================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-Q
---------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2005
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from to
------------ ------------
Commission File Number: 0-50801
-------------------
SI FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
-------------------
United States 84-1655232
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
803 Main Street, Willimantic, Connecticut 06226
(Address of principal executive offices) (Zip Code)
(860) 423-4581
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
-------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]
As of July 28, 2005, there were 12,563,750 shares of the Registrant's
common stock outstanding.
================================================================================
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
-----------------------------------------
TABLE OF CONTENTS
-----------------
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements of SI Financial Group, Inc. and
Subsidiaries (unaudited):
Consolidated Statements of Financial Condition at June 30, 2005
and December 31, 2004 1
Consolidated Statements of Income for the three months and six months
ended June 30, 2005 and 2004 2
Consolidated Statements of Changes in Stockholders' Equity for the
six months ended June 30, 2005 and 2004 4
Consolidated Statements of Cash Flows for the six months ended
June 30, 2005 and 2004 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
Item 4. Controls and Procedures 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 28
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information 29
Item 6. Exhibits 29
SIGNATURES 30
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
- ------------------------------
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
- -------------------------------------------------------------------------------------------------
(Unaudited / Dollars in Thousands, Except Share Amounts) June 30, December 31,
2005 2004
- -------------------------------------------------------------------------------------------------
ASSETS:
Cash and due from banks:
Noninterest-bearing deposits and cash $ 18,860 $ 21,647
Interest-bearing deposits 8,446 8,728
Federal funds sold 3,500 400
- -------------------------------------------------------------------------------------------------
Cash and cash equivalents 30,806 30,775
Available for sale securities, at fair value 124,299 120,557
Loans held for sale -- 200
Loans receivable (net of allowance for loan losses of $3.5 million at
June 30, 2005 and $3.2 million at December 31, 2004) 474,241 447,957
Accrued interest receivable 3,037 2,638
Federal Home Loan Bank Stock, at cost 4,969 4,313
Cash surrender value of bank-owned life insurance 7,698 7,561
Premises and equipment, net 8,075 6,586
Deferred tax asset, net 2,248 2,044
Other assets 2,562 2,018
- -------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 657,935 $ 624,649
=================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Deposits:
Noninterest-bearing $ 51,558 $ 46,049
Interest-bearing 433,138 411,709
- -------------------------------------------------------------------------------------------------
Total deposits 484,696 457,758
Mortgagors' and investors' escrow accounts 1,596 2,722
Federal Home Loan Bank advances 79,312 72,674
Junior subordinated debt owed to unconsolidated trust 7,217 7,217
Accrued expenses and other liabilities 3,334 3,469
- -------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 576,155 543,840
- -------------------------------------------------------------------------------------------------
Stockholders' Equity:
Preferred stock ($.01 par value; 1,000,000 shares authorized; no shares
issued and outstanding) -- --
Common stock ($.01 par value; 75,000,000 shares authorized;
12,563,750 shares issued and outstanding at June 30, 2005 and
December 31, 2004) 126 126
Additional paid-in capital 53,286 50,947
Unallocated common shares held by ESOP (4,844) (4,844)
Unearned restricted shares (2,425) --
Retained earnings 36,275 34,870
Accumulated other comprehensive loss (638) (290)
- -------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 81,780 80,809
- -------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 657,935 $ 624,649
=================================================================================================
See accompanying notes to unaudited interim consolidated financial statements.
1
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
- ---------------------------------------------------------------------------------------------------------
(Unaudited / Dollars in Thousands, Except Share Amounts) Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------
Interest and dividend income:
Loans, including fees $ 6,803 $ 5,955 $ 13,426 $ 11,865
Investment securities:
Taxable 1,243 878 2,382 1,692
Tax-exempt 5 6 11 12
Dividends 57 29 107 54
Other 84 35 158 63
- ---------------------------------------------------------------------------------------------------------
TOTAL INTEREST AND DIVIDEND INCOME 8,192 6,903 16,084 13,686
- ---------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 2,006 1,539 3,820 3,033
Federal Home Loan Bank advances 696 679 1,369 1,348
Subordinated debt 122 89 227 176
- ---------------------------------------------------------------------------------------------------------
TOTAL INTEREST EXPENSE 2,824 2,307 5,416 4,557
- ---------------------------------------------------------------------------------------------------------
NET INTEREST AND DIVIDEND INCOME BEFORE
PROVISION FOR LOAN LOSSES 5,368 4,596 10,668 9,129
Provision for loan losses 130 150 235 300
- ---------------------------------------------------------------------------------------------------------
NET INTEREST AND DIVIDEND INCOME AFTER
PROVISION FOR LOAN LOSSES 5,238 4,446 10,433 8,829
- ---------------------------------------------------------------------------------------------------------
Noninterest income:
Service fees 1,133 730 2,008 1,447
Wealth management fees 274 237 512 487
Increase in cash surrender value of bank-owned life
insurance 65 73 137 159
Net gain on available for sale securities 15 2 35 186
Net gain (loss) on sale of loans 48 5 147 (20)
Other 94 22 117 45
- ---------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST INCOME 1,629 1,069 2,956 2,304
- ---------------------------------------------------------------------------------------------------------
Noninterest expenses:
Salaries and employee benefits 3,094 2,554 5,873 4,836
Occupancy and equipment 916 1,113 1,797 1,956
Computer and electronic banking services 425 423 886 840
Outside professional services 397 184 660 379
Marketing 184 101 315 221
Impairment charge - other asset -- -- -- 51
Other real estate operations 1 78 6 85
Other 594 505 1,268 1,023
- ---------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST EXPENSES 5,611 4,958 10,805 9,391
- ---------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX PROVISION 1,256 557 2,584 1,742
Income tax provision 411 165 837 546
- ---------------------------------------------------------------------------------------------------------
NET INCOME $ 845 $ 392 $ 1,747 $ 1,196
=========================================================================================================
See accompanying notes to unaudited interim consolidated financial statements.
2
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - Continued
- ---------------------------------------------------------------------------------------
(Unaudited / Dollars in Thousands, Three Months Ended Six Months Ended
Except Share Amounts) June 30, June 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------
NET INCOME PER COMMON SHARE:
Basic $ 0.07 N/A $ 0.14 N/A
Diluted $ 0.07 N/A $ 0.14 N/A
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING:
Basic 12,087,104 N/A 12,083,278 N/A
Diluted 12,095,709 N/A 12,093,218 N/A
See accompanying notes to unaudited interim consolidated financial statements.
3
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 2005 AND 2004
- ------------------------------------------------------------------------------------------------------------------------------------
(Unaudited / Dollars in Thousands,
Except Share Amounts) Unallocated Accumulated Total
Common Stock Additional Common Unearned Other Stock-
------------ Paid-in Shares Held Restricted Retained Comprehensive holders'
Shares Dollars Capital By ESOP Shares Earnings Income (Loss) Equity
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2003 -- $ -- $ -- $ -- $ -- $ 33,582 $ 517 $ 34,099
Comprehensive income:
Net income -- -- -- -- -- 1,196 -- 1,196
Change in net unrealized
losses on available for sale
securities, net of taxes -- -- -- -- -- -- (802) (802)
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- -- 1,196 (802) 394
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2004 -- $ -- $ -- $ -- $ -- $ 34,778 $ (285) $ 34,493
====================================================================================================================================
BALANCE AT DECEMBER 31, 2004 12,563,750 $ 126 $ 50,947 $ (4,844) $ -- $ 34,870 $ (290) $ 80,809
Cash dividend declared ($0.03
per share) -- -- -- -- -- (317) -- (317)
Restricted stock activity -- -- 2,305 -- (2,487) (25) -- (207)
Equity incentive plan shares
earned -- -- 34 -- 62 -- -- 96
Comprehensive income:
Net income -- -- -- -- -- 1,747 -- 1,747
Change in net unrealized
losses on available for sale
securities, net of taxes -- -- -- -- -- -- (348) (348)
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- -- 1,747 (348) 1,399
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2005 12,563,750 $ 126 $ 53,286 $ (4,844) $ (2,425) $ 36,275 $ (638) $ 81,780
====================================================================================================================================
See accompanying notes to unaudited interim consolidated financial statements.
4
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ---------------------------------------------------------------------------------------------------------
(Unaudited / Dollars in Thousands) Six Months Ended June 30,
2005 2004
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,747 $ 1,196
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 235 300
Employee stock ownership plan expense 180 --
Equity incentive plan expense 96 --
Amortization and accretion of investment premiums and discounts, net 43 61
Amortization and accretion of loan premiums and discounts, net 110 170
Depreciation and amortization of premises and equipment 613 549
Amortization of core deposit intangible 49 49
Amortization of deferred debt issuance costs 18 18
Amortization of mortgage servicing rights 29 --
Net gain on available for sale securities (35) (186)
Deferred income taxes (24) --
Loans originated for sale (31,562) (5,300)
Proceeds from sale of loans 31,909 5,280
Net loss (gain) on sale of loans (147) 20
Net gain on sale of bank premises and equipment (72) --
Write-down of other real estate owned -- 60
Increase in cash surrender value of bank-owned life insurance (137) (159)
Impairment charge - long-lived assets -- 337
Impairment charge - other assets -- 51
Change in operating assets and liabilities:
Accrued interest receivable (399) (140)
Other assets (640) (344)
Accrued expenses and other liabilities (474) 1,825
- ---------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,539 3,787
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available for sale securities (18,719) (33,673)
Proceeds from sales of available for sale securities 48 4,992
Proceeds from maturities of and principal repayments on
available for sale securities 14,393 13,349
Proceeds from maturities of and principal repayments on held to
maturity securities -- 84
Net increase in loans (26,629) (20,834)
Purchases of Federal Home Loan Bank stock (656) (1,102)
Proceeds from sale of bank premises and equipment 226 --
Purchases of bank premises and equipment (2,256) (395)
- ---------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (33,593) (37,579)
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 26,938 26,985
Net increase (decrease) in mortgagors' and investors' escrow accounts (1,126) 202
Proceeds from Federal Home Loan Bank advances 19,943 11,000
Repayments of Federal Home Loan Bank advances (13,305) (3,343)
Cash dividends paid (158) --
Purchase common stock for equity incentive plan (207) --
- ---------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 32,085 34,844
- ---------------------------------------------------------------------------------------------------------
5
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
- ----------------------------------------------------------------------------------
(Unaudited / Dollars in Thousands) Six Months Ended June 30,
2005 2004
- ----------------------------------------------------------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 31 1,052
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 30,775 29,577
- ----------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $30,806 $30,629
==================================================================================
SUPPLEMENTAL CASH FLOW INFORMATION:
- -----------------------------------
Interest paid $ 5,378 $ 4,584
==================================================================================
Income taxes paid $ 1,001 $ 721
==================================================================================
See accompanying notes to unaudited interim consolidated financial statements.
6
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004 AND DECEMBER 31, 2004
================================================================================
NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
- ------------------
On August 6, 2004, SI Financial Group, Inc. (the "Company"), a
federally-chartered mid-tier stock holding company, was formed. On that date, SI
Bancorp, Inc., a Connecticut mutual holding company organized in 2000, converted
from a state-chartered mutual holding company to a federally-chartered mutual
holding company operating under the name SI Bancorp, MHC. In addition, Savings
Institute Bank and Trust Company (the "Bank"), formerly operating under the name
Savings Institute, completed its conversion from a state-chartered stock savings
bank to a federally-chartered stock savings bank. SI Bancorp, Inc. transferred
its ownership in all of the stock of Savings Institute Bank and Trust Company to
SI Financial Group, Inc. in exchange for all of the outstanding shares of SI
Financial Group, Inc. In addition, SI Financial Group, Inc. received all other
assets and liabilities held by SI Bancorp, Inc., including $7.2 million of
subordinated debt.
On September 30, 2004, the Company sold 5,025,500 shares of its common stock,
representing 40% of the 12,563,750 shares outstanding, at $10.00 per share to
eligible account holders and the Employee Stock Ownership Plan ("ESOP") of the
Bank in a subscription offering pursuant to a Plan of Reorganization and
Minority Stock Issuance. SI Bancorp, MHC was issued 58% of the Company's common
stock. SI Bancorp, MHC does not conduct any business other than owning a
majority of the common stock of SI Financial Group, Inc.
In connection with the offering, SI Financial Group, Inc. established SI
Financial Group Foundation (the "Foundation"), a charitable foundation dedicated
to community activities and the promotion of charitable causes in areas in which
the Bank operates. The Foundation was funded on September 30, 2004 with a
contribution of 2%, or 251,275 shares, of the Company's common stock. This
contribution resulted in the recognition of a $2.5 million expense, equal to the
value of the common shares contributed by the Company (net of taxes), for the
period ended December 31, 2004. The Company recognized an additional tax benefit
of $68,000 as an increase to stockholders' equity resulting from the higher tax
basis of the contribution.
The Bank established an ESOP for the benefit of its eligible employees. The Bank
borrowed the necessary funds from the Company to purchase 3.92%, or 492,499
shares, of the common shares issued and outstanding. The Bank intends to make
annual contributions adequate to fund the payment of regular debt service
requirements under the ESOP.
The Bank's deposits are insured under the Bank Insurance Fund, which is
administered by the Federal Deposit Insurance Corporation. The Bank provides a
full-range of banking services to consumer and commercial customers through its
main office in Willimantic, Connecticut, and fifteen branch offices located in
eastern Connecticut.
Principles of Consolidation
- ---------------------------
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, Savings Institute Bank and Trust
Company, and the Bank's wholly-owned subsidiaries, 803 Financial Corp., SI
Mortgage Company and SI Realty Company, Inc. All significant intercompany
accounts and transactions have been eliminated.
Basis of Financial Statement Presentation
- -----------------------------------------
The interim consolidated financial statements and related notes have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information, with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Securities and
Exchange Commission and generally accepted practices within the banking
industry. Accordingly, certain information and footnote disclosures required by
accounting principles generally accepted in the United States of America for
complete financial statements have been omitted. Information in the accompanying
interim consolidated financial statements and notes to the financial statements
of the Company as of June 30, 2005 and for the three months and the six months
ended June 30, 2005 and 2004 is unaudited. These unaudited interim consolidated
financial statements and related notes should be read in conjunction with the
audited financial statements of the Company and the accompanying notes for the
year ended December 31, 2004 contained in the Company's Form 10-K.
7
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004 AND DECEMBER 31, 2004
================================================================================
Interim financial statements are subject to possible adjustment in connection
with the annual audit of the Company for the year ended December 31, 2005. In
the opinion of management, the accompanying unaudited interim consolidated
financial statements reflect all of the adjustments (consisting of normal and
recurring in nature) necessary for a fair presentation of the financial
condition, results of operation and cash flows as of and for the period covered
herein. The results of operation for the three months and the six months ended
June 30, 2005 are not necessarily indicative of the operating results for the
twelve months ending December 31, 2005.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, and disclosures of contingent assets and liabilities, as of the
date of the statement of financial condition and reported amounts of revenues
and expenses for the periods presented. Actual results could differ from those
estimates. A material estimate that is particularly susceptible to significant
change in the near term relates to the determination of the allowance for loan
losses and the impairment of long-lived assets.
NOTE 2. EARNINGS PER SHARE
Basic net income per common share is calculated by dividing the net income
available to common stockholders by the weighted-average number of common shares
outstanding during the period. Diluted net income per common share is computed
in a manner similar to basic net income per common share except that the
weighted-average number of common shares outstanding is increased to include the
incremental common shares (as computed using the treasury stock method) that
would have been outstanding if all potentially dilutive common stock equivalents
were issued during the period. The Company's common stock equivalents relate
solely to stock option and restricted stock awards. Anti-dilutive shares are
common stock equivalents with weighted-average exercise prices in excess of the
weighted-average market value for the periods presented. The Company had no
anti-dilutive common shares outstanding for the three months and the six months
ended June 30, 2005. Unallocated common shares held by the ESOP are not included
in the weighted-average number of common shares outstanding for purposes of
calculating both basic and diluted net income per common share.
- ---------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------
Net income $ 845 $ 392 $ 1,747 $ 1,196
Weighted-average common shares outstanding:
Basic 12,087,104 N/A 12,083,278 N/A
Effect of dilutive stock options and restrictive
stock awards 8,605 N/A 9,940 N/A
----------- -----------
Diluted 12,095,709 N/A 12,093,218 N/A
Net income per common share:
Basic $ 0.07 N/A $ 0.14 N/A
Diluted $ 0.07 N/A $ 0.14 N/A
Per common share data is not presented for the three months and the six months
ended June 30, 2004, as the Company had no shares outstanding prior to the
Company's initial public offering on September 30, 2004.
NOTE 3. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board revised Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123R"). This Statement eliminates the alternative intrinsic
value method of accounting, in accordance with the Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" for recognizing the
cost of employee services received in share-based
8
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004 AND DECEMBER 31, 2004
================================================================================
payment transactions, thereby reflecting the economic consequences of those
transactions in the financial statements. SFAS 123R requires all entities to
follow the same accounting standard and account for such transactions using the
fair-value-based method. This Statement does not address the accounting for
employee stock ownership plans. On March 29, 2005, the SEC staff issued Staff
Accounting Bulletin No. 107 ("SAB 107"). SAB 107 expresses the views of the SEC
staff regarding SFAS 123R and certain rules and regulations and provides the
SEC's views regarding the valuation of share-based payment arrangements for
public companies. On April 14, 2005, the Securities and Exchange Commission (the
"SEC") delayed the effective date for SFAS 123R, which allows companies to
implement the statement at the beginning of their first fiscal year beginning
after June 15, 2005. The Company has elected to comply with SFAS 123R beginning
with the period ended June 30, 2005. See Note 6 - Equity Incentive Plan for
details on the impact of SFAS 123R on the Company's financial statements.
In May 2005, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154"). This Statement replaces Accounting Principles Board
Opinion No. 20 ("APB 20"), "Accounting Changes" and Statement of Financial
Accounting Standard No. 3, "Reporting Accounting Changes in Interim Financial
Statements," and changes the requirements for the accounting for and reporting
of a change in accounting principle. In accordance with the prior guidance of
APB 20, most voluntary changes in an accounting principle required recognizing
the cumulative effect of a change in accounting principle in net income in the
period of change. SFAS 154 requires retrospective application to prior periods'
financial statements for the direct effects of a change in accounting principle,
unless it is impracticable to determine either the period-specific effects of
the cumulative effect of the change. Indirect effects of a change in accounting
principle should be recognized in the period of accounting change. SFAS 154
carries forward the guidance of APB 20 relating to the reporting for correction
of an error in previously issued financial statements, change in accounting
estimate and the justification requirement for a change in accounting principle
on the basis of preferability. Provisions of this statement are effective for
accounting changes made in the fiscal years beginning after December 15, 2005.
At this time, the Company is uncertain how the application of SFAS 154 will
impact prior period financial statements for the implementation of future
accounting pronouncements.
NOTE 4. INVESTMENT SECURITIES
- ------------------------------
The carrying values and approximate fair values of investment securities at June
30, 2005 and December 31, 2004 are as follows:
- --------------------------------------------------------------------------------------------------
June 30, 2005 Gross Gross
- ------------- Amortized Unrealized Unrealized Fair
(Dollars in Thousands) Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------
AVAILABLE FOR SALE SECURITIES:
Debt securities:
U.S. Government and agency obligations $ 80,910 $ 167 $ (746) $ 80,331
Mortgage-backed securities 36,130 36 (452) 35,714
Corporate debt securities 5,549 5 (39) 5,515
Obligations of state and political subdivisions 1,499 71 -- 1,570
Tax-exempt securities 560 -- -- 560
Foreign government securities 75 -- -- 75
- --------------------------------------------------------------------------------------------------
Total debt securities 124,723 279 (1,237) 123,765
Equity securities:
Marketable equity securities 543 -- (9) 534
- --------------------------------------------------------------------------------------------------
TOTAL AVAILABLE FOR SALE SECURITIES $125,266 $ 279 $ (1,246) $124,299
==================================================================================================
9
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004 AND DECEMBER 31, 2004
==================================================================================================
- --------------------------------------------------------------------------------------------------
December 31, 2004 Gross Gross
- ----------------- Amortized Unrealized Unrealized Fair
(Dollars in Thousands) Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------
AVAILABLE FOR SALE SECURITIES:
Debt securities:
U.S. Government and agency obligations $ 73,950 $ 201 $ (475) $ 73,676
Mortgage-backed securities 40,926 86 (418) 40,594
Corporate debt securities 3,498 65 -- 3,563
Obligations of state and political subdivisions 1,499 85 -- 1,584
Tax-exempt securities 560 -- -- 560
Foreign government securities 75 -- -- 75
- --------------------------------------------------------------------------------------------------
Total debt securities 120,508 437 (893) 120,052
Equity securities:
Marketable equity securities 488 17 -- 505
- --------------------------------------------------------------------------------------------------
TOTAL AVAILABLE FOR SALE SECURITIES $120,996 $ 454 $ (893) $120,557
==================================================================================================
NOTE 5. OTHER COMPREHENSIVE LOSS
Other comprehensive loss, which is comprised solely of the change in unrealized
gains and losses on available for sale securities, net of taxes, for the six
months ended June 30, 2005 and 2004 is as follows:
- ---------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2005
- ------------------------------ Before-Tax Tax Benefit Net of Tax
(Dollars in Thousands) Amount (Expense) Amount
- ---------------------------------------------------------------------------------------------------
Unrealized holding losses arising during the period $ (493) $ 168 $ (325)
Reclassification adjustment for gains recognized in net income (35) 12 (23)
- ---------------------------------------------------------------------------------------------------
UNREALIZED HOLDING LOSSES ON AVAILABLE FOR SALE SECURITIES,
NET OF TAXES $ (528) $ 180 $ (348)
===================================================================================================
- ---------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2004
- ------------------------------ Before-Tax Tax Benefit Net of Tax
(Dollars in Thousands) Amount (Expense) Amount
- ---------------------------------------------------------------------------------------------------
Unrealized holding losses arising during the period $(1,030) $ 351 $ (679)
Reclassification adjustment for gains recognized in net income (186) 63 (123)
- ---------------------------------------------------------------------------------------------------
UNREALIZED HOLDING LOSSES ON AVAILABLE FOR SALE SECURITIES,
NET OF TAXES $(1,216) $ 414 $ (802)
===================================================================================================
10
SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005 AND 2004 AND DECEMBER 31, 2004
================================================================================
NOTE 6. EQUITY INCENTIVE PLAN
At the annual meeting of stockholders on May 11, 2005, stockholders of the
Company approved the SI Financial Group, Inc. 2005 Equity Incentive Plan (the
"Incentive Plan"). Under the Incentive Plan, the Company may grant 615,623 stock
options and 246,249 shares of restricted stock to its employees, officers,
directors and directors emeritus for up to 861,872 shares of the Company's
common stock for issuance upon the grant or exercise of awards. Both incentive
stock options and non-statutory stock options may be granted under the plan.
On May 17, 2005, 467,000 options to purchase the Company's common stock and
246,249 shares of restricted stock were awarded. Stock option awards are granted
with an exercise price equal to the market price of the Company's stock at the
date of grant with maximum terms of ten years. Both stock option and restricted
stock awards vest at 20% per year beginning on the first anniversary of the date
of grant.
Stock option and restricted stock awards are considered common stock equivalents
for the purpose of computing earnings per share on a diluted basis.
The Company has elected to comply with FAS 123R beginning with the period ended
June 30, 2005, prior to the mandatory compliance date for the Company of January
1, 2006. In accordance with FAS 123R, the Company has recorded share-based
compensation expense related to outstanding stock option and restricted stock
awards based upon the fair value at the date of grant over the vesting period of
such awards on a straight-line basis. The fair value of each restricted stock
allocation, based on the market price at the date of grant, is recorded to
unearned restricted shares. Unearned restricted shares are amortized to salaries
and employee benefits expense over the vesting period of the restricted stock
awards. The fair value of each stock option award is estimated on the date of
grant using the Black-Scholes option pricing model which includes several
assumptions such as volatility, expected dividends, expected term and risk-free
rate for each stock option award. The Company recorded share-based compensation
expense of $96,000 for the three months and the six months ended June 30, 2005
in connection with the stock option and restricted stock awards.
The weighted-average fair value of stock options granted on May 17, 2005 using
the Black-Scholes option pricing model was $2.89 per share. Assumptions used to
determine the weighted-average fair value of stock options granted were as
follows:
Dividend yield: 1.50%
Expected volatility: 17.00%
Risk-free rate: 4.32%
Expected life in years: 10 years
NOTE 7. DIVIDENDS
On June 23, 2005, the Company's Board of Directors declared a cash dividend of
$0.03 per outstanding common share, which was paid on July 29, 2005, to
stockholders of record as of the close of business on July 8, 2005. SI Bancorp,
MHC, the Company's mutual holding company parent, waived receipt of its dividend
upon non-objection from the Office of Thrift Supervision ("OTS").
11
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------------------------------------------------------------------------
Results of Operations.
- ---------------------
The following analysis discusses changes in financial condition at June 30, 2005
and December 31, 2004 and results of operation for the three months and the six
months ended June 30, 2005 and 2004 and should be read in conjunction with the
Company's consolidated financial statements and notes thereto, appearing in Part
I, Item I of this document.
Forward-Looking Statements
- --------------------------
This report contains forward-looking statements that are based on assumptions
and may describe future plans, strategies and expectations of the Company. These
forward-looking statements are generally identified by the use of the words
"believe," "expect," "intend," "anticipate," "estimate," "project" or similar
expressions. The Company's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which could have a
material adverse effect on the operations of the Company and its subsidiaries
include, but are not limited to, changes in interest rates, national and
regional economic conditions, legislative and regulatory changes, monetary and
fiscal policies of the United States government, including policies of the
United States Treasury and the Federal Reserve Board, the quality and
composition of the loan or investment portfolios, demand for loan products,
deposit flows, competition, demand for financial services in the Company's
market area, changes in real estate market values in the Company's market area
and changes in relevant accounting principles and guidelines. These risks and
uncertainties should be considered in evaluating forward-looking statements and
undue reliance should not be placed on such statements. Except as required by
applicable law or regulation, the Company does not undertake, and specifically
disclaims any obligation, to release publicly the result of any revisions that
may be made to any forward-looking statements to reflect events or circumstances
after the date of the statements or to reflect the occurrence of anticipated or
unanticipated events.
Critical Accounting Policies
- ----------------------------
The Company considers accounting policies involving significant judgments and
assumptions by management that have, or could have, a material impact on the
carrying value of certain assets or on income to be critical accounting
policies. The Company considers the allowance for loan losses and the impairment
of long-lived assets to be our critical accounting policies.
Allowance for Loan Losses. Determining the amount of allowance for loan losses
necessarily involves a high degree of judgment. Management reviews the level of
the allowance on a monthly basis and establishes the allowance for loan losses
based on the size and the composition of the loan portfolio, delinquency levels,
loss experience, the level of nonperforming loans, classified assets and
charge-offs, economic conditions and other factors related to the collectibility
of the loan portfolio. A portion of the allowance is established by segregating
the loans by loan category and assigning allocation percentages based on the
Company's historical loss experience and delinquency trends. The applied loss
factors are re-evaluated annually to ensure their relevance in the current real
estate environment. Accordingly, increases in the size of the loan portfolio and
the increased emphasis on commercial real estate and commercial business loans,
which carry a higher degree of risk of default and, thus, a higher allocation
percentage, increases the allowance. Additionally, a portion of the allowance is
established based on the level of specific nonperforming loans, classified
assets or charged-off loans.
Although the Company believes that it uses the best information available to
establish the allowance for loan losses, future additions to the allowance may
be necessary based on estimates that are susceptible to change as a result of
changes in economic conditions and other factors. In addition, the OTS, as an
integral part of its examination process, periodically reviews the Company's
allowance for loan losses. Such agency may require the Company to recognize
adjustments to the allowance based on its judgments about information available
to it at the time of its examination.
Impairment of Long-Lived Assets. The Company is required to record certain
assets it has acquired, including identifiable intangible assets such as core
deposit intangibles and certain liabilities that it has assumed, at fair value.
This may involve making estimates based on third party valuations, such as
appraisals or internal valuations, based on discounted cash flow analyses or
other valuation techniques. Further, long-lived assets, including intangible
assets and premises and equipment, that are held and used by the Company, are
presumed to
12
have a useful life. The determination of the useful lives of intangible assets
is subjective, as is the appropriate amortization period for such intangible and
long-lived assets. Additionally, long-lived assets are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. If impairment is indicated by that review, the
asset is written down to its estimated fair value through a charge to
noninterest expenses. Testing for impairment is a subjective process, the
application of which could result in different evaluations of impairment.
Comparison of Financial Condition at June 30, 2005 and December 31, 2004
- ------------------------------------------------------------------------
Summary:
- --------
Assets. The Company's total assets increased $33.3 million, or 5.3%, to $657.9
million at June 30, 2005, as compared to $624.6 million at December 31, 2004,
primarily due to increases in loans receivable, available for sale securities
and premises and equipment. Net loans receivable increased $26.3 million, or
5.9%, to $474.2 million at June 30, 2005, reflecting loan originations of $84.8
million offset by the sale of $31.6 million of predominately fixed-rate
residential mortgage loans. Available for sale securities increased $3.7
million, or 3.1%, to $124.3 million, as a portion of the proceeds from the loan
sales were invested in U.S. government and agency obligations and corporate debt
securities. Premises and equipment increased $1.5 million as a result of a rise
in capital expenditures associated with branch expansion during the first six
months of 2005.
Liabilities. Total liabilities increased $32.3 million, or 5.9%, from December
31, 2004 to June 30, 2005 primarily as a result of increases in deposits and
FHLB advances. Deposits, including mortgagors' and investors' escrow accounts,
increased $25.8 million, or 5.6%, to $486.3 million at June 30, 2005. The rise
in deposits reflects increases in NOW and money market accounts and
variable-rate certificates of deposit, reflecting customers' reluctance to
invest funds in longer-term and lower-rate certificates of deposit during a
rising interest rate environment. FHLB advances increased $6.6 million, or 9.1%,
to $79.3 million at June 30, 2005 to fund loan originations and to invest in
securities yielding greater returns than the cost of funds.
Equity. Total stockholders' equity increased $971,000 to $81.8 million at June
30, 2005, due to current year's earnings of $1.7 million, offset by an increase
in net unrealized holding losses on available for sale securities aggregating
$348,000 (net of taxes), dividends declared of $317,000 and a decrease of
$112,000 related to stock option and restricted stock awards granted under the
Company's new equity incentive plan for the six months ended June 30, 2005.
Investment Activities:
- ----------------------
At June 30, 2005, the Company's investment portfolio, excluding Federal Home
Loan Bank stock, consisted solely of available for sale securities which
amounted to $124.3 million, or 18.9% of assets. At December 31, 2004, the
Company's available for sale securities totaled $120.6 million, or 19.3% of
assets. The increase in available for sale securities of $3.7 million, or 3.1%,
was primarily due to the purchase of U.S. government and agency obligations and
corporate debt securities with a majority of the bond durations of five years or
less, partially offset by a decrease in mortgage-backed securities.
The net unrealized losses on available for sale securities, net of taxes,
increased $348,000 to $638,000 for the six months ended June 30, 2005, primarily
due to a decline in the market value of the debt securities portfolio, which was
recognized in accumulated other comprehensive loss on the consolidated statement
of changes in stockholders' equity. Management believes that none of the
unrealized losses on these securities are other than temporary because
substantially all of the unrealized losses relate to debt and mortgage-backed
securities issued by the U.S. Treasury or government agencies or private issuers
that maintain investment grade ratings, which the Company has both the intent
and the ability to hold until maturity or until the fair value fully recovers.
In addition, management considers the issuers of the securities to be
financially sound and believes the Company will receive all contractual
principal and interest related to these investments.
13
Lending Activities:
- -------------------
General. The Company's loan portfolio consists primarily of one- to four-family
residential mortgage loans, multi-family and commercial real estate loans and
commercial business loans. To a lesser extent, the Company's loan portfolio
includes construction and consumer loans. The Company historically and currently
originates loans primarily for investment purposes. However, the Company sold
$31.6 million of predominately fixed-rate residential mortgage loans in 2005. At
June 30, 2005 and December 31, 2004, loans held for sale were $0 and $200,000,
respectively.
Loan Portfolio. At June 30, 2005, the Company's loan portfolio, net, was $474.2
million, or 72.1% of assets. The following table summarizes the composition of
the loan portfolio in dollar amounts and as a percentage of the respective
portfolio at the dates indicated.
- ------------------------------------------------------------------------------------------------------
(Dollars in Thousands) June 30, 2005 December 31, 2004
------------- -----------------
Percent Percent
Amount of Total Amount of Total
- ------------------------------------------------------------------------------------------------------
Real estate loans:
Residential - 1 to 4 family $ 244,111 51.18% $ 252,180 55.99%
Multi-family and commercial 90,441 18.96 82,213 18.25
Construction 41,059 8.61 35,773 7.94
- ------------------------------------------------------------------------------------------------------
Total real estate loans 375,611 78.75 370,166 82.18
Consumer loans:
Home equity 20,613 4.32 18,335 4.07
Other 2,902 0.61 2,790 0.62
- ------------------------------------------------------------------------------------------------------
Total consumer loans 23,515 4.93 21,125 4.69
Commercial business loans 77,811 16.32 59,123 13.13
- ------------------------------------------------------------------------------------------------------
TOTAL LOANS 476,937 100.00% 450,414 100.00%
- ------------------------------------------------------------------------------------------------------
Deferred loan origination
costs, net of fees 814 743
Allowance for loan losses (3,510) (3,200)
- ------------------------------------------------------------------------------------------------------
LOANS, NET $ 474,241 $ 447,957
======================================================================================================
The Company's net loan portfolio increased $26.3 million, or 5.9%, resulting
from strong loan originations, offset by loan sales of $31.6 million of
predominately fixed-rate residential mortgage loans during the first six months
of 2005. The sale of loans is expected to mitigate the Company's exposure to
interest rate risk while improving liquidity. Residential mortgage loans
decreased $8.1 million, or 3.2%, as a result of the aforementioned mortgage loan
sales, despite loan originations of $48.1 million. Commercial loans, including
commercial real estate and commercial business loans, increased $26.9 million,
or 19.0%, due to the Company's continued emphasis on the commercial market by
increasing the staff in its commercial lending division. Consumer loans
increased $2.4 million, or 11.3%, as a result of an increase in home equity
lines of credit. The Company's level of loan closings was strong due to several
factors, including promotional and sales activities, a strong housing market and
a relatively stable local economy.
Allowance for Loan Losses. The allowance for loan losses is a valuation
allowance for losses inherent in the loan portfolio that are estimated to have
occurred. The allowance is maintained through a provision for loan losses that
is charged to earnings. Actual loan losses are charged against the allowance
when management believes the uncollectibility of the loan balance is confirmed.
Subsequent recoveries, if any, are credited to the allowance. The Company
evaluates the allowance for loan losses on a monthly basis.
14
The methodology for assessing the appropriateness of the allowance for loan
losses consists of three key elements:
o Specific allowances for identified problem loans, including certain
impaired or collateral-dependent loans. The loan portfolio is segregated
first between loans that are on the Company's "Managed Asset Report" and
loans that are not. The Managed Asset Report includes: (1) loans that are
sixty or more days delinquent, (2) loans with anticipated losses, (3)
loans referred to attorneys for collection or in the process of
foreclosure, (4) nonaccrual loans, (5) loans classified as "substandard,"
"doubtful" or "loss" by either the Company's internal classification
system or by regulators during the course of their examination of the
Company and (6) troubled debt restructurings and other nonperforming
loans.
The Managed Asset Committee, consisting of Company officers, reviews each
loan on the Managed Asset Report and may establish an individual reserve
allocation on certain loans based on such factors as (1) the strength of
the customer's personal or business cash flow; (2) the availability of
other sources of repayment; (3) the amount due or past due; (4) the type
and value of collateral; (5) the strength of the Company's collateral
position; (6) the estimated cost to sell the collateral; and (7) the
borrower's effort to cure the delinquency.
The Company also reviews and establishes, as needed, a specific allowance
for certain identified non- homogeneous problem loans. In accordance with
the Statement of Financial Accounting Standards No. 114, "Accounting by
Creditors for Impairment of a Loan," a loan is impaired when, based on
current information and events, it is probable that a creditor will be
unable to collect all amounts due under the contractual terms of the loan
agreement. Measurement of the impairment is based on the present value of
expected future cash flows or the fair value of the collateral, if the
loan is collateral dependent. A specific allowance on impaired loans is
established if the present value of the expected future cash flows, or
fair value of the collateral for collateral dependent loans, is lower than
the carrying value of the loan.
o General valuation allowance on certain identified problem loans. The
Company establishes a general allowance for loans on the Managed Asset
Report that do not have an individual allowance. The Company segregates
these loans by loan category and assigns allowance percentages to each
category based on inherent losses associated with each type of lending and
consideration that these loans, in the aggregate, represent an
above-average credit risk and that more of these loans will prove to be
uncollectible compared to loans in the general portfolio.
o General valuation allowance on the remainder of the loan portfolio. The
Company establishes another general allowance for loans that are not on
the Managed Asset Report to recognize the probable losses associated with
lending activities, but which, unlike specific allowances, has not been
allocated to particular problem assets. This general valuation allowance
is determined by segregating the loans by loan category and assigning
allowance percentages based on the Company's historical loss experience
and delinquency trends. The allowance may be adjusted for significant
factors that, in management's judgment, affect the collectibility of the
portfolio as of the evaluation date. These significant factors may include
changes in lending policies and procedures, changes in existing general
economic and business conditions affecting the Company's primary lending
areas, credit quality trends, collateral value, loan volumes and
concentrations, seasoning of the loan portfolio, specific industry
conditions within portfolio segments, recent loss experience in particular
segments of the portfolio, duration of the current business cycle and bank
regulatory examination results. The applied loss factors are re-evaluated
annually to ensure their relevance in the current economic environment.
15
The following table summarizes the activity in the allowance for loan losses at
and for the three months and the six months ended June 30, 2005 and 2004.
- ----------------------------------------------------------------------------------------------------
(Dollars in Thousands) Three Months Ended At and For the Six Months
June 30, Ended June 30,
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------
BALANCE AT BEGINNING OF PERIOD $ 3,376 $ 2,835 $ 3,200 $ 2,688
Provision for loan losses 130 150 235 300
Loans charged-off (3) (39) (3) (45)
Recoveries of loans previously charged-off 7 21 78 24
- ----------------------------------------------------------------------------------------------------
Net recoveries (charge-offs) 4 (18) 75 (21)
- ----------------------------------------------------------------------------------------------------
BALANCE AT END OF PERIOD $ 3,510 $ 2,967 $ 3,510 $ 2,967
====================================================================================================
Allowance for loan losses to total loans 0.74% 0.72%
Allowance for loan losses to nonperforming loans 369.47 200.34
The OTS, as an integral part of its examination process, periodically reviews
the Company's allowance for loan losses. The OTS may require the Company to make
additional provisions for loan losses based on judgments different from that of
the Company.
Although the Company believes that it uses the best information available to
establish the allowance for loan losses, future adjustments to the allowance for
loan losses may be necessary and the Company's results of operations could be
adversely affected if circumstances differ substantially from the assumptions
used in making the determinations. Furthermore, while management believes it has
established its allowance for loan losses in conformity with generally accepted
accounting principles, there can be no assurance that regulators, in reviewing
the Company's loan portfolio, will not request the Company to increase its
allowance for loan losses. In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
increases will not be necessary should the quality of any loans deteriorate as a
result of the factors discussed above. Any material increase in the allowance
for loan losses would adversely affect the Company's financial condition and
results of operations.
Nonperforming Assets and Restructured Loans. When a loan becomes ninety days
delinquent, the loan is placed on nonaccrual status, at which time the accrual
of interest ceases and the allowance for any uncollectible accrued interest is
established and charged against operations. Typically, payments received on
nonaccrual loans are applied to the outstanding principal and interest balance
as determined at the time of collection of the loan.
The Company considers repossessed assets and loans that are ninety days or more
past due to be nonperforming assets. Real estate that the Company acquires as a
result of foreclosure or by deed-in-lieu of foreclosure is classified as other
real estate owned until it is sold. When property is acquired, it is recorded at
the lower of its cost, which is the unpaid balance of the loan plus foreclosure
costs or fair value at the date of the foreclosure. Holding costs and declines
in fair value after acquisition of the property are charged against income as
incurred.
16
The following table provides information with respect to the Company's
nonperforming assets and troubled debt restructurings as of the dates indicated.
- -------------------------------------------------------------------------
(Dollars in Thousands) June 30, December 31,
2005 2004
- -------------------------------------------------------------------------
Nonaccrual loans:
Real estate loans $ 655 $ 943
Commercial business loans 288 --
Consumer loans 7 1
- -------------------------------------------------------------------------
Total nonaccrual loans 950 944
Real estate owned, net -- --
- -------------------------------------------------------------------------
TOTAL NONPERFORMING ASSETS 950 944
Troubled debt restructurings 75 76
- -------------------------------------------------------------------------
TOTAL NONPERFORMING ASSETS AND TROUBLED
DEBT RESTRUCTURINGS $ 1,025 $ 1,020
=========================================================================
Total nonperforming loans to total loans
0.20% 0.21%
Total nonperforming loans to total assets
0.14 0.15
Total nonperforming assets and troubled debt
restructurings to total assets 0.16 0.16
Other than the loans disclosed in the above table, there were no additional
loans at June 30, 2005 that management had serious doubts about the ability of
the borrowers to comply with the present loan repayment terms.
Deposits:
- ---------
The following table sets forth the distribution of the Company's deposit
accounts at the dates indicated.
- ---------------------------------------------------------------------------------------
(Dollars in Thousands) June 30, December 31,
2005 2004 Change
- ---------------------------------------------------------------------------------------
Noninterest-bearing demand deposits $ 51,558 $ 46,049 $ 5,509
NOW and money market accounts 124,867 110,564 14,303
Savings accounts (1) 95,075 95,310 (235)
Certificates of deposit (2) 214,792 208,557 6,235
- ---------------------------------------------------------------------------------------
TOTAL DEPOSITS $ 486,292 $ 460,480 $ 25,812
=======================================================================================
- ----------
(1) Includes mortgagors' and investors' escrow accounts in the amount of $1.6
million and $2.7 million at June 30, 2005 and December 31, 2004,
respectively.
(2) Includes brokered deposits of $5.0 million at June 30, 2005 and December
31, 2004.
Deposits, including mortgagors' and investors' escrow accounts, increased $25.8
million, or 5.6%, to $486.3 million at June 30, 2005. An increase in commercial
checking accounts contributed to the rise in noninterest-bearing demand
deposits. Interest-bearing deposits increased $20.3 million, or 4.9%, primarily
due to a promotion on individual retirement accounts, aggressive pricing on
certificates of deposit to attract additional funds and efforts to capitalize on
opportunities to increase deposits due to the consolidation of financial
institutions in the Company's market area. The decrease in savings accounts of
$235,000 was mainly due to a reduction in mortgagors' and investors' escrow
accounts as a result of periodic real estate tax disbursements processed during
the first half of 2005.
17
Analysis of Net Interest and Dividend Income
- --------------------------------------------
Average Balance Sheet. The following table presents information regarding
average balances of assets and liabilities, the total dollar amounts of interest
and dividend income from average interest-earning assets, the total dollar
amounts of interest expense on average interest-bearing liabilities and the
resulting average yields and costs. The yields and costs for the periods
indicated are derived by dividing income or expense by the average balances of
assets or liabilities, respectively, for the periods presented. For purposes of
this table, average balances have been calculated using average daily balances.
- -------------------------------------------------------------------------------------------------------------------------
2005 2004
At or For The Three Months ---- ----
- --------------------------
Ended June 30, Average Average
- -------------- Average Interest & Yield/ Average Interest & Yield/
(Dollars in Thousands) Balance Dividends Rate Balance Dividends Rate
- -------------------------------------------------------------------------------------------------------------------------
ASSETS:
INTEREST-EARNING ASSETS:
Loans (1)(2) $ 452,350 $ 6,803 6.03% $ 402,311 $ 5,955 5.95%
Investment securities (3) 132,527 1,307 3.96 92,309 915 3.99
Other interest-earning assets 11,639 84 2.89 14,760 35 0.95
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-EARNING ASSETS 596,516 8,194 5.51 509,380 6,905 5.45
Noninterest-earning assets 40,465 37,766
- -------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 636,981 $ 547,146
=========================================================================================================================
LIABILITIES AND EQUITY:
INTEREST-BEARING LIABILITIES:
Deposits:
NOW and money market $ 115,517 140 0.49 $ 110,776 95 0.34
Savings (4) 94,525 217 0.92 91,877 140 0.61
Certificates of deposit (5) 213,104 1,649 3.10 192,115 1,304 2.73
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 423,146 2,006 1.90 394,768 1,539 1.57
FHLB advances 72,211 696 3.87 64,887 679 4.21
Subordinated debt 7,217 122 6.78 7,217 89 4.96
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES 502,574 2,824 2.25 466,872 2,307 1.99
Noninterest-bearing liabilities 52,870 45,313
- -------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 555,444 512,185
- -------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 81,537 34,961
- -------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 636,981 $ 547,146
=========================================================================================================================
NET INTEREST-EARNING ASSETS $ 93,942 $ 42,508
=========================================================================================================================
TAX EQUIVALENT NET INTEREST AND
DIVIDEND INCOME (3) 5,370 4,598
TAX EQUIVALENT INTEREST RATE
SPREAD (6) 3.26 3.46
TAX EQUIVALENT NET INTEREST
MARGIN AS A PERCENTAGE OF
INTEREST-EARNING ASSETS (7) 3.61 3.63
AVERAGE OF INTEREST-EARNING
ASSETS TO AVERAGE INTEREST-
BEARING LIABILITIES 118.69 109.10
LESS: TAX EQUIVALENT ADJUSTMENT (3) (2) (2)
- -------------------------------------------------------------------------------------------------------------------------
NET INTEREST AND DIVIDEND INCOME
PER STATEMENTS OF INCOME $ 5,368 $ 4,596
=========================================================================================================================
18
- ----------
(1) Amount is net of deferred loan origination fees and costs. Average
balances include nonaccrual loans and loans held for sale.
(2) Loan fees are included in interest income and are insignificant.
(3) Investment securities income and net interest and dividend income are
presented on a tax equivalent basis using a tax rate of 34%. The tax
equivalent adjustment is deducted from tax equivalent net interest and
dividend income to agree to the amount reported in the statements of
income.
(4) Includes mortgagors' and investors' escrow accounts.
(5) Includes brokered deposits
(6) Tax equivalent net interest rate spread represents the difference between
the weighted-average tax equivalent yield on interest-earning assets and
the weighted-average cost of interest-bearing liabilities.
(7) Tax equivalent net interest margin represents tax equivalent net interest
and dividend income divided by average interest-earning assets.
- -------------------------------------------------------------------------------------------------------------------------
2005 2004
At or For The Six Months ---- ----
- ------------------------
Ended June 30, Average Average
- -------------- Average Interest & Yield/ Average Interest & Yield/
(Dollars in Thousands) Balance Dividends Rate Balance Dividends Rate
- -------------------------------------------------------------------------------------------------------------------------
ASSETS:
INTEREST-EARNING ASSETS:
Loans (1)(2) $450,103 $ 13,426 6.02% $397,544 $ 11,865 6.00%
Investment securities (3) 128,839 2,504 3.92 87,899 1,762 4.03
Other interest-earning assets 12,306 158 2.59 13,338 63 0.95
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-EARNING ASSETS 591,248 16,088 5.49 498,781 13,690 5.52
Noninterest-earning assets 39,739 37,026
- -------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $630,987 $535,807
=========================================================================================================================
LIABILITIES AND EQUITY:
INTEREST-BEARING LIABILITIES:
Deposits:
NOW and money market $113,312 246 0.44 $106,320 183 0.35
Savings (4) 93,941 402 0.86 89,940 270 0.60
Certificates of deposit (5) 211,818 3,172 3.02 190,240 2,580 2.73
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 419,071 3,820 1.84 386,500 3,033 1.58
FHLB advances 72,185 1,369 3.82 63,768 1,348 4.25
Subordinated debt 7,217 227 6.34 7,217 176 4.90
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES 498,473 5,416 2.19 457,485 4,557 2.00
Noninterest-bearing liabilities 51,232 43,489
- -------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 549,705 500,974
- -------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 81,282 34,833
- -------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $630,987 $535,807
=========================================================================================================================
NET INTEREST-EARNING ASSETS $ 92,775 $ 41,296
=========================================================================================================================
TAX EQUIVALENT NET INTEREST AND
DIVIDEND INCOME (3) 10,672 9,133
TAX EQUIVALENT INTEREST RATE
SPREAD (6) 3.30 3.52
TAX EQUIVALENT NET INTEREST
MARGIN AS A PERCENTAGE OF
INTEREST-EARNING ASSETS (7) 3.64 3.68
AVERAGE OF INTEREST-EARNING
ASSETS TO AVERAGE INTEREST-
BEARING LIABILITIES 118.61 109.03
LESS: TAX EQUIVALENT ADJUSTMENT (3) (4) (4)
=========================================================================================================================
NET INTEREST AND DIVIDEND INCOME
PER STATEMENTS OF INCOME $ 10,668 $ 9,129
=========================================================================================================================
19
- ----------
(1) Amount is net of deferred loan origination fees and costs. Average
balances include nonaccrual loans and loans held for sale.
(2) Loan fees are included in interest income and are insignificant.
(3) Investment securities income and net interest and dividend income are
presented on a tax equivalent basis using a tax rate of 34%. The tax
equivalent adjustment is deducted from tax equivalent net interest and
dividend income to agree to the amount reported in the statements of
income.
(4) Includes mortgagors' and investors' escrow accounts.
(5) Includes brokered deposits.
(6) Tax equivalent net interest rate spread represents the difference between
the weighted-average tax equivalent yield on interest-earning assets and
the weighted-average cost of interest-bearing liabilities.
(7) Tax equivalent net interest margin represents tax equivalent net interest
and dividend income divided by average interest-earning assets.
Rate/Volume Analysis. The following table sets forth the extent to which changes
in interest rates and changes in volume of interest-earning assets and
interest-bearing liabilities have on the Company's interest income and interest
expense for the periods presented. The rate column shows the effects
attributable to changes in rate (changes in rate multiplied by prior volume).
The volume column shows the effects attributable to changes in volume (changes
in volume multiplied by prior rate). The net column represents the sum of the
rate and volume columns. For purposes of this table, changes attributable to
both changes in rate and volume that cannot be segregated have been allocated
proportionately based on the changes due to rate and the changes due to volume.
- --------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
------------------ ----------------
June 30, 2005 and 2004 June 30, 2005 and 2004
---------------------- ----------------------
(Dollars in Thousands) Increase (Decrease) Increase (Decrease)
Due To Due To
------ ------
Rate Volume Net Rate Volume Net
- --------------------------------------------------------------------------------------------------------------
INTEREST-EARNING ASSETS:
Interest and Dividend Income:
Loans (1)(2) $ 82 $ 766 $ 848 $ 26 $ 1,535 $ 1,561
Investment securities (3) (50) 442 392 (143) 885 742
Other interest-earning assets 59 (10) 49 100 (5) 95
- --------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-EARNING ASSETS 91 1,198 1,289 (17) 2,415 2,398
INTEREST-BEARING LIABILITIES:
Interest Expense:
Deposits (4) 306 161 467 459 328 787
FHLB advances (251) 268 17 (300) 321 21
Subordinated debt 33 -- 33 51 -- 51
- --------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING
LIABILITIES 88 429 517 210 649 859
- --------------------------------------------------------------------------------------------------------------
CHANGE IN NET INTEREST AND
DIVIDEND INCOME (3) $ 3 $ 769 $ 772 $ (227) $ 1,766 $ 1,539
==============================================================================================================
20
- ----------
(1) Amount is net of deferred loan origination fees and costs. Average
balances include nonaccrual loans and loans held for sale.
(2) Loans fees are included in interest income and are insignificant.
(3) Investment securities income and net interest and dividend income are
presented on a tax equivalent basis using a tax rate of 34%. The tax
equivalent adjustment is deducted from tax equivalent net interest and
dividend income to agree to the amount reported in the statements of
income.
(4) Includes mortgagors' and investors' escrow accounts and brokered deposits.
Results of Operations for the Three Months and Six Months Ended June 30, 2005
- -----------------------------------------------------------------------------
and 2004
- --------
General. The Company's results of operation are dependent primarily on net
interest and dividend income, which is the difference between the interest and
dividend income earned on the Company's interest-earning assets, such as loans
and investments, and the interest expense on its interest-bearing liabilities,
such as deposits and borrowings. The Company also generates noninterest income
such as gains on securities and loan sales, fees from deposit and trust and
investment management services, insurance commissions, increases in cash
surrender value of bank-owned life insurance and other fees. The Company's
noninterest expenses primarily consist of salaries and employee benefits,
occupancy and equipment, computer and electronic banking services, outside
professional services, marketing and other general and administrative expenses.
The Company's results of operations are also significantly affected by general
economic and competitive conditions, particularly changes in market interest
rates, governmental policies and actions of regulatory agencies.
Summary. The Company recorded net income of $845,000, an increase of $453,000,
or 115.6%, for the three months ended June 30, 2005 compared to $392,000 for the
three months ended June 30, 2004. The increase was primarily attributable to
increases of $772,000 in net interest and dividend income and $560,000 in
noninterest income and a decrease of $20,000 in the provision for loan losses,
offset by an increase of $653,000 in noninterest expenses and an increase of
$246,000 in the provision for income taxes.
Net income increased $551,000, or 46.1% to $1.7 million for the six months ended
June 30, 2005 due to increases in net interest and dividend income of $1.5
million, noninterest income of $652,000 and a decrease of $65,000 in the
provision for loan losses, offset by increases of $1.4 million in noninterest
expenses and $291,000 in the provision for income taxes. For both the three
months and the six months ended June 30, 2005, net interest and dividend income
rose in response to an increase in average interest-earning assets, offset by an
increase in the cost of funds.
Interest and Dividend Income. Interest and dividend income increased $1.3
million, or 18.7%, to $8.2 million for the three months ended June 30, 2005 as a
result of an increase in the volume of interest-earning assets from $509.4
million to $596.5 million and an increase in the average yield on
interest-earning assets from 5.45% to 5.51%. Interest income from loans
increased as a result of increases of $50.0 million in the average balance and 8
basis points in the average yield from 5.95% to 6.03%. Although the average
yield declined 3 basis points in the second quarter of 2005, interest and
dividend income on investment securities increased in response to an increase of
$40.2 million in the average amount of securities outstanding.
For the six months ended June 30, 2005, interest and dividend income increased
$2.4 million to $16.1 million due to a higher average balance of earning assets,
offset by a 3 basis point decrease in the average yield from 5.52% to 5.49%.
Average yields on loans increased 2 basis points while average yields on
investment securities decreased 11 basis points.
Interest Expense. Interest expense increased $517,000, or 22.4%, to $2.8 million
compared to $2.3 million due primarily to increases in the average balance of
interest-bearing deposit accounts and FHLB debt outstanding during the period,
as well as an increase in the average yields paid on deposits and subordinated
debt. The average rate paid on interest-bearing deposit accounts increased 33
basis points from 1.57% to 1.90% due primarily to aggressive pricing on
certificates of deposit. Additionally, the average yield on FHLB advances
decreased from 4.21% to 3.87%, but increased on subordinated debt from 4.96% to
6.78% for the second quarter of 2005.
For the six months ended June 30, 2005, interest expense increased $859,000 as a
result of increases in both the average balance of interest-bearing liabilities
from $457.5 million to $498.5 million and the average yield from 2.00% to 2.19%.
The increase of $32.6 million in interest-bearing deposits and the 26 basis
point increase in the average yield on deposit accounts were the primary reasons
for the rise in interest expense for the period.
21
Provision for Loan Losses. The Company's provision for loan losses decreased
$20,000 to $130,000 for the three months ended June 30, 2005 from $150,000 for
the three months ended June 30, 2004. For the six months ended June 30, 2005,
the provision for loan losses decreased $65,000 to $235,000 from $300,000 for
the same period in 2004. Continued improvements in the real estate market has
favorably impacted both the Company's customers and the quality of the loan
portfolio and improved asset quality. The interest rate market continues to
positively affect the Company's variable-rate borrowers, resulting in lower
payments on loans. However, if interest rates continue to rise, variable-rate
borrowers will be burdened by higher loan payments attributable to increased
interest incurred on borrowed funds. The higher quality loan portfolio is
evidenced by a reduction in nonperforming loans to $950,000 at June 30, 2005
compared to $1.5 million at June 30, 2004 and net recoveries from loan losses of
$75,000 for the six months ended June 30, 2005 compared to net charge-offs of
$21,000 for the six months ended June 30, 2004.
Noninterest Income. The following table shows the components of noninterest
income and the dollar changes for the three months and the six months ended June
30, 2005 and 2004.
- -----------------------------------------------------------------------------------------------------------
(Dollars in Thousands) Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2005 2004 Change 2005 2004 Change
- -----------------------------------------------------------------------------------------------------------
Service fees $ 1,133 $ 730 $ 403 $ 2,008 $ 1,447 $ 561
Wealth management fees 274 237 37 512 487 25
Increase in cash surrender value of
bank-owned life insurance 65 73 (8) 137 159 (22)
Net gain on sale of securities 15 2 13 35 186 (151)
Net gain (loss) on sale of loans 48 5 43 147 (20) 167
Other 94 22 72 117 45 72
- -----------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST INCOME $ 1,629 $ 1,069 $ 560 $ 2,956 $ 2,304 $ 652
===========================================================================================================
A reduction in the volume of securities sold, due to unrealized losses on
available for sale securities, resulted in lower realized gains on the sale of
securities for the first half of 2005. For both the three months and the six
months ended June 30, 2005, the rise in service fees resulted from the Bank's
new courtesy overdraft protection program offered to its deposit customers,
which commenced in the first quarter of 2005, as well as electronic banking fees
as a result of customers' escalating usage of the Bank's electronic banking
products. Wealth management fees, which include trust and investment services
fees, increased due to a larger amount of assets under management, offset
slightly by a decrease in fees associated with the Bank's insurance products.
Net gains on the sale of loans reflect the sale of $31.6 million of loans in the
first half of 2005, compared to loan sales of $5.3 million for the same period
of 2004. A gain of $72,000 was recognized in other noninterest income from the
sale of real property, which was previously used as an operations training
facility, during the second quarter of 2005.
Noninterest Expenses. The following table shows the components of noninterest
expenses and the dollar changes for the three months and the six months ended
June 30, 2005 and 2004.
- -----------------------------------------------------------------------------------------------------------
(Dollars in Thousands) Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2005 2004 Change 2005 2004 Change
- -----------------------------------------------------------------------------------------------------------
Salaries and employee benefits $ 3,094 $ 2,554 $ 540 $ 5,873 $ 4,836 $ 1,037
Occupancy and equipment 916 1,113 (197) 1,797 1,956 (159)
Computer and electronic banking services 425 423 2 886 840 46
Outside professional services 397 184 213 660 379 281
Marketing 184 101 83 315 221 94
Impairment charge - other assets -- -- -- -- 51 (51)
Other real estate operations 1 78 (77) 6 85 (79)
Other 594 505 89 1,268 1,023 245
- -----------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST EXPENSES $ 5,611 $ 4,958 $ 653 $10,805 $ 9,391 $ 1,414
===========================================================================================================
22
For both the three and the six month periods of 2005, the increase in salaries
and employee benefits primarily reflects additional salaries, benefits and taxes
for elevated staffing levels in response to the expansion of branch facilities
and the commercial lending division. In addition, the adoption of SFAS 123R
during the second quarter of 2005, resulted in share-based compensation expense
of $96,000 for the amortization of stock option and restricted stock awards over
their requisite service period. Increases in outside professional services were
attributable to higher legal and auditing costs associated with the Company's
public reporting requirements. In 2005, marketing expenses increased as a result
of an aggressive marketing campaign for the Bank's products and services and
promotions related to new branch openings. Other noninterest expenses increased
due to a rise in printing and supplies related to various direct mailings to
customers, occupancy costs were higher due to an impairment charge of $337,000
to reduce the carrying value on a former branch facility to its estimated net
market value and other real estate operations included a $60,000 charge to
reduce the carrying value of other real estate owned property. The first half of
2004 included a $51,000 impairment charge which was recorded to reduce the
carrying value of the Company's investment in a Small Business Investment
Company ("SBIC") limited partnership.
Income Tax Provision. For the three months and the six months ended June 30,
2005, the Company's income tax expense increased $246,000 and $546,000,
respectively, as a result of higher taxable income. The effective tax rate for
the six months ended June 30, 2005 and 2004 was 32.4% and 31.4%, respectively.
Liquidity and Capital Resources
- -------------------------------
Liquidity is the ability to meet current and future financial obligations of a
short-term nature. The Company's primary sources of funds consist of deposit
inflows, loan repayments and sales, maturities and sales of investment
securities and borrowings from the FHLB. While maturities and scheduled
amortization of loans and securities are predictable sources of funds, deposit
flows and mortgage prepayments are greatly influenced by general interest rates,
economic conditions and competition.
The Company regularly adjusts its investments in liquid assets based upon its
assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields
available on interest-earning deposits and securities and (4) the objectives of
our asset/liability management, funds management and liquidity policies. The
Company's policy is to maintain liquid assets less short-term liabilities within
a range of 12.5% to 20.0% of total assets. Excess liquid assets are generally
invested in interest-earning deposits and short- and intermediate-term U.S.
government and agency obligations.
The Company's most liquid assets are cash and cash equivalents. The levels of
these assets depend on the Company's operating, financing, lending and investing
activities during any given period. At June 30, 2005, cash and cash equivalents
totaled $30.8 million, which included interest-bearing deposits of $8.4 million.
Securities classified as available for sale, which provide additional sources of
liquidity, totaled $124.3 million at June 30, 2005. In addition, at June 30,
2005, the Company had the ability to borrow a total of approximately $181.9
million from the FHLB, which included overnight lines of credit of $6.2 million,
before deducting outstanding advances. On that date, the Company had advances
outstanding of $79.3 million and no overnight lines of credit advances
outstanding. The Company believes that its most liquid assets combined with the
available line from the FHLB provide adequate liquidity to meet its current
financial obligations.
At June 30, 2005, the Company had $84.1 million in loan commitments outstanding,
which included $28.2 million in undisbursed construction loans, $20.4 million in
unused home equity lines of credit, $8.4 million in commercial lines of credit
and $1.1 in standby letters of credit. Certificates of deposit due within one
year of June 30, 2005 totaled $93.0 million, or 19.1%, of total deposits
(including mortgagors' and investors' escrow accounts). Management believes that
the amount of deposits in shorter-term certificates of deposit reflects
customers' hesitancy to invest their funds in longer-term certificates of
deposit in the current interest rate environment. If these maturing certificates
of deposit do not remain with the Company, it will be required to seek other
sources of funds, including other certificates of deposit and lines of credit.
Depending on market conditions, the Company may be required to pay higher rates
on such deposits or other borrowings than it currently pays on the certificates
of deposit. Additionally, the Company maintains a shorter duration in its
securities portfolio to provide necessary liquidity to compensate for any
deposit outflows. The Company believes, based on past experience that a
significant portion of the Company's certificates of deposit will remain with
it. The Company has the ability to attract and retain deposits by favorably
adjusting the interest rates offered to its customers.
23
The Company's primary investing activities are the origination of loans and the
purchase of securities. For the six months ended June 30, 2005, the Company
originated $84.8 million of loans and purchased $18.7 million of securities. For
the twelve months ended December 31, 2004, the Company originated $178.4 million
of loans and purchased $90.7 million of securities.
Financing activities consist primarily of activities in deposit accounts and
FHLB advances. Historically, liquidity needed to fund asset growth has been
provided through deposits, FHLB borrowings and raising capital through the
issuance of trust preferred securities and the initial public offering. The
Company experienced a net increase in total deposits, including mortgagors' and
investors' escrow accounts, of $25.8 million, $43.2 million and $19.0 million
for the six months ended June 30, 2005 and for the years ended December 31, 2004
and 2003, respectively. Deposit flows are affected by the overall level of
interest rates, products offered by the Company and its local competitors and
other factors. The Company generally manages the pricing of its deposits to be
competitive and to increase core deposits and commercial banking relationships.
Occasionally, the Company offers promotional rates on certain deposit products
to attract deposits. The Company experienced an increase of $6.6 million in FHLB
advances for the six months ended June 30, 2005 to fund loan demand and to
invest in securities. The Company had increases of $15.5 million and $13.3
million in FHLB advances for the years ended December 31, 2004 and 2003,
respectively.
The Company's initial stock offering increased its capital and liquidity.
However, over time, the Company's liquidity will be reduced as net proceeds from
the stock offering are deployed. The Company's financial condition and results
of operation will be enhanced by the capital from the offering, resulting in
increased net interest-earning assets and net income. However, the large
increase in equity resulting from the capital raised in the offering will,
initially, have an adverse impact on the Company's return on equity. In the
future, the Company may continue to utilize capital management tools such as
cash dividends and common share repurchases. However, under OTS regulations, the
Company will not be allowed to repurchase any shares during the first year
following the offering, except to fund restricted stock awards under any
stock-based benefit plans, unless the Company receives regulatory approval due
to extraordinary circumstances.
Regulatory Capital
- ------------------
The Bank is subject to various regulatory capital requirements administered by
the OTS, including a risk-based capital measure. The risk-based capital
guidelines include both a definition of capital and a framework for calculating
risk-weighted assets by assigning balance sheet assets and off-balance sheet
items to broad risk categories. As a savings and loan holding company regulated
by the OTS, the Company is not subject to any separate regulatory capital
requirements.
At June 30, 2005 and December 31, 2004, the Bank met all capital adequacy
requirements to which it was subject and the Bank is considered "well
capitalized" under regulatory guidelines.
The following is a summary of the Bank's regulatory capital amounts and ratios
as of June 30, 2005 and December 31, 2004.
- -------------------------------------------------------------------------------------------------------
June 30, 2005 To Be Well
- ------------- For Capital Capitalized Under
(Dollars in Thousands) Adequacy Prompt Corrective
Actual Purposes Action Provisions
------ -------- -----------------
Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------
Total Capital to Risk Weighted Assets $ 65,570 17.28% $ 30,356 8.00% $ 37,946 10.00%
Tier I Capital to Risk Weighted Assets 62,093 16.36 15,182 4.00 22,772 6.00
Tier I Capital to Total Assets 62,093 9.75 25,474 4.00 31,843 5.00
Tangible Equity Ratio 62,093 9.75 9,553 1.50 N/A N/A
24
- -------------------------------------------------------------------------------------------------------
December 31, 2004 To Be Well
- ----------------- For Capital Capitalized Under
(Dollars in Thousands) Adequacy Prompt Corrective
Actual Purposes Action Provisions
------ -------- -----------------
Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------
Total Capital to Risk Weighted Assets $ 63,459 18.03% $28,157 8.00% $35,196 10.00%
Tier I Capital to Risk Weighted Assets 60,253 17.12 14,078 4.00 21,117 6.00
Tier I Capital to Total Assets 60,253 9.99 24,125 4.00 30,157 5.00
Tangible Equity Ratio 60,253 9.99 9,047 1.50 N/A N/A
Off-Balance Sheet Arrangements
- ------------------------------
In the normal course of operations, the Company engages in a variety of
financial transactions that, in accordance with accounting principles generally
accepted in the United States of America, are not recorded in its financial
statements. These transactions involve, to varying degrees, elements of credit,
interest rate and liquidity risk. Such transactions are used primarily to manage
customers' requests for funding and take the form of loan commitments, lines of
credit and letters of credit.
The contractual amount of commitments to extend credit represent the amount of
potential accounting losses should the contract be fully drawn upon, the
customer defaults and the value of any existing collateral becomes worthless.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. Financial instruments
whose contract amounts represent credit risk at June 30, 2005 and December 31,
2004 are as follows:
- -------------------------------------------------------------------------------
(Dollars in Thousands) June 30, December 31,
2005 2004
- -------------------------------------------------------------------------------
Commitments to extend credit: (1)
Future loan commitments (2) $ 24,676 $ 27,073
Undisbursed construction loans 28,246 27,527
Undisbursed home equity lines of credit 20,440 19,351
Undisbursed commercial lines of credit 8,440 8,433
Overdraft protection lines 1,171 1,060
Standby letters of credit (3) 1,092 997
- -------------------------------------------------------------------------------
TOTAL COMMITMENTS $ 84,065 $ 84,441
===============================================================================
- ----------
(1) Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments may require payment of a fee and generally have fixed
expiration dates or other termination clauses.
(2) Includes fixed-rate loan commitments of $7.6 million at interest rates
ranging from 4.875% to 7.75% and $10.2 million at interest rates ranging
from 4.875% to 7.125% at June 30, 2005 and December 31, 2004,
respectively.
(3) Standby letters of credit are conditional commitments issued to guarantee
the performance of a customer to a third party.
In 1998, the Bank became a limited partner in a SBIC and made a commitment to
make a capital investment of $1.0 million in the limited partnership. At June
30, 2005 and December 31, 2004, the Bank's remaining off-balance sheet
commitment for capital investment in the SBIC was approximately $194,000.
In 2004, the Bank established an ESOP for the benefit of its eligible employees.
As of December 31, 2004, the Bank repaid principal payments on the loan to the
ESOP of $56,000 and released 8,069 shares held in a suspense account for
allocation to participants. As of June 30, 2005, the amount of unallocated
common shares held in the suspense account totaled 484,430, with a fair value of
$5.6 million, representing a potential commitment of the Bank to the ESOP.
For the six months ended June 30, 2005, we did not engage in any off-balance
sheet transactions reasonably likely to have a material effect on our financial
condition, results of operation or cash flows.
25
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
- --------------------------------------------------------------------
Qualitative Aspects of Market Risk
- ----------------------------------
The primary market risk factor affecting the financial condition and operating
results of the Company is interest rate risk. Interest rate risk is the exposure
of current and future earnings and capital arising from movements in interest
rates. This risk is managed by periodic evaluation of the interest rate risk
inherent in interest-earning assets and interest-bearing liabilities in an
effort to minimize the adverse effects of changes in the interest rate
environment. Deposit accounts typically react more quickly to changes in market
interest rates than mortgage loans because of the shorter maturities of
deposits. As a result, sharp increases in interest rates may adversely affect
earnings while decreases in interest rates may beneficially affect earnings. To
reduce the potential volatility of earnings, the Company has sought to improve
the match between asset and liability maturities and rates, while maintaining an
acceptable interest rate spread. Pursuant to this strategy, the Company
originates adjustable-rate mortgage loans for retention in its loan portfolio.
However, the ability to originate adjustable-rate loans depends, to a great
extent, on market interest rates and borrowers' preferences. As an alternative
to adjustable-rate mortgage loans, the Company offers fixed-rate mortgage loans
with maturities of fifteen years. This product enables the Company to compete in
the fixed-rate mortgage market while maintaining a shorter maturity. Fixed-rate
mortgage loans typically have an adverse effect on interest rate sensitivity
compared to adjustable-rate loans. Accordingly, the Company has sold more
long-term fixed-rate mortgage loans in the secondary market in recent periods to
manage interest rate risk. In recent years, the Company also has used investment
securities with terms of three years or less, longer-term borrowings from the
FHLB and a four-year $5.0 million brokered deposit to help manage interest rate
risk. The Company currently does not participate in hedging programs, interest
rate swaps or other activities involving the use of derivative financial
instruments.
The Company has an Asset/Liability Committee to communicate, coordinate and
control all aspects involving asset/liability management. The committee
establishes and monitors the volume, maturities, pricing and mix of assets and
funding sources with the objective of managing assets and funding sources to
provide results that are consistent with liquidity, growth, risk limits and
profitability goals.
Quantitative Aspects of Market Risk
- -----------------------------------
The Company analyzes its interest rate sensitivity position to manage the risk
associated with interest rate movements through the use of interest income
simulation. The matching of assets and liabilities may be analyzed by examining
the extent to which such assets and liabilities are "interest rate sensitive."
An asset or liability is said to be interest rate sensitive within a specific
time period if it will mature or reprice within that time period. The Company's
goal is to manage asset and liability positions to moderate the effect of
interest rate fluctuations on net interest and dividend income.
Income Simulation Analysis. Interest income simulations are completed quarterly
and presented to the Company's Asset/Liability Committee. The simulations
provide an estimate of the impact of changes in interest rates on net interest
and dividend income under a range of assumptions. The numerous assumptions used
in the simulation process are reviewed by the Asset/Liability Committee on a
quarterly basis. Changes to these assumptions can significantly affect the
results of the simulation. The simulation incorporates assumptions regarding the
potential timing in the repricing of certain assets and liabilities when market
rates change and the changes in spreads between different market rates. The
simulation analysis incorporates management's current assessment of the risk
that pricing margins will change adversely over time due to competition or other
factors.
Simulation analysis is only an estimate of the Company's interest rate risk
exposure at a particular point in time. The Company continually reviews the
potential effect that changes in interest rates could have on the repayment of
rate sensitive assets and funding requirements of rate sensitive liabilities.
The tables below set forth an approximation of the Company's exposure as a
percentage of estimated net interest and dividend income for the next twelve and
twenty-four month periods using interest income simulation. The simulation uses
projected repricing of assets and liabilities at June 30, 2005 and at December
31, 2004 on the basis of contractual maturities, anticipated repayments and
scheduled rate adjustments. Prepayment rates can have a significant impact on
interest income simulation. Because of the Company's large percentage of loans
and mortgage-backed securities, rising or falling interest rates have a
significant impact on the prepayment speeds of
26
its earning assets that in turn affect the rate sensitivity position. The
prepayment rates on investment securities are assumed to fluctuate between 9%
and 18% in a flat interest rate environment, between 6% and 15% in an increasing
interest rate environment and between 18% and 50% in a decreasing interest rate
environment, depending on the type of security. Loan prepayment rates are
assumed to fluctuate between 6% and 24% in a flat interest rate environment,
between 6% and 18% in a rising rate environment and between 6% and 48% in a
falling rate environment, depending on the type of loan. As evidenced by these
assumptions, when interest rates rise, prepayments tend to slow and when
interest rates fall, prepayments tend to increase. The Company's asset
sensitivity would be reduced if prepayments slow and vice versa. Because
prospective effects of hypothetical interest rate changes are based on a number
of assumptions, these computations should not be relied upon as indicative of
actual results. While the Company believes such assumptions to be reasonable,
there can be no assurance that assumed prepayment rates will approximate actual
future mortgage-backed securities, collateralized mortgage obligations and loan
repayment activity. Further, the computations do not reflect any actions that
management may undertake in response to changes in interest rates. Management
periodically reviews its rate assumptions based on existing and projected
economic conditions.
The Company's management generally simulates changes to net interest and
dividend income using three different interest rate scenarios. The first
scenario anticipates the maximum foreseeable increase in rates over the next
twelve months; management currently assumes this to be 300 basis points. The
second scenario anticipates management's view of the most likely change in
interest rates over the next twelve months; management's current assumption is a
100 basis point increase in rates. The third scenario anticipates the maximum
foreseeable decrease in rates over the next twelve months; management's
assumption was 200 basis points at June 30, 2005 and 100 basis points at
December 31, 2004. The basis point change in each of the three scenarios is
assumed to occur evenly over both the twelve and twenty-four months presented.
As of June 30, 2005 and December 31, 2004, the Company's estimated exposure as a
percentage of estimated net interest margin for the twelve-month and twenty-four
month periods are as follows:
- --------------------------------------------------------------------------------
June 30, 2005: Percent Change in Estimated Net
- ------------- Interest and Dividend
Income Over
12 Months 24 Months
- --------------------------------------------------------------------------------
300 basis point increase in rates (5.93)% (6.58)%
100 basis point increase in rates 0.52 1.05
200 basis point decrease in rates (6.11) (10.70)
- --------------------------------------------------------------------------------
December 31, 2004: Percent Change in Estimated Net
- ----------------- Interest and Dividend
Income Over
12 Months 24 Months
- --------------------------------------------------------------------------------
300 basis point increase in rates (9.95)% (12.57)%
100 basis point increase in rates (3.20) (4.25)
100 basis point decrease in rates (3.70) (6.35)
As of June 30, 2005, based on the scenarios above, net interest and dividend
income would be adversely affected in both the twelve and twenty-four month
periods if interest rate increase 300 basis points or if interest rates decrease
200 basis points. Net interest and dividend income is positively impacted if
interest rates increase 100 basis points. Using net interest and dividend income
for the quarter ended June 30, 2005, for each percentage point change in net
interest and dividend income, the effect on the Company's annual net income
would be $142,000, assuming a 34% income tax rate.
27
As of December 31, 2004, based on the scenarios above, net interest and dividend
income would be adversely affected in both the twelve and twenty-four month
periods if interest rates rose by 100 or 300 basis points or if interest rates
decreased 100 basis points. Using net interest and dividend income for the
quarter ended December 31, 2004, for each percentage point change in net
interest and dividend income, the effect on the Company's annual net income
would be $140,000, assuming a 34% income tax rate.
For both the twelve and twenty-four month periods, the effect on net interest
and dividend income has improved, in the event of a sudden and sustained
increase in prevailing market interest rates of 100 and 300 basis points at June
30, 2005 compared to December 31, 2004, as a result of the Company's strategy to
better position the balance sheet for the eventual rise in market interest rates
primarily through the sale of fixed-rate residential mortgages.
Item 4. Controls and Procedures.
- ---------------------------------
The Company's management, including the Company's principal executive officer
and principal financial officer, have evaluated the effectiveness of the
Company's "disclosure controls and procedures," as such term is defined in Rule
13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended,
(the "Exchange Act"). Based upon their evaluation, the principal executive
officer and principal financial officer concluded that, as of the end of the
period covered by this report, the Company's disclosure controls and procedures
were effective for the purpose of ensuring that the information required to be
disclosed in the reports that the Company files or submits under the Exchange
Act with the Securities and Exchange Commission (1) is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms and (2) is accumulated and communicated to the Company's management,
including its principal executive officer and principal financial officer, as
appropriate to allow timely decisions regarding required disclosure.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
- ---------------------------
Periodically, there have been various claims and lawsuits against the Bank, such
as claims to enforce liens, condemnation proceedings on properties in which the
Bank holds a security interest, claims involving the making and servicing of
real property loans and other issues incident to our business. The Company is
not a party to any pending legal proceedings that it believes would have a
material adverse effect on its financial condition, results of operations or
cash flows.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
- ---------------------------------------------------------------------
The Company did not repurchase any shares of its common stock in the quarter
ended June 30, 2005.
Item 3. Defaults Upon Senior Securities.
- -----------------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders.
- -------------------------------------------------------------
a. The Annual Meeting of Stockholders (the "Annual Meeting") was held
on May 11, 2005.
b. The items voted upon at the Annual Meeting and the votes for each
proposal were as follows:
1. Election of directors for a three-year term.
Nominees For Withheld
-------- --- --------
Mark D. Alliod 11,995,182 157,845
Robert C. Cushman, Sr. 11,999,238 153,789
Robert O. Gillard 12,008,793 144,234
28
2. Approval of the SI Financial Group, Inc. 2005 Equity Incentive
Plan.
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
9,723,718 1,073,442 17,096 1,338,771
3. Ratification of the appointment of Wolf and Company, P.C. as
independent registered public accounting firm of the Company
for the fiscal year ended December 31, 2005.
For Against Abstain
--- ------- -------
12,064,212 47,849 40,966
Item 5. Other Information.
- ---------------------------
On May 11, 2005, the stockholders of the Company approved the SI Financial
Group, Inc. 2005 Equity Incentive Plan, under which 615,623 stock options
(consisting of both incentive stock options and non-statutory stock options) may
be issued and 246,249 shares may be issued as restricted stock. Employees,
directors and directors emeritus of the Company and its affiliates are eligible
to participate in the plan. The terms of the Incentive Plan were previously
disclosed in and a copy of the plan was contained as an appendix to the
Company's definitive proxy materials for the 2005 Annual Meeting of
Stockholders, filed with the Securities and Exchange Commission on April 6,
2005.
Item 6. Exhibits.
- ------------------
3.1 Charter of SI Financial Group, Inc. (1)
3.2 Bylaws of SI Financial Group, Inc. (1)
4.0 Specimen Stock Certificate of SI Financial Group, Inc. (1)
10.1 SI Financial Group, Inc. 2005 Equity Incentive Plan (2)
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.0 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- ----------
(1) Incorporated by reference into this document from the Exhibits filed
with the Securities and Exchange Commission on the Registration
Statement on Form S-1, and any amendments thereto, Registration No.
333- 116381.
(2) Incorporated by reference into this document from the Appendix to
the Proxy Statement for the 2005 Annual Meeting of Stockholders
filed with the Securities and Exchange Commission on April 6, 2005.
29
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.
SI FINANCIAL GROUP, INC.
August 10, 2005 By: /s/ Rheo A. Brouillard
---------------------------------------------
Rheo A. Brouillard
President and Chief Executive Officer
(principal executive officer)
August 10, 2005 By: /s/ Brian J. Hull
---------------------------------------------
Brian J. Hull
Executive Vice President, Treasurer
and Chief Financial Officer
(principal financial and accounting officer)
30