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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 2004
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from _____ to _____
Commission File Number: 0-50801
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SI FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
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United States 84-1655232
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
803 Main Street, Willimantic, Connecticut 06226
(Address of principal executive offices) (Zip Code)
(860) 423-4581
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |_| No |X|
The aggregate market value of the voting and non-voting common equity held
by non-affiliates as of June 30, 2004 was $0.
As of March 14, 2005, there were 12,563,750 shares of the Registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of SI Financial Group, Inc.'s Proxy Statement for the 2005 Annual
Meeting of Stockholders are incorporated by reference in Part III of this Form
10-K.
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SI FINANCIAL GROUP, INC. AND SUBSIDIARIES
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TABLE OF CONTENTS
PART I. Page No.
- ------- --------
Item 1. Business 1
Item 2. Properties 33
Item 3. Legal Proceedings 34
Item 4. Submission of Matters to a Vote of Security Holders 35
PART II.
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Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities 35
Item 6. Selected Financial Data 35
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operation 37
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 50
Item 8. Financial Statements and Supplementary Data 52
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 52
Item 9A. Controls and Procedures 53
Item 9B. Other Information 53
PART III.
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Item 10. Directors and Executive Officers of the Registrant 53
Item 11. Executive Compensation 53
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 53
Item 13. Certain Relationships and Related Transactions 54
Item 14. Principal Accountant Fees and Services 54
PART IV.
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Item 15. Exhibits and Financial Statement Schedules 54
Signatures 56
This report contains forward-looking statements that are based on assumptions
and may describe future plans, strategies and expectations of SI Financial
Group, Inc. (the "Company"). These forward-looking statements are generally
identified by the use of the words "believe," "expect," "intend," "anticipate,"
"estimate," "project" or similar expressions. The Company's ability to predict
results or the actual effect of future plans or strategies is inherently
uncertain. Factors which could have a material adverse effect on the operations
of the Company and its subsidiaries include, but are not limited to, changes in
interest rates, national and regional economic conditions, legislative and
regulatory changes, monetary and fiscal policies of the United States
government, including policies of the United States Treasury and the Federal
Reserve Board, the quality and composition of the loan or investment portfolios,
demand for loan products, deposit flows, competition, demand for financial
services in the Company's market area, changes in real estate market values in
the Company's market area and changes in relevant accounting principles and
guidelines. These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be placed on such
statements. Except as required by applicable law or regulation, the Company does
not undertake, and specifically disclaims any obligation, to release publicly
the result of any revisions that may be made to any forward-looking statements
to reflect events or circumstances after the date of the statements or to
reflect the occurrence of anticipated or unanticipated events.
PART I.
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Item 1. Business.
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General
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In certain instances where appropriate, the terms "we," "us" and "our" refer to
SI Financial Group, Inc. and Savings Bank and Trust Company or both.
Savings Institute Bank and Trust Company (the "Bank" or "Savings Institute")
became the wholly-owned subsidiary of SI Financial Group, Inc., which was
established on August 6, 2004, in connection with the conversion of SI Bancorp,
Inc., the Bank's former mutual holding company parent, and Savings Institute
from state-chartered to federally-chartered institutions. The Company's business
is the ownership of the outstanding capital stock of the Bank and management of
the investment of the proceeds it retained from the stock offering. The Company
does not own or lease any property but instead uses the premises, equipment and
other property of the Bank. Thus, the financial information and discussion
contained herein primarily relates to the activities of the Bank.
The Savings Institute was incorporated by an act of the Connecticut legislature
in 1842 under the name Willimantic Savings Institute. It was shortened to
Savings Institute in 1991 to reflect the Bank's expanded geographic territory.
In 2000, the Bank converted to stock form and became the wholly-owned subsidiary
of SI Bancorp, Inc., a Connecticut-chartered mutual holding company. On August
6, 2004, Savings Institute converted to a federal charter and now operates under
the name Savings Institute Bank and Trust Company. At that time, SI Bancorp,
Inc. converted to a federal charter operating under the name SI Bancorp, MHC and
transferred all of the common stock of the Bank to SI Financial Group, Inc.
The Bank operates as a community-oriented financial institution offering a full
range of financial services to consumers and businesses in our market area,
including insurance, trust and investment services. The Bank attracts deposits
from the general public and uses those funds to originate one- to four-family
residential, multi-family and commercial real estate, commercial business and
consumer loans, which we hold primarily for investment.
Availability of Information
- ---------------------------
The Company's annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and any amendments to such reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, are made available free of charge on our website,
www.mysifi.com, as soon as reasonably practicable after the Company
electronically files such material with, or furnishes it to, the Securities and
Exchange Commission. The information on our website shall not be considered as
incorporated by reference into this Form 10-K.
1
Market Area
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The Company is headquartered in Willimantic, Connecticut, which is located in
eastern Connecticut approximately 30 miles east of Hartford. In addition to the
Bank's main office located in Windham County, we operate fourteen branch offices
in Hartford, New London, Tolland and Windham Counties, which the Bank considers
its primary market area. The economy in our market area is primarily oriented to
the educational, service, entertainment, manufacturing and retail industries.
The major employers in the area include several institutions of higher
education, the Mohegan Sun and Foxwoods casinos, General Dynamics Defense
Systems and Pfizer, Inc. According to published statistics, Windham County's
population in 2003 was approximately 113,000 and consisted of 41,000 households.
The population increased approximately 3.2% from 2000. Median household income
in Windham County is $45,000, compared to $54,000 for Connecticut as a whole and
$43,000 nationally. Hartford, New London and Tolland Counties have median
household incomes of $51,000, $51,000 and $59,000, respectively.
Competition
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The Bank faces significant competition for the attraction of deposits and
origination of loans. Our most direct competition for deposits has historically
come from the several financial institutions operating in our market area and,
to a lesser extent, from other financial service companies, such as brokerage
firms, credit unions and insurance companies. We also face competition for
investors' funds from money market funds and other corporate and government
securities. At June 30, 2004, which is the most recent date for which data is
available from the Federal Deposit Insurance Corporation ("FDIC"), we held
approximately 17.55% of the deposits in Windham County, which is the largest
market share out of eleven financial institutions with offices in this county.
Also, at June 30, 2004, we held approximately 0.79% of the deposits in Hartford,
New London and Tolland Counties, which is the 14th market share out of 37
financial institutions with offices in these counties. In addition, banks owned
by Bank of America Corp., Webster Financial Corporation, Banknorth Group, Inc.,
Sovereign Bancorp, Inc. and Citizens Financial Group, Inc., all of which are
large regional bank holding companies, also operate in our market area. These
institutions are significantly larger than us and, therefore, have significantly
greater resources.
The Bank's competition for loans comes primarily from financial institutions in
our market area, and to a lesser extent from other financial service providers,
such as mortgage companies and mortgage brokers. Competition for loans also
comes from the increasing number of non-depository financial service companies
entering the mortgage market, such as insurance companies, securities companies
and specialty finance companies.
We expect competition to increase in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Technological advances, for example, have
lowered barriers to entry, allowed banks to expand their geographic reach by
providing services over the Internet and made it possible for non-depository
institutions to offer products and services that traditionally have been
provided by banks. Changes in federal law permit affiliation among banks,
securities firms and insurance companies, which promotes a competitive
environment in the financial services industry. Competition for deposits and the
origination of loans could limit our growth in the future.
Lending Activities
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General. Our loan portfolio consists primarily of one- to four-family
residential mortgage loans, multi-family and commercial real estate loans and
commercial business loans. To a much lesser extent, our loan portfolio includes
construction and consumer loans. We historically and currently originate loans
primarily for investment purposes. At December 31, 2004, we had $200,000 in
loans that were held for sale.
2
The following table summarizes the composition of the Bank's loan portfolio in
dollar amounts and as a percentage of the respective portfolio at the dates
indicated.
At December 31,
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(Dollars in Thousands) 2004 2003 2002
-------------------- -------------------- --------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
--------- -------- --------- -------- --------- --------
Real estate loans:
Residential - 1 to 4 Family $ 252,180 55.99% $ 226,881 58.29% $ 213,831 63.29%
Multi-family and
commercial 82,213 18.25 73,428 18.87 61,214 18.12
Construction 35,773 7.94 20,652 5.30 21,104 6.25
--------- ------ --------- ------ --------- ------
Total real estate loans 370,166 82.18 320,961 82.46 296,149 87.66
Consumer loans:
Home equity 18,335 4.07 14,411 3.70 10,786 3.19
Other 2,790 0.62 3,107 0.80 3,936 1.16
--------- ------ --------- ------ --------- ------
Total consumer loans 21,125 4.69 17,518 4.50 14,722 4.35
Commercial business loans 59,123 13.13 50,746 13.04 27,003 7.99
--------- ------ --------- ------ --------- ------
Total loans 450,414 100.00% 389,225 100.00% 337,874 100.00%
====== ====== ======
Deferred loan origination
costs, net of fees 743 387 (209)
Allowance for loan losses (3,200) (2,688) (3,067)
--------- --------- ---------
Loans, net $ 447,957 $ 386,924 $ 334,598
========= ========= =========
At December 31,
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(Dollars in Thousands) 2001 2000
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Percent Percent
Amount of Total Amount of Total
--------- -------- --------- --------
Real estate loans:
Residential - 1 to 4 Family $ 193,672 65.36% $ 174,186 65.14%
Multi-family and
commercial 56,376 19.02 47,016 17.58
Construction 10,155 3.43 11,815 4.42
--------- ------ --------- ------
Total real estate loans 260,203 87.81 233,017 87.14
Consumer loans:
Home equity 7,752 2.62 6,888 2.58
Other 7,174 2.42 6,039 2.26
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Total consumer loans 14,926 5.04 12,927 4.84
Commercial business loans 21,192 7.15 21,442 8.02
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Total loans 296,321 100.00% 267,386 100.00%
====== ======
Deferred loan origination
costs, net of fees (349) (228)
Allowance for loan losses (2,861) (2,605)
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Loans, net $ 293,111 $ 264,553
========= =========
One- to Four-Family Residential Loans. Our primary lending activity is the
origination of mortgage loans to enable borrowers to purchase or refinance
existing homes or to construct new residential dwellings in our market area. We
offer fixed-rate and adjustable-rate mortgage loans with terms up to 30 years.
Borrower demand for adjustable-rate loans versus fixed-rate loans is a function
of the level of interest rates, the expectations of changes in the level of
interest rates, the difference between the interest rates and loan fees offered
for fixed-rate mortgage loans and the initial period interest rates and loan
fees for adjustable-rate loans. The relative amount of fixed-rate mortgage loans
and adjustable-rate mortgage loans that can be originated at any time is largely
determined by the demand for each in a competitive environment and the effect
each has on our interest rate risk. The loan fees charged, interest rates and
other provisions of mortgage loans are determined by us on the basis of our own
pricing criteria and competitive market conditions.
The Bank offers fixed-rate loans with terms of 15, 20 or 30 years. Our
adjustable-rate mortgage loans are based on 15, 20 or 30 year amortization
schedules. Interest rates and payments on our adjustable-rate mortgage loans
adjust annually after a one, three, five, seven or ten-year initial fixed
period. Interest rates and payments on our adjustable-rate loans are adjusted to
a rate typically equal to 2.75% (2.875% for jumbo loans) above the one-year
constant maturity Treasury index. The maximum amount by which the interest rate
may be increased or decreased is generally 2% per adjustment period and the
lifetime interest rate cap is generally 6% over the initial interest rate of the
loan.
While we anticipate that adjustable-rate loans will better offset the adverse
effects of an increase in interest rates as compared to fixed-rate mortgages,
the increased mortgage payments required of adjustable-rate loan borrowers in a
rising interest rate environment could cause an increase in delinquencies and
defaults. The marketability of the underlying property also may be adversely
affected in a high interest rate environment. In addition, although
adjustable-rate mortgage loans help make our asset base more responsive to
changes in interest rates, the extent of this interest sensitivity is limited by
the annual and lifetime interest rate adjustment limits.
We generally do not make conventional loans with loan-to-value ratios exceeding
95% and generally make loans with a loan-to-value ratio in excess of 80% only
when secured by first liens on owner-occupied one- to four-family residences.
Loans with loan-to-value ratios in excess of 80% generally require private
mortgage insurance or additional collateral. We require all properties securing
mortgage loans to be appraised by a board approved
3
independent licensed appraiser. We require title insurance on all first mortgage
loans. Borrowers must obtain hazard insurance and flood insurance for loans on
property located in a flood zone, before closing the loan.
In an effort to provide financing for moderate income and first-time buyers, we
offer Federal Housing Authority, Veterans Administration and Connecticut Housing
Finance Agency loans and a first-time home buyers program. We offer fixed-rate
residential mortgage loans through these programs to qualified individuals and
originate the loans using modified underwriting guidelines.
Multi-Family and Commercial Real Estate Loans. The Bank offers fixed rate and
adjustable-rate mortgage loans secured by multi-family and commercial real
estate. Our multi-family and commercial real estate loans are generally secured
by condominiums, apartment buildings, single-family subdivisions as well as
owner occupied properties located in our market area and used for businesses. We
intend to continue to grow this segment of our loan portfolio.
We originate adjustable-rate multi-family and commercial real estate loans for
terms up to 25 years. Interest rates and payments on these loans typically
adjust every five years after a five-year initial fixed rate period. Interest
rates and payments on our adjustable-rate loans are adjusted to a rate typically
2.5-3.5% above the classic advance rates offered by the Federal Home Loan Bank
of Boston ("FHLB"). There are no adjustment period or lifetime interest rate
caps. Loans are secured by first mortgages that generally do not exceed 75% of
the property's appraised value. At December 31, 2004, the largest outstanding
commercial real estate loan commitment was $2.9 million, of which $2.9 million
was outstanding. This loan is secured by the assets of a healthcare facility and
was performing according to its terms at December 31, 2004.
Loans secured by multi-family and commercial real estate generally have larger
balances and involve a greater degree of risk than one- to four-family
residential mortgage loans. Of primary concern in multi-family and commercial
real estate lending is the borrower's creditworthiness and the feasibility and
cash flow potential of the project. Payments on loans secured by income
properties often depend on successful operation and management of the
properties. As a result, repayment of such loans may be subject, to a greater
extent than residential real estate loans, to adverse conditions in the real
estate market or the economy. To monitor cash flows on income properties, we
require borrowers and loan guarantors, if any, to provide annual financial
statements on multi-family and commercial real estate loans. In reaching a
decision on whether to make a multi-family or commercial real estate loan, we
consider the net operating income of the property, the borrower's expertise,
credit history and profitability and the value of the underlying property. In
addition, with respect to commercial real estate rental properties, we will also
consider the term of the lease and the quality of the tenants. We have generally
required that the properties securing these real estate loans have debt service
coverage ratios of at least 1.25. The debt service coverage ratio is equal to
cash flows before interest, rent, income taxes and required principal payments
divided by amounts paid for interest, rent, income taxes and required principal
payments. Environmental surveys are generally required for commercial real
estate loans over $250,000.
Construction Loans. The Bank originates loans to individuals, and to a lesser
extent, builders, to finance the construction of residential dwellings. We also
make construction loans for commercial development projects, including
condominiums, apartment buildings, single-family subdivisions as well as
owner-occupied properties used for businesses. Our construction loans generally
provide for the payment of interest only during the construction phase, which is
usually twelve months. At the end of the construction phase, the loan generally
converts to a permanent mortgage loan. Loans generally can be made with a
maximum loan to value ratio of 85% on residential construction and 75% on
commercial construction of the lower of appraised value or cost of the project,
whichever is less. At December 31, 2004, the largest outstanding residential
construction loan commitment was for $1.0 million, of which $600,000 was
outstanding. At December 31, 2004, the largest outstanding commercial
construction loan commitment was $4.1 million, of which $1.9 million was
outstanding. These loans were performing according to their terms at December
31, 2004. Before making a commitment to fund a residential construction loan, we
require an appraisal of the property by a board approved independent licensed
appraiser. We also will require an inspection of the property before
disbursement of funds during the term of the construction loan.
4
The Bank also originates land loans to individuals and local contractors and
developers only for the purpose of making improvements on approved building
lots, subdivisions and condominium projects within two years of the date of the
loan. Such loans to individuals generally are written with a maximum
loan-to-value ratio based upon the appraised value or purchase price of the land
of 75% for a 10-year loan and 60% for a 15-year loan, whichever is less. We
offer fixed-rate land loans and variable-rate land loans that adjust annually.
Interest rates and payments on our adjustable-rate land loans are adjusted to a
rate typically equal to 2.75% above the one-year constant maturity Treasury
index. The maximum amount by which the interest rate may be increased or
decreased is generally 2% annually and the lifetime interest rate cap is
generally 6% over the initial rate of the loan. If applicable, we require title
insurance and a hazardous waste survey reporting that the land is free of
hazardous or toxic waste.
Construction financing is generally considered to involve a higher degree of
risk of loss than long-term financing on improved, occupied real estate. Risk of
loss on a construction loan depends largely upon the accuracy of the initial
estimate of the property's value at completion of construction or development
and the estimated cost, including interest, of construction. During the
construction phase, a number of factors could result in delays and cost
overruns. If the estimate of construction costs proves to be inaccurate, we may
be required to advance funds beyond the amount originally committed to permit
completion of the development. If the estimate of value proves to be inaccurate,
we may be confronted, at or before the maturity of the loan, with a project
having a value which is insufficient to assure full repayment. As a result of
the foregoing, construction lending often involves the disbursement of
substantial funds with repayment dependent, in part, on the success of the
ultimate project rather than the ability of the borrower or guarantor to repay
principal and interest. If we are forced to foreclose on a project before or at
completion due to a default, there can be no assurance that we will be able to
recover all of the unpaid balance of, and accrued interest on, the loan as well
as related foreclosure and holding costs.
Commercial Loans. The Bank makes commercial business loans to a variety of
professionals, sole proprietorships and small businesses primarily in our market
area. We offer a variety of commercial lending products, the maximum amount of
which is limited by our in-house loans-to-one-borrower limit, which was $6.0
million at December 31, 2004. Our largest commercial loan was a $900,000 loan
secured by accounts receivable, of which $702,000 was outstanding as of December
31, 2004. This loan was performing according to its original terms at December
31, 2004.
Until November 2004, we maintained a Business Manager Program under which
accounts receivable financing was offered to small and medium-sized businesses
in our market area. Under that program, we purchased accounts receivable on a
full recourse basis. Our income from the program arose primarily from: (1)
service charges, which range from two to five percent, which are discounted from
each receivable purchased, and (2) the interest, if any, charged to account
debtors on unpaid balances. To mitigate the risk associated with such lending, a
flexible cash reserve was established for each participant. Any excess reserves
were returned to the small business once a month. Additionally, we obtained
accounts receivable fraud insurance to protect our exposure on these loans. The
Company decided to discontinue the Business Manager Program when it was
determined that the volume of new business was not sufficient to warrant the
time and cost associated with maintenance on the accounts under the program. The
outstanding balances at December 31, 2004 under the Business Manager Program,
totaling $1.4 million, will be either converted to one of our traditional
commercial loan products or transferred to another lender that offers the
Business Manager Program.
We also offer loans secured by business assets other than real estate, such as
business equipment and inventory. These loans are originated with maximum
loan-to-value ratios of 75% of the value of the personal property. We originate
lines of credit to finance the working capital needs of businesses to be repaid
by seasonal cash flows or to provide a period of time during which the business
can borrow funds for planned equipment purchases. These loans convert to a term
loan at the expiration of a draw period, which is not to exceed twelve months
and will be paid over a pre-defined amortization period. We also offer time
notes, letters of credit and Small Business Administration guaranteed loans.
Time notes are short-term loans and will only be granted on the basis of a
defined source of repayment of principal and interest from a specific
foreseeable event.
5
When making commercial business loans, we consider the financial statements of
the borrower, the borrower's payment history of both corporate and personal
debt, the debt service capabilities of the borrower, the projected cash flows of
the business, viability of the industry in which the customer operates and the
value of the collateral.
Unlike residential mortgage loans, which generally are made on the basis of the
borrower's ability to make repayment from his or her employment or other income,
and which are secured by real property whose value tends to be more easily
ascertainable, commercial loans are of higher risk and typically are made on the
basis of the borrower's ability to make repayment from the cash flow of the
borrower's business. As a result, the availability of funds for the repayment of
commercial loans may depend substantially on the success of the business itself.
Further, any collateral securing such loans may depreciate over time, may be
difficult to appraise and may fluctuate in value.
Consumer Loans. To a much lesser extent, the Bank offers a variety of consumer
loans, primarily home equity lines of credit, and, to a lesser extent, loans
secured by marketable securities, passbook or certificate accounts, motorcycles,
automobiles and recreational vehicles as well as unsecured loans. Unsecured
loans generally have a maximum borrowing limit of $15,000 and a maximum term of
five years.
The procedures for underwriting consumer loans include an assessment of the
applicant's payment history on other debts and their ability to meet existing
obligations and payments on the proposed loans. Although the applicant's
creditworthiness is a primary consideration, the underwriting process also
includes a comparison of the value of the collateral, if any, to the proposed
loan amount. Home equity lines of credit have adjustable rates of interest that
are indexed to the prime rate as reported in The Wall Street Journal. We will
offer home equity loans with maximum combined loan-to-value ratios of 100%,
provided that loans in excess of 80% will be charged a higher rate of interest.
A home equity line of credit may be drawn down by the borrower for an initial
period of five years from the date of the loan agreement. During this period,
the borrower has the option of paying, on a monthly basis, either principal and
interest or only interest. If not renewed, the borrower has to pay back the
amount outstanding under the line of credit over a term not to exceed ten years,
beginning at the end of the five-year period.
Consumer loans may entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
assets that depreciate rapidly. In such cases, repossessed collateral for a
defaulted consumer loan may not provide an adequate source of repayment for the
outstanding loan and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, consumer loan
collections depend on the borrower's continuing financial stability, and
therefore, are more likely to be adversely affected by job loss, divorce,
illness or personal bankruptcy. Furthermore, the application of various federal
and state laws, including federal and state bankruptcy and insolvency laws, may
limit the amount which can be recovered on such loans.
Loan Originations, Loan Purchases and Sales and Servicing of Loans. Loan
originations come from a number of sources. The primary source of loan
originations are our in-house loan originators, and to a lesser extent, local
mortgage brokers, advertising and referrals from customers.
From time to time, the Bank will purchase whole participations in loans fully
guaranteed by the United States Department of Agriculture and the Small Business
Administration. The loans are primarily for commercial and agricultural
properties located throughout the United States. We purchased $12.2 million and
$26.4 million of these loans in fiscal 2004 and 2003, respectively.
The Bank generally originates loans for portfolio but from time to time will
sell loans in the secondary market, primarily fixed-rate one- to four-family
residential mortgage loans with servicing retained, based on prevailing market
interest rate conditions, an analysis of the composition and risk of the loan
portfolio, liquidity needs and interest rate risk management. Generally, loans
are sold without recourse. The Bank utilizes the proceeds from these sales
primarily to meet liquidity needs and manage interest rate risk. We sold $15.5
million, $23.0 million and $12.8 million of loans in the years ended December
31, 2004, 2003 and 2002, respectively.
6
At December 31, 2004, the Bank retained the servicing rights on $50.5 million of
loans for others, consisting primarily of fixed-rate mortgage loans sold with or
without recourse to third parties. Loan servicing includes collecting and
remitting loan payments, accounting for principal and interest, contacting
delinquent mortgagors, processing insurance and tax payments on behalf of
borrowers, assisting in foreclosures and property dispositions when necessary
and general administration of loans. The gross servicing fee income from loans
sold with servicing rights retained is typically 25 basis points of the total
balance of serviced loans. The servicing rights, included in other assets,
related to these loans was $165,000 and $124,000 at December 31, 2004 and 2003,
respectively. Amortization of mortgage servicing rights totaled $24,000, $0 and
$0 for the years ended December 31, 2004, 2003 and 2002, respectively.
The following table sets forth the Bank's loan originations and purchases, loan
sales, principal repayments, charge-offs and other reductions on loans for the
periods indicated.
Years Ended December 31,
---------------------------------
(Dollars in Thousands) 2004 2003 2002
--------- --------- ---------
Loans at beginning of period $ 389,225 $ 337,874 $ 296,321
Originations:
Real estate loans 147,899 180,962 133,150
Commercial business loans 14,465 10,034 4,025
Consumer loans 16,063 16,682 11,837
--------- --------- ---------
Total loan originations 178,427 207,678 149,012
Loans Purchased 12,152 26,448 3,538
Deductions:
Principal loan repayments, prepayments and other 113,803 157,095 97,821
Sale of loans, principal balance 15,549 22,996 12,795
Loan charge-offs, net 38 1,981 331
Transfers to OREO -- 703 50
--------- --------- ---------
Total deductions 129,390 182,775 110,997
--------- --------- ---------
Net loan activity 61,189 51,351 41,553
--------- --------- ---------
Loans at end of period $ 450,414 $ 389,225 $ 337,874
========= ========= =========
Loan Maturity. The following table shows the contractual maturity of the Bank's
loan portfolio at December 31, 2004. The table does not reflect any estimate of
prepayments, which significantly shortens the average life of all loans, and may
cause our actual repayment experience to differ from that shown below. Demand
loans having no stated schedule of repayment and no stated maturity are reported
as due in one year or less.
7
Amounts Due In
--------------------------------------------------
(Dollars in Thousands) More Than Total
One Year or One to Five More Than Amount
Less Years Five Years Due
----------- ----------- ---------- ---------
Real estate loans:
Residential - 1 to 4 family $ 34 $ 5,055 $ 247,091 $ 252,180
Multi-family and commercial 312 2,877 79,024 82,213
Construction 8,629 4,092 23,052 35,773
-------- -------- --------- ---------
Total real estate loans 8,975 12,024 349,167 370,166
Commercial business loans 8,815 7,237 43,071 59,123
Consumer loans 859 17,837 2,429 21,125
-------- -------- --------- ---------
Total loans $ 18,649 $ 37,098 $ 394,667 $ 450,414
======== ======== ========= =========
While one- to four-family residential real estate loans are normally originated
with up to 30-year terms; such loans typically remain outstanding for
substantially shorter periods because borrowers often prepay their loans in full
upon the sale of the property pledged as security or upon refinancing the
original loan. Therefore, average loan maturity is a function of, among other
factors, the level of purchase and sale activity in the real estate market,
prevailing interest rates and the interest rates payable on outstanding loans.
The following table sets forth, at December 31, 2004, the dollar amount of gross
loans receivable contractually due after December 31, 2005, and whether such
loans have either fixed interest rates, floating or adjustable interest rates.
The amounts shown below exclude deferred loan fees and costs and the allowance
for loan losses and include $944,000 of nonperforming loans.
Floating or
(Dollars in Thousands) Fixed Adjustable
Rates Rates Total
--------- ----------- ---------
Real estate loans:
Residential - 1 to 4 family $ 204,279 $ 47,867 $ 252,146
Multi-family and commercial 10,527 71,374 81,901
Construction 21,623 5,521 27,144
--------- --------- ---------
Total real estate loans 236,429 124,762 361,191
Commercial business loans 21,715 28,593 50,308
Consumer loans 7,186 13,080 20,266
--------- --------- ---------
Total loans $ 265,330 $ 166,435 $ 431,765
========= ========= =========
Loan Approval Procedures and Authority. The Bank's lending activities follow
written, nondiscriminatory, underwriting standards and loan origination
procedures established by our Board of Directors and management. All residential
mortgages and consumer home equity lines of credit in excess of $6.0 million or
all commercial loans and other consumer loans in excess of $2.0 million require
the approval of the Board of Directors. The loan committee has the authority to
approve: (1) residential mortgage loans and consumer home equity lines of credit
of up to $6.0 million and (2) commercial and other consumer loans of up to $2.0
million. The President and the Senior Credit Officer have approval for: (1)
residential mortgage loans that conform to Fannie Mae and Freddie Mac standards
up to $2.0 million or $359,650 for those that are non-conforming, (2) consumer
and commercial loans up to $250,000 individually or $2.0 million jointly for
consumer home equity lines of credit or $1.0 million
8
jointly for commercial and other consumer loans. The Senior Commercial Officer
may approve consumer home equity lines of credit and commercial loans of up to
$200,000 individually or $500,000 with the additional approval of the President
or Senior Credit Officer. Various bank personnel have been delegated authority
to approve loans up to $359,650.
Loans to One Borrower. The maximum amount that we may lend to one borrower and
the borrower's related entities is limited, by regulation, to generally 15% of
our stated capital and reserves. At December 31, 2004, our regulatory limit on
loans to one borrower was $9.4 million. At that date, our largest lending
relationship was $9.0 million, of which $5.0 million was outstanding, and
included fourteen commercial real estate loans, all of which were performing
according to the original repayment terms at December 31, 2004.
Loan Commitments. The Bank issues commitments for fixed-rate and adjustable-rate
mortgage loans conditioned upon the occurrence of certain events. Commitments to
originate mortgage loans are legally binding agreements to lend to our customers
and generally expire in 90 days or less from the date of application.
Delinquencies. When a borrower fails to make a required loan payment, the Bank
takes a number of steps to have the borrower cure the delinquency and restore
the loan to current status. We make initial contact with the borrower when the
loan becomes 15 days past due. If payment is not then received by the 30th day
of delinquency, additional letters and phone calls generally are made. When the
loan becomes 90 days past due, we send a letter notifying the borrower that we
will commence foreclosure proceedings if the loan is not brought current within
30 days. When the loan becomes 120 days past due, we will commence foreclosure
proceedings against any real property that secures the loan or attempt to
repossess any personal property that secures a consumer or commercial loan. If a
foreclosure action is instituted and the loan is not brought current, paid in
full, or refinanced before the foreclosure sale, the real property securing the
loan is typically sold at foreclosure. We may consider loan workout arrangements
with certain borrowers under certain circumstances.
Management informs the Board of Directors monthly of the amount of loans
delinquent more than 30 days, all loans in foreclosure and all foreclosed and
repossessed property that we own.
The following table sets forth the delinquencies in the Bank's loan portfolio as
of the dates indicated.
December 31, 2004 December 31, 2003
----------------------------------------------- -----------------------------------------------
(Dollars in Thousands) 60 - 89 Days 90 Days or More 60 - 89 Days 90 Days or More
---------------------- ---------------------- ---------------------- ----------------------
Principal Principal Principal Principal
Number of Balance of Number of Balance of Number of Balance of Number of Balance of
Loans Loans Loans Loans Loans Loans Loans Loans
--------- ---------- --------- ---------- --------- ---------- --------- ----------
Real estate loans:
Residential - 1 to 4 family 5 $ 547 2 $ 522 2 $ 169 3 $ 205
Multi-family and commercial -- -- 3 421 -- -- 2 873
Construction -- -- -- -- -- -- -- --
--- ----- --- ----- --- ----- --- -------
Total real estate loans 5 547 5 943 2 169 5 1,078
Consumer loans:
Home equity 1 20 -- -- -- -- -- --
Other -- -- 1 1 1 1 -- --
--- ----- --- ----- --- ----- --- -------
Total consumer loans 1 20 1 1 1 1 -- --
Commercial business loans -- -- -- -- -- -- -- --
--- ----- --- ----- --- ----- --- -------
Total delinquent loans (1) 6 $ 567 6 $ 944 3 $ 170 5 $ 1,078
=== ===== === ===== === ===== === =======
- ----------
(1) Represents delinquent loans 60 days or more past due.
Classified Assets. Management of the Company, including the Watched Asset
Committee, consisting of a number of the Bank's officers, review and classify
the assets of the Company on a monthly basis and the Board of Directors reviews
the results of the reports on a quarterly basis. Federal regulations and the
Company's internal policies require that management utilize an internal asset
classification system to monitor and evaluate the credit
9
risk inherent in its loan portfolio. The Company currently classifies problem
and potential problem assets as "substandard," "doubtful" or "loss" assets. An
asset is considered "substandard" if it is inadequately protected by the current
net worth and paying capacity of the obligor or of the collateral pledged, if
any. "Substandard" assets include those assets that are characterized by the
distinct possibility that the Company will sustain some loss if the deficiencies
are not corrected. Assets characterized as "doubtful" have all the weaknesses
inherent in those classified as "substandard" with the additional characteristic
that the weaknesses present make collection or liquidation in full, on the basis
of currently existing facts, conditions and values, questionable, and there is a
high probability of loss. Assets classified as "loss" are those assets
considered uncollectible and of such little value that their continuance as
assets, without the establishment of a specific loss reserve, is not warranted.
In addition, assets which do not currently expose the Company to sufficient risk
to warrant classification in one of the aforementioned categories but possess
credit deficiencies or potential weaknesses are required to be designated
"special mention." When we classify an asset as "substandard" or "doubtful," we
may establish a specific allowance for loan losses. If an asset is classified as
a "loss," the Company charges-off an amount equal to the portion of the asset
classified as "loss." All the loans mentioned above are included in the
Company's Watch List Report. This report serves as an integral part in the
evaluation of the adequacy of the Company's allowance for loan losses.
The following table sets forth the Company's classified loans as of December 31,
2004.
Loss Doubtful Substandard Special Mention
Principal Principal Principal Principal
(Dollars in Thousands) Balance Balance Balance Balance
--------- --------- ----------- ---------------
Real estate loans:
Residential - 1 to 4 family $ -- $ -- $ 682 $ 226
Multi-family and commercial -- -- 421 3,136
Construction -- -- -- --
---- ---- ------- -------
Total real estate loans -- -- 1,103 3,362
Consumer loans:
Home equity -- -- 20 --
Other 1 -- -- 2
---- ---- ------- -------
Total consumer loans 1 -- 20 2
Commercial business loans -- -- -- 1,271
---- ---- ------- -------
Total classified loans $ 1 $ -- $ 1,123 $ 4,635
==== ==== ======= =======
Of the $1.1 million of substandard loans at December 31, 2004, $943,000 are
considered nonperforming loans. Of the $4.6 million of special mention loans,
only $104,000 are more than 30 days past due at December 31, 2004.
Nonperforming Assets and Restructured Loans. When a loan becomes 90 days
delinquent, the loan is placed on nonaccrual status at which time the accrual of
interest ceases and the allowance for any uncollectible accrued interest is
established and charged against operations. Typically, payments received on
nonaccrual loans are applied to the outstanding principal and interest balance
as determined at the time of collection of the loan.
We consider repossessed assets and loans that are 90 days or more past due to be
nonperforming assets. Real estate that we acquire as a result of foreclosure or
by deed-in-lieu of foreclosure is classified as real estate owned until it is
sold. When property is acquired it is recorded at the lower of its cost, which
is the unpaid balance of the loan plus foreclosure costs or fair value at the
date of the foreclosure. Holding costs and declines in fair value after
acquisition of the property are charged against income as incurred.
10
The following table provides information with respect to the Company's
nonperforming assets and troubled debt restructurings as of the dates indicated.
December 31,
-----------------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
------- ------- ------- ------- -------
Nonaccrual loans:
Real estate loans $ 943 $ 1,295 $ 1,347 $ 1,597 $ 1,028
Commercial business loans -- -- 418 517 86
Consumer loans 1 -- 72 29 23
------- ------- ------- ------- -------
Total nonaccrual loans 944 1,295 1,837 2,143 1,137
Accruing loans past due 90 days or more:
Real estate loans -- -- 5 46 394
Commercial business loans -- -- -- 1 --
Consumer loans -- -- -- -- --
------- ------- ------- ------- -------
Total accruing loans past due 90 days
or more -- -- 5 47 394
------- ------- ------- ------- -------
Total nonperforming loans 944 1,295 1,842 2,190 1,531
Real estate owned, net (1) -- 328 43 43 43
------- ------- ------- ------- -------
Total nonperforming assets 944 1,623 1,885 2,233 1,574
Troubled debt restructurings 76 77 78 78 79
------- ------- ------- ------- -------
Total nonperforming assets and troubled
debt restructurings $ 1,020 $ 1,700 $ 1,963 $ 2,311 $ 1,653
======= ======= ======= ======= =======
Total nonperforming loans to total loans 0.21% 0.33% 0.55% 0.74% 0.57%
Total nonperforming loans to total assets 0.15% 0.25% 0.38% 0.51% 0.41%
Total nonperforming assets and troubled
debt restructurings to total assets 0.16% 0.33% 0.40% 0.54% 0.44%
- ----------
(1) Real estate owned balances are shown net of related loss allowance.
Other than disclosed in the above table, there are no other loans at December
31, 2004 that management has serious doubts about the ability of the borrowers
to comply with the present loan repayment terms.
Interest income that would have been recorded for the years ended December 31,
2004 and December 31, 2003 had nonaccruing loans and troubled debt
restructurings been current in accordance with their original terms and had been
outstanding throughout the period amounted to $56,000 and $67,000, respectively.
The amount of interest related to nonaccrual loans and troubled debt
restructurings included in interest income was $9,000 and $0 for the years ended
December 31, 2004 and 2003, respectively.
Allowance for Loan Losses. The allowance for loan losses is a valuation
allowance for probable incurred losses inherent in the loan portfolio. The
allowance is maintained through a provision for loan losses that is charged to
earnings. Actual loan losses are charged against the allowance when management
believes the uncollectibility of the loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance. The Company evaluates the
allowance for loan losses on a regular basis.
11
The methodology for assessing the appropriateness of the allowance for loan
losses consists of three key elements:
o Specific allowances for identified problem loans, including certain
impaired or collateral-dependent loans;
o General valuation allowance on certain identified problem loans; and
o General valuation allowance on the remainder of the loan portfolio
Specific Allowance on Identified Problem Loans. The loan portfolio is segregated
first between loans that are on our "watch list" and loans that are not. Our
watch list includes: (1) loans that are 60 or more days delinquent, (2) loans
with anticipated losses, (3) loans referred to attorneys for collection or in
the process of foreclosure, (4) nonaccrual loans, (5) loans classified as
"substandard," "doubtful" or "loss" by either our internal classification system
or by regulators during the course of their examination of us, and (6) troubled
debt restructurings and other nonperforming loans.
The Watched Asset Committee, consisting of a number of the Bank's officers, will
review each loan on the watch list and establish an individual reserve
allocation on certain loans based on such factors as (1) the strength of the
customer's personal or business cash flow; (2) the availability of other sources
of repayment; (3) the amount due or past due; (4) the type and value of
collateral; (5) the strength of our collateral position; (6) the estimated cost
to sell the collateral; and (7) the borrower's effort to cure the delinquency.
The Company reviews and establishes, as needed, a specific allowance for certain
identified non-homogeneous problem loans. In accordance with the Statement of
Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment
of a Loan" ("SFAS 114"), a loan is impaired when, based on current information
and events, it is probable that a creditor will be unable to collect all amounts
due under the contractual terms of the loan agreement. Measurement of the
impairment is based on the present value of expected future cash flows or the
fair value of the collateral, if the loan is collateral dependent. A specific
allowance on impaired loans is established if the present value of the expected
future cash flows, or fair value of the collateral for collateral dependent
loans, is lower than the carrying value of the loan.
General Valuation Allowance on Certain Identified Problem Loans. The Company
establishes a general allowance for watch list loans that do not have an
individual allowance. We segregate these loans by loan category and assign
allowance percentages to each category based on inherent losses associated with
each type of lending and consideration that these loans, in the aggregate,
represent an above-average credit risk and that more of these loans will prove
to be uncollectible compared to loans in the general portfolio.
General Valuation Allowance on the Remainder of the Loan Portfolio. The Company
establishes another general allowance for loans that are not on the watch list
to recognize the probable losses associated with lending activities, but which,
unlike specific allowances, has not been allocated to particular problem assets.
This general valuation allowance is determined by segregating the loans by loan
category and assigning allowance percentages based on our historical loss
experience and delinquency trends. The allowance may be adjusted for significant
factors that, in management's judgment, affect the collectibility of the
portfolio as of the evaluation date. These significant factors may include
changes in lending policies and procedures, changes in existing general economic
and business conditions affecting our primary lending areas, credit quality
trends, collateral value, loan volumes and concentrations, seasoning of the loan
portfolio, specific industry conditions within portfolio segments, recent loss
experience in particular segments of the portfolio, duration of the current
business cycle and bank regulatory examination results. The applied loss factors
are re-evaluated annually to ensure their relevance in the current economic
environment.
The Office of Thrift Supervision ("OTS"), as an integral part of its examination
process, periodically reviews our allowance for loan losses. The OTS may require
us to make additional provisions for loan losses based on judgments different
from that of the Company.
Although we believe that we use the best information available to establish the
allowance for loan losses, future adjustments to the allowance for loan losses
may be necessary and our results of operations could be adversely affected if
circumstances differ substantially from the assumptions used in making the
determinations.
12
Furthermore, while management believes we have established our allowance for
loan losses in conformity with generally accepted accounting principles, there
can be no assurance that regulators, in reviewing our loan portfolio, will not
request us to increase our allowance for loan losses. In addition, because
future events affecting borrowers and collateral cannot be predicted with
certainty, there can be no assurance that the existing allowance for loan losses
is adequate or that increases will not be necessary should the quality of any
loans deteriorate as a result of the factors discussed above. Any material
increase in the allowance for loan losses may adversely affect our financial
condition and results of operations.
The following table sets forth an analysis of the allowance for loan losses for
the periods indicated.
Years Ended December 31,
-----------------------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
-------- -------- -------- -------- ---------
Allowance at beginning of period $ 2,688 $ 3,067 $ 2,861 $ 2,605 $ 2,284
Provision for loan losses 550 1,602 537 440 290
Charge-offs:
Real estate loans -- 1,523 77 40 86
Commercial business loans 13 374 111 218 18
Consumer loans 62 216 218 146 5
-------- -------- -------- -------- ---------
Total charge-offs 75 2,113 406 404 109
Recoveries:
Real estate loans 19 89 35 40 60
Commercial business loans 6 24 32 161 70
Consumer loans 12 19 8 19 10
-------- -------- -------- -------- ---------
Total recoveries 37 132 75 220 140
-------- -------- -------- -------- ---------
Net charge-offs/(recoveries) 38 1,981 331 184 (31)
-------- -------- -------- -------- ---------
Allowance at end of period $ 3,200 $ 2,688 $ 3,067 $ 2,861 $ 2,605
======== ======== ======== ======== =========
Allowance to total loans outstanding at
end of period 0.71% 0.69% 0.91% 0.97% 0.97%
Allowance to nonperforming loans 338.98% 207.57% 166.50% 130.64% 170.15%
Net charge-offs (recoveries) to average
loans outstanding during the period 0.01% 0.55% 0.11% 0.07% (0.01)%
Recoveries to charge-offs 49.30% 6.25% 18.47% 54.46% (128.44)%
Lower charge-offs in 2004, as compared to 2003, were primarily the result of
improved asset quality in the Bank's loan portfolio. In addition, charge-offs
for 2003 included the charge-off of two commercial business loans and two
commercial real estate loans that aggregated $1.8 million. The larger of the two
commercial real estate loans, which at the time of charge-off had a principal
balance of $1.6 million, was charged-off after the loan was nonperforming and
the Company determined that the value of the real estate underlying the loan was
insufficient to cover the outstanding principal balance. Additionally, because
we held a junior collateral position, the Company determined that the likelihood
of any recovery was remote. During the year ended December 31, 2003, charge-offs
exceeded the provision for loan losses as specific allowances of $237,000 were
established in prior periods for a portion of the charged-off loans once it had
been determined that collection or liquidation in full was unlikely.
13
The following table sets forth the breakdown of the allowance for loan losses by
loan category at the dates indicated.
December 31,
------------------------------------------------------------------------------------------------
2004 2003 2002
----------------------------- ------------------------------ ------------------------------
% of % of % of
Loans in Loans in Loans in
% of each % of each % of each
Allowance Category Allowance Category Allowance Category
to Total to Total to Total to Total to Total to Total
(Dollars in Thousands) Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
------- --------- -------- ------- -------------------- ------- --------- -------
Real estate loans $ 2,403 75.08% 82.18% $ 2,093 77.86% 82.46% $ 2,237 72.94% 87.66%
Commercial business 641 20.02 13.13 461 17.15 13.04 488 15.91 7.99
Consumer loans 152 4.74 4.69 80 2.98 4.50 318 10.37 4.35
Unallocated 4 0.16 -- 54 2.01 -- 24 0.78 --
------- ------ ------ ------- ------ ------ ------- ------ ------
Total allowance for
loan losses $ 3,200 100.00% 100.00% $ 2,688 100.00% 100.00% $ 3,067 100.00% 100.00%
======= ====== ====== ======= ====== ====== ======= ====== ======
December 31,
---------------------------------------------------------------
2001 2000
----------------------------- ------------------------------
% of % of
Loans in Loans in
% of each % of each
Allowance Category Allowance Category
to Total to Total to Total to Total
(Dollars in Thousands) Amount Allowance Loans Amount Allowance Loans
------- --------- -------- ------------------------------
Real estate loans $ 1,866 65.22% 87.81% $ 1,759 67.52% 87.14%
Commercial business 647 22.62 7.15 537 20.61 8.02
Consumer loans 277 9.68 5.04 139 5.34 4.84
Unallocated 71 2.48 -- 170 6.53 --
------- ------ ------ ------- ------ ------
Total allowance for
loan losses $ 2,861 100.00% 100.00% $ 2,605 100.00% 100.00%
======= ====== ====== ======= ====== ======
Investment Activities
- ---------------------
The Company has legal authority to invest in various types of liquid assets,
including U.S. Treasury obligations, securities of various federal agencies,
state and municipal governments, mortgage-backed securities and certificates of
deposit of federally-insured institutions. Within certain regulatory limits, we
also may invest a portion of our assets in corporate securities and mutual
funds. We also are required to maintain an investment in FHLB stock. While we
have the authority under applicable law and our investment policies to invest in
derivative securities, we had no such investments at December 31, 2004.
The Company's investment objectives are to provide and maintain liquidity, to
maintain a balance of high quality, diversified investments to minimize risk, to
provide collateral for pledging requirements, to establish an acceptable level
of interest rate and credit risk, to provide an alternate source of low-risk
investments when demand for loans is weak, to generate a favorable return and to
assist in the financing needs of various local public entities, subject to
credit quality review and liquidity concerns. Our Board of Directors has the
overall responsibility for the investment portfolio, including approval of the
investment policy and appointment of the Investment Committee. The Investment
Committee is responsible for approval of investment strategies and monitoring
our investment performance. The Chief Financial Officer, in conjunction with the
Chief Executive Officer, is primarily responsible for implementation of the
investment policies. The Board of Directors provides designated individuals with
authority to make investment decisions. Currently, the President and Chief
Executive Officer and the Chief Financial Officer are authorized to enter into
fixed income transactions up to $2.5 million and equity transactions up to
$250,000. Two Senior Vice Presidents may enter into fixed income transactions up
to $1.0 million and equity transactions up to $100,000. Transactions exceeding
these limitations require the approval of two of these officers, one of whom
must be either the President and Chief Executive Officer or the Chief Financial
Officer. Individual
14
investment transactions will be reviewed and approved by the Board of Directors
on a monthly basis, while portfolio composition and performance will be reviewed
at least quarterly by the Investment Committee.
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS No. 115"), requires that
securities be categorized as either "held to maturity," "trading securities" or
"available for sale" based on management's intent as to the ultimate disposition
of each security. Debt securities may be classified as "held-to-maturity," and
reported in the financial statements at amortized cost, only if the Company has
the positive intent and ability to hold those securities until maturity.
Securities purchased and held principally for the purpose of trading in the near
term are classified as "trading securities." These securities are reported at
fair value in the financial statements, with unrealized gains and losses
recognized in earnings. Debt and equity securities not classified as either
"held to maturity" or "trading securities" are classified as "available for sale
securities." These securities are reported at fair value with unrealized gains
and losses excluded from earnings and reported in other comprehensive income,
net of taxes.
At December 31, 2004, the Company's investment portfolio included only available
for sale securities which totaled $120.6 million and represented 19.3% of
assets. The Company's available for sale securities consisted primarily of U.S.
government and agency securities with maturities of 15 years or less,
mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae with
stated final maturities of 30 years or less, corporate debt securities and
securities of state and municipal governments.
The following table sets forth the amortized cost and fair values of our
securities portfolio at the dates indicated.
December 31,
-------------------------------------------------------------------
(Dollars in Thousands) 2004 2003 2002
--------------------- -------------------- --------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- --------- --------- -------- --------- --------
Available for sale securities:
U.S. Government and agency
securities $ 73,950 $ 73,676 $ 38,583 $ 38,999 $ 27,931 $ 28,821
Mortgage-backed securities 40,926 40,594 19,050 18,364 32,569 32,770
Corporate debt securities 3,498 3,563 15,540 16,451 21,054 21,779
Obligations of state and political
subdivisions 1,499 1,584 3,129 3,217 3,199 3,309
Tax-exempt 560 560 -- -- -- --
Other debt securities 75 75 75 75 75 75
--------- --------- -------- -------- -------- --------
Total debt securities 120,508 120,052 76,377 77,106 84,828 86,754
Marketable equity securities 488 505 531 587 1,251 1,160
--------- --------- -------- -------- -------- --------
Total available for sale securities 120,996 120,557 76,908 77,693 86,079 87,914
Held to maturity securities:
Mortgage-backed securities -- -- 1,728 1,344 9,463 8,985
--------- --------- -------- -------- -------- --------
Total securities $ 120,996 $ 120,557 $ 78,636 $ 79,037 $ 95,542 $ 96,899
========= ========= ======== ======== ======== ========
The Company had no investments that had an aggregate book value in excess of 10%
of its equity at December 31, 2004.
The following table sets forth the amortized cost, weighted average yields and
contractual maturities of securities at December 31, 2004. Weighted average
yields on tax-exempt securities are not presented on a tax equivalent basis
because the impact would be insignificant. Certain mortgage-backed securities
have adjustable interest rates and will reprice periodically within the various
maturity ranges. These repricing schedules are not reflected in the table below.
At December 31, 2004, mortgage-backed securities with adjustable rates totaled
$13.5 million.
15
More than One Year More than Five Years
(Dollars in Thousands) One Year or Less to Five Years to Ten Years More than Ten Years
-------------------- -------------------- -------------------- --------------------
Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield
--------- -------- --------- -------- --------- -------- --------- --------
Available for sale
securities:
U.S. government and agency
securities $ 13,559 3.65% $ 52,876 3.42% $ 5,308 4.01% $ 2,207 3.59%
Mortgage-backed securities -- -- 3,385 5.61 8,724 4.00 28,817 4.29
Corporate debt securities 2,998 7.83 -- -- -- -- 500 5.13
Obligations of state and
political subdivisions -- -- 999 6.80 -- -- 500 5.67
Tax-exempt securities 70 3.87 280 3.87 210 3.88 -- --
Other debt securities -- -- 50 4.72 25 7.30 -- --
-------- -------- -------- --------
Total debt securities 16,627 4.40 57,590 3.59 14,267 4.00 32,024 4.28
Marketable equity
securities -- -- -- -- -- -- 488 5.34
-------- -------- -------- --------
Total available for sale
securities $ 16,627 4.40% $ 57,590 3.59% $ 14,267 4.00% $ 32,512 4.30%
======== ======== ======== ========
(Dollars in Thousands) Total
--------------------
Weighted
Amortized Average
Cost Yield
--------- --------
Available for sale
securities:
U.S. government and agency
securities $ 73,950 3.51%
Mortgage-backed securities 40,926 4.34
Corporate debt securities 3,498 7.45
Obligations of state and
political subdivisions 1,499 6.42
Tax-exempt securities 560 3.87
Other debt securities 75 5.58
---------
Total debt securities 120,508 3.92
Marketable equity
securities 488 5.34
---------
Total available for sale
securities $ 120,996 3.93%
=========
Deposit Activities and Other Sources of Funds
- ---------------------------------------------
General. Deposits and loan repayments are the major sources of our funds for
lending and other investment purposes. Our primary source of funds are retail
deposit accounts held primarily by individuals and businesses within our market
area. Loan repayments are a relatively stable source of funds, while deposit
inflows and outflows and loan prepayments are significantly influenced by
general interest rates and money market conditions.
Deposit Accounts. Substantially all of the Bank's depositors are residents of
the State of Connecticut. Deposits are attracted from within our market area
through the offering of a broad selection of deposit instruments, including NOW,
money market accounts, regular savings accounts and certificates of deposit. We
also utilize brokered certificates of deposits, which at December 31, 2004
amounted to $5.0 million, as an alternate source of funds. Deposit account terms
vary according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rates offered, among other factors. In
determining the terms of our deposit accounts, we consider the rates offered by
our competition, our liquidity needs, profitability to us, matching deposit and
loan products and customer preferences and concerns. We generally review our
deposit mix and pricing weekly. The Bank's current strategy is to offer
competitive rates, and even higher rates on long-term deposits, but not be the
market leader in every account type and maturity.
We also offer a variety of deposit accounts designed for the businesses
operating in our market area. Our business banking deposit products include a
commercial checking account that provides an earnings credit to offset monthly
service charges and a checking account specifically designed for small business
and nonprofit organizations. Additionally, we offer sweep accounts and money
market accounts for businesses. We have sought to increase our commercial
deposits through the offering of these products, particularly to our commercial
borrowers and to local municipalities.
16
The following table sets forth the deposit activity for the periods indicated,
including mortgagors' and investors' escrow accounts and brokered deposits.
Years Ended December 31,
---------------------------------
(Dollars in Thousands) 2004 2003 2002
--------- --------- ---------
Beginning balance $ 417,311 $ 398,315 $ 363,029
Increase before interest credited 36,833 12,389 26,781
Interest credited 6,336 6,607 8,505
--------- --------- ---------
Net increase in deposits 43,169 18,996 35,286
--------- --------- ---------
Ending balance (1) $ 460,480 $ 417,311 $ 398,315
========= ========= =========
----------
(1) Includes mortgagors' and investors' escrow accounts in the amount of
$2.7 million, $2.2 million and $2.0 million at December 31, 2004,
2003 and 2002, respectively. Includes brokered deposits of $5.0
million at December 31, 2004 and 2003.
The following table sets forth the distribution of the Company's deposit
accounts for the dates indicated.
December 31,
------------------------------------------------------------
(Dollars in Thousands) 2004 2003 2002
------------------------------------------------------------
% of % of % of
Balance Total Balance Total Balance Total
--------- ------ --------- ------ --------- ------
Noninterest-bearing demand
deposits $ 46,049 10.00% $ 40,371 9.67% $ 37,624 9.45%
NOW and money market accounts 110,564 24.01 101,852 24.41 90,516 22.72
Savings accounts (1) 95,310 20.70 89,846 21.53 84,201 21.14
Certificates of deposit (2) 208,557 45.29 185,242 44.39 185,974 46.69
--------- ------ --------- ------ --------- ------
Total deposits $ 460,480 100.00% $ 417,311 100.00% $ 398,315 100.00%
========= ====== ========= ====== ========= ======
- ----------
(1) Includes mortgagors' and investors' escrow accounts in the amount of $2.7
million, $2.2 million and $2.0 million at December 31, 2004, 2003 and
2002, respectively.
(2) Includes brokered deposits of $5.0 million at December 31, 2004 and 2003.
The Company had $51.3 million of certificates of deposit of $100,000 or more
outstanding as of December 31, 2004, maturing as follows:
Weighted Average
(Dollars in Thousands) Amount Rate
-------- ----------------
Maturity Period:
----------------
Three months or less $ 12,637 1.89%
Over three through six months 5,096 2.11
Over six through twelve months 6,443 2.03
Over twelve months 27,130 3.73
--------
Total $ 51,306 2.90%
========
17
The following table presents the amount of certificates of deposit accounts
outstanding by the various rate categories, periods to maturity and percent of
total certificate accounts at December 31, 2004.
Amount Due
--------------------------------------------------------------------------
(Dollars in Thousands) More Than More Than Percent of
More Than Two Years Three Years Total
Less Than One Year to to Three to Four More Than Certificate
One Year Two Years Years Years Four Years Total Accounts
--------- ----------- --------- ----------- ---------- --------- -----------
0.00 - 1.00% $ 1,457 $ -- $ -- $ -- $ -- $ 1,457 0.70%
1.01 - 2.00% 61,621 4,111 109 -- -- 65,841 31.57
2.01 - 3.00% 16,762 20,099 7,105 97 4 44,067 21.13
3.01 - 4.00% 9,200 9,858 32,258 6,878 6,038 64,232 30.80
4.01 - 5.00% 3,379 9,387 5,999 95 1,417 20,277 9.72
5.01 - 6.00% 290 2,053 7,992 4 296 10,635 5.10
6.01 - 7.02% 1,828 140 80 -- -- 2,048 0.98
-------- -------- -------- ------- ------- --------- ------
Total $ 94,537 $ 45,648 $ 53,543 $ 7,074 $ 7,755 $ 208,557 100.00%
======== ======== ======== ======= ======= ========= ======
Borrowings. We utilize advances from the FHLB to supplement our supply of
lendable funds and to meet deposit withdrawal requirements. The FHLB functions
as a central reserve bank providing credit for member financial institutions. As
a member, we are required to own capital stock in the FHLB and are authorized to
apply for advances on the security of such stock and certain of our mortgage
loans and other assets (principally securities which are obligations of, or
guaranteed by, the United States), provided certain standards related to
creditworthiness have been met. Advances are made under several different
programs, each having its own interest rate and range of maturities. Depending
on the program, limitations on the amount of advances are based either on a
fixed percentage of an institution's net worth or on the FHLB's assessment of
the institution's creditworthiness. Under its current credit policies, the FHLB
generally limits advances to 25% of a member's assets, and short-term borrowings
of less than one year may not exceed 10% of the institution's assets. The FHLB
determines specific lines of credit for each member institution.
Advances from the FHLB increased $15.5 million, or 27.1%, for the year ended
December 31, 2004. The new advances, which have longer durations, were obtained
to mitigate interest rate risk by matching the durations of the longer-term
mortgage loans in our portfolio. The increased borrowings were used as a
supplement to deposits to fund asset growth.
Junior Subordinated Debt Owed to Unconsolidated Trust. To a lesser extent, the
Company utilizes the proceeds raised from the issuance of trust preferred
securities. In 2002, SI Capital Trust I (the "Trust"), a business trust formed
by SI Bancorp, MHC (formerly SI Bancorp, Inc.), issued $7.0 million of preferred
securities in a private placement and issued approximately $217,000 of common
securities to SI Bancorp, MHC. The Trust used the proceeds of these issuances to
purchase $7.2 million of SI Bancorp, MHC's floating rate junior subordinated
deferrable interest debentures. The interest rate on the debentures and the
trust preferred securities is variable and adjustable quarterly at 3.70% over
the six-month LIBOR. The interest rate on these securities at December 31, 2004
was 6.0%. A rate cap of 11.00% is effective through April 22, 2007. On September
24, 2004, all of the common stock of SI Capital Trust I was contributed to the
Company from SI Bancorp, MHC, at which point, SI Capital Trust I became a
wholly-owned subsidiary of the Company.
The debentures are the sole assets of SI Capital Trust I and are subordinate to
all of the Company's existing and future obligations for borrowed money, its
obligations under letters of credit and certain derivative contracts and any
guarantees by the Company of any such obligations. The trust preferred
securities generally rank equal to the trust common securities in priority of
payment, but rank before the trust common securities if and so long as the
Company fails to make principal or interest payments on the debentures.
Concurrently with the issuance of the debentures and the trust preferred and
common securities, the Company issued a guarantee related to the trust
securities for the benefit of the holders. SI Bancorp, MHC's obligations under
the guarantee and the Company's obligations under the debentures, the related
indenture and the trust agreement relating to the trust securities,
18
constitute a full and unconditional guarantee by the Company of the obligations
of SI Capital Trust I under the trust preferred securities.
The stated maturity of the debentures is April 22, 2032. In addition, the
debentures are subject to redemption at par at the option of the Company,
subject to prior regulatory approval, in whole or in part on any interest
payment date after April 22, 2007. The debentures are also subject to redemption
before April 22, 2007 at a specified price after the occurrence of certain
events that would either have a negative tax effect on SI Capital Trust I or the
Company or would result in SI Capital Trust I being treated as an investment
company that is required to be registered under the Investment Company Act of
1940. Upon repayment of the debentures at their stated maturity or following
their redemption, the Trust will use the proceeds of such repayment to redeem an
equivalent amount of outstanding trust preferred securities and trust common
securities.
Additionally, the Company occasionally utilizes collateralized borrowings, which
represent loans sold that do not meet the criteria for derecognition, due
primarily to recourse and other provisions that could not be measured at the
date of transfer. Such borrowings are derecognized when all recourse and other
provisions that could not be measured at the time of transfer either expire or
become measurable. The Company had no collateralized borrowings at December 31,
2004.
The following table sets forth information regarding the Company's borrowings at
the dates or for the periods indicated.
At or For the Years Ended December 31,
--------------------------------------
(Dollars in Thousands) 2004 2003 2002
----------- ----------- ----------
Maximum amount of advances outstanding at any month-end during
the period:
FHLB advances $ 72,674 $ 57,168 $ 47,718
Subordinated debt 7,217 7,217 7,217
Other borrowings -- 1,951 1,955
Average balance outstanding during the period:
FHLB advances $ 65,154 $ 46,693 $ 40,618
Subordinated debt 7,217 7,217 4,718
Other borrowings -- 1,233 1,378
Weighted average interest rate during the period:
FHLB advances 4.12% 4.66% 5.28%
Subordinated debt 5.14 4.99 6.38
Other borrowings -- 6.00 6.31
Balance outstanding at end of period:
FHLB advances $ 72,674 $ 57,168 $ 43,918
Subordinated debt 7,217 7,217 7,217
Other borrowings -- -- 1,951
Weighted average interest rate at end of period:
FHLB advances 3.80% 4.29% 4.94%
Subordinated debt 5.92 4.85 5.32
Other borrowings -- -- 6.68
19
Trust Services
- --------------
The Bank's trust department primarily provides trust services to individuals,
partnerships, corporations and institutions and also acts as a fiduciary of
estates and conservatorships as a trustee under various wills, trusts and other
plans. Consistent with our operating strategy, we will continue to emphasize the
growth of our trust service operations to grow assets and increase fee-based
income. We have implemented several policies governing the practices and
procedures of the trust department, including policies relating to maintaining
confidentiality of trust records, investment of trust property, handling
conflicts of interest and maintaining impartiality. At December 31, 2004, the
trust department had assets under administration of $118.4 million, representing
277 accounts, the largest of which totaled $9.6 million, or 8.1%, of the trust
department's total assets. For the year ended December 31, 2004 and 2003, trust
services revenue was $631,000 and $596,000, respectively.
Subsidiary Activities
- ---------------------
The Company has one subsidiary other than the Savings Institute Bank and Trust
Company. In 2002, SI Capital Trust I was established as a statutory trust under
Delaware law as a wholly-owned subsidiary of SI Bancorp, MHC for the purpose of
issuing trust preferred securities. SI Capital Trust I issued trust preferred
securities on April 10, 2002. All of the common stock of SI Capital Trust I was
contributed to the Company from SI Bancorp, MHC on September 24, 2004. At that
point, SI Capital Trust I became a wholly-owned subsidiary of the Company. In
accordance with Financial Accounting Standards Board Interpretation No. 46R,
"Consolidation of Variable Interest Entities," SI Capital Trust I is not
consolidated for financial reporting purposes.
The following are descriptions of the Bank's wholly-owned subsidiaries.
803 Financial Corp. 803 Financial Corp. was established in 1995 as a Connecticut
corporation to maintain an ownership interest in a third-party registered
broker-dealer, Infinex Investments, Inc. Infinex operates offices at the Bank
and offers customers a complete range of nondeposit investment products,
including mutual funds, debt, equity and government securities, retirement
accounts, insurance products and fixed and variable annuities. The Bank receives
a portion of the commissions generated by Infinex from sales to customers. For
the years ended December 31, 2004 and 2003, the Bank received fees of $184,000
and $121,000, respectively, through its relationship with Infinex. Due to a
regulatory restriction on federally-chartered thrifts, on December 31, 2004, 803
Financial Corp. sold its interest in Infinex which was subsequently purchased by
SI Financial Group, Inc. As of December 31, 2004, 803 Financial Corp. has no
other holdings.
SI Realty Company, Inc. SI Realty, established in 1999 as a Connecticut
corporation, holds real estate owned by the Bank, including foreclosure
properties. At December 31, 2004, SI Realty had $225,000 in assets.
SI Mortgage Company. In January 1999, the Bank formed SI Mortgage to manage and
hold loans secured by real property. SI Mortgage qualifies as a "passive
investment company," which exempts it from Connecticut income tax under current
law. Income tax savings to the Bank from the use of a passive investment company
was approximately $92,000 and $190,000 for the years ended December 31, 2004 and
2003, respectively.
Personnel
- ---------
At December 31, 2004, the Company had 165 full-time employees and 35 part-time
employees. None of the Company's employees is represented by a collective
bargaining unit. The Company believes its relationship with its employees is
good.
Risk Factors
- ------------
o Additional public company and annual stock employee compensation and
benefit expenses will reduce the Company's profitability and
stockholders' equity. The Company's noninterest expense is likely to
increase as a result of the financial accounting, legal and various
other additional expenses usually associated with operating as a
public company. The Company also will recognize additional annual
employee compensation and benefit
20
expenses stemming from the shares purchased or granted to employees
and executives under new benefit plans. These additional expenses
will adversely affect the Company's profitability and stockholders'
equity. The Company cannot predict the actual amount of the new
stock-related compensation and benefit expenses because applicable
accounting standards require that they be based on the fair market
value of the shares of common stock at specific points in the
future; however, the Company expects them to be material. The
Company will recognize expenses for its employee stock ownership
plan when shares are committed to be released to participants'
accounts and, assuming implementation of any stock-based benefit
plans following the requisite stockholder approval, will recognize
expenses for restricted stock awards and stock options over the
vesting period of awards made to recipients.
o SI Bancorp, MHC's majority control of the Company's common stock
will enable it to exercise voting control over most matters put to a
vote of shareholders, including preventing a sale, a merger or a
second-step conversion transaction. SI Bancorp, MHC owns a majority
of the Company's common stock and, through its Board of Directors,
will be able to exercise voting control over most matters put to a
vote of shareholders. The same directors and officers who manage the
Company and the Bank also manage SI Bancorp, MHC. As a
federally-chartered mutual holding company, the Board of Directors
of SI Bancorp, MHC must ensure that the interests of depositors of
the Bank are represented and considered in matters put to a vote of
shareholders of the Company. Therefore, the votes cast by SI
Bancorp, MHC may not be in your personal best interests as a
shareholder. For example, SI Bancorp, MHC may exercise its voting
control to prevent a sale or merger transaction in which
shareholders could receive a premium for their shares or to defeat a
shareholder nominee for election to the Board of Directors of the
Company. In addition, SI Bancorp, MHC may exercise its voting
control to prevent a second-step conversion transaction. Preventing
a second-step conversion transaction may result in a lower value of
the Company's stock price than otherwise could be achieved as,
historically, fully-converted institutions trade at higher multiples
than mutual holding companies. The matters as to which shareholders,
other than SI Bancorp, MHC, will be able to exercise voting control
are limited and include any proposal to implement a stock-based
incentive plan.
o Due to the time it will take to deploy the offering proceeds into
higher-yielding assets, the Company expects that its return on
equity initially will decline after the offering. Return on equity,
which equals net income divided by average equity, is a ratio used
by many investors to compare the performance of a particular company
with other companies. Over time, the Company intends to deploy the
net proceeds from the offering, which were initially invested into
investment securities, into higher-yielding assets with the goal of
increasing earnings per share and book value per share, without
assuming undue risk, and achieving a return on equity that is
competitive with other publicly held subsidiaries of mutual holding
companies. This goal could take a number of years to achieve, and
the Company cannot assure you that it will be attained.
Consequently, you should not expect a competitive return on equity
in the near future. Failure to achieve a competitive return on
equity might make an investment in the Company's common stock
unattractive to some investors and might cause the Company's common
stock to trade at lower prices than comparable companies with higher
returns on equity.
o The Company's increased emphasis on commercial lending may expose it
to increased lending risks. At December 31, 2004, $141.3 million, or
31.4%, of the Company's loan portfolio consisted of commercial real
estate and commercial business loans. The Company intends to
continue to emphasize these types of lending. These types of loans
generally expose a lender to greater risk of non-payment and loss
than one- to four-family residential mortgage loans because
repayment of the loans often depends on the successful operation of
the property and the income stream of the borrowers. Such loans
typically involve larger loan balances to single borrowers or groups
of related borrowers compared to one- to four-family residential
mortgage loans. Also, many of the Company's commercial borrowers
have more than one loan outstanding with the Company. Consequently,
an adverse development with respect to one loan or one credit
relationship can expose the Company to a significantly greater risk
of loss compared to an adverse development with respect to a one- to
four-family residential mortgage loan.
21
o The Company's inability to achieve profitability on new branches may
negatively impact its earnings. The Company considers its primary
market area to consist of Hartford, New London, Tolland and Windham
counties. However, the majority of the Company's facilities are
located in and a substantial portion of the Company's business is
derived from Windham county, which has a lower median household
income and a higher unemployment rate than other counties in the
Company's market area and the rest of Connecticut. To address this,
in recent years, the Company has expanded its presence throughout
its market area and the Company intends to pursue further expansion
through the establishment of additional branches in Hartford, New
London, Tolland and Middlesex counties, each of which has more
favorable economic conditions than Windham County. The profitability
of the Company's expansion policy will depend on whether the income
that it generates from the additional branches it establishes will
offset the increased expenses resulting from operating new branches.
The Company expects that it may take a period of time before new
branches can become profitable, especially in areas in which it does
not have an established presence. During this period, operating
these new branches may negatively impact the Company's net income.
o Rising interest rates may hurt the Company's profits. Interest rates
were recently at historically low levels. The recent increase in
interest rates has negatively affected the Company's net interest
income. If interest rates continue to rise, the Company's net
interest income and the value of its assets likely would be reduced
if interest paid on interest-bearing liabilities, such as deposits
and borrowings, increased more quickly than interest received on
interest-earning assets, such as loans and investments. If there is
an increasing interest rate environment, the Company's interest rate
spread and net interest margin could be compressed, which would have
a negative effect on its profitability.
o Strong competition within the Company's market area could hurt the
Company's profits and slow growth. The Company faces intense
competition both in making loans and attracting deposits. This
competition has made it more difficult for the Company to make new
loans and at times has forced the Company to offer higher deposit
rates. Price competition for loans and deposits might result in the
Company earning less on its loans and paying more on its deposits,
which reduces net interest income. As of June 30, 2004, the Company
held 0.79% of the deposits in Hartford, New London, Tolland and
Windham counties in Connecticut, which represented the 14th market
share of deposits out of 37 financial institutions in these
counties. Some of the institutions with which the Company competes
have substantially greater resources and lending limits than the
Company has and may offer services that the Company does not
provide. The Company expects competition to increase in the future
as a result of legislative, regulatory and technological changes and
the continuing trend of consolidation in the financial services
industry. The Company's profitability depends upon its continued
ability to compete successfully in its market area.
o The Company has broad discretion in allocating the proceeds of the
offering. Its failure to effectively utilize such proceeds would
reduce its profitability. The Company contributed approximately 50%
of the net proceeds of the offering to Savings Institute Bank and
Trust Company. It may use the remaining net proceeds to repurchase
common stock, purchase investment securities, finance the
acquisition of other financial institutions or other businesses that
are related to banking or for other general corporate purposes. The
Company used a portion of the net proceeds to fund the purchase by
the employee stock ownership plan of shares in the offering. Savings
Institute Bank and Trust Company may use the proceeds it received to
fund new loans, purchase investment securities, establish or acquire
new branches, acquire financial institutions or other businesses
that are related to banking or for general corporate purposes.
Savings Institute Bank and Trust Company has not allocated specific
amounts of proceeds for any of these purposes and has significant
flexibility in determining how much of the net proceeds it applies
to different uses and the timing of such applications. Its failure
to utilize these funds effectively would reduce its profitability.
o Office of Thrift Supervision policy on remutualization transactions
could prohibit acquisition of the Company, which may adversely
affect its stock price. Current Office of Thrift Supervision
regulations permit a mutual holding company to be acquired by a
mutual institution in a remutualization transaction. The possibility
of a
22
remutualization transaction has recently resulted in a degree of
takeover speculation for mutual holding companies that is reflected
in the per share price of mutual holding companies' common stock.
However, the Office of Thrift Supervision has issued a policy
statement indicating that it views remutualization transactions as
raising significant issues concerning disparate treatment of
minority stockholders and mutual members of the target entity and
raising issues concerning the effect on the mutual members of the
acquiring entity. Under certain circumstances, the Office of Thrift
Supervision intends to give these issues special scrutiny and reject
applications providing for the remutualization of a mutual holding
company unless the applicant can clearly demonstrate that the Office
of Thrift Supervision's concerns are not warranted in the particular
case. Should the Office of Thrift Supervision prohibit or otherwise
restrict these transactions in the future, the Company's per share
stock price may be adversely affected.
o The Company operates in a highly regulated environment and it may be
adversely affected by changes in laws and regulations. The Company
is subject to extensive regulation, supervision and examination by
the Office of Thrift Supervision, the Company's chartering authority
and the Federal Deposit Insurance Corporation, as insurer of the
Bank's deposits. SI Bancorp, MHC, the Company and the Bank are all
subject to regulation and supervision by the Office of Thrift
Supervision. Such regulation and supervision governs the activities
in which an institution and its holding company may engage, and are
intended primarily for the protection of the insurance fund and
depositors. Regulatory authorities have extensive discretion in
their supervisory and enforcement activities, including the
imposition of restrictions on the Company's operations, the
classification of its assets and determination of the level of the
Bank's allowance for loan losses. Any change in such regulation and
oversight, whether in the form of regulatory policy, regulations,
legislation or supervisory action, may have a material impact on the
Company's operations.
REGULATION AND SUPERVISION
- --------------------------
General
- -------
The Bank is subject to extensive regulation, examination and supervision by the
Office of Thrift Supervision, as its primary federal regulator, and the FDIC, as
its deposits insurer. The Bank is a member of the Federal Home Loan Bank System
and its deposit accounts are insured up to applicable limits by the Bank
Insurance Fund managed by the FDIC. The Bank must file reports with the OTS and
the FDIC concerning its activities and financial condition in addition to
obtaining regulatory approvals before entering into certain transactions such as
mergers with, or acquisitions of, other financial institutions. There are
periodic examinations by the OTS and, under certain circumstances, the FDIC, to
evaluate the Bank's safety and soundness and compliance with various regulatory
requirements. This regulatory structure is intended primarily for the protection
of the insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies