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EX-31 - EXHIBIT 31.2 - Newport Bancorp Incex31-2.htm
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EX-32 - EXHIBIT 32.1 - Newport Bancorp Incex32-1.htm
 
 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

OR

o
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: 0-51856
 
Newport Bancorp, Inc.
(Exact name of registrant as specified in its charter)

United States of America
20-4465271
State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
   
100 Bellevue Avenue, Newport, Rhode Island
02840
(Address of principal executive offices)
(Zip Code)
 
 
(401) 847-5500
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý          No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ý          No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  (See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act).

Large accelerated filer o     Accelerated filer o     Non-accelerated filer o     Smaller Reporting Company ý

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

As of August 1, 2011 the registrant had 3,488,777 shares of common stock outstanding.


 
 

 

NEWPORT BANCORP, INC.
Table of Contents

     
Page No.
       
 
1
       
   
1
       
   
2
       
   
3
       
   
4
       
   
5-14
       
 
14-23
       
 
23-24
       
 
24
       
       
 
25
       
 
25
       
 
25
       
 
25
       
Item 4.
(Removed and Reserved)
   
       
 
25
       
 
25
       
   
26


PART I.                      FINANCIAL INFORMATION

Item 1.                        Financial Statements

CONSOLIDATED BALANCE SHEETS
ASSETS
 
   
June 30,
2011
   
December 31,
 2010
 
   
(Unaudited)
(Dollars in thousands, except per share data)
 
             
Cash and due from banks
  $ 18,831     $ 8,194  
Short-term investments
    449       1,181  
Cash and cash equivalents
    19,280       9,375  
                 
Securities held to maturity, at amortized cost
    41,810       47,021  
Federal Home Loan Bank stock, at cost
    5,730       5,730  
 
Loans
    358,862       359,721  
Allowance for loan losses
    (3,687 )     (3,672 )
Loans, net
    355,175       356,049  
 
Premises and equipment
    14,843       14,477  
Accrued interest receivable
    1,418       1,413  
Net deferred tax asset
    2,600       2,600  
Bank-owned life insurance
    10,898       10,705  
Foreclosed real estate
    195       100  
Prepaid FDIC insurance
    828       1,052  
Other assets
    1,133       1,163  
Total assets
  $ 453,910     $ 449,685  
   
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
Deposits
  $ 262,320     $ 261,050  
Short-term borrowings
    -       3,000  
Long-term borrowings
    137,117       132,236  
Accrued expenses and other liabilities
    3,603       3,696  
Total liabilities
    403,040       399,982  
                 
Preferred stock, $.01 par value; 1,000,000 shares authorized;
       none issued
    -       -  
Common stock, $.01 par value; 19,000,000 shares authorized; 4,878,349 shares issued
    49       49  
Additional paid-in capital
    50,615       50,435  
Retained earnings
    19,572       18,832  
Unearned compensation (324,497 and 338,030 shares at
               
    June 30, 2011 and December 31, 2010, respectively)
    (2,617 )     (2,864 )
Treasury stock, at cost (1,389,572 shares)
    (16,749 )     (16,749 )
Total stockholders’ equity
    50,870       49,703  
Total liabilities and stockholders’ equity
  $ 453,910     $ 449,685  

See accompanying notes to unaudited consolidated financial statements.


CONSOLIDATED STATEMENTS OF INCOME

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
(Dollars in thousands, except per share data)
 
                         
Interest and dividend income:
                       
Loans
  $ 4,862     $ 5,008     $ 9,714     $ 10,025  
Securities
    509       616       1,081       1,261  
Other interest-earning assets
    9       3       16       6  
Total interest and dividend income
    5,380       5,627       10,811       11,292  
                                 
Interest expense
                               
Deposits
    477       642       971       1,354  
Short-term borrowings
    -       -       3       -  
Long-term borrowings
    1,147       1,212       2,286       2,499  
Total interest expense
    1,624       1,854       3,260       3,853  
                                 
Net interest income
    3,756       3,773       7,551       7,439  
Provision for loan losses
    207       80       522       394  
                                 
Net interest income, after provision for loan losses
    3,549       3,693       7,029       7,045  
                                 
Non-interest income:
                               
 Customer service fees
    505       497       948       921  
Net gain (loss) on sales of available-for-sale securities
    -       13       -       (204 )
Bank-owned life insurance
    92       101       194       202  
 Miscellaneous
    8       11       17       24  
Total non-interest income
    605       622       1,159       943  
                                 
Non-interest expenses:
                               
Salaries and employee benefits
    1,935       1,964       3,886       3,866  
Occupancy and equipment
    535       458       1,110       949  
Data processing
    366       372       761       749  
Professional fees
    152       117       286       234  
Marketing
    185       306       379       528  
Foreclosed real estate
    20       41       58       41  
FDIC insurance
    106       132       234       244  
Other general and administrative
    200       176       377       372  
Total non-interest expenses
    3,499       3,566       7,091       6,983  
                                 
Income before income taxes
    655       749       1,097       1,005  
                                 
Provision for income taxes
    216       248       357       403  
                                 
Net income
  $ 439     $ 501     $ 740     $ 602  

Weighted-average shares outstanding:
                       
     Basic
    3,314,598       3,520,517       3,311,609       3,571,442  
     Diluted
    3,346,169       3,520,517       3,333,851       3,571,442  
                                 
Earnings per share:
                               
     Basic
  $ .13     $ .14     $ .22     $ .17  
     Diluted
  $ .13     $ .14     $ .22     $ .17  
 
 
See accompanying notes to unaudited consolidated financial statements


   
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands)
 
                                       
Accumulated
       
               
Additional
                     
Other
   
Total
 
   
Common Stock
   
Paid-in
   
Retained
   
Unearned
   
Treasury
   
Comprehensive
   
Stockholders’
 
   
Shares
   
Amount
   
Capital
   
Earnings
   
Compensation
   
Stock
   
Income (Loss)
   
Equity
 
Balance at December 31, 2009
    4,878,349     $ 49     $ 50,504     $ 17,032     $ (3,465 )   $ (12,590 )   $ (139 )   $ 51,391  
Comprehensive income:
                                                               
      Net income
    -       -       -       602       -       -       -       602  
      Net unrealized gain on
      securities available for sale
    -       -       -       -       -       -       205       205  
Total comprehensive income
                                                            807  
Share-based compensation –
   restricted stock
    -       -       -       -       191       -       -       191  
Share-based compensation  – options
    -       -       193       -       -       -       -       193  
Purchase of treasury shares
                                                               
    (191,508 shares)
    -       -       -       -       -       (2,309 )     -       (2,309 )
ESOP shares committed to be
     released (13,009 shares)
    -       -       24       -       131       -       -       155  
Balance at June 30, 2010
    4,878,349     $ 49     $ 50,721     $ 17,634     $ (3,143 )   $ (14,899 )   $ 66     $ 50,428  
Balance at December 31, 2010
    4,878,349     $ 49     $ 50,435     $ 18,832     $ (2,864 )   $ (16,749 )   $ -     $ 49,703  
Comprehensive income:
                                                               
      Net income
    -       -       -       740       -       -       -       740  
Share-based compensation –
   restricted stock
    -       -       -       -       117       -       -       117  
Share-based compensation – options
    -       -       131       -       -       -       -       131  
ESOP shares committed to be
     released (13,009 shares)
    -       -       49       -       130       -       -       179  
Balance at June 30, 2011
    4,878,349     $ 49     $ 50,615     $ 19,572     $ (2,617 )   $ (16,749 )   $ -     $ 50,870  

See accompanying notes to unaudited consolidated financial statements.


CONSOLIDATED STATEMENTS OF CASH FLOWS
   
Six Months Ended
June 30,
 
   
2011
   
2010
 
   
(Unaudited)
(Dollars in thousands)
 
Cash flows from operating activities:
 
Net income
  $ 740     $ 602  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    522       394  
Accretion of securities
    (81 )     (79 )
Net loss on sales of  securities available for sale
    -       204  
Amortization of net deferred loan fees
    (149 )     (144 )
Depreciation and amortization of premises and equipment
    396       438  
Share-based compensation and ESOP allocation
    427       539  
Deferred income tax benefit
    -       (108 )
Income from bank-owned life insurance
    (194 )     (202 )
Amortization of prepaid FDIC insurance
    224       219  
Net change in:
               
Accrued interest receivable
    (5 )     52  
Other assets
    31       574  
Accrued expenses and other liabilities
    (93 )     (317 )
Net cash provided by operating activities
    1,818       2,172  
                 
Cash flows from investing activities:
 
Sales of securities available for sale
    -       4,999  
Purchases of securities held to maturity
    -       (5,975 )
Reinvested dividends on mutual funds
    -       (8 )
Principal payments received on securities held to maturity
    5,292       5,781  
Net loan principal payments
    236       3,019  
Proceeds from sales of foreclosed real estate
    170       -  
Additions to premises and equipment
    (762 )     (372 )
Net cash provided by investing activities
    4,936       7,444  
                 
Cash flows from financing activities:
               
Net increase (decrease) in deposits
    1,270       (584 )
Net decrease in borrowings with maturities of three months or less
    (3,000 )     -  
Proceeds from borrowings with maturities in excess of three months
    10,500       3,000  
Repayment of borrowings with maturities in excess of three months
    (5,619 )     (9,615 )
Purchase of treasury stock
    -       (2,309 )
Net cash provided (used) by financing activities
    3,151       (9,508 )
                 
Net change in cash and cash equivalents
    9,905       108  
Cash and cash equivalents at beginning of period
    9,375       19,368  
Cash and cash equivalents at end of period
  $ 19,280     $ 19,476  
                 
Supplementary information:
               
Interest paid on deposit accounts
  $ 1,059     $ 1,389  
Interest paid on borrowings
    2,301       2,533  
 Income taxes paid, net of refunds
    503       686  
Transfers from loans to foreclosed real estate
    265       -  
                 
See accompanying notes to unaudited consolidated financial statements.


 NEWPORT BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 – BASIS OF PRESENTATION

The accompanying unaudited consolidated interim financial statements include the accounts of Newport Bancorp, Inc. (the “Company”), its wholly-owned subsidiary, Newport Federal Savings Bank (the “Bank” or “Newport Federal”) and the Bank’s wholly-owned subsidiary, Newport Federal Investments, Inc.  These financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.

In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included.  The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Newport Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2010.  The results for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

NOTE 2 – EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS

In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-05, Comprehensive Income (Topic 220) Presentation of Comprehensive Income.  This ASU amends the disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the statement of changes in stockholder’s equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Early application is permitted. There will be no impact to the consolidated financial results as the amendments relate only to changes in financial statement presentation.

In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310), A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  This Update provides additional guidance and clarification to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring (“TDR”).  The measurement of impairment will be done prospectively in the period of adoption for loans that are newly identified as TDRs upon adoption of this Update.  In addition, the TDR disclosures required by ASU 2010-20, Receivables (Topic 310), Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses will be provided beginning in the period of adoption of this Update.  The Company will adopt this Update on July 1, 2011 and does not expect the Update to have a material impact on its consolidated financial statements.

 In April 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860), Reconsideration of Effective Control for Repurchase Agreements.  This Update provides additional guidance which affects all entities that enter into agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity.  The amendment removes from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion.  The amendment is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  The amendment is not expected to have a significant impact on the Company’s consolidated financial statements.




NOTE 3 –SECURITIES

The amortized cost and estimated fair value of securities, with gross unrealized gains and losses, follows:
 
                         
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
   
(Dollars in thousands)
 
June 30, 2011
                       
                         
    Government-sponsored enterprise
                       
       residential mortgage-backed securities
  $ 41,810     $ 2,491     $ -     $ 44,301  
                                 
December 31, 2010
                               
                                 
    Government-sponsored enterprise
                               
       residential mortgage-backed securities
  $ 47,021     $ 2,300     $ (7 )   $ 49,314  
 
At June 30, 2011 and December 31, 2010, certain mortgage-backed securities were pledged to secure repurchase agreements (see Note 8).

Information pertaining to securities with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

   
Less Than Twelve Months
   
Over Twelve Months
 
   
Gross
         
Gross
       
   
Unrealized
   
Fair
   
Unrealized
   
Fair
 
   
Losses
   
Value
   
Losses
   
Value
 
   
(Dollars in thousands)
 
December 31, 2010
                       
                         
    Government-sponsored enterprise
                       
       residential mortgage-backed securities
  $ 7     $ 9,785     $ -     $ -  



NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES

The following is a summary of the balances of loans at June 30, 2011 and December 31, 2010:

   
June 30,
   
December 31,
 
   
2011
   
2010
 
   
(Dollars in thousands)
 
Mortgage loans:
           
   Residential:
           
      One-to-four family residential
  $ 206,583     $ 203,893  
      Multi-family residential
    20,050       22,540  
      Equity loans and lines of credit
    21,452       23,112  
   Commercial
    104,658       104,531  
   Construction
    5,733       4,948  
      358,476       359,024  
Commercial loans
    1,295       1,638  
Consumer loans
    287       288  
                     Total loans
    360,058       360,950  
                 
Less:  Allowance for loan losses
    (3,687 )     (3,672 )
           Net deferred loan fees
    (1,196 )     (1,229 )
                 
                     Loans, net
  $ 355,175     $ 356,049  
                 









The following table provides further information pertaining to the allowance for loan losses and impaired loans:

   
Residential
   
Commercial
                         
   
Mortgages
   
Mortgages
   
Construction
   
Commercial
   
Consumer
   
Total
 
   
(Dollars in thousands)
 
                                     
Three months ending June 30, 2011
                                   
Allowance for loan losses:
                                   
Balance at March 31, 2011
  $ 1,616     $ 1,984     $ 99     $ 23     $ 4     $ 3,726  
     Provision for loans losses
    (2 )     213       (2 )     (2 )     -       207  
     Loans charged-off
    (60 )     (186 )     -       -       -       (246 )
Balance at June 30, 2011
  $ 1,554     $ 2,011     $ 97     $ 21     $ 4     $ 3,687  
                                                 
Six months ending June 30, 2011
                                               
Allowance for loan losses:
                                               
Balance at December 31, 2010
  $ 1,578     $ 1,976     $ 89     $ 25     $ 4     $ 3,672  
     Provision for loans losses
    39       479       8       (4 )     -       522  
     Loans charged-off
    (63 )     (444 )     -       -       -       (507 )
Balance at June 30, 2011
  $ 1,554     $ 2,011     $ 97     $ 21     $ 4     $ 3,687  
                                                 
June 30, 2011
                                               
                                                 
Amount of allowance for  loan losses
                                               
   for loans deemed to be impaired
  $ -     $ -     $ -     $ -     $ -     $ -  
                                                 
Amount of allowance for  loan losses
                                               
   for loans not deemed to be impaired
    1,554       2,011       97       21       4       3,687  
                                                 
Recorded investment in:
                                               
    Loans deemed to be impaired
    1,108       -       -       -       -       1,108  
                                                 
    Loans deemed not to be impaired
    248,064       103,571       5,733       1,295       287       358,950  
                                                 
Total unpaid principal
                                               
   balance of impaired loans
    71       1,273       -       -       -       1,344  
                                                 
                                                 
December 31, 2010
                                               
                                                 
Amount of allowance for  loan losses
                                               
   for loans deemed to be impaired
  $ -     $ -     $ -     $ -     $ -     $ -  
                                                 
Amount of allowance for  loan losses
                                               
   for loans not deemed to be impaired
    1,578       1,976       89       25       4       3,672  
                                                 
Loans deemed to be impaired
    108       -       -       -       -       108  
                                                 
Loans deemed not to be impaired
    249,437       104,531       4,948       1,638       288       360,842  






The following is a summary of past due and non-accrual loans at June 30, 2011 and December 31, 2010:

   
30-59 Days
   
60-89 Days
   
Greater than
   
Total
   
Loans on
 
   
Past Due
   
Past Due
   
90 Days
   
Past Due
   
Non-accrual
 
June 30, 2011
 
(Dollars in thousands)
 
                               
Residential mortgages:
                             
     One-to-four family
  $ 746     $ 35     $ -     $ 781     $ -  
     Multi-family
    244       229       858       1,331       1,087  
     Equity loans and lines of credit
    -       -       21       21       21  
Commercial mortgages
    459       468       -       927       -  
Construction
    -       -       -       -       -  
Commercial
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
          Total
  $ 1,449     $ 732     $ 879     $ 3,060     $ 1,108  
                                         
December 31, 2010
                                       
                                         
Residential mortgages:
                                       
     One-to-four family
  $ 220     $ -     $ 108     $ 328     $ 108  
     Multi-family
    -       -       -       -       -  
     Equity loans and lines of credit
    -       -       -       -       -  
Commercial mortgages
    618       -       -       618       -  
Construction
    -       -       -       -       -  
Commercial
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
          Total
  $ 838     $ -     $ 108     $ 946     $ 108  
                                         
 
At June 30, 2011 and December 31, 2010, there were no additional funds committed to be advanced in connection with impaired loans.  For the quarters ended June 30, 2011 and June 30, 2010, the average recorded investment in impaired loans amounted to $567,000 and $1.2 million, respectively.  For the six months ended June 30, 2011 and June 30, 2010, the average recorded investment in impaired loans amounted to $430,000 and $1.1 million, respectively. For the three months ended June 30, 2011 and June 30, 2010, the Company recognized $5,000 and $4,000 of interest income on impaired loans, respectively.  The Company recognized $22,000 and $5,000 of interest income on impaired loans during the first six months of 2011 and 2010, respectively.  At June 30, 2011 and December 31, 2010, there were no loans greater than ninety days past due and still accruing interest.

Credit Quality Information:

The Company utilizes a nine grade internal loan rating system for multi-family mortgages, commercial mortgages, construction mortgages and commercial loans as follows:

Loans rated 1 – 4: Loans in these categories are considered “pass” rated loans with low to average risk.

Loans rated 5: Loans in this category are considered “watch” loans.  Loans classified as watch are pass rated loans that management is monitoring more closely but remain acceptable credit.
 
Loans rated 6: Loans in this category are considered “special mention.”  These loans are starting to show signs of potential weakness and are being closely monitored by management.




Loans rated 7: Loans in this category are considered “substandard.”  Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged.  There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.

Loans rated 8: Loans in this category are considered “doubtful.”  Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.

Loans rated 9: Loans in this category are considered uncollectible (“loss”) and of such little value that their continuance as loans is not warranted.

On a quarterly basis, or more often if needed, the Company formally reviews the ratings on all multi-family residential real estate, commercial real estate, construction and commercial loans. Annually, the Company engages an independent third-party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its review process.

Information pertaining to the Company’s loans by risk rating follows:

 
   
Multi-family
   
Commercial
         
Commercial
       
   
Mortgages
   
Mortgages
   
Construction
   
Loans
   
Total
 
   
(Dollars in thousands)
       
June 30, 2011
                             
                               
Loans rated 1 - 4
  $ 14,821     $ 76,966     $ 1,285     $ 1,084     $ 94,156  
Loans rated 5
    1,580       14,117       4,448       159       20,304  
Loans rated 6
    2,317       10,491       -       52       12,860  
Loans rated 7
    1,332       3,084       -       -       4,416  
Loans rated 8
    -       -       -       -       -  
Loans rated 9
    -       -       -       -       -  
    $ 20,050     $ 104,658     $ 5,733     $ 1,295     $ 131,736  
                                         
December 31, 2010
                                       
                                         
Loans rated 1 - 4
  $ 18,271     $ 80,961     $ 1,168     $ 1,577     $ 101,977  
Loans rated 5
    2,053       13,103       3,382       -       18,538  
Loans rated 6
    2,216       7,355       398       61       10,030  
Loans rated 7
    -       3,112       -       -       3,112  
Loans rated 8
    -       -       -       -       -  
Loans rated 9
    -       -       -       -       -  
    $ 22,540     $ 104,531     $ 4,948     $ 1,638     $ 133,657  
                                         
 
The Company utilizes a rating scale of pass, special mention, substandard or doubtful for one-to-four family mortgages and equity loans and lines of credit.  On a quarterly basis, or more often if needed, the Company reviews the ratings of these loans and makes adjustments as deemed necessary.  At June 30, 2011, one home equity loan was rated substandard and amounted to $21,000.  At December 31, 2010, one residential mortgage loan was rated substandard and amounted to $92,000.  All other residential real estate and equity loans and lines of credit were classified as pass at June 30, 2011 and December 31, 2010.








NOTE 5 – COMMITMENTS

Outstanding loan commitments totaled $24.3 million at June 30, 2011, as compared to $23.8 million as of December 31, 2010.  Loan commitments consist of commitments to originate new loans as well as the outstanding unused portions of lines of credit. 

On June 4, 2011, the Bank entered into a purchase and sales agreement to sell the 2 Wilder Avenue, Westerly, Rhode Island property, which has a net carrying value of $441,000 at June 30, 2011, for $460,000.

NOTE 6 – EARNINGS PER SHARE

Basic earnings per share (“EPS”) represents net income available to common stockholders divided by the weighted-average number of shares of common stock outstanding during the period.  If rights to dividends on unvested options/awards are non-forfeitable, these unvested awards/options are considered outstanding in the computation of basic earnings per share.  Diluted EPS reflects additional common shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents (stock options and unvested restricted stock) were issued during the period.  Treasury shares and unallocated ESOP shares are not deemed outstanding for earnings per share calculations.

Earnings per common share have been computed based on the following:
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
                         
Net income applicable to common stock
  $ 439     $ 501     $ 740     $ 602  
                                 
Weighted average number of common shares issued
    4,878       4,878       4,878       4,878  
Less:  Weighted average treasury shares
    (1,390 )     (1,197 )     (1,390 )     (1,143 )
Less:  Weighted average unallocated ESOP shares
    (250 )     (276 )     (254 )     (280 )
Add:  Weighted average unvested restricted stock plan shares
                               
   with non-forfeitable dividend rights
    77       116       78       116  
Weighted average number of common shares outstanding
                               
   used to calculate basic earnings per common share
    3,315       3,521       3,312       3,571  
                                 
Effect of dilutive common stock equivalents
    31       -       22       -  
Weighted average number of common shares outstanding
                               
   used to calculate diluted earnings per common share
    3,346       3,521       3,334       3,571  
                                 
 
    Options for 456,264 and 465,591 shares of common stock were not included in the computation of diluted EPS because they were anti-dilutive for the three and six month periods ended June 30, 2011, respectively.  Options for 487,834 shares of common stock were not included in the computation of diluted EPS because they were anti-dilutive for the three and six month periods ended June 30, 2010.

NOTE 7 – FAIR VALUES OF ASSETS AND LIABILITIES

The Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.



Level 2 – Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.  For example, Level 2 assets and liabilities may include debt securities with quoted prices that are traded less frequently than exchange-traded instruments or mortgage loans held for sale, for which the fair value is based on what the securitization market is currently offering for mortgage loans with similar characteristics.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The following methods and assumptions were used by the Company in estimating fair value disclosures:

Cash and cash equivalents:  The carrying amounts of cash and cash equivalents approximate fair values.

Securities held to maturity:  Fair values are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.

FHLB stock:  The carrying value of Federal Home Loan Bank of Boston (“FHLB”) stock approximates fair value based on the redemption provisions of the FHLB.

Loans:  For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  Fair values for other loans are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms, adjusted for credit risk.

Accrued interest:  The carrying amounts of accrued interest approximate fair values.

Deposits:  The fair values for non-certificate accounts are, by definition, equal to the amount payable on demand at the reporting date which is the carrying amount.  Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Short-term borrowings:  The carrying amounts of short-term borrowings approximate fair value.

Long-term borrowings:  Fair values of long-term debt are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.

Off-balance-sheet instruments:  Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  The estimated fair values of off-balance-sheet instruments are immaterial.

Assets Measured at Fair Value

There were no assets or liabilities measured at fair value on a recurring basis at June 30, 2011 and December 31, 2010. The Company does not measure any liabilities at fair value on a non-recurring basis.






Assets measured at fair value on a non-recurring basis are summarized below:

                     
Total Losses
 
                     
Three Months Ended
   
Six Months Ended
 
                     
June 30,
   
June 30,
 
   
Level 1
   
Level 2
   
Level 3
   
2011
   
2010
   
2011
   
2010
 
   
(Dollars in thousands)
 
June 30, 2011
                                         
                                           
Impaired loans
  $ -     $ -     $ 1,108     $ 246     $ 25     $ 507     $ 335  
Foreclosed real estate
    -       -       195       -       -       -       -  
    $ -     $ -     $ 1,303     $ 246     $ 25     $ 507     $ 335  
                                                         
December 31, 2010
                                                       
                                                         
Foreclosed real estate
  $ -     $ -     $ 100                                  
                                                         

Losses applicable to impaired loans are based on the appraisal value of the underlying collateral, less selling costs and adjusted for management’s estimates of changes in market conditions since the appraisal date.

Summary of Fair Value of Financial Instruments

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows.  Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements.  Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.
 
   
June 30,
   
December 31,
 
   
2011
   
2010
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
   
(Dollars in thousands)
 
                         
Financial assets:
                       
   Cash and cash equivalents
  $ 19,280     $ 19,280     $ 9,375     $ 9,375  
   Securities held to maturity
    41,810       44,301       47,021       49,314  
   FHLB stock
    5,730       5,730       5,730       5,730  
   Loans, net
    355,175       367,449       356,049       364,968  
   Accrued interest receivable
    1,418       1,418       1,413       1,413  
                                 
Financial liabilities:
                               
   Deposits
    262,320       263,116       261,050       261,851  
   Short-term borrowings
    -       -       3,000       3,000  
   Long-term borrowings
    137,117       138,867       132,236       133,866  
   Accrued interest payable
    435       435       535       535  
                                 
NOTE 8 – SECURED BORROWINGS AND ASSETS PLEDGED AS COLLATERAL

FHLB borrowings at June 30, 2011 and December 31, 2010 amounted to $97,117,000 and $95,236,000, respectively.  All FHLB borrowings are secured by a blanket lien on certain qualified collateral, defined principally as 75% of the carrying value of first mortgage loans on owner-occupied residential property, 50% of the carrying value of certain pledged commercial mortgages and 65% of the carrying value of certain pledged multi-family real estate loans.  At June 30, 2011 and December 31, 2010, the carrying amount of assets qualifying as collateral for FHLB advances amounted to $205,360,000 and $204,031,000, respectively.




During 2008, the Company entered into a repurchase agreement for $15,000,000 at a rate of 2.58%.  This agreement matures in November 2013 and is callable on a quarterly basis.
 
During 2007, the Company entered into a repurchase agreement for $25,000,000 at a rate of 3.36%, subject to adjustment if 3-month LIBOR exceeds 5.05%.  In November 2009 the rate became fixed at 3.36%.  This agreement matures in November 2012 and is callable on a quarterly basis.

The amounts of securities collateralizing these repurchase agreements are classified as securities held to maturity and the obligation to repurchase securities sold is reflected as a liability in the consolidated balance sheets.  Government-sponsored enterprise residential mortgage-backed securities pledged to secure these agreements have a carrying value of $41.8 million and $47.0 million and a fair value of $44.3 million and $49.3 million at June 30, 2011 and December 31, 2010, respectively.  These mortgage-backed securities are held-to-maturity and cannot be sold until the liability that they are pledged against has been paid. In addition, the Company has $2.0 million in cash pledged as collateral to secure these agreements at June 30, 2011.  There was no cash pledged at December 31, 2010.

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Management’s discussion and analysis of the financial condition and results of operations at June 30, 2011 and for the three and six months ended June 30, 2011 and 2010 is intended to assist in understanding the financial condition and results of operations of the Company.  The information contained in this section should be read in conjunction with the unaudited consolidated financial statements and the notes thereto, appearing in Part I, Item 1 of this quarterly report on Form 10-Q.

Forward-Looking Statements

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company.  These forward-looking statements are generally identified by 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 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 U.S. government, including policies of the U.S. 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.  Additional factors are discussed in the Company’s 2010 Annual Report on Form 10-K under “Item 1A – Risk Factors.”  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
 
Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assessments by management, and which could potentially result in materially different results under different assumptions and conditions. As discussed in the Company’s 2010 Annual Report on Form 10-K, the Company considers the allowance for loan losses and the valuation of the net deferred tax asset to be our critical accounting policies. The Company’s critical accounting policies have not changed since December 31, 2010.


Comparison of Financial Condition at June 30, 2011 and December 31, 2010

 Total assets at June 30, 2011 were $453.9 million, an increase of $4.2 million compared to $449.7 million at December 31, 2010.  The increase in assets was primarily concentrated in cash and cash equivalents, partially offset by a decrease in securities and a decrease in net loans.

Cash and cash equivalents increased by $9.9 million, or 105.7%, due to principal payments received on mortgage-backed securities and an increase in deposits and borrowings.  Securities held to maturity decreased by $5.2 million, or 11.1%.

The net loan portfolio decreased by $874,000, or 0.2%, during the first six months of 2011.  The loan portfolio decrease was attributable to a decrease in home equity loans and lines (a decrease of $1.7 million, or 7.2%) and a decrease in commercial loans (a decrease of $343,000, or 20.9%), partially offset by an increase in construction loans (an increase of $785,000, or 15.9%), residential mortgages (an increase of $200,000 or 0.1%) and commercial real estate mortgages (an increase of $127,000, or 0.1%).

During the six months ended June 30, 2011, deposit balances increased by $1.3 million, or 0.5%. The increase in deposits occurred in NOW/Demand accounts (an increase of $1.4 million, or 1.2%), savings accounts (an increase of $1.1 million, or 3.8%) and time deposit accounts (an increase of $561,000 or 0.8%), partially offset by a decrease in money market accounts (a decrease of $1.8 million, or 3.5%).

Borrowings, consisting of FHLB advances and two repurchase agreements totaling $40.0 million, increased $1.9 million, or 1.4%, to $137.1 million at June 30, 2011, compared to an outstanding balance of $135.2 million at December 31, 2010.

Total stockholders’ equity at June 30, 2011 was $50.9 million compared to $49.7 million at December 31, 2010.  The increase was primarily attributable to net income and stock-based compensation credits.

Comparison of Operating Results for the Three and Six Months Ended June 30, 2011 and 2010

 General.  Net income decreased by $62,000, or 12.4%, to $439,000 for the three months ended June 30, 2011, compared to $501,000 for the three months ended June 30, 2010.  The decrease was primarily due to an increase in the provision for loan losses, partially offset by a decrease in non-interest expenses.
 
Net income increased by $138,000, or 22.9%, to $740,000 for the six months ended June 30, 2011, compared to $602,000 for the six months ended June 30, 2010.  The increase was primarily due to an increase in net interest income and non-interest income, partially offset by an increase in the provision for loan losses and non-interest expenses.

Net Interest Income.  Net interest income for the three months ended June 30, 2011 and June 30, 2010 was $3.8 million.  Net interest income remained relatively the same between the two periods, as a decrease in interest expense on deposits and borrowings was offset by a decrease in the interest earned on loans and securities.  The Company’s second quarter 2011 interest rate spread increased to 3.51% from 3.45% in the second quarter of 2010, an increase of 6 basis points.

Net interest income for the six months ended June 30, 2011 was $7.6 million, which was $112,000, or 1.5%, more than net interest income of $7.4 million for the six months ended June 30, 2010.  The increase was primarily due to a decrease in interest expense on deposits and borrowings, partially offset by a decrease in the interest earned on loans and securities.  For the six months ended June 30, 2011, the interest rate spread increased to 3.51% from 3.36% in 2010, an increase of 15 basis points.





The following table summarizes average balances and average yields and costs for the three months ended June 30, 2011 and 2010.

   
Three Months Ended June 30,
 
   
2011
   
2010
 
   
Average
Balance
   
Interest
and Dividends
   
Yield/
Cost
   
Average
Balance
 
Interest
and Dividends
 
Yield/
Cost
 
   
(Dollars in thousands)
 
Assets:
                                   
Interest-earning assets:
                                   
   Loans
  $ 356,096     $ 4,862       5.46 %   $ 348,966     $ 5,008       5.74 %
   Securities
    42,895       509       4.75       48,455       616       5.09  
   Other interest-earning assets
    6,097       9       0.59       11,478       3       0.10  
     Total interest-earning assets
    405,088       5,380       5.31       408,899       5,627       5.50  
                                                 
   Bank-owned life insurance
    10,837                       10,454                  
   Noninterest-earning assets
    36,073                       29,996                  
     Total assets
  $ 451,998                     $ 449,349                  
                                                 
Liabilities and equity:
                                               
Interest-bearing liabilities:
                                               
   Interest-bearing demand deposits
  $ 71,993       128       0.71     $ 74,139       226       1.22  
   Savings accounts
    30,492       13       0.17       27,728       14       0.20  
   Money market accounts
    52,155       93       0.71       48,357       130       1.08  
   Certificates of deposit
    69,711       243       1.39       75,059       272       1.45  
     Total interest-bearing deposits
    224,351       477       0.85       225,283       642       1.14  
                                                 
   Borrowings
    136,006       1,147       3.37       136,329       1,212       3.56  
     Total interest-bearing liabilities
    360,357       1,624       1.80       361,612       1,854       2.05  
                                                 
   Demand deposits
    36,831                       33,467                  
   Noninterest-bearing liabilities
    3,941                       3,414                  
     Total liabilities
    401,129                       398,493                  
                                                 
   Stockholders’ equity
    50,869                       50,856                  
     Total liabilities and stockholders’
        equity
  $ 451,998                     $ 449,349                  
                                                 
   Net interest income
          $ 3,756                     $ 3,773          
   Interest rate spread
                    3. 51 %                     3.45 %
   Net interest margin
                    3.71 %                     3.69 %
   Average interest-earning assets to
     average interest-bearing liabilities
                    112.41 %                     113.08 %

Total interest and dividend income decreased $247,000, or 4.4%, between the two periods due to a decrease in interest earned on loans and securities.  Interest earned on loans decreased $146,000, or 2.9%, for the three months ended June 30, 2011 due to a decrease in the yield earned on loans.  The average balance of loans increased 0.2% to $356.1 million for the three months ended June 30, 2011 from $349.0 million for the three months ended June 30, 2010, while the yield earned on loans decreased to 5.46% for the three months ended June 30, 2011 from 5.74% for the three months ended June 30, 2010.  Interest earned on securities decreased $107,000 due to the decrease in the average balance of securities to $42.9 million for the three months ended June 30, 2011 from $48.5 million for the three months ended June 30, 2010, in addition to the 34 basis points decrease in the average yield earned on securities.  Interest earned on other-interest earning assets increased to $9,000 for three months ended June 30, 2011 from $3,000 for the three months ended June 30, 2010 due to the increase in the average yield to 0.59% from 0.10%, despite the decrease in the average balance.





Total interest expense decreased $230,000 to $1.6 million for the three months ended June 30, 2011 from $1.9 million for the three months ended June 30, 2010, primarily due to a 25 basis point decrease in the total average cost of interest-bearing liabilities, including a 29 basis point decrease in the total average cost of interest-bearing deposits.  The largest reductions in interest expense related to interest-bearing deposits were seen in demand deposit accounts (a decrease of $98,000 or 51 basis points in the average cost), money market accounts (a decrease of $37,000 or 37 basis points in the average cost) and certificate of deposit accounts (a decrease of $29,000 or 6 basis points in the average cost).  With decreases in short-term market interest rates, customers have increasingly shown a preference for our higher-yielding core accounts, rather than the longer-term time deposit accounts.  The cost of total borrowings decreased 5.4% to $1.1 million for the three months ended June 30, 2011 from $1.2 million for the three months ended June 30, 2010, due to a decrease in the average cost to 3.37% from 3.56% and a slight decrease in the average balance of $323,000 to $136.0 million from $136.3 million.




The following table summarizes average balances and average yields and costs for the six months ended June 30, 2011 and 2010.

   
Six Months Ended June 30,
 
   
2011
   
2010
 
   
Average
Balance
   
Interest
and Dividends
   
Yield/
Cost
   
Average
Balance
 
Interest
and Dividends
 
Yield/
Cost
 
   
(Dollars in thousands)
 
Assets:
                                   
Interest-earning assets:
                                   
   Loans
  $ 356,215     $ 9,714       5.45 %   $ 349,753     $ 10,025       5.73 %
   Securities
    44,180       1,081       4.89       50,985       1,261       4.95  
   Other interest-earning assets
    6,159       16       0.52       11,012       6       0.11  
     Total interest-earning assets
    406,554       10,811       5.32       411,750       11,292       5.48  
                                                 
   Bank-owned life insurance
    10,791                       10,404                  
   Noninterest-earning assets
    34,335                       29,931                  
     Total assets
  $ 451,680                     $ 452,085                  
                                                 
Liabilities and equity:
                                               
Interest-bearing liabilities:
                                               
   Interest-bearing demand deposits
  $ 72,293       267       0.74     $ 72,945       484       1.33  
   Savings accounts
    30,021       28       0.19       27,075       31       0.23  
   Money market accounts
    52,443       195       0.74       48,464       263       1.09  
   Certificates of deposit
    69,540       481       1.38       75,755       576       1.52  
     Total interest-bearing deposits
    224,297       971       0.87       224,239       1,354       1.21  
                                                 
   Borrowings
    136,387       2,289       3.36       139,410       2,499       3.59  
     Total interest-bearing liabilities
    360,684       3,260       1.81       363,649       3,853       2.12  
                                                 
   Demand deposits
    36,507                       33,588                  
   Noninterest-bearing liabilities
    3,871                       3,623                  
     Total liabilities
    401,062                       400,860                  
                                                 
   Stockholders’ equity
    50,618                       51,225                  
     Total liabilities and stockholders’
        equity
  $ 451,680                     $ 452,085                  
                                                 
   Net interest income
          $ 7,551                     $ 7,439          
   Interest rate spread
                    3.51 %                     3.36 %
   Net interest margin
                    3.71 %                     3.61 %
   Average interest-earning assets to
     average interest-bearing liabilities
                    112.72 %                     113.23 %
 
Total interest and dividend income decreased $481,000, or 4.3%, between the two periods due to a decrease in interest earned on loans and securities.  Interest earned on loans decreased $311,000, or 3.1%, for the six months ended June 30, 2011 due to a 28 basis point decrease in the yield earned on loans, while the average balance of loans increased 1.8% to $356.2 million for the six months ended June 30, 2011 from $349.8 million for the six months ended June 30, 2010.  Interest earned on securities decreased $180,000, due to a 6 basis point decrease in the average yield and a $6.8 million decrease in the average balance of securities to $44.2 million for the six months ended June 30, 2011 compared to $51.0 million for the six months ended June 30, 2010.



Total interest expense decreased $593,000 to $3.3 million for the six months ended June 30, 2011 from $3.9 million for the six months ended June 30, 2010, primarily due to a 31 basis point decrease in the total average cost of interest-bearing liabilities, including a 34 basis point decrease in the total average cost of interest-bearing deposits.  The largest reductions in interest expense related to interest-bearing deposits were seen in demand deposit accounts (a decrease of $217,000 or 59 basis points in the average cost), certificate of deposit accounts (a decrease of $95,000 or 14 basis points in the average cost) and money market accounts (a decrease of $68,000 or 35 basis points in the average cost).  With decreases in short-term market interest rates, customers have increasingly shown a preference for our higher-yielding core accounts, rather than the longer-term time deposit accounts.  The cost of total borrowings decreased 8.4% to $2.3 million for the six months ended June 30, 2011 from $2.5 million for the six months ended June 30, 2010, due to a decrease in the average cost to 3.36% from 3.59%, and a decrease in the average balance of $3.0 million to $136.4 million from $139.4 million.



Rate/Volume Analysis.  The following table sets forth the effects of changing rates and volumes on our net interest income.  The rate column shows the effects attributable to changes in rates (changes in rate multiplied by prior volume).  The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate).  Changes due to both volume and rate have been allocated proportionately to the volume and rate changes.  The net column represents the sum of the prior columns.
 
   
For the Three Months Ended June 30, 2011
Compared to the
Three Months Ended June 30, 2010
 
   
Increase (Decrease)
Due to
 
   
Volume
   
Rate
   
Net
 
   
(Dollars in thousands)
 
Interest Income:
                 
   Loans
  $ 533     $ (679 )   $ (146 )
   Securities
    (68 )     (39 )     (107 )
   Other interest-earning assets
    (10 )     16       6  
   Total interest-earning assets
    455       (702 )     (247 )
                         
Interest Expense:
                       
   Deposits
    (3 )     (162 )     (165 )
   Borrowings
    (3 )     (62 )     (65 )
   Total interest-bearing liabilities
    (6 )     (224 )     (230 )
   Change in net interest income
  $ 461     $ (478 )   $ (17 )

   
For the Six Months Ended June 30, 2011
Compared to the
Six Months Ended June 30, 2010
 
   
Increase (Decrease)
Due to
 
   
Volume
   
Rate
   
Net
 
   
(Dollars in thousands)
 
Interest Income:
                 
   Loans
  $ 451     $ (762 )   $ (311 )
   Securities
    (167 )     (13 )     (180 )
   Other interest-earning assets
    (8 )     18       10  
   Total interest-earning assets
    276       (757 )     (481 )
                         
Interest Expense:
                       
   Deposits
    1       (384 )     (383 )
   Borrowings
    (53 )     (157 )     (210 )
   Total interest-bearing liabilities
    (52 )     (541 )     (593 )
   Change in net interest income
  $ 328     $ (216 )   $ 112  





Provision for Loan Losses.  The Bank’s management reviews the level of the allowance for loan losses on a quarterly basis and establishes the provision for loan losses based upon the volume and types of lending, delinquency levels, loss experience, the amount of impaired and classified loans, economic conditions and other factors related to the collectability of the loan portfolio.  The Company’s loan loss provision for the three months ended June 30, 2011 was $207,000 compared to $80,000 the three months ended June 30, 2010.  The Company’s loan loss provision for the six months ended June 30, 2011 was $522,000 compared to $394,000 for the six months ended June 30, 2010. 

At June 30, 2011 there were $17.3 million of classified and criticized loans.  At June 30, 2011, loans classified as special mention totaled $12.9 million, which consisted primarily of commercial and multi-family residential mortgages, compared to $10.0 million at December 31, 2010.  This increase in special mention loans is due to concerns about the local commercial real estate market. Loans classified as substandard, including all impaired loans, totaled $4.4 million at June 30, 2011, compared to $3.2 million at December 31, 2010. Total classified and criticized loans represent 4.8% of the Company’s total gross loans at June 30, 2011, compared to 4.0% at June 30, 2010.

There were no changes in the methodology of calculating the allowance for loan losses from the first six months of 2010 through the first six months of 2011. The percentages used to calculate the required reserves for non-classified residential mortgages, multi-family and commercial real estate mortgages, consumer loans, and construction loans, were consistent for the periods. The percentages used to calculate the required reserves for residential home equity lines and loans and substandard loans were higher in the six months ended June 30, 2011, when compared to the same period in 2010, due to an increase in the trend of charge-offs and delinquencies, which resulted in a higher loan loss provision during the 2011 period.  The allowance for loan losses to total loans was 1.03%, 1.02% and 1.00% at June 30, 2011, December 31, 2010 and June 30, 2010, respectively. The ratio increased slightly from December 31, 2010 to June 30, 2011 due to the increase in the total classified and criticized loans that, although currently performing, represent increased risk, due to deteriorating economic conditions.  The Company has no exposure to subprime loans in its loan portfolio.

The following table provides information with respect to our non-performing assets at the dates indicated.  There were no troubled debt restructurings or accruing loans past due 90 days or more at the dates indicated. All nonaccrual loans are impaired.  There were no impaired loans which required a valuation reserve at the dates indicated.

   
June 30,
   
December 31,
   
June 30,
 
   
2011
   
2010
   
2010
 
   
(Dollars in thousands)
 
Nonaccrual loans:
                 
  Real estate – mortgage:
                 
     One-to-four family
  $ -     $ 108     $ 255  
     Multi-family
    1,087       -       -  
     Commercial
    -       -       835  
     Home equity loans and lines of credit
    21       -       43  
     Total nonaccrual loans
    1,108       108       1,133  
   Foreclosed real estate
    195       100       225  
     Total non-performing assets
  $ 1,303     $ 208     $ 1,358  
Total non-performing loans to total loans
    0.31 %     0.03 %     0.32 %
Total non-performing loans to total assets
    0.24 %     0.02 %     0.25 %
Total non-performing assets to total assets
    0.29 %     0.05 %     0.30 %

Nonaccrual loans were $1.1 million at June 30, 2011, an increase of $1.0 million, from December 31, 2010.  There were $1.1 million of nonaccrual loans at June 30, 2010.  Nonaccrual loans have increased in the first six months of 2011 as the deterioration in general economic conditions continues, including decreased real estate values, which have resulted in significant challenges for some commercial borrowers.



At June 30, 2011, the Company had two commercial real estate properties, valued at $195,000, classified as foreclosed real estate.  Charge-offs through the allowance for loan losses totaling $246,000 were recognized during the quarter ended June 30, 2011 on nonaccrual loans.  Charge-offs through the allowance for loan losses totaling $507,000 were recognized year to date for nonaccrual loans and on loans transferred to foreclosed real estate.

Non-interest Income.  Non-interest income for the three months ended June 30, 2011 totaled $605,000, a decrease of $17,000, or 2.7%, compared to $622,000 for the three months ended June 30, 2010.   The decrease in non-interest income for the quarter ended June 30, 2011 from the quarter ended June 30, 2010 is largely attributable to the $13,000 gain on sale of securities available for sale in the second quarter of 2010.

Non-interest income for the first six months of 2011 totaled $1.2 million, an increase of $216,000, or 22.9%, compared to the first six months of 2010.  The increase in non-interest income for the six months ended June 30, 2011 when compared to the same period in 2010 is due to a $27,000 increase in fees earned on checking accounts and no loss on sales of securities available for sale recorded in the first half of 2011, as compared to the $204,000 net realized loss on sales of securities available for sale recorded in 2010.  The loss on sales of securities available for sale in the first six months of 2010 was due to the sale of the Bank’s entire holdings in one mutual fund, which resulted in a $267,000 realized loss, partially offset by gains on sales of other securities available for sale.
 
Non-interest Expense.  Non-interest expenses totaled $3.5 million for the quarter ended June 30, 2011 compared to $3.6 million for the quarter ended and June 30, 2010.  The $121,000 decrease in marketing expenditures in the second quarter of 2011 is the primary reason for the decrease in non-interest expenses.

For the six months ended June 30, 2011, non-interest expenses totaled $7.1 million, an increase of $108,000, or 1.5%, compared to the same period in 2010. The increase in non-interest expenses for the first six months of 2011 when compared to the first six months of 2010 is attributable to increases in salaries and employee benefits, occupancy and equipment expense, data processing fees, professional fees and foreclosed real estate, offset by decreases in marketing costs and FDIC insurance costs.  The $20,000 increase in salaries and benefits is primarily due to an increase in retirement and incentive compensation expenses, partially offset by a reduction in the stock-based compensation expense associated with option grants and restricted stock awards.  The accelerated method of expense recognition was adopted at the inception of the equity incentive plan on October 1, 2007, resulting in a higher stock-based compensation expense in the 2010 period compared to the 2011 period.  The $161,000 increase in occupancy and equipment expense and $12,000 increase in data processing fees were due to the overall increase in operating costs and an increase in depreciation expense in 2011 as a result of a relocation of an existing branch in the beginning of 2011.  The $17,000 increase in the foreclosed real estate expense is a result of an overall increase in foreclosed real estate assets. The $149,000 decrease in marketing costs is due to management’s concerted effort to curtail marketing expenditures in 2011.

Income Taxes. The provision for income taxes for the three months ended June 30, 2011 was $216,000 compared to $248,000 for the three months ended June 30, 2010.  The decrease in the tax provision is due to lower income before taxes of $655,000 for the three months ended June 30, 2011, compared to net income before income taxes of $749,000 for the three months ended June 30, 2010.  The effective tax rate for the second quarter of 2011 was 33.0%, versus 33.1% for the 2010 period.

The provision for income taxes for the six months ended June 30, 2011 was $357,000, compared to $403,000 for the six months ended June 30, 2010.   The effective tax rate for the six month period of 2011 was 32.5%, versus 40.1% for the 2010 period.  The higher effective tax rate for the 2010 period was a result of the increase in the valuation reserve to offset the tax benefit associated with the loss on sales of securities available for sale.

Liquidity Management.  Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the Federal Home Loan Bank of Boston.  While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.



We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy.

Our most liquid assets are cash and cash equivalents and interest-bearing deposits.  The levels of these assets depend on our operating, financing, lending and investing activities during any given period.  At June 30, 2011, cash and cash equivalents totaled $19.3 million.  On June 30, 2011, we had $97.1 million of borrowings outstanding with the Federal Home Loan Bank of Boston and we had the ability to borrow an additional $47.3 million from the Federal Home Loan Bank of Boston.

At June 30, 2011, we had $24.3 million in loan commitments outstanding, which consisted of $1.3 million of real estate loan commitments, $15.3 million in unused home equity lines of credit, $3.9 million in construction loan commitments and $3.8 million in commercial lines of credit commitments.  Certificates of deposit due within one year of June 30, 2011 totaled $49.4 million, or 70.3% of certificates of deposit.  This percentage of certificates of deposit that mature within one year reflects customers’ hesitancy to invest their funds for long periods in the recent interest rate environment.  If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings.  Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before June 30, 2011.  We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us.  We have the ability to attract and retain deposits by adjusting the interest rates offered.

Capital Management. At June 30, 2011, Newport Federal was subject to various regulatory capital requirements administered by the Office of Thrift Supervision, (Office of the Comptroller of the Currency, effective July 21, 2011), including a risk-based capital measure.  The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.  At June 30, 2011, we exceeded all of our regulatory capital requirements.  We are considered “well capitalized” under regulatory guidelines.

Off-Balance Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our consolidated financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.

For the three months ended June 30, 2011, we did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

Item 3.   Quantitative and Qualitative Disclosures About Market Risk.

Qualitative Aspects of Market Risk.  The Company’s most significant form of market risk is interest rate risk.  We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment.  Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits.  As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings.  To reduce the potential volatility of our earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread.  Our strategy for managing interest rate risk emphasizes:  adjusting the maturities of borrowings; adjusting the investment portfolio mix and duration; and periodically selling fixed-rate mortgage loans and available-for-sale investment securities.

We have an Asset Liability Management Committee to communicate, coordinate and control all aspects involving asset/liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.




Quantitative Aspects of Market Risk.   We use an interest rate sensitivity analysis prepared by the Office of Thrift Supervision to review our level of interest rate risk.  This analysis measures interest rate risk by computing changes in net portfolio value of our cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates.  Net portfolio value represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items.  This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 300 basis point increase or 100 basis point decrease in market interest rates with no effect given to any steps that we might take to counter the effect of that interest rate movement.  We measure interest rate risk by modeling the changes in net portfolio value over a variety of interest rate scenarios.

The following table presents the change in our net portfolio value at March 31, 2011 (the most current information available), that would occur in the event of an immediate change in interest rates based on Office of Thrift Supervision assumptions, with no effect given to any steps that we might take to counteract that change. The Bank expects that its net portfolio value at June 30, 2011 is consistent with the table below.

   
Net Portfolio Value
(Dollars in thousands)
 
Net Portfolio Value as % of
Portfolio Value of Assets
Basis Point (“bp”)
Change in Rates
 
Amount
   
Change
   
% Change
 
NPV Ratio
   
Change (bp)
     
 
                         
  300     $ 30,278     $ -22,526       -43       6.99 %     -424  
  200       38,728       -14,076       -27       8.69 %     -254  
  100       46,555       -6,248       -12       10.15 %     -108  
  50       49,834       -2,970       -6       10.73 %     -50  
  0       52,804       0       0       11.23 %     0  
  (50 )     54,407       1,603       3       11.46 %     23  
  (100 )     55,428       2,624       5       11.59 %     35  

The Office of Thrift Supervision uses certain assumptions in assessing the interest rate risk of savings associations.  These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others.  As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates.  Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset.  Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.

Item 4.    Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”).  Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.  In addition, no change in the Company’s internal control over financial reporting occurred during the quarter ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


PART II.
OTHER INFORMATION

Item 1.
Legal Proceedings.

From time to time, we may be party to various legal proceedings incident to our business.  At June 30, 2011, we were not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

Item 1A.
Risk Factors.

Risk factors that may affect future results were discussed in the Company’s 2010 Annual Report on Form 10-K.  The Company’s evaluation of its risk factors has not changed materially since December 31, 2010.

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

 
a)
Not applicable
 
b)
Not applicable
 
c)
The Company did not repurchase any shares of its common stock during the quarter ended June 30, 2011.

Item 3.
Defaults Upon Senior Securities.

Not applicable

Item 5.
Other Information.

None.


Item 6.
Exhibits.

 
31.1
Rule 13a-14(a)/15d-14(c) Certification of Chief Executive Officer*

 
31.2
Rule 13a-14(a)/15d-14(c) Certification of Chief Financial Officer*

 
32.1
Section 1350 Certifications*

 
101
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets  as of June 30, 2011 and December 31, 2010, (ii) the Consolidated Statements of Income for the three and six months ended June 30, 2011 and 2010, (iii) the Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2011 and 2010, (iv) the Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010, and (v) the notes to the Consolidated Financial Statements.*

 
*
This information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

 
 
 
 
 

Signatures

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

 
Newport Bancorp, Inc.
     
     
     
Date:  August 12, 2011
By:
/s/ Kevin M. McCarthy
   
Kevin M. McCarthy
   
President and Chief Executive Officer
     
     
     
Date:  August 12, 2011
By:
/s/ Bruce A. Walsh
   
Bruce A. Walsh
   
Senior Vice President and Chief Financial Officer
   
 (Principal Financial and Chief Accounting Officer)
     



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