UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
___________________
F
O R M 10 - KSB
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[
X
]
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ANNUAL
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the
Fiscal Year Ended December 31, 2006.
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[
]
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
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For
the
transition period from ____________________ to ____________________
Commission
file number 333-59824
SOUTHERN
CONNECTICUT BANCORP, INC.
(Name
of
Small Business Issuer in Its Charter)
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Connecticut
(State
or other jurisdiction of incorporation or organization)
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06-1609692
(I.R.S.
Employer Identification Number)
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215
Church Street
New
Haven, Connecticut
(Address
of Principal Executive Offices)
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06510
(Zip
Code)
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Issuer's
telephone number
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(203)
782-1100
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Securities
registered under Section 12(b) of the Exchange Act:
Common
Stock, par value $.01 per share American
Stock Exchange
(Title
of
Class) (Name of each exchange on which registered)
Securities
registered under Section 12(g) of the Exchange Act:
None
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 (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
Yes
__X
No
_____
Check
if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained,
to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes_____
No _X_
State
issuer's revenue for its most recent fiscal year: $7,884,190
Aggregate
market value of the voting and non-voting common equity held by non-affiliates
(assumes all directors, executive officers and 10% or greater holders are
affiliates) of the registrant as of March 13, 2007: $20,087,098.
State
the
number of shares outstanding of each of the issuer’s classes of common equity:
Common Stock, par value $.01 per share, outstanding as of March
28,
2007: 2,942,219
DOCUMENTS
INCORPORATED BY REFERENCE
|
Portions
of the registrant’s definitive Proxy Statement for its 2007 Annual Meeting
of Shareholders which is expected to be filed with the Securities
and
Exchange Commission within 120 days after the close of the fiscal
year
covered by this Form 10-KSB, are incorporated by reference into Part
III
of this report on Form 10-KSB.
|
Transitional
Small Business Disclosure Format (check one):
Yes
_____; No__X__
Table
of
Contents
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Page
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PART
I
Item
1. Description
of Business.
Background
Southern
Connecticut Bancorp (“Bancorp”) is a bank holding company headquartered in New
Haven, Connecticut that was incorporated on November 8, 2000. Bancorp’s
strategic objective is to serve
as
a bank holding company for a community-based commercial bank serving the greater
New Haven and greater New
London
markets, as well as approximately 62 miles of coastal towns and communities
located between these two cities and extending to Rhode Island (the “Southern
Connecticut Market”). As of December 31, 2006, Bancorp had consolidated total
assets of $124.3 million, net loans of $75.3 million, and total deposits of
$101.3 million. Net interest margin for the year ended December 31, 2006 was
5.27%.
Bancorp
owns 100% of the capital stock of The Bank of Southern Connecticut, (the “Bank”)
a Connecticut-chartered bank with its headquarters in New Haven, Connecticut.
The Bank commenced operations on October 1, 2001. The Bank operates five
branches through three “brand” names. The Bank of Southern Connecticut is
headquartered in New Haven, Connecticut with branch offices in the
Amity/Westville section of New Haven and in Branford, Connecticut, just east
of
New Haven. The Bank of Southeastern Connecticut, a division of The Bank of
Southern Connecticut, opened March 6, 2006, and is headquartered in New London,
Connecticut. The Bank of North Haven, a division of The Bank of Southern
Connecticut, opened July 10, 2006, and is headquartered in North Haven,
Connecticut. Each division is marketed as an independent entity and is staffed
with senior executives who take an active role in community affairs.
The
Bank
focuses on serving the banking needs of small to medium-sized businesses,
professionals and professional corporations, and their owners and employees
in
the greater New Haven and New London markets. The Bank’s target commercial
customer has between $1.0 and $30.0 million in revenues, 15 to 150 employees,
and borrowing needs of up to $3.0 million. The primary focus on this commercial
market makes the Bank uniquely qualified to move deftly in responding to the
needs of its clients. The Bank has been successful in winning business by
offering a combination of competitive pricing for its services, quick decision
making processes and a high level of personalized, “high touch” customer
service.
Southern
Connecticut Market
The
Bank serves the Southern Connecticut Market, which is comprised of the
communities located in the New Haven, Middlesex, and New London Counties along
the coast of Long Island Sound, and communities bordering or economically linked
to these counties. The Southern Connecticut Market is located in the center
of,
and is a critical component of, the commercial activity of the northeast
corridor in New England. The market focus resides in the busy transportation
and
commercial area between New York City to the south, Hartford to the north,
Providence to the east, and Boston to the northeast. The diversified economic
base of this market region includes pharmaceutical, advanced manufacturing,
healthcare, defense, technology, service and energy companies, as well as
Connecticut’s leading port. The region is also one of New England’s most popular
tourist destinations, featuring popular shoreline and heritage sites.
Additionally, New England’s largest casinos, Foxwoods and the Mohegan Sun, are
located in the region. In addition, the Bank’s headquarters is located in
downtown New Haven, in the area of Yale University’s campus.
1
Growth
and Operating Strategy
The
Bank
seeks to differentiate itself by offering prompt, personal “high touch” service
and quality banking products. The Bank’s target customers are small to
medium-sized businesses, professionals and professional corporations, and their
owners and employees. The Bank emphasizes personal relationships with customers,
community involvement by employees and the board of directors, and responsive
lending decisions by an accessible and experienced local management team.
The
key
elements of the Bank’s business strategy include:
| · |
Provision
of individualized attention with local underwriting and credit
decision-making authority.
As
the only commercial bank based in and wholly focused on the greater
New
Haven and New London area, the Bank is better able to provide the
individualized customer service, combined with prompt local underwriting
and credit decision-making authority that management believes small
to
medium-sized businesses desire.
|
| · |
Employing
qualified and experienced banking professionals.
Bancorp and the Bank seek to continue to hire and retain highly
experienced and qualified local commercial lenders and other banking
professionals with successful track records and established relationships
with small to medium-sized businesses in targeted market areas. The
experience and expertise of these individuals serves to enhance the
Bank’s
image within the communities it serves, thereby increasing the Bank’s
business.
|
| · |
Leveraging
personal relationships and community involvement.
The directors, officers and senior employees of Bancorp and the Bank
have
extensive personal contacts, business relationships and involvement
in
communities in which they live and work and which the Bank serves.
By
building on and leveraging these relationships and community involvement,
management believes that the Bank has generated and will continue
to
generate enthusiasm and interest from small to medium-sized businesses
and
professionals in the targeted market
areas.
|
| · |
Offering
a suite of products attractive to our core customer base.
The
Bank seeks to offer competitive basic, popular products to its commercial
and consumer customer base. In 2006, the Bank began to offer internet
banking services to its customers through a partnership with Digital
Insight, a subsidiary of Intel. This internet banking package offers
our
customers a well-designed host of products commonly utilized by small
businesses. Also in 2006, the Bank began a pilot program of remote
deposit
capture. Remote deposit capture allows our customers to deposit checks
from their places of business, rather than having to make a trip
to the
Bank. Based on the success of the pilot program, the Bank expects
remote
deposit capture to bolster transaction deposits in
2007.
|
2
| · |
Maintaining
high credit quality.
The success of the Bank’s business plan depends to a significant extent on
the quality of the Bank’s assets, particularly loans. The Bank has built a
strong internal emphasis on credit quality and has established stringent
underwriting standards and loan approval processes. The Bank actively
manages past-due and non-performing loans in an effort to minimize
credit
loss and related expenses and to ensure that the allowance for loan
losses
is adequate.
|
| · |
Taking
market share from large, non-local competitors.
The markets of New Haven and New London are dominated by large,
non-locally owned, financial institutions with headquarters typically
located outside of Connecticut. Management believes that the Bank
has
attracted and can continue to attract small to medium-sized businesses
and
professionals that prefer local decision-making authority and interaction
with banking professionals who can provide prompt personalized and
knowledgeable service.
|
| · |
Optimizing
net interest margin.
The Bank seeks to optimize net interest margin by funding commercial
loans, when possible, with low cost money market and non-interest
bearing
demand deposits.
|
Lending,
Depository and Other Products
Lending
Products.
The
Bank offers a broad range of loans to businesses and individuals in its service
area, including commercial and business loans, industrial loans, personal loans,
commercial and home 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 greater New Haven and New
London business communities and companies located throughout the State of
Connecticut. The Bank holds certified lending status (“CLP”) from the
SBA.
Loans
are
made on a variable or fixed rate basis, with fixed rate loans typically limited
to three to five year terms. All loans are approved pursuant to lending policies
and procedures authorized by the Bank’s board of directors. The Bank, at times,
participates in multi-bank loans to companies in its market area. Commercial
loans and commercial real estate loans may be written for maturities of up
to
twenty years. Loans to purchase or refinance commercial real estate are
typically supported by personal guarantees of the principal owners and related
parties, and are collateralized by the subject real estate, which may in certain
cases be supplemented by additional collateral in the form of liquid assets.
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.
Depository
Products.
The
Bank has attracted a base of core deposits, including interest bearing and
non-interest bearing checking accounts, money market accounts, savings accounts,
sweep accounts, NOW accounts, repurchase agreements, and a variety of
certificates of deposits and IRA accounts. To continue to attract deposits,
the
Bank employs an aggressive marketing plan in its service area and features
a
broad product line and rates and services competitive with those offered in
the
greater New Haven and New London markets. The primary sources of deposits have
been and are expected to continue to be small to medium-sized businesses,
professionals (lawyers, doctors, accountants, etc.) and professional
corporations, and their owners and employees in greater New Haven and New
London. The Bank obtains these deposits through personal solicitation by its
officers and directors, outside programs and advertisements published and/or
broadcasted in the local media. The Bank offers internet banking services to
its
customers, including commercial cash management services and personal banking
services. The Bank offers remote deposit capture, which offers check deposit
capabilities for customers from their place of business. The Bank also offers
drive-in teller services, automated teller services, wire transfer, lock box
and
safe deposit services.
3
Other
Services.
The
Bank provides a broad range of other services and products, including cashier’s
checks, money orders, travelers’ checks, bank-by mail, 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 expect to offer trust services directly in the near
future, but may offer trust services in the future independently or possibly
through a joint venture with a larger institution. To directly offer trust
services, the Bank would need the approval of the Connecticut Banking
Commissioner and the FDIC.
Investment
Services
On
November 17, 2003, SCB Capital, Inc., a wholly-owned subsidiary of Bancorp,
was
incorporated and is intended to engage in a limited range of investment banking,
advisory and financial brokerage services primarily to small to medium-sized
business clients of Bancorp and others in the target market. SCB Capital has
received $20,000 in capital and has not yet commenced operations.
Investment
Securities
Investment
securities are held by Bancorp and the Bank with the objective of maximizing
the
long-term rate of return for shareholders. Investments are overseen by the
Board
of Directors and a committee of officers who take into account returns,
liquidity needs, and the overall asset/liability management of Bancorp and
the
Bank. 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’s current investment portfolio
is limited to U.S. Government sponsored agency obligations and sponsored agency
issued collateralized mortgage obligations, which have been 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. The Bank does not
take credit risk for the purposes of increasing interest income. Management
continually reviews its portfolio and prevailing market conditions, and under
certain market conditions, Bancorp’s strategy may be reviewed and revised by
management and the board of directors.
4
Asset
and Liability Management
Interest
rate risk measures the impact that changing interest rates have on current
and
future earnings. Bancorp’s goal is to optimize long-term profitability while
minimizing exposure to interest rate fluctuations. Interest rate risk exposure,
including among other things Bancorp’s exposure to changes in interest income
and equity value base on fluctuations in interest rates, is monitored by senior
management and reported to the Bank’s Asset
Liability Committee (ALCO)
and the
board of directors on a quarterly basis. The Bank employs the services of a
national service provider for interest rate risk management.
Regulatory
Compliance
Bancorp
operates in a heavily regulated industry and is subject to increasing regulatory
review and scrutiny from the Federal Reserve Board, the Connecticut Banking
Commissioner, and the FDIC. Bancorp has invested and continues to invest
significant time and resources to ensure compliance and conformity with
applicable regulations (see “REGULATION AND SUPERVISION”). The Bank is committed
to meeting its obligations under the Bank Secrecy Act, the Gramm-Leach-Bliley
Act and the USA PATRIOT Act, as well as various other regulations. Management
meets and reports to the board of directors on a regular basis regarding new
developments in compliance and the Bank’s efforts to comply
therewith.
Competition
There
are
numerous banks and other financial institutions serving the Southern Connecticut
Market posing significant competition to attract deposits and loans. The Bank
competes for loans and deposits with other commercial banks, savings and loan
associations, finance companies, money market funds, insurance companies, credit
unions and other financial institutions, a number of which are much larger
and
have substantially greater resources. To grow, the Bank will have to win
existing customers away from existing banks and financial institutions as well
as successfully compete for new customers from growth in the target
markets.
The
greater New Haven market is currently served by approximately 80 offices of
14
commercial and savings banks. The majority 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 impractical 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. Many of such banks and
financial institutions are well established and better capitalized than the
Bank, allowing them to provide a greater range of services.
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. Increased customer awareness of product and service differences among
competitors has also increased competition among banks.
5
Employees
As
of
December 31, 2006, the Bank had 43 full-time employees and 1 part-time employee.
Relationships with all employees are believed to be excellent.
REGULATION
AND SUPERVISION
Banks
and
bank holding companies are extensively regulated under both federal and state
law. Bancorp and the Bank have set forth below brief summaries of various
aspects of supervision and regulation to which they are subject. These summaries
do not purport to be complete and which are qualified in their entirety by
reference to applicable laws, rules and regulations.
Laws
and Regulations to which Bancorp is Subject
General.
As a
bank holding company registered in accordance with the Bank Holding Company
Act
of 1956 (the “BHC Act”), Bancorp is regulated by and subject to the supervision
of the Federal Reserve Board and is required to file with the Federal Reserve
Board an annual report and such other information as may be required. The
Federal Reserve Board has the authority to conduct examinations of Bancorp
as
well. The Federal Reserve Board has the authority to issue orders to bank
holding companies to cease and desist from unsound banking practices and
violations of conditions imposed by, or violations of agreements with, the
Federal Reserve Board. The Federal Reserve Board is also empowered to assess
civil money penalties against companies or individuals who violate the BHC
Act
or orders or regulations thereunder, to order termination of non-banking
activities of non-banking subsidiaries of bank holding companies, and to order
termination of ownership and control of a non-banking subsidiary by a bank
holding company.
The
BHC Act—Acquisitions and Permissible Activities.
The BHC
Act requires the prior approval of the Federal Reserve Board for a bank holding
company to acquire substantially all the assets of a bank or acquire direct
or
indirect ownership or control of more than 5% of any class of the voting shares
of any bank, bank holding company or savings association, or increase any such
non-majority ownership or control of any bank, bank holding company or savings
association, or merge or consolidate with any bank holding company. Federal
law
generally authorizes bank holding companies to acquire banks located in any
state, subject to certain state-imposed age and deposit concentration limits,
and also generally authorizes interstate bank holding company and bank mergers
and to a lesser extent, interstate branching.
Unless
a
bank holding company becomes a financial holding company under the
Gramm-Leach-Bliley Act of 1999 (“GLBA”) (as discussed below), the BHC Act
prohibits a bank holding company from acquiring a direct or indirect interest
in
or control of more than 5% of any class of the voting shares of a company that
is not a bank or a bank holding company and from engaging directly or indirectly
in activities other than those of banking, managing or controlling banks or
furnishing services to its subsidiary banks, except that it may engage in and
may own shares of companies engaged in certain activities the Federal Reserve
Board has determined to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto.
6
The
GLBA
permits a qualifying bank holding company to become a “financial holding
company” and thereby engage in a broader range of activities than is permissible
for a traditional bank holding company. In order to qualify for this election,
all of the depository institution subsidiaries of the bank holding company
must
be well capitalized and well managed, as defined under Federal Reserve Board
regulations, and all such subsidiaries must have achieved a rating of
“satisfactory” or better with respect to meeting community credit needs.
Pursuant to the GLBA, financial holding companies are permitted to engage in
activities that are “financial in nature” or incidental or complementary
thereto, as determined by the Federal Reserve Board. The GLBA identifies several
activities as “financial in nature,” including, among others, insurance
underwriting and agency activities, investment advisory services, merchant
banking and underwriting, and dealing in or making a market in securities.
At
this time, Bancorp has not elected to become a financial holding company and
has
no immediate plans to do so.
Capital
Requirements.
The
Federal Reserve Board has adopted capital adequacy guidelines pursuant to which
it assesses the adequacy of capital in examining and supervising a bank holding
company and in analyzing applications submitted to it under the BHC Act. These
capital adequacy guidelines generally require bank holding companies to maintain
total capital equal to at least 8% of total risk-adjusted assets and off-balance
sheet items (the “Total Risk-Based Capital Ratio”), with at least one-half of
that amount consisting of Tier I or core capital and the remaining amount
consisting of Tier II or supplementary capital. Tier
I
capital for bank holding companies generally consists of the sum of common
shareholders’ equity and perpetual preferred stock (subject in the case of the
latter to limitations on the kind and amount of such stocks which may be
included as Tier I capital), less goodwill and other non-qualifying intangible
assets.
Tier
II
capital generally consists of: hybrid capital instruments; perpetual preferred
stock, which is not eligible to be included as Tier I capital;
term
subordinated debt and intermediate-term preferred stock; and, subject to
limitations, general allowances for loan losses. Assets are adjusted under
the
risk-based guidelines to take into account different risk characteristics.
In
addition to the risk-based capital requirements, the Federal Reserve Board
requires bank holding companies to maintain a minimum leverage capital ratio
of
Tier I capital (defined by reference to the risk-based capital guidelines)
to
total average assets (the “Leverage Ratio”) of 3.0%. Total average assets for
this purpose do not include goodwill and any other intangible assets and
investments that the Federal Reserve Board determines should be deducted from
Tier I capital. The Federal Reserve Board has announced that the 3.0% Leverage
Ratio requirement is the minimum for the top-rated bank holding companies
without any supervisory, financial or operational weaknesses or deficiencies
or
those that are not experiencing or anticipating significant growth. For all
other bank holding companies, the minimum leverage ratio is 4%, and bank holding
companies with supervisory, financial, managerial or operational weaknesses
or
organizations expecting significant growth are expected to maintain capital
ratios well above minimum levels.
Bancorp
is currently in compliance with the Total Risk-Based Capital Ratio, Tier I
Capital and the Leverage Ratio requirements. As of December 31, 2006, Bancorp
had a Tier I Risk-Based Capital Ratio and a Total Risk-Based Capital Ratio
equal
to 21.80% and 22.96%, respectively, and a Leverage Ratio equal to 17.56%. U.S.
bank regulatory authorities and international
bank
supervisory organizations, principally the Basel Committee on Banking
Supervision, currently are considering changes to the risk-based capital
adequacy framework, including emphasis on credit, market and operational risk
components, which ultimately could affect the appropriate capital guidelines.
7
Limitations
on Acquisitions of Common Stock.
The
federal Change in Bank Control Act prohibits a person or group of persons from
acquiring “control” of a depository institution or a depository institution
holding company unless the appropriate federal banking agency has been given
at
least 60 days to review the proposal and public notice has been provided.
“Control” is generally defined under this act as ownership of 25% or more of any
class of voting stock. In addition, under a rebuttable presumption established
by the Federal Reserve Board, the acquisition of 10% or more of a class of
voting stock of a depository institution or a depository institution holding
company with a class of securities registered under Section 12 of the Exchange
Act would, under the circumstances set forth in the presumption, constitute
the
acquisition of control. Furthermore, any company, as that term is broadly
defined in the BHC Act, would be required to obtain the approval of the Federal
Reserve Board under BHC Act before acquiring 25% (5% in the case of an acquirer
that is a bank holding company) or more of any class of voting securities of
a
depository institution or a depository institution holding company, or such
lesser percentage as the Federal Reserve Board deems to constitute a
“controlling influence.”
Bank
Holding Company Dividends.
The
Federal Reserve Board has authority to prohibit bank holding companies from
paying cash dividends if such payment is deemed to be an unsafe or unsound
practice. The Federal Reserve Board has indicated generally that it may be
an
unsafe or unsound practice for bank holding companies to pay dividends unless
the bank holding company’s net income over the preceding year is sufficient to
fund the dividends and the expected rate of earnings retention is consistent
with the organization’s capital needs, asset quality, and overall financial
condition. Bancorp’s ability to pay dividends is also subject to laws and
regulations of the Connecticut Department of Banking.
Bank
Holding Company Support of Subsidiary Banks.
Under
Federal Reserve Board policy, a bank holding company is expected to act as
a
source of financial and managerial strength to each of its subsidiary banks
and
to commit resources to their support. This support may be required at times
when
the bank holding company may not have the resources to provide it. Similarly,
under the cross-guarantee provisions of the Federal Deposit Insurance Act
(“FDIA”), the FDIC can hold any FDIC-insured depository institution liable for
any loss suffered or anticipated by the FDIC in connection with (1) the
“default” of a commonly controlled FDIC-insured depository institution; or (2)
any assistance provided by the FDIC to a commonly controlled FDIC-insured
depository institution “in danger of default.”
The
Sarbanes-Oxley Act.
The
Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) implements a broad range of
corporate governance and accounting measures for public companies (including
publicly-held bank holding companies such as Bancorp) designed to promote
honesty and transparency in corporate America. Sarbanes-Oxley’s principal
provisions, many of which have been interpreted through regulations released
in
2003, provide for and include, among other things: (i) the creation of an
independent accounting oversight board; (ii) auditor independence provisions
that restrict non-audit services that accountants may provide to their audit
clients; (iii) additional corporate governance and responsibility measures,
including the requirement that the chief executive officer and chief financial
officer of a public company certify financial statements; (iv) the forfeiture
of
bonuses or other incentive-based compensation and profits from the sale of
an
issuer’s securities by directors and senior officers in the twelve month period
following initial publication of any financial statements that later require
restatement; (v) an increase in the oversight of, and enhancement of certain
requirements relating to, audit committees of public companies and how they
interact with the company’s independent auditors; (vi) requirements that audit
committee members must be independent and are barred from accepting consulting,
advisory or other compensatory fees from the issuer; (vii) requirements that
companies disclose whether at least one member of the audit committee is a
“financial expert” (as such term is defined by the SEC); (viii) expanded
disclosure requirements for corporate insiders, including accelerated reporting
of stock transactions by insiders and a prohibition on insider trading during
pension blackout periods; (ix) a prohibition on personal loans to directors
and
officers, except certain loans made by insured financial institutions on
non-preferential terms and in compliance with other bank regulatory
requirements; (x) disclosure of a code of ethics and filing a Form 8-K for
a
change or waiver of such code; and (xi) a range of enhanced penalties for fraud
and other violations. The
Securities and Exchange Commission extended the compliance deadline for
non-accelerated filers to comply with the filing requirements under Section
404
of Sarbanes-Oxley. Under the extension, a company that is not required to file
annual and quarterly reports on an accelerated basis must first comply with
the
Sarbanes-Oxley 404 requirements for its first fiscal year ending on or after
December 15, 2007.
A
non-accelerated filer such as Bancorp is not required to file the auditor’s
attestation report on internal control over financial reporting until it files
an annual report for its first fiscal year ending on or after December 15,
2008.
8
USA
PATRIOT ACT.
The
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”), designed to
deny terrorists and others the ability to obtain access to the United States
financial system, has significant implications for depository institutions,
broker-dealers and other businesses involved in the transfer of money. The
Patriot Act, as implemented by various federal regulatory agencies, requires
financial institutions, including Bancorp and the Bank, to implement new
policies and procedures or amend existing policies and procedures with respect
to, among other matters, anti-money laundering, compliance, suspicious activity
and currency transaction reporting, and due diligence on customers. The Patriot
Act and its underlying regulations also permit information sharing for
counter-terrorist purposes between federal law enforcement agencies and
financial institutions, as well as among financial institutions, subject to
certain conditions, and require the Federal Reserve Board (and other federal
banking agencies) to evaluate the effectiveness of an applicant in combating
money laundering activities when considering applications filed under the BHC
Act or the Bank Merger Act.
Significant
Laws and Regulations to which the Bank is Subject
General.
The
Bank is organized under the Banking Law of the State of Connecticut. Its
operations are subject to federal and state laws applicable to commercial banks
and to extensive regulation, supervision and examination by the Connecticut
Banking Commissioner, as well as by the FDIC, as its primary federal regulator
and insurer of deposits. While the Bank is not a member of the Federal Reserve
System, it is subject to certain regulations of the Federal Reserve Board.
In
addition to banking laws, regulations and regulatory agencies, the Bank is
subject to various other laws, regulations and regulatory agencies, all of
which
directly or indirectly affect the Bank’s operations. The Connecticut Banking
Commissioner and the FDIC examine the affairs of the Bank for the purpose of
determining its financial condition and compliance with laws and regulations.
The Connecticut Banking Commissioner and the FDIC have the authority to limit
the Bank’s payment of cash dividends based on such factors as the maintenance of
adequate capital, which could reduce the amount of dividends otherwise payable.
9
The
Connecticut Banking Commissioner and the FDIC have significant discretion in
connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the FDIC, Congress, the Connecticut Banking
Commissioner, or the Connecticut General Assembly, could have a material adverse
impact on the Bank.
Activities
and Investments of Insured State-Chartered Banks.
Section
24 of the FDIA generally limits the activities of principal and equity
investments of FDIC-insured, state-chartered banks to those that are permissible
for national banks. Bancorp does not expect such provisions to have a material
adverse effect on Bancorp or the Bank.
Capital
Requirements.
The FDIC
has issued regulations and adopted a statement of policy regarding the capital
adequacy of state-chartered banks, such as the Bank. Under the regulations,
a
bank generally is deemed to be (i) “well-capitalized” if it has a Total
Risk-Based Capital Ratio of 10.0% or more, a Tier I Risk-Based Capital Ratio
of
6.0% or more, a Leverage Ratio of 5.0% or more and is not subject to any written
capital order or directive; or (ii) “adequately capitalized” if it has a Total
Risk-Based Capital Ratio of 8.0% or more, a Tier I Risk-Based Capital Ratio
of
4.0% or more, and a Leverage Ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of “well-capitalized;” or (iii)
“undercapitalized” if it has a Total Risk-Based Capital Ratio that is less than
8.0%, a Tier I Risk-Based Capital Ratio that is less than 4.0% or a Leverage
Ratio that is less than 4.0% (3.0% under certain circumstances); or (iv)
“significantly undercapitalized” if it has a Total Risk-Based Capital Ratio that
is less than 6.0%, a Tier I Risk-Based Capital Ratio that is less than 3.0%
or a
Leverage Ratio that is less than 3.0%, and (v) “critically undercapitalized” if
it has a ratio of tangible equity to total assets that is equal to or less
than
2.0%. If an institution becomes undercapitalized, it would become subject to
significant additional oversight and regulation, as mandated by the FDIA.
|
The
following table illustrates Bancorp's and the Bank's regulatory
capital
ratios at:
|
|
Bancorp
|
Bank
|
||||||||||||||||||
|
Capital
|
Capital
|
||||||||||||||||||
|
December
31,
|
December
31,
|
Adequacy
|
December
31,
|
December
31,
|
Adequacy
|
||||||||||||||
|
2006
|
2005
|
Target
Ratio
|
2006
|
2005
|
Target
Ratio
|
||||||||||||||
|
Total
Capital to Risk Weighted Assets
|
22.96
|
%
|
30.30
|
%
|
8.00
|
%
|
19.72
|
%
|
25.17
|
%
|
8.00
|
%
|
|||||||
|
Tier
1 Capital to Risk Weighted Assets
|
21.80
|
%
|
29.17
|
%
|
4.00
|
%
|
18.52
|
%
|
23.96
|
%
|
4.00
|
%
|
|||||||
|
Tier
1 (Leverage) Capital Ratio to Average Assets
|
17.56
|
%
|
24.17
|
%
|
4.00
|
%
|
14.82
|
%
|
20.38
|
%
|
4.00
|
%
|
|||||||
10
As
of
December
31, 2006, the
Bank and
Bancorp were deemed to be well-capitalized institutions.
Prompt
Corrective Action and Other Enforcement Mechanisms.
Federal
law requires each federal banking agency to take prompt corrective action to
resolve the problems of insured depository institutions, including but not
limited to those that fall below one or more prescribed minimum capital ratios.
An institution that, based upon its capital levels, is classified as “well
capitalized,” “adequately capitalized” or “undercapitalized” may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. The federal banking agencies,
however, may not treat an institution as “critically undercapitalized” unless
its capital ratio actually warrants such treatment.
In
addition to restrictions and sanctions imposed under the prompt corrective
action provisions, commercial banking organizations may be subject to potential
enforcement actions by the federal regulators for unsafe or unsound practices
in
conducting their businesses or for violations of any law, rule, regulation
or
any condition imposed in writing by the agency or any written agreement with
the
agency. Enforcement actions may include the imposition of a conservator or
receiver, the issuance of a cease and desist order that can be judicially
enforced, the termination of insurance of deposits (in the case of a depository
institution), the imposition of civil money penalties, the issuance of
directives to increase capital, the issuance of formal and informal agreements,
the issuance of removal and prohibition orders against institution-affiliated
parties and the enforcement of such actions through injunctions or restraining
orders based upon a judicial determination that the agency would be harmed
if
such equitable relief was not granted.
Premiums
for Deposit Insurance. The
FDIC
has implemented a risk-based assessment system, under which an institution’s
deposit insurance premium assessment is based on the probability that the
deposit insurance fund will incur a loss with respect to the institution, the
likely amount of any such loss, and the revenue needs of the deposit insurance
fund.
Under
this risk-based assessment system, banks are categorized into one of three
capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three categories based on supervisory evaluations
by its primary federal regulatory. The three supervisory categories are:
financially sound with only a few minor weaknesses (Group A), demonstrates
weaknesses that could result in significant deterioration (Group B), and poses
a
substantial probability of loss (Group C). The capital ratios used by the FDIC
to define well capitalized, adequately capitalized and undercapitalized are
the
same in the FDIC’s prompt corrective action regulations.
FDIC
insurance of deposits may be terminated by the FDIC, after notice and hearing,
upon finding by the FDIC that the insured institution has engaged in unsafe
or
unsound practices, or is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule or order of,
or
conditions imposed by, the FDIC.
11
Safety
and Soundness Standards.
Federal
law requires each federal banking agency to prescribe for depository
institutions under its jurisdiction standards relating to, among other things:
internal controls; information systems and audit systems; loan documentation;
credit underwriting; interest rate risk; asset growth; compensation; fees and
benefits; and such other operational and managerial standards as the agency
deems appropriate. The federal banking agencies have promulgated regulations
and
Interagency Guidelines Establishing Standards for Safety and Soundness (the
“Guidelines”) to implement these safety and soundness standards. The Guidelines
set forth the safety and soundness standards that the federal banking agencies
use to identify and address problems at insured depository institutions before
capital becomes impaired. The Guidelines address internal controls and
information systems; internal audit system; credit underwriting; loan
documentation; interest rate risk exposure; asset quality; earnings and
compensation; fees and benefits. If the appropriate federal banking agency
determines that an institution fails to meet any standards prescribed by the
Guidelines, the agency may require the institution to submit to the agency
an
acceptable plan to achieve compliance with the standard set by the FDIA.
The
federal banking agencies also have adopted regulations for real estate lending
prescribing uniform guidelines for real estate lending. The regulations require
insured depository institutions to adopt written policies establishing
standards, consistent with such guidelines, for extensions of credit secured
by
real estate. The policies must address loan portfolio management, underwriting
standards and loan to value limits that do not exceed the supervisory limits
prescribed by the regulations.
Community
Reinvestment Act. Under
the
Community Reinvestment Act (“CRA”), as implemented by FDIC regulations, the Bank
has a continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including
low
and moderate income neighborhoods. The CRA does not prescribe specific lending
requirements or programs for financial institutions nor does it limit an
institution’s discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The CRA requires the FDIC, in connection with its examination of a depository
institution, to assess the institution’s record of meeting the credit needs of
its community and to take such record into account in its evaluation of certain
applications by such institution. The FDIC is required to provide a written
evaluation and make public disclosure of an institution’s CRA performance
utilizing a four-tiered descriptive rating system. Institutions are evaluated
and rated by the FDIC as “Outstanding,” “Satisfactory,” “Needs to Improve,” or
“Substantial Non Compliance.” Failure to receive at least a “Satisfactory”
rating may inhibit an institution from undertaking certain activities, including
acquisitions of other financial institutions, which require regulatory approval
based, in part, on CRA compliance considerations. In
its
most recent CRA evaluation, dated July 31, 2003, the Bank was rated as
“Satisfactory.”
Transactions
with Affiliates.
Sections
23A and 23B of the Federal Reserve Act restrict transactions between a bank
and
an affiliated company, including a parent bank holding company. The Bank is
subject to certain restrictions on loans to affiliated companies, on investments
in the stock or securities thereof, on the taking of such stock or securities
as
collateral for loans to any borrower, and on the issuance of a guarantee or
letter of credit on their behalf. Among other things, these restrictions limit
the amount of such transactions, require collateral in prescribed amounts for
extensions of credit, prohibit the purchase of low quality assets and require
that the terms of such transactions be substantially equivalent to terms of
similar transactions with nonaffiliates. Generally, the Bank is limited in
its
extensions of credit to any affiliate to 10% of the Bank’s capital and in its
extensions of credit to all affiliates to 20% of the Bank’s capital.
12
Customer
Information Security.
The
FDIC and other bank regulatory agencies have adopted guidelines (the “Security
Guidelines”) for safeguarding confidential, personal customer information. The
Security Guidelines require each financial institution, under the supervision
and ongoing oversight of its board of directors or an appropriate committee
thereof, to create, implement and maintain a comprehensive written information
security program designed to ensure the security and confidentiality of customer
information, protect against any anticipated threats or hazards to the security
or integrity of such information, and protect against unauthorized access to
or
use of such information, and ensure the proper disposal of information that
could result in substantial harm or inconvenience to any customer.
Privacy.
Financial institutions are required to implement policies and procedures
regarding their information collection practices and the disclosure of nonpublic
personal information about consumers to nonaffiliated third parties. In general,
the statute requires explanations to consumers on policies and procedures
regarding the disclosure of such nonpublic personal information, and, except
as
otherwise required by law, prohibits disclosing such information except as
provided in the financial institution’s policies and procedures.
Item
2. Description of Property.
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, Connecticut
|
|
11,306
|
|
Leased
|
|
Branford
Office
|
|
445
West Main Street, Branford, Connecticut
|
|
3,714
|
|
Leased
|
|
Amity
Office
|
|
1475
Whalley Avenue, New Haven, Connecticut
|
|
2,822
|
|
Owned
|
|
New
London Office
|
15
Masonic Street, New London, Connecticut
|
4,341
|
Leased
|
|||
|
North
Haven Office
|
24
Washington Avenue, North Haven, Connecticut
|
2,430
|
Leased
|
Bancorp
executed a lease for a free-standing building located at 215 Church Street,
New
Haven, Connecticut, in the central business and financial district of New Haven.
The lease was assigned to The Bank of Southern Connecticut, and the Bank assumed
all obligations thereunder. The location is a former bank branch which has
been
renovated for use as the headquarters of the Bank and Bancorp. The building
has
a drive-up teller, an automated teller machine, two vaults and a night deposit
drop.
The
Bank
entered into a five-year lease with an option to extend the lease for up to
three additional terms of five years. The Bank has exercised its first extension
and is in its sixth year at this location. The Bank’s annual rent, which is
fixed in the terms of the lease, including during the option periods, is
currently $133,411. The Bank is responsible for all costs to maintain the
interior of the building, other than structural repairs, and for all real estate
taxes. The Bank, as Bancorp’s assignee, will have a right of first refusal to
purchase the building.
13
To
the
extent that the building contains space not needed for operations, the Bank
subleases such excess to the extent practicable. The Bank of Southern
Connecticut had two tenants in 2006, including the sublease of approximately
1,045 square feet to Laydon and Company, LLC, an entity owned by Elmer A.
Laydon, the son of Elmer F. Laydon, one of Bancorp’s directors.
The
Bank
of Southern Connecticut entered into a lease agreement on August 7, 2002 to
lease the facility at 445 West Main Street, Branford, Connecticut, the site
of
the Branford branch, which opened for business on October 7, 2002.
The
Branford branch lease is for an initial term of five years, with
an
option to extend the lease
for up
to three additional terms of five years. The base rent payable for the
initial
term and
monthly rent is $3,095 until September 30, 2007. The base rent for the option
periods increases and is fixed in the lease. The Bank is responsible for all
costs to maintain the building, other than structural repairs, and for all
real
estate taxes.
On
August
15, 2002 the Bank purchased a one acre site with a single story, stucco facility
of approximately 2,822 square feet for an additional branch facility at 1475
Whalley Avenue, New Haven, Connecticut, the site of the Amity branch location
which opened March 24, 2003.
On
January 14, 2004, Bancorp entered into a lease agreement to lease the facility
at 15 Masonic Street, New London, Connecticut, the site of The Bank of
Southeastern Connecticut, a division of The Bank of Southern Connecticut. The
lease was subsequently assigned to The Bank of Southern Connecticut. The Bank
of
Southeastern Connecticut, a division of The Bank of Southern Connecticut, opened
for operations on March 6, 2006. The Lease is for an initial term of five years,
with three successive five-year option periods. Base rent is $45,581 annually
until December 31, 2008. The base rent for the option years is subject to
increases. The Bank is responsible for the pro rata allocations for taxes,
utilities, common facility charges and other customary tenant expenses of the
premises.
In
June
2005, Bancorp purchased a one acre improved site with two buildings in Clinton,
Connecticut for the primary purpose of establishing a branch office of the
Bank.
The net purchase price of the property was $495,000. On December 15, 2005,
Bancorp leased one of the buildings for a base annual rent of
$12,775.
On
February 16, 2006, Bancorp entered into a lease agreement to lease the facility
at 24 Washington Avenue, North Haven, Connecticut the site of The
Bank
of North Haven, a division of The Bank of Southern Connecticut. The facility
has
been improved to accommodate the new branch, and $295,000
has been
expended for improvement, furnishings, and equipment. The Bank of North Haven,
a
division of The Bank of Southern Connecticut, opened for operations on July
10,
2006. The
Lease
is for an initial term of five years, with three successive five year option
periods. Base rent is $38,880 annually until April 30, 2011. The base rent
for
the option periods increases and is fixed in the lease. The Bank is responsible
for the pro rata share of operating expenses.
14
There
are
no legal
proceedings currently
pending or threatened against Bancorp, its subsidiaries or their property.
Bancorp is not aware of any proceeding contemplated by a governmental entity
involving Bancorp or a subsidiary.
Item
4. Submission
of Matters to a Vote of Security Holders.
No
matter
was submitted to a vote of shareholders of Bancorp during
the fourth quarter of the fiscal year covered by this Form
10-KSB.
15
PART
II
Item
5. Market
for Common Equity and Related Stockholder
Matters.
Bancorp’s
Common Stock is quoted on the American Stock Exchange under the symbol
"SSE.".
The
following table sets forth the high and low sales price* per share of Bancorp’s
Common Stock for the last two years:
|
Quarter
Ended
|
High
|
Low
|
|||||
|
March
31,2006
|
$
|
7.55
|
$
|
6.95
|
|||
|
June
30, 2006
|
$
|
7.55
|
$
|
6.96
|
|||
|
September
30, 2006
|
$
|
7.19
|
$
|
6.80
|
|||
|
December
31, 2006
|
$
|
7.29
|
$
|
6.89
|
|||
|
March
31,2005
|
$
|
8.24
|
$
|
7.81
|
|||
|
June
30, 2005
|
$
|
8.09
|
$
|
7.47
|
|||
|
September
30, 2005
|
$
|
8.26
|
$
|
7.50
|
|||
|
December
31, 2005
|
$
|
8.16
|
$
|
6.90
|
|||
*2005
share prices have been adjusted to reflect the 5% stock dividend declared April
12, 2005.
Holders
There
were approximately 112
registered shareholders of record of Bancorp’s Common Stock as of March 12,
2007.
Dividends
No
cash
dividends have been declared to date by Bancorp. Management expects that
earnings, if any, will be retained and that no cash dividends will be paid
in
the near future. Bancorp may, however, declare stock dividends at the discretion
of its Board of Directors. Bancorp
declared a 5% stock dividend on April 12, 2005 to shareholders of record as
of
April 26, 2005 pursuant to which Bancorp issued 139,814 shares. No dividends
were declared in 2006.
Bancorp’s
sole operating subsidiary is the Bank. Bancorp is dependent upon the ability
of
the Bank to declare and pay dividends to Bancorp. The Bank’s ability to declare
cash dividends is dependent upon the Bank’s ability to earn profits and to
maintain acceptable capital ratios, as well as meet regulatory requirements
and
remain compliant with banking law.
The
policy of the Connecticut Banking Commissioner is to prohibit payment of any
cash dividends prior to recapture of organization and pre-operating expenses
from operating profits. In addition, the Bank is prohibited by Connecticut
law
from declaring a cash dividend on its Common
Stock
without
prior approval of the Connecticut Banking Commissioner except from its net
profits for that year and any retained net profits of the preceding two years.
“Net profits” is defined as the remainder of all earnings from current
operations. In some instances, further restrictions on dividends may be imposed
by the FDIC.
At
December 31, 2006 and 2005, no cash dividends may be declared by the Bank
without regulatory approval.
16
The
payment of cash dividends by the Bank may also be affected by other factors,
such as the requirement to maintain capital in accordance with regulatory
guidelines. If, in the opinion of the Connecticut Banking Commissioner, the
Bank
were engaged in
or
was
about to
engage in an unsafe or unsound practice, the Commissioner could require, after
notice and a hearing, the Bank to cease and desist from the practice. The
federal banking agencies have indicated that paying dividends that deplete
a
depository institution’s capital base to an inadequate level would be an unsafe
and unsound banking practice. Under the Federal Deposit Insurance Corporation
Improvements Act of 1991, a depository institution may not pay any cash dividend
if payment would cause it to become undercapitalized or if it already is
undercapitalized. Moreover, the federal banking
agencies
have issued policy statements that provide that bank holding companies and
insured banks should generally only pay dividends out of current operating
earnings.
Equity
Compensation Plan Information
The
following schedule provides information with respect to the compensation plans
(including individual compensation arrangements) under which equity securities
of Bancorp are authorized for issuance as of December 31, 2006:
|
Plan
Category
|
Number
of securities to
|
Weighted-average
|
Number
of securities
|
|||||||
|
be
issued upon exercise
|
exercise
price of
|
remaining
available for
|
||||||||
|
of
outstanding options,
|
outstanding
options,
|
future
issuance under
|
||||||||
|
warrants
and rights
|
warrants
and rights
|
equity
compensation
|
||||||||
|
(a)
|
(b)
|
plans
(excluding
|
||||||||
|
column
(a)
|
||||||||||
|
Equity
Compensation Plans approved
by security holders
|
458,566
|
$
|
7.91
|
120,576
|
||||||
|
Equity
Compensation Plan not
approved by security holders
(1)
|
77,184
|
$
|
10.39
|
0
|
||||||
|
Total
|
535,750
|
$
|
8.27
|
120,576
|
||||||
(1)
Bancorp
adopted a 2001 Warrant Plan and 2001 Supplemental Warrant Plan (collectively,
the “Warrant Plans”) on April 11, 2001 and October 16, 2001,respectively. The
Warrant Plans were not approved by security holders. Under the Warrant Plans,
each director of Bancorp, other than Mr. Joseph V. Ciaburri, and each
director of the Bank who is not a director of Bancorp, as of the initial
public
offering of Bancorp in July 2001, received a warrant to purchase one share
of
Bancorp common stock for each four shares purchased in the offering by such
director or members of such director’s immediate family. Under the 2001
Supplemental Warrant Plan, certain organizers of Bancorp who are not directors,
officers or employees of Bancorp or the Bank but who made contributions to
Bancorp’s enterprise received a warrant to purchase one share of Bancorp common
stock for each five shares purchased in the offering by such person or member
of
such person’s immediate family. The warrants have a term of ten years.
The
exercise price of the warrants is $10.39, the price at which Bancorp’s common
stock was sold in the initial public offering, as adjusted for subsequent
stock
dividends. As of December 31, 2006, the warrants are fully exercisable.
17
Recent
Sales of Unregistered Securities
Bancorp
has
not
sold unregistered
securities.
Repurchase
of Securities
In
December 2005, the Board of Directors of Bancorp authorized the repurchase
of up
to 146,879 shares of Bancorp common stock. As of March 28, 2007, Bancorp has
not
repurchased any of its shares.
The
following discussion is intended to assist you in understanding the financial
condition and results of operations of Bancorp and the Bank, and should be
read
in conjunction with the consolidated financial statements and related notes
beginning on
page
F-3.
Overview
Southern
Connecticut Bancorp is a bank holding company headquartered in New Haven,
Connecticut that was incorporated on November 8, 2000. Bancorp’s strategic
objective is
to
serve as a bank holding company for community based commercial banks serving
the
greater New Haven and greater New London markets, as well as the approximately
62 miles of coastal
towns
and communities located between these two cities and extending to Rhode Island.
Bancorp owns 100% of the capital stock of The Bank of Southern Connecticut,
a
Connecticut-chartered bank with its headquarters in New Haven, Connecticut,
which commenced operations on October 1, 2001.
Bancorp’s
net loss for fiscal year 2006 was $118,000, an improvement of $160,000 from
the
net loss of $278,000 in fiscal year 2005. In comparison to 2005, the 2006
operating results reflect increased net interest income due to increased average
earning assets and interest rates. Additionally, non-interest income (from
fees
and other income) increased during 2006 due to an increase in service charges
and fees, resulting from increases in deposit account balances, deposit account
activity and deposit account charges; SBA servicing income, loan prepayment
penalties, and letter of credit fees. The increases in non-interest expenses
in
2006 in comparison to 2005 were due primarily to the opening of the two new
branches, The Bank of Southeastern Connecticut, and The Bank of North Haven,
both of which are divisions of The Bank of Southern Connecticut, which
contributed to an increase in salaries and benefits associated with the staffing
of such branches.
18
The
Bank
offers a wide range of services to businesses, professionals, and individuals.
The Bank focuses on serving the banking needs of small to medium-sized
businesses in its geographic areas. The Bank makes commercial loans, industrial
loans, real estate and construction loans, consumer loans, and accepts demand,
savings, and time deposits and provides a broad range of other services to
its
customers, either directly or through third parties. In 2006, the Bank began
offering internet banking services to its customers. The Bank derives revenues
principally from interest earned on loans and fees from other banking-related
services. The operations of the Bank are influenced significantly by general
economic conditions and by policies of financial institution regulatory
agencies, primarily the Connecticut Banking Commissioner and the FDIC. The
Bank’s cost of funds is influenced by interest rates on competing investments
and general market interest rates. Lending activities are affected by the demand
for financing of real estate and other types of loans, which in turn is affected
by the interest rates at which such financings may be offered.
Selected
Financial Data -
Years
Ended December 31, 2006 and December 31, 2005
|
Operating
Data
|
2006
|
2005
|
|||||
|
Interest
income
|
$
|
7,080,124
|
$
|
5,220,624
|
|||
|
Interest
expense
|
2,223,065
|
1,151,557
|
|||||
|
Net
interest income
|
4,857,059
|
4,069,067
|
|||||
|
Provision
for loan losses
|
253,495
|
216,329
|
|||||
|
Noninterest
income
|
804,066
|
606,700
|
|||||
|
Noninterest
expenses
|
5,525,424
|
4,737,888
|
|||||
|
Net
loss
|
(117,794
|
)
|
(278,450
|
)
|
|||
|
Basic
and diluted loss per share
|
(0.04
|
)
|
(0.09
|
)
|
|||
|
Balance
sheet data
|
|||||||
|
Cash
and due from banks
|
$
|
5,821,084
|
$
|
966,732
|
|||
|
Federal
funds sold
|
22,700,000
|
9,579,000
|
|||||
|
Short-term
investments
|
6,288,663
|
6,023,555
|
|||||
|
Investment
securities
|
8,054,821
|
9,973,488
|
|||||
|
Loans,
net
|
75,306,255
|
55,881,508
|
|||||
|
Total
assets
|
124,262,545
|
88,574,234
|
|||||
|
Total
deposits
|
101,273,520
|
65,279,516
|
|||||
|
Repurchase
agreements
|
883,603
|
1,363,368
|
|||||
|
Total
shareholders' equity
|
20,331,849
|
20,296,843
|
|||||
Segment
Reporting
The
Company’s only business segment is Community Banking. During the periods
presented this segment represented all the revenues and income of the
consolidated group and therefore, is the only reported segment as defined by
SFAS No. 131, “Disclosures
about Segments of an Enterprise and Related Information.”
19
Assets
Bancorp’s
total assets were $124.3 million as of December 31, 2006, an increase of $35.7
million over December 31, 2005. Earning assets comprise $113.6 million of the
total asset volume, and consist of Federal funds sold, short-term investments,
securities and loans, which collectively increased $30.9 million from 2005.
Bancorp has maintained liquidity by maintaining balances in overnight Federal
funds sold and in short-term investments, primarily money market mutual funds,
to provide funding for higher yielding loans as they are approved. As of
December 31, 2006, Federal funds sold balances were $22.7 million and short-term
investments balances were $6.3 million. Investment securities classified as
available for sale were $8.1 million and $10.0 million as of December 31, 2006
and 2005, respectively. The gross loan portfolio was $76.4 million and $56.7
million as of December 31, 2006 and 2005 respectively, a net increase of $19.7
million.
The
earning asset increase in 2006 has been funded by deposit growth within the
Bank’s market area. Deposits were $101.3 million and $65.3 million as of
December 31, 2006 and 2005 respectively, a net increase of $36.0 million. The
mix of deposits as of December 31, 2006 includes non-interest bearing checking
accounts of $29.5 million, interest-bearing checking deposits of $5.0 million,
savings deposits of $2.1 million, money market deposits of $36.3 million, as
well as time certificates of deposit of $28.4 million. The deposit mix between
2006 and 2005 has changed with time deposits representing 28% of the Bank’s
deposits as of December 31, 2006. Core deposits, comprised of demand, savings,
money market and checking accounts, represented 72% of the Bank’s deposits as of
December 31, 2006. The Bank has not accepted brokered deposits.
Investments
The
following table presents the maturity distribution of the amortized cost of
investment securities at December 31, 2006, and the weighted average yield
of
such securities. The weighted average yields were calculated based on the
amortized cost and effective yields to maturity of each security.
|
Available
for sale
|
One
Year
or
Less
|
|
Over
One
Year Through Five Years
|
|
Over
Five
Years
Through
Ten
Years
|
|
Over
Ten
Years
|
|
No
Maturity
|
|
Total
|
|
Weighted
Average
Yield
|
|||||||||
|
U.
S. Government sponsored
|
||||||||||||||||||||||
|
agency obligations
|
$
|
2,499,608
|
$
|
3,400,000
|
$
|
1,799,859
|
$
|
500,000
|
$
|
-
|
$
|
8,199,467
|
3.36
|
%
|
||||||||
|
Mortgage-backed
securities
|
-
|
-
|
-
|
-
|
105,431
|
105,431
|
4.48
|
%
|
||||||||||||||
|
Total
|
$
|
2,499,608
|
$
|
3,400,000
|
$
|
1,799,859
|
$
|
500,000
|
$
|
105,431
|
$
|
8,304,898
|
||||||||||
|
Weighted
Average Yield
|
2.86
|
%
|
3.54
|
%
|
3.46
|
%
|
4.18
|
%
|
4.32
|
%
|
3.37
|
%
|
||||||||||
20
The
following table presents a summary of investments for any issuer that exceeds
10% of shareholders’ equity at December 31, 2006:
|
Amortized
|
Fair
|
||||||
|
Cost
|
Value
|
||||||
|
Federal
Home Loan Bank
|
3,799,467
|
3,723,368
|
|||||
|
Federal
Home Loan Mortgage Corporation
|
2,505,431
|
2,421,763
|
|||||
Please
see also, “Notes to Consolidated Financial Statements.”
Loans
The
Bank’s
net loan
portfolio was $75.3 million at December 31, 2006 versus $55.9 million at
December 31, 2005, an increase of $19.4 million. Loan demand has been
significant throughout the year. Bancorp attributes the 2006 loan growth to
the
success of the Bank’s loan business development program in generating loan
demand to small to medium-sized businesses, an improving economy, as well as
the
opening of the two new branches in 2006. Management believes that the loan
growth will continue as the
Bank’s branch system deposit base grows and additional lending capacity is
developed. The Bank’s loans have been made to borrowers primarily in the New
Haven and New London Counties of Connecticut. There are no other significant
loan concentrations in
the loan
portfolio.
The
following table presents the maturities of loans in Bancorp’s portfolio at
December 31, 2006 by type of loan, and the sensitivities of loans to changes
in
interest rates:
|
Due
after
|
||||||||||||||||
|
Due
in
|
one
year
|
|||||||||||||||
|
one
year
|
through
|
Due
after
|
||||||||||||||
|
or
less
|
five
years
|
five
years
|
Total
|
%
of Total
|
||||||||||||
|
Commercial
loans secured
|
||||||||||||||||
|
by real estate
|
$
|
14,173,736
|
$
|
17,294,882
|
$
|
536,322
|
$
|
32,004,940
|
41.87
|
%
|
||||||
|
Commercial
loans
|
30,388,296
|
7,836,618
|
1,396,753
|
39,621,667
|
51.83
|
%
|
||||||||||
|
Construction
loans
|
2,400,949
|
852,562
|
-
|
3,253,511
|
4.26
|
%
|
||||||||||
|
Residential
real estate
|
7,028
|
33,559
|
108,771
|
149,358
|
0.20
|
%
|
||||||||||
|
Consumer
home equity
|
281,159
|
125,876
|
196,359
|
603,394
|
0.79
|
%
|
||||||||||
|
Consumer
installment
|
441,874
|
344,470
|
19,682
|
806,026
|
1.05
|
%
|
||||||||||
|
Total
|
$
|
47,693,042
|
$
|
26,487,967
|
$
|
2,257,887
|
$
|
76,438,896
|
100.00
|
%
|
||||||
|
Fixed
rate loans
|
$
|
6,950,429
|
$
|
3,295,670
|
$
|
2,257,887
|
$
|
12,503,986
|
||||||||
|
Variable
rate loans
|
40,742,613
|
23,192,297
|
-
|
63,934,910
|
||||||||||||
|
Total
|
$
|
47,693,042
|
$
|
26,487,967
|
$
|
2,257,887
|
$
|
76,438,896
|
||||||||
Please
see also, “Notes to Consolidated Financial Statements.”
21
Critical
Accounting Policy
In
the
ordinary course of business, Bancorp has made a number of estimates and
assumptions relating to reporting the results of operations and financial
condition in preparing its financial statements in conformity with accounting
principles 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. Bancorp has reviewed this critical accounting policy and estimates
with its audit committee. Refer to the discussion below under “Allowance
for Loan Losses” and Note 1 to the
consolidated financial statements for a detailed description of our estimation
process and methodology related to the allowance for loan losses.
Allowance
for Loan Losses
The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loans are
charged against the allowance when management believes the uncollectibility
of a
loan balance is confirmed. Subsequent recoveries, if any, are credited to the
allowance.
The
allowance for loan losses is evaluated on a regular basis by management and
is
based upon management’s periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower’s ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes
available.
The
allowance consists of specific, general and unallocated components. The specific
component relates to loans that are classified loss, 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 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
upon this evaluation, management believes the allowance for loan losses of
$1,063,000 or
1.39%
of gross
loans at December 31, 2006 is adequate, under prevailing economic conditions,
to
absorb losses on existing loans. At December 31, 2005, the allowance for loan
losses was $778,000 or 1.37% of gross loans outstanding. The increase in the
allowance is primarily due to loan growth, and the increase in the allowance
as
a percentage of loans is due to the increase in specific reserves needed for
impaired loans at December 31, 2006 as compared to December 31,
2005.
The
accrual of interest income on loans is discontinued whenever reasonable doubt
exists as to its collectibility and generally is discontinued when loans are
past due 90 days as to either principal or interest, or are otherwise considered
impaired. When the accrual of interest income is discontinued, all previously
accrued and uncollected interest is reversed against interest income. The
accrual of interest on loans past due 90 days or more may be continued if the
loan is well secured, and it is believed all principal and accrued interest
income due on the loan will be realized, and the loan is in the process of
collection. A non-accrual loan is restored to an accrual status when it is
no
longer delinquent and collectibility of interest and principal is no longer
in
doubt.
22
Management
considers all non-accrual loans, other loans past due 90 days or more, based
on
contractual terms, and restructured loans to be impaired. In most cases, loan
payments that are past due less than 90 days and the related loans are not
considered to be impaired.
|
Allowance
for Loan Losses as of December 31, 2006 and 2005:
|
|||||||
|
2006
|
2005
|
||||||
|
Balance,
beginning of year
|
$
|
778,051
|
$
|
752,394
|
|||
|
Provision
for
loan losses
|
253,495
|
216,329
|
|||||
|
Recoveries
of
loans previously charged-off
|
68,182
|
4,714
|
|||||
|
Loans
charged-off
|
(37,067
|
)
|
(195,386
|
)
|
|||
|
Balance,
end of year
|
$
|
1,062,661
|
$
|
778,051
|
|||
|
Net
(recoveries) charge-offs to average loans
|
(.05%)
|
|
.35%
|
|
|||
|
Allocation
of the Allowance for Loan Losses at December 31:
|
|||||||||||||
|
2006
|
2005
|
||||||||||||
|
Percent
of
|
Percent
of
|
||||||||||||
|
Loans
in Each
|
Loans
in Each
|
||||||||||||
|
Category
to
|
Category
to
|
||||||||||||
|
Balance
|
Total
Loans
|
Balance
|
Total
Loans
|
||||||||||
|
Commercial
loans secured by real estate
|
$
|
444,937
|
41.87
|
%
|
$
|
338,070
|
47.08
|
%
|
|||||
|
Commercial
loans
|
550,824
|
51.83
|
%
|
327,035
|
45.55
|
%
|
|||||||
|
Construction
loans
|
45,231
|
4.26
|
%
|
32,559
|
4.53
|
%
|
|||||||
|
Residential
mortgages
|
2,076
|
0.20
|
%
|
1,972
|
0.27
|
%
|
|||||||
|
Consumer
home equity loans
|
8,388
|
0.79
|
%
|
9,489
|
1.32
|
%
|
|||||||
|
Consumer
installment loans
|
11,205
|
1.05
|
%
|
8,944
|
1.25
|
%
|
|||||||
|
Unallocated
|
-
|
0.00
|
%
|
59,982
|
0.00
|
%
|
|||||||
|
$
|
1,062,661
|
100.00
|
%
|
$
|
778,051
|
100.00
|
%
|
||||||
Non-Accrual,
Past Due and Restructured Loans
Non-accrual
loans at December 31, 2006 and 2005 totaled $301,833 and $578,826 respectively.
In 2006 and 2005, there were no loans considered “troubled debt restructurings”
and no loans greater than 90 days past due and still accruing
interest.
23
Potential
Problem Loans
Other
than loans identified as non-accrual at December 31, 2006, the Bank had no
material loans as to which management has significant doubts as to the ability
of the borrower to comply with the present repayment terms.
Deposits
Total
deposits were $101.3 million at December 31, 2006, an increase of $36.0 million
in comparison to total deposits as of December 31, 2005 of $65.3 million.
Bancorp attributes the 2006 deposit growth to the success of the opening of
the
two new branches in 2006. The deposits total at December 31, 2006 consisted
of
non-interest bearing checking of $29.5 million (29.1%), interest bearing
checking and money market deposits of $41.3 million (40.8%), savings deposits
of
$2.1 million (2.1%) and certificates of deposit of $28.4 million (28.0%). The
Bank continues to emphasize growth in core non-interest checking accounts and
related interest bearing checking, money market deposit, and savings accounts
and is less aggressive in attracting higher cost time deposits: as of December
31, 2006, these categories of deposits represented 72% of total deposits. The
Bank has not accepted any brokered deposits and has no present plans to review
this policy.
The
Bank
continues to offer competitive interest rates in the very competitive Southern
Connecticut market in order to fund expected
loan
growth.
|
As
of December 31, 2006 the Bank's maturities of time deposits
were:
|
||||||||||
|
$100,000
|
Less
than
|
|||||||||
|
or
greater
|
$100,000
|
Totals
|
||||||||
|
(
Thousands of dollars)
|
||||||||||
|
Three
months or less
|
$
|
2,712
|
$
|
1,689
|
$
|
4,401
|
||||
|
Over
three months to six months
|
3,367
|
2,289
|
5,656
|
|||||||
|
Over
six months to one year
|
6,590
|
5,453
|
12,043
|
|||||||
|
Over
one year
|
1,534
|
4,759
|
6,293
|
|||||||
|
$
|
14,203
|
$
|
14,190
|
$
|
28,393
|
|||||
Other
The
increase in Other Assets is primarily due to an increase in Prepaid Expenses
of
$32,900 related to the purchasing of supplies for the two new branches, and
an
increase in the Cash Surrender Value of Bank Owned Life Insurance in the amount
of $40,000.
24
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 years ended
December
31, 2006 and 2005.
|
Distribution
of Assets, Liabilities and Shareholders'
Equity;
|
||||||||||||||||||||||
|
Interest
Rates and Interest Differential
|
||||||||||||||||||||||
|
2006
|
2005
|
|||||||||||||||||||||
|
|
|
Fluctuations
|
|
|||||||||||||||||||
|
|
|
|
|
Interest
|
|
|
|
|
|
Interest
|
|
|
|
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)
|
$
|
64,477
|
$
|
5,836
|
9.05
|
%
|
$
|
53,786
|
$
|
4,410
|
8.20
|
%
|
$
|
1,426
|
||||||||
|
Short-term
investments
|
5,757
|
279
|
4.85
|
%
|
8,365
|
251
|
3.00
|
%
|
28
|
|||||||||||||
|
Investments
|
9,307
|
313
|
3.36
|
%
|
11,074
|
344
|
3.11
|
%
|
(31
|
)
|
||||||||||||
|
Federal
funds sold
|
12,630
|
652
|
5.16
|
%
|
6,960
|
216
|
3.10
|
%
|
436
|
|||||||||||||
|
Total
interest earning assets
|
92,171
|
7,080
|
7.68
|
%
|
80,185
|
5,221
|
6.51
|
%
|
1,859
|
|||||||||||||
|
Cash
and due from banks
|
2,049
|
464
|
||||||||||||||||||||
|
Premises
and equipment, net
|
4,443
|
4,052
|
||||||||||||||||||||
|
Allowance
for loan losses
|
(903
|
)
|
(725
|
)
|
||||||||||||||||||
|
Other
|
1,399
|
1,416
|
||||||||||||||||||||
|
Total
assets
|
$
|
99,159
|
$
|
85,392
|
||||||||||||||||||
|
Interest
bearing liabilities
|
||||||||||||||||||||||
|
Time
certificates
|
$
|
17,078
|
738
|
4.32
|
%
|
$
|
10,195
|
293
|
2.87
|
%
|
445
|
|||||||||||
|
Savings
deposits
|
2,651
|
37
|
1.40
|
%
|
3,448
|
48
|
1.39
|
%
|
(11
|
)
|
||||||||||||
|
Money
market / checking deposits
|
35,234
|
1,254
|
3.56
|
%
|
31,730
|
623
|
1.96
|
%
|
631
|
|||||||||||||
|
Capital
lease obligations
|
1,189
|
175
|
14.72
|
%
|
1,190
|
173
|
14.54
|
%
|
2
|
|||||||||||||
|
Repurchase
agreements
|
1,253
|
19
|
1.52
|
%
|
1,087
|
15
|
1.38
|
%
|
4
|
|||||||||||||
|
Total
interest bearing liabilities
|
57,405
|
2,223
|
3.87
|
%
|
47,650
|
1,152
|
2.42
|
%
|
1,071
|
|||||||||||||
|
Non-interest
bearing deposits
|
20,894
|
17,178
|
||||||||||||||||||||
|
Accrued
expenses and other liabilities
|
576
|
363
|
||||||||||||||||||||
|
Shareholder's
equity
|
20,284
|
20,201
|
||||||||||||||||||||
|
Total
liabilities and equity
|
$
|
99,159
|
$
|
85,392
|
||||||||||||||||||
|
Net
interest income
|
$
|
4,857
|
$
|
4,069
|
$
|
788
|
||||||||||||||||
|
Interest
spread
|
3.81
|
%
|
4.09
|
%
|
||||||||||||||||||
|
Interest
margin
|
5.27
|
%
|
5.07
|
%
|
||||||||||||||||||
|
(1)
Includes nonaccruing loans.
|
||||||||||||||||||||||
25
RATE
VOLUME VARIANCE ANALYSIS
The
following table summarizes the variance in interest income and expense for
2006
and 2005 resulting from changes in assets and liabilities and fluctuations
in
interest rates earned and paid. The changes in interest income and expense
attributable to both rate and volume have been allocated to both rate and volume
on a pro rata basis.
|
2006
vs 2005
|
||||||||||
|
Variance
due to:
|
||||||||||
|
(Dollars
in thousands)
|
Volume
|
|
Rate
|
|
Total
|
|||||
|
Interest
earning assets
|
||||||||||
|
Loans
|
$
|
817
|
$
|
609
|
$
|
1,426
|
||||
|
Short-term investments
|
(62
|
)
|
90
|
28
|
||||||
|
Investments
|
(52
|
)
|
21
|
(31
|
)
|
|||||
|
Federal funds sold
|
111
|
325
|
436
|
|||||||
|
Total
interest earning assets
|
814
|
1,045
|
1,859
|
|||||||
|
Interest
bearing liabilities
|
||||||||||
|
Time certificates
|
141
|
304
|
445
|
|||||||
|
Savings deposits
|
(11
|
)
|
-
|
(11
|
)
|
|||||
|
Money market / checking deposits
|
63
|
568
|
631
|
|||||||
|
Capital lease obligations
|
-
|
2
|
2
|
|||||||
|
Repurchase agreements
|
2
|
2
|
4
|
|||||||
|
Total
interest bearing liabilities
|
195
|
876
|
1,071
|
|||||||
|
Net
interest income
|
$
|
619
|
$
|
169
|
$
|
788
|
||||
The
improvements realized in net interest income during 2006 reflect an increase
in
earning asset volume over 2005, as the average earning assets in 2006 of $92.2
million were 15% greater than average earning assets in 2005, and the yields
on
all interest earning assets increased due to general increases in market
interest rates. Overall, interest income attributed to rate increases
considerably outweighed volume considerations (increase of $1.0 million versus
an increase of $814,000). Variances in the 2006 cost of interest bearing
liabilities in comparison to 2005 were due to increased volume considerations
of
$195,000 and increased rate considerations of $876,000. The increase in the
cost
of interest bearing liabilities was due principally to an increase in rates
paid
on deposit accounts.
Bancorp
intends for the Bank to continue to emphasize lending to small to medium-sized
businesses in its market area as its strategy to increase assets under
management and to improve earnings. The Bank will seek opportunities to increase
its deposit base, with a primary objective of attracting core non-interest
checking and related money market deposit accounts, in order to support its
earning assets through marketing, and by considering additional branch locations
and new product and service offerings.
26
The
following are measurements of Bancorp’s loss in relation to assets and equity,
and average equity to average assets for the years ended December 31, 2006
and
2005:
|
2006
|
2005
|
||||||
|
Loss
on average assets
|
(.12
|
%)
|
(.33
|
%)
|
|||
|
Loss
on average equity
|
(.58
|
%)
|
(1.38
|
%)
|
|||
|
Average
equity to average assets
|
20.46
|
%
|
23.66
|
%
|
|||
Results
of Operations
Bancorp’s
net loss for fiscal year 2006 was $118,000, an improvement of $160,000 from
the
net loss of $278,000 in fiscal year 2005. In comparison to 2005, the 2006
operating results reflect increased net interest income due to increased average
earning assets and
interest rates.
Additionally, non-interest income (from fees and other income) increased during
2006 due to an increase in service charges and fees, resulting from increases
in
deposit account balances, deposit account activity and deposit account charges;
and increases in SBA servicing income, loan prepayment penalties, and letter
of
credit fees. The increases in non-interest expenses in 2006 in comparison to
2005 were primarily due to the opening of the two new branches, The Bank of
Southeastern Connecticut, and The Bank of North Haven, both of which are
divisions of The Bank of Southern Connecticut, which contributed to an increase
in salaries and benefits associated with the staffing of such branches.
.
Net
Interest Income
The
principal source of revenues is net interest income. The Bank’s net interest
income is dependent primarily upon the difference or spread between the average
yield earned on loans receivable and securities and the average rate paid on
deposits and borrowings, as well as the relative amounts of such assets and
liabilities. The Bank, like other banking institutions, is subject to interest
rate risk to the degree that its interest-bearing liabilities mature or reprice
at different times, or on a different basis, than its interest-earning assets.
For
the
year ended
December
31,
2006,
net interest income was $4.9 million versus $4.1 million for the year ended
December 31, 2005, an
increase
of $800,000 or 19.5%. The 2006 increase was primarily the result of increases
in
the yields on interest earning assets, net of the increased cost of funds on
interest bearing liabilities, and a $12.0 million increase in average interest
earning assets. The
increase in average interest earning assets was comprised of increases in
average loans of $10.7 million, decreases in investments of $1.8 million,
decreases in short term investments of $2.6 million, and increases in federal
funds sold of $5.7 million.
The
yield
on average interest earning assets for the twelve months ended December 31,
2006
was 7.68% versus 6.51% for same period in 2005, a favorable increase of 117
basis points. The
increase in the yield on assets reflects the increases in market interest rates
that occurred throughout 2006, particularly in the prime lending rate and the
Bank’s base lending rate.
The
cost
of average interest bearing liabilities was 3.87% for the twelve months ended
December 31, 2006 versus 2.42% for the same period in 2005, an unfavorable
increase of 145 basis points, reflecting a general increase in market interest
rates. The
increase in the cost of interest bearing liabilities was due principally to
an
increase in rates paid on deposit accounts. The average rate of interest paid
on
money market and interest bearing checking deposits increased 160 basis points
in 2006 in comparison to 2005. In addition, the Bank’s average cost of funds for
time deposits increased 145 basis points in 2006 in comparison to
2005.
27
Due
to
the increase in the cost of interest bearing liabilities, which offsets the
increase in the average yield on earning assets, the interest spread decreased
to 3.81% for fiscal year 2006, a decrease of 28 basis points from the interest
spread realized in 2005. Net interest margin increased to 5.27% in 2006 from
5.07% in 2005, an increase of 20 basis points which largely reflects the
increasing rates during 2006.
Noninterest
Income
The
$197,000 increase in non-interest income for the twelve months ended December
31, 2006 versus 2005 is comprised of an increase of $139,000 in service charges
and fees, resulting from increases in deposit account balances, deposit account
activity and deposit account charges; an increase of $23,000 in loan prepayment
penalties, an increase of $20,000 in letters of credit fees, and an increase
of
$41,000 in gains on sales of loan participations related to SBA guaranteed
loans, partially offset by a decrease in all other loan fees of
$26,000.
Noninterest
Expenses
Total
noninterest expenses were $5.5 million for the year ended December 31, 2006
versus $4.7 million for 2005, an increase of $800,000 or 17%. The increase
in
expenses is primarily due to the opening of the two new branches, The Bank
of
Southeastern Connecticut, and The Bank of North Haven, both of which are
divisions of The Bank of Southern Connecticut. During the twelve months ended
December 31, 2006, additional staff was hired to support the new branches,
extensive advertising took place to promote the new branches, branch supplies
were purchased, and occupancy expenses were incurred. As a result, salaries
and
benefits increased $643,000 to $3.0 million in fiscal year 2006 in comparison
to
fiscal year 2005, occupancy and equipment expenses increased $156,000 to
$764,000 in fiscal year 2006 in comparison to fiscal year 2005, and advertising
increased $78,000 to $224,000 in fiscal year 2006 in comparison to fiscal year
2005.
Off-Balance-Sheet
Arrangements
See
Note
12 to the accompanying consolidated Financial Statements for required disclosure
regarding off-balance-sheet arrangements.
Liquidity
Bancorp’s
liquidity position as of December 31, 2006 and December 31, 2005 consisted
of
liquid assets totaling $42.9 million and $26.6 million, respectively. This
represents 35.0% and 30.0% of total assets at December 31, 2006 and 2005,
respectively. 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.
28
Management
believes Bancorp’s short-term assets provide sufficient liquidity to cover
potential fluctuations in deposit accounts and loan demand and to meet other
anticipated operating cash and investment requirements.
Capital
|
Bancorp
|
Bank
|
||||||
|
Capital
|
Capital
|
||||||
|
December
31,
|
December
31,
|
Adequacy
|
December
31,
|
December
31,
|
Adequacy
|
||
|
2006
|
2005
|
Target
Ratio
|
2006
|
2005
|
Target
Ratio
|
||
|
Total
Capital to Risk Weighted Assets
|
22.96%
|
30.30%
|
8.00%
|
19.72%
|
25.17%
|
8.00%
|
|
|
Tier
1 Capital to Risk Weighted Assets
|
21.80%
|
29.17%
|
4.00%
|
18.52%
|
23.96%
|
4.00%
|
|
|
Tier
1 (Leverage) Capital Ratio to Average Assets
|
17.56%
|
24.17%
|
4.00%
|
14.82%
|
20.38%
|
4.00%
|
|
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%.
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 the nature of Bancorp’s business, market risk is
primarily limited to interest rate risk, which is defined as the impact of
changing interest rates 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 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 Senior Management of the Bank
and
reported quarterly to the Asset and Liability Management Committee and the
Board
of Directors. Management reviews the interrelationships within the balance
sheet
to maximize net interest income within acceptable levels of risk.
29
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 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.
Factors
Affecting Future Results
Some
of
the statements under “Management’s Discussion and Analysis or Plan of
Operations,” “Business” and elsewhere in this Annual Report on Form 10-KSB
may include forward-looking statements which reflect our current views with
respect to future events and financial performance. Statements which include
the
words “expect,” “intend,” “plan,” “believe,” “project,” “anticipate” and similar
statements of a future or forward-looking nature identify forward-looking
statements for purposes of the federal securities laws or otherwise. All
forward-looking statements address matters that involve risks and uncertainties.
Accordingly, there are or will be important factors that could cause actual
results to differ materially from those indicated in these statements or that
could adversely affect the holders of our common stock.
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 interest 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 impractical for Bancorp to provide, (7) the volatility
of
quarterly earnings, due in part to the variation in the number, dollar volume
and profit realized from SBA guaranteed loan participation sales in different
quarters, (8) the effect of a loss of any executive officer, key personnel,
or
directors, (9) the effect of Bancorp’s opening of branches and the receipt of
regulatory approval to complete such actions, (10) concentration of Bancorp’s
business in southern and southeastern Connecticut, (11) the concentration of
Bancorp’s loan portfolio in commercial loans to small-to-medium sized
businesses, which may be impacted more severely than larger businesses during
periods of economic weakness, (12) lack of seasoning in Bancorp’s loan
portfolio, which may increase the risk of future credit defaults, and (13)
the
effect of any decision by Bancorp to engage in any business not historically
permitted to it. Other such factors may be described in other filings made
by
Bancorp 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.
30
Any
forward-looking statement speaks only as of the date on which such statement
is
made, and we undertake no obligation to publicly update or review any
forward-looking statement, whether as a result of new information, future
developments or otherwise.
Item
7. Financial
Statements.
The
consolidated balance sheets of Bancorp
as
of
December 31, 2006 and 2005, and the related consolidated statements of
operations, shareholders’ equity and cash flows for the years then ended,
together with the report thereon of McGladrey & Pullen, LLP dated
March
27,
2007
are
included as part of this Form 10-KSB following page 40
hereof.
Item
8. Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not
applicable.
Item
8A. 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, Chief Operating Officer, and its Chief Financial
Officer as of the end of the period covered by this report, Bancorp’s Chief
Executive Officer, Chief Operating Officer, and its Chief Financial Officer
concluded that Bancorp’s disclosure controls and procedures have been effective
in ensuring that material information relating to Bancorp, including its
consolidated subsidiary, is made known to the certifying officers by others
within Bancorp and the Bank during the period covered by this report.
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 Commission’s 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 material changes in Bancorp’s internal controls or in other
factors that occurred during Bancorp’s last fiscal quarter ended December 31,
2006 that have materially affected or are reasonably likely to materially affect
these controls subsequent to the evaluation referenced in paragraph (a)
above.
31
Item
8A(T). Controls
and Procedures
Not
Applicable.
Item
8B. Other
Information.
Not
Applicable.
PART
III
Item
9. Directors
and Executive Officers, Promoters, Control Persons and
Corporate Governance; Compliance with Section 16(a) of the Exchange
Act.
The
information required by this
Item
9
is
incorporated into this Form 10-KSB by reference from Bancorp's definitive proxy
statement for its 2007 Annual Meeting of Shareholders (the "Definitive Proxy
Statement").
Item
10. Executive
Compensation.
The
information required by
this
Item 10
is
incorporated into this Form 10-KSB by reference from the Definitive Proxy
Statement.
Item
11. Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The
information required by this
Item
11 is
incorporated into this Form 10-KSB by reference from the Definitive Proxy
Statement.
Item
12. Certain
Relationships and Related Transactions, and Director
Independence
The
information required by this
Item
12 is
incorporated into this Form 10-KSB by reference from the Definitive Proxy
Statement.
Item
13. Exhibits.
Exhibit
No. Description
|
3(i)
|
Amended
and Restated Certificate of Incorporation of the Issuer (incorporated
by
reference to Exhibit 3(i) to the 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 dated April 30, 2001(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 dated April 30, 2001(No.
333-59824))
|
32
| 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 dated April 30, 2001(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 dated April 30, 2001(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 dated April 30, 2001(No.
333-59824))
|
| 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 dated April 30, 2001(No.
333-59824))
|
| 10.6 |
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 dated
April 30, 2001(No. 333-59824))
|
| 10.7 |
Sublease
dated January 1, 2001 between Laydon & 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 dated April 30, 2001(No.
333-59824))
|
| 10.8 |
Lease
dated August 2, 2002 between 469 West Main Street LLC and The Bank
of
Southern Connecticut (incorporated by reference to Exhibit 10.17
to the
Issuer’s Form 10-KSB dated March 30,
2004)
|
| 10.9 |
Lease
dated January 14, 2004 between The City of New London and the Registrant
(incorporated by reference to Exhibit 10.16 to the Issuer’s Form 10-KSB
dated March 30, 2004)
|
| 10.10 |
Purchase
Agreement dated June 22, 2004 between Dr. Alan Maris and James S.
Brownstein, Trustee relating to property and premises located at
51-53
West Main Street, Clinton, Connecticut (incorporated by reference
to
Exhibit 10.20 to the Issuer’s Form 10-QSB dated November 15,
2004)
|
| 10.11 |
Employment
Agreement dated as of January 23, 2001, among 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 dated
April 30, 2001(No. 333-59824))
|
| 10.12 |
Amendment
to Employment Agreement dated as of October 20, 2003 among the Issuer,
The
Bank of Southern Connecticut and Joseph V. Ciaburri (incorporated
by
reference to Exhibit 10.6 to the Issuer’s Registration Statement on Form
SB-2 dated April 30, 2001(No.
333-59824))
|
| 10.13 |
Amendment
to Employment Agreement dated as of January 20, 2005, among the Issuer
The
Bank of Southern Connecticut and Michael M. Ciaburri (incorporated
by
reference to Exhibit 10.13 to the Issuer’s Annual Report on Form 10-KSB
dated March 28, 2005)
|
| 10.14 |
Issuer’s
2001 Stock Option Plan (incorporated by reference to Exhibit 10.8
to the
Issuer’s Registration Statement on Form SB-2 dated April 30, 2001(No.
333-59824))
|
33
| 10.15 |
Issuer’s
2001 Warrant Plan (incorporated by reference to Exhibit 10.9 to the
Issuer’s Registration Statement on Form SB-2 dated April 30, 2001(No.
333-59824))
|
| 10.16 |
Issuer’s
2001 Supplemental Warrant Plan (incorporated by reference to Exhibit
10.12
to the Issuer’s Annual Report on Form 10-KSB dated March 28,
2002)
|
| 10.17 |
Issuer’s
2002 Stock Option Plan (incorporated by reference to Appendix B to
the
Issuer’s Definitive Proxy Statement dated April 18,
2002)
|
| 10.18 |
Form
of Stock Option Agreement for Non-qualified Stock Option granted
under the
Issuer’s 2002 Stock Option Plan (incorporated by reference to the Issuer’s
Form 10-QSB dated November 15,
2004)
|
| 10.19 |
Form
of Stock Option Agreement for Incentive Stock Option granted under
the
Issuer’s 2002 Stock Option Plan (incorporated by reference to the Issuer’s
Form 10-QSB dated November 15,
2004)
|
| 10.20 |
Underwriting
agreement dated June 16, 2004 among A.G.Edwards & Sons, Inc. and
Keefe, Bruyette & Woods, and the Issuer (incorporated by reference to
Exhibit 1.1 to the Issuer’s Registration Statement on Form SB-2 (no.
333-598824))
|
| 10.21 |
Employment
Agreement dated October 26, 2005, by and among Registrant, and The
Bank of
Southern Connecticut and John H. Howland (incorporated by reference
to the
Issuer’s Form 8-K filed October 31,
2005)
|
| 14 |
Amended
and Restated Code of Ethics (incorporated by reference to Exhibit
14 to
the Issuer’s Form 10-KSB dated March 30,
2004)
|
|
21
|
Subsidiaries
(incorporated by reference to Exhibit 21 to the Issuer’s form 10-KSB dated
March 31, 2003)
|
34
| 99.1 |
2005
Stock Option and Award Plan (incorporated by reference to Exhibit
99.1 to
the Issuer’s form S-8 dated January 13,
2006)
|
| 99.2 |
Common
Stock Award Agreement (incorporated by reference to Exhibit 99.2
to the
Issuer’s form S-8 dated January 13,
2006)
|
Item
14. Principal
Accountant Fees and Services.
McGladrey
& Pullen, LLP and RSM McGladrey, Inc., provide audit, audit related and tax
advisory and tax return preparation services for Bancorp and The Bank of
Southern Connecticut. The following table summarizes the fees provided in 2006
and 2005, respectively:
|
2006
|
2005
|
||||||
|
Audit
fees
|
$
|
145,157
|
$
|
134,774
|
|||
|
Audit
Related Fees
|
NONE
|
4,500
|
|||||
|
Tax
fees
|
10,575
|
8,575
|
|||||
|
All
Other fees
|
NONE
|
NONE
|
|||||
Audit
fees consist of fees for professional services rendered for the audit of the
consolidated financial statements, review of financial statements included
in
quarterly reports included on Form 10-QSB, and services connected with statutory
and regulatory filings or engagements including, in 2006, fees in connection
with the 2006 registration statement filed on Form
S-8.
Audit related fees are principally for consultations on various accounting
and
reporting
matters.
Tax service fees consist of fees for tax return preparation for
Bancorp.
The
audit
committee of Bancorp’s Board of Directors has established policies and
procedures for the engagement of the independent auditor to provide non-audit
services, including a requirement for approval in advance of all non-audit
services to be provided by the independent auditor. To ensure that this does
not
restrict access to the independent accountant by management on matters where
the
advice and consultation of the independent auditor is sought by management
and
such advice or consultation, in the opinion of management, cannot practically
be
delayed pending preapproval by the audit committee, the committee authorizes
management to use their judgment and retain the independent accountant for
such
matters and consider such services to be preapproved provided the estimated
cost
of such services does not exceed 5% of the annual fees paid to the independent
accountant and such services are formally approved by the audit committee at
its
next meeting.
35
SIGNATURES
In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto
duly
authorized.
SOUTHERN
CONNECTICUT BANCORP, INC.
(Registrant)
By:
/S/
Joseph V. Ciaburri
Name:
Joseph V. Ciaburri
Title:
Chairman and Chief Executive Officer
Date:
March
28, 2007
In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in capacities and on the
dates
indicated.
|
/S/
Joseph V. Ciaburri
|
March
28, 2007
|
|
Joseph
V. Ciaburri
|
Date
|
|
Chairman,
Chief Executive Officer and Director
|
|
|
/S/
Elmer F. Laydon
|
March
28, 2007
|
|
Elmer
F. Laydon
|
Date
|
|
Vice
Chairman and Director
|
|
|
/S/
Michael M. Ciaburri
|
March
28, 2007
|
|
Michael
M. Ciaburri
|
Date
|
|
President,
Chief Operating Officer and Director
|
|
|
/S/
Joshua H. Sandman, Ph.D.
|
March
28, 2007
|
|
Joshua
H. Sandman
|
Date
|
|
Director
|
|
|
/S/
Alphonse F. Spadaro, Jr.
|
March
28, 2007
|
|
Alphonse
F. Spadaro, Jr.
|
Date
|
|
Director
|
|
36
|
/S/Juan
Miguel Salas-Romer
|
March
28, 2007
|
|
Juan
Miguel Salas-Romer
|
Date |
|
Director
|
|
|
/S/
Carlota I. Grate
|
March
28, 2007
|
|
Carlota
I. Grate
|
Date
|
|
Senior
Vice President, Chief Financial Officer
|
|
|
/S/
Anthony M. Avellani
|
March
28, 2007
|
|
Anthony
M. Avellani
|
Date
|
|
Vice
President, Chief Accounting Officer
|
37
Exhibit
Index
Exhibit
No. Description
|
3(i)
|
Amended
and Restated Certificate of Incorporation of the Issuer (incorporated
by
reference to Exhibit 3(i) to the 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 dated April 30, 2001(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 dated April 30, 2001(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 dated April 30, 2001(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 dated April 30, 2001(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 dated April 30, 2001(No.
333-59824))
|
| 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 dated April 30, 2001(No.
333-59824))
|
| 10.6 |
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 dated
April 30, 2001(No. 333-59824))
|
| 10.7 |
Sublease
dated January 1, 2001 between Laydon & 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 dated April 30, 2001(No.
333-59824))
|
| 10.8 |
Lease
dated August 2, 2002 between 469 West Main Street LLC and The Bank
of
Southern Connecticut (incorporated by reference to Exhibit 10.17
to the
Issuer’s Form 10-KSB dated March 30,
2004)
|
| 10.9 |
Lease
dated January 14, 2004 between The City of New London and the Registrant
(incorporated by reference to Exhibit 10.16 to the Issuer’s Form 10-KSB
dated March 30, 2004)
|
| 10.10 |
Purchase
Agreement dated June 22, 2004 between Dr. Alan Maris and James
S.
Brownstein, Trustee relating to property and premises located at
51-53
West Main Street, Clinton, Connecticut (incorporated by reference
to
Exhibit 10.20 to the Issuer’s Form 10-QSB dated November 15,
2004)
|
38
| 10.11 |
Employment
Agreement dated as of January 23, 2001, among 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 dated
April 30, 2001(No. 333-59824))
|
| 10.12 |
Amendment
to Employment Agreement dated as of October 20, 2003 among the
Issuer, The
Bank of Southern Connecticut and Joseph V. Ciaburri (incorporated
by
reference to Exhibit 10.6 to the Issuer’s Registration Statement on Form
SB-2 dated April 30, 2001(No.
333-59824))
|
| 10.13 |
Amendment
to Employment Agreement dated as of January 20, 2005, among the
Issuer The
Bank of Southern Connecticut and Michael M. Ciaburri (incorporated
by
reference to Exhibit 10.13 to the Issuer’s Annual Report on Form 10-KSB
dated March 28, 2005)
|
| 10.14 |
Issuer’s
2001 Stock Option Plan (incorporated by reference to Exhibit 10.8
to the
Issuer’s Registration Statement on Form SB-2 dated April 30, 2001(No.
333-59824))
|
| 10.15 |
Issuer’s
2001 Warrant Plan (incorporated by reference to Exhibit 10.9 to
the
Issuer’s Registration Statement on Form SB-2 dated April 30, 2001(No.
333-59824))
|
| 10.16 |
Issuer’s
2001 Supplemental Warrant Plan (incorporated by reference to Exhibit
10.12
to the Issuer’s Annual Report on Form 10-KSB dated March 28,
2002)
|
| 10.17 |
Issuer’s
2002 Stock Option Plan (incorporated by reference to Appendix B
to the
Issuer’s Definitive Proxy Statement dated April 18,
2002)
|
| 10.18 |
Form
of Stock Option Agreement for Non-qualified Stock Option granted
under the
Issuer’s 2002 Stock Option Plan (incorporated by reference to the Issuer’s
Form 10-QSB dated November 15,
2004)
|
| 10.19 |
Form
of Stock Option Agreement for Incentive Stock Option granted under
the
Issuer’s 2002 Stock Option Plan (incorporated by reference to the Issuer’s
Form 10-QSB dated November 15,
2004)
|
| 10.20 |
Underwriting
agreement dated June 16, 2004 among A.G.Edwards & Sons, Inc. and
Keefe, Bruyette & Woods, and the Issuer (incorporated by reference to
Exhibit 1.1 to the Issuer’s Registration Statement on Form SB-2 (no.
333-598824))
|
| 10.21 |
Employment
Agreement dated October 26, 2005, by and among Registrant, and
The Bank of
Southern Connecticut and John H. Howland (incorporated by reference
to the
Issuer’s Form 8-K filed October 31,
2005)
|
| 14 |
Amended
and Restated Code of Ethics (incorporated by reference to Exhibit
14 to
the Issuer’s Form 10-KSB dated March 30,
2004)
|
39
|
21
|
Subsidiaries
(incorporated by reference to Exhibit 21 to the Issuer’s form 10-KSB dated
March 31, 2003)
|
| 99.1 |
2005
Stock Option and Award Plan (incorporated by reference to Exhibit
99.1 to
the Issuer’s form S-8 dated January 13,
2006)
|
| 99.2 |
Common
Stock Award Agreement (incorporated by reference to Exhibit 99.2
to the
Issuer’s form S-8 dated January 13,
2006)
|
40
FINANCIAL
STATEMENTS
December
31, 2006 and 2005
CONTENTS
|
|
|
|
CONSOLIDATED
FINANCIAL STATEMENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
.
REPORT
OF INDEPENDENT REGISTERED
PUBLIC
ACCOUNTING FIRM
To
the
Board of Directors
Southern
Connecticut Bancorp, Inc. and Subsidiaries
New
Haven, Connecticut
We
have
audited the accompanying consolidated balance sheets of Southern Connecticut
Bancorp, Inc. and Subsidiaries (the “Company”) as of December 31, 2006 and 2005,
and the related consolidated statements of operations, shareholders’ equity and
cash flows for the years then ended. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Southern Connecticut
Bancorp, Inc. and Subsidiaries as of December 31, 2006 and 2005, and the results
of their operations and their cash flows for the years then ended, in conformity
with U.S. generally accepted accounting principles.
As
discussed in Note 1 to the consolidated financial statements, the Company
adopted SFAS No. 123(R), Share-Based payment, on January 1, 2006.
/s/
McGladrey & Pullen, LLP
New
Haven, Connecticut
March
27,
2007
McGladrey
& Pullen, LLP is a member firm of RSM International,
an
affiliation of separate and independent legal entities.
F-2
| SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARIES | ||||||||||
| CONSOLIDATED BALANCE SHEETS | ||||||||||
| December 31, 2006 and 2005 | ||||||||||
|
2006
|
2005
|
|||||||||
|
ASSETS
|
|
|||||||||
|
Cash
and due from banks (Note 2)
|
$
|
5,821,084
|
$
|
966,732
|
||||||
|
Federal
funds sold
|
22,700,000
|
9,579,000
|
||||||||
|
Short-term
investments
|
6,288,663
|
6,023,555
|
||||||||
|
Cash
and cash equivalents
|
34,809,747
|
16,569,287
|
||||||||
|
Available
for sale securities (at fair value) (Note 3)
|
8,054,821
|
9,973,488
|
||||||||
|
Federal
Home Loan Bank stock (Note 7)
|
66,100
|
60,000
|
||||||||
|
Loans
held for sale
|
118,223
|
401,503
|
||||||||
|
Loans
receivable (net of allowance for loan losses: 2006
$1,062,661;
|
||||||||||
|
2005 $778,051) (Note 4)
|
75,306,255
|
55,881,508
|
||||||||
|
Accrued
interest receivable
|
467,698
|
324,346
|
||||||||
|
Premises
and equipment, net (Note 5)
|
4,424,828
|
4,457,715
|
||||||||
|
Other
assets (Note 5)
|
1,014,873
|
906,387
|
||||||||
|
Total
assets
|
$
|
124,262,545
|
$
|
88,574,234
|
||||||
|
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
||||||||||
|
Liabilities
|
||||||||||
|
Deposits (Note 6)
|
||||||||||
|
Noninterest bearing deposits
|
$
|
29,463,030
|
$
|
18,091,849
|
||||||
|
Interest bearing deposits
|
71,810,490
|
47,187,667
|
||||||||
|
Total
deposits
|
101,273,520
|
65,279,516
|
||||||||
|
Repurchase
agreements
|
883,603
|
1,363,368
|
||||||||
|
Capital
lease obligations (Note 8)
|
1,188,128
|
1,189,212
|
||||||||
|
Accrued
expenses and other liabilities
|
585,445
|
445,295
|
||||||||
|
Total
liabilities
|
103,930,696
|
68,277,391
|
||||||||
|
Commitments
and Contingencies (Notes 7, 8, 10, 12, and 15)
|
||||||||||
|
Shareholders'
Equity (Notes 10 and 13)
|
||||||||||
|
Common stock, par value $.01; shares authorized: 5,000,000;
|
||||||||||
|
shares issued and outstanding: 2006 2,941,297; 2005
2,937,525
|
29,413
|
29,375
|
||||||||
|
Additional
paid-in capital
|
24,147,883
|
24,083,638
|
||||||||
|
Accumulated
deficit
|
(3,595,370
|
)
|
(3,477,576
|
)
|
||||||
|
Accumulated
other comprehensive loss - net unrealized loss on
|
||||||||||
|
available for sale securities
|
(250,077
|
)
|
(338,594
|
)
|
||||||
|
Total
shareholders' equity
|
20,331,849
|
20,296,843
|
||||||||
|
Total
liabilities and shareholders' equity
|
$
|
124,262,545
|
$
|
88,574,234
|
||||||
|
See
Notes to Consolidated Financial Statements.
|
||||||||||
F-3
|
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
|
|||||||
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|||||||
|
For
the Years Ended December 31, 2006 and 2005
|
|||||||
|
2006
|
2005
|
||||||
|
Interest
Income:
|
|||||||
|
Interest and fees on loans
|
$
|
5,836,127
|
$
|
4,409,619
|
|||
|
Interest on securities
|
312,995
|
344,047
|
|||||
|
Interest on Federal funds sold and short-term investments
|
931,002
|
466,958
|
|||||
|
Total
interest income
|
7,080,124
|
5,220,624
|
|||||
|
Interest
Expense:
|
|||||||
|
Interest expense on deposits (Note 6)
|
2,029,578
|
963,088
|
|||||
|
Interest expense on capital lease obligations
|
174,683
|
173,138
|
|||||
|
Interest expense on repurchase agreements and other
borrowings
|
18,804
|
15,331
|
|||||
|
Total
interest expense
|
2,223,065
|
1,151,557
|
|||||
|
Net
interest income
|
4,857,059
|
4,069,067
|
|||||
|
Provision
for Loan Losses (Note 4)
|
253,495
|
216,329
|
|||||
|
Net
interest income after
|
|||||||
|
provision
for
loan losses
|
4,603,564
|
3,852,738
|
|||||
|
Noninterest
Income:
|
|||||||
|
Service charges and fees
|
471,540
|
332,996
|
|||||
|
Gains on sales of loans
|
147,084
|
105,703
|
|||||
|
Other noninterest income
|
185,442
|
168,001
|
|||||
|
Total
noninterest income
|
804,066
|
606,700
|
|||||
|
Noninterest
Expenses:
|
|||||||
|
Salaries and benefits
|
3,037,132
|
2,394,430
|
|||||
|
Occupancy and equipment
|
763,944
|
608,172
|
|||||
|
Professional services
|
449,167
|
612,430
|
|||||
|
Data processing and other outside services
|
357,465
|
313,912
|
|||||
|
Advertising and promotional expenses
|
223,911
|
145,923
|
|||||
|
Forms, printing and supplies
|
135,330
|
94,808
|
|||||
|
Other operating expenses
|
558,475
|
568,213
|
|||||
|
Total
noninterest expenses
|
5,525,424
|
4,737,888
|
|||||
|
Net
loss
|
$
|
(117,794
|
)
|
$
|
(278,450
|
)
|
|
|
Basic
and Diluted Loss per Share
|
$
|
(0.04
|
)
|
$
|
(0.09
|
)
|
|
|
See
Notes to Consolidated Financial Statements.
|
|||||||
F-4
|
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
|
|||||||||||||||||||
|
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS' EQUITY
|
|||||||||||||||||||
|
For
the Years Ended December 31, 2006 and 2005
|
|||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
||||||
|
|
|
Number
|
|
|
|
Additional
|
|
|
|
Other
|
|
|
|
||||||
|
|
|
of
Common
|
|
Common
|
|
Paid-In
|
|
Accumulated
|
|
Comprehensive
|
|
|
|
||||||
|
|
|
Shares
|
|
Stock
|
|
Capital
|
|
Deficit
|
|
Loss
|
|
Total
|
|||||||
|
Balance,
December 31, 2004
|
2,797,711
|
$
|
27,977
|
$
|
24,085,612
|
$
|
(3,199,126
|
)
|
$
|
(216,736
|
)
|
$
|
20,697,727
|
||||||
|
Comprehensive
loss:
|
|||||||||||||||||||
|
Net loss
|
-
|
-
|
-
|
(278,450
|
)
|
-
|
(278,450
|
)
|
|||||||||||
|
Unrealized holding loss on available for
|
|||||||||||||||||||
|
sale securities
|
-
|
-
|
-
|
-
|
(121,858
|
)
|
(121,858
|
)
|
|||||||||||
|
Total
comprehensive loss
|
(400,308
|
)
|
|||||||||||||||||
|
5%
stock dividend declared
|
|||||||||||||||||||
|
April 12, 2005 (Note 10)
|
139,814
|
1,398
|
(1,398
|
)
|
-
|
-
|
-
|
||||||||||||
|
Fractional
shares paid in cash
|
-
|
-
|
(576
|
)
|
-
|
-
|
(576
|
)
|
|||||||||||
|
Balance,
December 31, 2005
|
2,937,525
|
29,375
|
24,083,638
|
(3,477,576
|
)
|
(338,594
|
)
|
20,296,843
|
|||||||||||
|
Comprehensive
loss:
|
|||||||||||||||||||
|
Net loss
|
-
|
-
|
-
|
(117,794
|
)
|
-
|
(117,794
|
)
|
|||||||||||
|
Unrealized holding gain on available for
|
|||||||||||||||||||
|
sale securities
|
-
|
-
|
-
|
-
|
88,517
|
88,517
|
|||||||||||||
|
Total
comprehensive loss
|
(29,277
|
)
|
|||||||||||||||||
|
Directors
fees settled in common stock (Note 10)
|
3,772
|
38
|
26,851
|
-
|
-
|
26,889
|
|||||||||||||
|
Restricted
stock compensation (Note 10)
|
-
|
-
|
4,675
|
-
|
-
|
4,675
|
|||||||||||||
|
Stock
option compensation (Note 10)
|
-
|
-
|
32,719
|
-
|
-
|
32,719
|
|||||||||||||
|
Balance,
December 31, 2006
|
2,941,297
|
$
|
29,413
|
$
|
24,147,883
|
$
|
(3,595,370
|
)
|
$
|
(250,077
|
)
|
$
|
20,331,849
|
||||||
|
See
Notes to Consolidated Financial Statements.
|
|||||||||||||||||||
F-5
|
SOUTHERN
CONNECTICUT BANCORP, INC. AND
SUBSIDIARIES
|
|||||||
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|||||||
|
For
the Years Ended December 31, 2006 and 2005
|
|||||||
|
2006
|
|
2005
|
|||||
|
Cash
Flows From Operations
|
|||||||
|
Net loss
|
$
|
(117,794
|
)
|
$
|
(278,450
|
)
|
|
|
Adjustments to reconcile net loss to net cash provided by
|
|||||||
|
operating activities:
|
|||||||
|
Amortization
and accretion of premiums and discounts
|
|||||||
|
on investments, net
|
(1,792
|
)
|
(3,836
|
)
|
|||
|
Provision
for
loan losses
|
253,495
|
216,329
|
|||||
|
Share
based compensation
|
64,283
|
-
|
|||||
|
Loans
originated for sale, net of principal payments received
|
(1,046,500
|
)
|
(1,389,441
|
)
|
|||
|
Proceeds
from
sales of loans
|
1,389,980
|
1,192,383
|
|||||
|
Gains
on sales of loans
|
(147,084
|
)
|
(105,703
|
)
|
|||
|
Depreciation
and amortization
|
392,980
|
307,118
|
|||||
|
Increase
in
cash surrender value of life insurance
|
(39,678
|
)
|
(38,530
|
)
|
|||
|
Changes
in assets and liabilities:
|
|||||||
|
Decrease in deferred loan fees
|
(34,989
|
)
|
(18,716
|
)
|
|||
|
Increase in accrued interest receivable
|
(143,352
|
)
|
(58,765
|
)
|
|||
|
(Increase)
decrease in other assets
|
(68,808
|
)
|
18,921
|
||||
|
Increase in accrued expenses and other liabilities
|
140,150
|
165,873
|
|||||
|
Net
cash provided by operating activities
|
640,891
|
7,183
|
|||||
|
Cash
Flows From Investing Activities
|
|||||||
|
Principal repayments on available for sale securities
|
8,976
|
280,384
|
|||||
|
Proceeds from maturities of available for sale securities
|
2,000,000
|
1,000,000
|
|||||
|
Purchase of FHLB stock
|
(6,100
|
)
|
(12,900
|
)
|
|||
|
Net increase in loans receivable
|
(19,556,369
|
)
|
(6,315,169
|
)
|
|||
|
Purchases of premises and equipment
|
(360,093
|
)
|
(1,248,019
|
)
|
|||
|
Net
cash used in investing activities
|
(17,913,586
|
)
|
(6,295,704
|
)
|
|||
|
Cash
Flows From Financing Activities
|
|||||||
|
Net increase in demand, savings and money market deposits
|
18,921,092
|
4,011,728
|
|||||
|
Net increase in certificates of deposit
|
17,072,912
|
2,567,411
|
|||||
|
Net (decrease) increase in repurchase agreements
|
(479,765
|
)
|
536,337
|
||||
|
Principal repayments on capital lease obligations
|
(1,084
|
)
|
(974
|
)
|
|||
|
Distribution in cash for fractional shares of common stock
|
-
|
(576
|
)
|
||||
|
Net
cash provided by financing activities
|
35,513,155
|
7,113,926
|
|||||
|
Net
increase in cash and cash equivalents
|
18,240,460
|
825,405
|
|||||
|
Cash
and cash equivalents
|
|||||||
|
Beginning
|
16,569,287
|
15,743,882
|
|||||
|
Ending
|
$
|
34,809,747
|
$
|
16,569,287
|
|||
|
(Continued)
|
|||||||
F-6
|
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
|
|||||||
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS, Continued
|
|||||||
|
For
the Years Ended December 31, 2006 and 2005
|
|||||||
|
2006
|
2005
|
||||||
|
Supplemental
Disclosures of Cash Flow Information:
|
|||||||
|
Cash paid for:
|
|||||||
|
Interest
|
$
|
2,157,053
|
$
|
1,120,146
|
|||
|
Income
taxes
|
$
|
1,000
|
$
|
900
|
|||
|
Supplemental
Disclosures of Non-Cash Investing and Financing
Activities:
|
|||||||
|
Transfer of loans held for sale to loans receivable
|
$
|
86,884
|
$
|
-
|
|||
|
Unrealized
holding gains (losses) on available for sale securities
arising
|
|||||||
|
during the period
|
$
|
88,517
|
$
|
(121,858
|
)
|
||
|
See
Notes to Consolidated Financial Statements.
|
|||||||
F-7
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
| Note 1. |
Nature
of Operations and Summary of Significant Accounting
Policies
|
Southern
Connecticut Bancorp, Inc. (the “Company”), a Connecticut corporation, is a bank
holding company incorporated on November 8, 2000 and is 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 and New London Counties of Connecticut, through its main office
in
New Haven, Connecticut and four branch offices in New Haven, Branford, North
Haven and New London, Connecticut. In 2003, SCB Capital, Inc. was formed as
a
Connecticut corporation, and in 2004, the Company capitalized SCB Capital,
Inc.,
which became a subsidiary of the Company. SCB Capital, Inc., which is currently
inactive, will engage in a limited range of investment banking, advisory and
brokerage services, primarily with small and medium size business clients.
In
December 2006, TBSC Asset Liquidation, LLC was formed as a Connecticut
corporation, which became a subsidiary of the Company. TBSC Asset Liquidation,
LLC, which is currently inactive, will acquire, hold and liquidate
assets.
Principles
of consolidation and basis of financial statement presentation
The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries, and have been prepared in accordance with accounting
principles generally accepted in the United States of America and general
practices within the banking industry. All significant intercompany balances
and
transactions have been eliminated. In preparing the consolidated financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities, and disclosures of contingent
assets and liabilities as of the date of the balance sheet and the reported
amounts of income and expenses for the reporting period. Actual results could
differ from those estimates.
Significant
group concentrations of credit risk
Most
of
the Company’s activities are with customers located within the New Haven and New
London Counties of Connecticut. Note 3 discusses the types of securities that
the Company invests in and Note 4 discusses the types of lending that the
Company engages in. The Company does not have any significant concentrations
in
any one industry or customer.
The
following is a summary of the Company's significant accounting
policies.
Cash
and cash equivalents and statement of cash flows
Cash
and
due from banks, Federal funds sold, and short-term investments are recognized
as
cash equivalents in the statements of cash flows. Federal funds sold generally
mature in one day. For purposes of reporting cash flows, the Company considers
all highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents. Cash flows from loans, deposits, and
short-term borrowings are reported net. The Company maintains amounts due from
banks and Federal funds sold which, at times, may exceed Federally insured
limits. The Company has not experienced any losses from such
concentrations.
F-8
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Investments
in debt and marketable equity securities
Management
determines the appropriate classification of securities at the date individual
investment securities are acquired, and the appropriateness of such
classification is reassessed at each balance sheet date.
Debt
securities that management has the positive intent and ability to hold to
maturity are classified as “held to maturity” and recorded at amortized cost.
“Trading” securities, if any, are carried at fair value with unrealized gains
and losses recognized in earnings. Securities not classified as held to maturity
or trading, including equity securities with readily determinable fair values,
are classified as “available for sale” and recorded at fair value, with
unrealized gains and losses excluded from earnings and reported in other
comprehensive income, net of taxes.
Purchase
premiums and discounts are recognized in interest income using the interest
method over the terms of the securities. Declines in the fair value of held
to
maturity and available for sale securities below their cost that are deemed
to
be other than temporary are reflected in earnings as realized losses. In
estimating other-than-temporary impairment losses, management considers (1)
the
length of time and the extent to which the fair value has been less than cost,
(2) the financial condition and near-term prospects of the issuer, and (3)
the
intent and ability of the Company to retain its investment in the issuer for
a
period of time sufficient to allow for any anticipated recovery in fair value.
Gains and losses on the sale of securities are recorded on the trade date and
are determined using the specific identification method.
The
sale
of a held to maturity security within three months of its maturity date or
after
collection of at least 85% of the principal outstanding at the time the security
was acquired is considered a maturity for purposes of classification and
disclosure.
Loans
held for sale
Loans
held for sale are primarily the guaranteed portions of SBA loans the Company
has
the intent to sell in the foreseeable future, and are carried at the lower
of
aggregate cost or market value. Gains and losses on sales of loans are
determined by the difference between the sales proceeds and the carrying value
of the loans.
Transfers
of financial assets
Transfers
of financial assets are accounted for as sales when control over the assets
has
been surrendered. Control over transferred assets is deemed to be surrendered
when (1) the assets have been isolated from the Company, (2) the transferee
obtains the right to pledge or exchange the transferred assets and no condition
both constrains the transferee from taking advantage of that right and provides
more than a trivial benefit for the transferor, and (3) the transferor does
not
maintain effective control over the transferred assets through either (a) an
agreement that both entitles and obligates the transferor to repurchase or
redeem the assets before maturity or (b) the ability to unilaterally cause
the
holder to return specific assets, other than through a cleanup
call.
F-9
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Servicing
Servicing
assets are recognized as separate assets when rights are acquired through
purchase or through sale of financial assets. Generally, purchased servicing
rights are capitalized at the cost to acquire the rights. For sales of loans,
a
portion of the original cost of the loan is allocated to the servicing right,
and if the pass-through rate to the investor is less than the note rate,
to an
interest-only strip, based on relative fair value. Fair value is based on
a
valuation model that calculates the present value of estimated future net
servicing and interest income. The valuation model incorporates assumptions
that
market participants would use in estimating future net servicing and interest
income, such as the cost to service, the discount rate, the custodial earnings
rate, an inflation rate, ancillary income, prepayment speeds and default
rates
and losses. Capitalized servicing rights are reported in other assets and
are
amortized into non-interest income in proportion to, and over the period
of, the
estimated future net servicing income of the underlying financial assets.
Interest only strips are also reported in other assets and are amortized
into
other noninterest income under the same method as servicing
assets.
Servicing
assets and interest-only strips are evaluated for impairment based upon the
fair
value of the assets as compared to amortized cost. Impairment is determined
by
stratifying the assets into tranches based on predominant risk characteristics,
such as interest rate, loan type and investor type. Impairment is recognized
through a valuation allowance for an individual tranche, to the extent that
fair
value is less than the capitalized amount for the tranche. If the Company later
determines that all or a portion of the impairment no longer exists for a
particular tranche, a reduction of the allowance may be recorded as an increase
to income.
Servicing
fee income is recorded for fees earned for servicing loans. The fees are based
on a contractual percentage of the outstanding principal, or a fixed amount
per
loan, and are recorded as income when earned. The amortization of mortgage
servicing rights is netted against loan servicing fee income, and the
amortization of interest-only strips is netted against other noninterest
income.
Loans
receivable
Loans
receivable are stated at their current unpaid principal balances, net of the
allowance for loan losses and net deferred loan origination fees and costs.
The
Company has the ability and intent to hold its loans receivable for the
foreseeable future or until maturity or payoff.
Impaired
loans, if any, are measured based on the present value of expected future cash
flows discounted at the loan’s effective interest rate or, as a practical
expedient, at the loan’s observable market price or the fair value of the
collateral, if the loan is collateral dependent. The amount of impairment,
if
any, and any subsequent changes are recorded as adjustments to the allowance
for
loan losses. A loan is impaired when it is probable the Company will be unable
to collect all contractual principal and interest payments due in accordance
with the terms of the loan agreement.
A
loan is
classified as a restructured loan when certain concessions have been made to
the
original contractual terms, such as a reduction in interest rate or deferral
of
interest or principal payments, due to the borrower’s financial
condition.
Management
considers all nonaccrual loans, other loans past due 90 days or more, and
restructured loans to be impaired. In most cases, loan payments that are past
due less than 90 days, based on contractual terms, are considered minor
collection delays, and the related loans are not considered to be
impaired.
F-10
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Allowance
for loan losses
The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loans are
charged against the allowance when management believes the uncollectibility
of a
loan balance is confirmed. Subsequent recoveries, if any, are credited to the
allowance.
The
allowance for loan losses is evaluated on a regular basis by management and
is
based upon management’s periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower’s ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes
available.
The
allowance consists of specific, general and unallocated components. The specific
component relates to loans that are classified as either 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 if the loan is collateral dependent) of the impaired
loan is lower than the carrying value of that loan. The general component covers
non-classified 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.
Interest
and fees on loans
Interest
on loans is accrued and included in operating income based on contractual rates
applied to principal amounts outstanding. The accrual of interest income is
discontinued whenever reasonable doubt exists as to its collectibility and
generally is discontinued when loans are past due 90 days, based on contractual
terms, as to either principal or interest, or are otherwise considered impaired.
When the accrual of interest income is discontinued, all previously accrued
and
uncollected interest is reversed against interest income. The accrual of
interest on loans past due 90 days or more may be continued if the loan is
well
secured, and it is believed all principal and accrued interest income due on
the
loan will be realized, and the loan is in the process of collection. A
nonaccrual loan is restored to an accrual status when it is no longer delinquent
and collectibility of interest and principal is no longer in doubt.
Loan
origination fees, net of direct loan origination costs, are deferred and
amortized as an adjustment of the loan's yield generally over the contractual
life of the loan, utilizing the interest method.
Other
real estate owned
Other
real estate owned, if any, consists of properties acquired through, or in lieu
of, loan foreclosure or other proceedings and is initially recorded at fair
value at the date of foreclosure, which establishes a new cost basis. After
foreclosure, the properties are held for sale and are carried at the lower
of
cost or fair value less estimated costs of disposal. Any write-down to fair
value at the time of acquisition is charged to the allowance for loan losses.
Properties are evaluated regularly to ensure the recorded amounts are supported
by current fair values, and valuation allowances are recorded as necessary
to
reduce the carrying amount to fair value less estimated cost of disposal.
Revenue and expense from the operation of other real estate owned and valuation
allowances are included in operations. Costs relating to the development and
improvement of the property are capitalized, subject to the limit of fair value
of the collateral. Gains or losses are included in operations upon
disposal.
F-11
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Premises
and equipment
Premises
and equipment are stated at cost for purchased assets, and, for assets under
capital lease, at the lower of fair value or the net present value of the
minimum lease payments required over the term of the lease, net of accumulated
depreciation and amortization. Leasehold improvements are capitalized and
amortized over the shorter of the terms of the related leases or the estimated
economic lives of the improvements. Depreciation is charged to operations using
the straight-line method over the estimated useful lives of the related assets
which range from 3 to 20 years. Gains and losses on dispositions are recognized
upon realization. Maintenance and repairs are expensed as incurred and
improvements are capitalized.
Impairment
of long-lived assets
Long-lived
assets, including premises and equipment, which are held and used by the
Company, are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. If
impairment is indicated by that review, the asset is written down to its
estimated fair value through a charge to noninterest expense.
Repurchase
agreements
Repurchase
agreements, which are classified as secured borrowings, generally mature within
one to three days from the transaction date, and are reflected at the amount
of
cash received in connection with the transaction. The Company may be required
to
provide additional collateral based on the fair value of the underlying
securities.
Income
taxes
The
Company recognizes income taxes under the asset and liability method. Under
this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and loss carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized.
Stock
compensation plans
Effective
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 123 (revised 2004), Share-Based Payment, utilizing the modified
prospective transition method. Prior to the adoption of SFAS 123(R), Bancorp
accounted for stock option grants in accordance with APB Opinion No. 25,
Accounting for Stock Issued to Employees (the intrinsic value method), and
accordingly, recognized no compensation expense for stock option grants for
the
year ended December 31, 2005. Because there were no unvested share-based awards
at January 1, 2006, the adoption of this statement had no initial effect on
the
Company’s financial statements.
F-12
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
SFAS
123(R) requires the measurement and recognition of compensation expense for
all
share-base payment awards to employees and directors based on the grant-date
fair value of the awards and is recognized over the service period, which is
usually the vesting period.
On
December 22, 2005, the Compensation Committee of the Board of Directors approved
the acceleration of all unvested options, outstanding as of December 31, 2005,
granted under the Company’s 2002 Stock Option Plan, held by 48 employees and
directors. The decision to accelerate the vesting of all unvested options was
made primarily to reduce compensation expense that would have been recognized
in
future periods under SFAS 123(R). Pursuant to the acceleration of all unvested
options, options to purchase 197,571 shares of the Company’s common stock became
immediately exercisable as of December 31, 2005. The exercise prices for such
accelerated options range from $6.90 to $10.39 per share. As a result of
accelerating the vesting of these options, approximately $300,000 of
compensation expense, before taxes, that would have been recorded in 2006
through 2008 under SFAS 123(R), is reflected as 2005 pro forma compensation
expense in the table below. There was no impact to the 2005 financial statements
resulting from this action.
Had
compensation cost for issuance of such options been recognized based on the
fair
values of awards on the grant dates, in accordance with the method described
in
SFAS No. 123(R), reported net loss and per share amounts for 2005 would have
been increased to the pro forma amounts shown below:
|
2005
|
||||
|
Net
loss as reported
|
$
|
(278,450
|
)
|
|
|
Add:
total stock based employee
|
||||
|
compensation expense included in reported net loss
|
-
|
|||
|
Deduct:
total stock based employee
|
||||
|
compensation expense determined under fair value based
|
||||
|
method
for all awards
|
(605,242
|
)
|
||
|
Pro
forma net loss
|
$
|
(883,692
|
)
|
|
|
Basic
loss per share:
|
||||
|
As reported
|
$
|
(0.09
|
)
|
|
|
Pro
forma
|
$
|
(0.30
|
)
|
|
|
Diluted
loss per share:
|
||||
|
As reported
|
$
|
(0.09
|
)
|
|
|
Pro forma
|
$
|
(0.30
|
)
|
|
Related
party transactions
Directors
and officers of the Company and the Bank and their affiliates have been
customers of and have had transactions with the Bank, and it is expected that
such persons will continue to have such transactions in the future. Management
believes that all deposit accounts, loans, services and commitments comprising
such transactions were made in the ordinary course of business, and on
substantially the same terms, including interest rates, as those prevailing
at
the time for comparable transactions with other customers who are not directors
or officers. In the opinion of management, the transactions with related parties
did not involve more than normal risks of collectibility or favored treatment
or
terms, or present other unfavorable features. Notes 8 and 14 contain details
regarding related party transactions.
F-13
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Comprehensive
income
Accounting
principles generally require that recognized revenue, expenses, gains and losses
be included in net income. Although certain changes in assets and liabilities,
such as unrealized gains and losses on available for sale securities, are
reported as a separate component of the shareholders’ equity section of the
balance sheets, such items, along with net income or loss, are components of
comprehensive income.
Segment
Reporting
The
Company’s only business segment is Community Banking. During the periods
presented this segment represented all the revenues and income of the
consolidated group and therefore, is the only reported segment as defined by
SFAS No. 131, “Disclosures
about Segments of an Enterprise and Related Information.”
Fair
value of financial instruments
The
following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments.
Cash
and due from banks, Federal funds sold, short-term investments, accrued interest
receivable, accrued interest payable and repurchase
agreements
The
carrying amount is a reasonable estimate of fair value.
Securities
Fair
values, excluding restricted Federal Home Loan Bank stock, are based on quoted
market prices or dealer quotes, if available. If a quoted market price is not
available, fair value is estimated using quoted market prices for similar
securities. The carrying value of Federal Home Loan Bank stock approximates
fair
value based on the redemption provisions of the stock.
Loans
held for sale
The
fair
value is based on prevailing market prices.
Loans
receivable
For
variable rate loans which reprice frequently, and have no significant changes
in
credit risk, fair value is based on the loan’s carrying value. The fair value of
fixed rate loans is estimated by discounting the future cash flows using the
year-end rates at which similar loans would be made to borrowers.
F-14
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Servicing
assets
The
fair
value is based on market prices for comparable servicing contracts, when
available, or alternatively, is based on a valuation model that calculates
the
present value of estimated future net servicing income.
Interest
only strips
The
fair
value is based on a valuation model that calculates the present value of
estimated future cash flows.
Deposits
The
fair
value of demand deposits, regular savings and certain money market deposits
is
the amount payable on demand at the reporting date. The fair value of
certificates of deposit and other time deposits is estimated using a discounted
cash flow calculation that applies interest rates currently being offered for
deposits of similar remaining maturities to a schedule of aggregated expected
maturities on such deposits.
Off-balance-sheet
instruments
Fair
values for the Company’s off-balance-sheet instruments (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.
Recent
accounting pronouncements
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments,” which permits, but does not require, fair value
accounting for any hybrid financial instrument that contains an embedded
derivative that would otherwise require bifurcation in accordance with SFAS
133,
“Accounting for Derivative Instruments and Hedging Activities.” The statement
also subjects beneficial interests in securitized financial assets to the
requirements of SFAS 133. This statement is effective for all financial
instruments acquired, issued, or subject to re-measurement after December 31,
2006. The Company does not expect that the adoption of this statement will
have
a material impact on its financial statements.
In
March
2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets, an Amendment of FASB Statement No. 140.” The statement amends SFAS No.
140 by (1) requiring the separate accounting for servicing assets and servicing
liabilities, which arise from the sale of financial assets; (2) requiring all
separately recognized servicing assets and servicing liabilities to be
initially measured at fair value, if practicable; and (3) permitting an entity
to choose between an amortization method or a fair value method for subsequent
measurement for each class of separately recognized servicing assets and
servicing liabilities. This statement is effective for fiscal years beginning
after September 15, 2006. The Company does not expect that the adoption of
this
statement will have a material impact on its financial statements.
In
July
2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement 109.” FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with FASB Statement No. 109,
“Accounting for Income Taxes.” FIN 48 prescribes a comprehensive model for
recognizing, measuring, presenting and disclosing in the financial statements
tax positions taken or expected to be taken on a tax return. FIN 48 is effective
for fiscal years beginning after December 15, 2006. If there are changes in
net
assets as a result of application of FIN 48 these will be accounted for as
an
adjustment to retained earnings. The Company is required to adopt FIN 48 in
the
first quarter of 2007 and is currently assessing the impact of FIN 48 on its
financial statements.
F-15
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This
statement defines fair value, establishes a framework for measuring fair value,
and expands disclosures about fair value measurements. It clarifies that fair
value is the price that would be received to sell an asset or paid to transfer
a
liability in an orderly transaction between market participants in the market
in
which the reporting entity operates. This statement does not require any new
fair value measurements, but rather, it provides enhanced guidance to other
pronouncements that require or permit assets or liabilities to be measured
at
fair value. This statement is effective for fiscal years beginning after
November 15, 2007, with earlier adoption permitted. The Company does not expect
that the adoption of this statement will have a material impact on its financial
statements.
At
its
September 2006 meeting, the Emerging Issues Task Force (“EITF”) reached a final
consensus on Issue 06-04, “Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements.” The consensus stipulates that an agreement by an employer to
share a portion of the proceeds of a life insurance policy with an employee
during the postretirement periods is a postretirement benefit arrangement
required to be accounted for under SFAS No. 106 or Accounting Principles Board
Opinion (“APB”) No. 12, “Omnibus Opinion - 1967.” The consensus concludes that
the purchase of a split-dollar life insurance policy does not constitute a
settlement under SFAS No. 106 and, therefore, a liability for the postretirement
obligation must be recognized under SFAS No. 106 if the benefit is offered
under
an arrangement that constitutes a plan, or under APB No. 12 if it is not part
of
a plan. Issue 06-04 is effective for annual or interim reporting periods
beginning after December 15, 2007. At this time, management believes this
statement will have no effect on the Company’s financial
statements.
Reclassifications
Certain
2005 amounts have been reclassified to conform with the 2006 presentation,
and
such reclassifications had no effect on 2005 net loss or shareholders’
equity.
| Note 2. |
Restrictions
on Cash and Cash
Equivalents
|
The
Company is required to maintain reserves against its respective transaction
accounts and non-personal time deposits. At December 31, 2006 and 2005, the
Company was required to have cash and liquid assets of approximately $582,000
and $435,000, respectively, to meet these requirements. In addition, at both
December 31, 2006 and 2005, the Company was required to maintain $125,000 in
the
Federal Reserve Bank for clearing purposes.
F-16
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
| 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 December 31, 2006 and 2005
are
as follows:
|
|
|
Gross
|
|
Gross
|
|
|
|
||||||
|
|
|
Amortized
|
|
Unrealized
|
|
Unrealized
|
|
Fair
|
|
||||
|
2006
|
|
Cost
|
|
Gains
|
|
Losses
|
|
Value
|
|||||
|
U.S.
Government Sponsored Agency
|
$
|
8,199,467
|
$
|
-
|
$
|
(247,627
|
)
|
$
|
7,951,840
|
||||
|
obligations
|
|||||||||||||
|
Mortgage-backed
securities
|
105,431
|
-
|
(2,450
|
)
|
102,981
|
||||||||
|
$
|
8,304,898
|
$
|
-
|
$
|
(250,077
|
)
|
$
|
8,054,821
|
|||||
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
||
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
2005
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
U.S.
Government Sponsored Agency
|
$
|
10,197,667
|
$
|
-
|
$
|
(337,415
|
)
|
$
|
9,860,252
|
||||
|
obligations
|
|||||||||||||
|
Mortgage-backed
securities
|
114,415
|
-
|
(1,179
|
)
|
113,236
|
||||||||
|
$
|
10,312,082
|
$
|
-
|
$
|
(338,594
|
)
|
$
|
9,973,488
|
|||||
F-17
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
The
following table presents the Company’s available for sale securities’ gross
unrealized losses and fair value, aggregated by the length of time the
individual securities have been in a continuous loss position, at December
31,
2006 and 2005 are as follows:
|
Less
Than 12 Months
|
|
12
Months or More
|
|
Total
|
|
||||||||||||||
|
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
||||||
|
2006
|
|
Value
|
|
Loss
|
|
Value
|
|
Loss
|
|
Value
|
|
Loss
|
|
||||||
|
U.S.
Government
|
|||||||||||||||||||
|
Sponsored Agency
|
|||||||||||||||||||
|
obligations
|
$
|
-
|
$
|
-
|
$
|
7,951,840
|
$
|
247,627
|
$
|
7,951,840
|
$
|
247,627
|
|||||||
|
Mortgage-backed
|
|||||||||||||||||||
|
securities
|
-
|
-
|
102,981
|
2,450
|
102,981
|
2,450
|
|||||||||||||
|
Totals
|
$
|
-
|
$
|
-
|
$
|
8,054,821
|
$
|
250,077
|
$
|
8,054,821
|
$
|
250,077
|
|||||||
|
|
Less
Than 12 Months
|
|
|
12
Months or More
|
|
|
Total
|
|
|||||||||||
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
2005
|
|
|
Value
|
|
|
Loss
|
|
|
Value
|
|
|
Loss
|
|
|
Value
|
|
|
Loss
|
|
|
U.S.
Government
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
Sponsored Agency
|
|||||||||||||||||||
|
obligations
|
$
|
2,948,130
|
$
|
50,865
|
$
|
6,912,122
|
$
|
286,550
|
$
|
9,860,252
|
$
|
337,415
|
|||||||
|
Mortgage-backed
|
|||||||||||||||||||
|
securities
|
-
|
-
|
113,236
|
1,179
|
113,236
|
1,179
|
|||||||||||||
|
Totals
|
$
|
2,948,130
|
$
|
50,865
|
$
|
7,025,358
|
$
|
287,729
|
$
|
9,973,488
|
$
|
338,594
|
|||||||
At
December 31, 2006 and 2005, the Company had 14 and 16 available for sale
securities in an unrealized loss position, respectively. Management believes
that none of the unrealized losses on available for sale securities are other
than temporary because all of the unrealized losses in the Company’s investment
portfolio are due to market interest rate changes related to debt and
mortgage-backed securities issued by U.S. Government sponsored agencies, which
the Company has both the intent and the ability to hold until maturity or until
the fair value fully recovers. In addition, management considers the issuers
of
the securities to be financially sound and the Company will receive all
contractual principal and interest related to these investments.
The
amortized cost and fair value of available for sale debt securities at December
31, 2006 by contractual maturity are presented below. Actual maturities of
mortgage-backed securities may differ from contractual maturities because the
mortgages underlying the securities may be called or repaid without any
penalties.
F-18
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Because mortgage-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following summary:
|
Amortized
|
|
Fair
|
|
|||||||
|
|
|
|
|
Cost
|
|
Value
|
||||
|
Maturity:
|
|
|||||||||
|
Within
one year
|
$
|
2,499,608
|
$
|
2,457,650
|
||||||
|
After
1 but within 5 years
|
3,400,000
|
3,324,162
|
||||||||
|
After
5 but within 10 years
|
1,799,859
|
1,698,688
|
||||||||
|
Over
10 years
|
500,000
|
471,340
|
||||||||
|
Mortgage-backed
securities
|
105,431
|
102,981
|
||||||||
|
$
|
8,304,898
|
$
|
8,054,821
|
|||||||
At
December 31, 2006 and 2005, available for sale securities with a carrying value
of $4,521,653 and $4,501,168, respectively, were pledged as collateral under
repurchase agreements with Bank customers and to secure public
deposits.
There
were no sales of available for sale securities in 2006 and 2005.
| Note 4. |
Loans
Receivable and Allowance for Loan
Losses
|
|
A
summary of the Company's loan portfolio at December 31, 2006 and
2005 is
as follows:
|
|||||||
|
2006
|
2005
|
||||||
|
Commercial
loans secured by real estate
|
$
|
32,004,940
|
$
|
26,724,972
|
|||
|
Commercial
loans
|
39,621,667
|
25,852,655
|
|||||
|
Construction
and land loans
|
3,253,511
|
2,573,809
|
|||||
|
Residential
mortgages
|
149,358
|
155,909
|
|||||
|
Consumer
home equity loans
|
603,394
|
750,114
|
|||||
|
Consumer
installment loans
|
806,026
|
707,069
|
|||||
|
Total
loans
|
76,438,896
|
56,764,528
|
|||||
|
Net
deferred loan fees
|
(69,980
|
)
|
(104,969
|
)
|
|||
|
Allowance
for loan losses
|
(1,062,661
|
)
|
(778,051
|
)
|
|||
|
Loans
receivable, net
|
$
|
75,306,255
|
$
|
55,881,508
|
|||
F-19
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
The
Company services certain loans that it has sold without recourse to third
parties. The aggregate of loans serviced for others approximated $5,673,000
and
$6,332,000 as of December 31, 2006 and 2005, respectively.
The
balance of capitalized servicing rights, included in other assets at December
31, 2006 and 2005, was $60,448 and $56,568, respectively. No impairment charges
related to servicing rights were recognized during the years ended December
31,
2006 and 2005.
The
changes in the allowance for loan losses for the years ended December 31, 2006
and 2005 are as follows:
|
2006
|
2005
|
||||||
|
Balance,
beginning of year
|
$
|
778,051
|
$
|
752,394
|
|||
|
Provision
for
loan losses
|
253,495
|
216,329
|
|||||
|
Recoveries
of
loans previously charged-off
|
68,182
|
4,714
|
|||||
|
Loans
charged-off
|
(37,067
|
)
|
(195,386
|
)
|
|||
|
Balance,
end of year
|
$
|
1,062,661
|
$
|
778,051
|
|||
At
December 31, 2006 and 2005, the unpaid principal balances of loans placed on
nonaccrual status were $301,833 and $578,826, respectively. At December 31,
2006
and 2005, there were no loans delinquent 90 days or more and still accruing
interest.
The
following information relates to impaired loans as of and for the years ended
December 31, 2006 and 2005:
|
2006
|
2005
|
||||||
|
Impaired
loans for which there is a specific allowance
|
$
|
215,420
|
$
|
38,436
|
|||
|
Impaired
loans for which there is no specific allowance
|
$
|
86,413
|
$
|
540,390
|
|||
|
Allowance
for loan losses related to impaired loans
|
$
|
112,431
|
$
|
38,436
|
|||
|
Average
recorded investment in impaired loans
|
$
|
249,298
|
$
|
454,884
|
|||
Interest
income collected and recognized on impaired loans was $65,051 and $16,771 in
2006 and 2005, respectively. If nonaccrual loans had been current throughout
their terms, additional interest income of approximately $26,600 and $28,700
would have been recognized in 2006 and 2005, respectively. The Company has
no
commitments to lend additional funds to borrowers whose loans are
impaired.
The
Company’s lending activities are conducted principally in the New Haven and New
London Counties of Connecticut. The Company grants commercial and residential
real estate loans, commercial business loans and a variety of consumer loans.
In
addition, the Company may grant loans for the construction of residential homes,
residential developments and for land development projects. All residential
and
commercial mortgage loans are collateralized by first or second mortgages on
real estate. The ability and willingness of borrowers to satisfy their loan
obligations is dependent in large part upon the status of the regional economy
and regional real estate market. Accordingly, the ultimate collectibility of
a
substantial portion of any resulting real estate acquired is susceptible to
changes in market conditions.
F-20
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
The Company has established credit policies applicable to each type of lending activity in which it engages, evaluates the creditworthiness of each customer on an individual basis and, when deemed appropriate, obtains collateral. Collateral varies by each borrower and loan type. The market value of collateral is monitored on an ongoing basis and additional collateral is obtained when warranted. Important types of collateral include business assets, real estate, automobiles, marketable securities and time deposits. While collateral provides assurance as a secondary source of repayment, the Company ordinarily requires the primary source of repayment to be based on the borrower’s ability to generate continuing cash flows.
| Note 5. |
Premises
and Equipment
|
At
December 31, 2006 and 2005, premises and equipment consisted of the
following:
|
2006
|
2005
|
||||||
|
Land
|
$
|
533,187
|
$
|
533,187
|
|||
|
Premises
under capital lease
|
1,192,036
|
1,192,036
|
|||||
|
Buildings
and improvements
|
926,414
|
908,286
|
|||||
|
Leasehold
improvements
|
1,510,627
|
852,647
|
|||||
|
Furniture
and fixtures
|
694,553
|
447,410
|
|||||
|
Equipment
|
850,302
|
630,771
|
|||||
|
Software
|
81,510
|
70,701
|
|||||
|
Construction
in process
|
-
|
793,498
|
|||||
|
5,788,629
|
5,428,536
|
||||||
|
Less
accumulated depreciation and amortization
|
(1,363,801
|
)
|
(970,821
|
)
|
|||
|
$
|
4,424,828
|
$
|
4,457,715
|
||||
For
the
years ended December 31, 2006 and 2005, depreciation and amortization expense
related to premises and equipment totaled $392,980 and $307,118,
respectively.
Premises
under capital lease of $1,192,036, and related accumulated amortization of
$284,496 and $224,894, as of December 31, 2006 and 2005, respectively, are
included in premises and equipment.
F-21
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
| Note 6. |
Deposits
|
|
At
December 31, 2006 and 2005, deposits consisted of the
following:
|
|||||||
|
2006
|
2005
|
||||||
|
Noninterest
bearing
|
$
|
29,463,030
|
$
|
18,091,849
|
|||
|
Interest
bearing:
|
|||||||
|
Checking
|
4,985,187
|
6,175,953
|
|||||
|
Money
Market
|
36,324,952
|
27,001,393
|
|||||
|
Savings
|
2,107,354
|
2,690,236
|
|||||
|
Time
certificates, less than $100,000
|
14,190,207
|
4,498,286
|
|||||
|
Time
certificates, $100,000 or more
|
14,202,790
|
6,821,799
|
|||||
|
Total
interest bearing
|
71,810,490
|
47,187,667
|
|||||
|
Total
deposits
|
$
|
101,273,520
|
$
|
65,279,516
|
|||
Contractual
maturities of time certificates of deposit as of December 31, 2006 are
summarized below:
|
Due
within:
|
||||
|
1
year
|
$
|
22,099,671
|
||
|
1-2
years
|
1,897,707
|
|||
|
2-3
years
|
1,847,988
|
|||
|
3-4
years
|
371,218
|
|||
|
4-5
years
|
2,176,413
|
|||
|
$
|
28,392,997
|
|||
Interest
expense on certificates of deposit in denominations of $100,000 or more
was
$383,531 and $184,137 for
the
years ended December 31, 2006 and 2005, respectively.
| Note 7. |
Commitments
|
Federal
Home Loan Bank borrowings and stock
The
Bank
is a member of the Federal Home Loan Bank of Boston (“FHLB”). At December 31,
2006 and 2005, the Bank had the ability to borrow from the FHLB based on a
certain percentage of the value of the Bank’s qualified collateral, as defined
in the FHLB Statement of Products Policy, at the time of the borrowing. In
accordance with an agreement with the FHLB, the qualified collateral must be
free and clear of liens, pledges and encumbrances. There were no borrowings
outstanding with the FHLB at December 31, 2006 and 2005.
The
Bank
is required to maintain an investment in capital stock of the FHLB in an amount
equal to a percentage of its outstanding mortgage loans and contracts secured
by
residential properties, including mortgage-backed securities. No ready market
exists for FHLB stock and it has no quoted market value. For disclosure
purposes, such stock is assumed to have a market value which is equal to cost
since the Bank can redeem the stock with FHLB at cost.
F-22
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Employment
agreements
The
Company entered into an employment agreement (the “Chairman Agreement”) with the
Chairman and Chief Executive Officer of the Company and the Bank with an initial
term of five years beginning October 1, 2001, which may be extended for
additional one-year terms at the end of the initial term. In October 2003,
the
Company amended the Chairman Agreement to extend the initial five-year term
by
one year. On March 1, 2007, the Company amended the Chairman Agreement as
follows:
| · |
The
Amendment shortens the term of the employment agreement so that the
employment agreement will expire on June 30, 2007 instead of December
31,
2007.
|
| · |
On
June 30, 2007, the Chairman will resign as Chairman and Chief Executive
Officer of the Company and the
Bank.
|
| · |
The
Amendment eliminates the automatic renewal provision that was previously
contained in the employment
agreement.
|
| · |
The
Amendment eliminates the requirement that the Company enter into
a
consulting agreement with the Chairman upon the termination of his
employment.
|
| · |
The
Amendment provides that the Chairman will continue to receive his
current
base salary through June 30, 2007.
|
| · |
The
Amendment provides that the Chairman has the right to exchange the
115,000
stock options that he currently holds for a number of shares of stock
to
be mutually agreed upon at a later
date.
|
In
the
event of the early termination of the Chairman for any reason other than cause,
the Company would be obligated to compensate the Chairman, in accordance with
the terms of the Chairman Agreement, through the full term of the Chairman
Agreement. Further, in the event the Chairman’s position shall end or his
responsibilities be significantly reduced as a result of a business combination
(as defined), the Chairman will be entitled to a lump sum payment equal to
three
times his then current annual compensation.
On
March
1, 2007, the Company also entered into a consulting agreement (the “Consulting
Agreement”) with the Chairman. The term of the Consulting Agreement begins on
July 1, 2007 and ends on December 31, 2010. The Consulting Agreement provides
that the Chairman will serve as a good will ambassador and a director of the
Company. The Chairman’s duties under the agreement will be subject to the
directon of the Company’s board of directors. During the term of the Consulting
Agreement, the Chairman will be paid a fixed annual rate and will receive title
to a certain vehicle currently leased by the Bank. He will also receive office
space and secretarial and administrative support.
Also,
on
February 28, 2007, the Company entered into a new employment agreement (the
“President Agreement”) with the President of the Bank effective as of February
28, 2007, which replaces the President’s previous employment agreement that
became effective as of January 1, 2005. Under the President Agreement the
President will continue to serve as the President and Chief Operating Officer
of
the Company and the Bank until June 30, 2007. On and after July 1, 2007, the
President will serve as President and Chief Executive Officer of the Company
and
the Bank. The term of the Agreement ends on December 31, 2009 with an automatic
extension through December 31, 2010, unless the Company earlier terminates
the
President’s employment under the terms of the Agreement. The President will
receive a base salary that increases over the term of the agreement. The
President will be eligible for salary increases and other merit bonuses at
the
discretion of the Company’s board of directors. The President will receive 7,500
shares of restricted stock that will vest in installments of 40%, 30% and 30%
on
December 31, 2007, 2008 and 2009, respectively. The shares will become fully
vested on December 31, 2009. The President will be provided with health and
life
insurance, will be reimbursed for expenses and will be eligible to participate
in the profit sharing or 401(k) plan of the Company (or its subsidiary). The
Company will also pay the President’s automobile lease payments and certain club
membership fees. Also, under a prior agreement, the Company issued to the
President options to purchase 20,000 shares of the Company’s stock under the
terms of the Company’s 2002 Stock Option Plan (see Note 10).
F-23
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
In
the
event of the early termination of the President for any reason other than cause,
the Company would be obligated to compensate the President, in accordance with
the terms of the President Agreement, through the full term of the President
Agreement. Further, in the event the President’s position shall end or his
responsibilities be significantly reduced as a result of a business combination
(as defined), the President will be entitled to a lump sum payment equal to
three times his then current annual compensation, plus his bonus for the prior
calendar year, and all of the President’s previously granted stock options and
restricted stock will immediately become fully vested.
In
addition, the Company entered into an employment agreement with the Chief
Administrative Officer of the Bank effective on October 26, 2005, which expires
on December 31, 2007, unless earlier terminated by the Company. The agreement
provides for a base salary, with annual adjustments, and an annual bonus as
determined by the Board of Directors. The agreement also provides for vacation
and various insurance benefits and reimbursement for travel, entertainment,
and
bank-related education and convention expenses. Also, under this agreement,
the
Company issued options to purchase 20,000 shares of the Company’s stock under
the terms of the Company’s 2002 Stock Option Plan (see Note 10). On February 28,
2007, the Chief Administrative Officer was appointed as the Company’s Chief
Operating Officer. This appointment will become effective on July 1, 2007.
The
Chief Administrative Officer will continue to serve in his current position
until the appointment becomes effective.
| Note 8. |
Lease
and Subleases
|
The
Company leases the Bank’s main office under a twenty-year capital lease that
expires in 2021. In addition, the Company leases its Branford branch office
under a twenty-year capital lease that expires in 2022. Under the terms of
the
leases, the Bank will pay all executory costs including property taxes,
utilities and insurance. The Company has also entered into operating leases
for
its New London and North Haven branches, which opened in 2006. The Company
also
leases the driveway to its main office and certain equipment under
non-cancelable operating leases.
F-24
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
|
At
December 31, 2006, future minimum lease payments to be made and
received
under these
leases by year and in the aggregate, are as
follows:
|
||||||||||
|
|
||||||||||
|
Capital
|
|
Operating
|
|
Sublease
|
|
|||||
|
Year
|
|
Leases
|
|
Leases
|
|
Income
|
||||
|
2007
|
$
|
171,424
|
$
|
101,199
|
$
|
12,775
|
||||
|
2008
|
178,564
|
96,652
|
12,775
|
|||||||
|
2009
|
183,087
|
97,994
|
12,775
|
|||||||
|
2010
|
187,609
|
93,505
|
12,775
|
|||||||
|
2011
|
206,741
|
96,340
|
12,775
|
|||||||
|
2012
and thereafter
|
2,245,530
|
1,401,816
|
38,325
|
|||||||
|
3,172,955
|
$
|
1,887,506
|
$
|
102,200
|
||||||
|
Less
amount representng interest
|
(1,984,827
|
)
|
||||||||
|
Present
value of future minimum lease
|
||||||||||
|
payments - capital lease obligation
|
$
|
1,188,128
|
||||||||
Total
rent expense charged to operations under the operating leases approximated
$99,900 and $71,900 for the years ended December 31, 2006 and 2005,
respectively. Rental income under the subleases, and a lease of space in
premises owned, approximated $30,400 and $18,500 for the years ended December
31, 2006 and 2005, respectively.
| Note 9. |
Income
Taxes
|
A
reconciliation of the anticipated income tax benefit (computed by applying
the
statutory Federal income tax rate of 34% to the loss before income taxes) to
the
amount reported in the statement of operations for the years ended December
31,
2006 and 2005 is as follows:
|
2006
|
2005
|
||||||
|
Benefit
for income taxs at statutory Federal rate
|
$
|
(40,050
|
)
|
$
|
(94,673
|
)
|
|
|
State
tax benefit, net of Federal benefit
|
(5,171
|
)
|
(13,123
|
)
|
|||
|
Increase
in valuation allowance
|
55,043
|
120,937
|
|||||
|
Other
|
(9,822
|
)
|
(13,141
|
)
|
|||
|
|
$
|
- |
$
|
-
|
|||
F-25
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
|
At
December 31, 2006 and 2005, the components of gross deferred tax
assets
and liabilities are as follows:
|
|||||||
|
2006
|
2005
|
||||||
|
Deferred
tax assets:
|
|||||||
|
Allowance for loan losses
|
$
|
413,906
|
$
|
303,051
|
|||
|
Net operating loss carryforwards
|
921,018
|
965,813
|
|||||
|
Start-up costs
|
-
|
38,837
|
|||||
|
Unrealized loss on available for sale securities
|
97,405
|
131,882
|
|||||
|
Other
|
182,964
|
128,679
|
|||||
|
Gross deferred tax assets
|
1,615,293
|
1,568,262
|
|||||
|
Less valuation allowance
|
(1,505,041
|
)
|
(1,484,475
|
)
|
|||
|
Deferred tax assets - net of valuation allowance
|
110,252
|
83,787
|
|||||
|
Deferred
tax liabilities:
|
|||||||
|
Tax bad debt reserve
|
40,438
|
15,295
|
|||||
|
Depreciation
|
69,814
|
68,492
|
|||||
|
Gross deferred tax liabilities
|
110,252
|
83,787
|
|||||
|
Net deferred taxes
|
$
|
-
|
$
|
-
|
|||
As
of
December 31, 2006, the Company had tax net operating loss carryforwards
of
approximately $2,364,000
and $2,368,000 available to reduce future Federal and state taxable income,
respectively, which
expire in 2021 through 2026.
The
net
changes in the valuation allowance for 2006 and 2005 were increases of $20,566
and $168,400, respectively. The changes in the valuation allowance have been
allocated between operations and equity to adjust the deferred tax asset to
an
amount considered by management more likely than not to be realized. The portion
of the change in the valuation allowance allocated to equity is to eliminate
the
tax benefit related to the unrealized holding gains or losses on available
for
sale securities.
| Note 10. |
Shareholders’
Equity
|
Stock
repurchases
The
Company’s board of directors has approved the repurchase of up to 146,879 shares
of the Company’s common stock. As of December 31, 2006, there have been no
repurchases.
Stock
dividend
On
April
12, 2005, the Company declared a 5% stock dividend that was distributed on
April
26, 2005. Generally accepted accounting principles require such dividends to
be
recorded at fair value; however, when there is an accumulated deficit, the
Securities and Exchange Commission (“SEC”) advises that such stock dividends be
accounted for by capitalizing the stock issued at par value only, through a
reduction in additional paid-in capital.
F-26
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Income
(loss) per share
The
Company is required to present basic income (loss) per share and diluted income
(loss) per share in its statements of operations. Basic and diluted income
(loss) per share 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 instruments unless the effect is to
reduce the loss or increase the income per share. Weighted average shares
outstanding were 2,939,399 and 2,937,525 for the years ended December 31, 2006
and 2005, respectively.
Share-based
plans
The
Company has adopted three share-based plans, the 2001 Stock Option Plan (the
“2001 Plan”), the 2002 Stock Option Plan (the “2002 Plan”), and the 2005 Stock
Option and Award Plan (the “2005 Plan”), under which an aggregate of 582,914
shares of the Company’s common stock are reserved for issuance of the Company’s
common stock, or upon the exercise of both incentive options and nonqualified
options, granted under the share-based plans.
Under
all
three plans, the exercise price for each share covered by an option may not
be
less than the fair market value of a share of the Company’s common stock on the
date of grant. For incentive options granted to a person who owns more than
10%
of the combined voting power of the Company or any subsidiary (“ten percent
shareholder”), the exercise price cannot be less than 110% of the fair market
value on the date of grant.
Options
under all three plans have a term of ten years unless otherwise determined
at
the time of grant, except that incentive options granted to any ten percent
shareholder will have a term of five years unless a shorter term is fixed.
Under
the 2001 and 2002 plans, unless otherwise fixed at the time of grant, 40% of
the
options become exercisable one year from the date of grant, and 30% of the
options become exercisable at each of the second and third anniversaries from
the date of grant. Under the 2005 plan, the vesting terms of the awards is
determined at the date of grant. Dividends are not paid on unexercised
options.
Also,
under the 2005 Plan, awards in the form of the Company’s common stock may be
granted. The vesting terms of the awards are determined at the time of the
grant.
Upon
adoption of the 2002 Option Plan in May 2002, the Company determined that no
additional options will be granted under the 2001 Option Plan.
F-27
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
|
A
summary of the status of stock options at December 31, 2006, and
changes
during the year
then ended, is as follows:
|
|||||||||||||
|
|
|||||||||||||
|
2006
|
|||||||||||||
|
|
|
|
|
|
|
Weighted-
|
|
|
|
||||
|
|
|
|
|
Weighted-
|
|
Average
|
|
|
|
||||
|
|
|
Number
|
|
Average
|
|
Remaining
|
|
Aggregate
|
|
||||
|
|
|
of
|
|
Exercise
|
|
Contractual
|
|
Intrinsic
|
|
||||
|
|
|
Shares
|
|
Price
|
|
Term
|
|
Value
|
|||||
|
Outstanding
at beginning of year
|
431,068
|
$
|
8.03
|
||||||||||
|
Granted
|
50,400
|
7.42
|
|||||||||||
|
Exercised
|
-
|
||||||||||||
|
Forfeited
|
(22,902
|
)
|
7.99
|
||||||||||
|
Outstanding
at end of year
|
458,566
|
7.91
|
7.1
|
$
|
24,742
|
||||||||
|
Vested
or expected to vest at
|
|||||||||||||
|
the
end of year
|
449,981
|
$
|
7.92
|
7.1
|
$
|
24,707
|
|||||||
|
Exercisable
at end of year
|
408,566
|
$
|
7.97
|
6.9
|
$
|
24,542
|
|||||||
|
Weighted-average
fair value per option
|
|||||||||||||
|
of options granted during the period
|
$
|
3.40
|
|||||||||||
|
The
weighted-average fair value per option of options granted during
the year
ended December
31, 2005 was $2.78.
|
|||||||||||||
|
|
|||||||||||||
The
fair
value of options granted in the twelve months ended December 31, 2006 and
2005
was estimated at the
grant
date using the Black-Sholes option-pricing model with the following
assumptions:
|
2006
|
|
2005
|
|||||
|
Dividend
rate
|
-
|
-
|
|||||
|
Risk
free rate
|
5.05%
to 5.17
|
%
|
3.80%
to 4.46
|
%
|
|||
|
Expected
term (in years)
|
9
Years
|
8
Years
|
|||||
|
Weighted-average
volatility
|
25
|
%
|
20
|
%
|
|||
|
Expected
volatility
|
25
|
%
|
20
|
%
|
|||
F-28
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
The
fair
value of nonvested shares is determined based on the trading price of the
Company's shares
on
the grant date. A summary of the status of the Company's nonvested shares
related
to restricted stock at December 31, 2006 and changes during the year then
ended
is
as follows:
|
2006
|
|||||||
|
Weighted-
|
|||||||
|
Number
|
|
Average
|
|
||||
|
|
|
of
|
|
Grant-Date
|
|
||
|
|
|
Shares
|
|
Fair
Value
|
|||
|
Nonvested
restricted stock at beginning
|
|||||||
|
of the period
|
-
|
$
|
-
|
||||
|
Granted
|
2,500
|
7.48
|
|||||
|
Vested
|
-
|
||||||
|
Forfeited
|
-
|
||||||
|
Nonvested
restricted stock at end of the period
|
2,500
|
7.48
|
|||||
|
As
of December 31, 2006, there was $108,107 of total unrecognized
compensation cost related to nonvested
options granted under the option plans and $14,025 of total unrecognized
compensation related
to restricted stock. That cost is expected to be recognized over
a
weighted-average period of
2.7 years. During the twelve months ended December 31, 2006, $32,719
for
options and $4,675
for restricted stock, was recognized as compensation cost. No tax
benefit
related to the compensation cost was recognized due to the uncertainty
of
realizing the tax benefit in the
future.
|
|||||||
|
|
|||||||
As
of
January 1, 2006, compensation of members of the Board of Directors is paid
fifty
percent in cash and fifty percent in stock, versus one hundred percent in
options as done in prior years. The total director fees paid or to be paid
in
stock charged to noninterest expense for the twelve months ended December 31,
2006 was $34,695. During the twelve months ended December 31, 2006, 3,772 shares
of stock with a fair value of $26,889 were issued in payment of director fees
accrued.
Stock
warrants
The
Company adopted the 2001 Warrant Plan and the 2001 Supplemental Warrant Plan
(the “Warrant Plans”), under which an aggregate of 77,184 shares of the
Company’s common stock are reserved for issuance upon the exercise of warrants
granted to non-employee directors of the Company and the Bank, and certain
other
individuals involved in the organization of the Bank.
Warrants
under the Warrant Plans have a term of ten years. Forty percent of the warrants
became exercisable one year from the date of grant, and 30% of the warrants
became exercisable at each of the second and third anniversaries from the date
of grant.
F-29
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
|
A
summary of the status of the warrants at December 31, 2006, and
changes
during the twelve months
then ended, is as follows:
|
|||||||||||||
|
|
|||||||||||||
|
2006
|
|||||||||||||
|
Weighted-
|
|
|
|
||||||||||
|
|
|
|
|
Weighted-
|
|
Average
|
|
|
|
||||
|
|
|
Number
|
|
Average
|
|
Remaining
|
|
Aggregate
|
|
||||
|
|
|
of
|
|
Exercise
|
|
Contractual
|
|
Intrinsic
|
|
||||
|
|
|
Shares
|
|
Price
|
|
Term
|
|
Value
|
|||||
|
Outstanding
at beginning of year
|
77,184
|
$
|
10.39
|
||||||||||
|
Granted
|
-
|
||||||||||||
|
Exercised
|
-
|
||||||||||||
|
Terminated
|
-
|
||||||||||||
|
Outstanding
at end of period
|
77,184
|
10.39
|
4.7
|
$
|
-
|
||||||||
|
Exercisable
and vested at end of period
|
77,184
|
$
|
10.39
|
4.7
|
$
|
-
|
|||||||
| Note 11. |
401(k)
Profit Sharing Plan
|
The
Bank’s employees are eligible to participate in The Bank of Southern Connecticut
401(k) Profit Sharing Plan (the “Plan”) under Section 401(k) of the Internal
Revenue Code. The Plan covers substantially all employees of the Bank. Under
the
terms of the Plan, participants can contribute a discretionary percentage of
compensation, with total annual contributions subject to Federal limitations.
The Bank may make discretionary contributions to the Plan. Participants are
immediately vested in their contributions and become fully vested in employer
contributions after three years of service. There were no discretionary
contributions made by the Bank during 2006 and 2005.
| Note 12. |
Financial
Instruments with Off-Balance-Sheet
Risk
|
In
the
normal course of business, the Company 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 the Company has in particular
classes of financial instruments.
The
contractual amounts of commitments to extend credit represents 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. The Company
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments and evaluates each customer’s
creditworthiness on a case-by-case basis. Management believes that the Company
controls the credit risk of these financial instruments through credit
approvals, credit limits, monitoring procedures and the receipt of collateral
as
deemed necessary.
F-30
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
|
Financial
instruments whose contract amounts represent credit risk are as
follows at
December 31:
|
||||||||||
|
2006
|
2005
|
|||||||||
|
Commitments
to extend credit
|
|
|||||||||
|
Future
loan commitments
|
$
|
7,044,313
|
$
|
3,982,679
|
||||||
|
Unused
lines of credit
|
22,537,570
|
8,561,405
|
||||||||
|
Undisbursed
construction loans
|
1,588,933
|
437,825
|
||||||||
|
Financial
standby letters of credit
|
3,100,188
|
1,908,888
|
||||||||
|
$
|
34,271,004
|
$
|
14,890,797
|
|||||||
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 the Company upon extension of credit, is based on 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 the Company 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. As of January 1, 2003, newly issued or modified
guarantees that are not derivative contracts have been recorded on the Company’s
consolidated balance sheet at their fair value at inception. The liability
related to guarantees recorded at December 31, 2006 and 2005 was not
significant.
| Note 13. |
Regulatory
Matters
|
The
Company (on a consolidated basis) and the Bank are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure
to
meet minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could
have
a direct material effect on the Company’s and the Bank’s financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of the assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings,
and
other factors.
Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2006, that the
Company and the Bank meet all capital adequacy requirements to which they are
subject.
As
of
December 31, 2006, the most recent notification from the Federal Deposit
Insurance Corporation and the State of Connecticut Department of Banking
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the table. There are no conditions or events since then, that
management believes have changed the Bank’s category.
F-31
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
|
The
Company's and the Bank's actual capital amounts and ratios at
December 31,
2006 and December 31, 2005 were
|
|||||||||||||||||||
|
(dollars
in thousands):
|
|||||||||||||||||||
|
To
Be Well
|
|||||||||||||||||||
|
Capitalized
Under
|
|||||||||||||||||||
|
For
Capital
|
Prompt
Corrective
|
||||||||||||||||||
|
2006
|
Actual
|
Adequacy
Purposes
|
Action
Provisions
|
||||||||||||||||
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|||||||||
|
The
Company:
|
|||||||||||||||||||
|
Total
Capital to Risk Weighted Assets
|
$
|
21,677
|
22.96
|
%
|
$
|
7,554
|
8.00
|
%
|
N/A
|
N/A
|
|||||||||
|
Tier
1 Capital to Risk Weighted Assets
|
20,582
|
21.80
|
%
|
3,776
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
Tier
1 (Leverage) Capital to Average Assets
|
20,582
|
17.56
|
%
|
4,689
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
|
|
|
|
|
|
||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
To
Be Well
|
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
Capitalized
Under
|
|
||||||||
|
|
|
|
|
|
|
For
Capital
|
|
Prompt
Corrective
|
|
||||||||||
|
|
|
Actual
|
|
Adequacy
Purposes
|
|
Action
Provisions
|
|||||||||||||
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|||||||||
|
The
Bank:
|
|||||||||||||||||||
|
Total
Capital to Risk Weighted Assets
|
$
|
18,044
|
19.72
|
%
|
$
|
7,321
|
8.00
|
%
|
$
|
9,151
|
10.00
|
%
|
|||||||
|
Tier
1 Capital to Risk Weighted Assets
|
16,949
|
18.52
|
%
|
3,660
|
4.00
|
%
|
$
|
5,490
|
6.00
|
%
|
|||||||||
|
Tier
1 (Leverage) Capital to Average Assets
|
16,949
|
14.82
|
%
|
4,574
|
4.00
|
%
|
$
|
5,718
|
5.00
|
%
|
|||||||||
|
|
|
To
Be Well
|
|
||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
Capitalized
Under
|
|
||||||||
|
|
|
|
|
|
|
For
Capital
|
|
Prompt
Corrective
|
|
||||||||||
|
2005
|
|
Actual
|
|
Adequacy
Purposes
|
|
Action
Provisions
|
|
||||||||||||
|
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|||||||
|
The
Company:
|
|||||||||||||||||||
|
Total
Capital to Risk Weighted Assets
|
$
|
21,436
|
30.30
|
%
|
$
|
5,660
|
8.00
|
%
|
N/A
|
N/A
|
|||||||||
|
Tier
1 Capital to Risk Weighted Assets
|
20,636
|
29.17
|
%
|
2,830
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
Tier
1 (Leverage) Capital to Average Assets
|
20,636
|
24.17
|
%
|
3,415
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
|
|
|
|
|
|
||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
To
Be Well
|
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
Capitalized
Under
|
|
||||||||
|
|
|
|
|
|
|
For
Capital
|
|
Prompt
Corrective
|
|
||||||||||
|
|
|
Actual
|
|
Adequacy
Purposes
|
|
Action
Provisions
|
|||||||||||||
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|||||||||
|
The
Bank:
|
|||||||||||||||||||
|
Total
Capital to Risk Weighted Assets
|
$
|
16,670
|
25.17
|
%
|
$
|
5,298
|
8.00
|
%
|
$
|
6,623
|
10.00
|
%
|
|||||||
|
Tier
1 Capital to Risk Weighted Assets
|
15,870
|
23.96
|
%
|
2,649
|
4.00
|
%
|
3,974
|
6.00
|
%
|
||||||||||
|
Tier
1 (Leverage) Capital to Average Assets
|
15,870
|
20.38
|
%
|
3,115
|
4.00
|
%
|
3,893
|
5.00
|
%
|
||||||||||
F-32
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Restrictions
on dividends, loans or advances
The
Company’s ability to pay cash dividends is dependent on the Bank’s ability to
pay dividends to the Company. However, certain restrictions exist regarding
the
ability of the Bank to transfer funds to the Company in the form of cash
dividends, loans or advances. Regulatory approval is required to pay cash
dividends in excess of the Bank’s net earnings retained in the current year plus
retained net earnings for the preceding two years. The Bank is also prohibited
from paying dividends that would reduce its capital ratios below minimum
regulatory requirements, and the Federal Reserve Board may impose further
dividend restrictions on the Company. At December 31, 2006 and 2005, no
dividends may be declared by the Bank without regulatory approval.
Under
Federal Reserve regulation, the Bank is also limited to the amount it may loan
to the Company, unless such loans are collateralized by specified obligations.
Loans or advances to the Company by the Bank are limited to 10% of the Bank’s
capital stock and surplus on a secured basis.
| Note 14. |
Related
Party Transactions
|
In
the
normal course of business, the Company may grant loans to executive officers,
directors and members of their immediate families, as defined, and to entities
in which these individuals have more than a 10% equity ownership. Such loans
are
transacted at terms including interest rates, similar to those available to
unrelated customers.
|
Changes
in loans outstanding to such related parties during 2006 and 2005
are as
follows:
|
|||||||
|
2006
|
2005
|
||||||
|
Balance,
at beginning of year
|
$
|
1,393,330
|
$
|
788,695
|
|||
|
Additional
loans
|
3,051,659
|
1,191,312
|
|||||
|
Repayments
|
(2,685,413
|
)
|
(2,086,677
|
)
|
|||
|
Other
|
-
|
1,500,000
|
|||||
|
Balance,end
of year
|
$
|
1,759,576
|
$
|
1,393,330
|
|||
|
Other
related party loan transactions represent loans to related parties
who
either became related parties, or
ceased being related parties, during the year.
|
|||||||
|
|
|||||||
|
Related
party deposits aggregated approximately $5,070,800 and $5,113,600
as of
December 31, 2006 and
2005, respectively.
|
|||||||
|
|
|||||||
Included
in professional services for the year ended December 31, 2005 was approximately
$53,600 of legal fees and accounting services incurred for services provided
by
law firms, principals of which were directors of the Company. No such services
were provided for the year ended December 31, 2006.
During
2006 and 2005, the Company paid approximately $1,200 and $26,400, respectively,
for capital expenditures and maintenance to certain companies, principals of
which are directors of the Company.
F-33
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
Rental
income and expense reimbursements of approximately $19,000 and $19,300 were
received in 2006 and 2005, respectively, from a tenant, the principal of which
is related to the Company’s Vice Chairman.
| Note 15. |
Fair
Value of Financial Instruments and Interest Rate
Risk
|
SFAS
No.
107, "Disclosures About Fair Value of Financial Instruments" ("Statement No.
107"), requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. In cases where quoted market prices are
not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rates and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparisons to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. Statement No. 107 excludes certain
financial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value
of
the Company.
Management
uses its best judgment in estimating the fair value of the Company's financial
instruments; however, there are inherent weaknesses in any estimation technique.
Therefore, for substantially all financial instruments, the fair value estimates
presented herein are not necessarily indicative of the amounts the Company
could
have realized in a sales transaction at December 31, 2006 and 2005. The
estimated fair value amounts for 2006 and 2005 have been measured as of their
respective year-ends, and have not been reevaluated or updated for purposes
of
these consolidated financial statements subsequent to those respective dates.
As
such, the fair values of these financial instruments subsequent to the
respective reporting dates may be different from the amounts reported at each
year-end.
The
information presented should not be interpreted as an estimate of the fair
value
of the entire Company since a fair value calculation is only required for a
limited portion of the Company's assets and liabilities. Due to the wide range
of valuation techniques and the degree of subjectivity used in making the
estimate, comparisons between the Company's disclosures and those of other
bank
holding companies may not be meaningful.
F-34
SOUTHERN
CONNECTICUT BANCORP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS, Continued
December
31, 2006 and 2005
As
of
December 31, 2006 and 2005, the recorded book balances and estimated fair
values
of the Company's
financial instruments were:
|
2006
|
|
2005
|
|
|||||||||||||
|
|
|
|
|
Recorded
|
|
|
|
Recorded
|
|
|
|
|||||
|
|
|
|
|
Book
|
|
|
|
Book
|
|
|
|
|||||
|
|
|
|
|
Balance
|
|
Fair
Value
|
|
Balance
|
|
Fair
Value
|
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Financial
Assets:
|
|
|||||||||||||||
|
Cash
and due from banks
|
$
|
5,821,084
|
$
|
5,821,084
|
$
|
966,732
|
$
|
966,732
|
||||||||
|
Federal
funds sold
|
22,700,000
|
22,700,000
|
9,579,000
|
9,579,000
|
||||||||||||
|
Short-term
investments
|
6,288,663
|
6,288,663
|
6,023,555
|
6,023,555
|
||||||||||||
|
Available
for sale securities
|
8,054,821
|
8,054,821
|
9,973,488
|
9,973,488
|
||||||||||||
|
Federal
Home Loan Bank stock
|
66,100
|
66,100
|
60,000
|
60,000
|
||||||||||||
|
Loans
receivable, net
|
75,306,255
|
74,930,000
|
55,881,508
|
55,851,952
|
||||||||||||
|
Loans
held for sale
|
118,223
|
118,223
|
401,503
|
401,503
|
||||||||||||
|
Accrued
interest receivable
|
467,698
|
467,698
|
324,346
|
324,346
|
||||||||||||
|
Servicing
rights
|
60,448
|
97,454
|
56,568
|
118,085
|
||||||||||||
|
Interest
only strips
|
82,203
|
94,863
|
88,946
|
141,119
|
||||||||||||
|
Financial
Liabilities:
|
||||||||||||||||
|
Noninterest-bearing
deposits
|
29,463,030
|
29,463,030
|
18,091,849
|
18,091,849
|
||||||||||||
|
Interest
bearing checking accounts
|
4,985,187
|
4,985,187
|
6,175,953
|
6,175,953
|
||||||||||||
|
Money
market deposits
|
36,324,952
|
36,324,952
|
27,001,393
|
27,001,393
|
||||||||||||
|
Savings
deposits
|
2,107,354
|
2,107,354
|
2,690,236
|
2,690,236
|
||||||||||||
|
Time
certificates of deposits
|
28,392,997
|
28,491,000
|
11,320,085
|
11,296,652
|
||||||||||||
|
Repurchase
agreements
|
883,603
|
883,603
|
1,363,368
|
1,363,368
|
||||||||||||
|
Accrued
interest payable
|
171,610
|
171,610
|
105,598
|
105,598
|
||||||||||||
Unrecognized financial instruments
Loan
commitments on which the committed interest rate is less than the current market
rate are insignificant at December 31, 2006 and 2005.
The
Company assumes interest rate risk (the risk that general interest rate levels
will change) as a result of its normal operations. As a result, the fair values
of the Company's financial instruments will change when interest rate levels
change and that change may be either favorable or unfavorable to the Company.
Management attempts to match maturities of assets and liabilities to the extent
believed necessary to minimize interest rate risk. However, borrowers with
fixed
rate obligations are less likely to prepay in a rising rate environment and
more
likely to prepay in a falling rate environment. Conversely, depositors who
are
receiving fixed rates are more likely to withdraw funds before maturity in
a
rising rate environment and less likely to do so in a falling rate environment.
Management monitors rates and maturities of assets and liabilities and attempts
to minimize interest rate risk by adjusting terms of new loans and deposits
and
by investing in securities with terms that mitigate the Company's overall
interest rate risk.
F-35