UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarter ended June 30, 1999 ------------- Commission file number 000-23904 --------- SLADE'S FERRY BANCORP ----------------------------------------------------- (Exact name of registrant as specified in its charter) Massachusetts 04-3061936 ------------- ---------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number) 100 Slade's Ferry Avenue 02726 Somerset, Massachusetts ----------------------- ----- (Address of principal executive offices) (Zip Code) (508)675-2121 ------------- (Registrant's telephone number, including area code) Check 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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date: Common stock ($.01 par value) 3,469,495.192 shares as of June 30, 1999. - ----------------------------------------------------------------------- PART I ITEM 1 Financial Statements - ---------------- SLADE'S FERRY BANCORP CONSOLIDATED BALANCE SHEET UNAUDITED) June 30, 1999 December 31, 1998 ---------------------------------- ASSETS Cash and due from banks $ 14,324,341 $ 15,686,520 Federal funds sold -0- 14,500,000 Investment securities(1) 19,664,200 20,921,254 Securities available for sale(2) 66,633,638 58,199,292 Federal Home Loan Bank stock 1,013,400 899,900 Loans (net) 224,361,401 213,938,277 Premises and equipment 7,024,549 6,687,271 Other real estate owned 559,095 1,026,095 Accrued interest receivable 1,889,821 1,598,282 Goodwill 2,740,368 2,853,768 Cash surrender value of life insurance 1,618,841 1,613,517 Other assets 3,688,224 2,430,544 ------------------------------- TOTAL ASSETS $343,517,878 $340,354,720 =============================== LIABILITIES & STOCKHOLDERS' EQUITY: Deposits $305,098,092 $303,785,865 Notes payable 799,330 847,990 Advances from Federal Home Loan Bank 4,427,688 4,475,454 Other borrowed funds 1,220,502 42,329 Other liabilities 1,842,740 1,495,697 ------------------------------- TOTAL LIABILITIES 313,388,352 310,647,335 STOCKHOLDERS' EQUITY: Common stock 34,695 34,464 Paid in capital 22,603,675 22,285,220 Retained earnings 8,413,389 7,103,642 Accumulated other comprehensive income (loss) (922,233) 284,059 ------------------------------- TOTAL STOCKHOLDERS' EQUITY 30,129,526 29,707,385 ------------------------------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $343,517,878 $340,354,720 =============================== - -------------------- <F1> Investment securities are to be held to maturity and have a fair market value of $19,635,934 as of June 30, 1999 and $21,282,941 as of December 31, 1998. <F2> Securities classified as Available for Sale are stated at fair value with any unrealized gains or losses reflected as an adjustment in Stockholders' Equity. CONSOLIDATED STATEMENT OF INCOME AND EXPENSE (UNAUDITED) 6 MONTHS ENDING JUNE 30, 1999 1998 -------------------------- INTEREST AND DIVIDEND INCOME: Interest and fees on loans $ 9,771,498 $ 9,751,293 Interest and dividends on investments 2,388,492 1,845,215 Other interest 182,902 335,647 -------------------------- Total interest and dividend income 12,342,892 11,932,155 -------------------------- INTEREST EXPENSE: Interest on deposits 5,188,905 5,231,751 Interest on other borrowed funds 188,673 84,178 -------------------------- Total interest expense 5,377,578 5,315,929 -------------------------- Net interest and dividend income 6,965,314 6,616,226 -------------------------- PROVISION FOR LOAN LOSSES 300,000 300,000 Net interest and dividend income after provision for loan losses 6,665,314 6,316,226 -------------------------- OTHER INCOME: Service charges on deposit accounts 456,806 442,517 Security gains, net 492,189 184,469 Other income 181,490 158,115 -------------------------- Total other income 1,130,485 785,101 -------------------------- OTHER EXPENSE: Salaries and employee benefits 2,745,596 2,653,819 Occupancy expense 406,294 344,851 Equipment expense 274,996 291,617 Loss (gain) on sale of other real estate owned Write down of other real estate owned 28,030 4,236 Writedown of other real estate owned 57,024 0 Other expense 1,374,845 1,143,844 -------------------------- Total other expense 4,886,785 4,438,367 -------------------------- Income before income taxes 2,909,014 2,662,960 Income taxes 1,114,299 1,053,553 -------------------------- NET INCOME$ 1,794,715 $ 1,609,407 ========================== Basic earnings per share $ 0.52 $ 0.48 ========================== Diluted earnings per share $ 0.52 $ 0.48 ========================== Average shares outstanding 3,460,858 3,373,842 ========================== CONSOLIDATED STATEMENT OF INCOME AND EXPENSE (UNAUDITED) 3 MONTHS ENDING JUNE 30, 1999 1998 ------------------------ INTEREST AND DIVIDEND INCOME: Interest and fees on loans $5,002,558 $4,865,934 Interest and dividends on investments 1,194,675 992,578 Other interest 78,863 215,530 ------------------------ Total interest and dividend income 6,276,096 6,074,042 ------------------------ INTEREST EXPENSE: Interest on deposits 2,581,250 2,660,322 Interest on other borrowed funds 95,383 43,944 ------------------------ Total interest expense 2,676,633 2,704,266 ------------------------ Net interest and dividend income 3,599,463 3,369,776 ------------------------ PROVISION FOR LOAN LOSSES 150,000 150,000 Net interest and dividend income after provision for loan losses 3,449,463 3,219,776 ------------------------ OTHER INCOME: Service charges on deposit accounts 229,726 224,209 Security gains, net 200,623 128,189 Other income 84,543 73,130 ------------------------ Total other income 514,892 425,528 ------------------------ OTHER EXPENSE: Salaries and employee benefits 1,298,274 1,335,703 Occupancy expense 196,459 166,017 Equipment expense1 37,248 141,544 Loss (gain) on sale of other real estate owned 7,665 0 Write down of other real estate owned 57,024 0 Other expense 766,652 576,281 ------------------------ Total other expense 2,463,322 2,219,545 ------------------------ Income before income taxes 1,501,033 1,425,759 Income taxes 578,760 561,700 ------------------------ NET INCOME$ 922,273 $ 864,059 ======================== Basic earnings per share $ 0.27 $ 0.25 ======================== Diluted earnings per share $ 0.27 $ 0.25 ======================== Average shares outstanding 3,466,189 3,415,284 ======================== SLADE'S FERRY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30 ------------------------ (Unaudited) Reconciliation of net income to net cash used in operating activities: 1999 1998 -------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,794,715 $ 1,609,407 Adjustments to reconcile net income to net cash used in operating activities: Accretion, net of amortization of fair market value adjustments (4,359) (4,359) Amortization of goodwill 113,400 113,400 Depreciation and amortization 336,339 330,860 Gain on sale of fixed assets -0- (2,700) Securities available for sale gains, net (492,189) (184,469) Provision for loan losses 300,000 300,000 Increase (decrease) in taxes payable (11,850) 100,101 Increase in interest receivable (291,539) (88,935) Decrease in interest payable (5,198) (8,456) Increase (decrease) in accrued expenses 391,592 153,313 (Increase) decrease in prepaid expenses (333,381) 41,762 Accretion of securities, net of amortization (42,420) (70,230) Accretion of securities available for sale, net of amortization 34,527 12,658 Loss (gain) on sale of other real estate owned 28,030 4,236 Writedown of other real estate owned 57,024 0 Change in unearned income (50,300) 17,376 (Increase) decrease in other assets (148,310) (1,898,843) Decrease in other liabilities (40,692) (151,708) -------------------------- Net cash provided by operating activities 1,635,389 273,413 -------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of securities available for sale (21,778,663) (20,241,024) Maturities of interest bearing time deposits -0- 106,688 Maturities of securities available for sale 10,084,259 9,053,434 Sales of securities available for sale 1,741,964 514,416 Proceeds from sale of other real estate owned 599,990 62,764 Proceeds from maturities of investment securities 6,475,534 5,096,059 Purchases of investment securities (5,176,058) (7,150,038) Net increase in loans (10,925,961) (1,435,675) Capital expenditures (673,617) (82,542) Proceeds from sale of fixed assets -0- 2,700 Purchases of Federal Home Loan Bank Stock (113,500) (9,300) Recoveries of previously charged-off loans 40,792 16,633 -------------------------- Net cash used in investing activities (19,725,260) (14,065,885) -------------------------- SLADE'S FERRY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30 ------------------------ (Unaudited) (Continued) 1999 1998 -------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of stock $ 318,686 $ 323,709 Net increase (decrease) in demand deposits, NOW, money market and savings accounts (2,051,185) 1,641,404 Net increase in time deposits 3,363,412 8,406,159 Net increase in short-term borrowing 1,178,173 58,275 Dividends paid (484,968) (349,462) Advances (payments) on Federal Home Loan Bank (47,766) 1,321,600 Increase (decrease) in notes payable (48,660) (48,659) -------------------------- Net cash provided by financing activities 2,227,692 11,353,026 -------------------------- Net decrease in cash and cash equivalents (15,862,179) (2,439,446) Cash and cash equivalents at beginning of period 30,186,520 20,323,501 -------------------------- Cash and cash equivalents at end of period $14,324,341 $17,884,055 ========================== SUPPLEMENTAL DISCLOSURES: Loans originating from sales of Other Real Estate Owned $ 237,000 $ 60,800 Interest paid$ 5,382,776 $ 5,324,385 Income taxes paid $ 1,126,149 $ 953,452 Loans transferred to Other Real Estate Owned $ 218,045 $ 248,095 SLADE'S FERRY BANCORP AND SUBSIDIARY, SLADE'S FERRY TRUST COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) June 30, 1999 Note A - Basis of Presentation - ------------------------------ The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and, accordingly, do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of the management of Slade's Ferry Bancorp, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 1999 are not necessarily indicative of the results that may be expected for the year ending December 31, 1999. 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 at year end 1998. The consolidated financial statements of Slade's Ferry Bancorp include its wholly-owned subsidiary, Slade's Ferry Trust Company, and its subsidiaries, the Slade's Ferry Realty Trust, and the Slade's Ferry Securities Corporation. All significant intercompany balances have been eliminated. ITEM 2 Management's Discussion and Analysis - ------------------------------------ Financial Condition - ------------------- Assets at June 30, 1999 increased to $343.5 Million from $340.4 Million reported at December 31, 1998. The most noted variances in the asset components occurred in net loans, which increased by $10.4 Million, and the Securities Available for Sale category, which increased $8.4 Million. The Bank has also set aside an additional $2.0 Million as short term investments maturing in the mid November early December 1999 time frame to provide additional liquidity, if needed, for the Y2K (year 2000) event. Funding for the increase in loans and expansion of the investment portfolio was provided from excess daily liquidity that was temporarily invested in the Federal Funds category. Management attributes loan growth to a favorable economy and an active business development program. New loans that were recorded during the last six months were predominately in the commercial sector, represented by multi- type business and collateralized by various types of real estate located in the southeastern area of Massachusetts and in the abutting state of Rhode Island. Deposits increased slightly by $1.3 Million at June 30, 1999 to $305.1 Million when compared to $303.8 Million reported at year end 1998. Deposit levels remained relatively flat with the exception of additional deposits being generated by the new branches opened in early 1999. The Bank continues to pay competitive interest rates on certificate of deposit accounts to attract new deposits in order to meet the increasing loan demand. However, if necessary, investments in the Available for Sale category may be used to help fund new loans. The Bank also has the ability to borrow from other entities such as the Federal Home Loan Bank. At June 30, 1999, securities classified as Available for Sale had net unrealized losses of $841,348 as a result of current market conditions and the recent increase in the prime rate. Besides the utilization of the sale of these securities to meet loan demand, they may also be sold from time to time to improve interest rate risk by reinvesting the proceeds from their sales into higher yielding investments. Management, through the Asset-Liability Committee (ALCO), constantly manages interest rate risk to minimize any exposure to rising or decreasing interest rates. Despite current market conditions, investment securities, when held to maturity, will mature at par value. Investment Securities are securities that the Company will hold to maturity and are carried at amortized cost on the balance sheet, and are summarized as follows as of June 30, 1999. Gross Gross Unrealized Amortized Unrealized Holding (Dollars in Thousands) Cost Basis Holding Gains Losses Fair Value - -------------------------------------------------------------------------------------------------- Debt securities issued by the U. S. Treasury and other U. S. Government corporations and agencies $ 7,553 $24 $ 11 $ 7,566 Debt securities issued by states of the United States and political subdivisions of the states 12,024 52 94 11,982 Mortgage-backed securities 87 -0- -0- 87 Other debt securities -0- -0- -0- -0- - -------------------------------------------------------------------------------------------------- $19,664 $76 $105 $19,635 ================================================================================================== Investments in Available for Sale securities are carried at fair value on the balance sheet and are summarized as follows as of June 30, 1999. Gross Gross Unrealized Amortized Unrealized Holding (Dollars in Thousands) Cost Basis Holding Gains Losses Fair Value - ---------------------------------------------------------------------------------------------- Debt securities issued by the U. S. Treasury and other U. S. Government corporations and Agencies $45,243 $ 1 $ 926 $44,318 Corporate Bonds 522 -0- 15 507 Marketable Equities 3,924 6 26 3,904 Mortgage-backed securities 18,344 3 442 17,905 Asset-backed securities -0- -0- -0- -0- - --------------------------------------------------------------------------------------------- $68,033 $10 $1,409 $66,634 ============================================================================================= Decrease to Stockholders' Equity: (In Whole Dollars) Unrealized loss on Available for Sale securities $1,398,633 Less tax effect 557,285 ---------- Net unrealized loss on Available for Sale securities $ 841,348 ========== INFORMATION WITH RESPECT TO NONACCRUAL AND PAST DUE LOANS AT JUNE 30, 1999 AND 1998 AND DECEMBER 31, 1998 AND 1997 At June 30 At December 31 ------------------ ------------------ (Dollars in Thousands) 1999 1998 1998 1997 - ------------------------------------------------------------------------------------------- Nonaccrual Loans $2,647 $4,047 $3,331 $4,597 Loans 90 days or more past due and still Accruing 560 705 317 147 Real estate acquired by foreclosure or substantively repossessed 559 340 1,026 159 Percentage of nonaccrual loans to total loans 1.16% 1.89% 1.53% 2.15% Percentage of nonaccrual loans and real estate acquired by foreclosure or substantively epossessed to total assets .93% 1.39% 1.54% 2.00% Percentage of allowance for possible loan losses to nonaccrual loans 146.11% 85.05% 107.15% 80.36% The $2.6 Million in nonaccrual loans consists of $2.2 Million of real estate mortgages and $.4 Million attributed to commercial loans. Of the total nonaccrual loans outstanding, there are no loans restructured at June 30, 1999. The Company's nonperforming assets which consists of nonaccrual loans, loans 90 days or more past due and still accruing, and real estate acquired by foreclosure or substantively repossessed, decreased to $3.8 Million at June 30, 1999 from $4.7 Million reported on December 31, 1998. Nonaccrual loans, which is the largest component of nonperforming assets, were down by $684,000 compared to year end 1998. The decrease was a combination of loans totaling $316,000 that became nonaccrual during the last six months offset by $612,000 of payments on previously classified nonaccrual loans, $190,000 of loans brought back on accrual, $1,000 of loans charged off, and $197,000 of loans transferred to Other Real Estate Owned. Loans past due 90 days or more but still accruing increased by $243,000 during this six month period. These loans are residential real estate mortgages with substantial values collateralizing each loan. Real estate acquired through foreclosure or substantively repossessed decreased to $599,095 from $1,026,095 reported at December 31, 1998, and consists of three parcels of real estate with appraised values totaling $670,000. The Company is in the process of finalizing sales on several of these properties and currently has one purchase and sales agreement with a closing planned for late August 1999. The percentage of nonaccrual loans to total loans decreased from 1.53% reported at year end 1998 to 1.16% at June 30, 1999 primarily due to the combinations of an increase in total loans and a decrease in the nonaccrual category. INFORMATION WITH RESPECT TO NONACCRUAL AND RESTRUCTURED LOANS AT JUNE 30, 1999 AND 1998 AND DECEMBER 31, 1998 AND 1997 At June 30 At December 31 ------------------ ------------------ (Dollars in Thousands) 1999 1998 1998 1997 - -------------------------------------------------------------------------------------------- Nonaccrual Loans $2,647 $4,047 $3,331 $4,597 Interest income that would have been recorded under original terms $ 115 $ 176 $ 318 $ 394 Interest income recorded during the period $ 5 $ 13 $ 37 $ 58 The Company stops accruing interest on a loan once it becomes past due 90 days or more unless there is adequate collateral and the financial condition of the borrower is sufficient. When a loan is placed on a nonaccrual status, all previously accrued but unpaid interest is reversed and charged against current income. Interest is thereafter recognized only when payments are received and the loan becomes current. Loans in the nonaccrual category will remain until the possibility of collection no longer exists, the loan is paid off or becomes current. When a loan is determined to be uncollectible, it is then charged off against the Allowance for Loan Losses. Statement of Financial Accounting Standards No. 114 "Accounting by Creditors for Impairment of a Loan" applies to all loans except large groups of smaller- balance homogeneous loans that are collectively evaluated for impairment, loans measured at fair value or at a lower of cost or fair value, leases, and debt securities as defined in Statement 115. Statement 114 requires that impaired loans be valued at the present value of expected future cash flows discounted at the loan's effective interest rate or as a practical expedient, at the loan's observable market value of the collateral if the loan is collateral dependent. Smaller balance homogeneous loans are considered by the Company to include consumer installment loans and credit card loans. Included in the $2,646,914 in nonaccrual loans are $2,537,396 which the Company has determined to be impaired, for which $187,486 have a related allowance for credit losses of $109,089 and $2,349,910 have no related allowance for credit losses. Management is not aware of any other loans that pose a potential credit risk or where the loans are current but the borrowers are experiencing financial difficulty. There were no other loans classified for regulatory purposes at June 30, 1999 that management reasonably expects will materially impact future operating results, liquidity or capital resources. ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES Six Months Years Ended At June 30 At December 31 ------------------ ------------------ (Dollars in Thousands) 1999 1998 1998 1997 - ----------------------------------------------------------------------------------- Balance at January 1 $3,569 $3,694 $3,694 $3,354 - ----------------------------------------------------------------------------------- Charge-offs: Commercial (36) (549) --- (40) Real estate - construction --- --- --- --- Real estate - mortgage --- --- (716) (147) Installment/consumer (7) (20) (76) (68) - ----------------------------------------------------------------------------------- (43) (569) (792) (255) - ----------------------------------------------------------------------------------- Recoveries: Commercial 7 4 8 41 Real estate - construction --- --- --- --- Real estate - mortgage 23 2 43 16 Installment/consumer 11 11 16 38 - ----------------------------------------------------------------------------------- 41 17 67 95 - ----------------------------------------------------------------------------------- Net Charge-offs (2) (552) (725) (160) - ----------------------------------------------------------------------------------- Additions charged to operations 300 300 600 500 - ----------------------------------------------------------------------------------- Balance at end of period $3,867 $3,442 $3,569 $3,694 =================================================================================== Ratio of net charge-offs to average loans outstanding 0.001% 0.259% 0.340% 0.080% The Allowance for Loan Losses at June 30, 1999 was $3,867,496, compared to $3,569,282 at year end 1998. The Allowance for Loan Losses as a percentage of outstanding loans increased by 0.05% during the six month period to 1.69% from 1.64% reported at year end 1998. The Bank provided $600,000 in 1998, $500,000 in 1997, and $300,000 as of June 30, 1999 to the Allowance for Loan Losses. Loans charged off were $792,000 in 1998, $255,000 in 1997, and $43,000 as of June 30, 1999. Recoveries on loans previously charged off were $67,000 in 1998, $95,000 in 1997 and $41,000 as of June 30, 1999. Management believes that the Allowance for Loan Losses of $3,867,496 is adequate to absorb any losses in the foreseeable future, recognizing the credit risk and the dependency on economic conditions associated with commercial loans, and the overall growth of the loan portfolio. The level of the Allowance for Loan Losses is evaluated by management and encompasses several factors, which include but are not limited to, recent trends in the nonperforming loans, the adequacy of the assets which collateralize the nonperforming loans, current economic conditions in the market area, and various other external and internal factors. This table shows an allocation of the allowance for loan losses as of the end of each of the periods indicated. June 30, 1999 December 31, 1998 December 31, 1997 ----------------------- ---------------------- ---------------------- Percent of Percent of Percent of Loans in Loans in Loans in Each Each Each Category Category Category to Total to Total to Total Amount Loans Amount Loans Amount Loans - ------------------------------------------------------------------------------------------------------------ (Dollars in Thousands) Domestic: Commercial $1,541(1) 21.51% $1,249(1) 20.06% $ 984(1) 17.14% Real estate - Construction 57 3.44 27 1.73 44 3.12 Real estate - mortgage 1,942(2) 71.55 1,964(2) 75.21 2,311(2) 76.50 Consumer(3) 327(4) 3.50 329(4) 3.00 355(4) 3.24 - --------------------------------------------------------------------------------------------------------- $3,867 100.00% $3,569 100.00% $3,694 100.00% - ------------------- <F1> Includes amounts specifically reserved for impaired loans of $264,892 as of June 30, 1999, $128,207 as of December 31, 1998 and $42,937 as of December 31, 1997 as required by Financial Accounting Standard No. 114, Accounting for Impairment of Loans. <F2> Includes amounts specifically reserved for impaired loans of $153,919 as of June 30, 1999, $187,554 as of December 31, 1998 and $566,220 as of December 31, 1997 as required by Financial Accounting Standard No. 114, Accounting for Impairment of Loans. <F3> Includes consumer, obligations of states and political subdivisions and other. <F4> Includes amounts specifically reserved for impaired loans of $5,087 as of June 30, 1999, $9,126 as of December 31, 1998, and $14,413 as of December 31, 1997, as required by Financial Accounting Standard No. 114, Accounting for Impairment of Loans. The loan portfolio's largest segment of loans is commercial real estate loans, which represent 55.4% of gross loans. Residential real estate represents 16.1% of gross loans. The Company requires a loan to value ratio of 80% in both commercial and residential mortgages. These mortgages are secured by real properties which have a readily ascertainable appraised value. Generally, commercial real estate loans have a higher degree of credit risk than residential real estate loans because they depend primarily on the success of the business. When granting these loans, the Company evaluates the financial statements of the borrower(s), the location of the real estate, the quality of management, and general economic and competitive conditions. When granting a residential mortgage, the Company reviews the borrower(s)' repayment history on past debts, and assesses the borrower(s)' ability to meet existing obligations and payments on the proposed loans. Commercial loans consist of loans predominantly collateralized by inventory, furniture and fixtures, and accounts receivable. In assessing the collateral for this type of loan, management applies a 40% liquidation value to inventories, 25% to furniture, fixtures and equipment; and 60% to accounts receivable. Commercial loans represent 21.5% of the loan portfolio. Consumer loans are generally unsecured credits and represent 3.5% of the total loan portfolio. These loans have a higher degree of risk then residential mortgage loans. The underlying collateral of a secured consumer loan tends to depreciate in value. Consumer loans are typically made based on the borrower's ability to repay the loan through continued financial stability. The Company endeavors 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 loans. The allocation of the Allowance for Loan Losses is based on management's judgement of potential losses in the respective portfolios. While management has allocated reserves to various portfolio segments, the Allowance is general in nature and is available for the portfolio in its entirety. Results of Operations - --------------------- Net interest and dividend income for six months ending June 30, 1999 increased by $349,088 to $6,965,314 compared to $6,616,226 recorded during the same period in 1998. Total interest and dividend income was up by $410,737 due to a larger loan and investment base. This was offset by an increase in interest expense of $61,649 which was created by higher deposit levels held during these last six months, despite the lower rates paid on deposit accounts than in the same six month period in the prior year. The Provision for Loan Losses is a charge against earnings and funds the Allowance for Loan Losses. The Bank's provision during the six month period ending June 30, 1999 was $300,000, the same amount recorded during the first six months of 1998. Total Other Income increased by $345,384 to $1,130,485 for the first six months of 1999 when compared to $785,101 reported during the same period in 1998. Service charges on deposit accounts reflects an increase of $14,289 due to a larger customer base being serviced. The growth of the customer base is primarily attributed to the two new branches that were opened in early 1999. Gains realized on sale of securities totaled $492,189 compared to $184,469 realized in the same period in the prior year. Management sold certain selected corporate equities due to favorable market conditions. Corporate equities generally have a greater risk as they are subject to rapid market fluctuations. These securities are constantly monitored and evaluated to determine their suitability for sale or retention in the portfolio. Management minimizes its risk by limiting the total amount invested into marketable equity securities to 5% of the total investment portfolio. Other Income was up by $23,375 mainly as a result of a net increase in checkbook fees derived by the Bank printing customers' checks internally rather than outsourcing to check printing vendors. This new service took effect in early 1999. Total Other Expense for the first six months in 1999 was up by $448,418 to $4,886,785 when compared to $4,438,367 recorded during the same period in 1998. Salaries and employee benefits which is the largest component of Other Expense, had a total increase of $91,777 of which $220,169 is attributed to salaries and various benefits including contributions to a new Profit Sharing Plan established in 1998. Offsetting this increase is a FASB 87 adjustment of $121,304 associated with the employee Defined Benefit Retirement Plan that became suspended as of December 31, 1998. Occupancy and equipment expense combined were up by $44,822 primarily due to depreciation of the two new branch facilities opened in early 1999. A loss of $28,030 was realized on the sale of properties previously acquired through foreclosure during the first six months compared to a loss of $4,236 recorded in the same period of the prior year. Also, as of June 30, 1999, the expense associated with the writedown of other real estate owned (OREO) to reflect the current values of the properties totaled $57,024. During the same period in the prior year, there were no writedowns on OREO properties. The following table sets forth the components of the line item Other Expense. This table reflects an increase of $190,371 to $766,652 from $576,281 for the three month period ending June 30, 1999, and an increase of $231,001 to $1,374,845 from $1,143,844 for the six month period ending June 30, 1999. Second Quarter Six Months -------------------------- ------------------------------ Dollars in Thousands 1999 1998 Variance 1999 1998 Variance - --------------------------------------------------------------------------------------------------- Amortization of Goodwill $ 57 $ 57 0 $ 113 $ 113 0 Advertising & Public Relations 130 100 30 248 199 49 Stationery & Supplies 88 62 26 157 116 41 Communications 80 66 14 166 151 15 Professional fees & Other Services 49 73 (24) 96 137 (41) Other Miscellaneous Expenses 363 218 145 595 428 167 - ------------------------------------------------------------------------------------------------- Other Expense $767 $576 $191 $1,375 $1,144 $231 ================================================================================================= The increases in Advertising and Public Relations and Stationery and Supplies were primarily due to the promoting and supplying of the two new branch facilities. Communications increased primarily due to increases in general postage and telephone usage at the new facilities along with the installation of a new telephone system at the main office. Professional Fees decreased as a result of reduced collection and repossession expense and reduced legal activity. Miscellaneous Expense increased due to expenditures associated with the acquisition and maintenance of OREO property, and an increase in Directors Fees for meetings attended. Income, before income taxes, totaled $2,909,014 at June 30, 1999, up by $246,054 when compared to $2,662,960 reported on June 30, 1998. Applicable taxes increased by $60,746 to $1,114,299 when compared to $1,053,553 reported in the prior year. Net income of $1,794,715 reflects an increase of 11.51% when compared to earnings of $1,609,407 reported at June 30, 1998. Diluted earnings per share were $0.52 for six months ending June 30, 1999 compared to $0.48 for the same period in 1998. The results of operation for the second quarter in 1999 indicates that the net interest income was up by $229,687 to $3,599,463 from $3,369,766 earned during the same period in the previous year. This is a result of the steady growth in the loan portfolio and the maintenance of interest expense on deposit accounts. The Provision for Loan Losses remained the same as incurred during the second quarter in 1998. Total Other Income increased by $89,364 of which $5,517 is associated with service charges due to increased number of customers being serviced, $72,434 is capital gains recognized on sale of corporate equities, and $9,400 due to the check printing process as aforementioned. Total Other Expense increased by $243,777. Salaries and employee benefits decreased by $37,429 which includes increases in salaries and benefits of $83,875 offset by the FASB 87 adjustment of $121,304 to the Defined Benefit Retirement Plan as mentioned above. Occupancy and equipment expense combined increased by $26,146 predominately attributed to the depreciation of the two new branch facilities opened in early 1999. In the second quarter a loss of $7,665 was incurred on sale of other real estate owned and $57,024 is attributed to the writedown of other real estate owned. During the same period in the previous year, the Bank did not incur any expense associated with the writedown or sale of other real estate owned. Variances in Advertising and Public Relations and Stationery and Supplies during the second quarter compared to the same period in the previous year were associated with the promotion, advertising and supplying of the new branches. Communications was up by $14,000 due to increased postage and additional cost of telephone lines and usage. Professional fees indicates a decrease of $24,000 due to a decrease in legal fees and collection and repossession costs. Other miscellaneous expense increased by $145,000 of which $107,000 is associated with acquisition and maintenance of OREO properties and $38,000 related to increased committee fees and ACH and ATM fees. Income before taxes for the second quarter in 1999 was up by $75,274 to $1,501,033 from $1,425,759 reported for the same period in the prior year. Applicable taxes increased by $17,060 to $578,760 when compared to $561,700 reported in the second quarter in 1998. The net income for the three month period ending June 30, 1999 was $922,273, or an increase of 6.74%, when compared to $864,059 earned in the second quarter in 1998. Diluted earnings per share were $0.27 compared to $0.25 per share for the same period in 1998. Year 2000 Compliance - -------------------- The approaching Year 2000 presents companies in all industries with a myriad of challenges including the ongoing operation of their data systems to check proper interpretation of calendar year digits and resulting calculations. To meet these challenges, the Company has completed an assessment of Year 2000 issues, developed a plan to resolve these issues, and commenced the implementation of changes and testing required to achieve compliance. The Company, as of March 31, 1999, has completed changes and testing of all essential systems utilizing both internal and external resources. Previously identified applications for processing depositors' and borrowers' accounts, stockholder information, origination and receiving electronic charges and credits (ACH) items, general ledger processing and the PC network system, including the teller system, went through a four phase testing schedule to ensure full compliance to Year 2000 needs. As of March 31, 1999, all four phases of the testing schedule have been completed, verified, and are satisfactory. The testing of the Federal Reserve Bank's fedline system, which provides the Company the ability to perform various operations including originating and receiving ACH items, performing wire transfers and purchasing securities, was completed and verified in December, 1998. The ATM renovation and testing has also been completed. Key vendors and customers have been identified and contacted to determine any vulnerability the Company may have due to the failure of these parties to remedy their own Year 2000 issues. The above mentioned testing has been performed using the resources of key vendors and the Company's own internal resources. To the extent that key vendors, customers or other general suppliers not affiliated with the Company, such as communications and electric suppliers, are unsuccessful in properly addressing the Year 2000 issue, the Company could possibly be negatively impacted. Although the Company does not anticipate any system to be non-compliant, should a problem arise with a key vendor, customer or general supplier, the Company is finalizing a contingency plan to deal with these issues. It is impossible at this time to determine the impact this could have on the Company's operations, liquidity and financial condition. The total cost of the Year 2000 project is estimated to be approximately $40,000 to $50,000. These costs are not expected to be material to the Company's operations, liquidity or financial condition. These estimated costs are based upon management's best estimates which have been derived from numerous assumptions of future events which include the availability of certain resources, third party modification plans, and other factors. However, there is no guarantee that these estimates will hold true, and actual results could differ from those anticipated. To date, the company has incurred Year 2000 related expenses totaling $21,750 with all phases of the testing schedule completed. It is anticipated that any further cost pertaining to Year 2000 will be immaterial. The Federal Deposit Insurance Corporation (FDIC) has established Year 2000 standards for safety and soundness consistent with the Federal Financial Institution's Examination Council (FFIEC) guidance papers describing certain essential steps that each FDIC - supervised financial institution must take to become Year 2000 ready. There is ongoing regulatory oversight by the FDIC of all insured financial institutions, including the Company, concerning Year 2000 compliance. The Company is presently conducting a study to determine the amount of excess liquidity that may be required to meet unusual cash requirements for the year 2000 event. Management recognizes the possibility of depositors withdrawing excess cash and is preparing for this event accordingly. Liquidity - --------- The Company's principal sources of funds are customer deposits, loan amortization, loan payoffs, and the maturities of investment securities. Through these sources, funds are provided for customer withdrawals from their deposit accounts, loan originations, draw-downs on loan commitments, acquisition of investment securities and other normal business activities. Investors' capital also provides a source of funding. The largest source of funds is provided by depositors. The largest component of the Company's deposit base is reflected in the Time Deposit category. The Company does not participate in brokered deposits. Deposits are obtained from consumers and commercial customers within the Bank's community reinvestment area, being Bristol County, Massachusetts and several abutting towns in Rhode Island. The Company also has the ability to borrow funds for liquidity purposes from correspondent banks, the Federal Home Loan Bank, as well as the Federal Reserve Bank of Boston by pledging various investment securities as collateral. The Company did not have the need to borrow for liquidity purposes in 1998. During the first six months of 1999, the Company borrowed for three days an average of $2.3 Million. Tax payments made by our customers which are owed to the Federal Reserve Bank Treasury Tax and Loan account are classified as Short Term borrowings. The Notes Payable represents a note due Fleet Bank. The note is attributable to Fairbank, Inc. and was assumed at the time of the merger. It has a final maturity in November, 1999. Due to the applicable prepayment fees, it is advantageous for the Bank to continue with the applicable terms of the note. There is also a $4,427,688 borrowing from the Federal Home Loan Bank representing the match funding program that is available to qualified borrowers. Excess available funds are invested on a daily basis as Federal Funds Sold and can be withdrawn daily. The Bank attempts through its cash management strategies to maintain a minimum level of Federal Funds Sold to further enhance its liquidity. Liquidity represents the ability of the Bank to meet its funding requirements. In assessing the appropriate level of liquidity, the Bank considers deposit levels, lending requirements, and investment maturities in light of prevailing economic conditions. Through this assessment, the Bank manages its liquidity level to optimize earnings and respond to fluctuations in customer borrowing needs. At June 30, 1999, the Bank's liquidity ratio stood at 29.5% as compared to 32.8% at December 31, 1998. The liquidity ratio is determined by dividing the Bank's short term assets (cash and due from banks, interest bearing deposits due from other banks, securities, and federal funds sold) by the Bank's total deposits. Management believes the Bank's liquidity to be adequate to meet the current and presently foreseeable needs of the Bank. The comparison of cash flows for the six months ending June 30, 1999 and 1998 shows an increase in the net cash provided by operating activities of $1.4 Million. This is largely attributable to the decrease in other assets which includes $1.6 Million of single premium life insurance policies purchased in 1998, which provided each member of the Board of Directors with a supplemental life insurance benefit. Cash flows from investing activities show a net increase in cash used in investing activities of $5.7 Million when compared to 1998. Purchases of securities decreased by $0.4 Million offset by an increase in maturities and sales of securities of $3.6 Million when compared to the same six months in 1998.The remaining $9.5 Million is attributable to the increase in cash used in loan activity. Cash provided by financing activities decreased $9.1 Million during the first six months of 1999 when compared to the same period in 1998. The change in cash provided by time deposits represented $5.0 Million of the decrease. There were also decreases in cash provided by demand, NOW, money market and savings accounts of $4.0 Million, and advances from the Federal Home Loan Bank of $1.4 Million. This was offset by an increase in short term borrowings of $1.1 Million. Capital - ------- As of June 30, 1999, the Company had total capital of $30,129,526. This represents an increase of $422,141 from $29,707,385 reported on December 31, 1998. The increase in capital was a combination of several factors. Additions consisted of six months earnings of $1,794,715 and transactions originating through the Dividend Reinvestment Program whereby 7,644.214 shares were issued for cash contributions of $102,792 and 15,437.156 shares were issued for $215,894 in lieu of cash dividend payments. These additions were offset by dividends paid of $484,968. Also, affecting capital is accumulated other comprehensive income (loss) which reflects net unrealized gains or losses, net of taxes, on securities classified as Available-for-Sale and the minimum pension liability adjustment. On December 31, 1998 the Available-for-Sale portfolio had unrealized gains, net of taxes, of $364,944, and on June 30, 1999, as a result of current market values, the portfolio reflects unrealized losses, net of taxes, of $841,348. There was no change in the minimum pension liability adjustment of $80,885, net of taxes, recorded December 31, 1998. 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. At June 30, 1999 the actual Risk Based Capital of the Bank was $25,368,000 for Tier 1 Capital, exceeding the minimum requirements of $9,767,120 by $15,600,880. Total Capital of $28,430,000 exceeded the minimum requirements of $19,534,240 by $8,895,760 and Leverage Capital of $25,368,000 exceeded the minimum requirements of $13,663,040 by $11,704,960. In addition to the "minimum" capital requirements, "well capitalized" standards have also been established by the Federal Banking Regulators. The table below illustrates the capital ratios of the Company and the Bank on June 30, 1999 and at December 31, 1998. Well June 30, 1999 December 31, 1998 Capitalized ------------------ ------------------ Requirement Bancorp Bank Bancorp Bank - ------------------------------------------------------------------------------------------------ Total Capital (to Risk Weighted Assets) 10% 12.79% 11.64% 12.80% 11.69% - ------------------------------------------------------------------------------------------------ Tier I Capital (to Risk Weighted Assets) 6% 11.54% 10.39% 11.47% 10.36% - ------------------------------------------------------------------------------------------------ Leverage Capital (to Average Assets) 5% 8.22% 7.43% 8.12% 7.38% - ------------------------------------------------------------------------------------------------ ITEM 3 Quantitative and Qualitative Disclosure of Market Risk - ------------------------------------------------------ Interest Rate Risk - ------------------ Volatility in interest rates requires the Company to manage interest rate risk that arises from the differences in the timing of repricing of assets and liabilities. The Company considers interest rate risk, the exposure of earnings to adverse movements in interest rates, to be a significant market risk as it could potentially have an effect on the Company's financial condition and results of operation. The Company's Asset-Liability Management Committee, comprised of the Bank's Executive Management team, has the responsibility of managing interest rate risk, and monitoring and adjusting the difference between interest-sensitive assets and interest-sensitive liabilities ("GAP" position) within various time periods. Management's objective is to reduce and control the volatility of its net interest margin by managing the relationship of interest-earning assets and interest-bearing liabilities. In order to manage this relationship, the committee utilizes a GAP report prepared on a monthly basis. The GAP report indicates the differences or gap between interest-earning assets and interest- bearing liabilities in various maturity or repricing time periods. This, in conjunction with certain assumptions, and other related factors, such as anticipated changes in interest rates and projected cash flows from loans, investments and deposits, provides management a means of evaluating interest rate risk. In addition to the GAP report, the Company also uses an analysis to measure the exposure of net interest income to changes in interest rates over a relatively short (i.e., 12 months) time frame. The analysis projects future interest income and expenses from the Company's earning assets and interest- bearing liabilities. Depending on the GAP position, the Company's policy limit on interest rate risk specifies that if interest rates were to change immediately up or down 200 basis points, estimated net interest income for the next twelve months should not decline by more than ten percent. The following table reflects the Company's estimated exposure as a percentage of estimated net interest income for the next twelve months, assuming an immediate change in interest rates: Estimated Exposure as a Percentage Rate Change of Net Interest Income (Basis Points) June 30, 1999 ------------------------------------------------------------ +200 (1.09%) -200 (1.00%) The model used to monitor earnings-at-risk provides management a measurement tool to assess the effect of changes in interest rates on the Company's current and future earnings. The 10% limit established by the Company provides an internal tolerance level to control interest rate risk exposure. PART II OTHER INFORMATION ITEM 1 Legal Proceedings - ----------------- The civil suit brought in Plymouth Superior Court by a former employee of the acquired National Bank of Fairhaven was adjudicated during the period June 22 through June 29, 1999. Although no judgement has yet been entered, the jury awarded in favor of the plaintiff $145,432 plus interest, costs and attorney's fees in an amount that is yet to be determined. The Company is considering filing a motion to overturn the jury decision and if necessary, will consider filing an appeal. At present, the Company has not made any payment nor accrued any liability. ITEM 4 Proposal One - Election of Clerk/Secretary - ------------------------------------------ The following individual was reelected by the stockholders to serve as Clerk/Secretary until the next annual meeting of the stockholders, and until his successor is elected and qualified. VOTES -------------------------- Nominee For Against --------------------------------------------------------------- Attorney Peter G. Collias 2,547,049 10,780 Proposal Two - Election of Class One Directors - ---------------------------------------------- The following five individuals were re-elected to serve as directors of the Company until the 2002 Annual Meeting of stockholders, and until their successors are elected or qualified. VOTES -------------------------- Nominee For Against --------------------------------------------------------------- Donald T. Corrigan 2,529,346 23,433 Lawrence J. Oliveira DDS 2,517,692 35,086 Peter Paskowski 2,520,190 32,588 Kenneth R. Rezendes Sr. 2,538,104 14,675 Charles Veloza 2,538,104 14,675 The following additional directors continued their terms in office after the meeting. Thomas B. Almy William A. MacLean Jr. James D. Carey Francis A. Macomber Peter G. Collias Majed Mouded MD Melvyn A. Holland William J. Sullivan Shaun O'Hearn Sr. David F. Westgate At the same meeting, the stockholders also approved amendments to the 1996 Stock Option Plan (i) eliminating the three (3) year waiting period prior to issuance of stock options to new directors, (ii) eliminating provisions on vesting and repurchase by the Corporation under the Automatic Grant Program; and (iii) eliminating the provision requiring a retiring director to exercise any outstanding options within six months or lose them. The vote on this matter was 2,488,536 For and 67,981 Against ITEM 6 Exhibits and Reports on Form 8-K (a) Exhibits: See exhibit index (b) Reports on Form 8-K: None EXHIBIT INDEX Exhibit No. Description Page - ----------- ----------- ---- 10 Stock Option Plan (as amended)] 27 Financial Data Schedule 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) Date Signature August 9, 1999 /s/ Kenneth R. Rezendes ---------------------------------- Kenneth R. Rezendes President/CEO August 9, 1999 /s/ James D. Carey(Date) ---------------------------------- James D. Carey Executive Vice President August 9, 1999 /s/ Ralph S. Borges ---------------------------------- Ralph S. Borges Treasurer Chief Financial Officer Chief Accounting Officer