UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.

 

FORM 10-Q/A

 

Amendment No. 1 to

Quarterly Report Under Section 13 of the Securities Exchange Act of 1934

 

For the quarter ended: March 31, 2007

 

Commission File No. 001-16101

 

BANCORP RHODE ISLAND, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Rhode Island

05-0509802

(State or Other Jurisdiction of

(IRS Employer

Incorporation or Organization)

Identification No.)

 

ONE TURKS HEAD PLACE, PROVIDENCE, RI 02903

(Address of Principal Executive Offices)

 

(401) 456-5000

(Issuer'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 a large accelerated filer, an accelerated filer, or a non-accelerated filer, as defined in Section 12b-2 of the Exchange Act of 1934.

 

Large accelerated filer [  ]      Accelerated filer [X]      Non-accelerated filer [  ]

 

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes [  ]  No [X]

 

      Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of May 1, 2007:

 

Common Stock - Par Value $0.01

4,845,821 shares

(class)

(outstanding)

 


<PAGE>  

      This amendment to Form 10-Q for the quarter ended March 31, 2007 is being filed to correct the Consolidated Statement of Operations on page 4, for which professional services and marketing expenses for the three months ended March 31, 2007 were inadvertently transposed in the Edgarization process.

 


<PAGE>  

Bancorp Rhode Island, Inc.

Quarterly Report on Form 10-Q

Table of Contents

 

Description

 

Page Number

     

Cover Page

1

Table of Contents

2

     

Part I - Financial Information

     

Item 1

Financial Statements (unaudited)

 
     
 

Consolidated Balance Sheets

3

 

Consolidated Statements of Operations

4

 

Consolidated Statements of Changes in Shareholders' Equity

5

 

Consolidated Statements of Cash Flows

6

 

Condensed Notes to Consolidated Financial Statements

7-10

     

Item 2.

Management's Discussion and Analysis of Financial Condition

 
 

  and Results of Operations

11-28

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

29-30

Item 4.

Controls and Procedures

30

     

Part II - Other Information

     

Item 1

Legal Proceedings

31

Item 1A.

Risk Factors

31

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

31

Item 3.

Defaults Upon Senior Securities

31

Item 4.

Submission of Matters to a Vote of Security Holders

31

Item 5.

Other Information

31

Item 6.

Exhibits

32

 

Signature Page

33

 

Special Note Regarding Forward Looking Statements

 
 

      We make certain forward looking statements in this Quarterly Report on Form 10-Q and in other documents that we incorporate by reference into this report that are based upon our current expectations and projections about current events. We intend these forward looking statements to be covered by the safe harbor provisions for "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended, and we are including this statement for purposes of these safe harbor provisions. You can identify these statements by reference to a future period or periods by our use of the words "estimate," "project," "may," "believe," "intend," "anticipate," "plan," "seek," "expect" and similar terms or variations of these terms.

 

      Actual results may differ materially from those set forth in forward looking statements as a result of risks and uncertainties, including those detailed from time to time in our filings with the Securities and Exchange Commission. Our forward looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make. We do not assume any obligation to update any forward looking statements.

<PAGE>  2

BANCORP RHODE ISLAND, INC.

Consolidated Balance Sheets (unaudited)

 

 

March 31,
2007

 

December 31,
2006

 


 


 

(In thousands)

   

ASSETS:

         

Cash and due from banks

$

21,170 

   

$

24,469 

Overnight investments

 

35,409 

   

37,295 

 


   


        Total cash and cash equivalents

 

56,579 

   

61,764 

Investment securities available for sale (amortized cost of $121,221 and

         

  $104,266 at March 31, 2007 and December 31, 2006, respectively)

 

120,481 

   

103,425 

Mortgage-backed securities available for sale (amortized cost of

         

  $232,895 and $244,258 at March 31, 2007 and December 31,

         

  2006, respectively)

 

230,174 

   

240,462 

 


   


        Total securities available for sale

 

350,655 

   

343,887 

Stock in Federal Home Loan Bank of Boston

 

15,671 

   

16,530 

Loans and leases receivable:

         

    Commercial loans and leases

 

532,452 

   

519,790 

    Residential mortgage loans

 

258,981 

   

263,945 

    Consumer and other loans

 

216,015 

   

220,557 

 


   


        Total loans and leases receivable

 

1,007,448 

   

1,004,292 

    Allowance for loan and lease losses

 

(12,438)

   

(12,377)

 


   


        Net loans and leases receivable

 

995,010 

   

991,915 

Premises and equipment, net

 

14,806 

   

13,736 

Goodwill, net

 

11,317 

   

11,317 

Accrued interest receivable

 

6,910 

   

6,755 

Investment in bank-owned life insurance

 

23,400 

   

23,148 

Prepaid expenses and other assets

 

8,809 

   

10,047 

 


   


        Total assets

$

1,483,157 

   

$

1,479,099 

 


   


LIABILITIES:

         

Deposits:

         

    Demand deposit accounts

$

181,513 

   

$

200,282 

    NOW accounts

 

79,002 

   

70,736 

    Money market accounts

 

6,697 

   

6,991 

    Savings accounts

 

371,105 

   

356,707 

    Certificate of deposit accounts

 

390,295 

   

381,707 

 


   


         Total deposits

 

1,028,612 

   

1,016,423 

Overnight and short-term borrowings

 

51,602 

   

56,341 

Wholesale repurchase agreements

 

10,000 

   

20,000 

Federal Home Loan Bank of Boston borrowings

 

242,176 

   

242,198 

Subordinated deferrable interest debentures

 

18,558 

   

18,558 

Other liabilities

 

16,852 

   

13,494 

 


   


        Total liabilities

 

1,367,800 

   

1,367,014 

 


   


SHAREHOLDERS' EQUITY:

         

Preferred stock, par value $0.01 per share, authorized 1,000,000 shares:

         

    Issued and outstanding: none

 

-- 

   

-- 

Common stock, par value $0.01 per share, authorized 11,000,000

         

  shares:

         

    Issued and outstanding 4,845,821 shares and 4,792,380 shares,

         

      respectively

 

48 

   

48 

Additional paid-in capital

 

69,236 

   

67,960 

Treasury stock, at cost (5,000 shares at March 31, 2007)

 

(223)

   

-- 

Retained earnings

 

48,545 

   

47,091 

Accumulated other comprehensive loss, net

 

(2,249)

   

(3,014)

 


   


        Total shareholders' equity

 

115,357 

   

112,085 

 


   


        Total liabilities and shareholders' equity

$

1,483,157 

   

$

1,479,099 

 


   


   

See accompanying notes to consolidated financial statements

<PAGE>  3

BANCORP RHODE ISLAND, INC.
Consolidated Statements of Operations (unaudited)

 
   

Three Months Ended
March 31,

   


   

2007

 

2006

   


   

(Dollars and shares in thousands
except per share data)

Interest and dividend income:

           

    Loans and leases

 

$

16,332

 

$

14,829

    Available for sale securities

   

4,202

   

4,325

    Overnight investments

   

287

   

30

    Federal Home Loan Bank of Boston stock dividends

   

281

   

211

   


 


        Total interest and dividend income

   

21,102

   

19,395

   


 


Interest expense:

           

    Deposits

   

7,051

   

4,486

    Overnight and short-term borrowings

   

667

   

315

    Wholesale repurchase agreements

   

196

   

189

    Federal Home Loan Bank of Boston borrowings

   

2,591

   

3,007

    Subordinated deferrable interest debentures

   

369

   

348

   


 


        Total interest expense

   

10,874

   

8,345

   


 


            Net interest income

   

10,228

   

11,050

Provision for loan and lease losses

   

100

   

267

   


 


            Net interest income after provision for loan and lease losses

   

10,128

   

10,783

   


 


             

Noninterest income:

           

    Service charges on deposit accounts

   

1,316

   

1,187

    Commissions on lease originated for others

   

342

   

62

    Income from bank-owned life insurance

   

251

   

179

    Loan related fees

   

155

   

144

    Commissions on nondeposit investment products

   

120

   

312

    Commissions on loans originated for others

   

45

   

23

    Other income

   

333

   

398

   


 


        Total noninterest income

   

2,562

   

2,305

   


 


             

Noninterest expense:

           

    Salaries and employee benefits

   

5,262

   

5,507

    Occupancy

   

906

   

873

    Data processing

   

704

   

737

    Professional services

   

652

   

416

    Marketing

   

373

   

340

    Equipment

   

333

   

379

    Loan servicing

   

193

   

198

    Loan workout and other real estate owned expense

   

9

   

143

    Loss on note receivable

   

--

   

868

    Other expenses

   

1,079

   

1,363

   


 


        Total noninterest expense

   

9,511

   

10,824

   


 


        Income before income taxes

   

3,179

   

2,264

Income tax expense

   

1,001

   

739

   


 


        Net income

 

$

2,178

 

$

1,525

   


 


             

Weighted average shares outstanding - basic

   

4,815

   

4,746

Weighted average shares outstanding - diluted

   

4,962

   

4,906

             

Per share data:

           

Basic earnings per common share

 

$

0.45

 

$

0.32

Diluted earnings per common share

 

$

0.44

 

$

0.31

Cash dividends declared per common share

 

$

0.15

 

$

0.15

             

See accompanying notes to consolidated financial statements

<PAGE>  4

BANCORP RHODE ISLAND, INC.
Consolidated Statements of Changes in Shareholders' Equity (unaudited)

 






Three months ended March 31,





Common
Stock

 




Additional
Paid-in
Capital

 

Treasury
Stock

 





Retained
Earnings

 

Accumulated
Other
Compre-
hensive
Income
(Loss)

 






Total

 


 


 


 


 


 


 

(In thousands)

2006

                     

Balance at December 31, 2005

$47

 

$65,768

 

$     -- 

 

$42,241 

 

$(3,224)

 

$104,832 

    Net income

--

 

--

 

-- 

 

1,525 

 

-- 

 

1,525 

    Other comprehensive loss:

                     

        Unrealized holding losses on
          securities available for sale,
          net of taxes of $1,239

               

(2,301)

 

(2,301)

                     


    Total comprehensive income

                   

(776)

                       

    Exercise of stock options

1

 

881

 

-- 

 

-- 

 

-- 

 

882 

    Share-based compensation

--

 

6

 

-- 

 

-- 

 

-- 

 

    Excess tax benefit from exercise
      of stock options

--

 

122

 

-- 

 

-- 

 

-- 

 

122 

    Dividends on common stock ($ 0.15
      per common share)


--

 

--

 

-- 

 

(714)

 

-- 

 

(714)

 


 


 


 


 


 


Balance at March 31, 2006

$48

 

$66,777

 

$     -- 

 

$43,052 

 

$(5,525)

 

$104,352 

 


 


 


 


 


 


                       

2007

                     

Balance at December 31, 2006

$48

 

$67,960

 

$     -- 

 

$47,091 

 

$(3,014)

 

$112,085 

    Net income

--

 

--

 

-- 

 

2,178 

 

-- 

 

2,178 

    Other comprehensive income:

                     

        Unrealized holding gains on
          securities available for sale,
          net of taxes of $(411)

               

765 

 

765 

                     


    Total comprehensive income

                   

2,943 

                       

    Exercise of stock options

--

 

785

 

-- 

 

-- 

 

-- 

 

785 

    Stock repurchase

--

 

--

 

(223)

 

-- 

 

-- 

 

(223)

    Share-based compensation

--

 

38

 

-- 

 

-- 

 

-- 

 

38 

    Excess tax benefit from exercise
      of stock options

--

 

453

 

-- 

 

-- 

 

-- 

 

453 

    Dividends on common stock ($ 0.15
      per common share)

--

 

--

 

-- 

 

(724)

 

-- 

 

(724)

 


 


 


 


 


 


Balance at March 31, 2007

$48

 

$69,236

 

$(223)

 

$48,545 

 

$(2,249)

 

$115,357 

 


 


 


 


 


 


                       

See accompanying notes to consolidated financial statements

<PAGE>  5

BANCORP RHODE ISLAND, INC.
Consolidated Statements of Cash Flows (unaudited)

 
 

Three Months Ended
March 31

 


 

2007

 

2006

 


 


 

(In thousands)

Cash flows from operating activities:

     

    Net income

$   2,178 

 

$1,525 

    Adjustments to reconcile net income to net cash from operating activities:

     

        Depreciation, amortization and accretion

(164)

 

255 

        Provision for loan and lease losses

100 

 

300 

        Income from bank-owned life insurance

(251)

 

(179)

        Share-based compensation expense

38 

 

        Increase in accrued interest receivable:

(155)

 

(179)

        Decrease in prepaid expenses and other assets

827 

 

1,315 

        Increase (decrease) in other liabilities

3,358 

 

(1,673)

        Other, net

 

 


 


                Net cash provided by operating activities

5,937 

 

1,376 

 


 


Cash flows from investing activities:

     

    Investment securities available for sale:

     

        Purchases

(24,992)

 

(8,000)

        Maturities and principal repayments

8,006 

 

-- 

    Mortgage-backed securities available for sale:

     

        Purchases

-- 

 

10,617 

        Maturities and principal repayments

11,339 

 

-- 

    Net (increase) decrease in loans and leases

11,506 

 

1,100 

    Purchases of loans and leases, including purchased interest

(13,979)

 

(7,502)

    Proceeds from sale (purchase) of Federal Home Loan Bank of Boston stock

859 

 

(468)

    Capital expenditures for premises and equipment

(1,580)

 

(986)

    Purchase of bank-owned life insurance

-- 

 

(1,108)

 


 


                Net cash used by investing activities

(8,841)

 

(6,347)

 


 


Cash flows from financing activities:

     

    Net increase (decrease) in deposits

12,189 

 

(24,836)

    Net increase (decrease) in overnight and short-term borrowings

(4,739)

 

2,145 

    Proceeds from long-term borrowings

30,000 

 

100,000 

    Repayment of long-term borrowings

(40,022)

 

(86,595)

    Exercise of stock options

785 

 

882 

    Purchase of treasury stock

(223)

 

-- 

    Excess tax benefit from exercise of stock options

453 

 

122 

    Dividends on common stock

(724)

 

(714)

 


 


                Net cash used in financing activities

(2,281)

 

(8,996)

 


 


    Net decrease in cash and cash equivalents

(5,185)

 

(13,967)

    Cash and cash equivalents at beginning of period

61,764 

 

40,547 

 


 


    Cash and cash equivalents at end of period

$ 56,579 

 

$  26,580 

 


 


Supplementary Disclosures:

     

    Cash paid for interest

$ 11,725 

 

$    8,352 

    Cash paid for income taxes

12 

 

20 

    Non-cash transactions:

     

        Change in accumulated other comprehensive loss, net

765 

 

(2,301)

       

See accompanying notes to consolidated financial statements

<PAGE>  6

BANCORP RHODE ISLAND, INC.
Notes to Consolidated Financial Statements

 

(1)  Basis of Presentation

 

      Bancorp Rhode Island, Inc. (the "Company"), a Rhode Island corporation, is the holding company for Bank Rhode Island (the "Bank"). The Company has no significant assets other than the common stock of the Bank. For this reason, substantially all of the discussion in this Quarterly Report on Form 10-Q relates to the operations of the Bank and its subsidiaries.

 

      In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change relate to the determination of the allowance for credit losses and review of goodwill for impairment.

 

      The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Bank Rhode Island, along with the Bank's wholly-owned subsidiaries, BRI Investment Corp. (a Rhode Island passive investment company), BRI Realty Corp. (a Rhode Island real estate holding company), Acorn Insurance Agency, Inc. (a licensed insurance agency) and Macrolease Corporation (an equipment leasing company). All significant intercompany accounts and transactions have been eliminated in consolidation.

 

      The unaudited interim consolidated financial statements of the Company conform to U.S. generally accepted accounting principles and prevailing practices within the banking industry and include all necessary adjustments (consisting of only normal recurring adjustments) that, in the opinion of management, are required for a fair presentation of the results and financial condition of the Company. Certain prior period amounts have been reclassified to conform to the current year classification. Such reclassifications have no effect on previously reported net income or shareholders' equity.

 

      The unaudited interim results of consolidated operations are not necessarily indicative of the results for any future interim period or for the entire year. These interim consolidated financial statements do not include all disclosures associated with annual financial statements and, accordingly, should be read in conjunction with the annual consolidated financial statements and accompanying notes included in the Company's 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC").

 

(2)  Earnings Per Share

 

      Basic earnings per share ("EPS") excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of additional common stock that then share in the earnings of the Company.

 

(3)  Allowance for Credit Losses

 

      The allowance for loan and lease losses and reserve for unfunded lending commitments, collectively referred to as the allowance for credit losses, are established for credit losses inherent in the loan and lease portfolio and inherent in the unfunded lending commitments through a charge to earnings. The allowance for credit losses is maintained at a level management considers appropriate to provide for the current inherent risk of loss based upon an evaluation of known and inherent risks in the loan and lease portfolio, as well as the unfunded lending commitments.

<PAGE>  7

      When management believes that the collectibility of a loan or lease's principal balance, or portions thereof, is unlikely, the principal amount is charged against the allowance for loan and lease losses. Recoveries on loans and leases that have been previously charged off are credited to the allowance for loan and lease losses as received. Increases to the allowance for loan and leases are made by charges to provision for loan and lease losses.

 

      In addition to the allowance for loan and lease losses, management also estimates probable losses related to unfunded lending commitments. In the third quarter of 2006, the Company reclassified the reserve for unfunded lending commitments from the allowance for loan and losses to other liabilities for all periods presented. Additions to the reserve for unfunded lending commitments are made by charges to other expenses.

 

      Management's methodology to estimate loss exposure inherent in the portfolio includes an analysis of individual loans or leases deemed to be impaired, reserve allocations for various loan and lease types based on payment status or loss experience and an unallocated allowance that is maintained based on management's assessment of many factors including, but not limited to, the growth, composition and quality of the loan portfolio, historical loss experience, industry loss experience and general economic conditions. Management employs a similar process with respect to unfunded lending commitments. While management evaluates currently available information in establishing the allowance for loan and lease losses and the reserve for unfunded lending commitments, future adjustments to the allowance for credit losses may be necessary if conditions differ substantially from the assumptions used in making the evaluations. The factors supporting the allowance for loan and lease losses do not diminish the fact that the entire allowance for loan and lease losses is available to absorb losses in the loan and lease portfolio. The Company's primary concern is the appropriateness of the total allowance for loan and lease losses, as well as the reserve for unfunded lending commitments. Management performs a comprehensive review of the allowance for loan and lease losses and the reserve for unfunded lending commitments on a quarterly basis.

 

      In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution's allowance for credit losses. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

 

      An analysis of the activity in the allowance for credit losses is as follows:

 
 

Three Months
Ended
March 31, 2007

 

Year Ended
December 31, 2006

 


 


Allowance for Loan and Lease Losses

(In thousands)

    Balance at beginning of period

$12,377 

 

$11,665 

        Loans charged-off

(48)

 

(519)

        Recoveries of loans previously charged-off:

 

29 

        Provision for loan and lease losses charged against income

100 

 

1,202 

 


 


    Balance at end of period

12,438 

 

12,377 

 


 


       

Reserve for Unfunded Lending Commitments(1)

     

    Balance at beginning of period

567 

 

503 

        Provision for unfunded lending commitments

23 

 

64 

 


 


    Balance at end of period

590 

 

567 

 


 


       

Allowance for Credit Losses

     

    Balance at end of period

$13,028 

 

$12,944 

 


 


       

(1)

In 2006, the Company reclassified the reserve for unfunded lending commitments from the allowance for loan and lease losses to other liabilities for all periods presented.

<PAGE>  8

      The following table represents the allocation of the allowance for loan and lease losses as of the dates indicated:

 

March 31,
2007

 

December 31,
2006

 


 


Allowance for Loan and Lease Losses

(In thousands)

    Loan category

     

        Commercial loans and leases

$  8,011

 

$  7,944

        Residential mortgage loans

1,385

 

1,440

        Consumer and other loans

2,030

 

2,086

        Unallocated

1,012

 

907

 


 


            Total

$12,438

 

$12,377

 


 


(4)  Supplemental Executive Retirement Plans

 

      The Bank maintains Supplemental Executive Retirement Plans ("SERPs") for certain of its senior executives under which participants designated by the Board of Directors are entitled to an annual retirement benefit. Expenses associated with the SERPs were $143,000 and $151,000 for the three months ending March 31, 2007 and 2006, respectively. Accrued liabilities associated with the SERPs were $2.4 million and $2.2 million for March 31, 2007 and December 31, 2006, respectively.

 

(5)  Income Taxes

 

      Effective January 1, 2007, the Company adopted Financial Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes." FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS 109, "Accounting for Income Taxes." The adoption of FIN 48 did not have a material impact on our financial statements.

 

      The evaluation of a tax position in accordance with FIN 48 is a two-step process. First, the Company determines whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. Second, a tax position that meets the more likely than not threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more likely than not recognition threshold are recognized in the first subsequent reporting period in which the threshold is met. Previously recognized tax positions that no longer meet the more likely than not recognition threshold are derecognized in the first subsequent reporting period in which the threshold is no longer met.

 

      The Company had no unrecognized tax benefits at both January 1, 2007 and March 31, 2007. Additionally, there are no unrecognized tax benefits that, if recognized, would affect the Company's effective tax rate.

 

      As of both January 1, 2007 and March 31, 2007, the Company did not have any accrued income tax-related interest and penalties. The Company's policy is to classify income tax related interest and penalties as a component of income tax expense.

 

      The Company's federal income tax returns are open and subject to examination from the 2003 tax return year and forward. The Company's state income tax returns are generally open from the 2002 and later tax return years based on individual state statute of limitations.

<PAGE>  9

(6)  Recent Accounting Pronouncements

 

      In March 2006, the FASB Emerging Issues Task Force ("EITF") issued interpretive guidance in Issue 06-4 ("EITF 06-4"), in which agreements by companies to share a portion of the proceeds of life insurance policies with an employee during the postretirement period is a postretirement benefit arrangement that must be accounted for under SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". Under EITF 06-4, the EITF also concluded the purchase of a split-dollar life insurance policy does not constitute a settlement of the postretirement benefit as defined in SFAS 106. Thus, companies will be required to record a liability upon adoption of EITF 06-4, which is effective for periods beginning after December 15, 2007. The Company is currently evaluating the impact EITF 06-4 will have on its consolidated financial statements upon adoption on January 1, 2008.

 

      In September 2006, the FASB issued SFAS No. 157 ("SFAS 157"), "Fair Value Measurements". SFAS 157 provides guidance for measuring assets and liabilities at fair value. This standard is applicable whenever other standards require or permit assets and liabilities to be measured at fair value, but does not expand upon the use of fair value in any new circumstances. SFAS 157 establishes a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data and requires fair value measurements to be disclosed by level within the hierarchy. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact SFAS 157 will have on its consolidated financial statements upon adoption on January 1, 2008.

 

      In February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial Assets and Financial Liabilities". SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value and to provide additional information that will help investors and other users of financial statements to understand more easily the effect on earnings of the company's choice to use fair value. It also requires companies to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The Company is currently evaluating the impact SFAS 159 will have on its consolidated financial statements upon adoption on January 1, 2008.

<PAGE>  10

BANCORP RHODE ISLAND, INC.
Management's Discussion and Analysis

 

ITEM 2. Management's Discussion and Analysis

 

General

 

      The Company's principal subsidiary, Bank Rhode Island, is a commercial bank chartered as a financial institution in the State of Rhode Island. The Bank pursues a community banking mission and is principally engaged in providing banking products and services to individuals and businesses in Rhode Island and nearby areas of Massachusetts. The Bank is subject to competition from a variety of traditional and nontraditional financial service providers both within and outside of Rhode Island. The Bank offers its customers a wide range of business, commercial real estate, consumer and residential loans and leases, deposit products, nondeposit investment products, cash management, private banking and other banking products and services designed to meet the financial needs of individuals and small- to mid-sized businesses. The Bank also offers both commercial and consumer online banking products and maintains a web site at http://www.bankri.com. The Company and Bank are subject to the regulations of certain federal and state agencies and undergo periodic examinations by certain of those regulatory authorities. The Bank's deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"), subject to regulatory limits. The Bank is also a member of the Federal Home Loan Bank of Boston ("FHLB"). The Company's common stock is traded on the Nasdaq Global Select MarketSM under the symbol "BARI". The Company's financial reports can be accessed through its website within 24 hours of filing with the SEC.

 

Critical Accounting Policies

 

      Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on the carrying value of certain assets or net income, are considered critical accounting policies. The preparation of financial statements in accordance with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. As discussed in the Company's 2006 Annual Report on Form 10-K, management has identified the accounting for the allowance for loan and lease losses, which is now reported as a component of the allowance for credit losses, and review of goodwill for impairment and income taxes as the Company's most critical accounting policies. There have been no significant changes in the methods or assumptions used in accounting policies that require material estimates or assumptions.

 

Overview

 

      The primary drivers of the Company's operating income are net interest income, which is strongly affected by the net yield on interest-earning assets ("net interest margin"), and the quality of the Company's assets.

 

      The Company's net interest income represents the difference between interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities. The net interest margin is calculated by dividing net interest income by average interest-earning assets. Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin generally exceeds the net interest spread as a portion of interest-earning assets are funded by various noninterest-bearing sources (primarily noninterest-bearing deposits and shareholders' equity). The increases (decreases) in the components of interest income and interest expense, expressed in terms of fluctuation in average volume and rate, are summarized in the Rate/Volume Analysis tables shown on page 25. Information as to the components of interest income and interest expense and average rates is provided under "Average Balances, Yields and Costs" on page 24.

<PAGE>  11

      Because the Company's assets are not identical in duration and in repricing dates to its liabilities, the spread between the two is vulnerable to changes in market interest rates as well as the overall shape of the yield curve. These vulnerabilities are inherent to the business of banking and are commonly referred to as "interest rate risk". How to measure interest rate risk and, once measured, how much risk to take are based on numerous assumptions and other subjective judgments. See also discussion under "Interest Rate Risk" on page 29.

 

      The quality of the Company's assets also influences its earnings. Loans and leases that are not paid on a timely basis and exhibit other weaknesses can result in the loss of principal and/or interest income. Additionally, the Company makes timely provisions to the allowance for loan and lease losses based on estimates of probable losses inherent in the loan and lease portfolio; these additions, which are charged against earnings, are necessarily greater when greater probable losses are expected. Further, the Company incurs expenses as a result of resolving troubled assets. All of these reflect the "credit risk" that the Company takes on in the ordinary course of business and is further discussed under "Financial Condition - Asset Quality" on page 17.

 

      The Company's business strategy has been to concentrate its asset generation efforts on commercial and consumer loans and its deposit generation efforts on checking and savings accounts. These deposit accounts are commonly referred to as "core deposit accounts". This strategy is based on the Company's belief that it can distinguish itself from its larger competitors, and indeed attract customers from them, through a higher level of service and through its ability to set policies and procedures, as well as make decisions, locally. The loan and deposit products referenced also tend to be geared more toward customers who are relationship oriented than those who are seeking stand-alone or single transaction products. The Company believes that its service-oriented approach enables it to compete successfully for relationship-oriented customers. Additionally, the Company is predominantly an urban franchise with a high concentration of businesses, which makes deployment of funds in the commercial lending area practicable. Commercial loans are attractive to the Company, among other reasons, because of their higher yields. Similarly, core deposits are attractive to the Company because of their generally lower interest cost and potential for fee income.

 

      The Company also seeks to leverage business opportunities presented by its customer base, franchise footprint and resources. In 2005, the Bank formed a private banking division and completed the Bank's first acquisition, acquiring the operations of an equipment leasing company located in Long Island, New York ("Macrolease"). The Bank is using the Macrolease platform to increase its portfolio of equipment leases, as well as generating additional income by originating equipment leases for third parties. The Company also has introduced Macrolease to the Bank's commercial customers, thereby expanding the Bank's product offerings.

 

      The deposit market in Rhode Island is highly concentrated. The State's three largest banks have an aggregate market share of approximately 85% in Providence and Kent Counties, the Bank's primary marketplace (based upon June 2006 FDIC statistics, excluding one bank that draws its deposits primarily from the internet). Competition for loans and deposits has remained intense during the past few years. This competition has resulted in increases in competitors' advertising and promotional product offerings in print and television media, as well as direct mailings.

 

      For the three months ended March 31, 2007, approximately 80.0% of the Company's revenues (defined as net interest income plus noninterest income) are derived from its level of net interest income. In a continuing effort to diversify its sources of revenue, the Company has attempted to expand its sources of noninterest income (primarily fees and charges for products and services the Bank offers). Consistent with recent periods, the largest source of noninterest income for the Company is service charges on deposit accounts. In the current quarter, the Company experienced growth in commissions on leases originated for third parties.

 

      The future operating results of the Company will again depend on its ability to maintain and expand its net interest margin, while minimizing its exposure to credit risk, along with increasing sources of noninterest income, while controlling the growth of noninterest or operating expenses.

<PAGE>  12

Financial Condition - Executive Summary

 

      Selected balance sheet data is presented in the table below as of the dates indicated:

 

(In thousands)

March 31,
2007

 

December 31,
2006

 

September 30,
2006

 

June 30,
2006

 

March 31,
2006

 


 


 


 


 


Balance sheet data:

                 

    Total assets (a)

$1,483,157

 

$1,479,099

 

$1,496,855

 

$1,467,128

 

$1,431,376

    Loans and leases receivable

1,007,448

 

1,004,292

 

1,008,148

 

996,838

 

957,408

    Securities available for sale

350,655

 

343,887

 

327,198

 

363,708

 

379,594

    Core deposits (b)

638,317

 

634,716

 

620,743

 

632,104

 

607,794

    Certificates of deposit

390,295

 

381,707

 

366,880

 

360,407

 

348,339

    Borrowings

322,336

 

337,097

 

362,483

 

359,190

 

360,319

    Total shareholders' equity

115,357

 

112,085

 

109,387

 

104,579

 

104,352

                   

Core deposit ratio

62.1%

 

62.4%

 

62.9%

 

63.7%

 

63.6%

 

(a)

The Company has reclassified its reserve for unfunded lending commitments to other liabilities from the allowance for loan and lease losses. Prior period results have been reclassified to conform to the current period presentation.

(b)

Core deposits consist of demand deposit, NOW, money market and savings accounts.

   

      Total assets increased by $4.1 million since December 31, 2006. The total loan and lease portfolio increased by $3.2 million from the prior year-end, highlighted by an increase in commercial loans and leases of $12.7 million, or 2.4%, during the first quarter of 2007. The available for sale security portfolio moderately increased $6.8 million, or 2.0%, since year-end. From a liability perspective, the Bank increased both core and total deposits, while decreasing total borrowings. The Bank increased its core deposits by $3.6 million, or 0.6%, despite the normal first quarter seasonal decline in demand deposit accounts (decrease of $18.8 million, or 9.4%, since year-end). Within deposits, customer demand remained strong for higher-yielding term deposit accounts (also referred to as certificates of deposits or CDs) and also premium rate savings accounts. This demand for higher yields and increases in short-term rates over the past few years have contributed to higher funding costs. Shareholders' equity as a percentage of total assets at March 31, 2007 at 7.8% increased from the December 31, 2006 ratio of 7.6%.

 

      The Company's financial position at March 31, 2007 as compared to the prior year quarter-end (March 31, 2006) reflects net growth of over $50.0 million in loans and leases. This increase reflects the continuing conversion of the balance sheet to a more commercial profile with increases in commercial loans and leases of $90.9 million (up 20.6%). Consumer loans remained relatively constant, with an overall increase of $2.5 million (up 1.2%). The residential mortgage portfolio (consisting primarily of purchased mortgages) has decreased $43.4 million (down 14.3%) since March 31, 2006. Also, available for sale securities at March 31, 2007 were down $28.9 million from prior year quarter-end balances, with the difference being redeployed into higher-yielding commercial loans and overnight investments. Deposits have increased $72.5 million, or 7.6%, since the prior year quarter-end. This deposit growth was centered in certificates of deposit (up $42.0 million), savings balances (up $27.0 million), demand deposit accounts (up $6.4 million), along with a moderate increase in NOW accounts (up $211,000). These gains were somewhat offset by declines in money market accounts (down $3.0 million). Overall core deposits increased $30.5 million, or 5.0%. Borrowings have decreased since March 31, 2006 by $38.0 million, due in part to the deposit growth noted above.

<PAGE>  13

Financial Condition - Detailed Analysis

 

Investments

 

      Total investments consists of available for sale securities (investment securities and mortgage-backed securities ("MBSs")), stock in the FHLB and overnight investments. Total investments comprised $401.7 million, or 27.1% of total assets, at March 31, 2007, compared to $397.7 million, or 26.9% of total assets, at December 31, 2006, representing an increase of $4.0 million or 1.0%. All $350.7 million of investment securities and MBSs at March 31, 2007 were classified as available for sale. These available for sale securities carried a total of $3.5 million in net unrealized losses at the end of the quarter, compared to $4.6 million of net unrealized losses at December 31, 2006.

 

      The available for sale securities have been deemed to be not other-than-temporarily impaired after considering that substantially all available for sale securities were rated "investment grade" with unrealized losses primarily caused by market interest rate changes. In addition, the Company has the intent and ability to hold all securities with unrealized losses until recovery or maturity. In making these other-than-temporary impairment determinations, management considers, among other things, the length of time and extent to which the fair value has been less than cost and the credit worthiness and near-term prospects of the issuer. Also management considers capital adequacy, interest rate risk, liquidity and business plans in assessing the intent and ability to hold all securities with unrealized losses until recovery or maturity.

 

      The investment portfolio provides the Company a source of short-term liquidity and acts as a counterbalance to loan and deposit flows. During the first quarter of 2007, the Company purchased $25.0 million of available for sale securities, while maturities and principal repayments totaled $19.3 million. Current market conditions have generally made purchases of available for sale securities less attractive than deploying funds in higher-yielding internally generated assets or holding available funds in overnight investments.

 

Loans and Leases

 

      Total loans and leases at both March 31, 2007 and December 31, 2006 were $1.0 billion, or 67.9% of total assets. The Company attempts to concentrate its asset growth in its loan and lease portfolios to maximize the yield on new assets and to take advantage of demand for both commercial and home equity loan products in its market area. Total loans and leases as of March 31, 2007 are segmented in three broad categories: commercial loans and leases that aggregate $532.5 million, or 52.9% of the portfolio; residential mortgages that aggregate $259.0 million, or 25.7% of the portfolio; and consumer and other loans that aggregate $216.0 million, or 21.4% of the portfolio.

 

      Commercial loans and leases - The commercial loan and lease portfolio (consisting of commercial real estate, business lending, equipment leases, multi-family real estate, construction and small business loans) increased $12.7 million, or 2.4%, during the first three months of 2007.

 

      Towards the end of 2006, the Bank reorganized its business lending function. The business lending group now concentrates its efforts on business lending relationships primarily in excess of $1.0 million. Business lending relationships of up to $1.0 million can now be originated by the Bank's business development group. This group formerly only originated business loans involving relationships under $250,000. Additionally, business loans under $100,000 can be originated by our retail branch system. Underwriting, processing and monitoring of the bulk of business credit relationships of under $1.0 million have been moved to the Bank's new lending services unit ("LSU"). Management believes this reorganization will enhance the Bank's ability to reach more borrowers with the same number of personnel as well as achieve more efficient processing and improved monitoring of these credits.

 

      The Bank's business lending group originates business loans, also referred to as commercial and industrial loans, including owner-occupied commercial real estate loans, term loans and revolving lines of credit. Within the business lending portfolio, owner-occupied commercial real estate loans increased $5.7 million, or 4.1%, since year-end.

<PAGE>  14

      The Bank historically has purchased equipment leases from originators outside of the Bank. The U.S. Government and its agencies are the principal lessees on the vast majority of these leases. These "government" leases generally have maturities of five years or less and are not dependent on residual collateral values. With the Macrolease platform, the Bank originates equipment leases for its own portfolio, as well as originates leases for third parties as a source of noninterest income. At March 31, 2007, leases comprised 13.3% of the commercial loan and lease portfolio, with $43.0 million of Macrolease-generated leases and $27.8 million of government leases.

 

      The Bank's commercial real estate ("CRE") group originates nonowner-occupied commercial real estate, multi-family residential real estate and construction loans. These real estate secured commercial loans are offered as both fixed and adjustable-rate products. Since December 31, 2006, nonowner-occupied real estate loans are up $2.7 million, or 2.7%.

 

      At March 31, 2007, small business loans were $42.3 million, compared to $41.8 million at December 31, 2006, representing 8.0% of the commercial portfolio at each period end. These loans reflect those historically originated by the Bank's small business lending group and branch system and now originated by the Bank's business development group and branch system. The Bank utilizes credit scoring and streamlined documentation, as well as traditional review standards in originating these credits.

 

      The Bank is a participant in the U.S. Small Business Administration ("SBA") Preferred Lender Program in both Rhode Island and Massachusetts. SBA guaranteed loans are found throughout the portfolios managed by the Bank's various lending groups.

 

      The Company believes it is well positioned for continued commercial growth. The Bank places particular emphasis on generation of small- to medium-sized commercial relationships (those with $10 million or less in total loan commitments). Unlike most community banks, the Bank is able to offer asset-based commercial loan facilities that monitor advances against receivables and inventories on a formula basis.

 

Residential mortgage loans - During the first three months of 2007, residential mortgage loans decreased $5.0 million, or 1.9%, as repayments ($10.7 million) exceeded total purchases ($5.7 million). Since inception, the Bank has concentrated its portfolio lending efforts on commercial and consumer lending opportunities, but originates mortgage loans for its own portfolio on a limited basis. The Bank does not employ any outside mortgage originators, but periodically purchases residential mortgage loans from third-party originators. Until such time as the Bank can originate sufficient commercial and consumer loans to utilize available cash flow, the Bank may purchase residential mortgage loans as opportunities arise. At March 31, 2007, the Bank did not have commitments to purchase residential mortgage loans within the next 60 days.

 

Consumer loans - The consumer loan portfolio decreased $4.5 million in total, or 2.1%, during the first three months of 2007. This decline has largely corresponded with the softening of local market area housing prices that first started in the latter portion of 2006; the Company believes the softening prices have discouraged consumers from borrowing against the value of their homes. However, the Company continues to promote consumer lending as it believes that these ten- to twenty-year fixed rate products, along with floating rate lines of credit, possess attractive cash flow characteristics in the current interest rate environment.

<PAGE>  15

      The following is a summary of loans and leases receivable:

 
 

March 31,
2007

 

December 31,
2006

 


 


 

(In thousands)

Commercial loans and leases:

     

    Commercial real estate - owner occupied

$   146,538 

 

$   140,812 

    Commercial real estate - nonowner occupied

105,115 

 

102,390 

    Commercial and industrial

98,029 

 

106,017 

    Small business

42,401 

 

41,785 

    Multi-family

37,648 

 

34,294 

    Construction

32,407 

 

37,237 

    Leases and other

76,498 

 

62,979 

 


 


        Subtotal

538,636 

 

525,514 

    Unearned lease income

(7,231)

 

(6,651)

    Net deferred loan origination costs

1,047 

 

927 

 


 


        Total commercial loans and leases

532,452 

 

519,790 

 


 


       

Residential mortgage loans:

     

    One- to four-family adjustable rate

161,869 

 

165,140 

    One- to four-family fixed rate

95,236 

 

96,880 

 


 


        Subtotal

257,105 

 

262,020 

    Premium on loans acquired

1,926 

 

1,979 

    Net deferred loan origination fees

(50)

 

(54)

 


 


        Total residential mortgage loans

258,981 

 

263,945 

 


 


       

Consumer loans:

     

    Home equity - term loans

150,087 

 

152,484 

    Home equity - lines of credit

62,301 

 

64,208 

    Savings secured

601 

 

587 

    Installment

463 

 

506 

    Automobile

160 

 

178 

    Unsecured and other

919 

 

1,088 

 


 


        Subtotal

214,531 

 

219,051 

    Net deferred loan origination costs

1,484 

 

1,506 

 


 


        Total consumer loans

216,015 

 

220,557 

 


 


        Total loans and leases receivable

$1,007,448 

 

$1,004,292 

 


 


       

Deposits

 

      Total deposits increased by $12.2 million, or 1.2%, during the first three months of 2007, from $1.02 billion, or 68.7% of total assets, at December 31, 2006, to $1.03 billion, or 69.4% of total assets, at March 31, 2007.

<PAGE>  16

      The following table sets forth certain information regarding deposits:

 
 

March 31, 2007

 

December 31, 2006

 


 


Amount

Percent
Of
Total

Weighted
Average
Rate

Amount

Percent
of
Total

Weighted
Average
Rate

 


 


 


 


 


 


 

(In thousands)

                       

NOW accounts

$     79,002

 

7.7%

 

0.60%

 

$     70,736

 

7.0%

 

0.67%

Money market accounts

6,697

 

0.7%

 

2.35%

 

6,991

 

0.7%

 

2.69%

Savings accounts

371,105

 

36.1%

 

2.89%

 

356,707

 

35.1%

 

2.81%

Certificate of deposit accounts

390,295

 

37.9%

 

4.62%

 

381,707

 

37.5%

 

4.45%

 


 


     


 


   

    Total interest bearing deposits

847,099

 

82.4%

 

3.47%

 

816,141

 

80.3%

 

3.40%

Noninterest bearing accounts

181,513

 

17.6%

 

--

 

200,282

 

19.7%

 

--

 


 


     


 


   

    Total deposits

$1,028,612

 

100.0%

 

2.86%

 

$1,016,423

 

100.0%

 

2.73%

 


 


 


 


 


 


                       

      The overall composition of total deposits remained relatively the same during the first three months of the year. At March 31, 2007, core deposit accounts comprised 62.1% of total deposits, compared to 62.4% of total deposits at December 31, 2006. The Bank continues its strategy of emphasizing the normally lower cost core deposits over CDs. However, during the past three months, as was the case for most of 2006, the Bank offered higher-yielding savings accounts in an effort to retain and attract deposits. In addition, demand for CDs remained strong, as it had during 2006.

 

      Throughout 2006 and into 2007, competition for deposits has been intense. In this competitive deposit gathering and rate environment, total deposits increased $12.2 million as compared to December 31, 2006. Savings and CD accounts grew $14.4 million and $8.6 million, respectively, over the past three months. In the first quarter, the Bank reduced its brokered CD amount by $10.0 million to stand at $20.0 million at March 31, 2007, or 1.9% of total deposits. The Bank may utilize brokered CDs if their rates are attractive compared to wholesale funding. NOW and money market accounts increased $8.0 million in aggregate. Offsetting the growth in these deposit categories was the normal demand deposit account seasonal decline from year-end (down $18.8 million). However, as compared to the end of the first quarter of 2006, demand deposit accounts were up $6.4 million.

 

Borrowings

 

      Overnight and short-term borrowings decreased $4.7 million during the first three months of 2007 as compared to the December 31, 2006 amount of $56.3 million. Through the Bank's membership in the FHLB, the Company has access to a number of different funding structures. FHLB borrowings remained consistent with the December 31, 2006 amount of $242.2 million. During the first quarter, wholesale repurchase agreements declined by $10.0 million. The Bank may utilize wholesale repurchase agreement funding in the future if spreads are favorable compared to FHLB borrowings or for diversification purposes.

 

      On a long-term basis, the Company intends to continue concentrating on increasing its core deposits, and will utilize FHLB borrowings or wholesale repurchase agreements as cash flows dictate, as opportunities present themselves and as part of the Bank's overall strategy to manage interest rate risk.

 

Asset Quality

 

      The definition of nonperforming assets includes nonperforming loans and other real estate owned ("OREO"). OREO consists of real estate acquired through foreclosure proceedings and real estate acquired through acceptance of a deed in lieu of foreclosure. Nonperforming loans are defined as nonaccrual loans, loans past due 90 days or more but still accruing and impaired loans. Under certain circumstances the Company may restructure the terms of a loan as a concession to a borrower. These restructured loans are generally considered impaired loans.

<PAGE>  17

      Nonperforming assets - At March 31, 2007, the Company had nonperforming assets of $1.8 million, which represented 0.12% of total assets. This compares to nonperforming assets of $1.4 million, or 0.10% of total assets, at December 31, 2006. Total nonperforming assets at March 31, 2007 consisted of nonaccrual loans and leases with commercial loans and leases aggregating $697,000, residential mortgage loans aggregating $940,000 and commercial loans and leases 90 days past due, but still accruing of $120,000. The Bank believes it is well-secured in its commercial and residential credits as the underlying collateral values exceed the value of the loans and leases. Nonperforming assets at December 31, 2006 were primarily comprised of nonaccrual residential and commercial loans. The increase in nonperforming assets relates primarily to a few commercial loans and leases.

 

      Included in nonaccrual loans and leases at March 31, 2007 were $638,000 of impaired loans and leases, with specific reserves against these impaired loans and leases of $143,000. At December 31, 2006, there were no impaired loans and leases and thus, no specific reserve allocated to impaired loans and leases. The increase in nonaccrual loans and leases since year-end relates primarily to a few commercial loans and leases.

 

      The Company evaluates the underlying collateral of each nonperforming loan and continues to pursue the collection of interest and principal. Management believes that the current level of nonperforming assets remains low relative to the size of the Company's loan portfolio. As the loan portfolio continues to grow and mature, or if economic conditions worsen, management believes it possible that the level of nonperforming assets may increase, as may its level of charged-off loans.

 

      Delinquencies - At March 31, 2007, loan balances of $637,000 were 60 to 89 days past due, up from $476,000 at December 31, 2006.

 

      The following table sets forth information regarding nonperforming assets and loans 60-89 days past due as of the dates indicated:

 
 

March 31,
2007

 

December 31,
2006

 


 


 

(In thousands)

       

Loans and leases accounted for on a nonaccrual basis

$1,637

 

$1,407

Loans and leases past due 90 days or more, but still accruing

120

 

6

Impaired loans and leases (not included in nonaccrual loans and leases)

--

 

--

   


   


    Total nonperforming loans and leases

1,757

 

1,413

Other real estate owned

--

 

--

   


   


    Total nonperforming assets

$1,757

 

$1,413

   


   


       

Delinquent loans 60-89 days past due

$   637

 

$   476

       

Nonperforming loans and leases as a percent of total loans and leases

0.17%

 

0.14%

Nonperforming assets as a percent of total assets

0.12%

 

0.10%

Delinquent loans and leases 60-89 days past due as a percent of total loans

0.06%

 

0.05%

       

      Adversely classified assets - The Company's management adversely classifies certain assets as "substandard," "doubtful" or "loss" based on criteria established under banking regulations. An asset is considered substandard if inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if existing deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions and values, "highly questionable and improbable." Assets classified as loss are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

<PAGE>  18

      At March 31, 2007, the Company had $9.2 million of assets that were classified as substandard. This compares to $8.2 million of assets that were classified as substandard at December 31, 2006. The Company had no assets that were classified as doubtful or loss at either date. Performing loans may or may not be adversely classified depending upon management's judgment with respect to each individual loan. At March 31, 2007, included in the assets that were classified as substandard were $7.4 million of performing loans. This compares to $6.8 million of adversely classified performing loans as of December 31, 2006. These amounts constitute assets that, in the opinion of management, could potentially migrate to nonperforming or doubtful status. Management believes that the March 31, 2007 level of adversely classified assets is low relative to the size of the Company's loan and lease portfolio. If a significant downturn in the local or regional market occurs or if other economic or market conditions worsen, management believes it possible that the level of adversely classified assets may increase. This in turn may necessitate an increase to the provision for loan losses in future periods.

 

Allowance for Credit Losses

 

      The allowance for credit losses is comprised of the allowance for loan and lease losses and the reserve for unfunded lending commitments. In the third quarter of 2006, the Company reclassified the reserve for unfunded lending commitments from the allowance for loan and lease losses to other liabilities for all periods presented. The allowance for credit losses was $13.0 million at March 31, 2007, compared to $12.9 million at December 31, 2006.

 

      During the first three months of 2007, the Company made additions to the allowance for loan and lease losses of $100,000 and experienced net charge-offs of $39,000. The net charge-offs were primarily from small business loans. At March 31, 2007, the allowance for loan and lease losses stood at $12.4 million and represented 707.9% of nonperforming loans and 1.23% of total loans and leases outstanding. This compares to an allowance for loan and lease losses of $12.4 million, representing 875.9% of nonperforming loans and 1.23% of total loans and leases outstanding at December 31, 2006.

 

      During the first three months of 2007, the Company increased the reserve for unfunded lending commitments by $23,000, bringing the balance to $590,000 at March 31, 2007. This compares to the December 31, 2006 balance in the reserve for unfunded lending commitments of $567,000.

<PAGE>  19

      An analysis of the activity in the allowance for credit losses is as follows:

 
 

Three Months
Ended
March 31, 2007

 

Year Ended
December 31, 2006

 


 


 

(In thousands)

Allowance for Loan and Lease Losses

     

    Balance at beginning of period

$12,377 

 

$11,665 

    Loans charged-off:

     

        Commercial loans and leases

(36)

 

(472)

        Residential mortgage loans

-- 

 

-- 

        Consumer and other loans

(12)

 

(47)

 


 


            Total loans charged-off

(48)

 

(519)

 


 


    Recoveries of loans previously charged-off:

     

        Commercial loans and leases

 

19 

        Residential mortgage loans

-- 

 

-- 

        Consumer and other loans

 

10 

 


 


            Total recoveries of loans previously charged-off

 

29 

 


 


            Net (charge-offs)

(39)

 

(490)

    Provision for loan and lease losses charged against income

100 

 

1,202 

 


 


    Balance at end of period

12,438 

 

12,377 

 


 


       

Reserve for Unfunded Lending Commitments

     

    Balance at beginning of period

567 

 

503 

    Provision for unfunded lending commitments

23 

 

64 

 


 


    Balance at end of period

590 

 

567 

 


 


       

Allowance for Credit Losses

     

    Balance at end of period

$13,028 

 

$12,944 

 


 


       

      Assessing the appropriateness of the allowance for credit losses involves substantial uncertainties and is based upon management's evaluation of the amounts required to meet estimated charge-offs in the loan and lease portfolio after weighing various factors. Management's methodology to estimate loss exposure includes an analysis of individual loans and leases deemed to be impaired, reserve allocations for various loan types based on payment status or loss experience and an unallocated allowance that is maintained based on management's assessment of many factors including the growth, composition and quality of the loan portfolio, historical loss experiences, general economic conditions and other pertinent factors. These risk factors are reviewed and revised by management where conditions indicate that the estimates initially applied are different from actual results. Management employs a similar process with respect to unfunded lending commitments. Based on this evaluation, management believes that the allowance for credit losses, as of March 31, 2007, is appropriate.

 

      A portion of the allowance for loan and lease losses is not allocated to any specific segment of the loan portfolio. This non-specific allowance is maintained for two primary reasons: (i) there exists an inherent subjectivity and imprecision to the analytical processes employed, and (ii) the prevailing business environment, as it is affected by changing economic conditions and various external factors, may impact the portfolio in ways currently unforeseen. Management, therefore, has established and maintains a non-specific allowance for loan and lease losses. The amount of this measurement imprecision allocation was $1.0 million at March 31, 2007, compared to $907,000 at December 31, 2006.

<PAGE>  20

      While management evaluates currently available information in establishing the allowance for loan and lease losses and the reserve for unfunded lending commitments, future adjustments to the allowance for credit losses may be necessary if conditions differ substantially from the assumptions used in making the evaluations. Management performs a comprehensive review of the allowance for loan and lease losses and the reserve for unfunded lending commitments on a quarterly basis. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution's allowance for loan and lease losses and carrying amounts of other real estate owned. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

 

Results of Operations -Executive Overview

 

      Selected income statement and per share data and operating ratios are presented in the table below for the three month periods indicated:

 

(In thousands,
except per share data)

For the three month periods ended

March 31,
2007

 

December 31,
2006

 

September 30,
2006

 

June 30,
2006

 

March 31,
2006

 


 


 


 


 


Income statement data:

                 

    Net interest income

$10,228

 

$10,173

   

$10,676

   

$10,329

 

$11,050

 

    Noninterest income

2,562

 

2,324

   

1,544

(a)

 

2,815

 

2,305

 

    Noninterest expense (c)

9,511

 

8,674

(b)

 

9,504

   

9,725

 

10,824

(b)

    Net income

2,178

 

2,537

   

1,643

   

2,006

 

1,525

 
                   

Per share data:

                 

    Diluted earnings per share

$    0.44

 

$    0.51

   

$    0.33

   

$    0.41

 

$    0.31

 

    Dividends per common share

0.15

 

0.15

   

0.15

   

0.15

 

0.15

 
                   

Operating ratios:

                 

    Net interest margin

2.97%

 

2.91%

   

3.08%

   

3.01%

 

3.25%

 

    Return on average assets

0.61%

 

0.69%

   

0.45%

   

0.56%

 

0.43%

 

    Return on average equity

7.79%

 

9.11%

   

6.10%

   

7.69%

 

5.89%

 

    Efficiency ratio (c)

74.36%

 

69.41%

   

77.78%

   

73.99%

 

81.05%

 
 

(a)

Noninterest income for the three month period ended September 30, 2006 includes losses on sales of available for sale securities of $858,000 incurred by the Company as it restructured a portion of its investment portfolio during that quarter.

(b)

Noninterest expense for the three month period ended March 31, 2006 reflects a non-recurring loss of $868,000. Noninterest expense for the three month period ended December 31, 2006 reflects the recovery of $803,000 of insurance proceeds relating to this loss.

(c)

Effective September 30, 2006, the Company reclassified its reserve for unfunded lending commitments to other liabilities from the allowance for loan and lease losses. Prior period results have been reclassified to conform to the current period presentation.

      The Company reported 2007 first quarter net income of $2.2 million, down $359,000, or 14.2%, from the prior quarter (three months ended December 31, 2006). Net income was up $653,000, or 42.8%, on a comparative quarter basis (as compared to the three months ended March 31, 2006). Diluted earnings per common share ("EPS") changed in a similar fashion as EPS decreased 14.3% on a linked-quarter basis (as compared to the three months ended December 31, 2006) and increased 41.2% as compared to the same quarter a year ago.

 

      The Company's GAAP earnings and GAAP EPS for the first and fourth quarters of 2006 were significantly affected by two related events. In the first quarter of 2006, the Company incurred a non-recurring loss of $868,000, while in the fourth quarter of 2006, the Company recovered $803,000 of insurance proceeds relating to this loss.

<PAGE>  21

      To provide additional analysis regarding the Company's operating results, the following tables set forth certain information relating to the reconciliation of GAAP net income, EPS and related operating ratios to pro forma amounts as described above. Management believes this information is useful to the investor in comparing the Company's operating results to those from prior periods.

 

(In thousands, except per share data)

Quarter
Ended
March 31,
2007

Quarter
Ended
December 31,
2006

Quarter
Ended
March 31,
2006

 


Net income (GAAP)

$2,178

$2,537 

$1,525

Adjust for:

     

    Non-recurring loss. net of tax

--

-- 

564

    Insurance proceeds, net of tax

--

(522)

--

 


Pro forma net income

$2,178

$2,015 

$2,089

 


       

Diluted earnings per share (GAAP)

$0.44

$0.51 

$0.31

Effect of:

     

    Non-recurring loss, net of tax

--

-- 

0.12

    Insurance proceeds, net of tax

--

(0.10)

--

 


Pro forma diluted earnings per share

$0.44

$0.41 

$0.43

 


   
 

Quarter Ended March 31, 2007

 


 

Return on
Average Assets

Return on
Average Equity

Efficiency
Ratio

 


GAAP ratios

0.61%

7.79%

74.36%

Effect of:

     

    Non-recurring loss, net of tax

--

--

--

    Insurance proceeds, net of tax

--

--

--

 


Pro forma ratios

0.61%

7.79%

74.36%

 


       
 

Quarter Ended December 31, 2006

 


 

Return on
Average Assets

Return on
Average Equity

Efficiency
Ratio

 


GAAP ratios

0.69%

9.11%

69.41%

Effect of:

     

    Non-recurring loss, net of tax

--

--

--

    Insurance proceeds, net of tax

-0.14%

-1.87%

6.42%

 


Pro forma ratios

0.55%

7.24%

75.83%

 


       
 

Quarter Ended March 31, 2006

 


 

Return on
Average Assets

Return on
Average Equity

Efficiency
Ratio

 


GAAP ratios

0.43%

5.89%

81.05%

Effect of:

     

    Non-recurring loss, net of tax

0.16%

2.17%

-6.50%

    Insurance proceeds, net of tax

--

--

--

 


Pro forma ratios

0.59%

8.06%

74.55%

 


       

<PAGE>  22

      On a pro forma operating basis, net income increased by $163,000 (up 8.1%) and EPS increased by 7.9% as compared to the fourth quarter of 2006. Additionally, 2007 first quarter pro forma net income and EPS were up 4.3% and 3.1%, respectively, compared to the same period a year ago. These increases have come largely through gains in noninterest income and through noninterest expense control, as net interest income continues to be affected by net interest margin compression.

 

      The increase in first quarter 2007 net interest income as compared to the fourth quarter of 2006 was due in part to increased yields on commercial loans and leases of 12 basis points ("bps") and investment securities of 43 bps. Overall, the yield on earning assets increased 15 bps, while the cost of liabilities rose 10 bps. The key driver in the rise in liability costs was an increase in the rates paid on CDs (up 19 bps), as overall competition for deposits has led to these increased liability costs. Compared to the first quarter of 2006, the net interest margin for the three months ended March 31, 2007 decreased 28 bps to 2.97%. In comparison to the same period a year ago, the flat-to-inverted yield curve and increases in short-term rates, in addition to competition for deposits, loans and customers in the Company's market area, have resulted in increases in cost of funds outpacing increases in earning asset yields for the current quarter.

 

      Noninterest income increased for the first quarter of 2007, both in comparison to the fourth quarter of 2006 and to the first quarter a year ago by $238,000 and $257,000, respectively. Significant drivers of this growth were commissions on leases originated for third parties and income from bank-owned life insurance ("BOLI"), which benefited from the tax-free exchange the Company entered into in late 2006. The Company also experienced solid increases in its largest component of noninterest income, service charges on deposit accounts. Compared to the previous quarter, deposit service charges were up $38,000, or 3.0%, and were up $129,000, or 10.9%, compared to the first quarter a year ago.

 

      Noninterest expenses for the current quarter were consistent with the pro forma amounts for the three months ended December 31, 2006, with a net increase of $34,000, or 0.4%. The Company maintained its noninterest expense level despite the normal seasonal increases in salaries and benefits and additional professional services costs incurred with the Company's contested election for its Board of Directors. Excluding the aforementioned non-recurring loss of $868,000 incurred in the first quarter of 2006, the Company reduced noninterest expenses by $445,000, or 4.5%. Salaries and benefits were down $245,000, or 4.4%, with additional savings in loan workout, equipment and data processing costs. These savings more than offset the Company's increased expenses for professional services.

 

      The Company's key operating ratios (return on average assets, return on average equity, and efficiency ratio) for the first quarter of 2007 were up from the pro forma ratios for the fourth quarter of 2006 and relatively consistent with the pro forma ratios for the first quarter of 2006. Throughout 2007, the Company will look to further capitalize upon the efficiencies identified during its ongoing operational process review in an effort to improve the Company's operating performance.

 

Results of Operations - Comparison of the Three Months Ended March 31, 2007 and 2006

 

Net Interest Income

 

      For the three month period ended March 31, 2007, net interest income was $10.2 million, compared to $11.1 million for the 2006 period. The net interest margin for the first quarter of 2007 of 2.97% was down from the net interest margin for the 2006 period of 3.25%. The decrease in net interest income of $822,000 or 7.4%, and margin decrease of 28 bps were attributable to the flat-to-inverted shape of the yield curve, increases in short-term rates and competition for deposits, loans and customers in our market area. Average earning assets were $16.5 million, or 1.2%, higher, and average interest-bearing liabilities were $6.9 million, or 0.6%, higher, than the comparable period a year earlier.

<PAGE>  23

      Average Balances, Yields and Costs - The following table sets forth certain information relating to the Company's average balance sheet and reflects the average yield on assets and average cost of liabilities for the three month periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities. Average balances are derived from daily balances and include nonperforming loans. Available for sale securities are stated at amortized cost.

 

(In thousands)

For the three months ended March 31,

 


 

2007

 

2006

 


 


Assets

Average
Balance

 

Interest
Earned/
Paid

 

Average
Yield

 

Average
Balance

 

Interest
Earned/
Paid

 

Average
Yield

 


                       

Earning assets:

                     

    Overnight investments

$     21,329 

 

$     287

 

5.46%

 

$       4,904 

 

$       30

 

2.44%

    Investment securities

107,614 

 

1,333

 

4.96%

 

157,259 

 

1,671

 

4.25%

    Mortgage-backed securities

239,235 

 

2,869

 

4.80%

 

232,519 

 

2,654

 

4.57%

    Stock in the FHLB

15,881 

 

281

 

7.18%

 

16,299 

 

211

 

5.25%

    Loans receivable:

                     

        Commercial loans and leases

520,279 

 

9,479

 

7.38%

 

439,598 

 

7,685

 

7.09%

        Residential mortgage loans

260,714 

 

3,501

 

5.37%

 

305,609 

 

4,082

 

5.34%

        Consumer and other loans

218,020 

 

3,352

 

6.24%

 

210,360 

 

3,062

 

5.90%

 


     


   

            Total earning assets

1,383,072 

 

21,102

 

6.15%

 

1,366,548 

 

19,395

 

5.72%

 


     


   
                       

Cash and due from banks

23,282 

         

23,287 

       

Allowance for loan and lease losses

(12,391)

         

(11,706)

       

Premises and equipment

14,757 

         

15,156 

       

Goodwill, net

11,317 

         

11,234 

       

Accrued interest receivable

5,685 

         

5,803 

       

Bank-owned life insurance

23,232 

         

19,796 

       

Prepaid expenses and other assets

9,428 

         

9,296 

       
 


         


       

            Total assets

$1,458,382 

         

$1,439,414 

       
 


         


       
                       

Liabilities and Shareholders' Equity

                     

Interest-bearing liabilities:

                     

    Deposits:

                     

        NOW accounts

$     64,285 

 

101

 

0.64%

 

$     79,964 

 

103

 

0.52%

        Money market accounts

6,660 

 

38

 

2.29%

 

11,455 

 

38

 

1.33%

        Savings accounts

361,539 

 

2,472

 

2.77%

 

333,046 

 

1,377

 

1.68%

        Certificate of deposit accounts

392,144 

 

4,440

 

4.59%

 

349,456 

 

2,968

 

3.44%

    Overnight and short-term borrowings

53,466 

 

667

 

5.06%

 

31,278 

 

315

 

4.09%

    Wholesale repurchase agreements

15,778 

 

196

 

4.97%

 

20,000 

 

189

 

3.84%

    FHLB borrowings

236,584 

 

2,591

 

4.44%

 

298,380 

 

3,007

 

4.09%

    Subordinated deferrable interest debentures

18,558 

 

369

 

8.02%

 

18,558 

 

348

 

7.61%

 


     


   

            Total interest-bearing liabilities

1,149,014 

 

10,874

 

3.84%

 

1,142,137 

 

8,345

 

2.96%

 


     


   
                       

Noninterest-bearing deposits

180,781 

         

174,451 

       

Other liabilities

15,234 

         

17,754 

       
 


         


       

            Total liabilities

1,345,029 

         

1,334,342 

       
                       

Shareholders' Equity:

113,353 

         

105,072 

       
 


         


       

            Total liabilities and shareholders' equity

$1,458,382 

         

$1,439,414 

       
 


         


       
                       

Net interest income

   

$10,228

         

$11,050

   
     


         


   
                       

Net interest rate spread

       

2.31%

         

2.76%

Net interest rate margin

       

2.97%

         

3.25%

                       

<PAGE>  24

      Rate/Volume Analysis - The following table sets forth certain information regarding changes in the Company's interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in rate (changes in rate multiplied by old average balance) and (ii) changes in volume (changes in average balances multiplied by old rate). The net change attributable to the combined impact of rate and volume was allocated proportionally to the individual rate and volume changes.

 
 

Three Months Ended March 31,
2007 vs. 2006
Increase/(decrease) due to

 


(In thousands)

Rate

 

Volume

 

Total

 


 


 


Interest income:

         

    Overnight investments

$     69 

 

$   188 

 

$    257 

    Investment securities

232 

 

(570)

 

(338)

    Mortgage-backed securities

129 

 

86 

 

215 

    Stock in the FHLB

76 

 

(6)

 

70 

    Commercial loans and leases

299 

 

1,495 

 

1,794 

    Residential mortgage loans

22 

 

(603)

 

(581)

    Consumer and other loans

201 

 

89 

 

290 

 


 


 


        Total interest income

1,028 

 

679 

 

1,707 

 


 


 


           

Interest expense:

         

    NOW accounts

20 

 

(22)

 

(2)

    Money market accounts

20 

 

(20)

 

-- 

    Savings accounts

968 

 

127 

 

1,095 

    Certificate of deposit accounts

1,078 

 

394 

 

1,472 

    Overnight and short-term borrowings

88 

 

264 

 

352 

    Wholesale repurchase agreements

52 

 

(45)

 

    FHLB borrowings

246 

 

(662)

 

(416) 

    Subordinated deferrable interest debentures

21 

 

-- 

 

21 

 


 


 


        Total interest expense

2,493 

 

36 

 

2,529 

 


 


 


        Net interest income

$(1,465)

 

$   643 

 

$  (822)

 


 


 


           

      Interest Income - Investments - Total investment income (consisting of interest on overnight investments, investment securities and MBSs and dividends on FHLB stock) was $4.8 million for the quarter ended March 31, 2007, compared to $4.6 million for the 2006 period. The increase in total investment income was $204,000, or 4.5%. Investment income for the current quarter benefited from the higher-yielding securities the Company purchased as part of the investment portfolio restructuring conducted in the third quarter of 2006.

 

      Going forward, the Company intends to redeploy cash flows available from maturing investment securities and MBSs into higher-yielding internally generated assets, such as commercial loans and leases. With respect to duration and repricing of the Company's investment portfolio, the majority of the Company's investments is comprised of U.S. Agency securities and MBSs with repricing periods or expected duration of less than five years.

 

Interest Income - Loans and Leases - Interest from loans and leases was $16.3 million for the three months ended March 31, 2007, and represented a yield on total loans and leases of 6.60%. This compares to $14.8 million of interest, and a yield of 6.27%, for the first quarter of 2006. Increased interest income resulting from the growth in the average balance of loans and leases of $43.4 million, or 4.5%, was augmented by an increase in the yield on loans and leases of 34 bps.

<PAGE>  25

      The average balance of the various components of the loan and lease portfolio changed from the first quarter of 2006 as follows: commercial loans and leases increased $80.7 million, or 18.4%, and consumer and other loans increased $7.7 million, or 3.6%, while residential mortgage loans decreased $44.9 million, or 14.7%. Changes in the average yields from the first quarter of 2006 were as follows: commercial loans and leases increased 29 bps, to 7.38%, and consumer and other loans increased 34 bps, to 6.24%, while residential mortgage loans increased 3 bps, to 5.37%. The yields on loans and leases benefited primarily from increases in market interest rates occurring over the past twelve months.

 

      Interest Expense - Deposits and Borrowings - Interest paid on deposits and borrowings increased $2.5 million, or 30.3%, to $10.9 million for the three months ended March 31, 2007, from $8.3 million for the same period during 2006. The overall average cost for interest-bearing liabilities increased 88 bps to 3.84% for the first quarter of 2007, compared to 2.96% for the first quarter of 2006. The average balance of total interest-bearing liabilities remained relatively unchanged at $1.1 billion for the three months ended March 31, 2007 and 2006.

 

      The growth in deposit average balances was centered primarily in CDs (up $42.7 million, or 12.2%) and savings accounts (up $28.5 million, or 8.6%). These increases were somewhat offset by decreases in lower-costing NOW accounts (down $15.7 million, or 19.6%) and money market accounts (down $4.8 million, or 41.9%). Borrowings decreased as compared to the first quarter of 2006, with increases in short-term borrowings (up $22.2 million, or 70.9%) surpassed by larger decreases in FHLB funding (down $61.8 million, or 20.7%), as well as wholesale repurchase agreements (down $4.2 million, or 21.1%).

 

      The rise in deposit and borrowing costs can be attributed to a number of factors. Customer demand remains strong for higher-yielding deposit products, due in part to increases in short-term rates. Competition for deposits continues to be intense. Additionally, bank advertising has been prevalent in the local market area, which has increased customer awareness of attractive rates. Moreover, online banking has enabled customers to more actively manage their finances and has facilitated the movement of available funds from demand deposit accounts and lower-yielding deposit accounts into higher-yielding deposit products. In an effort to attract and retain customers and deposit relationships, the Bank has offered not only the typically higher-costing CDs, but also higher-yielding savings accounts.

 

      Costs have also increased for short- and long-term borrowings. The Company's borrowing rates have been affected by the flat-to-inverted yield curve as well as the Federal Reserve Board's ("FRB") rate increases over the past few years. Overall, the Company's liability costs continue to be dependent upon a number of factors including general economic conditions, national and local interest rates, competition in the local deposit marketplace, interest rate tiers offered and the Company's cash flow needs.

 

Provision for Loan and Lease Losses

 

      The provision for loan and lease losses was $100,000 for the quarter ended March 31, 2007, down $167,000 from the first quarter of 2006. Additions to the allowance for loan and lease losses during the first quarter of 2007 were primarily in response to concern for general economic conditions and changes in the mix of the loan and lease portfolio.

 

      Management evaluates several factors including new loan originations, actual and estimated charge-offs and the risk characteristics of the loan and lease portfolio and general economic conditions when determining the provision for each quarter. As the loan portfolio continues to grow and mature, or if economic conditions worsen, management believes it possible that the level of nonperforming assets may increase, which in turn may lead to increases in the provision for loan and lease losses. Also see discussion under "Allowance for Credit Losses".

 

Noninterest Income

 

      Total noninterest income increased $257,000, or 11.1%, to $2.6 million for the first quarter of 2007, from $2.3 million for the first quarter of 2006. Commissions on leases originated for third parties was the most significant increase compared to the same period last year as these fees increased $280,000, or 451.6%. The Bank's largest component of noninterest income, service charges on deposit accounts, also increased

<PAGE>  26

compared to the first quarter of 2006, with an increase of $129,000, or 10.9%. Income from BOLI benefited from the tax-free exchange the Company entered into in the fourth quarter of 2006 and the additional purchases of BOLI made during 2006, with an overall increase of $72,000, or 40%. These increases were somewhat offset by lower commissions on nondeposit investment products in the first quarter of 2007 (down $192,000, or 61.5%).

 

Noninterest Expense

 

      Noninterest expense for the first quarter of 2007 decreased $1.3 million, or 12.1%, to $9.5 million from $10.8 million in 2006. In the 2006 first quarter, the Company incurred a non-recurring loss on a note receivable of $868,000. Excluding this loss, noninterest expenses decreased $445,000, or 4.5%, reflective of the Company's ongoing initiatives to control expense growth.

 

      Salaries and benefits costs declined $245,000, or 4.4%, compared to the first quarter a year ago. Additionally, loan workout expense decreased $134,000, or 93.7%. Within the overall decrease in noninterest expenses was the increase in professional services costs of $236,000, or 56.7%, due in part to expenses incurred in connection with the Company's contested election for its Board of Directors. Other miscellaneous expenses decreased $284,000, or 20.8%, for the first quarter of 2007 compared to the same period a year ago. The Company's efficiency ratio decreased from the first quarter 2006 pro forma ratio of 74.55% to 74.36% for the first quarter of 2007. These efficiency ratios continue to be negatively impacted by compression in the net interest margin, which partially negated the cost savings realized.

 

Income Tax Expense

 

      Income tax expense of $1.0 million was recorded for the three months ended March 31, 2007, compared to $739,000 for the same period during 2006. This represented total effective tax rates of 31.5% and 32.6%, respectively. Tax-favored income from BOLI, along with the Company's utilization of a Rhode Island passive investment company, has reduced the effective tax rate from the 40.9% combined statutory federal and state tax rates.

 

Liquidity and Capital Resources

 

Liquidity

 

      Liquidity is defined as the ability to meet current and future financial obligations of a short-term nature. The Company further defines liquidity as the ability to respond to the needs of depositors and borrowers, as well as to earnings enhancement opportunities, in a changing marketplace.

 

      The primary source of funds for the payment of dividends and expenses by the Company is dividends paid to it by the Bank. Bank regulatory authorities generally restrict the amounts available for payment of dividends if the effect thereof would cause the capital of the Bank to be reduced below applicable capital requirements. These restrictions indirectly affect the Company's ability to pay dividends. The primary sources of liquidity for the Bank consist of deposit inflows, loan repayments, borrowed funds and maturity of investment securities and sales of securities from the available for sale portfolio. Management believes that these sources are sufficient to fund the Bank's lending and investment activities.

 

      Management is responsible for establishing and monitoring liquidity targets as well as strategies and tactics to meet these targets. In general, the Company seeks to maintain a high degree of flexibility with a liquidity target of 10% to 30% of total assets. At March 31, 2007, overnight investments, investment securities and MBSs available for sale amounted to $386.1 million, or 26.0% of total assets. This compares to $381.2 million, or 25.8% of total assets at December 31, 2006. The Bank is a member of the FHLB and, as such, has access to both short- and long-term borrowings. In addition, the Bank maintains a line of credit at the FHLB as well as a line of credit with a correspondent bank. The Bank also has access to funding through wholesale repurchase agreements. There have been no adverse trends in the Company's liquidity or capital reserves. Management believes that the Company has adequate liquidity to meet its commitments.

<PAGE>  27

Capital Resources

 

      Total shareholders' equity of the Company at March 31, 2007 was $115.4 million, as compared to $112.1 million at December 31, 2006. This difference of $3.3 million was the result of net income of $2.2 million, proceeds from the exercise of stock options and related tax effects of $1.2 million, increase in accumulated other comprehensive income of $765,000 (attributable to decreases in unrealized losses on investments and MBSs) and share-based compensation of $38,000. Partially offsetting the aforementioned items were dividend payments of $724,000 and a stock repurchase of $223,000.

 

All FDIC-insured institutions must meet specified minimal capital requirements. These regulations require banks to maintain a minimum leverage capital ratio. In addition, the FDIC has adopted capital guidelines based upon ratios of a bank's capital to total assets adjusted for risk. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. These regulations require banks to maintain minimum capital levels for capital adequacy purposes and higher capital levels to be considered "well capitalized".

 

The FRB has also issued capital guidelines for bank holding companies. These guidelines require the Company to maintain minimum capital levels for capital adequacy purposes. In general, the FRB has adopted substantially identical capital adequacy guidelines as the FDIC. Such standards are applicable to bank holding companies and their bank subsidiaries on a consolidated basis.

 

As of March 31, 2007, the Company and the Bank met all applicable minimum capital requirements and were considered "well capitalized" by both the FRB and the FDIC. Additionally, at March 31, 2007, the Company had approximately $17 million of additional capital (held at the parent company), which is available to support the Bank's future growth.

 

The Company's and the Bank's actual and required capital amounts and ratios are as follows:

 
 



Actual

 

Minimum Required
For Capital
Adequacy Purposes

 

Minimum Required
To Be Considered
"Well Capitalized"

 


 


 


 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 


 


 


 


 


 


At March 31, 2007:

                     
                       

Bancorp Rhode Island, Inc.

                     

Tier I capital (to average assets)

$124,287

 

8.58%

 

$43,450

 

3.00%

 

$  72,417

 

5.00%

Tier I capital (to risk weighted assets)

124,287

 

12.35%

 

40,264

 

4.00%

 

60,396

 

6.00%

Total capital (to risk weighted assets)

136,725

 

13.58%

 

80,528

 

8.00%

 

100,660

 

10.00%

                       

Bank Rhode Island

                     

Tier I capital (to average assets)

$106,726

 

7.38%

 

$43,387

 

3.00%

 

$  72,312

 

5.00%

Tier I capital (to risk weighted assets)

106,726

 

10.61%

 

40,245

 

4.00%

 

60,368

 

6.00%

Total capital (to risk weighted assets)

119,164

 

11.84%

 

80,490

 

8.00%

 

100,613

 

10.00%

                       

At December 31, 2006:

                     
                       

Bancorp Rhode Island, Inc.

                     

Tier I capital (to average assets)

$121,782

 

8.37%

 

$43,658

 

3.00%

 

$  72,763

 

5.00%

Tier I capital (to risk weighted assets)

121,782

 

12.05%

 

40,428

 

4.00%

 

60,642

 

6.00%

Total capital (to risk weighted assets)

134,159

 

13.27%

 

80,856

 

8.00%

 

101,070

 

10.00%

                       

Bank Rhode Island

                     

Tier I capital (to average assets)

$104,213

 

7.18%

 

$43,540

 

3.00%

 

$  72,567

 

5.00%

Tier I capital (to risk weighted assets)

104,213

 

10.32%

 

40,405

 

4.00%

 

60,607

 

6.00%

Total capital (to risk weighted assets)

116,590

 

11.54%

 

80,809

 

8.00%

 

101,011

 

10.00%

                       

<PAGE>  28

BANCORP RHODE ISLAND, INC.
Quantitative and Qualitative Disclosures About Market Risk

 

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

 

Interest Rate Risk

 

      The principal market risk facing the Company is interest rate risk. The Company's objective regarding interest rate risk is to manage its assets and funding sources to produce results which are consistent with its liquidity, capital adequacy, growth and profitability goals, while maintaining interest rate risk exposure within established parameters over a range of possible interest rate scenarios.

 

      Interest rate risk management is governed by the Bank's Asset/Liability Committee ("ALCO"). The ALCO establishes exposure limits that define the Company's tolerance for interest rate risk. The ALCO monitors current exposures versus limits and reports results to the Board of Directors. The policy limits and guidelines serve as benchmarks for measuring interest rate risk and for providing a framework for evaluation and interest rate risk management decision making. The primary tools for managing interest rate risk currently are the securities portfolio, purchased mortgages, wholesale repurchase agreements and borrowings from the FHLB.

 

      The Company's interest rate risk position is measured using both income simulation and interest rate sensitivity "gap" analysis. Income simulation is the primary tool for measuring the interest rate risk inherent in the Company's balance sheet at a given point in time by showing the effect on net interest income, over a 24-month period, of 200 bps interest rate ramps. These simulations take into account repricing, maturity and prepayment characteristics of individual products. The ALCO reviews simulation results to determine whether the exposure resulting from changes in market interest rates remains within established tolerance levels over both a 12-month and 24-month horizon, and develops appropriate strategies to manage this exposure. The Company's guidelines for interest rate risk specify that if interest rates were to shift up or down 200 bps over a 12-month and 24-month period, estimated net interest income should decline by no more than 10.0%. As of March 31, 2007, net interest income simulation indicated that the Company's exposure to changing interest rates was within these tolerances. The ALCO reviews the methodology utilized for calculating interest rate risk exposure and may periodically adopt modifications to this methodology.

 

      The following table presents the estimated impact of interest rate ramps on the Company's estimated net interest income over a twenty-four month period beginning April 1, 2007:

 
 

Estimated Exposure
to Net Interest Income

 


 

Dollar
Change

 

Percent
Change

 


 


 

(Dollars in thousands)

Initial Twelve Month Period:

     
       

Up 200 bps

$   (758)

   

-1.7%

 

Down 200 bps

(401)

   

-0.9%

 
           

Subsequent Twelve Month Period:

         
           

Up 200 bps

(3,081)

   

-6.6%

 

Down 200 bps

(2,701)

   

-5.8%

 
           

      The Company also uses interest rate sensitivity "gap" analysis to provide a more general overview of its interest rate risk profile. The interest rate sensitivity gap is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. At March 31, 2007, the Company's one year cumulative gap was a negative $72.2 million, or 4.9% of total assets.

 

      For additional discussion on interest rate risk see the section titled "Asset and Liability Management" on pages 55 through 57 of the Company's 2006 Annual Report on Form 10-K.

 

ITEM 4. Controls and Procedures

 

      As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company carried out an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report. This evaluation was carried out under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and the Company's Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

 

      There was no significant change in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to affect, the Company's internal control over financial reporting. The Company continues to enhance its internal controls over financial reporting, primarily by evaluating and enhancing process and control documentation. Management discusses with and discloses these matters to the Audit Committee of the Board of Directors and the Company's auditors.

<PAGE>  29

BANCORP RHODE ISLAND, INC.
Other Information

 

PART II. Other Information

 

Item 1.    Legal Proceedings

 
 

There are no material pending legal proceedings to which the Company or its subsidiaries are a party, or to which any of their property is subject, other than ordinary routine litigation incidental to the business of banking.

 

Item 1A.    Risk Factors

 
 

There have been no material changes from the risk factors as previously disclosed in the Company's 2006 Annual Report on Form 10-K.

 

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

 
 

The table below summarizes the Company's repurchases of common stock during the quarter ended March 31, 2007:

 

 

Period

 

Total
number of
shares
purchased

 

Average
Price Paid
Per Share

 

Total Number
of Shares
Purchased as
Part of
Announced
Plan (a)

 

Maximum
number of
shares that may
yet be
purchased
under the plan

 


 

1/1/07 through 1/31/07

 

--

 

--

 

N/A

(1)

 

245,000

 

2/1/07 through 2/28/07

 

5,000

 

$44.60

 

5,000

   

240,000

 

3/1/07 through 3/31/07

 

--

 

--

 

5,000

   

240,000

                     

(a)

The Company's Board of Directors has authorized the repurchase of up to 245,000 shares of the Company's common stock or approximately five percent of the outstanding shares. The repurchases, which may be conducted through open market purchases or privately negotiated purchases, may be made periodically, subject to market conditions, at the discretion of management. As of March 31, 2007, 5,000 shares have been purchased to date.

Item 3.    Defaults Upon Senior Securities

 
 

No defaults upon senior securities have taken place.

 

Item 4.    Submission of Matters to a Vote of the Security Holders

 
 

No information to report.

 

Item 5.    Other Information

 
 

No information to report.

<PAGE>  30

Item 6.    Exhibits

 
 

23

 

Consent of KPMG LLP, as independent registered public accountants for the Company.*

       
 

31.1

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

       
 

31.2

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

       
 

32.1

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

       
 

32.2

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

       

*

Previously filed with the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007.

<PAGE>  31

BANCORP RHODE ISLAND, INC.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
   

Bancorp Rhode Island, Inc.

     
     

May 10, 2007

 

/s/ Merrill W. Sherman


 


(Date)

 

Merrill W. Sherman

   

President and

   

Chief Executive Officer

     
     

May 10, 2007

 

/s/ Linda H. Simmons


 


(Date)

 

Linda H. Simmons

   

Chief Financial Officer

   

and Treasurer

<PAGE>  32