share
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and resulted in the issuance of additional
common stock that then shared in the earnings of the Company.
(3) Share-Based Compensation
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standards ("SFAS") 123-R, "Share-Based Payment", which is a
revision to SFAS 123, "Accounting for Stock-Based Compensation". SFAS 123-R
focuses primarily on accounting for share-based payments made to
7
employees. Under SFAS 123-R, the grant date fair value of share-based awards
(primarily stock options for the Company) is recognized as an expense in the
income statement, whereas under SFAS 123, the Company accounted for share-
based awards under the intrinsic value method prescribed by Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25").
The Company adopted SFAS 123-R under the modified prospective adoption
method. Under that method of adoption, the provisions of SFAS 123-R are
generally only applied to share-based awards granted subsequent to adoption
and any unvested prior grants. Under SFAS 123-R, share-based awards
requiring future service are recognized as compensation expense over the
relevant service period. Share-based awards that do not require future
service ("vested awards") are expensed immediately. SFAS 123-R also requires
the Company to estimate expected forfeitures in determining compensation
expense. Additionally, compensation expense for share-based awards granted
to retirement-eligible employees is recognized immediately.
At the time of adoption of SFAS 123-R on January 1, 2006, all stock
options granted to employees and directors were fully vested and
exercisable. As a result, the transition impact of adopting SFAS 123-R was
not material to the Company's results of operations for the quarter.
In December 2005, the Executive and Compensation Committees of the
Company's Board of Directors accelerated the vesting of all 89,586 unvested
stock options. No other changes were made to the terms and conditions of the
options. The Company recorded expenses of $49,000 in connection with the
accelerated vesting. At the time of the vesting acceleration, approximately
79% of the expenses anticipated to be recorded over the next three years
related to stock options that had no intrinsic value, as the stock options
were "out-of-the-money". Additionally, 73% of the unvested options with a
positive intrinsic value, or "in-the-money", were scheduled to fully vest
within four months after December 31, 2005. As a result of this accelerated
vesting, the Company will not be required to recognize anticipated non-cash
compensation expense relating to stock options of approximately $370,000 in
2006, $260,000 in 2007 and $70,000 in 2008.
Under SFAS 123, the Company did not recognize compensation expense for
stock options issued prior to January 2006 because the stock options had no
intrinsic value at grant date, as the exercise price equaled the market
value of the Company's common stock on the grant date. The Company did
recognize compensation expense related to restricted stock compensation
during the first quarter of 2005. The relevant service period for this
restricted stock award concluded in December 2005.
8
If the Company had recognized compensation expense for stock options
over the relevant service period, generally 3 to 4 years under the fair
value method proscribed by SFAS 123, net income would have decreased for the
three months ended March 31, 2005, resulting in pro forma net income and
earnings per common share ("EPS") as summarized below:
Three Months
Ended
March 31,
2005
------------
Net income (in thousands):
As reported $2,407
Compensation cost, net of taxes (38)
------
Pro forma $2,369
======
Earnings per common share:
Basic:
As reported $ 0.60
Pro forma $ 0.59
Diluted:
As reported $ 0.57
Pro forma $ 0.56
Employee Stock Plans - The Company maintains a 1996 Incentive and
Nonqualified Stock Option Plan and a 2002 Equity Incentive Plan
(collectively the "Employee Stock Plans") under which it may grant awards of
its Common Stock to officers and key employees. The total number of shares
available for awards under the Employee Stock Plans is 760,000. The 2002
Equity Incentive Plan also provides for automatic incremental increases each
year in the number of shares authorized for issuance under such plan on the
date of the annual shareholders meeting equal to the least of (i) 2% of
total issued and outstanding common stock on the date of the shareholders
meeting, (ii) 75,000 shares and (iii) such lesser number as determined by
the Board of Directors of the Company. The Employee Stock Plans allow grants
of options, restricted stock, stock appreciation rights ("SARs"),
performance shares or units and other stock-based awards. To date, the
Company has only awarded options under the Employee Stock Plans, which have
been granted at an exercise price equal to the market value of the stock on
the date of the grant with vesting terms of generally three years. Unless
exercised, options granted under the Employee Stock Plans have a 10-year
contractual term. Certain stock option awards provide for accelerated
vesting if there is a change in control (as defined in the Employee Stock
Plans).
The fair value of each stock option award is estimated on the grant
date using the Black-Scholes option-pricing model with the following pricing
assumptions:
Three Months Ended
March 31,
2006 2005(1)
---- -------
Expected life 6 years --
Expected volatility 22% --
Risk-free interest rate 4.59% --
Dividends per share $0.60 --
Grant date fair value per share $8.69 --
There were no options granted during the first quarter of 2005.
However, for the year ended December 31, 2005, the fair value of each
option granted was estimated with the following pricing assumptions:
expected life of 7 years, expected volatility of 25%, average risk-
free interest rate of 3.90%, dividends per share of $0.60 and weighted
average grant date fair value per share of $9.13.
9
The activity related to these stock options is summarized below:
Weighted
Weighted Aggregate Average
Options Average Intrinsic Value Remaining Life
Outstanding Exercise Price (in thousands) (in years)
----------- -------------- --------------- --------------
Outstanding, December 31, 2005 428,980 $21.27
Granted 14,500 $34.37
Exercised 44,975 $15.88
Forfeited 10,550 $35.41
-------
Outstanding, March 31, 2006 387,955 $23.19 $4,548 6.1
=======
Exercisable, March 31, 2006 373,455 $22.75 $4,540 6.0
=======
The total intrinsic value of options exercised during the three months
ended March 31, 2006 and 2005 was $821,000 and $244,000, respectively. The
tax benefits recognized in equity upon issuance during the three months
ended March 31, 2006 and 2005 totaled $122,000 and $0, respectively. These
tax benefits are included within option exercises on the Statement of
Changes in Shareholders' Equity.
During the three months ended March 31, 2006 and 2005, the Company
recognized noncash employee share-based compensation of $6,000 and $24,000,
respectively. As of March 31, 2006, there was $107,000 of total unrecognized
compensation cost related to nonvested compensation arrangements. This cost
is expected to be recognized over a weighted average period of 2.8 years.
Director Stock Plan - The Company established a Non-Employee Director
Stock Plan (the "Director Stock Plan") under which it may grant up to 65,000
options to acquire its Common Stock to non-employee directors. Each non-
employee director elected at the 1998 shareholders meeting received an
option for 1,500 shares and each new non-employee director elected
subsequently receives an option for 1,000 shares. Non-employee directors
also receive an annual option grant for 500 shares as of the date of each
annual meeting of shareholders. Options are granted at an exercise price
equal to the market value of the stock on the date of the grant and vest six
months after the grant date. Unless exercised, options granted under the
Director Stock Plan have a 10-year contractual term.
During the three months ended March 31, 2006, there was no activity
under the Director Stock Plan options outstanding. At March 31, 2006, there
were 49,500 options outstanding and exercisable at a weighted average
exercise price of $22.75. These options had an intrinsic value of $602,000
and a weighted average remaining life of 5.7 years.
(4) Supplemental Executive Retirement Plans
The Bank maintains Supplemental Executive Retirement Plans ("SERPs")
for certain of its executives under which participants designated by the
Board of Directors are entitled to an annual retirement benefit. Expenses
associated with the SERPs were $151,000 and $144,000 for the three months
ending March 31, 2006 and 2005, respectively. Accrued liabilities associated
with the SERPs were $2.0 million and $1.8 million for March 31, 2006 and
December 31, 2005, respectively.
10
BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis
ITEM 2. Management's Discussion and Analysis
General
The Company's principal subsidiary, Bank Rhode Island, is a commercial
bank chartered as a financial institution in the State of Rhode Island. The
Bank pursues a community banking mission and is principally engaged in
providing banking products and services to individuals and businesses in
Rhode Island and nearby areas of Massachusetts. The Bank is subject to
competition from a variety of traditional and nontraditional financial
service providers both within and outside of Rhode Island. The Bank offers
its customers a wide range of commercial real estate, business, residential
and consumer loans and leases, deposit products, nondeposit investment
products, cash management, and other banking products and services designed
to meet the financial needs of individuals and small- to mid-sized
businesses. The Bank also offers both commercial and consumer online 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"). The Company's common stock is
traded on the Nasdaq Stock Market (r) under the symbol "BARI". The Company's
financial reports can be accessed through its website within 24 hours of
filing with the SEC.
Critical Accounting Policies
Accounting policies involving significant judgments and assumptions by
management, which have, or could have, a material impact on the carrying
value of certain assets or net income, are considered critical accounting
policies. The preparation of financial statements in accordance with U.S
generally accepted accounting principles ("GAAP") requires management to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and disclosure of contingent assets and
liabilities. Actual results could differ from those estimates. As discussed
in the Company's 2005 Annual Report on Form 10-K, management has identified
the accounting for the allowance for loan and lease losses and valuation of
goodwill and analysis for impairment as the Company's most critical
accounting policies. There have been no significant changes in the methods
or assumptions used in accounting policies that require material estimates
or assumptions.
Overview
The primary drivers of the Company's operating income are net interest
income, which is strongly affected by the net yield on interest-earning
assets ("net interest margin"), and the quality of the Company's assets.
The Company's net interest income represents the difference between
interest earned on interest-earning assets and interest incurred on
interest-bearing liabilities. The net interest margin is calculated by
dividing net interest income by average interest-earning assets. Net
interest spread is the difference between the average rate earned on
interest-earning assets and the average rate paid on interest-bearing
liabilities. Net interest margin generally exceeds the net interest spread
as a portion of interest-earning assets are funded by various noninterest-
bearing sources (primarily noninterest-bearing deposits and shareholders'
equity). The increases (decreases) in the components of interest income and
interest expense, expressed in terms of fluctuation in average volume and
rate, are summarized in the Rate/Volume Analysis shown on page 22.
Information as to the components of interest income and interest expense and
average rates is provided under "Average Balances, Yields and Costs" on page
21.
11
Because the Company's assets are not identical in duration and in
repricing dates to its liabilities, the spread between the two is vulnerable
to changes in market interest rates as well as the overall shape of the
yield curve. These vulnerabilities are inherent to the business of banking
and are commonly referred to as "interest rate risk". How to measure
interest rate risk and, once measured, how much risk to take are based on
numerous assumptions and other subjective judgments. See also discussion
under "Interest Rate Risk" on page 27.
The quality of the Company's assets also influences its earnings.
Loans and leases that are not being paid on a timely basis and exhibit other
weaknesses can result in the loss of principal and/or interest income.
Additionally, the Company must make timely provisions to its allowance for
loan and lease losses as a result of its estimates as to probable losses
inherent in the portfolio; these additions, which are charged against
earnings, are necessarily greater when greater probable losses are expected.
Finally, the Company will incur expenses as a result of resolving troubled
assets. All of these form the "credit risk" that the Company takes on in the
ordinary course of its business and is further discussed under "Financial
Condition - Asset Quality" on page 16.
The Company's business strategy has been to concentrate its asset
generation efforts on commercial and consumer loans and its deposit
generation efforts on checking and savings accounts. These deposit accounts
are commonly referred to as "core deposit accounts". This strategy is based
on the Company's belief that it can distinguish itself from its larger
competitors, and indeed attract customers from them, through a higher level
of service and through its ability to set policies and procedures, as well
as make decisions, locally. The loan and deposit products referenced also
tend to be geared more toward customers who are relationship oriented than
those who are seeking stand-alone or single transaction products. The
Company believes that its service-oriented approach enables it to compete
successfully for relationship-oriented customers. Additionally, the Company
is predominantly an urban franchise with a high concentration of businesses
making deployment of funds in the commercial lending area practicable.
Commercial loans are attractive, among other reasons, because of their
higher yields. Similarly, core deposits are attractive because of their
generally lower interest cost and potential for fee income.
In recent years, the Company also has sought to leverage business
opportunities presented by its customer base, franchise footprint and
resources. In the prior year, the Bank formed a private banking division and
completed the Bank's first acquisition, acquiring an equipment leasing
company located in Long Island, New York ("Macrolease"). The Bank is using
the Macrolease platform to increase its portfolio of equipment leases, as
well as generating additional income by originating equipment leases for
third parties. The Company also has introduced Macrolease to the Bank's
commercial customers, thereby expanding the Bank's product offerings.
The deposit market in Rhode Island is highly concentrated. The State's
three largest banks have an aggregate market share of 85% (based upon June
2005 FDIC statistics, excluding one bank that draws its deposits primarily
from the internet) in Providence and Kent Counties, the Bank's primary
marketplace. Competition for loans and deposits has intensified during the
past few years. Other institutions have increased their advertising and
promotional product offerings, spurred on by the various new entrants into
the market.
For the three months ended March 31, 2006, approximately 82.8% of the
Company's revenues (defined as net interest income plus noninterest income)
are derived from its level of net interest income. In a continuing effort
to diversify its sources of revenue, the Company has attempted to expand its
sources of noninterest income (primarily fees and charges for products and
services the Bank offers). The Company has increased its percentage of
noninterest income to total revenue from 12.0% in 2000, to 17.8% in 2005, as
the Company experienced growth in the area of commissions on loans and
leases originated for third parties, loan related fees and commissions on
nondeposit investment products.
12
The future operating results of the Company will again depend on its
ability to maintain and expand its net interest margin, while minimizing its
exposure to credit risk, along with increasing its sources of noninterest
income, and controlling the growth of noninterest or operating expenses.
Financial Condition
Executive Summary
-----------------
Selected balance sheet data is presented in the table below as of the
dates indicated:
March 31, December 31, September 30, June 30, March 31,
(In thousands) 2006 2005 2005 2005 2005
--------- ------------ ------------- -------- ---------
Balance sheet data:
Total assets $1,430,840 $1,442,279 $1,417,251 $1,377,973 $1,308,381
Securities available for sale 379,594 385,817 375,166 360,930 314,539
Loans and leases receivable 957,408 950,806 941,531 925,653 906,433
Deposits 956,133 980,969 961,499 933,963 901,101
Borrowings 360,319 344,769 343,533 331,441 321,450
Total shareholders' equity 104,352 104,832 103,686 103,186 77,790
Core deposit ratio 63.6% 64.0% 66.0% 67.5% 69.0%
Total assets decreased slightly by $11.4 million, or 0.8%, since
December 31, 2005. During the current quarter, the Bank experienced moderate
growth in both commercial and consumer loans, with a net increase of $10.3
million. The available for sale security portfolio decreased by $6.2 million
as maturities were partially utilized to offset the decline in deposits of
$24.8 million since year-end. In addition, borrowings increased by $15.6
million to counter the decrease in deposits. Core deposits as a percentage
of total deposits decreased slightly as consumers continued to indicate a
preference for higher yielding term deposits in this rate environment.
Increases in shareholders' equity during the quarter were largely offset by
the $2.3 million increase in unrealized losses on the investment portfolio.
The Company's financial position at March 31, 2006 as compared to the
prior year quarter-end (March 31, 2005) reflects net growth of over $50
million in loans and leases. The increase in loans reflects the continuing
shift of the balance sheet with increases in commercial loans and leases of
$36.5 million and consumer loans of $38.7 million. The residential mortgage
portfolio (consisting primarily of purchased mortgages) has decreased $24.2
million since March 31, 2005. In addition, deposits reflected a similar
increase of $55.0 million since the prior year quarter-end. This deposit
growth was largely centered in certificates of deposit (up $69.4 million),
offset by a decline in core deposits (down $14.3 million or 2.3%). Both
securities and borrowings are up ($65.1 million and $38.9 million,
respectively), reflecting the leverage transactions entered into in 2005 to
partially offset the dilution of EPS resulting from the issuance of
additional common stock in the second quarter of 2005. This capital offering
was the primary driver of the increase in total shareholders' equity of
$26.6 million from March 31, 2005 to March 31, 2006.
Investments
-----------
Total investments consists of available for sale securities
(investment securities and mortgage-backed securities ("MBSs")), stock in
the FHLB and overnight investments. Total investments comprised $399.8
million, or 27.9% of total assets, at March 31, 2006, compared to $412.2
million, or 28.6% of total assets, at December 31, 2005. Total investments
decreased by $12.4 million or 3.0%. All $379.6 million of investment
securities and MBSs at March 31, 2006 were classified as available for sale
and carried a total of $8.5 million in net unrealized losses at the end of
the quarter. The decrease in total investments reflects the Company's
strategy of targeting growth into internally generated assets, such as
commercial and consumer loans. During the quarter, $8.0 million of available
for sale securities were purchased, while maturities and principal
repayments totaled $10.6 million. Current market conditions make purchasing
assets, such as MBSs, less attractive than retirement of wholesale
borrowings or deployment of
13
funds into higher yielding assets. Accordingly, the Company does not
anticipate making additional purchases of investments in the near future, as
portfolio runoff will be redeployed as noted above.
Loans and Leases
----------------
Total loans and leases were $957.4 million, or 66.9% of total assets,
at March 31, 2006, compared to $950.8 million, or 65.9% of total assets, at
December 31, 2005. The Company attempts to concentrate its asset growth in
its loan and lease portfolios to maximize the yield on new assets and to
take advantage of demand for both commercial and home equity loan products
in its market area.
Commercial loans and leases - The commercial loan and lease portfolio
(consisting of commercial real estate, commercial and industrial, equipment
leases, multi-family real estate, construction and small business loans)
increased $3.2 million, or 0.7%, during the first three months of 2006. The
primary drivers of this change were increases in small business and
commercial real estate loans and moderate decreases in multi-family real
estate and commercial and industrial loans. The Company utilizes the term
"small business loans" to describe business lending relationships of
approximately $250,000 or less.
The Company believes it is well positioned for continued commercial
growth. Particular emphasis is placed on generation of small- to medium-
sized commercial relationships (those relationships with $7.0 million or
less in total loan commitments). Unlike many community banks, the Bank is
able to offer asset-based commercial loan facilities that monitor advances
against receivables and inventories on a formula basis.
The Bank is also active in small business lending in which it utilizes
credit scoring, in conjunction with traditional review standards, and
employs streamlined documentation. Small business loans increased as a
percentage of the commercial loan and lease portfolio to 9.2% at March 31,
2006 compared to 8.9% at December 31, 2005. The Bank is a participant in the
U.S. Small Business Administration ("SBA") Preferred Lender Program in both
Rhode Island and Massachusetts.
The Bank historically has purchased equipment leases from originators
outside of the Bank. The U.S. Government and its agencies were the principal
lessees on the vast majority of these leases. These "government" leases
generally have maturities of five years or less and are not dependent on
residual collateral values. With the Macrolease platform, the Bank is now
originating equipment leases for its own portfolio, as well as originating
leases for third parties as a new source of noninterest income. At March 31,
2006, leases comprised 10.7% of the commercial loan and lease portfolio,
with $23.8 million of government leases and $23.3 million of Macrolease-
generated leases.
Consumer loans - The consumer loan portfolio increased $7.1 million,
or 3.4%, during the first three months of 2006. This growth was centered in
home equity term loans with maximum loan-to-values of 85%. The Company
believes that these ten- and fifteen-year fixed-rate products, along with
the floating lines of credit, possess attractive cash flow characteristics
in the current interest rate environment and the Company anticipates that
growth in these products will continue.
Residential mortgage loans - During the first three months of 2006,
residential mortgage loans decreased $3.7 million, or 1.2%, as repayments
($14.5 million) exceeded total purchases ($5.6 million) and originations
($5.2 million). Since inception, the Bank has concentrated its portfolio
lending efforts on commercial and consumer lending opportunities, but
originates mortgage loans for its own portfolio on a limited basis. The
Bank does not employ any outside mortgage originators, but periodically
purchases residential mortgage loans from third-party originators. Until
such time as the Bank can originate sufficient commercial and consumer loans
to utilize available cash flow, the Bank may purchase residential mortgage
loans as opportunities develop. At March 31, 2006, the Bank did not have
commitments to purchase residential mortgage loans within the next 60 days.
The following is a breakdown of loans and leases receivable:
14
March 31, December 31,
2006 2005
--------- ------------
(In thousands)
Commercial loans:
Commercial real estate - owner occupied $113,824 $112,987
Commercial real estate - nonowner occupied 97,639 95,779
Commercial and industrial 70,885 73,620
Small business 40,821 33,725
Construction 38,944 38,641
Multi-family real estate 32,748 37,772
Leases and other 46,838 45,976
-------- --------
Subtotal 441,699 438,500
Net deferred loan origination fees (178) (191)
-------- --------
Total commercial loans 441,521 438,309
-------- --------
Residential mortgage loans:
One- to four-family adjustable rate 199,215 202,223
One- to four-family fixed rate 100,863 101,598
-------- --------
Subtotal 300,078 303,821
Premium on loans acquired 2,325 2,257
Net deferred loan origination fees (59) (62)
-------- --------
Total residential mortgage loans 302,344 306,016
-------- --------
Consumer loans:
Home equity - term loans 142,199 134,932
Home equity - lines of credit 67,838 67,959
Installment 421 365
Savings secured 359 358
Automobile 133 157
Unsecured and other 1,105 1,271
-------- --------
Subtotal 212,055 205,042
Premium on loans acquired 1 2
Net deferred loan origination costs 1,487 1,437
-------- --------
Total consumer loans 213,543 206,481
-------- --------
Total loans receivable $957,408 $950,806
======== ========
Deposits
--------
Total deposits decreased by $24.8 million, or 2.5%, during the first
three months of 2006, from $981.0 million, or 68.0% of total assets, at
December 31, 2005, to $956.1 million, or 66.8% of total assets, at March 31,
2006.
15
The following table sets forth certain information regarding deposits:
March 31, 2006 December 31, 2005
------------------------------- -------------------------------
Percent Weighted Percent Weighted
Of Average of Average
Amount Total Rate Amount Total Rate
-------- ------- -------- -------- ------- --------
(Dollars in thousands)
NOW accounts $ 78,791 8.3% 0.52% $ 89,594 9.1% 0.54%
Money market accounts 9,737 1.0% 1.57% 12,122 1.2% 1.31%
Savings accounts 344,134 36.0% 1.83% 341,115 34.8% 1.66%
Certificate of deposit accounts 348,339 36.4% 3.62% 353,049 36.0% 3.34%
-------- ----- -------- -----
Total interest bearing deposits 781,001 81.7% 2.49% 795,880 81.1% 2.28%
Noninterest bearing accounts 175,132 18.3% -- 185,089 18.9% --
-------- ----- -------- -----
Total deposits $956,133 100.0% 2.04% $980,969 100.0% 1.85%
======== ===== ==== ======== ===== ====
The overall composition of total deposits remained relatively
consistent during the quarter. At March 31, 2006, core deposit accounts
comprised 63.6% of total deposits, compared to 64.0% of total deposits at
December 31, 2005. The Bank continues its strategy of emphasizing core
deposits over certificates of deposit; however, consumer demand for higher
yielding term deposit products remained robust during the first three months
of 2006.
In this competitive rate and deposit gathering environment, the Bank
experienced a decline in core deposits of $20.1 million, or 3.2% during the
first quarter of 2006. Savings accounts grew $3.0 million, while NOW
accounts and money market accounts decreased $10.8 million and $2.4 million,
respectively. Demand deposit accounts decreased $10.0 million from December
31, 2005 levels, primarily due to normal seasonality of customer balances.
Additionally, certificates of deposit ("CDs") decreased $4.7 million during
the quarter. Included within CD balances at March 31, 2006, were $10.0
million of brokered CDs. The Bank anticipates increasing the use of brokered
CDs should their rates continue to remain attractive compared to wholesale
funding.
Borrowings
----------
FHLB borrowings increased $13.4 million, or 4.8%, during the first
three months of 2006. The increases were the result of the Company utilizing
borrowings to partially offset the overall decline in deposits. The Company,
through the Bank's membership in the FHLB, has access to a number of
different funding structures. Wholesale repurchase agreements remained
consistent with the December 31, 2005 level of $20.0 million. The Bank may
utilize wholesale repurchase agreement funding in the future if spreads are
favorable compared to FHLB borrowings.
On a long-term basis, the Company intends to continue concentrating on
increasing its core deposits, but will continue to utilize FHLB borrowings
or wholesale repurchase agreements as cash flows dictate and opportunities
present themselves.
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
generally considered impaired loans.
16
Nonperforming assets - At March 31, 2006, the Company had
nonperforming assets of $3.0 million, which represented 0.21% of total
assets. This compares to nonperforming assets of $415,000, or 0.03% of total
assets, at December 31, 2005. Total nonperforming assets at March 31, 2006
consisted of nonaccrual loans: commercial loans aggregating $2.6 million,
consumer loans of $57,000 and residential mortgage loans aggregating
$316,000. Nonperforming assets at December 31, 2005 were primarily comprised
of nonaccrual commercial and residential loans. The increase in
nonperforming loans relates primarily to one commercial credit.
Included in nonaccrual loans were $2.8 million, at March 31, 2006, and
$141,000, at December 31, 2005, of impaired loans, with specific reserves
against these impaired loans of $200,000 and $71,000, respectively. The
increase in nonaccrual loans since year-end relates primarily to one
commercial credit of $2.3 million. Management believes the Bank is well
secured in this loan and has not specifically reserved for this credit.
The Company evaluates the underlying collateral of each nonperforming
loan and continues to pursue the collection of interest and principal.
Management believes that the current level of nonperforming assets remains
low relative to the size of the Company's loan portfolio. As the loan
portfolio continues to grow and mature, or if economic conditions worsen,
management believes it possible that the level of nonperforming assets will
increase, as will its level of charged-off loans.
Delinquencies - At March 31, 2006, $398,000 of loan balances were 60
to 89 days past due, up slightly from $299,000 at December 31, 2005.
The following table sets forth information regarding nonperforming
assets and loans 60-89 days past due as to interest at the dates indicated.
March 31, December 31,
2006 2005
--------- ------------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis $2,960 $ 415
Loans past due 90 days or more, but still accruing -- --
Impaired loans (not included in nonaccrual loans) -- --
------ -----
Total nonperforming loans 2,960 415
Other real estate owned -- --
------ -----
Total nonperforming assets $2,960 $ 415
====== =====
Delinquent loans 60-89 days past due $ 398 $ 299
Nonperforming loans as a percent of total loans and leases 0.31% 0.04%
Nonperforming assets as a percent of total assets 0.21% 0.03%
Delinquent loans 60-89 days past due as a percent of total loans 0.04% 0.03%
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 March 31, 2006, the Company had $6.1 million of assets that were
classified as substandard. This compares to $6.8 million of assets that were
classified as substandard at December 31, 2005. 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
17
loan. At March 31, 2006, included in the assets that were classified as
substandard were $3.1 million of performing loans. This compares to $6.4
million of adversely classified performing loans as of December 31, 2005.
These amounts constitute assets that, in the opinion of management, could
potentially migrate to nonperforming or doubtful status. Management believes
that the March 31, 2006 level of adversely classified assets is low relative
to the size of the Company's loan and lease portfolio. As the loan and lease
portfolio continues to mature, or if economic conditions worsen, such as a
significant downturn in the local or regional real estate market, management
believes it possible that the level of adversely classified assets will
increase. This in turn may necessitate an increase to the provision for loan
losses in future periods.
Allowance for Loan and Lease Losses
-----------------------------------
During the first three months of 2006, the Company made provisions to
the allowance for loan and lease losses totaling $300,000 and had $185,000
of net charge-offs, bringing the balance in the allowance to $12.3 million,
compared to $12.2 million at December 31, 2005. The net charge-offs were
primarily small business loans. The allowance, expressed as a percentage of
total loans, was 1.28% as of March 31, 2006, consistent with the prior year-
end and stood at 415% of nonperforming loans at March 31, 2006, compared to
2932% of nonperforming loans at December 31, 2005.
Assessing the adequacy of the allowance for loan and lease losses
involves substantial uncertainties and is based upon management's evaluation
of the amounts required to meet estimated charge-offs in the loan portfolio
after weighing various factors. Management's methodology to estimate loss
exposure includes an analysis of individual loans deemed to be impaired,
reserve allocations for various loan types based on payments status or loss
experience and an unallocated allowance that is maintained based on
management's assessment of many factors including the growth, composition
and quality of the loan portfolio, historical loss experiences, general
economic conditions and other pertinent factors. Based on this evaluation,
management believes that the allowance for loan and lease losses, as of
March 31, 2006, is appropriate.
A portion of the allowance for loan and lease losses is not allocated
to any specific segment of the loan portfolio. This non-specific allowance
is maintained for two primary reasons: (i) there exists an inherent
subjectivity and imprecision to the analytical processes employed, and (ii)
the prevailing business environment, as it is affected by changing economic
conditions and various external factors, may impact the portfolio in ways
currently unforeseen. Management, therefore, has established and maintains a
non-specific allowance for loan and lease losses. The amount of this
measurement imprecision allocation was $1.6 million at March 31, 2006,
compared to $1.1 million at December 31, 2005.
While management evaluates currently available information in
establishing the allowance for loan and lease 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 and lease losses and
carrying amounts of other real estate owned. Such agencies may require the
financial institution to recognize additions to the allowance based on their
judgments about information available to them at the time of their
examination.
18
Results of Operations
Executive Overview
------------------
Selected income statement and per share data and operating ratios are
presented in the table below for the three month periods indicated:
For the three months ended
(In thousands, March 31, December 31, September 30, June 30, March 31,
except per share data) 2006 2005 2005 2005 2005
--------- ------------ ------------- -------- ---------
Income statement data:
Net interest income $11,050 $10,993 $10,767 $10,770 $10,371
Noninterest income 2,305 2,173 2,581 2,445 2,075
Noninterest expense 10,791 9,494 9,161 9,125 8,512
Net income 1,525 2,235 2,467 2,460 2,407
Per share data:
Diluted earnings per share 0.31 0.46 0.50 0.52 0.57
Dividends per common share 0.15 0.15 0.15 0.15 0.15
Operating ratios:
Net interest margin 3.25% 3.25% 3.25% 3.40% 3.52%
Return on assets 0.43% 0.63% 0.71% 0.74% 0.78%
Return on equity 5.89% 8.56% 9.44% 10.09% 12.34%
Efficiency ratio 80.80% 72.11% 68.63% 69.05% 68.39%
The Company reported net income for the first quarter of 2006 of $1.5
million, down $710,000, or 31.8%, from the prior quarter and down $882,000,
or 36.6%, from the first quarter of 2005. Diluted earnings per common share
("EPS") also decreased by 32.6% from the prior quarter. EPS decreased 45.6%
from the first quarter in 2005. EPS for the current quarter fully reflects
the 628,000 shares issued in the second quarter of 2005.
The decrease in net income is largely attributable to a non-recurring
pretax loss on a note receivable of $868,000. Excluding this non-recurring
item, net income would have been $2.1 million, with EPS of $0.43 per share.
See also discussion under "Noninterest expense". The remaining decrease in
net income on a comparative quarter basis (three months ended March 31, 2006
as compared to the three months ended March 31, 2005) can be attributed to
the decrease in net interest margin of 27 basis points ("bps"). During the
first quarter of 2006 and the latter portion of 2005, the net interest
margin has been compressed by the flattened yield curve. However, the net
interest margin has held at 3.25% for the past three quarters.
The Company has seen growth in the current quarter in its noninterest
income with an increase in commissions on nondeposit investment products of
$185,000 as compared to the 2005 fourth quarter and $112,000 on a
comparative quarter basis. Service charges on deposit accounts also showed
increases of $37,000 and $104,000 on a linked quarter and comparative
quarter basis. Loan related fees were down compared to both periods, but a
large dollar majority of those fees result from loan prepayments, which are
incurred normally when a customer exits the banking relationship.
Excluding the loss on a note receivable, noninterest expenses rose
$429,000 during the current quarter compared to the three months ended
December 31, 2005. Increases in salaries and benefits were due to normal
timing differences in benefits and non-recurring signing bonuses for the two
lenders the Company successfully recruited in January 2006 from a larger
competitor in the market. The Company experienced a decrease in professional
services costs as the Company expects lower outsourced audit costs as the
Company's internal audit department is now fully staffed. Compared to the
first quarter a year ago,
19
noninterest expense increased $1.4 million (excluding the non-recurring item
of $868,000). Increases in salaries and benefits and occupancy were driven
by the two new branch openings occurring after the first quarter of 2005 and
the addition of Macrolease and the Bank's new private banking division, One
Trust & Private Banking. Increases in loan workout expense were largely
offset by the decrease in professional services costs referred to above.
On a pro forma basis, excluding the non-recurring item, the Company's
return on average assets and equity for the first quarter of 2006 would have
been of 0.59% and 8.06%, respectively. The decrease in these ratios from the
last quarter and a year ago continue to reflect the compressed net interest
margin, the Company's continued growth, and the impact of the additional
equity raised in the second quarter of 2005. On a pro forma basis, the
Company's efficiency ratio would have been 74.30%. During the first quarter
of 2006, the Company began an operational process review under the direction
of the Bank's new Chief Operating Officer to identify opportunities to
reduce costs and increase efficiency. The Company expects to begin to
experience the benefits of this program in the latter portion of 2006 and in
2007.
The following tables set forth certain information relating to the
reconciliation of GAAP net income, EPS, and operating ratios as described
above.
Quarter Ended
(In thousands, except per share data) March 31, 2006
--------------
Net income (GAAP) $1,525
Add back non-recurring loss, net of tax 564
Pro forma net income $2,089
======
Diluted earnings per share (GAAP) $ 0.31
Effect of non-recurring loss, net of tax 0.12
Pro forma diluted earnings per share $ 0.43
======
Quarter Ended March 31, 2006
Return on Assets Return on Equity Efficiency Ratio
---------------- ---------------- ----------------
GAAP ratios 0.43% 5.89% 80.80%
Effect of non-recurring loss, net of tax 0.16% 2.17% (6.50)%
Pro forma ratios 0.59% 8.06% 74.30%
Net Interest Income
-------------------
For the quarter ended March 31, 2006, net interest income was $11.1
million, compared to $10.4 million for the 2005 period. The net interest
margin for the first quarter of 2006 at 3.25% was down from the net interest
margin for the 2005 period of 3.52%. The increase in net interest income of
$679,000, or 6.5%, was attributable to the continued growth of the Company,
while the decrease in the net interest margin of 27 bps was due to the
compression of the yield curve and current interest rate environment.
Average earning assets were $173.1 million, or 14.5%, higher, and average
interest-bearing liabilities were $141.9 million, or 14.2%, higher, than the
comparable period a year earlier.
20
Average Balances, Yields and Costs - The following table sets forth
certain information relating to the Company's average balance sheet and
reflects the average yield on assets and average cost of liabilities for the
three month periods indicated. Such yields and costs are derived by dividing
income or expense by the average balance of assets or liabilities. Average
balances are derived from daily balances and include nonperforming loans.
(Dollars in thousands) For the three months ended March 31,
------------------------------------------------------------------------
2006 2005
---------------------------------- ----------------------------------
Interest Interest
Average earned/ Average Average earned/ Average
Assets balance paid yield balance paid yield
------- -------- ------- ------- -------- -------
Earning assets:
Overnight investments $ 4,904 $ 30 2.44% $ 10,544 $ 56 2.15%
Investment securities 157,259 1,671 4.25% 119,217 1,237 4.15%
Mortgage-backed securities 232,519 2,654 4.57% 164,571 1,797 4.37%
Stock in the FHLB 16,299 211 5.25% 13,236 130 3.98%
Loans receivable:
Commercial loans and leases 439,598 7,685 7.09% 402,513 6,370 6.42%
Residential mortgage loans 305,609 4,082 5.34% 311,556 3,969 5.10%
Consumer and other loans 210,360 3,062 5.90% 171,847 2,186 5.16%
---------- ------- ---------- -------
Total earning assets 1,366,548 19,395 5.72% 1,193,484 15,745 5.32%
------- -------
Cash and due from banks 23,287 20,689
Allowance for loan and lease losses (12,384) (12,066)
Premises and equipment 15,156 12,003
Goodwill, net 11,234 10,766
Accrued interest receivable 5,803 4,620
Bank-owned life insurance 19,796 18,192
Prepaid expenses and other assets 9,296 4,336
---------- ----------
Total assets 1,438,736 1,252,024
========== ==========
Liabilities and Shareholder's Equity
Interest-bearing liabilities:
Deposits:
NOW accounts 79,964 103 0.52% 102,439 177 0.70%
Money market accounts 11,455 38 1.33% 17,978 55 1.24%
Savings accounts 333,046 1,377 1.68% 333,132 1,012 1.23%
Certificate of deposit accounts 349,456 2,968 3.44% 266,450 1,722 2.62%
Overnight and short-term borrowings 31,278 315 4.09% 22,652 115 2.06%
Wholesale repurchase agreements 20,000 189 3.84% 1,099 8 2.95%
FHLB borrowings 298,380 3,007 4.09% 237,933 1,988 3.39%
Subordinated deferrable interest debentures 18,558 348 7.61% 18,558 297 6.49%
---------- ------- ---------- -------
Total interest-bearing liabilities 1,142,137 8,345 2.96% 1,000,241 5,374 2.18%
------- -------
Noninterest-bearing deposits 174,451 164,480
Other liabilities 17,076 8,177
---------- ----------
Total liabilities 1,333,664 1,172,898
Shareholders' Equity: 105,072 79,126
---------- ----------
Total liabilities and shareholders' equity $1,438,736 $1,252,024
========== ==========
Net interest income $11,050 $10,371
======= =======
Net interest rate margin 3.25% 3.52%
Net interest rate spread 2.76% 3.14%
21
Rate/Volume Analysis - The following table sets forth certain
information regarding changes in the Company's interest income and interest
expense for the periods indicated. For each category of interest-earning
assets and interest-bearing liabilities, information is provided on changes
attributable to (i) changes in rate (changes in rate multiplied by old
average balance) and (ii) changes in volume (changes in average balances
multiplied by old rate). The net change attributable to the combined impact
of rate and volume was allocated proportionally to the individual rate and
volume changes.
Three Months Ended March 31,
2006 vs. 2005
Increase/(decrease) due to
----------------------------
(Dollars in thousands) Rate Volume Total
------ ------ ------
Interest income:
Overnight investments $ 7 $ (33) $ (26)
Investment securities 46 388 434
Mortgage-backed securities 73 784 857
Stock in the FHLB 47 34 81
Commercial loans and leases 540 775 1,315
Residential mortgage loans 192 (79) 113
Consumer and other loans 361 515 876
------ ------ ------
Total interest income 1,266 2,384 3,650
------ ------ ------
Interest expense:
NOW accounts (40) (34) (74)
Money market accounts 4 (21) (17)
Savings accounts 364 1 365
Certificate of deposit accounts 627 619 1,246
Overnight and short-term borrowings 146 54 200
Wholesale repurchase agreements 4 177 181
FHLB borrowings 455 564 1,019
Subordinated deferrable interest debentures 51 -- 51
------ ------ ------
Total interest expense 1,611 1,360 2,971
------ ------ ------
Net interest income $ (345) $1,024 $ 679
====== ====== ======
Interest Income - Investments - Total investment income (consisting of
interest on overnight investments, investment securities and MBSs and
dividends on FHLB stock) was $4.6 million for the quarter ended March 31,
2006, compared to $3.2 million for the 2005 period. The increase in total
investment income was $1.3 million, or 41.8%, and was attributable to higher
average balances. Yields did increase on a comparative quarter basis, but
the primary driver of the increase in investment income was higher average
balances due to the leverage program, which concluded in the fourth quarter
of 2005. The majority of the Company's investments are comprised of U.S.
Agency securities and MBSs with repricing periods or expected duration of
less than five years.
Interest Income - Loans and Leases - Interest from loans and leases
was $14.8 million for the three months ended March 31, 2006, and represented
a yield on total loans and leases of 6.27%. This compares to $12.5 million
of interest, and a yield of 5.71%, for the first quarter of 2005. Increased
interest income resulting from the growth in the average balance of loans
and leases of $69.7 million, or 7.9%, was augmented by an increase in the
yield on loans of 56 bps.
The average balance of the various components of the loan and lease
portfolio changed from the first quarter of 2005 as follows: commercial
loans and leases increased $37.1 million, or 9.2%, and consumer and other
loans increased $38.5 million, or 22.4%, while residential mortgage loans
decreased $5.9 million, or 1.9%. Changes in the average yields from the
first quarter of 2005 were as follows: commercial loans and leases increased
67 bps, to 7.09%, and consumer and other loans increased 74 bps,
22
to 5.90%, while residential mortgage loans increased 24 bps, to 5.34%. The
yields on loans and leases benefited primarily from the increases in short-
term interest rates occurring in both 2006 and 2005.
Interest Expense - Deposits and Borrowings - Interest paid on deposits
and borrowings increased $3.0 million, or 55.3%, to $8.3 million for the
three months ended March 31, 2006, from $5.4 million for the same period
during 2005. The overall average cost for interest-bearing liabilities
increased 78 bps to 2.96% for the first quarter of 2006, compared to 2.18%
for the first quarter of 2005. The average balance of total interest-bearing
liabilities increased $141.9 million, from $1.0 billion in the first quarter
of 2005 to $1.1 billion in the first quarter of 2006. The growth in deposit
average balances was centered primarily in CDs (up $83.0 million or 31.2%).
The increase in CDs was offset by decreases in lower- costing NOW accounts
(down $22.5 million or 21.9%) and money market accounts (down $6.5 million
or 36.3%). Savings accounts remained consistent compared to the same period
during 2005 with only a moderate decrease of $86,000.
Borrowings increased on a comparative quarter basis as the Bank
utilized FHLB funding (up $60.4 million or 25.4%) and short-term borrowings
(up $8.6 million or 38.1%) as both part of the leverage program in 2005 and
to partially offset the current quarter decrease in deposit balances. In
addition, the Company entered into wholesale repurchase agreements late in
the first quarter of 2005 and continued to utilize this funding source later
in 2005 and in 2006. As a result, the average balance for wholesale
repurchase agreements for the three months ended March 31, 2006 increased
compared to the same period in 2005 (up $18.9 million or 1720%).
The rise in borrowing costs overall can be attributed to several
factors. The higher volumes referred to above combined with rising interest
rate costs due to the competitive rate environment and continued customer
demand for higher yielding deposit products increased interest expense
during the first three months of 2006 compared to the same period a year
ago. The Company's 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 and Lease Losses
-----------------------------------
The provision for loan and lease losses was $300,000 for the quarter
ended March 31, 2006, remaining consistent with the first quarter of 2005.
Additions to the allowance for loan and lease losses during the first
quarter of 2006 were primarily in response to concern for general economic
conditions.
Management evaluates several factors including new loan originations,
actual and estimated charge-offs and the risk characteristics of the loan
portfolio and general economic conditions when determining the provision for
each quarter. As the loan portfolio continues to grow and mature, or if
economic conditions worsen, management believes it possible that the level
of nonperforming assets will increase, which in turn may lead to increases
in the provision for loan and lease losses. Also see discussion under
"Allowance for Loan and Lease Losses".
Noninterest Income
------------------
Total noninterest income increased $230,000, or 11.1%, to $2.3 million
for the first quarter of 2006, from $2.1 million for the first quarter of
2005. The Company experienced increases in service charges on deposit
accounts (up $104,000 or 9.6%) and commissions on nondeposit investment
products (up $112,000 or 56.0%). Consistent with prior quarters, deposit
account service charges continue to represent the largest source of
noninterest income for the Company. Loan related fees were down $139,000, or
49.1%, as the Company did not receive significant prepayment penalties
during the first quarter of 2006. Additionally, Other Income increased
$138,000, or 42.9%, due in large part to Macrolease-related commissions on
leases originated for third parties and an increase in customer related
sweep activity; however, credit card commissions decreased on a comparative
quarter basis.
23
Noninterest Expense
-------------------
Noninterest expense for the first quarter of 2006 increased $2.3
million, or 26.8%, to $10.8 million from $8.5 million in 2005. Overall,
noninterest expenses reflected the continued growth of the Company resulting
in higher operating costs. Such growth includes the opening of two new
branches in 2005, the additions to our business, operations and financial
senior management ranks, and the addition of Macrolease and One Trust &
Private Banking (both occurring in the second quarter of 2005). The
increases in costs were centered in the following areas: Salaries and
benefits (up $884,000 or 19.1%) and Occupancy costs (up $141,000, or 19.3%).
The Company plans to further expand its Rhode Island branch network by
opening two new branches in 2007 in Pawtucket and Narragansett.
Loan workout expense increased during the current quarter compared to
a year ago (up $132,000 or 1200%), but was relatively consistent on a linked
quarter basis. Also, Other Expenses increased from a year ago by $371,000,
or 38.7%, with increases in recruiting costs, charitable contributions and
customer related sweep activity. On a pro forma basis, excluding the item
referred to below, the Company's efficiency ratio increased from 68.39%
during the first quarter of 2005 to 74.30% in 2006.
During the quarter, the Company incurred a non-recurring loss on a
note receivable of $868,000 that was disclosed by the Company in December
2005 and in the Company's 2005 Annual Report on Form 10-K. The receivable
arose in connection with the unauthorized actions of a former employee. The
Company recorded this loss in March 2006 as the receivable was determined to
be not collectible. The Company has filed a claim with its insurance carrier
seeking recovery for the loss.
Income Tax Expense
------------------
Income tax expense of $739,000 was recorded for the three months ended
March 31, 2006, compared to $1.2 million for the same period during 2005.
This represented total effective tax rates of 32.6% and 33.8%, respectively.
Tax-favored income from Bank-owned life insurance (BOLI), along with the
Company's utilization of a Rhode Island passive investment company, has
reduced the 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 and maturity of investment securities and sales of securities from the
available for sale portfolio. Management believes that these sources are
sufficient to fund the Bank's lending and investment activities.
Management is responsible for establishing and monitoring liquidity
targets as well as strategies and tactics to meet these targets. In general,
the Company seeks to maintain a high degree of flexibility with a liquidity
target of 10% to 30% of total assets. At March 31, 2006, overnight
investments, investment securities and MBSs available for sale amounted to
$383.3 million, or 26.8% of total assets. This compares to $396.2 million,
or 27.5% of total assets at December 31, 2005. 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. The Bank also has access
24
to funding through wholesale repurchase agreements. 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 March 31, 2006 was $104.3
million, as compared to $104.8 million at December 31, 2005. This decrease
of $479,000 was primarily attributable to net income of $1.5 million, a
decrease in accumulated other comprehensive income of $2.3 million
(attributable to increases in unrealized losses on investments and MBSs),
proceeds from the exercise of stock options of $1.0 million and dividends
paid of $714,000.
All FDIC-insured institutions must meet specified minimal capital
requirements. These regulations require banks to maintain a minimum leverage
capital ratio. In addition, the FDIC has adopted capital guidelines based
upon ratios of a bank's capital to total assets adjusted for risk. The risk-
based capital guidelines include both a definition of capital and a
framework for calculating risk-weighted assets by assigning balance sheet
assets and off-balance sheet items to broad risk categories. These
regulations require banks to maintain minimum capital levels for capital
adequacy purposes and higher capital levels to be considered "well
capitalized".
The Federal Reserve Board ("FRB") has also issued capital guidelines
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 March 31, 2006, the Company and the Bank met all applicable
minimum capital requirements and were considered "well capitalized" by both
the FRB and the FDIC.
25
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 March 31, 2006:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $116,643 8.21% $ 42,624 3.00% $71,040 5.00%
Tier I capital (to risk weighted assets) 116,643 12.69% 36,761 4.00% 55,142 6.00%
Total capital (to risk weighted assets) 128,136 13.94% 73,522 8.00% 91,903 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $ 94,325 6.64% $ 42,603 3.00% $71,005 5.00%
Tier I capital (to risk weighted assets) 94,325 10.27% 36,745 4.00% 55,118 6.00%
Total capital (to risk weighted assets) 105,818 11.52% 73,490 8.00% 91,863 10.00%
At December 31, 2005:
Bancorp Rhode Island, Inc.
--------------------------
Tier I capital (to average assets) $114,822 8.21% $ 41,933 3.00% $69,889 5.00%
Tier I capital (to risk weighted assets) 114,822 12.62% 36,394 4.00% 54,592 6.00%
Total capital (to risk weighted assets) 126,200 13.87% 72,789 8.00% 90,986 10.00%
Bank Rhode Island
-----------------
Tier I capital (to average assets) $ 93,339 6.67% $ 41,965 3.00% 69,941 5.00%
Tier I capital (to risk weighted assets) 93,339 10.26% 36,378 4.00% 54,566 6.00%
Total capital (to risk weighted assets) 104,717 11.51% 72,755 8.00% 90,944 10.00%
26
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
maintaining interest rate risk exposure within established parameters over a
range of possible interest rate scenarios.
Interest rate risk management is governed by the Bank's
Asset/Liability Committee ("ALCO"). The ALCO establishes exposure limits
that define the Company's tolerance for interest rate risk. The ALCO
monitors current exposures versus limits and reports results to the Board of
Directors. The policy limits and guidelines serve as benchmarks for
measuring interest rate risk and for providing a framework for evaluation
and interest rate risk management decision making. The primary tools for
managing interest rate risk currently are the securities portfolio,
purchased mortgages, wholesale repurchase agreements and borrowings from the
FHLB.
The Company's interest rate risk position is measured using both
income simulation and interest rate sensitivity "gap" analysis. 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 200 bps interest rate
ramps. These simulations take into account repricing, maturity and
prepayment characteristics of individual products. The ALCO reviews
simulation results to determine whether the downside exposure resulting from
changes in market interest rates remains within established tolerance levels
over both a 12-month and 24-month horizon, and develops appropriate
strategies to manage this exposure. The Company's guidelines for interest
rate risk specify that if interest rates were to shift up or down 200 bps
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 March 31, 2006, net interest income simulation indicated
that the Company's exposure to changing interest rates was within these
tolerances. The ALCO reviews the methodology utilized for calculating
interest rate risk exposure and may periodically adopt modifications to this
methodology.
27
The following table presents the estimated impact of interest rate
ramps on the Company's estimated net interest income over a twenty-four
month period beginning April 1, 2006:
Estimated Exposure
to Net Interest Income
----------------------
Dollar Percent
Change Change
-------- -------
(Dollars in thousands)
Initial Twelve Month Period:
Up 200 bps $ (87) (0.2)%
Down 200 bps (397) (0.9)%
Subsequent Twelve Month Period:
Up 200 bps (2,131) (4.6)%
Down 200 bps (1,173) (2.5)%
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 March 31, 2006, the Company's one year cumulative
gap was a negative $162.5 million, or 11.4% of total assets.
For additional discussion on interest rate risk see the section titled
"Asset and Liability Management" on pages 51 and 52 of the Company's 2005
Annual Report on Form 10-K.
ITEM 4. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), the Company carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures as of the end of the period covered by this report.
This evaluation was carried out under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Company's Chief Financial Officer. Based upon that
evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.
There was no significant change in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter that has materially affected, or is reasonably likely to affect, the
Company's internal control over financial reporting. The Company continues
to enhance its internal controls over financial reporting, primarily by
evaluating and enhancing process and control documentation. Management
discusses with and discloses these matters to the Audit Committee of the
Board of Directors and the Company's auditors.
28
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 1A. Risk Factors
----------------------
There have been no material changes from the risk factors as
previously disclosed in the Company's 2005 Annual Report on Form
10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
---------------------------------------------------------------------
No information to report.
Item 3. Defaults 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
------------------
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
29
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.
May 8, 2006 /s/ Merrill W. Sherman
----------- -----------------------
(Date) Merrill W. Sherman
President and
Chief Executive Officer
May 8, 2006 /s/ Linda H. Simmons
----------- ---------------------
(Date) Linda H. Simmons
Chief Financial Officer
and Treasurer
30