U. S. SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C. 20549
-------------------
F O R M 10 - QSB
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the Quarterly Period Ended March 31, 2004
Commission file number 0-49784
SOUTHERN CONNECTICUT BANCORP, INC.
(Name of Small Business Issuer as Specified in Its Charter)
Connecticut 06-1594123
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
215 Church Street
New Haven, Connecticut 06510
(Address of Principal Executive Offices)
(203) 782-1100
--------------
(Issuer's Telephone Number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months, and (2) has been
subject to such filing requirements for the past 90 days. YES [X] No [ ]
The number of shares of the issuer's Common Stock, par value $.01 per share,
outstanding as of April 26, 2004: 1,068,864
---------
Transitional Small Business Disclosure Format
Yes No X
--- ---
1
Table of Contents
Part I
Financial Information
Page
Item 1. Financial Statements
Consolidated Balance Sheets as of
March 31, 2004 (unaudited) and December 31, 2003 3
Consolidated Statements of Operations
for the three months ended March 31, 2004
and 2003 (unaudited) 4
Consolidated Statements of Changes in
Shareholders' Equity for the three months ended
March 31, 2004 and 2003 (unaudited) 5
Consolidated Statements of Cash Flows for the three months ended
March 31, 2004 and 2003 (unaudited) 6 - 7
Notes to Consolidated Financial Statements (unaudited) 8
Item 2. Management's Discussion and Analysis or Plan of Operation 14
Item 3. Controls and Procedures 25
Part II
Other Information
Item 1. Legal Proceedings 27
Item 2. Changes in Securities and Small Business Issuer Purchases of
Equity Securities 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 30
Exhibit Index 31
2
PART I
Financial Information
Item 1. Financial Statements
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
March 31, 2004 (unaudited) and December 31, 2003
2004 2003
------------ ------------
Assets
Cash and due from banks $ 688,864 $ 1,147,883
Federal funds sold 4,350,000 966,000
Short-term investments 2,707,493 454,115
------------ ------------
Cash and cash equivalents 7,746,357 2,567,998
------------ ------------
Available for sale securities 7,319,300 8,478,068
Federal Home Loan Bank Stock 21,500 21,500
Loans receivable (net of allowance for loan losses of
$452,958 in 2004 and $421,144 in 2003) 45,747,641 40,818,718
Accrued interest receivable 222,560 196,545
Premises and equipment, net 3,421,814 3,459,915
Other real estate owned 116,513 -
Other assets 898,817 843,296
------------ ------------
Total assets $ 65,494,502 $ 56,386,040
============ ============
Liabilities and Stockholders' Equity
Liabilities
Deposits
Noninterest bearing deposits $ 13,060,917 $ 13,781,286
Interest bearing deposits 42,584,172 33,492,589
------------ ------------
Total deposits 55,645,089 47,273,875
Repurchase agreements 874,610 339,752
Accrued expenses and other liabilities 197,659 267,232
Capital lease obligations 1,190,668 1,190,879
------------ ------------
Total liabilities 57,908,026 49,071,738
------------ ------------
Commitments and Contingencies - -
Stockholders' Equity
Preferred stock, no par value; 500,000 shares authorized;
none issued
Common stock, par value $.01; 5,000,000, shares authorized;
shares issued and outstanding: 2004 1,068,864; 2003 1,063,320 10,689 10,633
Additional paid-in capital 10,764,693 10,704,269
Accumulated deficit (3,065,130) (3,100,842)
Accumulated other comprehensive loss - net unrealized
loss on available for sale securities (123,776) (299,758)
------------ ------------
Total stockholders' equity 7,586,476 7,314,302
------------ ------------
Total liabilities and stockholders' equity $ 65,494,502 $ 56,386,040
============ ============
See Notes to Consolidated Financial Statements.
3
SOUTHERN CONNECTICUT BANCORP,INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 2004 and 2003 (unaudited)
Three Months Ended
March 31
-------------------------
2004 2003
------------ ----------
Interest Income
Interest and fees on loans $ 815,211 $ 414,797
Interest on securities 47,849 81,929
Interest on federal funds sold and short-term investments 9,715 5,949
-------------------------
Total interest income 872,775 502,675
-------------------------
Interest Expense
Interest on deposits 152,336 92,464
Interest on capital lease obligations 42,572 41,958
Interest on repurchase agreements 2,102 802
-------------------------
Total interest expense 197,010 135,224
-------------------------
Net interest income 675,765 367,451
Provision for Loan Losses 31,750 62,900
-------------------------
Net interest income after
provision for loan losses 644,015 304,551
-------------------------
Noninterest Income:
Service charges and fees 57,611 20,217
Gains and fees from sales and referrals of SBA loans 131,834 -
Gains (losses) on sales of available for sale securities (944) 39,505
Other noninterest income 24,274 19,455
-------------------------
Total noninterest income 212,775 79,177
-------------------------
Noninterest Expense
Salaries and benefits 459,290 296,633
Occupancy and equipment 125,929 74,584
Professional services 61,766 65,642
Data processing and other outside services 69,229 39,010
Advertising and promotional expense 11,194 19,184
Forms, printing and supplies 15,814 12,179
Other operating expenses 77,856 60,679
-------------------------
Total noninterest expenses 821,078 567,911
-------------------------
Net income (loss) $ 35,712 $(184,183)
=========================
Basic Income (Loss) per Share $ 0.03 $ (0.17)
=========================
Diluted Income (Loss) per Share $ 0.03 $ (0.17)
=========================
Dividends per Share $ - $ -
=========================
See Notes to Consolidated Financial Statements.
4
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the Three Months
ended March 31, 2004 and 2003 (unaudited)
Accumulated
Additional Other
Number Common Paid-in Accumulated Comprehensive
of Shares Stock Capital Deficit Income (Loss) Total
------------------------------------------------------------------------------------
Balance December 31, 2002 966,667 $ 9,667 $10,705,382 $(2,502,915) $ 62,545 $ 8,274,679
Comprehensive Loss:
Net Loss - - - (184,183) - (184,183)
Unrealized holding loss on available
for sale securities - - - - (60,113) (60,113)
------------
Total comprehensive loss (244,296)
------------------------------------------------------------------------------------
Balance March 31, 2003 966,667 $ 9,667 $10,705,382 $(2,687,098) $ 2,432 $ 8,030,383
====================================================================================
Balance December 31, 2003 1,063,320 $ 10,633 $10,704,269 $(3,100,842) $ (299,758) $ 7,314,302
Comprehensive Income:
Net Income - - - 35,712 - 35,712
Unrealized holding gain on available
for sale securities - - - - 175,982 175,982
------------
Total comprehensive income 211,694
Exercise of stock warrants 5,544 56 60,424 60,480
------------------------------------------------------------------------------------
Balance March 31, 2004 1,068,864 $ 10,689 $10,764,693 $(3,065,130) $ (123,776) $ 7,586,476
====================================================================================
See Notes to Consolidated Financial Statements.
5
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2004 and 2003 (unaudited) Three Months Ended
March 31,
----------------------------
Cash Flows From Operations 2004 2003
----------- -----------
Net Income (loss) $ 35,712 $ (184,183)
Adjustments to reconcile net income (loss) to net cash used in
operating activities
Amortization and accretion of premiums and discounts on investments, net 14,663 49,377
Provision for loan losses 31,750 62,900
Loss (Gain) on sales of available for sale securities 944 (39,505)
Gains on sales of SBA loans (125,986) -
Depreciation and amortization 70,543 40,651
Increase in cash surrender value of life insurance (3,061)
Changes in assets and liabilities
Increase in deferred loan fees 8,262 8,645
(Increase) decrease in accrued interest receivable (26,015) 19,299
(Increase) decrease in other assets (52,460) 13,475
Decrease in accrued expenses and other liabilities (69,573) (33,710)
------------------------------
Net cash used in operating activities (115,221) (63,051)
------------------------------
Cash Flows From Investing Activities
Purchases of available for sale securities - (2,524,661)
Principal repayments on available for sale securities 319,768 -
Proceeds from maturities of available for sale securities - 2,491,452
Proceeds from sales of available for sale securities 999,375 2,553,000
Purchases of Federal Home Loan Bank Stock - (21,000)
Proceeds from sales of SBA loans 1,256,593 -
Net increase in loans receivable (6,216,055) (5,235,317)
Purchases of premises and equipment (32,442) (110,774)
------------------------------
Net cash used in investing activities (3,672,761) (2,847,300)
------------------------------
Cash Flows From Financing Activities
Net increase in demand, savings and money market deposits 3,581,539 7,503,889
Net increase in certificates of deposit 4,789,675 39,874
Increase in repurchase agreements 534,858 (456,733)
Principal payments on capital lease obligations (211) -
------------------------------
Net cash provided by financing activities 8,905,861 7,087,030
------------------------------
Cash Flows from Equity Transactions
Exercise of stock warrants 60,480 -
------------------------------
Net increase in cash and cash equivalents 5,178,359 4,176,679
Cash and cash equivalents
Beginning 2,567,998 3,051,429
------------------------------
Ending $ 7,746,357 $ 7,228,108
==============================
See Notes to Consolidated Financial Statements.
6
SOUTHERN CONNECTICUT BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the Three Months Ended March 31, 2004 and 2003 (unaudited)
Three Months Ended
March 31,
---------------------
2004 2003
-------- ---------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $184,512 $131,776
=======================
Income taxes $ - $ -
=======================
Supplemental disclosures of noncash investing activities
Transfer of Loans to OREO $116,513 $ -
=======================
See Notes to Consolidated Financial Statements.
7
Southern Connecticut Bancorp, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
Note 1. Nature of Operations
Southern Connecticut Bancorp, Inc. ("Bancorp"), a Connecticut
corporation, is a bank holding company incorporated on November 8, 2000 for the
purpose of forming, and becoming the sole shareholder of, The Bank of Southern
Connecticut (the "Bank"). The Bank provides a full range of banking services to
commercial and consumer customers, primarily concentrated in the New Haven
County area of Connecticut, through its main office in New Haven, Connecticut
and two branch offices in New Haven and Branford, Connecticut. In 2003, SCB
Capital Inc. was formed as a Connecticut Corporation, and in April 2004 Bancorp
capitalized SCB Capital, Inc., which became a subsidary of the Company. SCB
Capital, Inc. will engage in a limited range of investment banking, advisory,
and brokerage services, primarily with small to medium size business clients.
Note 2. Basis of Financial Statement Presentation
The consolidated balance sheet at December 31, 2003 has been derived
from the audited consolidated financial statements of Bancorp at that date, but
does not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements.
The accompanying consolidated unaudited financial statements as of and
for the three months ended March 31, 2004 and 2003 and related notes have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC"). Accordingly, certain information and note disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been omitted.
The accompanying consolidated financial statements and notes thereto should be
read in conjunction with the audited financial statements of Bancorp and notes
thereto as of December 31, 2003.
Certain 2003 amounts have been reclassified to conform with the 2004
presentation. Such reclassifications had no effect on the 2003 net loss.
The accompanying unaudited consolidated financial information reflects,
in the opinion of management, all adjustments, consisting of normal recurring
accruals, necessary for a fair presentation of the interim periods presented.
The results of operations for the three months ended March 31, 2004 are not
necessarily indicative of the results of operations that may be expected for all
of 2004.
Note 3. Available for Sale Securities
The amortized cost, gross unrealized gains, gross unrealized losses and
approximate fair values of available for sale securities at March 31, 2004, and
December 31, 2003 are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2004 Cost Gains Losses Value
-------------- ------------------------------------------------------------
U.S. Government Agency Obligations $6,199,476 $ 155 $ (97,916) $ 6,101,715
Mortgage Backed Securities 1,243,600 - (26,015) 1,217,585
------------------------------------------------------------
$7,443,076 $ 155 $(123,931) $ 7,319,300
============================================================
8
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2003 Cost Gains Losses Value
----------------- ------------------------------------------------------------
U.S. Government Agency Obligations $7,200,948 $ - $(269,550) $ 6,931,398
Mortgage Backed Securities 1,576,878 - (30,208) 1,546,670
------------------------------------------------------------
$8,777,826 $ - $(299,758) $ 8,478,068
============================================================
Note 4. Loans Receivable
A summary of Bancorp's loan portfolio at March 31, 2004 and December 31, 2003 is
as follows:
March 31, 2004 December 31, 2003
--------------- -----------------
Commercial loans secured by real estate $ 20,543,115 $ 18,043,588
Commercial loans 22,017,633 18,584,292
Construction and land loans, net of undisbursed
portion of $986,476 in 2004 and $729,220 in 2003 619,860 1,500,891
Residential mortgages 847,366 948,258
Consumer home equity loans 1,059,164 1,042,717
Consumer installment loans 1,206,527 1,204,920
------------- -------------
Total loans 46,293,665 41,324,666
Net deferred loan fees (93,066) (84,804)
Allowance for loan losses (452,958) (421,144)
------------- -------------
Loans receivable, net $ 45,747,641 $ 40,818,718
============= =============
Note 5. Deposits
At March 31, 2004 and December 31, 2003, deposits consisted of the following:
March 31, 2004 December 31, 2003
-------------- -----------------
Noninterest bearing deposits $13,060,917 $13,781,286
----------- -----------
Interest bearing deposits
Checking 6,240,911 3,499,378
Money Market 18,924,147 17,251,327
Savings 2,520,896 2,633,341
----------- -----------
Checking, money market & savings 27,685,954 23,384,046
----------- -----------
Time Certificates under $100,000 3,009,617 3,057,294
Time Certificates of $100,000 or more 11,888,601 7,051,249
----------- -----------
Time deposits 14,898,218 10,108,543
----------- -----------
42,584,172 33,492,589
----------- -----------
Total deposits $55,645,089 $47,273,875
=========== ===========
9
Note 6. Available Borrowings
During 2003 Bancorp obtained secured and unsecured lines of credit with
other financial institutions with total available borrowings of $4,400,000.
There are no borrowings against these lines of credit as of March 31, 2004.
Note 7. Income (Loss) Per Share
Bancorp is required to present basic income (loss) per share and
diluted income (loss) per share in its statements of operations. Basic per share
amounts are computed by dividing net income (loss) by the weighted average
number of common shares outstanding. Diluted per share amounts assume exercise
of all potential common stock in weighted average shares outstanding, unless the
effect is antidilutive. Bancorp is also required to provide a reconciliation of
the numerator and denominator used in the computation of both basic and diluted
income per share. The following is information about the computation of income
per share for the three months ended March 31, 2004 and 2003.
Three Months Ended March 31, 2004
Amount
Net Income Shares Per Share
---------------- ---------------- ----------------
Basic Income Per Share
Income available to common shareholders $ 35,712 1,064,599 $ 0.03
Effect of Dilutive Securities
Warrants/Stock Options outstanding - 61,936 -
---------------- ---------------- ----------------
Diluted Income Per Share
Income available to common shareholders
plus assumed conversions $ 35,712 1,126,535 $ 0.03
================ ================ ================
____________________
Weighted average shares outstanding for the three months ended March
31, 2003 were 1,063,320. For the three months ended March 31, 2003, common stock
equivalents have been excluded from the computation of the net loss per share
because the inclusion of such equivalents is antidilutive.
10
Note 8. Other Comprehensive Income
Other comprehensive income, which is comprised solely of the change in
unrealized gains and losses on available for sale securities, is as follows:
Three Months Ended
March 31, 2004
----------------------------------------------
Before-Tax Net-of-Tax
Amount Taxes Amount
----------------------------------------------
Unrealized holding gains arising during the period $ 175,038 $ - $ 175,038
Add: Reclassification adjustment for losses
recognized in net income 944 - 944
---------------------------------------------
Unrealized holding gain on available for sale
securities, net of taxes $ 175,982 $ - $ 175,982
=============================================
Three Months Ended
March 31, 2003
----------------------------------------------
Before-Tax Net-of-Tax
Amount Taxes Amount
----------------------------------------------
Unrealized holding losses arising during the period $ (58,961) $ 22,966 $ (35,995)
Less: Reclassification adjustment for gains
recognized in net income (39,505) 15,387 (24,118)
---------------------------------------------
Unrealized holding loss on available for sale
securities, net of taxes $ (98,466) $ 38,353 $ (60,113)
=============================================
Note 9. Stock Based Compensation
During the three months ended March 31, 2004, Bancorp granted 9,450
stock options to employees and directors at an exercise price of $9.50 per
share.
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting
for Stock-Based Compensation", encourages all entities to adopt a fair value
based method of accounting for employee stock compensation plans, whereby
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date (or other measurement date) over the
amount an employee must pay to acquire the stock. Stock options issued to
employees and directors under Bancorp's stock option and warrant plans have no
intrinsic value at the grant date, and under Opinion No. 25 no compensation cost
is recognized for them. Bancorp has elected to continue with the accounting
methodology in Opinion No. 25 and, as a result, has provided pro forma
disclosures of net loss and earnings per share and other disclosures, as if the
fair value based method of accounting had been applied.
Had compensation cost for issuance of such options and warrants been
recognized based on the fair values of awards on the grant dates, in accordance
with the method described in SFAS No. 123, reported net income (loss) and per
share amounts for the three months ended March 31, 2004 and 2003 would have
differed from the pro forma amounts as shown below:
11
For the three months ended March 31, 2004 and March 31, 2003
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
------------------------- -------------------
Net income (loss) as reported $ 35,712 $ (184,813)
Deduct: total stock based employee
compensation expense determined under fair value based
method for all awards (81,428) (32,968)
------------------------- -------------------
Pro forma net loss $ (45,716) $ (217,781)
========================= ===================
Basic income (loss) per share:
As reported $ 0.03 $ (0.17)
========================= ===================
Pro forma $ (0.04) $ (0.20)
========================= ===================
Diluted income (loss) per share:
As reported $ 0.03 $ (0.17)
========================= ===================
Pro forma $ (0.04) $ (0.20)
========================= ===================
Note 10. Bank Application and Capital Raising
During 2003, Bancorp's Board of Directors approved the establishment of
a new commercial bank in New London, Connecticut and Bancorp plans to raise
between $10 million and $15 million in capital through a public offering of its
common stock to fund the establishment of the new bank and for other corporate
purposes. In October 2003, Bancorp submitted its final application to the State
of Connecticut Department of Banking related to the establishment of the new
bank. On April 28, 2004, the State of Connecticut Department of Banking issued a
temporary certificate of authority in connection with this application. Subject
to applicable Federal agency regulatory approval and the issuance of a final
certificate of authority, and the successful raising of capital, Bancorp plans
to open the new bank in the fourth quarter of 2004 or the first quarter of 2005.
Note 11. Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, Bancorp is a party to financial
instruments with off-balance-sheet risk to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amounts recognized in the financial statements. The contractual amounts
of these instruments reflect the extent of involvement Bancorp has in particular
classes of financial instruments.
The contractual amounts of commitments to extend credit represent the
amounts of potential accounting loss should: the contract be fully drawn upon;
the customer default; and the value of any existing collateral become worthless.
Bancorp uses the came credit policies in making commitments and conditional
obligations as it does for on-balance-sheet and evaluates each customer's
creditworthiness on a case-by-case basis. Management believes that Bancorp
controls the credit risk of these financial instruments through credit
approvals, credit limits, monitoring procedures and the receipt of collateral as
deemed necessary.
12
Financial instruments whose contract amounts represent credit risk are as
follows at March 31, 2004 and December 31 2003:
March 31, December 31,
2004 2003
--------------------------------
Commitments to extend credit
Future Loan Commitments $ 5,378,000 $ 3,752,000
Unused Line of Credit 6,560,791 9,065,661
Undisbursed construction loans 986,476 729,220
Financial standby letters of credit 933,055 933,055
-------------------------------
$13,858,322 $14,479,936
===============================
Commitments to extend credit are agreements to lend to a customer
as long as there is no violation of any condition established in the contract.
Commitments to extend credit generally have fixed expiration dates or other
termination clauses and may require payment of a fee by the borrower. Since
these commitments could expire without being drawn upon, the total commitment
amounts do not necessarily represent future cash requirements. The amount of
collateral obtained, if deemed necessary by Bancorp upon extension of credit, is
based upon management's credit evaluation of the counter party. Collateral held
varies, but may include residential and commercial property, deposits and
securities.
Standby letters of credit are written commitments issued by
Bancorp to guarantee the performance of a customer to a third party. The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. Newly issued or modified
guarantees that are not derivative contracts have been recorded on Bancorp's
books at their fair value at inception. The liability related to guarantees
recorded at March 31, 2004 and December 31, 2003 was not significant.
13
Item 2. Management's Discussion and Analysis or Plan of Operation
(a) Plan of Operation
Southern Connecticut Bancorp
Bancorp, a Connecticut corporation, was incorporated on November 8,
2000 to serve as a bank holding company. Bancorp is a bank holding company
registered in accordance with the Bank Holding Company Act of 1956, as amended
(the "BHC Act") and is regulated by and subject to the supervision of the Board
of Governors of the Federal Reserve System ("Federal Reserve Board"). Bancorp
owns one hundred percent of the capital stock of The Bank of Southern
Connecticut ("Bank"), a Connecticut chartered bank headquartered in New Haven,
Connecticut. The Bank commenced operations on October 1, 2001 after receiving
its Final Certificate of Authority from the Connecticut Banking Commissioner and
its deposit insurance from the Federal Deposit Insurance Corporation ("FDIC").
Bancorp invested $10,000,000 of the net proceeds of its July 26, 2001 stock
offering to purchase the capital stock of the Bank and an additional $360,000 to
cover the Bank's pre-opening deficit. The $10,000,000 of initial equity capital
for the Bank, that was required under the Bank's Temporary Certificate of
Authority, substantially exceeded the statutory minimum equity capital for a new
Connecticut bank of $5,000,000.
Bancorp's holding company structure provides organizational flexibility
for its growth plans. Bancorp may in the future decide to engage in additional
businesses permitted to bank holding companies and would form a subsidiary to
provide these services. For example, Bancorp could acquire additional banks,
establish de novo banks and other businesses, including mortgage companies,
leasing companies, insurance agencies and small business investment companies,
without having to go through a corporate reorganization. Before Bancorp could
acquire interests in other banks, establish de novo banks or expand into other
businesses, it will need to obtain relevant regulatory approvals.
De novo banks in Connecticut have reached profitability on average
within three to four years after the commencement of operations. Bancorp was
marginally profitable in the fourth quarter of 2003, the ninth quarter of
operations, as well as profitable in the first quarter of 2004. The two recent
profitable quarters are largely attributable to fee income and gains on sale
derived from referrals and sales of SBA guaranteed loan participations.
Bancorp's plan of operation is to continue to operate the Bank and
increase its market share within the City of New Haven and the surrounding
areas, and possibly offer certain additional banking services, such as internet
based cash management services. Subject to receipt of regulatory approvals,
Bancorp also intends to charter and commence the operations of a second, wholly
owned bank subsidiary to serve the New London, Connecticut market, called The
Bank of Southeastern Connecticut. The Bank of Southeastern Connecticut is
expected to be staffed, managed and operated in a manner consistent with the
Bank.
Locations
Bancorp has leased a free-standing building located at 215 Church
Street, New Haven, Connecticut, located in the central business and financial
district of New Haven. It has assigned this lease to the Bank, and the Bank has
assumed all rights and obligations under this lease. Both Bancorp and the Bank
operate from this facility. On October 7, 2002 the Bank opened a new branch
office in Branford, Connecticut at West Main Street and Summit Place. On August
15, 2002 the Bank also purchased a building at 1475 Whalley Avenue in the
Westville section of New Haven for a branch office site which was opened on
March 24, 2003. The Bank is also evaluating locations for the establishment of
additional branch banking offices.
14
The following table sets forth the location of the Bank's branch offices and
other related information:
Office Location Square Feet Status
------ -------- ----------- ------
Main Office 215 Church Street, New Haven, CT 11,306 Leased
Branford Office 445 West Main Street, Branford, CT 3,714 Leased
Amity Office 1475 Whalley Avenue, New Haven, CT 2,822 Owned
The Bank focuses on serving the banking needs of small and mid sized
businesses, professionals and their employees. The Bank's target customer has $5
to $25 million in revenues, 35 to 100 employees, and borrowing needs between
$250,000 and $2 million. The Bank serves the greater New Haven marketplace and
has a Board of Directors and management team drawn from the communities served,
each of who is recognized and respected by the New Haven business community. The
Bank's focus on the commercial market makes it uniquely qualified to move deftly
in responding to the needs of its clients.
The Bank does not expect to compete with large institutions for the
primary banking relationships of large corporations, but it competes for the
small to medium-size businesses and for the consumer business of employees of
such entities. The Bank's geographic market focus also provides a unique
competitive advantage by clearly identifying the Bank as the independent local
bank focused on commercial lending and other commercial banking services. The
Bank's focus clients operate retail, service, wholesale distribution,
manufacturing and international businesses. Many of these customers use the
services of the Bank because of relationships and contacts with the Bank's
directors and management. We believe that the Bank is successfully winning new
business because of these relationships and a combination of a fair price for
our services, quick decision processes and a high level of personalized customer
service.
Lending, Depository and Other Products
The Bank currently has a wide range of "core" bank products and
services offerings which are more completely described below. Additionally,
through correspondent and other relationships, the Bank expects to be able to
help its customers meet all of their banking needs, including obtaining services
which the Bank may not offer directly.
The Bank continues to attract core deposits, including checking
accounts, money market accounts, savings accounts, sweep accounts, NOW accounts
and a variety of certificates of deposit and IRA accounts. To attract deposits,
the Bank is employing an aggressive marketing plan in its service area and
features a broad product line and rates and services competitive with those
offered in the New Haven market and the surrounding communities. The primary
sources of deposits have been and are expected to be businesses and their
employees located in, and residents of New Haven and the surrounding
communities. The Bank is obtaining these deposits through personal solicitation
by its officers and directors, outside programs and advertisements published and
/ or broadcasted in the local media.
Deposits and the Bank's equity capital are the sources of funds for
lending and investment activities. Repayments on loans, investment income and
proceeds from the sale and maturity of investment securities will also provide
additional funds for these purposes. While scheduled principal repayments on
loans and investment securities are a relatively predictable source of funds,
deposit flows and loan prepayments are greatly influenced by general interest
rates, economic conditions and competition. The Bank expects to manage the
pricing of deposits to maintain a desired deposit balance. The Bank offers
drive-in teller services, wire transfers and safe deposit services.
The Bank's loan strategy is to offer a broad range of loans to
businesses and individuals in its service area, including commercial and
business loans, personal loans, mortgage loans, home equity loans, and
automobile loans. The Bank has received lending approval status from the Small
Business Administration ("SBA") to enable it to make SBA loans to both the
15
greater New Haven business community and companies throughout the State of
Connecticut. The marketing focus on small to medium-size businesses and
professionals may result in an assumption of certain lending risks that are
different from or greater than those which would apply to loans made to larger
companies or consumers. Commercial loans generally entail certain additional
risks because repayment is usually dependent on the success of the enterprise.
The Bank seeks to manage the credit risk inherent in its loan portfolio through
credit controls, loan diversification and personal guarantees of the principal
owners of these small to medium-sized businesses. Prior to approving a loan the
Bank evaluates: the credit histories of potential borrowers; the value and
liquidity of available collateral; the purpose of the loan; the source and
reliability of funds for repayment and other factors considered relevant in the
circumstances.
Loans are made on a variable or fixed rate basis with fixed rate loans
limited to five-year terms. All loans are approved by the Bank's management and
the Loan Committee of the Bank's Board of Directors. At the present time, the
Bank is not syndicating or securitizing loans. The Bank at times participates in
multi-bank loans for companies in its service area. Commercial loans and
commercial real estate loans may be written for terms of up to twenty years.
Loans to purchase or refinance commercial real estate are collateralized by the
subject real estate. Loans to local businesses are generally supported by the
personal guarantees of the principal owners and are carefully underwritten to
determine appropriate collateral and covenant requirements.
Other services provided currently or to be provided include, cashier's
checks, money orders, travelers checks, bank by mail, lock box, direct deposit
and U. S. Savings Bonds. The Bank is associated with a shared network of
automated teller machines that its customers are able to use throughout
Connecticut and other regions. The Bank does not currently expect to offer trust
services but may offer trust services through a joint venture with a larger
institution. To offer trust services in the future, the Bank would need the
approval of the Connecticut Banking Commissioner.
Investment Securities
Another significant activity for the Bank is maintaining an investment
portfolio. Although granting a variety of loans to generate interest income and
loan fees is an important aspect of the Bank's business plan, the aggregate
amount of loans will be subject to maintaining a satisfactory loan-to-deposit
ratio. The Bank's overall portfolio objective is to maximize the long-term total
rate of return through active management of portfolio holdings taking into
consideration estimated asset/liability and liquidity needs, tax equivalent
yields and maturities. Permissible investments include debt securities such as
U. S. Government securities, government sponsored agency securities, municipal
bonds, domestic certificates of deposit that are insured by the FDIC,
mortgage-backed securities and collateralized mortgage obligations. The Bank
expects that investments in equity securities will be very limited. The Bank's
current investment portfolio is limited to U. S. government and agency
obligations and agency issue collateralized mortgage obligations classified as
available for sale. Accordingly, the principal risk associated with the Bank's
current investing activities is market risk (variations in value resulting from
general changes in interest rates) rather than credit risk.
Market and Competition
Greater New Haven is currently served by approximately 70 offices of
commercial banks, none of which is headquartered in New Haven. All of these
banks are substantially larger than the Bank expects to be in the near future
and are able to offer products and services which may be impracticable for the
Bank to provide at this time.
There are numerous banks and other financial institutions serving the
communities surrounding New Haven, which also draw customers from New Haven,
posing significant competition for the Bank to attract deposits and loans. The
Bank also experiences competition from out-of-state financial institutions with
little or no traditional bank branches in New Haven. To grow, the Bank will have
16
to win customers away from the customer base of existing banks and financial
institutions as well as win new customers from growth in New Haven and the
surrounding area. Many of such banks and financial institutions are well
established and well capitalized, allowing them to provide a greater range of
services than the Bank will be able to offer in the near future.
Intense market demands, economic pressures and significant legislative
and regulatory actions have eroded traditional banking industry classifications
and have increased competition among banks and other financial institutions.
Market dynamics, as well as legislative and regulatory changes have resulted in
a number of new competitors offering services historically offered only by
commercial banks; non-bank corporations offering services traditionally offered
only by banks; increased customer awareness of product and service differences
among competitors; and increased merger activity.
Additional legislative and regulatory changes may affect the Bank in
the future; however, the nature of such changes and the effect of their
implementation cannot be assessed. New rules and regulations may, among other
things, revise limits on interest rates on various categories of deposits and
may limit or influence interest rates on loans. Monetary and fiscal policies of
the United States government and its instrumentalities, including the Federal
Reserve, significantly influence the growth of loans, investments and deposits.
The banking regulatory environment is undergoing significant change both as it
affects the banking industry directly and as it affects competition between
banks and non-bank financial institutions.
The Bank of Southeastern Connecticut
On July 2, 2003, Bancorp submitted an application to the State of
Connecticut, Department of Banking ("Department"), for the establishment by
Bancorp of a new commercial bank in New London, Connecticut. The application was
subsequently temporarily withdrawn to complete additional information requested
by the Department, including a three-year balance sheet and income statement
forecast for the proposed new bank.
On August 7, 2003, the application, including the completed additional
information, was resubmitted to the Department, and on October 2, 2003, the
final application, including additional information, was submitted.
Bancorp entered into a lease on January 14, 2004 with the City of New
London for a facility located at 15 Mason Street, New London, Connecticut. This
facility is intended to be the main office of The Bank of Southeastern
Connecticut. The Bank of Southeastern Connecticut is expected to be staffed,
managed and operated in a manner consistent with the Bank.
On April 28, 2004, a temporary certificate of authority was issued by
the State of Connecticut Department of Banking in connection with the new bank
application. Additional applications to the Federal Insurance Deposit
Corporation for deposit insurance, and to the Federal Reserve Bank of Boston for
Bancorp to acquire the new bank, will be filed in the near future. Bancorp
expects the new bank to be operating by the end of the fourth quarter of 2004 or
the first quarter of 2005.
SCB Capital, Inc.
On November 17, 2003, SCB Capital, Inc., a wholly-owned subsidiary of
Bancorp, was incorporated. SCB Capital, Inc. will engage in a limited range of
investment banking, advisory and financial brokerage services primarily to small
to medium size business clients of Bancorp and the general public located in
Connecticut. SCB Capital, Inc. is in the process of applying for approval as a
broker-dealer and membership with the National Association of Security Dealers.
SCB Capital, Inc. has not commenced operations. The ultimate amount to be
invested in SCB Capital, Inc. will be determined by Bancorp's Board of Directors
following completion of the application.
17
Recent Developments
Bancorp expects to raise $10 to $15 million in new capital. The
expected use of this capital will be approximately$6.0 million to fund the start
up of the new bank and $2.5 million added to the capital of the Bank.
For a more detailed discussion of Bancorp's liquidity, see Liquidity on
page 24 of this Form 10-QSB. Currently, other than the potential start up of a
new bank in 2004 and the possible establishment of a new Bank branch office (as
previously discussed on page 14 under the "Locations" heading), there are no
plans involving the significant purchase or sale of property or equipment in the
next twelve months. Outside of staffing the new bank located in New London and
new offices of the Bank, Bancorp does not anticipate a significant change in the
number of its employees.
The Board of Directors of the Bank has recently adopted resolutions
designed to strengthen and enhance the Bank's Bank Secrecy Act compliance and
the Bank's Information Technology controls. The Bank recently has promoted a new
Bank Secrecy Act Officer and has amended its Bank Secrecy Act policies to
strengthen compliance. Additionally, the Bank has retained an experienced
outside consultant to assist it in developing and implementing Information
Technology controls.
Currently, the Bank has 27 full-time employees. Its employees perform
most routine day-to-day banking transactions for the Bank. However, the Bank has
entered into a number of arrangements for banking services such as correspondent
banking, data processing and armored carriers.
Overall, the Bank's plan of operation is focused on responsible growth
and pricing of deposits and loans, and investment in high quality U. S.
government securities to achieve a net interest margin sufficient to cover
operating expenses, achieve profitable operations and maintain liquidity.
(b) Management's Discussion and Analysis of Financial Condition and
Results of Operations
Summary
Bancorp had net income of $35,712 (or basic and diluted earnings per
share of $0.03) for the quarter ended March 31, 2004, compared to a net loss of
$184,183 (or basic and diluted loss per share of $0.17) for the quarter ended
March 31, 2003.
Financial Condition
Assets
Since commencing operations on October 1, 2001, Bancorp has reached
total assets of $65.5 million at March 31, 2004, an increase of $9.1 million
(16%) from $56.4 million in assets as of December 31, 2003. Earning assets
reached $60.6 million, increasing $9.4 million (18%) during the first three
months of 2004.
Bancorp has maintained liquidity by maintaining balances in overnight
Federal funds sold and short-term investments including money market mutual
funds to provide funding for higher yielding loans as they are approved and
closed. As of March 31, 2004, Federal funds sold were $4.4 million and money
market mutual fund balances were $2.7 million. Federal funds and Short-term
investments increased by $3.4 million and $2.2 million respectively during the
first quarter of 2004. The increases were due to the excess of deposit volume
over net new loan volume during the quarter. In addition, Bancorp has invested
$7.3 million in U.S. Government Agency and mortgage backed securities classified
as available for sale.
18
Investments
Available for sale securities decreased $1.2 million from December 31,
2003 to partially fund the increase in loans.
During the three months ended March 31, 2004, gross unrealized losses
on the available for sale securities portfolio totaled $123,776. These losses
were the result of volatility in market rates and yield curve changes and
impacted the market prices in government agency bonds and mortgage-backed
securities. Management does not believe these losses are other than temporary,
and Bancorp has the ability to hold these securities to maturity if necessary,
and has both the intent and ability to retain its investments for a period of
time sufficient to allow for any anticipated recovery in fair value. As a
result, management believes that these unrealized losses will not have a
negative impact on future earnings and capital.
Loans
The net loan portfolio increased $4.9 million (12%) from $40.8 million
at December 31, 2003 to $45.7 million at March 31, 2004. The increase in loans
is due to the addition of a branch office in 2003 and continued robust demand in
the greater New Haven and Connecticut markets. The increase in the loan
portfolio was funded primarily by increases in deposits and the decrease in
investments. The loans to deposits ratio as of March 31, 2004 was 82%. Bancorp
continues to target a loans to deposits ratio in the 80% to 85% range.
Critical Accounting Policy
In the ordinary course of business, Bancorp has made a number of
estimates and assumptions relating to reporting results of operations and
financial condition in preparing its financial statements in conformity with
accounting principals generally accepted in the United States of America. Actual
results could differ significantly from those estimates under different
assumptions and conditions. Bancorp believes the following discussion addresses
Bancorp's only critical accounting policy, which is the policy that is most
important to the portrayal of Bancorp's financial condition and results and
requires management's most difficult, subjective and complex judgments, often as
a result of the need to make estimates about the effect of matters that are
inherently uncertain.
Allowance for Loan Losses
The allowance for loan losses, a material estimate susceptible to
significant change in the near-term, is established as losses are estimated to
have occurred through a provision for losses charged against operations, and is
maintained at a level that management considers adequate to absorb losses in the
loan portfolio. Management's judgment in determining the adequacy of the
allowance is inherently subjective and is based on the evaluation of individual
loans, pools of homogeneous loans, the known and inherent risk characteristics
and size of the loan portfolios, the assessment of current economic and real
estate market conditions, estimates of the current value of underlying
collateral, past loan loss experience, review of regulatory authority
examination reports and evaluations of specific loans and other relevant
factors. Loans, including impaired loans, are charged against the allowance for
loan losses when management believes that the uncollectibility of principal is
confirmed. Any subsequent recoveries are credited to the allowance for loan
losses when received. In connection with the determination of the allowance for
loan losses, management obtains appraisals for significant properties, when
considered necessary.
The allowance consists of specific, general and unallocated components.
The specific component relates to loans that are classified as doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower than
the carrying value of that loan. The general component covers non-classified
19
loans and is based on historical loss experience adjusted for qualitative
factors. An unallocated component may be maintained to cover uncertainties that
could affect management's estimate of probable losses. The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.
Based on its evaluation, management believes the allowance for loan
losses of $452,958 at March 31, 2004, which represents 0.98% of gross loans
outstanding, is adequate, under prevailing economic conditions, to absorb
probable losses on existing loans. At December 31, 2003, the allowance for loan
losses was $421,144 or 1.02% of gross loans outstanding.
Analysis of Allowance for Loan Losses
The following represents the activity in the allowance for loan losses for the
three months ended March 31:
2004 2003
--------- ---------
Balance at beginning of period $ 421,144 $ 232,000
Charge-offs (153) -
Recoveries 217 -
Provision charged to operations 31,750 62,900
--------- ---------
Balance at end of period $ 452,958 $ 294,900
========= =========
Non-Accrual, Past Due and Restructured Loans
The following table presents non-accruing and past due loans:
(Thousands of dollars) March 31, 2004 December 31, 2003
--------------------------------------------------------------------------------------
Loans delinquent over 90 days and still accruing $14,999 $ -
Non-accruing loans 27,062 94,063
------- ----------
Total $42,061 $ 94,063
======= ==========
% of Total Loans 0.09% 0.23%
% of Total Assets 0.06% 0.17%
Potential Problem Loans
At March 31, 2004, the Bank had no other loans, other than those
disclosed in the table above, as to which management has significant doubts as
to the ability of the borrower to comply with the present repayment terms.
Deposits
The increase in earning assets for the three months ended March 31,
2004 has been funded primarily by increases in deposits generated from within
Bancorp's market area. Deposits reached $55.6 million at March 31, 2004, an
increase of $8.3 million (18%) from $47.3 million as of December 31, 2003. The
increase in deposits was primarily in interest bearing deposits including
certificates of deposits and money market accounts and reflects the continued
vigorous marketing effort of the Bank. Bancorp does not have any brokered
deposits.
Other
Repurchase agreements increased $534,858 from December 31, 2003 to
$874,610 as of March 31, 2004 due to increased activity in these customer
accounts.
20
Results of Operations
De Novo banks in Connecticut have reached profitability on average
within three to four years after commencement of operations. Bancorp was
profitable in the fourth quarter of 2003, the ninth quarter of operation.
Bancorp was also profitable in the quarter ended March 31, 2004.
Average balances, Yields and Rates
The following table presents average balance sheets (daily averages),
interest income, interest expense, and the corresponding annualized rates on
earning assets and rates paid on interest bearing liabilities for the three
months ended March 31, 2004 compared to the three months ended March 31, 2003.
Interest income on loans includes loan fee income which is not significant. In
addition, Bancorp does not have any tax-exempt securities or loans.
21
Distribution of Assets, Liabilities and Shareholders' Equity;
Interest Rates and Interest differential
Three months Ended Three months Ended
March 31, 2004 March 31, 2003
------------------------------- ---------------------------
Interest Interest Fluctuations in interest
Average Income/ Average Average Income/ Average Income/Expense
(Dollars in thousands) Balance Expense Rate Balance Expense Rate Total
------------------------------- --------------------------- -------------------------
Interest earning assets
Loans (1) $ 44,342 $ 815 7.35% $ 21,819 $ 415 7.61% $ 400
Federal funds sold 1,891 7 1.48% 1,774 5 1.13% 2
Short-term investments 2,583 3 0.46% 805 1 0.50% 2
Investments 7,911 48 2.43% 8,435 82 3.89% (34)
------------------- ----------------- ---------
Total interest earning assets 56,727 873 6.16% 32,833 503 6.13% 370
Cash and due from banks 1,387 1,540
Premises and equipment, net 3,449 3,065
Allowance for loan losses (434) (254)
Other 1,120 839
--------- ---------
Total assets $ 62,249 $ 38,023
========= =========
Interest bearing liabilities
Time certificates $ 14,090 74 2.10% $ 6,343 42 2.65% 32
Savings deposits 2,483 7 1.13% 1,066 3 1.13% 4
Money market / checking deposits 22,435 71 1.27% 13,964 47 1.35% 24
Capital lease obligations 1,191 43 14.44% 1,192 42 14.09% 1
Repurchase agreements 959 2 0.83% 530 1 0.75% 1
----------------------------------------------------------------------------
Total interest bearing liabilities 41,158 197 1.91% 23,095 135 2.34% 62
--------------- --------------- ---------
Non-interest bearing deposits 13,490 6,739
Accrued expenses and
other liabilities 185 130
Shareholder's equity 7,416 8,059
--------- ---------
Total liabilities and equity $ 62,249 $ 38,023
========= =========
Net interest income $ 676 $ 368 $ 308
====== ===== ======
Interest spread 4.25% 3.79%
======= =======
Interest margin 4.77% 4.48%
======= =======
(1) Includes nonaccruing loans.
22
Changes in Assets and Liabilities and Fluctuations in Interest Rates
The following table summarizes the variance in interest income and
expense for the three months ended March 31, 2004 and 2003 resulting in changes
in assets and liabilities and fluctuations in interest rates earned and paid.
The changes in interest attributable to both rate and volume have been allocated
to both rate and volume on a pro rata basis.
Three months Ended
March 31, 2004 v. 2003
-----------------------------------
Due to Change in
Increase Average
Or --------------------
(Dollars in thousands) (Decrease Volume Rate
---------------------- --------- ------ ----
(Dollars in thousands)
Interest earning assets
Loans $ 400 $ 494 $ (94)
Federal funds sold 2 - 2
Short-term investments 2 2 0
Investments (34) (5) (29)
----- ----- -----
Total interest earning assets 370 491 (121)
----- ----- -----
Interest bearing liabilities
Time certificates $ 32 90 (58)
Savings deposits 4 4 0
Money market / checking deposits 24 42 (18)
Capital lease obligations 1 1 0
Repurchase agreements 1 - 1
----- ----- -----
Total interest bearing liabilities 62 137 (75)
----- ----- -----
Net interest income $ 308 $ 354 $ (46)
===== ===== =====
Net Interest Income
For the quarter ended March 31, 2004, net interest income was $675,765
versus $367,451 for the same period in 2003, a $308,314 or 84% increase. This
was the result of a $23.9 million increase in average earning assets in the
quarter ended March 31, 2004 in comparison to the same period a year ago, due
primarily to increases in average loans of $22.5 million and short term
investments and federal funds of $1.9 million, partially offset by a decrease in
average investments of $524,000. Also, average interest bearing liabilities
increased $18.1 million during the quarter ended March 31, 2004 in comparison to
the same period a year ago, also partially offsetting the favorable net interest
income effect of the increase in average earning assets.
The yield on average interest earning assets for the three months ended
March 31, 2004 was 6.16% versus 6.13% for same period in 2003. The cost of
average interest bearing liabilities was 1.91% for the three months ended March
31, 2004 versus 2.34% for the same period in 2003. The decrease in the cost of
average interest bearing liabilities was the primarily the result of lower rates
paid on daily rate money market and interest bearing checking accounts and lower
roll-over rates offered to renewing and new time deposits in the first quarter
of 2004, in comparison to those paid and offered in the first quarter of 2003.
23
Provision for Loan Losses
The $31,750 provision for loan losses for the three months ended March
31, 2004 is due primarily to the increase in the Bank's loan volume. The
provision for loan losses for the three months ended March 31, 2003 was $62,900,
and was primarily due to the increase in the Bank's loan volume during the
period. The decrease in provision between the quarter ended March 31, 2004 in
comparison to the year earlier period is primarily due to portfolio mix and
seasoning considerations.
Noninterest Income
The $133,598 increase in total noninterest income for the first quarter
of 2004 versus 2003 is primarily the result of an increase in the gains from the
sales of the guaranteed portion of Small Business Administration ("SBA")
guaranteed loans of $125,986, fees from increased deposit related volume and
activity of $37,393, offset in part by a decrease in realized gains from the
sale of securities of $40,449. Bancorp intends to continue to originate SBA
guaranteed loans in the future and expects to continue to earn fee income from
SBA loan participation sales and referrals.
Noninterest Expense
Total noninterest expense was $821,078 for the first quarter of 2004
versus $567,911 for the same period in 2003, an increase of $253,167 or 45%. The
increase in expense is due to the growth in the Bancorp's loan and deposit
volume, the addition of the New Haven (Amity) office in March of 2003, as well
as the acquisition of additional infrastructure relating to administration and
compliance, requiring additional staffing and other operating expenses.
Salaries and benefits increased by $162,657 or 55% due to staff
increases relating to the New Haven (Amity) office and other new employees
engaged due to volume and infrastructure development.
Occupancy and equipment increased by $51,345 or 69% due primarily to
increases relating to depreciation of buildings, equipment and furniture of
$22,682, rent relating to New London of $7,597, maintenance of $7,392, and
utilities expense of $6,427.
Data processing and other outside services increased by $30,219, or
77%, primarily due to increased loan and deposit volumes.
Off-Balance Sheet Arrangements
See Note 11 for information regarding the Bancorp's off-balance sheet
arrangements.
Liquidity
Management believes that Bancorp's short-term assets have sufficient
liquidity to cover potential fluctuations in deposit accounts and loan demand
and to meet other anticipated operating cash requirements.
Bancorp's liquidity position as of March 31, 2004 and December 31, 2003
consisted of liquid assets totaling $15.1 million and $11.0 million,
respectively. This represents 23.0% and 19.6% of total assets at March 31, 2004
and December 31, 2003, respectively. The net increase in liquidity during the
first quarter of 2004 is the result of deposit growth exceeding the increase in
total loans and a decrease in available for sale securities. The liquidity ratio
is defined as the percentage of liquid assets to total assets. The following
categories of assets as described in the accompanying balance sheet are
considered liquid assets: cash and due from banks, federal funds sold,
short-term investments, and securities available for sale. Liquidity is a
measure of Bancorp's ability to generate adequate cash to meet financial
obligations. The principal cash requirements of a financial institution are to
cover downward fluctuations in deposits and increases in its loan portfolio.
24
Capital
The following table illustrates the Bank's regulatory capital ratios
at:
March 31, 2004 December 31, 2003
-------------- -----------------
Tier 1 (Leverage) Capital to Average Assets 12.31% 14.16%
Tier 1 Capital to Risk Weighted Assets 14.57% 16.33%
Total Capital to Risk Weighted Assets 15.43% 17.24%
Capital adequacy is one of the most important factors used to determine
the safety and soundness of individual banks and the banking system. Based on
the above ratios, the Bank is considered to be "well capitalized" under
applicable regulations. To be considered "well capitalized" an institution must
generally have a leverage capital ratio of at least 5%, a Tier 1 risk-based
capital ratio of at least 6% and a total risk-based capital ratio of at least
10%.
Bancorp is also considered to be well capitalized under the regulatory
framework specified by the Federal Reserve Bank. Bancorp's actual and required
ratios are not substantially different from those shown above.
Market Risk
Market risk is defined as the sensitivity of income to fluctuations in
interest rates, foreign exchange rates, equity prices, commodity prices and
other market-driven rates or prices. Based upon on the nature of the Company's
business, market risk is primarily limited to interest rate risk, which is the
impact that changing interest rates have on current and future earnings.
Bancorp's goal is to maximize long-term profitability, while minimizing
its exposure to interest rate fluctuations. The first priority is to structure
and price Bancorp's assets and liabilities to maintain an acceptable interest
rate spread, while reducing the net effect of changes in interest rates. In
order to reach an acceptable interest rate spread, Bancorp must generate loans
and seek acceptable long-term investments to replace the lower yielding balances
in Federal Funds sold and short-term investments. The focus also must be on
maintaining a proper balance between the timing and volume of assets and
liabilities re-pricing within the balance sheet. One method of achieving this
balance is to originate variable rate loans for the portfolio to offset the
short-term re-pricing of the liabilities. In fact, a number of the interest
bearing deposit products have no contractual maturity. Customers may withdraw
funds from their accounts at any time and deposits balances may therefore run
off unexpectedly due to changing market conditions.
The exposure to interest rate risk is monitored by the Asset and
Liability Management Committee ("ALCO") consisting of senior management
personnel and selected members of the Board of Directors. ALCO reviews the
interrelationships within the balance sheet to maximize net interest income
within acceptable levels of risk. ALCO reports to the Board of Directors on a
quarterly basis regarding the status of ALCO activities within the Company.
Impact of Inflation and Changing Prices
Bancorp's financial statements have been prepared in terms of
historical dollars, without considering changes in relative purchasing power of
money over time due to inflation. Unlike most industrial companies, virtually
all of the assets and liabilities of a financial institution are monetary in
nature. As a result, interest rates have a more significant impact on a
financial institution's performance than the effect of general levels of
inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as the prices of goods and services. Notwithstanding this
25
fact, inflation can directly affect the value of loan collateral, in particular,
real estate. Inflation, or disinflation, could significantly affect Bancorp's
earnings in future periods.
"Safe Harbor" Statement Under Private Securities Litigation Reform Act of 1995
Certain statements contained in Bancorp's public reports, including
this report, and in particular in this "Management's Discussion and Analysis or
Plan of Operation", may be forward looking and subject to a variety of risks and
uncertainties. These factors include, but are not limited to, (1) changes in
prevailing interest rates which would affect the interest earned on Bancorp's
interest earning assets and the interest paid on its bearing liabilities, (2)
the timing of re-pricing of Bancorp's interest earning assets and interest
bearing liabilities, (3) the effect of changes in governmental monetary policy,
(4) the effect of changes in regulations applicable to Bancorp and the conduct
of its business, (5) changes in competition among financial service companies,
including possible further encroachment of non-banks on services traditionally
provided by banks and the impact of recently enacted federal legislation, (6)
the ability of competitors which are larger than Bancorp to provide products and
services which it is impracticable for Bancorp to provide, (7) the effect of
Bancorp's opening of branches, (8) the effect of any decision by Bancorp to
engage in any business not historically permitted to it. Other such factors may
be described in Bancorp's filings with the SEC.
Although Bancorp believes that it offers the loan and deposit products
and has the resources needed for success, future revenues and interest spreads
and yields cannot be reliably predicted. These trends may cause Bancorp to
adjust its operations in the future. Because of the foregoing and other factors,
recent trends should not be considered reliable indicators of future financial
results or stock prices.
Item 3. Controls and Procedures
(a) Evaluation of disclosure controls and procedures
Based upon an evaluation of the effectiveness of Bancorp's disclosure
controls and procedures performed by Bancorp's management, with participation of
Bancorp's Chief Executive Officer and its Chief Financial Officer as of the end
of the period covered by this report, Bancorp's Chief Executive Officer and
Chief Financial Officer concluded that Bancorp's disclosure controls have been
effective.
As used herein, "disclosure controls and procedures" mean controls and
other procedures of Bancorp that are designed to ensure that information
required to be disclosed by Bancorp in the reports that it files or submits
under the Securities Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Commissions rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by
Bancorp in the reports that it files or submits under the Securities Exchange
Act is accumulated and communicated to Bancorp's management, including its
principal executive, and principal financial officers, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure.
(b) Changes in Internal Controls
There have not been any significant changes in Bancorp's internal
controls or in other factors that occurred during Bancorp's quarter ended March
31, 2004 that could significantly affect these controls subsequent to the
evaluation referenced in paragraph (a) above.
26
PART II
Other Information
Item 1. Legal Proceedings
Not Applicable
Item 2. Changes in Securities and Small Business Issuer Purchases of Equity
Securities
On March 11, 2004, Mr. Carl R. Borrelli, a director of Bancorp,
exercised a warrant granted to Mr. Borrelli under the Warrant Plan, and acquired
5,544 shares of common stock for an aggregate purchase price of $10.91 per
share. Bancorp relied on the exemption from registration under section 4(2) of
the Securities Act of 1933, as amended.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
The Board of Directors of the Bank recently adopted resolutions
designed to strengthen and enhance the Bank's Secrecy Act compliance and the
Bank's Information Technology controls. Pursuant to the resolutions, the Board
is assessing the Bank's staffing needs in the Bank Secrecy Act and Information
Technology areas. The Bank recently has promoted a new Bank Secrecy Act Officer
and has amended its Bank Secrecy Act policies to strengthen compliance.
Additionally, the Bank has retained an experienced outside consultant to assist
it in developing and implementing Information Technology controls.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
No. Description
--- -----------
3(i) Amended and Restated Certificate of Incorporation of the Issuer
(incorporated by reference to Exhibit 3(i) to Issuer's Quarterly Report
on Form 10-QSB dated June 30, 2002)
3(ii) By-Laws of the Issuer (incorporated by reference to Exhibit 3(ii) to
the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.1 Lease, dated as of August 17, 2000, between 215 Church Street, LLC and
the Issuer (incorporated by reference to Exhibit 10.1 to the Issuer's
Registration Statement on Form SB-2 (No. 333-59824))
10.2 Letter agreement dated January 3, 2001 amending the Lease between 215
Church Street, LLC and the Issuer (incorporated by reference to Exhibit
10.2 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.3 First Amendment to Lease dated March 30, 2001 between 215 Church
Street, LLC and the Issuer (incorporated by reference to Exhibit 10.3
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.4 Second Amendment to Lease dated March 31, 2001 between 215 Church
Street, LLC and the Issuer (incorporated by reference to Exhibit 10.4
to the Issuer's Registration Statement Form SB-2 (No. 333-59824))
27
10.5 Assignment of Lease dated April 11, 2001 between the Issuer and The
Bank of Southern Connecticut (incorporated by reference to Exhibit 10.5
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.6 Employment Agreement dated as of January 23, 2001, between The Bank of
Southern Connecticut, the Issuer and Joseph V. Ciaburri (incorporated
by reference to Exhibit 10.6 to the Issuer's Registration Statement on
Form SB-2 (No. 333-59824))
10.7 Employment Agreement dated as of March 29, 2001 between The Bank of
Southern Connecticut, and Gary D. Mullin (incorporated by reference to
Exhibit 10.7 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.8 Issuer's 2001 Stock Option Plan (incorporated by reference to Exhibit
10.8 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.9 Issuer's 2001 Warrant Plan (incorporated by reference to Exhibit 10.9
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.10 Sublease dated January 1, 2001 between Michael Ciaburri, d/b/a Ciaburri
Bank Strategies and The Bank of Southern Connecticut (incorporated by
reference to Exhibit 10.10 to the Issuer's Registration Statement on
Form SB-2 (No.
333-59824))
10.11 Sublease dated January 1, 2001 between Laydon and Company, LLC and The
Bank of Southern Connecticut (incorporated by reference to Exhibit
10.11 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.12 Issuer's 2001 Supplemental Warrant Plan (incorporated by reference to
Exhibit 10.12 to Issuer's Annual Report on Form 10-KSB dated March 29,
2002)
10.13 Issuer's 2002 Stock Option Plan (incorporated by reference to Appendix
B to Issuer's Definitive Proxy Statement dated April 18, 2002).
10.14 Employment Agreement dated as of February 12, 2003, between The Bank of
Southern Connecticut and Michael M. Ciaburri. (incorporated by
reference to Exhibit 10.14 to Issuer's Form 10-QSB dated May 14, 2003).
10.15 Bancorp's Board of Directors approval of the establishment by Bancorp
of a new commercial bank in New London, Connecticut and a capital
raising by Bancorp.
10.16 Amendment to Employment Agreement dated as of October 20, 2003, between
The Bank of Southern Connecticut and Southern Connecticut Bancorp, Inc.
and Joseph V. Ciaburri.
10.17 Lease dated January 14, 2004 between The City of New London and the
Issuer (incorporated by reference to Exhibit 10.17 to the Issuer's
Registration Statement on Form SB-2 (No. 333-59824))
10.18 Lease dated August 2, 2002, between 469 West Main Street LLC and The
Bank of Southern Connecticut (incorporated by reference to Exhibit
10.18 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
31.1 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by Chairman and
Chief Executive Officer.
31.2 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by President and
Chief Operating Officer.
31.3 Section Rule 13(a)-14(a)/15(d)-14(a) by Vice President and Chief
Financial Officer.
32.1 Section 1350 Certification by Chairman and Chief Executive Officer.
28
32.2 Section 1350 Certification by President and Chief Operating Officer.
32.3 Section 1350 Certification by Vice President and Chief Financial
Officer.
(b) Reports on Form 8-K
The issuer filed no reports on Form 8-K during the quarter
ended March 31, 2004.
29
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SOUTHERN CONNECTICUT BANCORP, INC.
By: /S/ Joseph V. Ciaburri
--------------------------------
Name: Joseph V. Ciaburri
Title: Chairman & Chief Executive Officer
Date: May 13, 2004
30
Exhibit Index
-------------
31.1 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by Chairman and
Chief Executive Officer. (filed herewith)
31.2 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by President and
Chief Operating Officer. (filed herewith)
31.3 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by Vice President
and Chief Financial Officer. (filed herewith)
32.1 Section 1350 Certification by Chairman and Chief Executive Officer.
(filed herewith)
32.2 Section 1350 Certification by President and Chief Operating Officer.
(filed herewith)
32.3 Section 1350 Certification by Vice President and Chief Financial
Officer. (filed herewith)
31