UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2006
------------------
Commission file number 000-23904
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SLADE'S FERRY BANCORP.
--------------------------------------------------------
(Exact name of registrant as specified in its character)
Massachusetts 04-3061936
------------------------------- ------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
100 Slade's Ferry Avenue 02726
Somerset, Massachusetts ------------------------------
------------------------------- (Zip code)
(Address of principal executive offices)
(508) 675-2121
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer [ ] Accelerated Filer [ ] Non Accelerated Filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date:
Common stock ($0.01 par value) 4,156,583 outstanding
shares as of October 31, 2006.
----------------------------------------------------
TABLE OF CONTENTS
Part I
ITEM 1 - Financial Statements (Unaudited) 3
Consolidated Balance Sheets - September 30, 2006 and
December 31, 2005
* Consolidated Statements of Income - Three Months Ended
September 30, 2006 and 2005
* Consolidated Statements of Income - Nine Months Ended
September 30, 2006 and 2005
* Consolidated Statement of Changes in Stockholder's Equity -
Nine Months Ended September 30, 2006
* Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 2006 and 2005
* Notes to Consolidated Financial Statements
ITEM 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
ITEM 3 - Quantitative and Qualitative Disclosures about Market Risk 37
ITEM 4 - Controls and Procedures 39
Part II
ITEM 1 - Legal Proceedings 40
ITEM 1A - Risk Factors 40
ITEM 2 - Unregistered Sales of Equity Securities and Use of Proceeds 40
ITEM 3 - Defaults Upon Senior Securities 41
ITEM 4 - Submission of Matters to a Vote of Security Holders 41
ITEM 5 - Other Information 41
ITEM 6 - Exhibits 41
2
ITEM 1
FINANCIAL STATEMENTS
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, 2006 December 31, 2005
------------------ -----------------
Assets (In thousands)
------
Cash and due from banks $ 11,841 $ 17,782
Interest-bearing demand deposits with other banks 1,102 36
Federal funds sold 2,000 2,200
-------- --------
Cash and cash equivalents 14,943 20,018
Interest-bearing certificates of deposit with other banks 100 100
Securities available for sale 107,409 94,298
Securities held to maturity (fair value approximates of $25,120
as of September 30, 2006 and $28,858 as of December 31, 2005) 25,752 29,306
Federal Home Loan Bank stock, at cost 6,856 6,304
Loans, net of allowance for loan losses of $4,374 at September 30, 2006
and $4,333 at December 31, 2005 426,430 409,610
Premises and equipment, net 5,710 5,917
Goodwill 2,173 2,173
Accrued interest receivable 2,459 2,298
Bank-owned life insurance 12,204 11,884
Deferred tax assets, net 2,048 2,089
Other assets 1,684 1,917
-------- --------
$607,768 $585,914
======== ========
Liabilities and Stockholders' Equity
------------------------------------
Deposits:
Noninterest-bearing $ 76,638 $ 80,705
Interest-bearing 346,033 335,141
-------- --------
Total deposits 422,671 415,846
Short-term borrowings - 7,000
Long-term borrowings 120,938 100,865
Subordinated debentures 10,310 10,310
Accrued expenses and other liabilities 3,092 3,038
-------- --------
Total liabilities 557,011 537,059
Stockholders' equity:
Common stock, par value $0.01 per share; authorized 10,000,000 shares;
issued and outstanding 4,154,355 shares at September 30, 2006 and
4,132,200 shares at December 31, 2005 42 41
Additional paid-in capital 31,463 31,014
Retained earnings 20,446 18,998
Accumulated other comprehensive loss (719) (1,198)
Unearned compensation (475) -
-------- --------
Total stockholders' equity 50,757 48,855
-------- --------
$607,768 $585,914
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
3
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended September 30,
2006 2005
---- ----
(In thousands, except per share data)
Interest and dividend income:
Interest and fees on loans $ 7,077 $ 5,943
Interest and dividends on securities:
Taxable 1,501 1,388
Tax-exempt 61 83
Interest on federal funds sold 44 41
Other interest 10 7
---------- ----------
Total interest and dividend income 8,693 7,462
Interest expense:
Interest on deposits 2,616 1,672
Interest on Federal Home Loan Bank advances 1,196 1,142
Interest on subordinated debentures 217 166
---------- ----------
Total interest expense 4,029 2,980
---------- ----------
Net interest and dividend income 4,664 4,482
Provision for loan losses - 44
---------- ----------
Net interest income, after provision for loan losses 4,664 4,438
Noninterest income:
Service charges on deposit accounts 373 203
Loss on sales of assets (5) (1)
Gain on sales of loans - 50
Gain on sales and calls of available-for-sale securities, net 19 10
Increase in cash surrender value of life insurance policies 107 106
Other income 238 234
---------- ----------
Total noninterest income 732 602
Noninterest expense:
Salaries and employee benefits 2,044 2,148
Occupancy and equipment expense 478 444
Professional fees 378 372
Marketing expense 86 162
Other expense 752 556
---------- ----------
Total noninterest expense 3,738 3,682
---------- ----------
Income before income taxes 1,658 1,358
Provision for income taxes 615 458
---------- ----------
Net income $ 1,043 $ 900
========== ==========
Earnings per share:
Basic $ 0.25 $ 0.22
========== ==========
Diluted $ 0.25 $ 0.22
========== ==========
Average common shares outstanding:
Basic 4,162,753 4,122,631
========== ==========
Diluted 4,174,460 4,145,566
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
4
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Nine Months Ended September 30,
2006 2005
---- ----
(In thousands, except per share data)
Interest and dividend income:
Interest and fees on loans $ 20,197 $ 16,937
Interest and dividends on securities:
Taxable 4,051 3,817
Tax-exempt 196 258
Interest on federal funds sold 109 198
Other interest 27 18
---------- ----------
Total interest and dividend income 24,580 21,228
Interest expense:
Interest on deposits 6,783 4,288
Interest on Federal Home Loan Bank advances 3,561 3,127
Interest on subordinated debentures 612 457
---------- ----------
Total interest expense 10,956 7,872
---------- ----------
Net interest and dividend income 13,624 13,356
Provision for loan losses 39 109
---------- ----------
Net interest income, after provision for loan losses 13,585 13,247
Noninterest income:
Service charges on deposit accounts 1,032 623
Gain (loss) on sales of assets (5) 51
Gain (loss) on sales and calls of available-for-sale securities, net (150) 27
Gain on sales of loans - 50
Increase in cash surrender value of life insurance policies 320 363
Other income 784 597
---------- ----------
Total noninterest income 1,981 1,711
Noninterest expense:
Salaries and employee benefits 6,442 6,243
Occupancy and equipment expense 1,461 1,253
Professional fees 1,178 986
Marketing expense 273 490
Other expense 2,086 1,647
---------- ----------
Total noninterest expense 11,440 10,619
---------- ----------
Income before income taxes 4,126 4,339
Provision for income taxes 1,550 1,491
---------- ----------
Net income $ 2,576 $ 2,848
========== ==========
Earnings per share:
Basic $ 0.62 $ 0.69
========== ==========
Diluted $ 0.62 $ 0.69
========== ==========
Average common shares outstanding:
Basic 4,079,396 4,104,304
========== ==========
Diluted 4,094,752 4,132,128
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
5
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
Accumulated
Shares of Additional Other
Common Common Paid-in Retained Comprehensive Unearned
Stock Stock Capital Earnings Loss Compensation Total
---------------------------------------------------------------------------------------
(In thousands, except per share data)
Balance at December 31, 2005 4,132,200 $41 $31,014 $18,998 $(1,198) $ - $48,855
Comprehensive income:
Net income - - - 2,576 - - 2,576
Other comprehensive income - - - - 479 - 479
-------
Comprehensive income 3,055
-------
Issuance of common stock 25,260 - 448 - - - 448
Stock options exercised 28,000 1 304 - - 305
Tax benefit of stock options exercised - - 82 - - 82
Stock-based compensation - - 185 - - 185
Purchase of treasury stock (31,105) - (570) - - (570)
Unearned compensation - - - - - (475) (475)
Dividends declared ($.27 per share) - - - (1,128) - - (1,128)
---------------------------------------------------------------------------------------
Balance at September 30, 2006 4,154,355 $42 $31,463 $20,446 $ (719) $(475) $50,757
=======================================================================================
The accompanying notes are an integral part of these consolidated financial statements.
6
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
-------------------------------
2006 2005
---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 2,576 $ 2,848
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization, net of accretion of securities 74 202
Loss (gain) on sales and calls of available-for-sale securities, net 150 (27)
Change in net deferred loan fees (45) 3
Provision for loan losses 39 109
Deferred tax provision (benefit) (152) 127
Depreciation and amortization 653 604
Loss (gain) on sale of assets 5 (51)
Gain on sale of loans - (50)
Increase in cash surrender value of life insurance (320) (351)
Stock-based compensation 185 -
Net change in:
Other assets 233 282
Accrued interest receivable (161) (307)
Other liabilities 54 630
-------- --------
Net cash provided by operating activities 3,291 4,019
-------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases (35,714) (27,665)
Sales 15,382 2,263
Maturities, calls and paydowns 7,790 8,811
Activity in held-to-maturity securities:
Maturities, calls and paydowns 3,515 5,404
Purchases of Federal Home Loan Bank stock (552) (1,654)
Loan principal originations, net (16,812) (33,584)
Recoveries of loans previously charged off, net (2) 64
Capital expenditures (475) (1,167)
Proceed from sale of property and equipment 24 29
Proceeds from sale of investment real estate - 653
Proceeds from sales of loans - 50
Redemption of life insurance policy - 120
-------- --------
Net cash used in investing activities (26,844) (46,676)
-------- --------
The accompanying notes are an integral part of these consolidated financial statements.
7
SLADE'S FERRY BANCORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
Nine Months Ended September 30,
-------------------------------
2006 2005
---- ----
(In thousands)
Cash flows from financing activities:
Net decrease in noninterest-bearing deposits $ (4,067) $ (1,451)
Net increase in interest-bearing deposits 10,892 6,885
Short-term advances from Federal Home Loan Bank 33,000 10,800
Long-term advances from Federal Home Loan Bank 40,000 33,000
Payments on Federal Home Loan Bank short-term advances (40,000) (8,000)
Payments on Federal Home Loan Bank long-term advances (19,927) (12,312)
Proceeds from issuance of common stock 448 482
Stock options exercised 305 316
Purchase of treasury stock (570) -
Unearned compensation (475) -
Dividends paid (1,128) (1,110)
-------- --------
Net cash provided by financing activities 18,478 28,610
-------- --------
Net decrease in cash and cash equivalents (5,075) (14,047)
Cash and cash equivalents at beginning of period 20,018 35,194
-------- --------
Cash and cash equivalents at end of period $ 14,943 $ 21,147
======== ========
Supplemental disclosures:
Interest paid $ 11,039 $ 4,772
Income taxes paid $ 737 $ 883
The accompanying notes are an integral part of these consolidated financial statements.
8
SLADE'S FERRY BANCORP. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2006
Note A - Basis of Presentation
------------------------------
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United
States of America ("GAAP") for interim financial information and the
instructions to Form 10-Q and, accordingly, do not include all of the
information and footnotes required by GAAP for complete financial statements.
In the opinion of the management of Slade's Ferry Bancorp. (the "Company"), all
adjustments (consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. Operating results for the nine months
ended September 30, 2006 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2006.
The year-end consolidated financial data was derived from audited financial
statements, but does not include all disclosures required by GAAP. This Form
10-Q should be read in conjunction with the Company's Annual Report filed on
Form 10-K for the year ended December 31, 2005.
Note B - Accounting Policies
----------------------------
The accounting principles followed by Slade's Ferry Bancorp. and subsidiary and
the methods of applying these principles which materially affect the
determination of financial position, results of operations, or changes in
financial position are consistent with those used for the year ended December
31, 2005, except for the adoption of Statement of Financial Accounting
Standards No. 123(R), Share-Based Payment, ("SFAS 123 (R)" or the "Statement")
effective January 1, 2006 applicable to the Company's stock-based employee
compensation plans. See Note C.
The consolidated financial statements include the accounts of Slade's Ferry
Bancorp., its wholly-owned subsidiary, Slade's Ferry Trust Company (the "Bank")
and the Bank's wholly-owned subsidiaries. All significant inter-company
balances and transactions have been eliminated in consolidation. The Company
accounts for its wholly-owned subsidiary, Slade's Ferry Statutory Trust I,
using the equity method.
Slade's Ferry Statutory Trust I, a subsidiary of the Company, was formed on
March 17, 2004 to sell capital securities to the public through a third party
trust pool. In accordance with Financial Accounting Standards Board ("FASB")
Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN
46R"), the subsidiary has not been included in the consolidated financial
statements.
Note C - Stock Based Compensation
---------------------------------
The Company adopted Statement of Financial Accounting Standards No. 123(R),
Share-Based Payment, ("SFAS 123(R)" or the "Statement") effective January 1,
2006 applicable to the Company's stock-based employee compensation plans. The
Company's stock-based compensation plans are described in Note 15 to the
Company's consolidated financial statements included in its Form 10-K for the
year ended December 31, 2005. No changes have been made to the plans during the
nine months ended September 30, 2006. In accordance with SFAS No. 123(R), for
the nine months ended September 30, 2006, the Company is expensing, on a
straight line basis, the previously unrecognized compensation costs related to
the non-vested portion of awards granted and outstanding as of January 1, 2006
based on the grant-date fair value of those awards as calculated under the
original provisions of Statement No. 123. Fair value has been determined using
the Black-Scholes option-pricing model. Compensation costs are now being
recognized over the period the
9
employee is required to provide services to obtain the award. The impact of
adopting SFAS No. 123(R) was a reduction of income before income taxes of
$185,000 and a reduction of net income by $122,000 for the nine months ended
September 30, 2006. Basic and diluted earnings per share were reduced by $0.03
per share, respectively. The impact of adopting SFAS No. 123(R) was a reduction
of income before income taxes of $49,000 and a reduction of net income of
$32,000 for the three months ended September 30, 2006. Basic and diluted
earnings per share were reduced by $0.01 per share.
Prior to the adoption of SFAS No. 123(R), the Company accounted for the plans
under the recognition and measurement principles of Accounting Principle Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations. Accordingly, no stock-based employee compensation cost was
reflected in net income, as all options granted under the plans had an exercise
price equal to the market value of the underlying common stock on the date of
grant.
A summary of the status of the Company's stock option plans (shares in
thousands) are presented below:
Stock Options Outstanding
---------------------------
Shares Available Weighted-Average
Options for Grant Shares Exercise Price
----------------------------- ---------------- ------ -----------------
Balance at December 31, 2005 164 255 $15.92
Granted (8) 8 18.40
Stock options exercised - (28) 10.89
Shares vested - - -
Forfeited or expired - (4) 14.18
--- ---
Balance at September 30, 2006 156 231
=== ===
The weighted-average grant-date fair value of options granted during the nine
months ended September 30, 2006 was $4.56. The total intrinsic value of
options exercised during the nine months ended September 30, 2006 was $200,000.
A summary of options outstanding (shares in thousands) at September 30, 2006 is
as follows:
Stock Options
---------------------------
Outstanding Exercisable
----------- -----------
Total number of shares 231 203
Weighted average exercise price $18.18 $18.03
Aggregate intrinsic value (in thousands) $ - $ 26
Weighted average remaining contractual term (in months) 8 8
10
The fair value of each option award is estimated on the date of grant based on
a number of factors including volatilities, dividends, and expected terms.
Listed below is a summary of the factors we employed:
September 30, 2006
------------------
Expected volatility 24% - 33%
Weighted-average volatility 29%
Expected dividends 1.90%
Expected term (in years) 5 - 10
Risk-free rate 3.98% - 5.22%
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of Statement
of Financial Accounting Standards ("SFAS") Statement No. 123(R), "Accounting
for Stock-Based Compensation," to stock-based employee compensation for the
three and nine months ended September 30, 2005.
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2005
------------------ -----------------
(In thousands, except per share data)
Net income, as reported $ 900 $2,848
Deduct: stock-based employee compensation expense
determined under fair value method, net of
related tax effects 41 123
----- ------
Net income, pro forma $ 859 $2,725
===== ======
Earnings per share - basic As reported $0.22 $ 0.69
===== ======
Pro forma $0.21 $ 0.66
===== ======
Earnings per share - assuming dilution As reported $0.22 $ 0.69
===== ======
Pro forma $0.21 $ 0.66
===== ======
11
Note D - Pension Plan
The components of net periodic pension expense are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2006 2005 2006 2005
---- ---- ---- ----
(In thousands)
Interest cost $ 15 $ 21 $ 48 $ 64
Expected return on plan assets (26) (37) (84) (111)
Settlements 108 167 241 167
Recognized net actuarial loss 6 9 21 26
---- ---- ---- -----
Net periodic benefit expense $103 $160 $226 $ 146
==== ==== ==== =====
The Company previously disclosed in its consolidated financial statements for
the year ended December 31, 2005 that it expects to make no contributions to
the plan in 2006.
Recent Accounting Pronouncements
--------------------------------
Defined Benefit Pension and Other Postretirement Plans
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123R, "Shared-Based Payment (Revised 2004)" (SFAS 123R). See Note
C for further information on the Company's share-based compensation plans.
In March 2006, the FASB issued Statement of Financial Accounting Standards No.
156, "Accounting for Servicing of Financial Assets" (SFAS 156). This statement
amends SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," with respect to the accounting for
separately recognized servicing assets and servicing liabilities. Consistent
with SFAS No. 140, SFAS 156 requires companies to recognize a servicing asset
or servicing liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract. However, the statement
permits a company to choose either the amortized cost method or fair value
measurement method for each class of separately recognized servicing assets.
Earlier adoption is permitted as of the beginning of an entity's fiscal year,
provided the entity has not yet issued financial statements, including interim
financial statements. The Company plans to adopt SFAS 156 at the beginning of
2007 and the adoption of this statement will have no material impact on its
consolidated financial statements.
In September 2006, the FASB Issued Statement of Financial Account Standards No.
157, "Fair Value Measurements" (SFAS 157). This statement defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements.
SFAS 157 is effective for the Company on January 1, 2008 and is not expected to
have a significant impact on the Company's consolidated financial statements.
In September 2006, the Financial Accounting Standards Board issued Statement
No. 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans". This Statement will require employers, such as the Bank,
to fully recognize the obligations associated with single-employer defined
benefit pension, retiree healthcare and other postretirement plans in their
financial statements. Specifically, the new standard requires an employer to
(a) recognize on its balance sheet an asset for a plan's over-funded status or
a liability for a plan's under-funded status, (b) measure a plan's assets and
its obligations that determine its
12
funded status as of the end of the employer's fiscal year, and (c) recognize
changes in the funded status of a defined benefit postretirement plan in the
year in which the changes occur.
The requirement to recognize the funded status of a benefit plan and the
disclosure requirements are effective for the Bank at the end of its fiscal
year ending December 31, 2006. The requirement to measure plan assets and
benefit obligations as of the date of the employer's fiscal year-end balance
sheet is effective for the Bank's fiscal year ending December 31, 2008.
Management is in the process of evaluating the impact of this Statement on the
Bank's consolidated financial statements.
In July 2006, the FASB issued Financial Accounting Standards Interpretation No.
48, "Accounting for Uncertainty in Income Taxes" (FIN 48). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprises'
financial statements in accordance with FASB Statement No. 109, "Accounting for
Income Taxes". FIN 48 prescribes a recognition threshold and measurement
attributable for the financial statement recognition and measurement of tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting
in interim periods, disclosures and transitions. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company is currently analyzing the
effects of FIN 48.
On September 13, 2006, the Securities and Exchange Commission "SEC" issued a
Staff Accounting Bulleting N. 108 (SAB 108"). SAB 108 provides interpretive
guidance on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a potential current year
misstatement. Prior to SAB 108, companies might evaluate the materiality of
financial-statement misstatements using either the income statement or balance
approach, with the income statement approach focusing on new misstatements
added in the current year, and the balance sheet approach focusing on the
cumulative amount of misstatement present in a company's balance sheet.
Misstatements that would be material under one approach could be viewed as
immaterial under another approach, and not be corrected. SAB 108 now requires
that companies view financial statement misstatements as material if they are
material according to either the income statement or balance sheet approach.
It is anticipated that SAB 108 will not have a significant impact on the
reported results of operations or financial condition.
On September 20, 2006, the FASB ratified EITF 06-4, "Accounting for Deferred
Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar
Life Insurance Arrangement." ("EITF 06-4). This issue addresses accounting for
split-dollar life insurance arrangements after the employer purchases a life
insurance policy on the covered employee. This EITF states that an obligation
arises as a result of a substantive agreement with an employee to provide
future postretirement benefits. Under EITF 06-4, the obligation is not settled
upon entering into an insurance agreement. Since the obligation is not settled,
a liability should be recognized in accordance with applicable authoritative
guidance. EITF 06-4 is effective for fiscal years beginning after December 15,
2007. The Company is in the process of analyzing the implications of EITF 06-4.
Also on September 20, 2006, the FASB ratified EITF 06-5, "Accounting for
Purchases of Life Insurance-Determining the Amount That Could Be Realized in
Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of
Life Insurance." This issue addresses how an entity should determine the amount
that could be realized under the insurance contract at the balance sheet date
in applying FTB 85-4 and if the determination could be on an individual or
group policy basis. EITF 06-5 is effective for fiscal years beginning after
December 15, 2006. The company is in the process of analyzing the implication
of EITF 06-5.
13
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Slade's Ferry Bancorp., a Massachusetts corporation, is a bank holding company
headquartered in Somerset, Massachusetts with consolidated assets of $607.8
million, consolidated net loans and leases of $426.4 million, consolidated
deposits of $422.7 million and consolidated shareholders' equity of $50.8
million as of September 30, 2006. We conduct our business principally through
our wholly-owned subsidiary, Slade's Ferry Trust Company (referred to herein as
the "Bank"), a Massachusetts-chartered trust company. Our common stock is
quoted on the Nasdaq Capital Market under the symbol "SFBC."
Forward-looking Statements
--------------------------
This Form 10-Q contains certain forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, including statements
regarding the strength of the company's capital and asset quality. Such
statements may be identified by words such as "believes," "will," "expects,"
"project," "may," "could," "developments," "strategic," "launching,"
"opportunities," "anticipates," "estimates," "intends," "plans," "targets" and
similar expressions. These statements are based upon the current beliefs and
expectations of management and are subject to significant risks and
uncertainties. Actual results may differ materially from those set forth in the
forward-looking statements as a result of numerous factors.
The following factors, among others, could cause actual results to differ
materially from the anticipated results or other expectations expressed in our
forward-looking statements:
(1) enactment of adverse government regulation;
(2) competitive pressures among depository and other financial
institutions may increase significantly and have an effect on
pricing, spending, third-party relationships and revenues;
(3) the strength of the United States economy in general and
specifically the strength of the New England economies may be
different than expected, resulting in, among other things, a
deterioration in overall credit quality and borrowers' ability to
service and repay loans, or a reduced demand for credit, including
the resultant effect on the our loan portfolio, levels of
charge-offs and non-performing loans and allowance for loan
losses;
(4) changes in the interest rate environment may reduce interest
margins and adversely impact net interest income; and
(5) changes in assumptions used in making such forward-looking
statements.
Should one or more of these risks materialize or should underlying beliefs or
assumptions prove incorrect, our All subsequent written and oral
forward-looking statements attributable to Slade's Ferry Bancorp. or any person
acting on its behalf are expressly qualified in their entirety by the
cautionary statements set forth above. We do does not intend or undertake any
obligation to update any forward-looking statement to reflect circumstances or
events that occur after the date the forward-looking statements are made.
As used throughout this report, the terms "we," "our," "us," or the "Company"
refer to Slade's Ferry Bancorp. and its consolidated subsidiary, unless the
context otherwise requires.
14
Critical Accounting Policies
----------------------------
Our significant accounting policies are incorporated by reference to Note 1 to
our Consolidated Financial Statements filed within Form 10-K for the year ended
December 31, 2005. In preparing consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and other-than-temporary
impairment losses.
Allowance for loan losses. The allowance for loan losses is established as
losses are estimated to have occurred through a provision for loan losses
charged to earnings. Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is confirmed.
Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans
in light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
Other than temporary impairment. In estimating other-than-temporary-impairment
losses, management considers (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to
retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
Comparison of Financial Condition at September 30, 2006 and December 31, 2005
-----------------------------------------------------------------------------
General
Total assets increased by $21.9 million, or 3.7%, from $585.9 million at
December 31, 2005 to $607.8 million at September 30, 2006. Our total investment
portfolio increased from $130.0 million at December 31, 2005 to $140.1 million
at September 30, 2006, an increase of 7.8%. Total net loans increased by $16.8
million, or 4.1%, from $409.6 million to $426.4 million. Deposits increased by
$6.8 million, or 1.6%, from $415.8 million to $422.7 million. Total short and
long-term borrowings also increased $13.1 million, or 12.1%, from $107.9
million at December 31, 2005 to $120.9 million at September 30, 2006.
Cash and Cash Equivalents
Cash and cash equivalents decreased by $5.1 million, from $20.0 million at
December 31, 2005 to $14.9 million at September 30, 2006. This decrease,
together with the increases in deposits and borrowings, was used to fund the
securities and loan growth.
Investment Portfolio
The main objectives of our investment portfolio are to achieve a competitive
rate of return over a reasonable time period and to provide liquidity.
15
Our normal investment strategy is to allow the investment portfolio to decrease
through normal paydowns and maturities and reinvest these funds into higher
yielding loans or investments. At September 30, 2006, the portfolio duration
was approximately 4.1 years which was within our investment policy limit of 5
years. We do not purchase investments with imbedded derivative characteristics,
or free-standing derivative instruments such as swaps, options, or futures.
Securities Available for Sale
Securities not designated as held-to-maturity are designated as available for
sale. Although we do not anticipate the sale of these securities, the
designation as available for sale allows the flexibility to alter the
investment strategy and sell these securities when conditions warrant.
Additionally, marketable equity securities that have no maturity date must be
designated as available-for-sale. These securities are carried at fair value.
The available-for-sale securities portfolio includes obligations of
government-sponsored enterprises and mortgage-backed securities of
government-sponsored enterprises, corporate debt and equity securities.
Available-for-sale securities increased from $94.3 million at December 31, 2005
to $107.4 million primarily as a result of the above-mentioned $20.0 million
purchase of securities in the three months ending September 30, 2006.
In the three month period ending June 20, 2006, the Board of Directors approved
a strategy to restructure the available-for-sale investment portfolio through
the sale of approximately $14.5 million of low-yielding obligations of
government-sponsored enterprises. Realized losses amounted to $176,000 or 1.2%
of the underlying cost basis of these securities.
The following table shows the amortized cost basis and fair value of securities
available for sale at September 30, 2006 and December 31, 2005.
September 30, 2006 December 31, 2005
---------------------- -------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------------------- ---------------------
(In thousands)
Debt Securities:
Government-sponsored enterprises $ 34,456 $ 33,801 $50,443 $49,581
Corporate 9,244 8,993 9,564 9,014
Mortgage-backed 60,317 60,065 31,574 31,232
-------- -------- ------- -------
Total debt securities 104,017 102,859 91,581 89,827
-------- -------- ------- -------
Marketable equity securities 3,337 3,356 3,426 3,271
Mutual funds 1,215 1,194 1,205 1,200
-------- -------- ------- -------
Total securities available for sale $108,569 $107,409 $96,212 $94,298
======== ======== ======= =======
16
Securities Held to Maturity
The held-to-maturity portfolio consists of mortgage-backed securities and
securities issued by states and municipalities. These securities are carried at
amortized cost. Held-to-maturity securities decreased from $29.3 million at
December 31, 2005 to $25.8 million at September 30, 2006. Management has
designated these mortgage-backed securities to secure advances from the Federal
Home Loan Bank of Boston. We have the positive intent and ability to hold these
securities to maturity.
The following table shows the amortized cost basis and fair value of securities
held to maturity at September 30, 2006 and December 31, 2005.
September 30, 2006 December 31, 2005
--------------------- ---------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------------------- ---------------------
(In thousands)
State and municipal obligations $ 5,002 $ 5,071 $ 6,766 $ 6,892
Mortgage-backed securities 20,750 20,049 22,540 21,966
------- ------- ------- -------
Total securities held to maturity $25,752 $25,120 $29,306 $28,858
======= ======= ======= =======
Loans
Our loan portfolio consists of residential and commercial real estate loans,
construction and land development loans, commercial loans, home equity lines of
credit and consumer loans originated primarily in our market area. There are no
foreign loans outstanding. Interest rates charged on loans are affected
principally by the demand for such loans, the supply of money available for
lending purposes and the rates offered by our competitors. Total net loans were
70.2% of total assets at September 30, 2006, compared to 69.9% of total assets
at December 31, 2005.
Multi-Family and Commercial Real Estate Lending
We originate multi-family and commercial real estate loans that are generally
secured by five or more unit apartment buildings and properties used for
business purposes, such as small office buildings, restaurants or retail
facilities. These loans generally involve larger principal amounts and a
greater degree of risk than one-to-four family residential mortgage loans.
Because payments on loans secured by multi-family and commercial real estate
properties are often dependent on successful operation or management of the
properties, repayment of such loans may be subject to adverse conditions in the
real estate market or the economy. We seek to minimize these risks through our
underwriting standards.
Multi-family and commercial real estate loans totaled $214.2 million and
comprised 49.7% of the total gross loan portfolio at September 30, 2006. At
December 31, 2005, the multi-family and commercial real estate loan portfolio
totaled $213.8 million, or 51.6% of total gross loans.
17
Residential Lending
We currently offer fixed-rate, one-to-four family mortgage loans with terms
from 10 to 30 years and a number of adjustable-rate mortgage loans with terms
of up to 30 years and interest rates that adjust every one or three years from
the outset of the loan.
We generally underwrite our residential real estate loans to comply with
secondary market standards established by the Federal National Mortgage
Association. Although loans are underwritten to standards that make them
readily saleable, we have not chosen to sell these loans. Rather, we maintain
them in our portfolio, consistent with our income and interest rate risk
management targets.
Residential real estate loans totaled $128.5 million and comprised 29.8% of the
total gross loan portfolio at September 30, 2006. At December 31, 2005, the
residential real estate loan portfolio totaled $120.3 million, or 29.0% of
total gross loans. Due to competitive pricing, our residential loan portfolio
continues to increase, and grew 6.8% as a function of total gross loan
portfolio dollars when comparing September 30, 2006 to December 31, 2005.
Commercial Loans
Commercial business loans consist of loans and lines predominantly
collateralized by inventory, furniture and fixtures, and accounts receivable.
In assessing the collateral for this type of loan, we apply a 50% liquidation
value to inventories; 25% to furniture, fixtures and equipment; and 70% to
accounts receivable less than 90 days of the invoice date.
Commercial loans totaled $47.1 million and comprised 10.9% of the total gross
loan portfolio at September 30, 2006. At December 31, 2005, the commercial loan
portfolio totaled $38.1 million, or 9.2% of total gross loans. With the
implementation of our loan portfolio management team, our commercial loan
officers are able to concentrate their efforts on this aspect of business
development.
Construction Lending
Fixed-rate construction loans are originated for the development of one-to-four
family residential properties. Although we do not generally make loans secured
by raw land, our policies permit the origination of such loans. We do not,
however, engage in speculative housing development. Construction loan proceeds
are disbursed periodically in increments as construction progresses and as
inspections by an independent construction specialist warrant.
Construction and land development loans totaled $21.3 million and comprised
4.9% of total gross loan portfolio at September 30, 2006. At December 31, 2005,
construction and land development loans totaled $21.5 million or 5.2% of total
gross loans. With the implementation of our loan portfolio management team, our
commercial loan officers are able to manage their efforts on business
development.
Home Equity Lines of Credit
Home equity lines of credit are secured by second mortgages on owner-occupied,
one-to-four family residences located in our primary market area. Interest
rates on our home equity lines of credit are generally indexed to the Wall
Street Journal Prime Rate and adjust on a monthly basis.
Home equity lines of credit totaled $17.1 million and comprised 4.0% of the
total gross loan portfolio at September 30, 2006. At December 31, 2005, home
equity lines of credit totaled $17.9 million, or 4.3% of total gross loans.
18
Consumer Lending
Consumer loans are either secured or unsecured by rapidly depreciable assets
such as recreational vehicles and automobiles and entail greater risks than
one-to-four family residential mortgage loans. Consumer loans are typically
made based on the borrower's ability to repay the loan through continued
financial stability. We endeavor to minimize risk by reviewing the borrower's
repayment history on past debts and assessing the borrower's ability to meet
existing obligations on the proposed loan. Consumer loans are both secured and
unsecured borrowings. Consumer loans totaled $2.9 million and comprised 0.7% of
the total gross loan portfolio at September 30, 2006. At December 31, 2005, the
consumer loans totaled $2.6 million, or 0.6% of total gross loans.
The following table summarizes our loan portfolio by category at September 30,
2006 and December 31, 2005.
Percentage
September 30, 2006 December 31, 2005 Increase/(Decrease)
------------------ ----------------- -------------------
(Dollars in thousands)
Real estate mortgage loans:
Commercial $214,227 $213,815 0.19%
Residential 128,534 120,345 6.80%
Construction and land development 21,268 21,490 -1.03%
Home equity lines of credit 17,064 17,915 -4.75%
Commercial, financial and agricultural loans 47,111 38,111 23.62%
Consumer loans 2,911 2,623 10.98%
-------- -------- -------
Total loans 431,115 414,299 4.06%
Less: Allowance for loan losses (4,374) (4,333) 0.95%
Net deferred loan fees (311) (356) -12.64%
-------- -------- -------
Loans, net $426,430 $409,610 4.11%
======== ======== =======
The increases in the loan portfolio are the result of the continued demand by
small businesses for commercial and industrial loans and the normal origination
process for residential loans. These increases were partially offset by a
weaker overall general market environment relating to commercial real estate
and home equity lines of credit.
The following table presents information with respect to non-performing loans
at September 30, 2006 and December 31, 2005.
September 30, 2006 December 31, 2006
------------------ -----------------
(Dollars in thousands)
Non-accrual loans $ 497 $ 906
Loans 90 days or more past due and still accruing - -
-------- --------
Total non-performing loans $ 497 $ 906
======== ========
Percentage of non-accrual loans to total gross loans 0.12% 0.22%
Percentage of allowance for loan losses to non-accrual loans 880.08% 478.26%
19
The $497,000 of non-accrual loans as of September 30, 2006 consists of $464,000
of commercial real estate loans, $28,000 of residential real estate loans and
$5,000 of consumer loans. There were no restructured loans included in
non-accrual loans for the nine months ended September 30, 2006.
It is our policy to manage our loan portfolio in order to recognize problem
loans at an early stage and thereby minimize loan losses. Loans are considered
delinquent when any payment of principal or interest is one month or more past
due. We generally commence collection procedures when accounts are 15 days past
due. Generally, when a loan becomes past due 90 days or more, management
discontinues the accrual of interest and reverses previously accrued interest,
unless the credit is well-secured and in process of collection. Loans are
returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are reasonably
assured. When a loan, or any portion of a loan, is determined to be
uncollectible, it is charged off to the Allowance for Loan Losses. If
applicable, any real estate securing the loan is acquired through foreclosure,
and recorded as Other Real Estate Owned at the then fair market value, and
thereby reducing the amount required to be charged against the Allowance for
Loan Losses.
Management defines non-performing loans to include non-accrual loans, loans
past due 90 days or more and still accruing, and restructured loans not
performing in accordance with amended terms.
Statement of Financial Accounting Standards No. 114 "Accounting by Creditors
for Impairment of a Loan" ("SFAS No. 114") applies to all loans except large
groups of smaller-balance homogeneous loans that are collectively evaluated for
impairment. For loans that are classified as impaired, an allowance is
established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan is lower than the carrying value of that
loan. Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. We do not separately identify consumer loans for
impairment disclosures. A loan is considered impaired when, based on current
information and events, it is probable that we will be unable to collect the
scheduled payments of principle or interest when due according to the
contractual terms of the loan agreement.
The following is a summary of information pertaining to impaired and
non-accrual loans:
September 30, 2006 December 31, 2006
------------------ -----------------
(Dollars in thousands)
Impaired loans without a valuation allowance $ 497 $ 49
Impaired loans with a valuation allowance - 906
------ -----
Total impaired loans $ 497 $ 955
====== =====
Valuation allowance related to impaired loans $ - $ 87
====== =====
Total non-accrual loans $ 497 $ 906
====== =====
Total loans past-due ninety days or more and still accruing $ 15 $ -
====== =====
20
Analysis of Allowance for Loan Losses
The table below illustrates the changes in the Allowance for Loan Losses for the periods indicated.
Nine Months Ended September 30,
-------------------------------
2006 2005
---- ----
(Dollars in thousands)
Balance at beginning of period $4,333 $4,101
Charge-offs:
Real estate mortgage loans:
Commercial - -
Residential - -
Home equity lines of credit - -
Commercial, financial and agricultural loans - -
Consumer 12 -
------ ------
12 -
------ ------
Recoveries:
Real estate mortgage loans:
Commercial - -
Residential 5 -
Home equity lines of credit - 16
Commercial, financial and agricultural loans 9 39
Consumer - 9
------ ------
14 64
------ ------
Net loan recoveries (charge-offs) 2 64
Provision for loan losses 39 109
------ ------
Balance at end of period $4,374 $4,274
====== ======
Allowance for loan losses as a percent of loans 1.01% 1.07%
====== ======
Ratio of net loan recoveries (charge-offs) to average loans outstanding 0.00% 0.01%
====== ======
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans
in light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. For
loans that are classified as impaired, a specific allowance is established when
the discounted cash flow (or collateral value or observable market price) of
the impaired loan is lower than the carrying value of that loan. The general
component covers non-classified loans and is based on historical loss
experience adjusted for qualitative factors. An unallocated component is
maintained to cover uncertainties that could affect management's estimate of
probable losses. The amount of the unallocated component of the allowance
reflects the margin of imprecision inherent in the underlying assumptions used
in the methodologies for estimating specific and general losses in the
portfolio.
As the composition of the loan portfolio changes and diversifies over time,
management must revaluate the adequacy of allowance for loan losses. After
thorough review and analysis of the adequacy of the loan loss allowance,
management determined a provision for losses of $39,000 was required for the
nine months ended
21
September 30, 2006 as compared to a provision of $109,000 for the nine months
ended September 30, 2005. The allowance for loan losses as a percentage of
total loans outstanding declined from 1.05% at December 31, 2005 to 1.01% at
September 30, 2006. The decline in the provision for loan losses in 2006, as
compared to the same period in 2005, was primarily attributable to refinements
made in calculating the risk components inherent in our loan portfolio, and the
continued positive credit quality trends inherent in our loan portfolio. These
refinements in the allocated risk factors attributable to all loan pools were
finalized in the second quarter of 2006.
This table below shows an allocation of the allowance for loan losses at the
dates indicated. The unallocated portion of the allowance for loan losses is
reflected in the allocation for real estate mortgage loans.
September 30, 2006 December 31, 2005
---------------------- ----------------------
Percent of Percent of
Loans in Loans in
Each Each
Category to Category to
Amount Total Loans Amount Total Loans
---------------------- ----------------------
(Dollars in thousands)
Commercial $ 750 10.9% $ 905 9.2%
Real estate construction 202 4.9% 248 5.2%
Real estate mortgage 3,216 83.5% 3,056 85.0%
Consumer 206 0.7% 124 0.6%
------------------- -------------------
$4,374 100.0% $4,333 100.0%
=================== ===================
Deposits
We continue our efforts to competitively price deposit products and develop and
maintain banking relationships with our customers. The flow of deposits is
influenced significantly by general economic conditions, changes in money
market rates, prevailing interest rates and competition from local branches of
nationwide and regional banks as well as local banks and credit unions. Our
total deposits increased from $415.8 million at December 31, 2005 to $422.7
million at September 30, 2006, an increase of $6.8 million or 1.6%. The
increase in total deposits was whollly attributable to increases in term
deposits. A $10.0 million certificate of deposit from the Commonwealth of
Massachusetts that is to be used to assist in promoting job growth through
loans to qualifying small businesses, and other reinvestments from
lower-yielding deposit products made up the majority of this increase offset by
run off in other non-certificate deposit products.
22
The following table presents deposits by category at September 30, 2006 and
December 31, 2005.
Percentage
September 30, 2006 December 31, 2005 Increase/(Decrease)
------------------ ----------------- -------------------
(Dollars in thousands)
Demand deposits $ 76,638 $ 80,705 -5.04%
NOW 49,388 55,493 -11.00%
Regular and other savings 79,413 87,146 -8.87%
Money market deposits 26,795 29,835 -10.19%
-------- -------- -------
Total non-certificate accounts 232,234 253,179 -8.27%
-------- -------- -------
Term certificates less than $100,000 122,290 116,861 4.65%
Term certificates of $100,000 or more 68,147 45,806 48.77%
-------- -------- -------
Total certificate accounts 190,437 162,667 17.07%
-------- -------- -------
Total deposits $422,671 $415,846 1.64%
======== ======== =======
Borrowings
There was no change in the balance of our subordinated debentures from December
31, 2005 to September 30, 2006. Short- and long-term advances from the Federal
Home Loan Bank of Boston totaled $120.9 million at September 30, 2006, as
compared to $107.9 million at December 31, 2005, an increase of $13.1 million,
or 12.1%. This increase primarily represents the difference between the growth
in our loans and investment securities compared to the growth in our deposits
and the reductions in our cash equivalents. Our strategy is to obtain an
appropriate overall cost of funds utilizing deposit growth combined with
advances from the Federal Home Loan Bank to support our loan growth, and
investment securities increases, if any.
23
Comparison of Results of Operations for the Three Months Ended September 30,
----------------------------------------------------------------------------
2006 and 2005
-------------
General
Net income increased from $900,000 or $0.22 per share on a diluted basis, for
the three months ended September 30, 2005 to $1.0 million or $0.25 per share on
a diluted basis, for the three months ended September 30, 2006, a 15.9%
increase. Net interest and dividend income remained relatively stable, with
large offsetting increases in interest income and interest expense, when
comparing the three months ended September 30, 2005 and 2006. The provision for
loan losses decreased by $44,000 for the three months ended September 30, 2006.
Non-interest income increased by $130,000 or 21.6% from $602,000 to $732,000
for the three months ended September 30, 2005 and 2006. Non-interest expense
increased by $56,000 or 1.5%, to $3.7 million for the three months ended
September 30, 2006 when compared to September 30, 2005.
Interest Income
Our operating performance is dependent on net interest and dividend income, the
difference between interest and dividend income earned on loans and investments
and interest expense paid on deposits and borrowed funds. The level of net
interest income and dividend income is significantly impacted by factors such
as economic conditions, interest rates, asset/liability management, and
strategic planning.
Interest and dividend income increased by $1.2 million or 16.5%, from $7.5
million for the three months ended September 30, 2005 to $8.7 million for the
three months ended September 30, 2006. The majority of this increase can be
attributed to growth in the loan portfolio and an increase in yields on loans.
The average balance of loans increased by $33.9 million or 8.5% and the yield
on the loan portfolio increased from 5.9% for the three months ended September
30, 2005 to 6.5% for the three months ended September 30, 2006. The increases
resulted from a greater volume and higher rates earned on commercial and real
estate loans reflecting current market conditions. Interest and dividends on
investments increased by $97,000 for the three months ended September 30, 2006
compared to the three months ended September 30, 2005. The increase was
primarily the result of the equivalent of two Federal Home Loan Bank of Boston
dividend payments in the third quarter of 2006, after not declaring a second
quarter dividend, compared to only one dividend payment in the comparable
period in the prior year.
Interest Expense
Total interest expense increased by $1.0 million or 35.2%, from $3.0 million
for the three months ended September 30, 2005 to $4.0 million for the three
months ended September 30, 2006. In response to competitive pressures and the
rising rate environment, we raised rates on certain deposit products with the
most significant increases in certificate of deposit and certain money-market
based products. As a result of the rate increases and a large movement of
balances from lower yielding deposit products to higher yielding term products,
the weighted average cost of deposits increased from 2.04% for the three months
ended September 30, 2005 to 2.97% for the three months ended September 30,
2006. The interest expense on Federal Home Loan Bank borrowings increased
$54,000 during this same time period due primarily to associated rate and
volume increases. Interest expense associated with subordinated debentures
increased by $51,000, the result of increased market interest rates. The
debentures carry an adjustable rate of interest tied to the three-month LIBOR
rate.
24
Net Interest Margin
As a result of the current interest rate environment and our corresponding rate
increases on deposit accounts, the net interest margin has compressed 1 basis
point from 3.32% for the three months ended September 30, 2005 to 3.31% at
September 30, 2006. The compression in net interest margin was mostly due to
the growth in an environment with an inverted yield curve and low yielding
loans and investments, combined with intense competition for deposits.
Provision for Loan Losses
After thorough review and analysis of the adequacy of the loan loss reserve,
management deemed it prudent not to provide a provision for possible loan
losses for the three months ended September 30, 2006 compared to $44,000 for
possible loan losses for the three months ended September 30, 2005. The decline
in the provision for loan losses in 2006 was attributable to continued
improvements in the overall loan quality, combined with the refinements made in
the allocated risk factors attributable to all components of our loan
portfolio, during the first six months of 2006.
25
The following table sets forth our average assets, liabilities, and stockholders' equity, interest income earned and interest
paid, average rates earned and paid, net interest spread and the net interest margin for the three months ended September 30,
2006 and 2005. Average balances reported are daily averages.
Three Months Ended September 30,
-----------------------------------------------------------------------------------
2006 2005
--------------------------------------- ---------------------------------------
Average Interest Average Average Interest Average
Balance Income/Expense Rate Balance Income/Expense Rate
--------------------------------------- ---------------------------------------
Assets: (Dollars in thousands)
-------
Interest earning assets (2)
Loans:
Commercial $ 50,928 $ 984 7.67% $ 33,618 $ 597 7.05%
Commercial real estate 229,519 3,864 6.68% 223,813 3,450 6.12%
Residential real estate 148,845 2,142 5.71% 138,309 1,858 5.33%
Consumer 2,660 87 12.98% 2,306 38 6.54%
----------------------- -----------------------
Total loans 431,952 7,077 6.50% 398,046 5,943 5.92%
Federal funds sold 2,947 44 5.92% 4,916 41 3.31%
Taxable debt securities 108,547 1,288 4.71% 120,487 1,284 4.23%
Tax-exempt debt securities (1) 5,654 94 6.59% 7,703 128 6.58%
Marketable equity securities 4,331 40 3.66% 4,021 38 3.75%
FHLB stock 6,415 173 10.70% 6,188 66 4.23%
Other investments 650 10 6.11% 1,184 7 2.35%
----------------------- -----------------------
Total interest earning assets 560,496 8,726 6.18% 542,545 7,507 5.49%
Allowance for loan losses (4,368) ------- (4,228) -------
Deferred loan fees (326) (383)
Cash and due from banks 12,970 14,734
Other assets 38,009 26,650
-------- --------
$606,781 $579,318
======== ========
Liabilities and Stockholders' Equity:
-------------------------------------
Interest bearing liabilities
Savings accounts $ 80,255 $ 302 1.49% $ 95,498 $ 304 1.26%
NOW accounts 53,506 170 1.26% 48,786 146 1.19%
Money market accounts 26,966 182 2.68% 30,028 101 1.33%
Time deposits 187,837 1,962 4.14% 150,647 1,121 2.95%
FHLB advances 106,472 1,196 4.46% 114,025 1,142 3.97%
Subordinated debt 10,310 217 8.35% 10,310 166 6.39%
----------------------- -----------------------
Total interest bearing liabilities 465,346 4,029 3.44% 449,294 2,980 2.63%
Demand deposits 75,343 ------- 79,441 -------
Other liabilities 16,269 2,119
-------- --------
Total liabilities 556,958 530,854
Total stockholders' equity 49,823 48,464
-------- --------
$606,781 $579,318
======== ========
Net interest income $ 4,697 $ 4,527
======= =======
Net interest spread 2.74% 2.86%
===== ====
Net interest margin 3.32% 3.31%
===== ====
(1) On a fully taxable basis based on tax rate of 35.0% for 2006 and 2005. Interest income on investments and net interest
income includes a fully taxable equivalent adjustment of $33,000 in 2006 and $45,000 in 2005.
(2) Average balance includes non-accruing loans. The effect of including such loans, although not material, is to reduce the
average rate earned on the Company's loans.
26
The following table presents the changes in components of net interest income
for the three months ended September 30, 2006 and 2005, which are the result of
changes in interest rates and changes that in the volume of the underlying asset
or liability. Changes that are attributable to the changes in both rate and
volume have been allocated equally to rate and volume.
Three Months Ended September 30,
2006 vs. 2005 Increase (Decrease)
---------------------------------
Total Due to Due to
Change Volume Rate
---------------------------------
(In thousands)
Commercial loans $ 387 $ 330 $ 57
Commercial real estate 414 90 324
Residential real estate 284 147 137
Consumer loans 49 7 42
Federal funds sold 3 (23) 26
Taxable debt securities 4 (134) 138
Tax-exempt debt securities (34) (34) -
Marketable equity securities 2 3 (1)
FHLB Stock 107 3 104
Other investments 3 (6) 9
-----------------------------
Total interest income 1,219 383 836
-----------------------------
Savings accounts (2) (53) 51
NOW accounts 24 15 9
Money market accounts 81 (15) 96
Time deposits 841 319 522
FHLB advances 54 (80) 134
Subordinated debt 51 - 51
-----------------------------
Total interest expense 1,049 186 863
-----------------------------
Net interest income $ 170 $ 197 $(27)
=============================
Non-Interest Income
Non-interest income increased from $602,000 for the three months ended
September 30, 2005 to $732,000 for the three months ended September 30, 2006,
an increase of $130,000 or 21.6%. The growth was primarily attributable to
increases in service charges on deposit accounts attributable to the
introduction of an overdraft protection program and increases in the volumes of
official check fees and debit card income offset by the non recurrence of a
gain on the sale of loans in the three months ended September 30, 2005.
Non-Interest Expense
Non-interest expense increased by $56,000 to $3.7 million for the three months
ended September 30, 2006 as compared to the same three month period in 2005.
The change is primarily related to increased expenses associated with the
outsourcing of substantial portions of back office operations to minimize risk,
increase efficiency and utilize advanced technologies which were partially
offset by savings in salary expenses.
27
Provision for Income Taxes
Income before income taxes was $1.4 million for the three months ended
September 30, 2005 compared to $1.7 million for the three months ended
September 30, 2006. Provision for income taxes totaled $458,000 and $615,000
million for the three months ended September 30, 2005 and 2006, respectively,
representing effective tax rates of 33.7% and 37.1%, respectively. The increase
in the overall tax rate was due to a decline in income for the Bank's
subsidiaries which are taxed at a lower state tax rate and a decline in
federally exempt municipal income.
28
Comparison of Results of Operations for the Nine Months Ended September 30,
---------------------------------------------------------------------------
2006 and 2005
-------------
General
Net income decreased from $2.8 million or $0.69 per share on a diluted basis,
for the nine months ended September 30, 2005 to $2.6 million or $0.62 per share
on a diluted basis, for the nine months ended September 30, 2006, a decrease of
9.6%. Net interest and dividend income increased by $268,000 or 2.0%, from
$13.4 million to $13.6 million when comparing the nine months ended September
30, 2005 and 2006. Over the same period, the provision for loan losses
decreased from $109,000 to $39,000. Non-interest income increased by $270,000
or 15.8% from $1.7 million to $2.0 million for the nine months ended September
30, 2005 and 2006. Non-interest expenses increased by $821,000 or 7.7%, from
$10.6 million for the nine months ended September 30, 2005 to $11.4 million for
the nine months ended September 30, 2006.
Interest Income
Our operating performance is dependent on net interest and dividend income, the
difference between interest and dividend income earned on loans and investments
and interest expense paid on deposits and borrowed funds. The level of net
interest income and dividend income is significantly impacted by factors such
as economic conditions, interest rates, asset/liability management, and
strategic planning.
Interest and dividend income increased by $3.4 million or 15.8%, to $24.6
million for the nine months ended September 30, 2006 from $21.2 million for the
nine months ended September 30, 2005. This increase is primarily attributable
to the growth in the loan portfolio and higher yields on loans. The average
balance of loans increased by $35.8 million or 9.2% and the yield on the loan
portfolio increased from 5.8% for the nine months ended September 30, 2005 to
6.4% for the nine months ended September 30, 2006. The increases were
principally the result of a greater volume and higher rates earned on
commercial and real estate loans reflecting current market conditions. Interest
and dividends on investments increased by $92,000, for the nine months ended
September 30, 2006 compared to the nine months ended September 30, 2005. The
increase was due to higher rates reduced by lower average balances.
Interest Expense
Total interest expense increased by $3.1 million or 39.2%, from $7.9 million
for the nine months ended September 30, 2005 to $11.0 million for the nine
months ended September 30, 2006. Market interest rates together with our own
deposit rates have increased. Interest on deposits increased by $2.5 million or
58.2% when comparing the nine months ended September 30, 2006 and 2005. In
response to competitive pressures and the rising rate environment, we raised
rates on certain deposit products with the most significant increases in
certificate of deposit and certain money-market based products. As a result of
the rate increases, the weighted average cost of deposits increased from 1.79%
for the nine months ended September 30, 2005 to 2.66% for the nine months ended
September 30, 2006. Interest expense associated with the Federal Home Loan
Borrowings increased by $434,000 due to a combination of rate and volume
increases related to the need to fund loan growth. Interest expense associated
with subordinated debentures increased by $155,000, the result of increased
market interest rates. The debentures carry an adjustable rate of interest tied
to the three-month LIBOR rate.
Net Interest Margin
As a result of the current interest rate environment and our corresponding rate
increases on deposit accounts, the net interest margin has compressed 9 basis
points from 3.41% for the nine months ended September 30, 2005 to 3.32% at
September 30, 2006. The compression in net interest margin was mostly due to
the growth in
29
an environment with an inverted yield curve and low yielding loans and
investments, combined with intense competition for deposits.
Provision for Loan Losses
After thorough review and analysis of the adequacy of the loan loss reserve,
management deemed it prudent to provide $39,000 for possible loan losses for
the nine months ended September 30, 2006 compared to $109,000 for possible loan
losses for the nine months ended September 30, 2005. The decline in the
provision for loan losses in 2006 was attributable to continued improvements in
the overall loan quality, combined with the refinements made in the allocated
risk factors attributable to all components of our loan portfolio, during the
nine months ended September 30, 2006, as compared to the same period in 2005.
30
The following table sets forth our average assets, liabilities, and stockholders' equity, interest income earned and interest
paid, average rates earned and paid, net interest spread and the net interest margin for the nine months ended September 30,
2006 and 2005. Average balances reported are daily averages.
Nine Months Ended September 30,
-----------------------------------------------------------------------------------
2006 2005
--------------------------------------- ---------------------------------------
Average Interest Average Average Interest Average
Balance Income/Expense Rate Balance Income/Expense Rate
--------------------------------------- ---------------------------------------
Assets: (Dollars in thousands)
-------
Interest earning assets (2)
Loans:
Commercial $ 46,611 $ 2,643 7.58% $ 31,397 $ 1,504 6.40%
Commercial real estate 229,006 11,183 6.53% 220,750 10,038 6.08%
Residential real estate 145,864 6,208 5.69% 133,893 5,288 5.28%
Consumer 2,592 163 8.41% 2,279 107 6.28%
----------------------- -----------------------
Total loans 424,073 20,197 6.37% 388,319 16,937 5.83%
Federal funds sold 2,811 109 5.14% 10,021 198 2.64%
Taxable debt securities 109,321 3,683 4.51% 111,464 3,517 4.22%
Tax-exempt debt securities (1) 6,057 302 6.66% 7,985 397 6.65%
Marketable equity securities 4,347 112 3.44% 4,681 121 3.46%
FHLB stock 6,341 256 5.40% 5,721 179 4.18%
Other investments 650 27 5.55% 775 18 3.11%
----------------------- -----------------------
Total interest earning assets 553,600 24,686 5.96% 528,966 21,367 5.40%
Allowance for loan losses (4,361) ------- (4,185) -------
Deferred loan fees (329) (394)
Cash and due from banks 12,958 16,539
Other assets 26,234 26,281
-------- --------
$588,102 $567,207
======== ========
Liabilities and Stockholders' Equity:
-------------------------------------
Interest bearing liabilities
Savings accounts $ 82,533 $ 830 1.34% $ 92,926 $ 772 1.11%
NOW accounts 55,633 531 1.28% 48,422 377 1.04%
Money market accounts 26,921 440 2.19% 34,858 320 1.23%
Time deposits 175,866 4,982 3.79% 144,474 2,819 2.61%
FHLB advances 109,447 3,561 4.35% 107,697 3,127 3.88%
Subordinated debt 10,310 612 7.94% 10,310 457 5.93%
----------------------- -----------------------
Total interest bearing liabilities 460,710 10,956 3.18% 438,687 7,872 2.40%
Demand deposits 74,334 ------- 78,579 -------
Other liabilities 12,641 2,229
-------- --------
Total liabilities 547,685 519,495
Total stockholders' equity 40,417 47,712
-------- --------
$588,102 $567,207
======== ========
Net interest income $13,730 $13,495
======= =======
Net interest spread 2.78% 3.00%
===== ====
Net interest margin 3.32% 3.41%
===== ====
(1) On a fully taxable basis based on tax rate of 35.0% for 2006 and 2005. Interest income on investments and net interest
income includes a fully taxable equivalent adjustment of $106,000 in 2006 and $139,000 in 2005.
(2) Average balance includes non-accruing loans. The effect of including such loans, although not material, is to reduce the
average rate earned on the Company's loans.
31
The following table presents the changes in components of net interest income
for the nine months ended September 30, 2006 and 2005, which are the result of
changes in interest rates and changes in the volume of the underlying asset or
liability. Changes that are attributable to the changes in both rate and volume
have been allocated equally to rate and volume.
Nine Months Ended September 30,
2006 vs. 2005 Increase (Decrease)
---------------------------------
Total Due to Due to
Change Volume Rate
---------------------------------
(In thousands)
Commercial loans $1,139 $ 826 $ 313
Commercial real estate 1,145 385 760
Residential real estate 920 492 428
Consumer loans 56 16 40
Federal funds sold (89) (211) 122
Taxable debt securities 166 (70) 236
Tax-exempt debt securities (95) (96) 1
Marketable equity securities (9) (9) -
FHLB Stock 77 21 56
Other investments 9 (4) 13
------------------------------
Total interest income 3,319 1,350 1,969
------------------------------
Savings accounts 58 (95) 153
NOW accounts 154 61 93
Money market accounts 120 (101) 221
Time deposits 2,163 702 1,461
FHLB advances 434 52 382
Subordinated debt 155 - 155
------------------------------
Total interest expense 3,084 619 2,465
------------------------------
Net interest income $ 235 $ 731 $ (496)
==============================
Non-Interest Income
Non-interest income increased from $1.7 million for the nine months ended
September 30, 2005 to $2.0 million for the nine months ended September 30,
2006, an increase of $270,000 or 15.8%. Service charges on deposit accounts
increased by $409,000 or 65.7% from $623,000 for the nine months ended
September 30, 2005 to $1.0 million for the nine months ended September 30,
2006. This was the result of an increase in overdraft fees with the
implementation of an overdraft protection program partially offset by a
decrease in service charges on checking accounts. For the nine months ended
September 30, 2006, losses recognized on the sale of assets and securities
amounted to $155,000 when compared to gains of $128,000 for the nine months
ended September 30, 2005. The losses were primarily attributable to the sale of
low-yielding securities in the second quarter of 2006 which was part of a
restructuring strategy to obtain higher-yielding investments. Cash surrender
value increases pertaining to bank-owned life insurance policies decreased
$43,000 to $320,000 for the nine months ended September 30, 2006 from $363,000
for the nine months ended September 30, 2005. Additionally, other income
increased from $597,000 for the nine months ended September 30, 2005 to
$784,000 for the nine months ended September 30, 2006, an increase of $187,000
or 31.3%, primarily as a result of increased commissions earned on the sale of
non-deposit investment products, combined with increased volumes in official
check fees and debit card income.
32
Non-Interest Expense
Non-interest expense increased from $10.6 million for the nine months ended
September 30, 2005 to $11.4 million for the nine months ended September 30,
2006, an increase of $821,000 or 7.3%. Salaries and employee benefits increased
by $199,000 or 3.2%, from $6.2 million for the nine months ended September 30,
2005 to $6.4 million for the nine months ended September 30, 2006. The increase
in salaries and benefits includes the adoption of SFAS 123(R) effective January
1, 2006 applicable to the Company's stock-based employee compensation plan
which resulted in the recognition of $185,000 in expense, an increase in the
Bank's defined benefit plan expense of $80,000 which includes the recognition
of settlement accounting. The increases were partially offset by salary
reductions attributable to the outsourcing of substantial portions of our back
room operations. Occupancy and equipment expense for the nine months ended
September 30, 2006 increased $208,000 to $1.5 million as compared to $1.3
million for the nine months ended September 30, 2005. The increase was the
result of additional depreciation expense incurred from both our Assonet branch
that was opened April 2005 and the upgrade in software associated with the
modernization of teller and platform systems. Professional fees increased
$192,000 due primarily to the outsourcing of our internal audit function
commencing January 1, 2006 and consultations regarding accounting and
regulatory matters. Marketing expense decreased $217,000 to $273,000 for the
nine months ended September 30, 2006 from $490,000 for the nine months ended
September 30, 2005 which is attributable to the timing of certain advertising
and community sponsorship initiatives in 2006. Other expense increased $439,000
or 26.7% from $1.6 million for the nine months ended September 30, 2005 to $2.1
million for the nine months ended September 30, 2006. This increase was due to
the increased volume of internet banking and cash management fees, increased
postage cost, the outsourcing of our courier service, and the increase of
meetings and committee fees for two additional Board members.
Provision for Income Taxes
Income before income taxes was $4.3 million for the nine months ended September
30, 2005 as compared to $4.1 million for the nine months ended September 30,
2006. Provision for income taxes totaled $1.5 million and $1.6 million for the
nine months ended September 30, 2005 and 2006, respectively, representing
effective tax rates of 34.4% and 37.6%, respectively. The increase in the
overall tax rate was primarily due to a decline in income for the Bank's
subsidiaries which are taxed at a lower state tax rate and a decline in
federally exempt municipal income for the nine months ended September 30, 2006
compared to 2005.
33
Liquidity
---------
Our principal sources of funds are customer deposits, amortization and payoff
of existing loan principal, and sales, amortization or maturities of various
investment securities. The Bank is a voluntary member of the Federal Home Loan
Bank of Boston and as such, may take advantage of the Federal Home Loan Bank of
Boston's borrowing programs to enhance liquidity and leverage its favorable
capital position. The Bank also may draw on lines of credit at the Federal Home
Loan Bank of Boston or the Federal Reserve Board, and enter into repurchase or
reverse repurchase agreements with authorized brokers. These various sources of
liquidity are used to fund withdrawals, new loans, and investments.
Management seeks to promote deposit growth while controlling the cost of funds.
Sales-oriented programs to attract new depositors and the cross-selling of
various products to its existing customer base are currently in place.
Management reviews, on an ongoing basis, possible new products, with particular
attention to products and services, which will aid in retaining our base of
lower-costing deposits.
Maturities and sales of investment securities provide us with liquidity. Our
policy of purchasing shorter-term debt securities reduces market risk in the
bond portfolio while providing significant cash flow. For the nine months ended
September 30, 2006, cash flow from maturities of securities was $11.3 million
and the proceeds from sales of securities totaled $15.4 million. In comparison,
maturities of securities aggregated $14.2 million, and the proceeds from sales
of securities aggregated $2.3 million for the nine months ended September 30,
2005. Purchases of securities for the nine months ended September 30, 2006
totaled $35.7 million compared to $27.7 million at September 30, 2005.
Amortization and pay-offs of the loan portfolio also provide us with
significant liquidity. Traditionally, amortization and pay-offs are reinvested
into loans.
We have also used borrowed funds as a source of liquidity. At September 30,
2006, the Bank's outstanding borrowings from the Federal Home Loan Bank of
Boston were $120.9 million. The Bank has the capacity to borrow in excess of
additional $25.7 million at the Federal Home Loan Bank.
Loan originations for the nine months ended September 30, 2006 totaled $84.4
million. Commitments to originate loans at September 30, 2006 were $5.5
million, excluding unadvanced construction funds totaling $13.3 million,
unadvanced commercial lines of credit totaling $18.6 million and unadvanced
home equity lines totaling $16.1 million. Management believes that adequate
liquidity is available to fund loan commitments utilizing deposits, loan
amortization, maturities of securities, or borrowings.
Capital
-------
At September 30, 2006, our total shareholders' equity was $50.8 million, an
increase of $1.9 million from $48.9 million at December 31, 2005. Additions to
shareholders' equity consisted primarily of net income of $2.6 million and
accumulated other comprehensive income of $479,000 for the nine months ended
September 30, 2006. In addition, there were 25,260 shares of common stock
issued at a value of $448,000, pursuant to our Dividend Reinvestment Program,
in lieu of cash dividends or for optional cash contributions. Furthermore,
stock option exercises resulted in the issuance of 28,000 shares common stock
at a value of $305,000, plus a related tax benefit of $82,000 and stock-based
compensation of $185,000. These additions were offset by dividends declared of
$1.1 million, the repurchase of 31,105 shares of treasury stock for $570,000,
and the contribution of $475,000 to a trust for the purchase of our common
stock to be used for restricted stock awards. In May 2006, the Board authorized
the purchase of 50,000 shares of common stock to be held in trust for future
restricted stock awards under the 2004 Equity Incentive Plan. The $475,000,
which is reflected on our balance sheet as unearned compensation under
34
stockholder's equity has been contributed to the trust to fund the purchase of
some of these shares. No shares have yet been awarded.
Under the requirements for Risk Based and Leverage Capital of the federal
banking agencies, a minimum level of capital will vary among banks based on
safety and soundness of operations. Risk Based Capital ratios are calculated
with reference to risk-weighted assets, which include both on and off balance
sheet exposure.
In addition to meeting the required levels, the Company's and the Bank's
capital ratios met the criteria of the well-capitalized category established by
the federal banking agencies at September 30, 2006 and at December 31, 2005.
The Tier I Capital leverage ratio and Tier I Capital to risk weighted assets
ratio for Slade's Ferry Bancorp are 9.86% and 14.04%, respectively, at
September 30, 2006. Slade's Ferry Bancorp's Tier I Capital leverage ratio and
Tier I Capital to risk weighted assets ratio at December 31, 2005 were 10.07%
and 14.66%, respectively. The Tier I Capital leverage ratio and Tier I Capital
to risk weighted assets ratio for the Bank are 8.80% and 12.22%, respectively,
at September 30, 2006. The Bank's Tier I Capital leverage ratio and Tier I
Capital to risk weighted assets ratio at December 31, 2005 were 8.56% and
12.51%, respectively.
35
Off-Balance Sheet Arrangements
------------------------------
We do not have any off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, revenues
or expenses, results of operations, liquidity, capital expenditures or capital
resources that are material to investors.
36
ITEM 3
QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We consider interest rate risk to be a significant market risk as it could
potentially have an effect on our financial condition and results of operation.
The definition of interest rate risk is the exposure of our earnings to adverse
movements in interest rates, arising from the differences in the timing of
repricing of assets and liabilities; the differences in the various pricing
indices inherent in our assets and liabilities; and the effects of overt and
embedded options in our assets and liabilities. Our Asset/Liability Committee,
comprised of the executive management, is responsible for managing and
monitoring interest rate risk, and reviewing with the Board of Directors, at
least quarterly, the interest rate risk positions, the impact changes in
interest rates could have on net interest income, and the maintenance of
interest rate risk exposure within approved guidelines.
The potentially volatile nature of market interest rates requires us to manage
interest rate risk on an active and dynamic basis. Our objective is to reduce
and control the volatility of net interest income to within tolerance levels
established by the Board of Directors, by managing the relationship of
interest-earning assets and interest-bearing liabilities. In order to manage
this relationship, the Asset/Liability Committee utilizes an income simulation
model to measure the net interest income at risk under differing interest rate
scenarios. Additionally, the Committee uses Economic Value of Equity ("EVE")
analysis to measure the effects of changing interest rates on the market values
of rate-sensitive assets and liabilities, taken as a whole. The Board of
Directors and management believe that static measures of timing differences,
such as "gap analysis", do not accurately assess the levels of interest rate
risk inherent in our balance sheet. Gap analysis does not reflect the effects
of overt and embedded options on net interest income, given a shift in interest
rates, nor does it take into account basis risk, the risk arising from using
various different indices on which to base pricing decisions.
The income simulation model currently utilizes a 200 basis point increase and
decrease in interest rate shocks. The interest rate movements used assume an
instant and parallel change in interest rates with no ability to implement any
strategic plans in response to the change in rates. Prepayment speeds for loans
are based on median dealer forecasts for each interest rate scenario.
The Board of Directors has established a risk limit of a 5.00% change in net
interest income for each 100 basis point shift in market interest rates. The
limit provides an internal tolerance level to control interest rate risk. We
are within our policy-mandated risk limit for net interest income at risk.
The following table reflects our estimated exposure as a percentage of net
interest income and the change in basis points for the next twelve months,
assuming an immediate change in interest rates set forth below:
Rate Change Estimated Exposure as a Percentage Change
(Basis Points) of Net Interest Income (Basis Points)
------------------------------------------------------------------------
+200 12.36% (22)
-200 5.95% 11
37
Additionally we use the model to estimate the effects of changes in interest
rates on our EVE. EVE represents our theoretical market value, given the rate
shocks applied in the model. The Board of Directors has established a risk limit
for EVE which provides that the EVE will not fall below 6.00%, the FDIC's
minimum capital level to be classified as "well capitalized". We are within our
risk limit for EVE.
The following table presents the changes in EVE given rate shocks.
Rate Change Economic Value Change from
(Basis Points) of Equity Flat Rates
-------------------------------------------------
Flat 13.02% N/A
+200 11.39% -1.63%
-200 12.99% -0.03%
38
ITEM 4
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of the
end of the period covered by this report, the Company carried out an evaluation
under the supervision and with the participation of the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the Company's disclosure controls and procedures. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were effective
as of September 30, 2006 to ensure that information required to be disclosed by
the Company in the reports it files or submits under the Exchange Act is (i)
recorded, processed, summarized and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms and (ii)
accumulated and communicated to the Company's management, including its
principal executive officer and principal financial officer, as appropriate to
allow timely decisions regarding disclosure. In connection with the rules
regarding disclosure and control procedures, we intend to continue to review
and document our disclosure controls and procedures, including our internal
controls and procedures for financial reporting, and may from time to time make
changes aimed at enhancing their effectiveness and to ensure that our systems
evolve with our business.
(b) Changes in Internal Controls over Financial Reporting
There were no changes in the Company's internal controls over financial
reporting identified in connection with the Company's evaluation of its
disclosure controls and procedures that occurred during the Company's last
fiscal quarter that have materially affected, or are reasonably likely to
materially affects the Company's internal control over financial reporting.
39
PART II
OTHER INFORMATION
ITEM 1
LEGAL PROCEEDINGS
None.
ITEM 1A
RISK FACTORS
There have been no material changes to the risk factors that are included in
our Annual Report on Form 10-K for the year ended December 31, 2005 that could
affect our business, results of operations or financial condition.
ITEM 2
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
This table provides certain information with respect to our purchase of our
common stock during the three months ended September 30, 2006.
(c) Total Number of (d) Maximum Number (or
(a) Total Shares Purchased as Approximate Dollar Value) of
Number of (b) Average Part of Publicly Shares that may yet be
Shares Price Paid Announced Plans or Purchased under the Plans or
Period Purchased per Share Programs (1) Programs (1)
---------------------------------------------------------------------------------------------------------------------------
July 1, 2006 through July 31, 2006 - N/A - 208,036
---------------------------------------------------------------------------------------------------------------------------
Aug. 1, 2006 through Aug. 31, 2006 4,560 $18.08 4,560 203,476
---------------------------------------------------------------------------------------------------------------------------
Sept. 1, 2006 through Sept. 30, 2006 13,545 $19.04 13,545 189,931
---------------------------------------------------------------------------------------------------------------------------
Total 18,105 $18.80 18,105 189,931
---------------------------------------------------------------------------------------------------------------------------
(1) On July 18, 2006 the Company announced a stock repurchase plan pursuant to which the Company may repurchase up to
208,036 shares of its outstanding common stock. The shares shown in this table in column (c) were repurchased in the
months indicated, and the shares reflected in column (d) could still be repurchased as of the respective month end
under the plan.
40
ITEM 3
DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5
OTHER INFORMATION
None.
ITEM 6
EXHIBITS
Exhibits: See exhibit index.
41
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SLADE'S FERRY BANCORP.
-----------------------------------
(Registrant)
November 14, 2006 /s/ Mary Lynn D. Lenz
------------------------------ -----------------------------------
(Date) Mary Lynn D. Lenz
President and
Chief Executive Officer
November 14, 2006 /s/ Deborah A. McLaughlin
------------------------------ -----------------------------------
(Date) Deborah A. McLaughlin
Executive Vice President
Chief Financial Officer and Chief
Operations Officer
42
EXHIBIT INDEX
Exhibit No. Description Item
----------- ----------- ----
3.1 Amended and Restated Articles of Incorporation of Slade's Ferry Bancorp. (1)
3.2 Amended and Restated Bylaws of Slade's Ferry Bancorp. (2)
3.3 Articles of Amendment to the Amended and Restated Articles of Incorporation (3)
of Slade's Ferry Bank
10.1 Slade's Ferry Bancorp. 1996 Stock Option Plan, as amended (4)
10.2 Supplemental Executive Retirement Agreement between Slade's Ferry Bancorp. (5)
and Manuel J. Tavares
10.3 Form of Director Supplemental Retirement Program Director Agreement, (6)
Exhibit 1 thereto (Slade's Ferry Trust Company Director Supplemental
Retirement Program Plan) and Endorsement Method Split Dollar Plan
Agreement thereunder.
10.4 Form of Directors' Paid-up Insurance Policy (part of the Director Supplemental (7)
Retirement Program).
10.5 Supplemental Executive Retirement Agreement between Slade's Ferry Bancorp. (8)
and Mary Lynn D. Lenz
10.6 Employment Agreement between Slade's Ferry Bancorp. and Mary Lynn D. Lenz (9)
10.7 Employment Agreement between Slade's Ferry Bancorp. and Deborah A. McLaughlin (10)
10.8 Employment Agreement between Slade's Ferry Bancorp. and Manuel J. Tavares (11)
10.9 Form Change of Control Agreement (12)
10.10 Severance Pay Plan (13)
10.11 Slade's Ferry Bancorp. 2004 Equity Incentive Plan (14)
11.1 Statement Regarding Computation of Per Share Earnings
14.1 Code of Ethics (15)
31.1 Rule 13a-14(a)/15d-14(a) Certification of the CEO
31.2 Rule 13a-14(a)/15d-14(a) Certification of the CFO
32.1 Section 1350 Certification of the CEO
32.2 Section 1350 Certification of the CFO
--------------------
(1) Incorporated by reference to the Registrant's Registration Statement on Form SB-2 filed with the
Commission on April 14, 1997.
(2) Incorporated by reference to the Registrant's Form 8-K filed with the Commission on June 22, 2006.
(3) Incorporated by reference to the Registrant's Form 8-K filed with the Commission on December 21,
2004.
(4) Incorporated by reference to the Registrant's Form 10-Q/A for the quarter ended June 30, 1999.
(5) Incorporated by reference to the Registrant's Form 10-K/ASB for the fiscal year ended December 31,
1996. (6)
(6) Incorporated by reference to Exhibit 10 to the Registrant's Form 10-Q/A for the quarter ended
March 31, 1999.
(7) Incorporated by reference to Exhibit 10 to the Registrant's Form 10-Q/ASB for the quarter ended
June 30, 1998.
43
(8) Incorporated by reference to Exhibit 10.10 to the Registrant's Form 10-Q/A for the quarter ended
March 31, 2003.
(9) Incorporated by reference to Exhibit 10.11 to the Registrant's Form 10-Q/A for the quarter ended
June 30, 2004.
(10) Incorporated by reference to Exhibit 10.7 to the Registrant's Form 10-Q/A for the quarter ended
September 30, 2004.
(11) Incorporated by reference to Exhibit 10.8 to the Registrant's Form 10-Q/A for the quarter ended
September 30, 2004.
(12) Incorporated by reference to the Registrant's Form 8-K filed with the Commission on January 13,
2005.
(13) Incorporated by reference to the Registrant's Form 8-K filed with the Commission on January 14,
2005.
(14) Incorporated by reference to Appendix C to the Registrant's Proxy Statement filed on April 9, 2004
(15) Incorporated by reference to the Registrant's Form 10-K for the fiscal year ended December 31,
2003.
44