ITEM 1. Business
Washington Trust Bancorp, Inc.
Washington Trust Bancorp, Inc. (the “Bancorp”), a publicly-owned registered bank holding company and financial holding company, was organized in 1984 under the laws of the state of Rhode Island. The Bancorp owns all of the outstanding common stock of The Washington Trust Company (the “Bank”), a Rhode Island-chartered commercial bank. The Bancorp was formed in 1984 under a plan of reorganization in which outstanding common shares of the Bank were exchanged for common shares of the Bancorp. See additional information under the caption “Subsidiaries”.
Through its subsidiaries, the Bancorp offers a broad range of financial services to individuals and businesses, including wealth management, through its offices in Rhode Island, Massachusetts and southeastern Connecticut, ATMs, and its Internet website (www.washtrust.com). The Bancorp’s common stock is traded on the NASDAQ Stock MarketÒ under the symbol “WASH.”
The accounting and reporting policies of the Bancorp and its subsidiaries (collectively, the “Corporation” or Washington Trust”) are in accordance with accounting principles generally accepted in the United States of America and conform to general practices of the banking industry. At December 31, 2005, Washington Trust had total assets of $2.4 billion, total deposits of $1.6 billion and total shareholders’ equity of $158.4 million.
Commercial Banking
The Corporation offers a variety of banking and related financial services, including:
Residential mortgages
Telephone banking services
Commercial loans
Internet banking services
Construction loans
Commercial and consumer demand deposits
Home equity lines of credit
Savings, NOW and money market deposits
Home equity loans
Certificates of deposit
Consumer installment loans
Retirement accounts
Merchant credit card services
Cash management services
Automated teller machines (ATMs)
Safe deposit boxes
The Corporation’s largest source of income is net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing deposits and other borrowed funds.
The Corporation’s lending activities are conducted primarily in Rhode Island and, to a lesser extent, Connecticut and Massachusetts, as well as other states. Washington Trust offers a variety of commercial and retail lending products. In addition, Washington Trust purchases loans for its portfolio from various other financial institutions. In making commercial loans, Washington Trust may occasionally solicit the participation of other banks and may also occasionally participate in commercial loans originated by other banks. Washington Trust generally underwrites its residential mortgages based upon secondary market standards. Residential mortgages are originated for both sale in the secondary market as well as for retention in the Corporation’s loan portfolio. Loan sales in the secondary market provide funds for additional lending and other banking activities. The majority of loans are sold with servicing released.
Washington Trust offers a wide range of banking services, including the acceptance of demand, savings, NOW, money market and time deposits. Banking services are accessible through a variety of delivery channels including branch facilities, ATMs, telephone and Internet banking. Washington Trust also sells various business services products including merchant credit card processing and cash management services.
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Wealth Management Services
The Corporation generates fee income from providing trust, investment management and financial planning services. Washington Trust provides personal trust services, including services as executor, trustee, administrator, custodian and guardian. Corporate trust services are also provided, including services as trustee for pension and profit sharing plans. Investment management and financial planning services are provided for both personal and corporate clients.
The 2005 acquisition of Weston Financial Group, Inc. (“Weston Financial”) increased the size and range of products and service offered by Washington Trust’s wealth management group. As a result of the acquisition, the total market value of wealth management and trust assets under administration increased from approximately $1.9 billion at December 31, 2004 to $3.3 billion as of December 31, 2005. See additional information under the caption “Acquisitions” below and in Note 2 to the Consolidated Financial Statements.
Business Segments
Segment reporting information is presented in Note 19 to the Consolidated Financial Statements.
Acquisitions
The following summarizes Washington Trust’s recent acquisition history:
On August 31, 2005, the Bancorp completed its acquisition of Weston Financial, a registered investment advisor and financial planning company located in Wellesley, Massachusetts, with broker-dealer and insurance agency subsidiaries. Pursuant to the Stock Purchase Agreement, dated March 18, 2005, the acquisition was effected by the Bancorp’s acquisition of all of Weston Financial’s outstanding capital stock. (1)
On April 16, 2002, the Bancorp completed its acquisition of First Financial Corp., the parent company of First Bank and Trust Company, a Rhode Island-chartered community bank. First Financial Corp. was headquartered in Providence, Rhode Island and its subsidiary, First Bank and Trust Company, operated banking offices in Providence, Cranston, Richmond and North Kingstown, Rhode Island. The Richmond and North Kingstown branches were closed and consolidated into existing Bank branches in May 2002. Pursuant to the Agreement and Plan of Merger, dated November 12, 2001, the acquisition was effected by means of the merger of First Financial Corp. with and into the Bancorp and the merger of First Bank with and into the Bank. (1)
On June 26, 2000, the Bancorp completed its acquisition of Phoenix Investment Management Company, Inc. (“Phoenix”), an independent investment advisory firm located in Providence, Rhode Island. Pursuant to the Agreement and Plan of Merger, dated April 24, 2000, the acquisition was effected by means of merger of Phoenix with and into the Bank. (2)
On August 25, 1999, the Bancorp completed its acquisition of Pier Bank, a Rhode Island chartered community bank headquartered in South Kingstown, Rhode Island. Pursuant to the Agreement and Plan of Merger, dated February 22, 1999, the acquisition was effected by means of merger of Pier Bank with and into the Bank. (2)
(1)
These acquisitions have been accounted for as a purchase and, accordingly, the operations of the acquired companies are included in the Consolidated Financial Statements from their dates of acquisition.
(2)
These acquisitions were accounted for as poolings of interests and, accordingly, all financial data was restated to reflect the combined financial condition and results of operations as if these acquisitions were in effect for all periods presented.
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Subsidiaries
The Bancorp’s subsidiaries include the Bank and Weston Securities Corporations (“WSC”). The Bancorp also owns all of the outstanding common stock of WT Capital Trust I and WT Capital Trust II, special purpose finance entities formed in connection with the acquisition of Weston Financial and with the sole purpose of issuing trust preferred debt securities and investing the proceeds in junior subordinated debentures of the Bancorp. See Notes 2 and 12 to the Consolidated Financial Statements for additional information.
The following is a description of Bancorp’s primary operating subsidiaries:
The Washington Trust Company
The Bank was originally chartered in 1800 as the Washington Bank and is the oldest banking institution headquartered in its market area and is among the oldest banks in the United States. Its current corporate charter dates to 1902.
The Bank provides a broad range of financial services, including lending, deposit and cash management services, wealth management and trust services and merchant credit card services. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”), subject to regulatory limits.
The Bank’s subsidiary, Weston Financial, is a registered investment advisor and financial planning company located in Wellesley, Massachusetts, with an insurance agency subsidiary. In addition, the Bank has other passive investment subsidiaries whose primary functions are to provide servicing on passive investments, such as residential and consumer loans acquired from the Bank and investment securities.
Weston Securities Corporation
WSC is a licensed broker-dealer that markets several of Weston Financial’s investment programs, including mutual funds and variable annuities. WSC acts as the principal distributor to a group of mutual funds for which Weston Financial is the investment advisor.
Market Area and Competition
Washington Trust faces considerable competition in its market area for all aspects of banking and related financial service activities. Competition from both bank and non-bank organizations is expected to continue.
The Bank contends with strong competition both in generating loans and attracting deposits. The primary factors in competing are interest rates, financing terms, fees charged, products offered, personalized customer service, online access to accounts and convenience of branch locations, ATMs and branch hours. Competition comes from commercial banks, credit unions, and savings institutions, as well as other non-bank institutions.
The Bank operates ten of its sixteen branch offices in Washington County, Rhode Island. As of June 30, 2005, based upon information reported in the FDIC’s Deposit Market Share Report, the Bank had 53% of total deposits reported by all financial institutions for Washington County. The closest competitor held 27%, and the second closest competitor held 9% of total deposits in Washington County. The Corporation believes that being the largest commercial banking institution headquartered within this market area provides a competitive advantage over other financial institutions.
The Bank’s remaining six branch offices are located in Providence and Kent Counties in Rhode Island and New London County in southeastern Connecticut. Subject to the approval of state and federal regulators, Washington Trust expects to open two de novo branch offices in Providence and Kent Counties by the first half of 2007. Both the population and number of businesses in Providence and Kent Counties far exceed those in Washington County. The Bank faces strong competition from larger institutions with greater resources, broader product lines and larger delivery systems than the Bank.
Washington Trust operates in a highly competitive wealth management and trust services market place. Key competitive factors include investment performance, quality and level of service, and personal relationships. Principal competitors in the wealth management and trust services business are commercial banks and trust
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companies, investment advisory firms, mutual fund companies, stock brokerage firms, and other financial companies. Many of these companies have greater resources than Washington Trust.
Employees
At December 31, 2005, Washington Trust had 433 full-time and 45 part-time and other employees. Washington Trust maintains a comprehensive employee benefit program providing, among other benefits, group medical and dental insurance, life insurance, disability insurance, a pension plan and a 401(k) plan. Management considers relations with its employees to be good. See Note 13 to the Consolidated Financial Statements for additional information on certain employee benefit programs.
Supervision and Regulation
The business in which the Corporation is engaged is subject to extensive supervision, regulation, and examination by various bank regulatory authorities and other governmental agencies. State and federal banking laws have as their principal objective either the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system or the protection of consumers, or classes of consumers, and depositors, in particular, rather than the specific protection of shareholders of a bank or its parent company.
Set forth below is a brief description of certain laws and regulations that relate to the regulation of Washington Trust. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation. A change in applicable statutes, regulations or regulatory policy may have a material effect on our business.
Regulation of the Bancorp. As a registered bank holding company, the Bancorp is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), and the State of Rhode Island, Department of Business Regulation, Division of Banking (the “Rhode Island Division of Banking”).
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 BHCA or orders or regulations thereunder, to order termination of ownership and control of a non-banking subsidiary by a bank holding company.
During 2005, the Bancorp elected financial holding company status pursuant to the provisions of the Gramm-Leach-Bliley Act of 1999 (“GLBA”). As a financial holding company, the Bancorp is authorized to engage in certain financial activities that a bank holding company may not engage in. “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Currently, the Bancorp engages in broker dealer activities pursuant to this authority. If a financial holding company fails to remain well capitalized and well managed, the company and its affiliates may not commence any new activity that is authorized particularly for financial holding companies. If a financial holding company remains out of compliance for 180 days or such longer period as the Federal Reserve permits, the Federal Reserve may require the financial holding company to divest either its insured depository institution or all of its nonbanking subsidiaries engaged in activities not permissible for a bank holding company. If a financial holding company fails to maintain a “satisfactory” or better record of performance under the Community Reinvestment Act, it will be prohibited, until the rating is raised to satisfactory or better, from engaging in new activities, or acquiring companies other than bank holding companies, banks or savings associations, except that the Bancorp could engage in new activities, or acquire companies engaged in activities that are closely related to banking under the BHCA. In addition, if the Federal Reserve Board finds that the Bank is not well capitalized or well managed, the Bancorp would be required to enter into an agreement with the Federal Reserve Board to comply with all applicable capital and management requirements and which may contain additional limitations or conditions. Until corrected, the Bancorp would not be able to engage in any new activity or acquire companies engaged in
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activities that are not closely related to banking under the BHCA without prior Federal Reserve Board approval. If the Bancorp fails to correct any such condition within a prescribed period, the Federal Reserve Board could order the Bancorp to divest of its banking subsidiary or, in the alternative, to cease engaging in activities other than those closely related to banking under the BHCA.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Act”). The Interstate Act permits adequately capitalized and adequately managed bank holding companies, as determined by the Federal Reserve Board, to acquire banks in any state subject to certain concentration limits and other conditions. The Interstate Act also authorizes the interstate merger of banks. In addition, among other things, the Interstate Act permits banks to establish new branches on an interstate basis provided that the law of the host state specifically authorizes such action. Rhode Island and Connecticut, the two states in which the Corporation conducts branch-banking operations, have adopted legislation to “opt in” to interstate merger and branching provisions that effectively eliminated state law barriers. As a bank holding company, prior Federal Reserve Board approval is required before acquiring more than 5% of a class of voting securities, or substantially all of the assets, of a bank holding company, bank or savings association.
Control Acquisitions. The Change in Bank Control Act prohibits a person or a group of persons from acquiring “control” of a bank holding company, such as the Bancorp, unless the Federal Reserve Board has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting securities of a bank holding company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), would, under the circumstances set forth in the presumption, constitute the acquisition of control of the bank holding company. In addition, a company is required to obtain the approval of the Federal Reserve Board under the BHCA before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of outstanding voting securities of a bank holding company, or otherwise obtaining control or a “controlling influence” over that bank holding company.
Bank Holding Company Dividends. The Federal Reserve Board and the Rhode Island Division of Banking have authority to prohibit bank holding companies from paying 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. Additionally, under Rhode Island law, distributions of dividends cannot be made if a bank holding company would not be able to pay its debts as they become due in the usual course of business or the bank holding company’s total assets would be less than the sum of its total liabilities. The Bancorp’s revenues consist primarily of cash dividends paid to it by the Bank. As described below, the FDIC and the Rhode Island Division of Banking may also regulate the amount of dividends payable by the Bank. The inability of the Bank to pay dividends may have an adverse effect on the Bancorp.
Regulation of the Bank. The Bank is subject to the regulation, supervision and examination by the FDIC, the Rhode Island Division of Banking and the State of Connecticut, Department of Banking, in which the Bank has established branches. The Bank is also subject to various Rhode Island and Connecticut business and banking regulations.
Regulation of the Registered Investment Advisor and Broker-Dealer. WSC is a registered broker-dealer and a member of the National Association of Securities Dealers, Inc. (“NASD”) and is subject to extensive regulation, supervision, and examination by the Securities and Exchange Commission (“SEC”), NASD and the Commonwealth of Massachusetts. Weston Financial is registered as an investment advisor under the Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”) and is subject to extensive regulation, supervision, and examination by the SEC and the Commonwealth of Massachusetts, including related to sales methods, trading practices, the use and safekeeping of customers’ funds and securities, capital structure, record keeping and the conduct of directors, officers and employees.
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As an investment advisor, Weston Financial is subject to the Investment Advisers Act and any regulations promulgated thereunder, including fiduciary, recordkeeping, operational and disclosure obligations. Each of the mutual funds for which Weston Financial acts an advisor, or subadvisor, is registered with the SEC under the Investment Company Act of 1940, as amended (the “Investment Company Act”), and subject to requirements thereunder. Shares of each mutual fund are registered with the SEC under the Securities Act and are qualified for sale (or exempt from such qualification) under the laws of each state and the District of Columbia to the extent such shares are sold in any of those jurisdictions. In addition, an advisor or sub-advisor to a registered investment company generally has obligations with respect to the qualification of the registered investment company under the Internal Revenue Code of 1986, as amended (the “Code”).
The foregoing laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict Weston Financial from conducting its business in the event it fails to comply with such laws and regulations. Possible sanctions that may be imposed in the event of such noncompliance include the suspension of individual employees, limitations on business activities for specified periods of time, revocation of registration as an investment advisor, commodity trading advisor and/or other registrations, and other censures and fines.
ERISA
The Bank and Weston Financial are each also subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and related regulations, to the extent it is a “fiduciary” under ERISA with respect to some of its clients. ERISA and related provisions of the Code impose duties on persons who are fiduciaries under ERISA, and prohibit certain transactions involving the assets of each ERISA plan that is a client of the Bank or Weston Financial, as applicable, as well as certain transactions by the fiduciaries (and several other related parties) to such plans.
Insurance of Accounts and FDIC Regulation. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund (“BIF”) member institutions. The FDIC has established a risk-based assessment system under which the FDIC classifies institutions based on their capital ratios and on other relevant factors and generally assesses higher rates on those institutions that tend to pose greater risks to the federal deposit insurance funds. The Federal Deposit Insurance Act (“FDIA”) does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. The Corporation cannot predict whether the FDIC will be required to increase deposit insurance assessments above their current levels.
Federal Deposit Insurance Reform Act. In February 2006, Congress enacted the Federal Deposit Insurance Reform Act of 2005 (the “FDIR Act”). As a result of the passage of the FDIR Act, over the course of the next year, among other things: (1) the BIF will be merged with the FDIC’s Savings Association Insurance Fund creating the Deposit Insurance Fund (the “DIF”); (2) the $100,000 per account insurance level will be indexed to reflect inflation; (3) deposit insurance coverage for certain retirement accounts will be increased to $250,000; and (4) a cap will be placed on the level of the DIF and dividends will be paid to banks once the level of the DIF exceeds the specified threshold.
Bank Holding Company Support to Subsidiary Bank. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to its subsidiary bank and to commit resources to its 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 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 Bank is a FDIC-insured depository institution.
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Regulatory Capital Requirements. The Federal Reserve Board and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to United States banking organizations. In addition, these regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels, whether because of its financial condition or actual or anticipated growth.
The Federal Reserve Board risk-based guidelines define a three-tier capital framework. Tier 1 capital includes common shareholders’ equity, perpetual preferred stock and trust preferred securities (both subject to certain limitations and in the case of the latter, to specific limitations on the kind and amount of such securities that may be included as Tier 1 capital), and minority interest in the equity accounts of consolidated subsidiaries, less goodwill and other adjustments. Tier 2 capital consists of preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for loan losses up to 1.25% of risk-weighted assets. Tier 3 capital includes subordinated debt that is unsecured, fully paid, has an original maturity of at least two years, is not redeemable before maturity without prior approval by the Federal Reserve Board and includes a lock-in clause precluding payment of either interest or principal if the payment would cause the issuing bank’s risk-based capital ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier 2 capital less investments in unconsolidated subsidiaries represents qualifying total capital. Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk. The minimum Tier 1 capital ratio is 4% and the minimum total risk-based capital (Tier 1 and Tier 2) is 8%. At December 31, 2005, the Corporation’s net risk-weighted assets amounted to $1.4 billion, its Tier 1 capital ratio was 9.06% and its total risk-based capital ratio was 10.51%.
The leverage ratio is determined by dividing Tier 1 capital by adjusted average total assets. Although the stated minimum ratio is 100 to 200 basis points above 3%, banking organizations are required to maintain a ratio of at least 5% to be classified as well capitalized. The Corporation’s leverage ratio was 5.45% as of December 31, 2005.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, identifies five capital categories for insured depository institutions (well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the federal bank regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An “undercapitalized” bank must develop a capital restoration plan and its parent holding company must guarantee that bank’s compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of 5% of the bank’s assets at the time it became “undercapitalized” or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards.
The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital, and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a “well-capitalized” institution must have a Tier 1 risk-based capital ratio of at least 6%, a total risk-based capital ratio of at least 10% and a leverage ratio of at least 5% and not be subject to a capital directive order.
Regulators also must take into consideration (a) concentrations of credit risk; (b) interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance sheet position); and (c) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the
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institution’s regular safety and soundness examination. In addition, the Bancorp, and any bank with significant trading activity, must incorporate a measure for market risk in their regulatory capital calculations. At December 31, 2005, the Bank’s capital ratios placed it in the well-capitalized category. Reference is made to Note 17 to the Consolidated Financial Statements for additional discussion of the Corporation’s regulatory capital requirements.
In October of 2005, the federal banking agencies issued an advance notice of proposed rulemaking (“ANPR”) concerning potential changes in the risk-based capital rules (“Basel IA”) that are designed to apply to, and potentially reduce the risk capital requirements of bank holding companies, such as the Bancorp, that are not among the 20 or so largest U.S. bank holding companies. It remains uncertain whether the Basel IA rules will be adopted and, even if adopted, how closely the final Basel IA rules will resemble the rules described in the ANPR and what the effective date of such rules will be. Accordingly, the Corporation is not yet in a position to determine the effect of such rules on its risk capital requirements.
Transactions with Affiliates. Under Sections 23A and 23B of the Federal Reserve Act and Regulation W thereunder, there are various legal restrictions on the extent to which a bank holding company and its nonbank subsidiaries may borrow, obtain credit from or otherwise engage in “covered transactions” with its FDIC insured depository institution subsidiaries. Such borrowings and other covered transactions by an insured depository institution subsidiary (and its subsidiaries) with its nondepository institution affiliates are limited to the following amounts:
§
In the case of one such affiliate, the aggregate amount of covered transactions of the insured depository institution and its subsidiaries cannot exceed 10% of the capital stock and surplus of the insured depository institution.
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In the case of all affiliates, the aggregate amount of covered transactions of the insured depository institution and its subsidiaries cannot exceed 20% of the capital stock and surplus of the insured depository institution.
“Covered transactions” are defined by statute for these purposes to include a loan or extension of credit to an affiliate, a purchase of or investment in securities issued by an affiliate, a purchase of assets from an affiliate unless exempted by the Federal Reserve Board, the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any person or company, or the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate. Covered transactions are also subject to certain collateral security requirements. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property of any kind, or furnishing of any service.
Limitations on Bank Dividends. The Bancorp’s revenues consist primarily of cash dividends paid to it by the Bank. The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Payment of dividends by a bank is restricted pursuant to various state and federal regulatory limitations. Reference is made to Note 17 to the Consolidated Financial Statements for additional discussion of the Corporation’s ability to pay dividends.
Customer Information Security. The FDIC and other bank regulatory agencies have adopted final guidelines for establishing standards for safeguarding nonpublic personal information about customers that implement provisions of GLBA, which establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework. Specifically, the Information Security Guidelines established by the GLBA require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to 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 that could result in substantial harm or inconvenience to any customer. The federal banking regulators have issued guidance for banks on response programs for unauthorized access to customer information. This guidance, among other things, requires notice to be sent to customers whose “sensitive information” has been
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compromised if unauthorized use of this information is “reasonably possible”. Various states have enacted legislation concerning breaches of data security and various bills requiring consumer notice of data security breaches are being considered by Congress.
Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires the financial institution to explain to consumers its policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, the financial institution is prohibited from disclosing such information except as provided in its policies and procedures.
USA Patriot Act of 2001 (the “Patriot Act”). The Patriot Act, designed to deny terrorists and others the ability to obtain anonymous access to the United States financial system, has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act, together with the regulations implemented by various federal regulatory agencies, requires financial institutions, including the Bank, to implement new policies and procedures or amend existing policies or 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 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 to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act.
The Community Reinvestment Act (the “CRA”). The CRA requires lenders to identify the communities served by the institution’s offices and other deposit taking facilities and to make loans and investments and provide services that meet the credit needs of these communities. Regulatory agencies examine each of the banks and rate such institutions’ compliance with CRA as “Outstanding”, “Satisfactory”, “Needs to Improve” or “Substantial Noncompliance”. Failure of an institution to receive at least a “Satisfactory” rating could inhibit an institution or its holding company from undertaking certain activities, including engaging in activities newly permitted as a financial holding company under GLBA and acquisitions of other financial institutions. The Federal Reserve Board must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low- and moderate-income neighborhoods. The Bank has achieved a rating of “Outstanding” on its most recent examination dated November 2003.
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). 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:
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The creation of an independent accounting oversight board;
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Auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients;
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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;
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The forfeiture of bonuses or other incentive-based compensation and profits from the sale of a public company’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
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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;
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Requirements that audit committee members be independent and are barred from accepting consulting, advisory or other compensatory fees from public companies;
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Requirements that public companies disclose whether at least one member of the audit committee is a “financial expert” (as such term is defined by the SEC) and if not, why not;
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Expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;
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A prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions, such as the Bank, on nonpreferential terms and in compliance with other bank regulatory requirements;
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Disclosure of a code of ethics and filing a Form 8-K for a change to or waiver of such code; and
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A range of enhanced penalties for fraud and other violations.
The Corporation is monitoring the status of other related ongoing rulemaking by the SEC and other regulatory entities. Currently, management believes that the Corporation is in compliance with the rulemaking promulgated to date.
Securities and Exchange Commission Availability of Filings
Under Sections 13 and 15(d) of the Exchange Act, periodic and current reports must be filed or furnished with the SEC. Washington Trust makes available free of charge on its website (www.washtrust.com) its annual report on Form 10-K, its quarterly reports on Form 10-Q, current reports on Form 8-K, and exhibits and amendments to those reports as soon as practicable after it electronically files such material with, or furnishes it to, the SEC. Information on the Washington Trust website is not incorporated by reference into this Annual Report on Form 10-K.
Item 1A
Item 1A Risk Factors
In addition to the other information contained or incorporated by reference in this Annual Report on Form 10-K, you should consider the following factors relating to the business of the Corporation.
Interest Rate Volatility May Reduce Our Profitability
Significant changes in market interest rates may adversely affect both our profitability and our financial condition. Our profitability depends in part on the difference between rates earned on loans and investments and rates paid on deposits and other interest-bearing liabilities. Since market interest rates may change by differing magnitudes and at different times, significant changes in interest rates over an extended period of time could reduce overall net interest income. (See Item 7A, Quantitative and Qualitative Disclosures about Market Risk, for additional discussion on interest rate risk.)
Changes in the Market Value of Wealth Management and Trust Assets under Administration May Reduce Our Profitability
Wealth management and trust fees provide an important source of our total revenues. These fees are primarily dependent on the market value of wealth management and trust assets under administration. These assets primarily consist of marketable securities. Reductions in the market value of these assets due to market conditions or the inability to attract and retain wealth management clients could reduce the level of fees that we earn.
Reductions in Deposit Levels Necessitating Increased Borrowing to Fund Loans and Investments
The Bank’s principal source of funding is deposits and borrowings. As a general matter, deposits are a lower cost source of funds than borrowings because interest rates paid for deposits are typically less than interest rates charged for borrowings. If, as a result of general economic conditions, market interest rates, competitive pressures or otherwise, the level of the Bank’s deposits were to decline relative to the total sources of funds, the Bank may have to rely more heavily on higher cost borrowings in the future.
Our Allowance for Loan Losses May Not Be Adequate to Cover Actual Loan Losses
We make various assumptions and judgments about the collectibility of our loan portfolio and provide an allowance for potential losses based on a number of factors. If our assumptions are wrong, our allowance for loan losses may not be sufficient to cover our losses, which would have an adverse effect on our operating results, and
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may also cause us to increase the allowance in the future. Further, our net income would decrease if we had to add additional amounts to our allowance for loan losses. In addition to general real estate and economic factors, the following factors could affect our ability to collect our loans and require us to increase the allowance in the future:
•
Regional credit concentration - We are exposed to real estate and economic factors in southern New England, primarily Rhode Island and, to a lesser extent, Connecticut and Massachusetts, because a significant portion of our loan portfolio is concentrated among borrowers in these markets. Further, because a substantial portion of our loan portfolio is secured by real estate in this area, including residential mortgages, most consumer loans, commercial mortgages and other commercial loans, the value of our collateral is also subject to regional real estate market conditions and other factors that might affect the value of real estate, including natural disasters.
•
Industry concentration - A portion of our loan portfolio consists of loans to the hospitality, tourism and recreation industries. Loans to companies in this industry may have a somewhat higher risk of loss than some other industries because these businesses are seasonal, with a substantial portion of commerce concentrated in the summer season. Accordingly, the ability of borrowers to meet their repayment terms is more dependent on economic, climate and other conditions and may be subject to a higher degree of volatility from year to year.
For a more detailed discussion on the allowance for loan losses, see additional information disclosed in Item 7 under the caption “Application of Critical Accounting Policies and Estimates.”
We May Not Be Able to Compete Effectively Against Larger Financial Institutions in Our Increasingly Competitive Industry
The financial services industry in our market has experienced both significant concentration and deregulation. This means that we compete with larger bank and non-bank financial institutions for loans and deposits as well as other sources of funding in the communities we serve, and we will likely face even greater competition in the future as a result of recent federal legislative changes. Many of our competitors have significantly greater resources and lending limits than we have. As a result of those greater resources, the large financial institutions that we compete with may be able to provide a broader range of services to their customers and may be able to afford newer and more sophisticated technology. Our long-term success depends on the ability of the Bank to compete successfully with other financial institutions in the Bank’s service areas.
Changes in Legislation and/or Regulation and Accounting Principles, Policies and Guidelines
Changes in legislation and/or regulation governing financial holding companies and their subsidiaries could affect our operations. The Corporation is subject to extensive federal and state laws and regulations and is subject to supervision, regulation and examination by various federal and state bank regulatory agencies. The restrictions imposed by such laws and regulations limit the manner in which the Corporation may conduct business. There can be no assurance that any modification of these laws and regulations, or new legislation that may be enacted in the future, will not make compliance more difficult or expensive, or otherwise adversely affect the operations of the Corporation. See the section entitled “Supervision and Regulation” in Item 1 of this Annual Report on Form 10-K.
Changes in accounting principles generally accepted in the United States applicable to the Corporation could have a material impact on the Corporation’s reported results of operations.
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ITEM 1B.
ITEM 1B. Unresolved Staff Comments
None.
GUIDE 3 Statistical Disclosures
The information required by Securities Act Guide 3 “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.
ITEM 2.
ITEM 2. Properties
The Corporation conducts its business from sixteen branch offices, including its headquarters located at 23 Broad Street, Westerly, Rhode Island and branch offices located within Washington, Providence and Kent Counties in Rhode Island and New London County in southeastern Connecticut. The Corporation also provides wealth management and trust services from its main office and offices located in Providence and Narragansett, Rhode Island and Wellesley, Massachusetts. In addition, the Bank has two operations facilities located in Westerly, Rhode Island. At December 31, 2005, ten of the Corporation’s facilities were owned, nine were leased and one branch office was owned on leased land. Lease expiration dates range from seven months to fifty-eight months with renewal options of one to ten years. All of the Corporation’s properties are considered to be in good condition and adequate for the purpose for which they are used.
In addition to the branch locations mentioned above, the Bank has four owned offsite-ATMs in leased spaces. The terms of three of these leases are negotiated annually. The lease term for the fourth offsite-ATM expires in seven years with no renewal option.
The Bank also operates ATMs that are branded with the Bank’s logo under contracts with a third party vendor located in retail stores and other locations throughout Rhode Island and southeastern Connecticut.
For additional information regarding premises and equipments and lease obligations see Notes 8 and 15 to the Consolidated Financial Statements.
ITEM 3.
ITEM 3. Legal Proceedings
The Corporation is involved in various other claims and legal proceedings arising out of the ordinary course of business. Management is of the opinion, based on its review with counsel of the development of such matters to date, that the ultimate disposition of such other matters will not materially affect the consolidated financial position or results of operations of the Corporation.
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ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2005.
Executive Officers of the Registrant
The following is a list of all executive officers of the Bancorp and the Bank with their titles, ages, and length of service, followed by certain biographical information as of December 31, 2005.
John C. Warren joined the Bancorp and the Bank in 1996 as President and Chief Operating Officer. In 1997, he was elected President and Chief Executive Officer of the Bancorp and the Bank. In 1999, he was elected Chairman and Chief Executive Officer of the Bancorp and the Bank.
John F. Treanor joined the Bancorp and the Bank in April 1999 as President and Chief Operating Officer.
Galan G. Daukas joined the Bancorp and the Bank in August 2005 as Executive Vice President of Wealth Management. Prior to joining Washington Trust, he held the position of Chief Operating Officer of The Managers Funds, LLC from 2002 to 2005. He served as Chief Operating Officer and Chairman of the Management Committee of Harbor Capital Management Company from 2000 to 2002.
David V. Devault joined the Bank in 1986 as Controller. He was elected Vice President and Chief Financial Officer of the Bancorp and the Bank in 1987. He was elected Senior Vice President and Chief Financial Officer of the Bancorp and the Bank in 1990. In 1997, he was also elected Treasurer of the Bancorp and the Bank. In 1998, he was elected Executive Vice President, Treasurer and Chief Financial Officer of the Bancorp and the Bank. He was appointed to the position of Secretary of the Bank in 2002 and Secretary of the Bancorp in 2005.
Stephen M. Bessette joined the Bank in February 1997 as Senior Vice President - Retail Lending. He was named Executive Vice President - Retail Lending in 2005.
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B. Michael Rauh, Jr. joined the Bank in 1991 as Vice President - Marketing and was promoted in 1993 to Senior Vice President - Retail Banking. He was named Senior Vice President - Corporate Sales, Planning & Delivery in 2003. In 2005, he was appointed Executive Vice President - Corporate Sales, Planning & Delivery.
Dennis L. Algiere joined the Bank in April 1995 as Compliance Officer. He was named Vice President - Compliance in December 1996 and was promoted to Senior Vice President - Compliance and Community Affairs in September 2001. He was named Senior Vice President - Chief Compliance Officer and Director of Community Affairs in 2003.
Vernon F. Bliven joined the Bank in 1972 and was named Assistant Vice President in 1980, Vice President in 1986 and Senior Vice President - Human Resources in 1993.
Elizabeth B. Eckel joined the Bank in 1991 as Director of Advertising and Public Relations. In 1995, she was named Vice President - Marketing. She was promoted to Senior Vice President - Marketing in 2000.
William D. Gibson joined the Bank in March 1999 as Senior Vice President - Credit Administration.
Barbara J. Perino joined the Bank in 1988 as Financial Accounting Officer. She was named Controller in 1989 and Vice President - Controller in 1992. In 1998, she was promoted to Senior Vice President - Operations and Technology.
James M. Vesey joined the Bank in 1998 as Senior Vice President - Commercial Lending. In 2000, he was named Senior Vice President and Chief Credit Officer.
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PART II
ITEM 5.
ITEM 5. Market for the Registrant’s Common Stock, Related Stockholder Matters
The Bancorp’s common stock has traded on the NASDAQ National Market since May 1996. Previously, the Bancorp’s stock traded on the NASDAQ Small Cap Market since June 1992, and had been listed on the NASDAQ Over-The-Counter Market system since June 1987.
The quarterly common stock price ranges and dividends paid per share for the years ended December 31, 2005 and 2004 are presented in the following table. The stock prices are based on the high and low sales prices during the respective quarter.
The Bancorp will continue to review future common stock dividends based on profitability, financial resources and economic conditions. The Bancorp (including the Bank prior to 1984) has recorded consecutive quarterly dividends for over 100 years.
The Bancorp’s primary source of funds for dividends paid to shareholders is the receipt of dividends from the Bank. A discussion of the restrictions on the advance of funds or payment of dividends to the Bancorp is included in Note 17 to the Consolidated Financial Statements.
At February 24, 2006 there were 2,152 holders of record of the Bancorp’s common stock.
See additional disclosures on Equity Compensation Plan Information in Part III, Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
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ITEM 6.
ITEM 6. Selected Financial Data
The selected consolidated financial data set forth below does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information including the Consolidated Financial Statements and related Notes, and the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” appearing elsewhere in this Annual Report on Form 10-K.
Selected Operating Data and Financial Ratios:
(Dollars in thousands, except per share amounts)
(1)
Represents historical per share dividends declared by the Bancorp.
(2)
Represents the ratio of historical per share dividends declared by the Bancorp to diluted earnings per share.
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Selected Balance Sheet Data:
(Dollars in thousands)
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Selected Quarterly Financial Data
(Dollars in thousands, except per share amounts)
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Selected Quarterly Financial Data
(Dollars in thousands, except per share amounts)
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ITEM 7.
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following analysis is intended to provide the reader with a further understanding of the consolidated financial condition and results of operations of the Corporation for the periods shown. For a full understanding of this analysis, it should be read in conjunction with the Corporation’s Consolidated Financial Statements and Notes thereto included in Item 8 “Financial Statements and Supplementary Data.”
Forward-Looking Statements
This report contains statements that are “forward-looking statements.” We may also make written or oral forward-looking statements in other documents we file with the SEC, in our annual reports to shareholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “outlook,” “will,” “should,” and other expressions which predict or indicate future events and trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Corporation. These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Corporation to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements.
Some of the factors that might cause these differences include the following: changes in general national or regional economic conditions, changes in interest rates, reductions in the market value of wealth management and trust assets under administration, reductions in loan demand, reductions in deposit levels necessitating increased borrowing to fund loans and investments, changes in loan defaults and charge-off rates, changes in the size and nature of the Corporation’s competition, changes in legislation or regulation and accounting principles, policies and guidelines and changes in the assumptions used in making such forward-looking statements. In addition, the factors described under “Risk Factors” in Item 1A of this Annual Report on Form 10-K may result in these differences. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this report, and we do not promise to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.
Application of Critical Accounting Policies and Estimates
Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on income and the carrying value of certain assets, are considered critical accounting policies. The Corporation considers the following to be its critical accounting policies: allowance for loan losses, accounting for acquisitions and review of goodwill and intangible assets for impairment, other-than-temporary impairment, interest income recognition and tax estimates. There have been no significant changes in the methods or assumptions used in the accounting policies that require material estimates and assumptions.
Allowance for Loan Losses
Arriving at an appropriate level of allowance for loan losses necessarily involves a high degree of judgment. The Corporation uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: (1) identification of loss allocations for certain specific loans, (2) general loss allocations for certain loan types based on credit grade and loss experience factors, and (3) general loss allocations for other environmental factors. The methodology includes an analysis of individual loans deemed to be impaired in accordance with accounting principles generally accepted in the United States of America (SFAS 114, “Accounting by Creditors for Impairment of a Loan-an amendment of FASB Statements No. 5 and 15”). Other individual commercial loans and commercial mortgage loans are evaluated using an internal rating system and the application of loss allocation factors. The loan rating system and the related loss allocation factors take into consideration parameters including the borrower’s financial condition, the borrower’s performance with respect to loan terms, and the adequacy of collateral. Portfolios of more homogenous populations of loans including residential mortgages and consumer loans are analyzed as groups taking into account delinquency ratios and other
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indicators, the Corporation’s historical loss experience and comparison to industry standards of loss allocation factors for each type of credit product. Finally, an additional unallocated allowance is maintained based on a judgmental process whereby management considers qualitative and quantitative assessments of other environmental factors. For example, a significant portion of our loan portfolio is concentrated among borrowers in southern New England, primarily Rhode Island and, to a lesser extent, Connecticut and Massachusetts, and a substantial portion of the portfolio is collateralized by real estate in this area. A portion of the commercial loans and commercial mortgage loans are to borrowers in the hospitality, tourism and recreation industries. Further, economic conditions which may affect the ability of borrowers to meet debt service requirements are considered, including interest rates and energy costs. Results of regulatory examinations, historical loss ranges, portfolio composition including a trend toward somewhat larger credit relationships, and other changes in the portfolio are also considered.
The Corporation’s Audit Committee of the Board of Directors is responsible for oversight of the loan review process. This process includes review of the Bank’s procedures for determining the adequacy of the allowance for loan losses, administration of its internal credit rating systems and the reporting and monitoring of credit granting standards.
Accounting for Acquisitions and Review of Goodwill and Intangible Assets for Impairment
For acquisitions accounted for under the purchase method, the Corporation is required to record assets acquired and liabilities assumed at their fair value. The valuation techniques used to determine the carrying value of tangible and intangible assets acquired in acquisitions and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors. Any change in the estimates that are used to determine the carrying value of goodwill and identifiable intangible assets or that otherwise adversely affects their value or estimated lives could adversely affect the Corporation’s results of operations. Core deposit and other identifiable intangible assets are amortized to expense over their estimated useful lives and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Furthermore, the determination of which intangible assets have finite lives is subjective, as is the determination of the amortization period for such intangible assets. Goodwill and intangible assets are evaluated for impairment, based on fair values, at least annually. The valuation techniques contain estimates as to the comparability of selected market information to the specifics of the Corporation.
Other-Than-Temporary Impairment
The Corporation records an investment impairment charge at the point it believes an investment security has experienced a decline in value that is other-than-temporary. In determining whether an other-than-temporary impairment has occurred, the Corporation reviews information about the issuer of the security that is publicly available, analyst reports, applicable industry data, the magnitude of the impairment, the length of time the security has been impaired and other pertinent information. The investment is written down to its current fair value through a charge to earnings at the time the impairment is deemed to have occurred. Future adverse changes in market conditions, continued poor operating results of the issuer or other factors could result in further losses that may not be reflected in an investment’s current carrying value, possibly requiring an additional impairment charge in the future.
Interest Income Recognition
Interest on loans is included in income as earned based upon rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due unless they are adequately secured and in the process of collection or on other loans when management believes collection is doubtful. All loans considered impaired are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all interest previously accrued is reversed against current-period interest income; therefore, an increase in loans on nonaccrual status could have impact on interest income recognized in future periods.
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Tax Estimates
The Corporation accounts for income taxes by deferring income taxes based on estimated future tax effects of differences between the tax and book basis of assets and liabilities considering the provisions of enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in the Consolidated Balance Sheets. The Corporation must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and establish a valuation allowance for those assets determined to not likely be recoverable. Management judgment is required in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income. The Corporation has determined that a valuation allowance is not required for any of the deferred tax assets since it is more likely than not that these assets will be realized primarily through carryback to taxable income in prior years and future reversals of existing taxable temporary differences.
Results of Operations
Overview
Net income for the year ended December 31, 2005 amounted to $23.0 million, up 11% from $20.8 million reported for 2004. On a diluted per share basis, the Corporation earned $1.69 for 2005, up 10%, from the $1.54 earned in 2004.
The rates of return on average equity and average assets for 2005 were 14.80% and 0.98%, respectively. Comparable amounts for 2004 were 14.40% and 0.97%, respectively.
Selected financial highlights for 2005 and 2004 are presented in the table below:
(Dollars in thousands, except per share amounts)
On August 31, 2005, the Corporation completed the acquisition of Weston Financial, a registered investment advisor and financial planning company located in Wellesley, Massachusetts, with broker-dealer and insurance agency subsidiaries. The results of Weston Financial’s operations have been included in the Consolidated Statements of Income since that date. One-time expenses associated with the acquisition amounting to $605 thousand were recognized in the third quarter of 2005. After tax, this amounted to $440 thousand, or approximately 3 cents per diluted share. The acquisition of Weston Financial increased the size and range of products and services offered by Washington Trust’s wealth management group. As a result of the Weston Financial acquisition, investment management and trust assets under administration increased from approximately $1.9 billion to $3.3 billion. Washington Trust financed the payments made at closing through the issuance of two series of trust preferred stock by newly-formed special purpose finance entities in an aggregate amount of $22 million (see Note 12 to the Consolidated Financial Statements). In connection with the transaction,
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Washington Trust also elected to become a financial holding company. See Note 2 to the Consolidated Financial Statements for a more complete description of the acquisition transaction.
Net Interest Income
Net interest income is the difference between interest earned on loans and securities and interest paid on deposits and other borrowings, and continues to be the primary source of Washington Trust’s operating income. Net interest income is affected by the level of interest rates, changes in interest rates and by changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Net interest income totaled $60.7 million for 2005, an increase of $6.2 million, or 11%, from the amount reported for 2004. Included in interest income are loan prepayment fees and certain other fees, such as late charges. In connection with a portion of the loan prepayment fees received in 2005, a corresponding debt prepayment penalty expense of $129 thousand was incurred due to the payoff of a match-funded FHLB advance. The debt prepayment penalty expense was included in other noninterest expenses in 2005.
The following discussion presents net interest income on a fully taxable equivalent (“FTE”) basis by adjusting income and yields on tax-exempt loans and securities to be comparable to taxable loans and securities.
FTE net interest income for 2005 amounted to $61.7 million, up $6.3 million, or 11%, from the $55.4 million reported for 2004. The increase in net interest income reflected growth in the loan portfolio and a higher yield on earning assets, which were partially offset by growth in time deposits and an increase in cost of funds.
The net interest margin (FTE net interest income as a percentage of average interest-earning assets) increased 5 basis points to 2.79% in 2005. Excluding the impact of loan prepayment fees and certain other fees, such as late charges, the net interest margin was up 3 basis points from 2004. The increase in the net interest margin was attributable to the higher amount of loans as a percentage of interest-earning assets and to changes in loan and deposit rates.
Average interest-earning assets increased $191.1 million, or 9%, in 2005. This increase was mainly due to growth of $237.2 million, or 21%, in the loan portfolio, which was partially offset by reductions of $46.1 million, or 5%, in the securities portfolio. Growth in average loan balances resulted from purchases of primarily adjustable rate residential mortgage loans as well as internal growth in commercial and consumer loans. The yield on total loans increased 38 basis points in 2005. This increase in the yield on total loans was primarily due to higher marginal yields on loans as compared to the prior year and higher yields on new loan originations and purchases. Loan prepayment and other fees included in net interest income totaled $772 thousand and $375 thousand in 2005 and 2004, respectively. The contribution of loan prepayment and other fees to the yield on total loans was 6 basis and 3 basis points, respectively, for 2005 and 2004. Total average securities declined in 2005 as the flattening of the yield curve has made reinvestment of maturing balances relatively unattractive. The increase in the total yield on securities reflects a combination of higher yields on variable rate securities tied to short-term interest rates, runoff of lower yielding securities and higher marginal rates on reinvestment of cash flows in 2005 relative to the prior year.
Average interest-bearing liabilities rose $183.7 million, or 10%, in 2005. The Corporation experienced growth in time deposits, NOW accounts and money market accounts, and declines in savings account balances and FHLB advances. In the third quarter of 2005, the Corporation also issued junior subordinated debentures and recorded a liability for the minimum future payments due in connection with the acquisition of Weston Financial. (See additional discussion on the acquisition of Weston Financial in Note 2 of the Consolidated Financial Statements.) The increase in average interest-bearing liabilities was principally due to $165.6 million of growth in time deposits in 2005. The average rate paid on time deposits increased 38 basis points in 2005. Included in time deposits were brokered certificates of deposit, which are utilized by the Corporation as part of its overall funding program along with other sources. Average brokered certificates of deposit increased $45.5 million in 2005. The balance of average FHLB advances decreased $33.3 million in 2005, while the average rate paid on FHLB advances increased 51 basis points.
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Average Balances/Net Interest Margin (Fully Taxable Equivalent Basis)
The following table presents average balance and interest rate information. Tax-exempt income is converted to a fully taxable equivalent basis using the statutory federal income tax rate. For dividends on corporate stocks, the 70% federal dividends received deduction is also used in the calculation of tax equivalency. Unrealized gains (losses) on available for sale securities are excluded from the average balance and yield calculations. Nonaccrual and renegotiated loans, as well as interest earned on these loans (to the extent recognized in the Consolidated Statements of Income) are included in amounts presented for loans.
Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency for the years indicated:
(Dollars in thousands)
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Volume/Rate Analysis - Interest Income and Expense (Fully Taxable Equivalent Basis)
The following table presents certain information on a fully taxable equivalent basis regarding changes in our interest income and interest expense for the periods indicated. The net change attributable to both volume and rate has been allocated proportionately.
Provision and Allowance for Loan Losses
The allowance for loan losses is management’s best estimate of the probable loan losses incurred as of the balance sheet date. The allowance for loan losses was $17.9 million, or 1.28% of total loans, at December 31, 2005, compared to $16.8 million, or 1.34% of total loans, at December 31, 2004. For the years ended December 31, 2005 and 2004, the Corporation’s provision for loan losses amounted to $1.2 million and $610 thousand, respectively. The increase in the Corporation’s loan loss provision was in response to growth in the loan portfolio. See the additional discussion under the caption “Asset Quality” for further information on the Allowance for Loan Losses.
Noninterest Income
Noninterest income is an important source of revenue for Washington Trust. For the year ended December 31, 2005, recurring noninterest income, which excludes net realized gains on securities, accounted for 34% of total revenues (net interest income plus recurring noninterest income). Washington Trust’s primary sources of recurring noninterest income are wealth management and trust services fees, service charges on deposit accounts, merchant credit card processing fees, and net gains on loan sales. Also included in noninterest income are earnings generated from bank-owned life insurance (“BOLI”). Noninterest income, excluding net realized gains on securities, amounted to $30.6 million for 2005, up $3.9 million, or 15%, from 2004.
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The following table presents a noninterest income comparison for the years ended December 31, 2005 and 2004:
Revenue from wealth management and trust services continues to be the largest component of noninterest income. This revenue is largely dependent on the value of assets under administration and is closely tied to the performance of the financial markets. In 2005, revenue from wealth management and trust services represented 54% of noninterest income (excluding net realized gains on securities), compared to 49% in 2004. For the year 2005, revenue from wealth management and trust services increased $3.4 million, or 26%, from 2004. Approximately $3.0 million, or 88%, of this increase was attributable to the acquisition of Weston Financial that was completed on August 31, 2005. Assets under administration rose significantly due to the addition of Weston Financial, and amounted to $3.272 billion at December 31, 2005. This included approximately $1.376 billion attributable to Weston Financial. Assets under administration were $1.871 billion at December 31, 2004.
Service charges on deposit accounts were essentially unchanged from 2004. This revenue source was affected by deposit account pricing strategies and reflects a very competitive retail-banking environment.
Merchant processing fees increased $944 thousand, or 22%, in 2005 primarily due to increases in the volume of transactions processed. Merchant processing fees represents charges to merchants for credit card transactions processed.
Net gains on loan sales decreased $222 thousand, or 12%, in 2005, due to a decline in sales of Small Business Administration (“SBA”) loans. Included in net gains on loan sales in 2005 and 2004 were approximately $523 thousand and $789 thousand, respectively, in net gains on sales of SBA loans.
Income from BOLI amounted to $1.1 million and $1.2 million for the years ended December 31, 2005 and 2004, respectively. BOLI represents life insurance on the lives of certain employees who have consented to allowing the Bank to be the beneficiary of such policies. The Corporation expects to benefit from the BOLI contracts as a result of the tax-free growth in cash surrender value and death benefits that are expected to be generated over time. The cash surrender value of BOLI was $30.4 million at December 31, 2005, compared to $29.2 million at December 31, 2004. BOLI is invested in the “general account” of quality insurance companies. Standard & Poor’s rated all such general account carriers “AA” or better at December 31, 2005. The BOLI investment provides a means to mitigate increasing employee benefit costs.
Other income consists of mortgage servicing fees, non-customers ATM fees, safe deposit rents, wire transfer fees, fees on letters of credit, financial advisory services fees, commissions on annuities, and other fees. Other income amounted to $1.7 million in 2005, down 7% from 2004. Included in other noninterest income for 2004 was a first quarter non-routine item of $150 thousand unrelated to the Corporation’s normal course of earnings, and $280 thousand recovered in the second quarter of that year as a result of a favorable litigation decision.
In 2005 and 2004, net realized gains on securities totaled $357 thousand and $248 thousand, respectively. The Corporation recognized net realized gains on securities of $337 thousand and $387 thousand in the fourth quarter
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of 2005 and 2004, respectively, resulting principally from the Corporation’s annual contributions of appreciated equity securities to the Corporation’s charitable foundation. The cost of the contributions, included in noninterest expenses, amounted to $522 thousand and $454 thousand in 2005 and 2004, respectively.
Noninterest Expense
For the year ended December 31, 2005, total noninterest expense amounted to $56.4 million, up $6.0 million, or 12%, from 2004.
Included in noninterest expenses in 2005 were direct acquisition and acquisition related costs amounting to $605 thousand, which included $292 thousand in salaries and benefits, $50 thousand in legal, audit and professional fees, and $263 thousand in other noninterest expenses. Acquisition related costs included costs incurred in connection with management changes, organization costs related to the establishment of the trust preferred entities, accounting and legal costs and other charges.
As previously mentioned, 2005 financial results include the operations of Weston Financial for the period subsequent to August 31, 2005. Approximately $3.1 million, or 51%, of the total increase in noninterest expense was attributable to the one-time acquisition related charges and the operating expenses of Weston Financial.
The following table presents a noninterest expense comparison for the years ended December 31, 2005 and 2004:
Salaries and employee benefit expense, the largest component of total noninterest expense, increased $3.3 million, or 12%, in 2005. Excluding one-time acquisition related charges and the operating expenses of Weston Financial, salaries and employee benefits expense rose $1.5 million, or 5%, in 2005. This 5% increase was mainly due to an increase in salaries and wages, higher defined benefit pension costs and increases in performance-based and stock-based compensation. Salaries and wages increased $441 thousand, or 2%. Pension costs increased $398 thousand in 2005, primarily due to higher service cost and a lower discount rate. Performance-based compensation expense increased $219 thousand in 2005, and stock compensation expense associated with restricted stock and restricted stock unit awards increased $213 thousand.
Stock options granted during 2005 and in prior years did not require the recognition of any expense in the Consolidated Statements of Income during those periods. In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revised Statement No. 123, “Share-Based Payment”, (“SFAS 123 (revised 2004)”) that requires that all companies expense the fair value of employee stock options in accordance with the Statement. SFAS 123 (revised 2004) is effective at the beginning of the next fiscal year, which begins after June 15, 2005. For those option awards outstanding as of December 31, 2005 with requisite service periods remaining, the Corporation expects that the expense to be recognized in 2006 for such awards will amount to approximately $162 thousand, pretax.
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Net occupancy expense in 2005 increased 8%. The increase reflected higher rental expense for premises leased by the Bank and included operating expenses of Weston Financial. Equipment expense increased 6% in 2005 primarily due to additional investments in technology and other equipment.
Merchant processing costs increased 22% in 2005 due to increases in the volume of transactions processed. Merchant processing costs represent third-party costs incurred that are directly attributable to handling merchant credit card transactions.
As a result of stronger marketing and promotion efforts, advertising and promotion expense increased 13% in 2005. Legal, audit and professional fees totaled $1.9 million in 2005, up $365 thousand from 2004. This increase was primarily due to costs incurred for various consulting matters, of which approximately $250 thousand will not be incurred in future periods. Outsourced services increased 7% in 2005 due to higher costs for data processing services and third party vendor costs.
Amortization of intangibles amounted to $852 thousand in 2005, compared to $644 thousand in 2004. See Note 9 to the Consolidated Financial Statements for additional information on identifiable intangible assets.
Other noninterest expense increased $561 thousand, or 9%, in 2005. Excluding one-time acquisition related costs, other noninterest expense increased $298 thousand, or 5%, primarily due to the operations of Weston Financial. Also included in other noninterest expense in 2005 was $129 thousand in prepayment costs associated with the payoff of a match funded FHLB advance.
Taxes
Income tax expense amounted to $11.0 million and $9.5 million in 2005 and 2004, respectively. The Corporation’s effective tax rate was 32.3% in 2005, compared to a rate of 31.4% in 2004. These rates differed from the federal rate of 35.0% due to the benefits of tax-exempt income, the dividends received deduction and income from BOLI. The increase in the Corporation’s effective tax rate in 2005 was primarily due to a higher effective tax rate associated with Weston Financial.
The Corporation’s net deferred tax asset amounted to $3.6 million at December 31, 2005, compared to $3.2 million at December 31, 2004. The Corporation has determined that a valuation allowance is not required for any of the deferred tax assets since it is more likely than not that these assets will be realized primarily through future reversals of existing taxable temporary differences or carryback to taxable income in prior years. See Note 14 to the Consolidated Financial Statements for additional information regarding income taxes.
Comparison of 2004 with 2003
Net income for the year ended December 31, 2004 amounted to $20.8 million, up 10% from the amount reported for 2003. Washington Trust earned $1.54 per diluted share for 2004, up 9% from the $1.41 earned in 2003. The rates of return on average equity and average assets for 2004 were 14.40% and 0.97%, respectively. Comparable amounts for the year 2003 were 14.15% and 1.03%, respectively.
Net interest income, Washington Trust’s primary source of operating income, totaled $54.4 million in 2004, an increase of 12% from 2003. FTE net interest income for 2004 totaled $55.4 million, up 11% from 2003. The increase in net interest income resulted from an increase in average earning assets during the year, which was offset in part by a decline in the net interest margin.
Average interest-earnings assets amounted to $2.023 billion for 2004, up $297.9 million, or 17%, from 2003. Average loans increased $243.0 million, or 28%, in 2004 due to purchases of residential mortgage loans as well as growth in commercial and consumer loans. Average securities increased $54.8 million, or 6%, in 2004 mainly due to purchases of taxable debt securities.
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Although net interest income increased, the net interest margin for 2004 amounted to 2.74%, down 15 basis points from 2.89% for 2003. The decrease in the net interest margin reflected the decline in yields on loans and securities offset somewhat by lower funding costs.
The decrease in the yield on total loans from 6.01% in 2003 to 5.52% in 2004 was primarily due to lower marginal yields on loans as compared to the prior year and a decline in yields on new loan originations in 2004. The FTE rate of return on securities was 4.01% in 2004, down from 4.10% in 2003, reflecting a combination of lower yields on variable rate securities and lower marginal rates on reinvestment of cash flows in 2004 compared to 2003.
Average interest-bearing liabilities increased $272.0 million, or 18%, in 2004, as deposit growth, along with additional borrowings, were utilized to fund the Corporation’s asset growth. The increase in average interest-bearing liabilities was principally due to an increase in average deposits of $204.2 million in 2004. The rate paid on deposits in 2004 amounted to 1.93%, compared to $1.92% in 2003. The balance of average FHLB advances increased $87.8 million in 2004, while the average rate paid on FHLB advances decreased 25 basis points.
For the years ended December 31, 2004 and 2003, the Corporation’s provision for loan losses amounted to $610 thousand and $460 thousand, respectively. The allowance for loan losses amounted to $16.8 million, or 1.34% of total loans, at December 31, 2004, compared to $15.9 million, or 1.66% of total loans, at December 31, 2003.
Noninterest income, excluding net realized gains on securities, amounted to $26.7 million for the year 2004, up $552 thousand from $26.1 million for 2003. The increase in noninterest income was attributable to higher revenue from wealth management and trust services, merchant processing fees and other income, which were offset partly with declines services charges on deposits and net gains on loan sales.
The following table presents a noninterest income comparison for the years ended December 31, 2004 and 2003:
In 2004, revenue from wealth management and trust services represented 49% of noninterest income, excluding net realized gains on securities. Revenue from wealth management and trust services increased $2.3 million, or 21%, in 2004. The market value of wealth management and trust assets under administration amounted to $1.871 billion and $1.742 billion at December 31, 2004 and 2003, respectively.
Service charges on deposit accounts declined 9% in 2004, due in part to deposit account pricing strategies utilized to attract new deposits in a highly competitive marketplace. “In-market” deposit balances (which exclude brokered certificates of deposit) rose 18% in 2004 partly as a result of such strategies.
Merchant processing fees (charges to merchants for credit card transactions processed) increased 25% in 2004 due to increases in the volume of transactions processed.
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Net gains on loan sales decreased $2.8 million, or 59%, in 2004, reflecting a decline in fixed rate residential mortgage origination and sales activity.
Other income increased $636 thousand in 2004. Included in other income in 2004 was a non-routine item of $150 thousand unrelated to the Corporation’s normal course of business, and $280 thousand recovered as a result of a favorable litigation decision.
The Corporation recognized net realized gains on securities amounting to $248 thousand and $630 thousand in 2004 and 2003, respectively. Included in net realized gains on securities were gains of $387 thousand and $400 thousand in 2004 and 2003, respectively, resulting principally from the Corporation’s annual contributions of appreciated equity securities to the Corporation’s charitable foundation. The cost of the contributions, included in noninterest expenses, amounted to $454 thousand and $433 thousand in 2004 and 2003, respectively.
Noninterest expense amounted to $50.4 million in 2004, up 6% from the amount reported in 2003. In June 2003, the Corporation recorded debt prepayment penalties of $941 thousand ($649 thousand after tax, amounting to $.05 per diluted share), related to the prepayment of certain higher interest rate FHLB advances consummated to reduce future funding costs. Exclusive of the debt prepayment penalty charge of $941 thousand in 2003, noninterest expenses increased $3.7 million, or 8%, in 2004, with the largest increases in salaries and employee benefits and merchant processing costs.
The following table presents a noninterest expense comparison for the years ended December 31, 2004 and 2003:
Salaries and employee benefit expense, the largest component of total noninterest expense, increased $1.9 million, or 7%, in 2004, mainly due to merit pay increases as well as higher defined benefit pension costs, performance-based compensation and health insurance premiums. Merit pay increases resulted in a $645 thousand, or 3%, increase in salaries expense. Pension costs increased $346 thousand in 2004, primarily due to higher service cost and a lower discount rate. Performance-based compensation expense increased $216 thousand in 2004 and health insurance premiums increased $165 thousand from 2003.
Net occupancy expense in 2004 increased 7%. The increase was primarily due to higher rental expense for premises leased by the Bank. Equipment expense decreased 3% in 2004, primarily due to lower depreciation expense on furniture and equipment.
Merchant processing costs (third-party costs incurred that are directly attributable to handling merchant credit card transactions) increased 30% in 2004 due to increases in the volume of transactions processed.
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Advertising and promotion expense increased 21% in 2004. The increase was primarily attributable to stronger marketing and promotion efforts for products such as demand deposit accounts and home equity lines of credit.
Outsourced services increased 21% in 2004 due to higher costs for data processing services and third party vendor costs.
Legal, audit and professional fees totaled $1.5 million in 2004, up from $1.2 million in 2003. Included in legal, audit and professional fees in 2004 were approximately $602 thousand of audit and professional fees incurred to comply with the internal control documentation and testing standards of Section 404 of the Sarbanes-Oxley Act. The Corporation expects that some portion of these costs will be incurred annually in future years.
Included in other noninterest expense for 2004 were contributions of appreciated equity securities to the Corporation’s charitable foundation amounting to $454 thousand and $433 thousand in 2004 and 2003, respectively. These transactions resulted in realized securities gains of $387 thousand and $400 thousand, respectively, for the same periods. Also included in other noninterest expenses for 2004 were costs of $307 thousand associated with the conversion of certain technology systems.
In the second quarter of 2003, the Corporation recorded debt prepayment penalties of $941 thousand ($649 thousand after tax, amounting to $.05 per diluted share), related to the prepayment of certain higher interest rate FHLB advances consummated to reduce future funding costs. No debt prepayment penalties were incurred in 2004.
Income tax expense amounted to $9.5 million and $8.5 million in 2004 and 2003, respectively. The Corporation’s effective tax rate was 31.4% in 2004, compared to a rate of 31.0% in 2003.
Financial Condition
Summary
Consolidated total assets increased $94.2 million to $2.402 billion at December 31, 2005. The growth was mainly attributable to an increase in loans, which was offset in part by a decline in securities. Total liabilities increased $87.6 million in 2005, with total deposits increasing $181.4 million, FHLB advances decreasing $127.4 million and the issuance of $22.7 million in junior subordinated debentures issued related to the Weston Financial acquisition. Shareholders’ equity totaled $158.4 million at December 31, 2005, compared to $151.9 million at the end of 2004.
Securities
Washington Trust’s securities portfolio is managed to generate interest income, to implement interest rate risk management strategies, and to provide a readily available source of liquidity for balance sheet management. Securities are designated as either available for sale or held to maturity at the time of purchase. Securities available for sale may be sold in response to changes in market conditions, prepayment risk, rate fluctuations, liquidity, or capital requirements. Securities available for sale are reported at fair value, with any unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of tax, until realized. Securities designated as held to maturity are part of the Corporation’s portfolio of long-term interest-earning assets. These securities are classified as held to maturity because the Corporation has the intent and ability to hold them until maturity. Securities held to maturity are reported at amortized cost. At December 31, 2005, the Corporation’s portfolio consisted primarily of mortgage-backed securities and U.S. government treasury and agency securities. See Note 5 to the Consolidated Financial Statements for additional information.
Washington Trust may acquire, hold and transact various types of investment securities in accordance with applicable federal regulations, state statutes and guidelines specified in Washington Trust’s internal investment policy. Permissible bank investments include federal funds, banker’s acceptances, commercial paper, reverse repurchase agreements, interest-bearing deposits of federally insured banks, U.S. Treasury and government-sponsored agency debt obligations, including mortgage-backed securities and collateralized mortgage obligations,
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municipal securities, corporate debt, trust preferred securities, mutual funds, auction rate preferred stock, common and preferred equity securities, and FHLB stock.
Investment activity is monitored by an Investment Committee, the members of which also sit on the Corporation’s Asset/Liability Committee (“ALCO”). Asset and liability management objectives are the primary influence on the Corporation’s investment activities. However, the Corporation also recognizes that there are certain specific risks inherent in investment portfolio activity. The securities portfolio is managed in accordance with regulatory guidelines and established internal corporate investment policies that provide limitations on specific risk factors such as market risk, credit risk and concentration, liquidity risk and operational risk to help monitor risks associated with investing in securities.
The carrying amounts of securities as of the dates indicated are presented in the following tables:
Total investment securities declined $106.1 million in 2005. The flattening of the yield curve and associated changes in investment yields relative to funding costs made reinvestment of maturing balances unattractive during the year. The funds provided by reducing investment portfolio balances were primarily used to reduce the Corporation’s FHLB advance borrowing position. The carrying value of securities available for sale decreased $116.4 million, while the carrying value of the held to maturity portfolio increased $10.3 million in 2005. See Note 5 to the Consolidated Financial Statements for detail of unrealized gains and losses on securities.
Federal Home Loan Bank Stock
The Corporation is required to maintain a level of investment in FHLB stock that currently is based on the level of its FHLB advances. As of December 31, 2005 and 2004, the Corporation’s investment in FHLB stock totaled $35.0 million and $34.4 million, respectively.
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Loans
The following table sets forth the composition of the Corporation’s loan portfolio for each of the past five years:
(1)
Loans to businesses and individuals, a substantial portion of which are fully or partially collateralized by real estate.
(2)
Other consumer loans include personal installment loans and loans to individuals secured by general aviation aircraft and automobiles
Washington Trust’s loan portfolio amounted to $1.402 billion at December 31, 2005, up $152.2 million, or 12%, in 2005. Growth occurred in all lines of business with the largest increase in residential real estate loans, which was the result of both internal loan growth as well as loans purchased from other parties.
The Corporation originates residential mortgages for both portfolio and sale, and purchases mortgages from other financial institutions. Residential real estate loans grew $69.0 million, or 13%, in 2005, including an increase of $13.3 million in purchased residential mortgages. Substantially all of the increase in purchased mortgages consisted of adjustable rate loans.
Commercial loans, including commercial real estate and construction loans, increased $47.0 million, or 9%, from the balance at December 31, 2004. Substantially all of the growth in commercial loans was the result of internal growth.
Consumer loans increased $36.2 million, or 16%, in 2005, primarily due to $18.0 million of growth in home equity loans and $6.1 million of growth in home equity lines.
An analysis of the maturity and interest rate sensitivity of Real Estate Construction and Other Commercial loans as of December 31, 2005 follows:
(1)
Includes homeowner construction and commercial construction and development. Maturities of homeowner construction loans are included based on their contractual conventional mortgage repayment terms following the completion of construction.
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Sensitivity to changes in interest rates for Real Estate Construction and Other Commercial loans due after one year is as follows:
Asset Quality
The Board of Directors of the Bank monitors credit risk management through two committees, the Finance Committee and the Audit Committee. The Finance Committee reviews and approves large exposure credit requests, monitors asset quality on a regular basis and has approval authority for credit granting policies. The Audit Committee oversees management’s system and procedures to monitor the credit quality of the loan portfolio, conduct a loan review program, maintain the integrity of the loan rating system and determine the adequacy of the allowance for loan losses. The Bank’s practice is to identify problem credits early and take charge-offs as promptly as practicable.
Nonperforming Assets
Nonperforming assets include nonaccrual loans and other real estate owned. Nonperforming assets were .10% of total assets at December 31, 2005, compared to 0.21% at December 31, 2004. Nonaccrual loans as a percentage of total loans decreased from 0.38% at the end of 2004 to 0.17% at December 31, 2004.
The following table presents nonperforming assets for the dates indicated:
Nonaccrual Loans
Loans, with the exception of certain well-secured residential mortgage loans, are placed on nonaccrual status and interest recognition is suspended when such loans are 90 days or more past due with respect to principal and/or interest. Well-secured residential mortgage loans are permitted to remain on accrual status provided that full collection of principal and interest is assured. Loans are also placed on nonaccrual status when, in the opinion of management, full collection of principal and interest is doubtful. Interest previously accrued, but uncollected, is reversed against current period income. Subsequent cash receipts on nonaccrual loans are recognized as interest income, or recorded as a reduction of principal if full collection of the loan is doubtful or if impairment of the collateral is identified. Loans are removed from nonaccrual status when they have been current as to principal and interest for a period of time, the borrower has demonstrated an ability to comply with repayment terms, and when, in management’s opinion, the loans are considered to be fully collectible.
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For the year ended December 31, 2005, the gross interest income that would have been recognized if loans on nonaccrual status had been current in accordance with their original terms was approximately $171 thousand. Interest recognized on these loans amounted to approximately $176 thousand.
There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at December 31, 2005.
The following table presents additional detail on nonaccrual loans as of the dates indicated:
Restructured Loans
Loans are considered restructured when the Corporation has granted concessions to a borrower due to the borrower’s financial condition that it otherwise would not have considered. These concessions include modifications of the terms of the debt such as reduction of the stated interest rate other than normal market rate adjustments, extension of maturity dates, or reduction of principal balance or accrued interest. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit the Corporation by increasing the ultimate probability of collection. There were no significant commitments to lend additional funds to borrowers whose loans had been restructured.
There were no restructured accruing loans as of December 31 in each of the years 2001 through 2005.
There were no loans whose terms had been restructured included in nonaccrual loans at December 31, 2005 and 2004.
Potential Problem Loans
The Corporation classifies certain loans as “substandard,” “doubtful,” or “loss” based on criteria consistent with guidelines provided by banking regulators. Potential problem loans consist of classified accruing commercial loans that were less than 90 days past due at December 31, 2005. Such loans are characterized by weaknesses in the financial condition of borrowers or collateral deficiencies. Based on historical experience, the credit quality of some of these loans may improve as a result of collection efforts, while the credit quality of other loans may deteriorate, resulting in some amount of losses. These loans are not included in the analysis of nonaccrual or restructured loans above. At December 31, 2005, potential problem loans amounted to approximately $4.1 million. The Corporation’s loan policy provides guidelines for the review of such loans in order to facilitate collection.
Depending on future events, these potential problem loans, and others not currently identified, could be classified as nonperforming in the future.
Other Real Estate Owned and Repossessed Assets
Other real estate owned and repossessed assets is comprised of properties acquired through foreclosure and other legal means, and loans determined to be substantively repossessed. A loan is considered to be substantively repossessed when the Corporation has taken possession of the collateral, but has not completed legal foreclosure proceedings. These assets are carried at the lower of cost or fair value minus estimated costs to sell. A valuation allowance is maintained for declines in market value and estimated selling costs.
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At December 31, 2005 and 2004, the balance of other real estate owned and repossessed assets was insignificant and was reported in other assets in the Corporations’ Consolidated Balance Sheets. Washington Trust occasionally provides financing to facilitate the sales of some of these properties. Financing is generally provided at market rates with credit terms similar to those available to other borrowers.
Allowance for Loan Losses
The Corporation uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient allowance for loan losses. See additional discussion regarding the allowance for loan losses under the caption “Critical Accounting Policies”.
The allowance for loan losses is management’s best estimate of the probable loan losses incurred as of the balance sheet date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans.
At December 31, 2005, the allowance for loan losses was $17.9 million, or 1.28% of the total loan portfolio, and 742% of total nonaccrual loans. This compares with an allowance of $16.8 million or 1.34% of the total loan portfolio, and 354% of total nonaccrual loans at December 31, 2004.
The following table reflects the activity in the allowance for loan losses for the dates presented:
In 2005, the Corporation reclassified to other liabilities that portion of the allowance for loan losses related to off-balance sheet credit risk.
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The following table presents the allocation of the allowance for loan losses:
Investment in Bank-Owned Life Insurance (“BOLI”)
BOLI amounted to $30.4 million and $29.2 million at December 31, 2005 and 2004, respectively. BOLI provides a means to mitigate increasing employee benefit costs. The Corporation expects to benefit from the BOLI contracts as a result of the tax-free growth in cash surrender value and death benefits that are expected to be generated over time. The purchase of the life insurance policy results in an interest sensitive asset on the Consolidated Balance Sheet that provides monthly tax-free income to the Corporation. The largest risk to the BOLI program is credit risk of the insurance carriers. To mitigate this risk, annual financial condition reviews are completed on all carriers. BOLI is included in the Consolidated Balance Sheets at its cash surrender value. Increases in BOLI’s cash surrender value are reported as a component of noninterest income in the Consolidated Statements of Income.
Deposits
Total deposits amounted to $1.639 billion at December 31, 2005, up $181.4 million, or 12%, from the balance at December 31, 2004 with the largest increase in time deposits. Increases in rates paid on time deposits resulted in a shift in deposit mix from savings accounts to time deposits.
Demand deposits amounted to $196.1 million at December 31, 2005, up $6.5 million, or 3%, from December 31, 2004.
NOW account balances increased $4.0 million, or 2%, in 2005 and totaled $178.7 million at December 31, 2005.
Money market account balances totaled $223.3 million at December 31, 2005, up $26.5 million, or 13%, from December 31, 2004.
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During 2005, savings deposits declined $39.4 million, or 16%, and amounted to $212.5 million at December 31. 2005.
Time deposits (including brokered certificates of deposit) amounted to $828.7 million, up $183.9 million, or 29%, during 2005. The Corporation utilizes brokered time deposits as part of its overall funding program along with other sources. Brokered time deposits amounted to $200.1 million, up $30.5 million, or 18%, during 2005. Excluding the brokered time deposits, time deposits rose $153.4 million, or 32%, in 2005 due to growth in consumer and commercial certificates of deposit.
Borrowings
The Corporation utilizes advances from the FHLB as well as other borrowings as part of its overall funding strategy. FHLB advances were used to meet short-term liquidity needs, to purchase securities and to purchase loans from other institutions. During 2005, the Corporation reduced its FHLB advance borrowing position by $127.4 million, primarily in connection with the reduction of its securities portfolio. Included in the December 31, 2005 balance are $60.5 million of callable advances with call dates ranging from January 2006 through November 2007.
In the third quarter of 2005, the Corporation issued $22.7 million of junior subordinated debentures and recorded a liability of $5.4 million for minimum future payments due in connection with the acquisition of Weston Financial. See additional discussion on the acquisition in Note 2 to the Consolidated Financial Statements.
Liquidity and Capital Resources
Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. Washington Trust’s primary source of liquidity is deposits. Deposits (demand, NOW, money market, savings and time deposits) funded approximately 66.1% of total average assets in 2005. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and federal funds purchased), cash flows from the Corporation’s securities portfolios and loan repayments. In addition, securities designated as available for sale may be sold in response to short-term or long-term liquidity needs.
The ALCO establishes and monitors internal liquidity measures to manage liquidity exposure. Liquidity remained well within target ranges established by the ALCO during 2005. Net loans as a percentage of total assets amounted to 58% at December 31, 2005, compared to 53% at December 31, 2004. Total securities as a percentage of total assets amounted to 33% at December 31, 2005, down from 39% at December 31, 2004.
For 2005, net cash provided by financing activities amounted to $69.2 million and was generated primarily from overall growth in deposits, offset in part by reductions in FHLB advances. Deposits increased $181.4 million in 2005, including an increase of $30.5 million in brokered deposits. FHLB repayments exceeded advances by $127.4 million in 2005. Net cash used in investing activities was $84.3 million in 2005. Included in net cash used in investing activities in 2005 was $19.8 million of net cash paid in connection with the Weston Financial acquisition. In 2005, the Corporation purchased $73.5 million of mainly adjustable rate residential mortgages from other institutions and funded $78.8 million in loans originated. Net cash provided by operating activities amounted to $29.1 million in 2005, $23.0 million of which was generated by net income. See the Consolidated Statements of Cash Flows for further information about sources and uses of cash.
Total shareholders’ equity amounted to $158.4 million at December 31, 2005, compared to $151.9 million at December 31, 2004. The increase in shareholder’s equity in 2005 was primarily attributable to net income of $23.0 million, which was partially offset by $9.6 million in dividends to shareholders and an $8.6 million decrease in accumulated other comprehensive income. The decrease in accumulated other comprehensive income in 2005 was attributable to reductions in net unrealized gains on securities.
The ratio of total equity to total assets amounted to 6.60% at December 31, 2005, compared to 6.58% at December 31, 2004. Book value per share at December 31, 2005 amounted to $11.86, a 4% increase from the year-earlier amount of $11.44 per share. The acquisition of Weston Financial added approximately $31.3 million
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in goodwill and other intangible assets to the balance sheet and, accordingly, tangible book value declined from $9.64 per share at the end of 2004 to $7.79 per share at December 31, 2005.
The Corporation is subject to various regulatory capital requirements. The Corporation is categorized as well-capitalized under the regulatory framework for prompt corrective action. See Note 17 to the Consolidated Financial Statements for additional discussion of capital requirements.
Contractual Obligations and Commitments
The Corporation has entered into numerous contractual obligations and commitments. The following table summarizes our contractual cash obligation and other commitments at December 31, 2005.
(1)
All FHLB advances are shown in the period corresponding to their scheduled maturity.
See Note 10 to the Consolidated Financial Statements for more information regarding the nature and business purpose of financial instruments with off-balance sheet risk and derivative financial instruments.
Asset/Liability Management and Interest Rate Risk
The ALCO is responsible for establishing policy guidelines on liquidity and acceptable exposure to interest rate risk. Interest rate risk is the risk of loss to future earnings due to changes in interest rates. The objective of the ALCO is to manage assets and funding sources to produce results that are consistent with Washington Trust’s liquidity, capital adequacy, growth, risk and profitability goals.
The ALCO manages the Corporation’s interest rate risk using income simulation to measure interest rate risk inherent in the Corporation’s on-balance sheet and off-balance sheet financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 12-month horizon, the month 13 to month 24 horizon, and a 60-month horizon. The simulations assume that the size and general composition of the
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Corporation’s balance sheet remain static over the simulation horizons and take into account the specific repricing, maturity, call options, and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios. The characteristics of financial instrument classes are reviewed periodically by the ALCO to ensure their accuracy and consistency.
The ALCO reviews simulation results to determine whether the Corporation’s exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. As of December 31, 2005 and 2004, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Corporation. The Corporation defines maximum unfavorable net interest income exposure to be a change of no more than 5% in net interest income over the first 12 months, no more than 10% over the second 12 months, and no more than 10% over the full 60-month simulation horizon. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where both interest rates and the composition of the Corporation’s balance sheet remain stable for a 60-month period. In addition to measuring the change in net interest income as compared to an unchanged interest rate scenario, the ALCO also measures the trend of both net interest income and net interest margin over a 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios.
The ALCO reviews a variety of interest rate shift scenario results to evaluate interest risk exposure, including scenarios showing the effect of steepening or flattening changes in yield curve shape as well as parallel changes in interest rates. Because income simulations assume that the Corporation’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.
The following table sets forth the estimated change in net interest income from an unchanged interest rate scenario over the periods indicated for parallel changes in market interest rates using the Corporation’s on and off-balance sheet financial instruments as of December 31, 2005 and 2004. Interest rates are assumed to shift by a parallel 100 or 200 basis points upward or 100 basis points downward over the periods indicated, except for core savings deposits, which are assumed to shift by lesser amounts due to their historical insensitivity to rate changes. Further, deposits are assumed to have certain minimum rate levels below which they will not fall. It should be noted that the rate scenarios shown do not necessarily reflect the ALCO’s view of the “most likely” change in interest rates over the periods indicated.
The ALCO estimates that the negative exposure of net interest income to falling rates as compared to an unchanged rate scenario results from the difficulty of reducing rates paid on core savings deposits significantly below current levels. If rates were to fall and remain low for a sustained period, core savings deposit rates would likely not fall as fast as other market rates, while asset yields would decline as current asset holdings mature or reprice. The pace of asset cash flows would also be likely to increase in a falling rate environment due to more rapid mortgage-related prepayments and redemption of callable securities.
The modest positive exposure of net interest income to rising rates in Year 1 as compared to an unchanged rate scenario results from a more rapid relative rate of increase in asset yields than funding costs over the near term. For simulation purposes, core savings rate changes are anticipated to lag other market rates related to loan and investment yields in both timing and magnitude. The ALCO’s estimate of interest rate risk exposure to rising rate environments, including those involving a further flattening or inversion of the yield curve, incorporates certain
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assumptions regarding the shift in mix from low-cost core savings deposits to higher-cost time deposits, which has altered the composition of the balance sheet in the current rising interest rate cycle.
The negative exposure of net interest income to rising rates in Year 2 as compared to an unchanged rate scenario is primarily attributable to an increase in funding costs associated with retail deposits. With the flattening of the yield curve, consumer demand for time deposits has increased more rapidly than growth in other lower-cost deposit categories. For modeling purposes, this trend is expected to continue even if interest rates remain unchanged, since the ALCO believes that a shift in deposit mix more heavily weighted towards time deposits accurately reflects current operating conditions. Although asset yields would also increase in a rising interest rate environment, the cumulative impact of relative growth in the rate-sensitive time deposit category suggests that by Year 2 of rising interest rate scenarios, the increase in the Corporation’s cost of funds could result in a relative decline in net interest margin compared to an unchanged rate scenario.
While the ALCO reviews simulation assumptions to ensure that they are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin since the repricing, maturity and prepayment characteristics of financial instruments and the composition of the Corporation’s balance sheet may change to a different degree than estimated. Firstly, simulation modeling assumes a static balance sheet, with the exception of certain modeled deposit mix shifts from low-cost core savings deposits to higher-cost time deposits noted above. The static balance sheet assumption does not necessarily reflect the Corporation’s expectation for future balance sheet growth, which is a function of the business environment and customer behavior. Another significant simulation assumption is the sensitivity of core savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. The assumed relationship between short-term interest rate changes and core deposit rate and balance changes used in income simulation may differ from the ALCO’s estimates. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.
The Corporation also monitors the potential change in market value of its available for sale debt securities in changing interest rate environments. The purpose is to determine market value exposure that may not be captured by income simulation, but which might result in changes to the Corporation’s capital position. Results are calculated using industry-standard analytical techniques and securities data. Available for sale equity securities are excluded from this analysis because the market value of such securities cannot be directly correlated with changes in interest rates. The following table summarizes the potential change in market value of the Corporation’s available for sale debt securities as of December 31, 2005 and 2004 resulting from immediate parallel rate shifts:
See Note 10 to the Consolidated Financial Statements for more information regarding the nature and business purpose of financial instruments with off-balance sheet risk and derivative financial instruments.
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ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Information regarding quantitative and qualitative disclosures about market risk appears under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Asset/Liability Management and Interest Rate Risk”.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
The financial statements and supplementary data are contained herein.
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Management’s Annual Report on Internal Control Over Financial Reporting
The management of Washington Trust Bancorp, Inc. and subsidiaries (the “Corporation”) is responsible for establishing and maintaining adequate internal control over financial reporting for the Corporation. The Corporation’s internal control system was designed to provide reasonable assurance to management and the Board of Directors regarding the preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The Corporation’s management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2005. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of December 31, 2005, the Corporation’s internal control over financial reporting is effective based on those criteria.
Washington Trust Bancorp, Inc. acquired Weston Financial Group, Inc. during 2005, and management excluded from its assessment of the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2005, the internal control over financial reporting associated with the acquired entity’s total assets of $2.3 million and total revenues of $3.2 million included in the consolidated financial statements of the Corporation as of and for the year ended December 31, 2005.
The Corporation’s independent registered public accounting firm has issued an attestation report on our assessment of the Corporation’s internal control over financial reporting. This report appears on the following page of this Annual Report on Form 10-K.
/s/ John C. Warren
/s/ David V. Devault
John C. Warren
David V. Devault
Chairman and
Executive Vice President, Secretary,
Chief Executive Officer
Treasurer and Chief Financial Officer
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Washington Trust Bancorp, Inc.:
We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting, that Washington Trust Bancorp, Inc. and subsidiaries (the “Corporation”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Corporation’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the COSO. Also, in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the COSO.
Washington Trust Bancorp, Inc. acquired Weston Financial Group, Inc. during 2005, and management excluded from its assessment of the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2005, the internal control over financial reporting associated with the acquired entity’s total assets of $2.3 million and total revenues of $3.2 million included in the consolidated financial statements of the Corporation as of and for the year ended December 31, 2005. Our audit of the internal control over financial reporting of the Corporation also excluded an evaluation of the internal control over financial reporting of Weston Financial Group, Inc.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Corporation as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 15, 2006 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Providence, Rhode Island
March 15, 2006
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Washington Trust Bancorp, Inc.:
We have audited the consolidated financial statements of Washington Trust Bancorp, Inc. and subsidiaries (the “Corporation”) as listed in the accompanying index. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated 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 audit 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 Washington Trust Bancorp, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 15, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Providence, Rhode Island
March 15, 2006
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars in thousands)
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars and shares in thousands,
CONSOLIDATED STATEMENTS OF INCOME
except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars in thousands)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
(Dollars in thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005 and 2004
General
Washington Trust Bancorp, Inc. (the “Bancorp”) is a publicly-owned registered bank holding company and financial holding company. The Bancorp owns all of the outstanding common stock of The Washington Trust Company (the “Bank”), a Rhode Island chartered commercial bank founded in 1800. Through its subsidiaries, the Bancorp offers a complete product line of financial services including commercial, residential and consumer lending, retail and commercial deposit products, and wealth management and trust services through its branch offices in Rhode Island, Massachusetts and southeastern Connecticut.
(1) Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Bancorp and its subsidiaries (collectively, the “Corporation” or “Washington Trust”). All significant intercompany transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year classification.
The accounting and reporting policies of the Corporation conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices of the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change are the determination of the allowance for loan losses and the review of goodwill and other intangible assets for impairment.
Securities
Investments in debt securities that management has the positive intent to hold to maturity are classified as held to maturity and carried at amortized cost. Management determines the appropriate classification of securities at the time of purchase.
Investments not classified as held to maturity are classified as available for sale. Securities available for sale consist of debt and equity securities that are available for sale to respond to changes in market interest rates, liquidity needs, changes in funding sources and other similar factors. These assets are specifically identified and are carried at fair value. Changes in fair value of available for sale securities, net of applicable income taxes, are reported as a separate component of shareholders’ equity.
When a decline in market value of a security is considered other than temporary, the cost basis of the individual security is written down to fair value as the new cost basis and the write-down is charged to net realized securities losses in the consolidated statements of income. Washington Trust does not have a trading portfolio.
Premiums and discounts are amortized and accreted over the term of the securities on a method that approximates the interest method. Realized gains or losses from sales of equity securities are determined using the average cost method, while other realized gains and losses are determined using the specific identification method.
Federal Home Loan Bank Stock
The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Boston. As a requirement of membership, the Bank must own a minimum amount of FHLB stock, calculated periodically based primarily on its level of borrowings from the FHLB. The Bank may redeem FHLB stock in excess of the minimum required. In addition, the FHLB may require members to redeem stock in excess of the requirement. FHLB stock is redeemable at par value, which equals cost. Since no market exists for these shares, they are carried at par value.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Mortgage Banking Activities
Mortgage Loans Held for Sale - Residential mortgage loans originated for sale are classified as held for sale. These loans are specifically identified and are carried at the lower of aggregate cost, net of unamortized deferred loan origination fees and costs, or market. Gains or losses on sales of loans are included in noninterest income and are recognized at the time of sale.
Loan Servicing Rights - Rights to service loans for others are recognized as an asset, including rights acquired through both purchases and originations. The total cost of originated loans that are sold with servicing rights retained is allocated between the loan servicing rights and the loans without servicing rights based on their relative fair values. Capitalized loan servicing rights are included in other assets and are amortized as an offset to other income over the period of estimated net servicing income. They are periodically evaluated for impairment based on their fair value. Impairment is measured on an aggregated basis according to interest rate band and period of origination. The fair value is estimated based on the present value of expected cash flows, incorporating assumptions for discount rate, prepayment speed and servicing cost. Any impairment is recognized as a charge to earnings through a valuation allowance.
Loans
Portfolio Loans - Loans held in the portfolio are stated at the principal amount outstanding, net of unamortized deferred loan origination fees and costs. Interest income is accrued on a level yield basis based on principal amounts outstanding. Deferred loan origination fees and costs are amortized as an adjustment to yield over the life of the related loans.
Nonaccrual Loans - Loans, with the exception of certain well-secured residential mortgage loans, are placed on nonaccrual status and interest recognition is suspended when such loans are 90 days or more overdue with respect to principal and/or interest. Well-secured residential mortgage loans are permitted to remain on accrual status provided that full collection of principal and interest is assured. Loans are also placed on nonaccrual status when, in the opinion of management, full collection of principal and interest is doubtful. Interest previously accrued but not collected on such loans is reversed against current period income. Subsequent cash receipts on nonaccrual loans are applied to the outstanding principal balance of the loan or recognized as interest income depending on management’s assessment of the ultimate collectibility of the loan. Loans are removed from nonaccrual status when they have been current as to principal and interest for a period of time, the borrower has demonstrated an ability to comply with repayment terms, and when, in management’s opinion, the loans are considered to be fully collectible.
Impaired Loans - A loan is impaired when it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. All nonaccrual commercial loans are considered to be impaired. Impairment is measured on a discounted cash flow method, or at the loan’s observable market price, or at the fair value of the collateral if the loan is collateral dependent. Impairment is measured based on the fair value of the collateral if it is determined that foreclosure is probable.
Restructured Loans - Restructured loans include those for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments have been granted due to a borrower’s financial condition. Subsequent cash receipts on restructured loans are applied to the outstanding principal balance of the loan, or recognized as interest income depending on management’s assessment of the ultimate collectibility of the loan.
Allowance for Loan Losses
A methodology is used to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: (1) identification of loss allocations for certain specific loans, (2) general loss allocations for certain loan types based on credit grade and loss experience factors, and (3) general loss allocations for other
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
environmental factors. The methodology includes an analysis of individual loans deemed to be impaired in accordance with accounting principles generally accepted in the United States of America (SFAS 114, “Accounting by Creditors for Impairment of a Loan-an amendment of FASB Statements No. 5 and 15”). Other individual commercial and commercial mortgage loans are evaluated using an internal rating system and the application of loss allocation factors. The loan rating system and the related loss allocation factors take into consideration parameters including the borrower’s financial condition, the borrower’s performance with respect to loan terms, and the adequacy of collateral. Portfolios of more homogenous populations of loans including residential mortgages and consumer loans are analyzed as groups taking into account delinquency ratios and other indicators, the Corporation’s historical loss experience and comparison to industry standards of loss allocation factors for each type of credit product. Finally, an additional allowance is maintained based on a judgmental process whereby management considers qualitative and quantitative assessments of other factors including regional credit concentration, industry concentration, results of regulatory examinations, historical loss ranges, portfolio composition, economic conditions such as interest rates and energy costs and other changes in the portfolio. The allowance for loan losses is management’s best estimate of the probable loan losses incurred as of the balance sheet date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans (or portions thereof) deemed to be uncollectible.
While management believes that the allowance for loan losses is adequate, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation for financial reporting purposes is calculated on the straight-line method over the estimated useful lives of assets. Expenditures for major additions and improvements are capitalized while the costs of current maintenance and repairs are charged to operating expenses. The estimated useful lives of premises and improvements range from three to fifty years. For furniture, fixtures and equipment, the estimated useful lives range from two to twenty years.
Goodwill and Other Intangibles
Goodwill represents the excess of the purchase price over the fair value of net assets acquired for transactions accounted for using purchase accounting. Goodwill and intangible assets that are not amortized are tested for impairment, based on their fair values, at least annually. Identifiable intangible assets that are subject to amortization are also reviewed for impairment based on their fair value. Any impairment is recognized as a charge to earnings and the adjusted carrying amount of the intangible asset becomes its new accounting basis. The remaining useful life of an intangible asset that is being amortized is also evaluated each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization.
Impairment of Long-Lived Assets Other than Goodwill
Long-lived assets and other intangible assets are reviewed for impairment at least annually or whenever events or changes in business circumstances indicate that the remaining useful life may warrant revision or that the carrying amount of the long-lived asset may not be fully recoverable. If impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.
Other Real Estate Owned (“OREO”)
OREO consists of property acquired through foreclosure and loans determined to be substantively repossessed. Real estate loans that are substantively repossessed include only those loans for which the Corporation has taken possession of the collateral, but has not completed legal foreclosure proceedings.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
OREO is stated at the lower of cost or fair value minus estimated costs to sell at the date of acquisition or classification to OREO status. Fair value of such assets is determined based on independent appraisals and other relevant factors. Any write-down to fair value at the time of foreclosure is charged to the allowance for loan losses. A valuation allowance is maintained for declines in market value and for estimated selling expenses. Increases to the valuation allowance, expenses associated with ownership of these properties, and gains and losses from their sale are included in foreclosed property costs.
Bank-Owned Life Insurance (“BOLI”)
BOLI represents life insurance on the lives of certain Bank employees who have provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received, are recorded in other noninterest income, and are not subject to income taxes. The cash value is included in assets. The financial strength of the insurance carrier is reviewed prior to the purchase of BOLI and annually thereafter.
Transfers and Servicing of Assets and Extinguishments of Liabilities
The accounting for transfers and servicing of financial assets and extinguishments of liabilities is based on consistent application of a financial components approach that focuses on control. This approach distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. After a transfer of financial assets, the Corporation recognizes all financial and servicing assets it controls and liabilities it has incurred and derecognizes financial assets it no longer controls and liabilities that have been extinguished. This financial components approach focuses on the assets and liabilities that exist after the transfer. Many of these assets and liabilities are components of financial assets that existed prior to the transfer. If a transfer does not meet the criteria for a sale, the transfer is accounted for as a secured borrowing with a pledge of collateral.
Fee Revenue
Revenue from wealth management and trust services is primarily accrued as earned based upon a percentage of asset values under administration. Certain trust service and financial planning fee revenue is recognized to the extent that services have been completed. Fee revenue from deposit service charges is generally recognized when earned. Fee revenue for merchant processing services is generally accrued as earned.
Pension Costs
Pension benefits are accounted for using the net periodic benefit cost method, which recognizes the compensation cost of an employee’s pension benefit over that employee’s approximate service period.
Stock-Based Compensation
Compensation cost for stock-based compensation plans is measured using the intrinsic value based method prescribed by Accounting Principles Board (“APB”) Opinion No. 25. In addition, pro-forma disclosures are presented for net income and earnings per share computed using the fair value based method of accounting for these plans as required by Statement of Financial Accounting Standards (“SFAS”) No. 123 and SFAS No. 148.
In determining the pro forma disclosures required by SFAS No. 123 and SFAS No. 148, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following table presents pro forma net income and earnings per share assuming the stock option plan was accounted for using the fair value method prescribed by SFAS No. 123 and SFAS No. 148, the weighted average assumptions used and the grant date fair value of options granted in 2005, 2004 and 2003:
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
The pro forma effect on net income and earnings per share for 2005, 2004 and 2003 is not representative of the pro forma effect on net income and earnings per share for future years.
Income Taxes
Income tax expense is determined based on the asset and liability method, whereby 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. 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.
Earnings Per Share (EPS)
Diluted EPS is computed by dividing net income by the average number of common shares and common stock equivalents outstanding. Common stock equivalents arise from the assumed exercise of outstanding stock options, if dilutive. The computation of basic EPS excludes common stock equivalents from the denominator.
Comprehensive Income
Comprehensive income is defined as all changes in equity, except for those resulting from investments by and distribution to shareholders. Net income is a component of comprehensive income, with all other components referred to in the aggregate as other comprehensive income.
Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and other short-term investments. Generally, federal funds are sold on an overnight basis.
Guarantees
FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” considers standby letters of credit a guarantee of the Corporation. Standby letters of credit are conditional commitments issued 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
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
facilities to customers. Under the standby letters of credit, the Corporation is required to make payments to the beneficiary of the letters of credit upon request by the beneficiary contingent upon the customer’s failure to perform under the terms of the underlying contract with the beneficiary.
Derivative Instruments and Hedging Activities
Derivatives are accounted for in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS Nos. 137, 138 and 149. All derivatives are recognized as either assets or liabilities in the balance sheet and are measured at fair value. Changes in the fair value of the derivatives are reported in either earnings or other comprehensive income (loss), depending on the use of the derivative and whether or not it qualifies for hedge accounting. Hedge accounting treatment is permitted only if specific criteria are met, including a requirement that the hedging relationship be highly effective both at inception and on an ongoing basis. Accounting for hedges varies based on the type of hedge - fair value or cash flow. Results of effective hedges are recognized in current earnings for fair value hedges and in other comprehensive income (loss) for cash flow hedges. Ineffective portions of hedges are recognized immediately in earnings and are not deferred. There may be increased volatility in net income and other comprehensive income (loss) on an ongoing basis as a result of accounting for derivative instruments in accordance with SFAS No. 133, as amended.
Interest rate lock commitments are extended to borrowers that relate to the origination of readily marketable mortgage loans held for sale (“rate locks”). To mitigate the interest rate risk inherent in these rate locks, as well as closed mortgage loans held for sale (“loans held for sale”), best efforts forward commitments are established to sell individual mortgage loans (“forward commitments”). Rate locks and forward commitments are considered to be derivatives under SFAS No. 133, as amended. The estimated fair value of the rate locks and forward commitments are recorded on the balance sheet in other assets, with the offset to net gains on sales of loans included in noninterest income. Market value is estimated based on outstanding investor commitments or, in the absence of such information, current investor yield requirements.
From time to time, interest rate contracts (swaps and floors) are used as part of interest rate risk management strategy. Interest rate swap and floor agreements are entered into as hedges against future interest rate fluctuations on specifically identified assets or liabilities.
By using derivative financial instruments to hedge exposures to changes in interest rates, the Corporation exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Corporation, which creates credit risk for the Corporation. When the fair value of a derivative contract is negative, the Corporation owes the counterparty and, therefore, it does not possess credit risk. The credit risk in derivative instruments is minimized by entering into transactions with highly rated counterparties that management believes to be creditworthy.
Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. The market risk associated with interest rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.
The net amounts to be paid or received on outstanding interest rate contracts are recognized on the accrual basis as an adjustment to the related interest income or expense over the life of the agreements. Changes in fair value of interest rate contracts are recorded in current earnings. Gains or losses resulting from the termination of interest rate swap and floor agreements on qualifying hedges of existing assets or liabilities are deferred and amortized over the remaining lives of the related assets/liabilities as an adjustment to the yield. Unamortized deferred gains/losses on terminated interest rate swap and floor agreements are included in the underlying assets/liabilities hedged.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
(2) Acquisition
On August 31, 2005, the Corporation completed its acquisition of Weston Financial Group, Inc. (“Weston Financial”), a registered investment advisor and financial planning company located in Wellesley, Massachusetts, with broker-dealer and insurance agency subsidiaries. The results of Weston Financial’s operations have been included in the Consolidated Statements of Income since that date. The acquisition was accounted for as a purchase in accordance with SFAS No. 141 “Business Combinations” and the provisions of SFAS No. 142 “Goodwill and Other Intangible Assets” were also applied. See Note 9 for additional information on Goodwill and Other Intangibles.
The acquisition of Weston Financial increased the size and range of products and services offered by Washington Trust’s wealth management services group. As a result of the Weston Financial acquisition, investment management and trust assets under administration increased from approximately $1.9 billion to $3.3 billion.
Pursuant to the Stock Purchase Agreement dated March 18, 2005, by and among the Corporation, Weston Financial and Weston Financial’s shareholders, the Corporation purchased all of the outstanding shares of capital stock of Weston Financial in exchange for an aggregate amount of cash equal to $20.3 million plus certain future payments. The future payments include minimum payments of $2 million per year in each of the years 2007, 2008 and 2009. The present value of these minimum payments amounting to $5.5 million is included in Other Borrowings in the Consolidated Balance Sheet. In addition, the transaction is structured to provide for the contingent payment of additional amounts up to a maximum of $18.5 million based on operating results in each of the years during a three-year earn-out period ending December 31, 2008. Contingent payments will be added to goodwill and recorded as liabilities at the time the payments are determinable beyond a reasonable doubt.
The following table summarizes the fair values of the assets acquired and liabilities assumed for Weston Financial at August 31, 2005, the date of acquisition.
Washington Trust financed the payments made at closing through the issuance of two series of trust preferred stock by newly-formed special purpose finance entities in an aggregate amount of $22 million (see Note 12). In connection with the transaction Washington Trust also elected to become a financial holding company.
(3) New Accounting Pronouncements
In December 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” SOP 03-3 requires loans acquired through a transfer, such as a business combination, where there are differences in expected cash flows and contractual cash flows due in part to credit quality, to be recognized at their fair value. The yield
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
that may be accreted is limited to the excess of the investor’s estimate of undiscounted expected principal, interest and other cash flows over the investor’s initial investment in the loan. The excess of contractual cash flows over expected cash flows is not to be recognized as an adjustment of yield, loss accrual or valuation allowance. Valuation allowances cannot be created nor “carried over” in the initial accounting for loans acquired in a transfer of loans with evidence of deterioration of credit quality since origination. However, valuation allowances for non-impaired loans acquired in a business combination can be carried over. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. The adoption of SOP 03-3 did not have a material impact on the Corporation’s financial position or results of operations.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R (“SFAS 123R”)(revised December 2004), “Share-Based Payment”, which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS 123R does not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS 123, however non-employee directors are included in the scope of SFAS 123R. SFAS 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. SFAS 123R allows the use of valuation models other than those prescribed in SFAS 123. On April 14, 2005, the SEC delayed the effective date for SFAS 123R, which allows companies to implement the statement at the beginning of their first fiscal year beginning after June 15, 2005, which will be January 1, 2006 for the Corporation. The pro forma costs of stock option expense estimated in Note 1 using the Black-Scholes method may not be representative of the costs recognized by the Corporation upon adoption of SFAS 123R because of, among other things, changes in the number of options granted in the future as well as future changes to the valuation model and underlying assumptions.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”. SFAS No. 154 replaces Accounting Principles Board (“APB”) Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle. APB Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. This statement also redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. SFAS No. 154 requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. This statement carries forward without change the guidance contained in APB Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. This statement also carries forward the guidance in APB Opinion 20 requiring justification of a change in accounting principle on the basis of preferability. SFAS No. 154 shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this statement was issued. The Corporation believes the adoption of SFAS No. 154 will not have a material impact on the Corporation’s financial position or results of operations.
In November 2005, the FASB issued FASB Staff Position (FSP) 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP provides additional guidance on when an investment in a debt or equity security should be considered impaired, and when that impairment should be considered other-than-temporary and recognized as a loss in earnings. Specifically, the guidance clarifies that an
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. The FSP also requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.
(4) Cash and Due From Banks
The Bank is required to maintain certain average reserve balances with the Federal Reserve Board. Such reserve balances amounted to $18.9 million and $17.3 million at December 31, 2005 and 2004, respectively.
(5) Securities
Securities are summarized as follows:
(Dollars in thousands)
(Dollars in thousands)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Included in corporate stocks at December 31, 2005 are preferred stocks, which are callable at the discretion of the issuer, with an amortized cost of $7.2 million and a fair value of $7.4 million. Call features on these stocks range from three months to three years.
At December 31, 2005 and 2004, the securities portfolio included $(3.4) million and $13.3 million of net pretax unrealized (losses) gains, respectively. Included in these net amounts were gross unrealized losses amounting to $13.5 million and $5.1 million at December 31, 2005 and 2004, respectively.
The following tables summarize, for all securities in an unrealized loss position at December 31, 2005 and 2004, respectively, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position.
For those debt securities whose amortized cost exceeds fair value, the primary cause is related to interest rates. The majority of debt securities reported in an unrealized loss position at December 31, 2005 were purchased during 2005, 2004 and 2003, during which interest rates were at or near historical lows. The relative increase in short and medium term interest rates towards the end of 2005 resulted in a decline in market value for these debt securities. Other contributing factors for debt securities reported in an unrealized loss position at December 31, 2005 include widening of investment spreads on certain variable rate asset classes, which have resulted in relative declines in market value compared to amortized cost. The Corporation believes that the nature and duration of impairment on its debt
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
securities. Other contributing factors for debt securities reported in an unrealized loss position at December 31, 2005 include widening of investment spreads on certain variable rate asset classes, which have resulted in relative declines in market value compared to amortized cost. The Corporation believes that the nature and duration of impairment on its debt security holdings are primarily a function of future interest rate movements and changes in investment spreads, and does not consider full repayment of principal on the reported debt obligations to be at risk. The debt securities in an unrealized loss position at December 31, 2005 consisted of 173 debt security holdings. The largest loss percentage of any single holding was 6.4% of its amortized cost.
Causes of conditions whereby the fair value of corporate stock equity securities is less than cost include the timing of purchases and changes in valuation specific to individual industries or issuers. The relationship between the level of market interest rates and the dividend rates paid on individual equity securities may also be a contributing factor. The Corporation believes that the nature and duration of impairment on its equity securities holdings are a function of general financial market movements and industry conditions. The equity securities in an unrealized loss position at December 31, 2005 consisted of seven holdings of financial and commercial entities. The largest loss percentage position of any single holding was 11.8% of its cost.
The maturities of debt securities as of December 31, 2005 are presented below. Mortgage-backed securities are included based on weighted average maturities, adjusted for anticipated prepayments. All other securities are included based on contractual maturities. Actual maturities may differ from amounts presented because certain issuers have the right to call or prepay obligations with or without call or prepayment penalties. Yields on tax exempt obligations are not computed on a tax equivalent basis. Included in the securities portfolio at December 31, 2005 were debt securities with an aggregate carrying value of $127.7 million that are callable at the discretion of the issuers. Final maturities of the callable securities range from ten months to twenty-six years, with call features ranging from one month to ten years.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
The following is a summary of amounts relating to sales of securities available for sale:
Included in net realized gains on securities in 2005 were $32 thousand in loss write-downs on certain equity securities deemed to be other than temporarily impaired based on an analysis of the financial condition and operating outlook of the issuers.
Included in other noninterest expense for the years ended December 31, 2005, 2004 and 2003 were contributions of appreciated equity securities to the Corporation’s charitable foundation amounting to $522 thousand, $454 thousand and $433 thousand, respectively. These transactions resulted in realized securities gains of $369 thousand, $387 thousand and $400 thousand, respectively, for the same periods.
Securities available for sale and held to maturity with a fair value of $564.3 million and $574.7 million were pledged in compliance with state regulations concerning trust powers and to secure Treasury Tax and Loan deposits, borrowings and certain public deposits at December 31, 2005 and 2004, respectively. (See Note 12 to the Consolidated Financial Statements for additional discussion of FHLB borrowings). In addition, securities available for sale and held to maturity with a fair value of $13.8 million and $20.9 million were collateralized for the discount window at the Federal Reserve Bank at December 31, 2005 and 2004, respectively. There were no borrowings with the Federal Reserve Bank at either date. Securities available for sale with a fair value of $2.2 million and $2.4 million were designated in a rabbi trust for a nonqualified retirement plan at December 31, 2005 and 2004, respectively.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
(6) Loans
The following is a summary of loans:
Concentrations of Credit Risk
A significant portion of our loan portfolio is concentrated among borrowers in southern New England, primarily Rhode Island and, to a lesser extent, Connecticut and Massachusetts, and a substantial portion of the portfolio is collateralized by real estate in this area. In addition, a portion of the commercial loans and commercial mortgage loans are to borrowers in the hospitality, tourism and recreation industries. The ability of single family residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the market area and real estate values. The ability of commercial borrowers to honor their repayment commitments is dependent on the general economy as well as the health of the real estate economic sector in the Corporation’s market area.
Nonaccrual Loans
The balance of loans on nonaccrual status as of December 31, 2005 and 2004 was $2.4 million and $4.7 million, respectively. Interest income that would have been recognized had these loans been current in accordance with their original terms was approximately $171 thousand in 2005 and $371 thousand in 2004. Interest income attributable to these loans included in the Consolidated Statements of Income amounted to approximately $176 thousand in 2005 and $297 thousand in 2004.
There were no accruing loans 90 days or more past due at December 31, 2005 and 2004.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
There were no loans whose terms had been restructured included in nonaccrual loans at December 31, 2005 and 2004.
Impaired Loans
Impaired loans consist of all nonaccrual commercial loans. The following is a summary of impaired loans:
Loan Servicing Activities
An analysis of loan servicing rights for the years ended December 31, 2005, 2004 and 2003 follows:
(1)
Amortization expense is charged against loan servicing fee income.
(2)
(Increases) and decreases in the impairment reserve are recorded as (reductions) and additions to loan servicing fee income.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Estimated aggregate amortization expense related to loan servicing assets is as follows:
Mortgage loans and other loans sold to others are serviced on a fee basis under various agreements. Loans serviced for others are not included in the Consolidated Balance Sheets. Balance of loans serviced for others, by type of loan:
Loans to Related Parties
The Corporation has made loans in the ordinary course of business to certain directors and executive officers including their immediate families and their affiliated companies. Such loans were made under normal interest rate and collateralization terms. Activity related to these loans in 2005 was as follows:
(7) Allowance for Loan Losses
The following is an analysis of the allowance for loan losses:
Included in the allowance for loan losses at December 31, 2005, 2004 and 2003 was an allowance for impaired loans amounting to $44 thousand, $236 thousand and $134 thousand, respectively.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
(8) Premises and Equipment
The following is a summary of premises and equipment:
Depreciation of premises and equipment amounted to $3.0 million, $3.1 million and $3.2 million of expense for the years ended December 31, 2005, 2004 and 2003, respectively.
(9) Goodwill and Other Intangibles
The changes in the carrying value of goodwill and other intangible assets for the year ended December 31, 2005 were as follows:
Goodwill
There were no changes in the carrying value of goodwill during the year ended December 31, 2004. Goodwill is not deductible for tax purposes.
Other Intangible Assets
The value attributable to the core deposit intangible (“CDI”) is a function of the estimated attrition of the core deposit accounts, and the expected cost savings associated with the use of the existing core deposit base rather than alternative funding sources.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
During the third quarter of 2005, goodwill and intangible assets related to the acquisition of Weston Financial were recorded amounting to $17.4 million and $14.0 million, respectively.
The value attributed to the advisory contracts was based on the time period over which the advisory contracts are expected to generate economic benefits. The intangible values of advisory contracts are being amortized over a 20-year life using a declining balance method, based on expected attrition for Weston Financial’s current customer base derived from historical runoff data. The amortization schedule is based on the anticipated future customer runoff rate. This schedule will result in amortization of approximately 50% of the intangible asset after six years, and approximately 70% amortization of the balance after ten years.
The value attributable to the Weston Financial non-compete agreements was based on the expected receipt of future economic benefits related to provisions in the non-compete agreements that restrict competitive behavior. The intangible value of non-compete agreements is being amortized on a straight-line basis over the six-year contractual lives of the agreements.
Estimated annual amortization expense is as follows:
The components of intangible assets at December 31, 2005 and 2004 were as follows:
(10) Financial Instruments With Off-Balance Sheet Risk and Derivative Financial Instruments
The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage the exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, financial guarantees, interest rate swaps and floors, and commitments to originate and commitments to sell fixed rate mortgage loans. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Consolidated Balance Sheets. The contract or notional amounts of these instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation uses the same
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The contractual and notional amounts of financial instruments with off-balance sheet risk are as follows:
Commitments to Extend Credit
Commitments to extend credit are agreements to lend to a customer as long as there are no violations of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each borrower’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the borrower.
Standby Letters of Credit
Standby letters of credit are conditional commitments issued 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. Under the standby letters of credit, the Corporation is required to make payments to the beneficiary of the letters of credit upon request by the beneficiary contingent upon the customer’s failure to perform under the terms of the underlying contract with the beneficiary. Standby letters of credit extend up to five years. At December 31, 2005 and 2004, the maximum potential amount of undiscounted future payments, not reduced by amounts that may be recovered, totaled $11.0 million and $9.7 million, respectively. At December 31, 2005 and 2004, there was no liability to beneficiaries resulting from standby letters of credit.
At December 31, 2005, a substantial portion of the standby letters of credit were supported by pledged collateral. The collateral obtained is determined based on management’s credit evaluation of the customer. Should the Corporation be required to make payments to the beneficiary, repayment from the customer to the Corporation is required.
Interest Rate Risk Management Agreements
Interest rate swaps and floors are used from time to time as part of its interest rate risk management strategy. Swaps are agreements in which the Corporation and another party agree to exchange interest payments (e.g., fixed-rate for variable-rate payments) computed on a notional principal amount. A floor is a purchased contract that entitles the Corporation to receive payment from a counterparty if a rate index falls below a contractual rate. The amount of the payment is the difference between the contractual floor rate and the rate index multiplied by the notional principal amount of the contract. If the rate index does not fall below the contractual floor rate, no payment is received. The credit risk associated with swap and floor transactions is the risk of default by the counterparty. To minimize this risk, the Corporation enters into interest rate agreements only with highly rated counterparties that management believes to be creditworthy. The notional amounts of these agreements do not represent amounts exchanged by the parties and thus, are not a measure of the potential loss exposure.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
For the years ended December 31, 2005, 2004 and 2003, the Corporation did not engage in such agreements.
Forward Loan Commitments
Commitments to originate and commitments to sell fixed rate mortgage loans are derivative financial instruments. Accordingly, the fair value of these commitments is recognized in other assets on the balance sheet and the changes in fair value of such commitments are recorded in current earnings in the income statement. The carrying values of such commitments as of December 31, 2005 and 2004 and the respective changes in fair values for the years then ended were insignificant.
(11) Time Certificates of Deposit
Scheduled maturities of time certificates of deposit at December 31, 2005 were as follows:
The aggregate amount of time certificates of deposit in denominations of $100 thousand or more was $424.6 million and $310.4 million at December 31, 2005 and 2004, respectively.
The following table represents the amount of certificates of deposit of $100 thousand or more at December 31, 2005 maturing during the periods indicated:
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
(12) Borrowings
Federal Home Loan Bank Advances
The following table presents maturities and weighted average interest rates paid on FHLB advances outstanding at December 31, 2005 and 2004:
(1)
Callable FHLB advances are shown in the respective periods assuming that the callable debt is redeemed at the call date while all other advances are shown in the periods corresponding to their scheduled maturity date.
(2)
Weighted average rate based on scheduled maturity dates.
In addition to the outstanding advances, the Bank also has access to an unused line of credit amounting to $8.0 million at December 31, 2005. Under agreement with the FHLB, the Bank is required to maintain qualified collateral, free and clear of liens, pledges, or encumbrances that, based on certain percentages of book and market values, has a value equal to the aggregate amount of the line of credit and outstanding advances. The FHLB maintains a security interest in various assets of the Bank including, but not limited to, residential mortgage loans, U.S. government or agency securities, U.S. government-sponsored agency securities, and amounts maintained on deposit at the FHLB. The Bank maintains qualified collateral in excess of the amount required to collateralize the line of credit and outstanding advances at December 31, 2005. Included in the collateral were securities available for sale and held to maturity with a fair value of $498.0 million and $515.8 million that were specifically pledged to secure FHLB borrowings at December 31, 2005 and December 31, 2004, respectively. Unless there is an event of default under the agreement, the Corporation may use, encumber or dispose any portion of the collateral in excess of the amount required to secure FHLB borrowings, except for that collateral which has been specifically pledged.
In June 2003, the Corporation incurred $941 thousand in prepayment penalty charges associated with the prepayment of certain FHLB advances totaling $23 million. The prepayment penalty charges were reported in noninterest expenses in the Consolidated Statements of Income.
Junior Subordinated Debentures
In August 2005, the Bancorp sponsored the creation of WT Capital Trust I (“Trust I”) and WT Capital Trust II (“Trust II”). Trust I and Trust II are Delaware statutory trusts created for the sole purpose of issuing trust preferred securities and investing the proceeds in junior subordinated debentures of the Bancorp. The Bancorp is the owner of all of the common securities of Trust I and Trust II. In accordance with FASB Interpretation 46-R, “Consolidation of Variable Interest Entities-Revised”, Trust I and Trust II are treated as unconsolidated subsidiaries. The common stock investment in the statutory trusts is included in “Other Assets” in the Consolidated Balance Sheet.
On August 29, 2005, Trust I issued $8 million of Capital Securities in a private placement of trust preferred securities. The Capital Securities mature in September 2035, are redeemable at the Bancorp’s option beginning after five years, and require quarterly distributions by Trust I to the holder of the Capital Securities, at a rate of 5.965% until September 15, 2010, and thereafter at a rate equal to the three-month LIBOR rate plus 1.45%. The
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Bancorp has guaranteed the Capital Securities and, to the extent not paid by Trust I, accrued and unpaid distributions on the Capital Securities, as well as the redemption price payable to the Capital Securities holders. The proceeds of the Capital Securities, along with proceeds from the issuance of common securities by Trust I to the Bancorp, were used to purchase $8.3 million of the Bancorp’s junior subordinated deferrable interest notes (the “Trust I Debentures”) and constitute the primary asset of Trust I. Like the Capital Securities, the Trust I Debentures bear interest at a rate of 5.965% until September 15, 2010, and thereafter at a rate equal to the three-month LIBOR rate plus 1.45%. The Trust I Debentures mature on September 15, 2035, but may be redeemed at par at the Bancorp’s option, subject to the approval of the applicable banking regulator to the extent required under applicable guidelines or policies, at any time on or after September 15, 2010, or upon the occurrence of certain special qualifying events.
On August 29, 2005, Trust II issued $14 million of Capital Securities in a private placement of trust preferred securities. The Capital Securities mature in November 2035, are redeemable at the Bancorp’s option beginning after five years, and require quarterly distributions by Trust II to the holder of the Capital Securities, at a rate of 5.96% until November 23, 2010, and thereafter at a rate equal to the three-month LIBOR rate plus 1.45%. The Bancorp has guaranteed the Capital Securities and, to the extent not paid by Trust II, accrued and unpaid distributions on the Capital Securities, as well as the redemption price payable to the Capital Securities holders. The proceeds of the Capital Securities, along with proceeds from the issuance of common securities by Trust II to the Bancorp, were used to purchase $14.4 million of the Bancorp’s junior subordinated deferrable interest notes (the “Trust II Debentures”) and constitute the primary asset of Trust II. Like the Capital Securities, the Trust II Debentures bear interest at a rate of 5.96% until November 23, 2010, and thereafter at a rate equal to the three-month LIBOR rate plus 1.45%. The Trust II Debentures mature on September 15, 2035, but may be redeemed at par at the Bancorp’s option, subject to the approval of the applicable banking regulator to the extent required under applicable guidelines or policies, at any time on or after September 15, 2010, or upon the occurrence of certain special qualifying events.
Other Borrowings
The following is a summary of other borrowings:
There were no securities sold under repurchase agreements outstanding at December 31, 2005, 2004 and 2003. Securities sold under repurchase agreements generally mature within 90 days. The securities underlying the agreements are held in safekeeping by the counterparty in the name of the Corporation and are repurchased when the agreement matures. Accordingly, these underlying securities are included in securities available for sale and the obligations to repurchase such securities are reflected as a liability.
(13) Employee Benefits
Defined Benefit Pension Plans
The Corporation’s noncontributory tax-qualified defined benefit pension plan covers substantially all employees. Benefits are based on an employee’s years of service and compensation earned during the years of service. The plan is funded on a current basis, in compliance with the requirements of the Employee Retirement Income Security Act of 1974, as amended. At December 31, 2005 and 2004, the accrued benefit costs relating to the defined benefit pension plan amounted to $1.9 million and $1.3 million, respectively.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
The Corporation has a non-qualified retirement plan to provide supplemental retirement benefits to certain employees, as defined in the plan. The primary purpose of this plan is to restore benefits that would otherwise be provided by the level of the tax-qualified defined benefit pension plan but which are limited by the Internal Revenue Code of 1986, as amended. The accrued pension liability related to this plan amounted to $2.6 million and $2.0 million at December 31, 2005 and 2004, respectively. The actuarial assumptions used for this supplemental plan are the same as those used for the Corporation’s tax-qualified pension plan. The projected benefit obligation for this plan amounted to $3.3 million at December 31, 2005 and $2.6 million at December 31, 2004.
The Corporation has a non-qualified retirement plan to provide supplemental retirement benefits to certain executives, as defined by the plan. The accrued pension liability of this plan amounted to $821 thousand at December 31, 2005 and $611 thousand at December 31, 2004. Using the same actuarial assumptions as the other aforementioned pension plans, the projected benefit obligation of this plan amounted to $2.0 million and $1.6 million at December 31, 2005 and 2004, respectively.
As a result of the second quarter 2002 acquisition of First Financial Corp., the Corporation assumed a non-qualified executive retirement plan to provide supplemental retirement benefits to a former First Financial Corp. executive. The accrued pension liability of this plan amounted to $3.3 million at December 31, 2005 and $3.2 million at December 31, 2004. Using the same assumptions as the other aforementioned pension plans, the projected benefit obligation amounted to $3.3 million and $3.2 million at December 31, 2005 and 2004, respectively.
The non-qualified retirement plans provide for the designation of assets in rabbi trusts. Securities available for sale designated for this purpose, with the carrying value of $2.8 million and $3.0 million, are included in the Consolidated Balance Sheets at December 31, 2005 and 2004, respectively.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Obligations And Funded Status:
Amounts recognized in the Consolidated Balance Sheets consist of:
The accumulated benefit obligation for the qualified pension plan was $22.9 million and $19.7 million at December 31, 2005 and 2004, respectively. The accumulated benefit obligation for the non-qualified pension plans amounted to $6.7 million and $5.8 million at December 31, 2005 and 2004, respectively.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Information For Pension Plans With An Accumulated Benefit Obligation In Excess Of Plan Assets:
Components of Net Periodic Benefit Cost:
Additional Information:
Assumptions:
The measurement date and weighted-average assumptions used to determine benefit obligations at December 31, 2005 and 2004 were as follows:
The measurement date and weighted-average assumptions used to determine net periodic benefit cost for the years ended December 31, 2005, 2004 and 2003 were as follows:
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
The expected long-term rate of return on plan assets is based on what the Corporation believes is realistically achievable based on the types of assets held by the plan and the plan’s investment practices. The assumption is updated at least annually, taking into account the asset allocation, historical asset return trends on the types of assets held and the current and expected economic conditions. At September 30, 2004, the measurement date used in the determination of net periodic benefit cost for 2005, the Corporation determined that a revision to the assumption was not necessary based upon expected market performance and the expected long-term rate of return assumption remained at 8.25%. The discount rate assumption for defined benefit pension plans is reset annually based on the published yield index for “AA” long-term corporate bonds, which is considered to be representative of the estimated future benefit payments.
Plan Assets:
The asset allocations of the qualified pension plan at December 31, 2005 and 2004, by asset category were as follows:
The assets of the qualified defined benefit pension plan trust (the “Pension Trust”) are managed to balance the needs of cash flow requirements and long-term rate of return. Cash inflow is typically comprised of invested income from portfolio holdings and Bank contributions, while cash outflow is for the purpose of paying plan benefits. As early as possible each year, the trustee is advised of the projected schedule of employer contributions and estimations of benefit payments. As a general rule, the trustee shall invest the funds so as to produce sufficient income to cover benefit payments and maintain a funded status that exceeds the regulatory requirements for tax-qualified defined benefit plans.
The investment philosophy used for the Pension Trust emphasizes consistency of results over an extended market cycle, while reducing the impact of the volatility of the security markets upon investment results. The assets of the Pension Trust should be protected by substantial diversification of investments, providing exposure to a wide range of quality investment opportunities in various asset classes.
The investment objective with respect to the Pension Trust assets is to secure a balanced mix of current income with capital appreciation. At any time, the portfolio will typically be invested in the following ranges: 40% to 60% in equities; 40% to 60% in fixed income; and 0% to 25% in cash and cash equivalents. The trustee investment manager will have authorization to invest within these ranges, making decisions based upon market conditions.
Fixed income bond investments should be limited to those in the top four categories used by the major credit rating agencies. In order to reduce the volatility of the annual rate of return of the bond portfolio, attention will be given to the maturity structure of the portfolio in the light of money market conditions and interest rate forecasts. Generally, the Pension Trust shall not purchase bonds with a maturity of more than twelve years and the maturity schedule will have a laddered character avoiding large concentrations in any single year. Common stock and equity holdings provide opportunities for dividend and capital appreciation returns. Holdings will typically consist of large-cap companies. Diversification of equity holdings should be influenced by forecasts of economic activity, corporate profits and allocation among different segments of the economy. The fair value of equity securities of any one issuer will not be permitted to exceed 10% of the total fair value of equity holdings of the Pension Trust. Investments in publicly traded real estate investment trust securities and low-risk derivatives securities such as
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
callable securities, floating rate notes, mortgage backed securities and treasury inflation protected securities, are permitted.
Cash Flows:
Contributions
The Internal Revenue Code permits flexibility in plan contributions so that normally a range of contributions is possible. The Corporation’s current funding policy has been generally to contribute the minimum required contribution and additional amounts up to the maximum deductible contribution. The Corporation expects to contribute $1.3 million to the qualified pension plan in 2006. In addition, the Corporation expects to contribute $335 thousand in benefit payments to the non-qualified retirement plans in 2006.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:
401(k) Plan
The Corporation’s 401(k) Plan provides a specified match of employee contributions for substantially all employees. Total employer matching contributions under this plan amounted to $528 thousand, $504 thousand and $463 thousand in 2005, 2004 and 2003, respectively.
Other Incentive Plans
The Corporation maintains several non-qualified incentive compensation plans. Substantially all employees participate in one of the incentive compensation plans. Incentive plans provide for annual or more frequent payments based on a combination of individual performance targets and the achievement of target levels of net income, earnings per share and return on equity, or for certain employees, solely on the achievement of individual performance targets. Total incentive based compensation amounted to $4.9 million, $3.8 million and $3.6 million in 2005, 2004 and 2003, respectively. In general, the terms of incentive plans are subject to annual renewal and may be terminated at any time by the Board of Directors.
Deferred Compensation Plan
The Nonqualified Deferred Compensation Plan provides supplemental retirement and tax benefits to directors and certain officers. The plan is funded primarily through pre-tax contributions made by the participants. The assets and liabilities of the deferred compensation plan are recorded at fair value in the Consolidated Balance Sheets. The participants in the plan bear the risk of market fluctuations of the underlying assets. The accrued liability related to this plan amounted to $2.2 million and $1.9 million at December 31, 2005 and 2004, respectively, and is included in other liabilities on the accompanying Consolidated Balance Sheets. The corresponding invested assets are reported in other assets.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
(14) Income Taxes
The components of income tax expense were as follows:
Total income tax expense varied from the amount determined by applying the Federal income tax rate to income before income taxes. The reasons for the differences were as follows:
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
The approximate tax effects of temporary differences that give rise to gross deferred tax assets and gross deferred tax liabilities at December 31, 2005 and 2004 are as follows:
The Corporation has determined that a valuation allowance is not required for any of the deferred tax assets since it is more likely than not that these assets will be realized primarily through future reversals of existing taxable temporary differences or carryback to taxable income in prior years.
(15) Operating Leases
At December 31, 2005, the Corporation was committed to rent premises used in banking operations under noncancellable operating leases. Rental expense under the operating leases amounted to $706 thousand, $569 thousand and $464 thousand for 2005, 2004 and 2003, respectively. The minimum annual lease payments under the terms of these leases, exclusive of renewal provisions, are as follows:
(16) Litigation
The Corporation is involved in various claims and legal proceedings arising out of the ordinary course of business. Management is of the opinion, based on its review with counsel of the development of such matters to date, that
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
the ultimate disposition of such matters will not materially affect the consolidated financial position or results of operations of the Corporation.
(17) Shareholders’ Equity
Stock Repurchase Plan
In September 2001, the Bancorp’s Board of Directors approved a stock repurchase plan authorizing up to 250,000, or 2.1%, of its outstanding common shares to be repurchased. The Bancorp plans to hold the repurchased shares as treasury stock to be used for general corporate purposes. No shares were repurchased under this plan for the year ended December 31, 2005. The Bancorp purchased 5,000 shares at a total cost of $125 thousand during 2004. In addition, from time to time shares are acquired pursuant to the Nonqualified Deferred Compensation Plan.
Rights
In August 1996, the Bancorp declared a dividend of one common share purchase right (a “Right”) for each share of common stock payable on September 3, 1996 to shareholders of record on that date. Such Rights also apply to new issuances of shares after that date. Each Right entitles the registered holder to purchase from the Corporation one share of its common stock at a price of $35.56 per share, subject to adjustment.
The Rights are not exercisable or separable from the common stock until the earlier of 10 days after a person or group (an “Acquiring Person”) acquires beneficial ownership of 15% or more of the outstanding common shares or announces a tender offer to do so. The Rights, which expire on August 31, 2006, may be redeemed by the Bancorp at any time prior to the acquisition by an Acquiring Person of beneficial ownership of 15% or more of the common stock at a price of $.001 per Right. In the event that any party becomes an Acquiring Person, each holder of a Right, other than Rights owned by the Acquiring Person, will have the right to receive upon exercise that number of common shares having a market value of two times the purchase price of the Right. In the event that, at any time after any party becomes an Acquiring Person, the Corporation is acquired in a merger or other business combination transaction or 50% or more of its assets or earning power are sold, each holder of a Right will have the right to purchase that number of shares of the acquiring company having a market value of two times the purchase price of the Right.
Dividends
The primary source of liquidity for the Bancorp is dividends received from the Bank. The Bancorp and the Bank are regulated enterprises and their abilities to pay dividends are subject to regulatory review and restriction. Certain regulatory and statutory restrictions exist regarding dividends, loans, and advances from the Bank to the Bancorp. Generally the Bank has the ability to pay dividends to the Bancorp subject to minimum regulatory capital requirements. The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. In addition, the Rhode Island Division of Banking may also restrict the declaration of dividends if a bank would not be able to pay its debts as they become due in the usual course of business or the bank’s total assets would be less than the sum of its total liabilities. Under the most restrictive of these requirements, the Bank could have declared aggregate additional dividends of $37.7 million as of December 31, 2005.
Stock Incentive Plans
The Bancorp’s 2003 Stock Incentive Plan, as amended (the “2003 Plan”) permits the granting of options and other equity incentives to officers, employees, directors, and other key persons. Up to 600,000 shares of the Bancorp’s common stock may be used from authorized but unissued shares or shares reacquired from the Corporation. No more than 200,000 shares may be issued in the form of awards other than stock options or stock appreciation rights. Options are designated either as non-qualified or incentive options. The exercise price of each option may not be less than fair market value of the common stock on the date of the grant. In general, the option price is payable in cash, by the delivery of shares of common stock already owned by the grantee, or a combination thereof. Incentive stock option awards may be granted at any time until February 20, 2013.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
The Bancorp’s 1997 Equity Incentive Plan, as amended (the “1997 Plan”) permits the granting of options and other equity incentives to key employees, directors, advisors, and consultants. Up to 1,012,500 shares of the Bancorp’s common stock may be used from authorized but unissued shares, treasury stock, or shares available from expired awards. Options are designated either as non-qualified or incentive options. The exercise price of each option may not be less than fair market value of the common stock on the date of the grant. In general, the option price is payable in cash, by the delivery of shares of common stock already owned by the grantee, or a combination thereof. Incentive stock option awards may be granted at any time until April 29, 2007.
The Bancorp has also granted restricted stock unit and restricted stock awards under the 1997 Plan. Such awards are valued at the fair market value of common stock as of the award date and the associated cost is recognized in salaries and benefits expense over the vesting period of each award. Corresponding additions to paid-in-capital are recognized over the vesting period. In 2005, the Bancorp awarded 16,200 restricted stock units that will vest on the third anniversary date of the award at which time, a share of common stock will be issued for each unit. In addition, in 2005, the Bancorp awarded 5,000 shares of restricted stock that will vest on the fifth anniversary date of the award. Total unearned compensation expense for the 2005 awards amounted to $565 thousand at the award date. In 2004, 36,000 restricted stock units were awarded that will vest on the third anniversary date of the award at which time, a share of common stock will be issued for each unit. The total unearned stock-based compensation for these awards amounted to $850 thousand at the award date. During 2003, 2,460 restricted stock share awards were issued that vest over a three-year period. For the years ended December 31, 2005, 2004 and 2003, compensation expense related to restricted stock unit and restricted stock awards amounted to $360 thousand, $147 thousand, and $31 thousand, respectively.
The Amended and Restated 1988 Stock Option Plan (the “1988 Plan”) provided for the granting of options to directors, officers and key employees. The 1988 Plan permitted options to be granted at any time until December 31, 1997. The 1988 Plan provided for shares of the Bancorp’s common stock to be used from authorized but unissued shares, treasury stock, or shares available from expired options. Options were designated either as non-qualified or incentive options. The exercise price of options granted was equal to the fair market value on the date of grant. In general, the option price is payable in cash, by the delivery of shares of the Bancorp’s common stock already owned by the grantee, or a combination thereof.
The 1997 Plan, the 1988 Plan and the 2003 Plan permit options to be granted with stock appreciation rights (“SARs”), however, no options have been granted with SARs.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Options granted under the plans vest according to various terms and expire at the end of ten years. The following table presents changes in options outstanding during 2005, 2004 and 2003:
The weighted average exercise price and remaining contractual life for options outstanding at December 31, 2005 were as follows:
As discussed in Note 1, the Corporation accounts for its stock option plan using the intrinsic value based method prescribed by APB Opinion No. 25, and in addition, is required to disclose pro forma net income and earnings per share using the fair value based method prescribed by SFAS No. 123 and SFAS No. 148. Accordingly, no compensation cost for these plans has been recognized in the Consolidated Statements of Income for 2005, 2004 and 2003.
Dividend Reinvestment
Under the Amended and Restated Dividend Reinvestment and Stock Purchase Plan, 607,500 shares of common stock were originally reserved to be issued for dividends reinvested and cash payments to the plan.
Reserved Shares
As of December 31, 2005, a total of 1,783,612 common stock shares were reserved for issuance under the 1988 Plan, 1997 Plan, 2003 Plan and the Amended and Restated Dividend Reinvestment and Stock Purchase Plan.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Regulatory Capital Requirements
The Bancorp and the Bank are subject to various regulatory capital requirements administered by the Federal Reserve Board and the FDIC, respectively. These requirements were established to more accurately assess the credit risk inherent in the assets and off-balance sheet activities of financial institutions. 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 consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation 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 Corporation to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2005 that the Corporation meets all capital adequacy requirements to which it is subject.
As of December 31, 2005, the most recent notification from the FDIC 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 1 risk-based and Tier 1 leverage ratios. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The following table presents the Corporation’s and the Bank’s actual capital amounts and ratios at December 31, 2005 and 2004, as well as the corresponding minimum regulatory amounts and ratios:
In connection with the Weston Financial acquisition, trust preferred securities totaling $22 million were issued in the third quarter of 2005 by Trust I and Trust II, capital trusts created by the Bancorp. In accordance with FIN 46-
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
R, Trust I and Trust II are not consolidated into the Corporation’s financial statements; however, the Corporation reflects the amounts of junior subordinated debentures payable to the preferred shareholders of Trust I and Trust II as debt in its financial statements. The trust preferred securities qualify as Tier 1 capital.
The Corporation’s capital ratios at December 31, 2005 place the Corporation in the “well-capitalized” category according to regulatory standards. On March 1, 2005, the Federal Reserve Board issued a final rule that would retain trust preferred securities in Tier 1 capital of bank holding companies, but with stricter quantitative limits and clearer standards. Under the proposal, after a five-year transition period that would end on March 31, 2009, the aggregate amount of trust preferred securities would be limited to 25% of Tier 1 capital elements, net of goodwill. The Corporation has evaluated the potential impact of such a change on its Tier 1 capital ratio and has concluded that the regulatory capital treatment of the trust preferred securities in the Corporation’s total capital ratio would be unchanged.
(18) Earnings per Share
(Dollars in thousands, except per share amounts)
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
(19) Business Segments
Washington Trust segregates financial information in assessing its results among two operating segments: Commercial Banking and Wealth Management Services. The amounts in the Corporate column include activity not related to the segments, such as the investment securities portfolio, wholesale funding activities and administrative units. The Corporate column is not considered to be an operating segment. The methodologies and organizational hierarchies that define the business segments are periodically reviewed and revised. Results may be restated, when necessary, to reflect changes in organizational structure or allocation methodology. The following table presents the statement of operations and total assets for Washington Trust’s reportable segments.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Management uses certain methodologies to allocate income and expenses to the business lines. A funds transfer pricing methodology is used to assign interest income and interest expense to each interest-earning asset and interest-bearing liability on a matched maturity funding basis. Certain indirect expenses are allocated to segments. These include support unit expenses such as technology and processing operations and other support functions. Taxes are allocated to each segment based on the effective rate for the period shown.
Commercial Banking
The Commercial Banking segment includes commercial, commercial real estate, residential and consumer lending activities; mortgage banking, secondary market and loan servicing activities; deposit generation; merchant credit card services; cash management activities; and direct banking activities, which include the operation of ATMs, telephone and internet banking services and customer support and sales.
Wealth Management Services
Wealth Management Services includes asset management services provided for individuals and institutions; personal trust services, including services as executor, trustee, administrator, custodian and guardian; corporate trust services, including services as trustee for pension and profit sharing plans; and other financial planning and advisory services. The increase in revenues and expenses for this segment in 2005 is primarily attributable to the acquisition of Weston Financial.
Corporate
Corporate includes the Treasury Unit, which is responsible for managing the wholesale investment portfolio and wholesale funding needs. It also includes income from bank-owned life insurance as well as administrative and executive expenses not allocated to the business lines and the residual impact of methodology allocations such as funds transfer pricing offsets.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
(20) Fair Value of Financial Instruments
SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, requires the disclosure of estimated fair values of its financial instruments. Fair value estimates are made as of a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any pricing adjustments that could result from the sale of the entire holding of a particular financial instrument. Because no quoted market exists for a portion of the financial instruments, fair value estimates are based on subjective judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. Changes in assumptions could significantly affect the estimates of fair value. Fair value estimates, methods, and assumptions are set forth as follows:
Cash and Securities
The carrying amount of short-term instruments such as cash and federal funds sold is used as an estimate of fair value.
The fair value of securities available for sale and held to maturity is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. No market exists for shares of the FHLB. Such stock may be redeemed at par upon termination of FHLB membership and is, therefore, valued at par, which equals cost.
Mortgage Loans Held for Sale
The fair value of mortgage loans held for sale is the estimated value to sell the loans using the quoted market prices for sales of similar loans on the secondary market.
Bank-Owned Life Insurance
The carrying amount of BOLI represents its cash surrender value and approximates fair value.
Loans
Fair values are estimated for categories of loans with similar financial characteristics. Loans are segregated by type and are then further segmented into fixed rate and adjustable rate interest terms to determine their fair value. The fair value of fixed rate commercial and consumer loans is calculated by discounting scheduled cash flows through the estimated maturity of the loan using interest rates offered at December 31, 2005 and 2004 that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Corporation’s historical repayment experience. For residential mortgages, fair value is estimated by using quoted market prices for sales of similar loans on the secondary market, adjusted for servicing costs. The fair value of floating rate commercial and consumer loans approximates carrying value. The fair value of nonaccrual loans is calculated by discounting estimated cash flows, using a rate commensurate with the risk associated with the loan type or by other methods that give consideration to the value of the underlying collateral.
Deposit Liabilities
The fair value of demand deposits, NOW accounts, money market accounts and savings accounts is equal to the amount payable on demand as of December 31, 2005 and 2004. The discounted values of cash flows using the rates currently offered for deposits of similar remaining maturities were used to estimate the fair value of certificates of deposit.
Securities Sold Under Agreements to Repurchase
The carrying amount of securities sold under repurchase agreements approximates fair value.
Federal Home Loan Bank Advances
Rates currently available to the Corporation for advances with similar terms and remaining maturities are used to estimate fair value of existing advances.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
Junior Subordinated Debentures
The fair value of the junior subordinated debentures is estimated using rates currently available to the Corporation for debentures with similar terms and maturities.
Derivative Financial Instruments
Forward Loan Commitments to Sell Loans Held for Sale - The fair value of forward loan commitments to sell loans reflects the estimated amounts that the Corporation would receive or pay to terminate the commitment at the reporting date. It also considers the difference between current levels of interest rates and the committed rates. The fair values of such commitments as of December 31, 2005 and 2004 were insignificant.
Letters of Credit - The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. Letters of credit contain provisions for fees, conditions and term periods that are consistent with customary market practices. Accordingly, the fair value amounts (considered to be the discounted present value of the remaining contractual fees over the unexpired commitment period) would not be material and therefore are not disclosed.
The following table presents the fair values of financial instruments:
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
(21) Parent Company Financial Statements
The following are parent company only financial statements of Washington Trust Bancorp, Inc. reflecting the investment in the Bank on the equity basis of accounting. The Statements of Changes in Shareholders’ Equity for the parent company only are identical to the Consolidated Statements of Changes in Shareholders’ Equity and are therefore not presented.
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WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2005 and 2004
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ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A.
ITEM 9A. Controls and Procedures
As required by Rule 13a-15 under the Exchange Act, the Corporation carried out an evaluation under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures as of the end of the period ended December 31, 2005. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are adequate and designed to ensure that information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. The Corporation will continue to review and document its disclosure controls and procedures and consider such changes in future evaluations of the effectiveness of such controls and procedures, as it deems appropriate. There has been no change in our internal control over financial reporting during the period ended December 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. In the third quarter of 2005, the Corporation completed its acquisition of Weston Financial, as discussed previously. The Corporation has not yet completed the documentation, evaluation and testing of Weston Financial’s internal controls over financial reporting, which is ongoing.
ITEM 9B.
ITEM 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant
Required information regarding directors is presented under the caption “Nominee and Director Information” in the Bancorp’s Proxy Statement dated March 17, 2006 prepared for the Annual Meeting of Shareholders to be held April 25, 2006, which is incorporated herein by reference.
Required information regarding audit committee financial experts is included under the caption “Board of Directors and Committees - Audit Committee” in the Bancorp’s Proxy Statement dated March 17, 2006 prepared for the Annual Meeting of Shareholders to be held April 25, 2006, which is incorporated herein by reference.
Required information regarding executive officers of the Corporation is included in Part I of this Annual Report under the caption “Executive Officers of the Registrant.”
Information required with respect to compliance with Section 16(a) of the Exchange Act appears under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Bancorp’s Proxy Statement dated March 17, 2006 prepared for the Annual Meeting of Shareholders to be held April 25, 2006, which is incorporated herein by reference.
The Corporation adopted a code of ethics that applies to all of the Corporation's directors, officers and employees. This code of ethics is available on the Corporation's website at www.washtrust.com, under the heading Investor Relations.
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ITEM 11.
ITEM 11. Executive Compensation
The information required by this Item appears under the captions “Compensation of Directors”, “Executive Compensation” and “Change of Control Agreements” in the Bancorp’s Proxy Statement dated March 17, 2006 prepared for the Annual Meeting of Shareholders to be held April 25, 2006, which are incorporated herein by reference.
ITEM 12.
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Required information regarding security ownership of certain beneficial owners and management appears under the caption “Nominee and Director Information” in the Bancorp’s Proxy Statement dated March 17, 2006 prepared for the Annual Meeting of Shareholders to be held April 25, 2006, which is incorporated herein by reference.
Equity Compensation Plan Information
The following table provides information as of December 31, 2005 regarding shares of common stock of the Bancorp that may be issued under our existing equity compensation plans, including the 1988 Plan, the 1997 Plan, the 2003 Plan and the Nonqualified Deferred Compensation Plan (the “Deferred Compensation Plan”).
The Deferred Compensation Plan
The Deferred Compensation Plan was established as of January 1, 1999. The Deferred Compensation Plan has not been approved by our shareholders.
The Deferred Compensation Plan allows our directors and officers to defer a portion of their
compensation. The deferred compensation is contributed to a rabbi trust. The trustee of the rabbi trust invests the assets of the trust in shares of selected mutual funds as well as shares of the Bancorp’s common stock pursuant to the directions of the plan participants. All shares of the Bancorp’s common stock are purchased in the open market.
The Deferred Compensation Plan was included as part of Exhibit 4.4 to the Bancorp’s Form S-8 Registration Statement (File No. 333-72277) filed with the SEC on February 12, 1999.
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ITEM 13.
ITEM 13. Certain Relationships and Related Transactions
The information required by this Item is incorporated herein by reference to the caption “Indebtedness and Other Transactions” in the Bancorp’s Proxy Statement dated March 17, 2006 prepared for the Annual Meeting of Shareholders to be held April 25, 2006.
ITEM 14.
ITEM 14. Principal Accounting Fees and Services
The information required by this Item is incorporated herein by reference to the caption “Independent Auditors” in the Bancorp’s Proxy Statement dated March 17, 2006 prepared for the Annual Meeting of Shareholders to be held April 25, 2006.
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules
(a)
1.
Financial Statements. The financial statements of the Corporation required in response to this Item are listed in response to Part II, Item 8 of this Annual Report on Form 10-K.
2.
Financial Statement Schedules. All schedules normally required by Article 9 of Regulation S-X and all other schedules to the consolidated financial statements of the Corporation have been omitted because the required information is either not required, not applicable, or is included in the consolidated financial statements or notes thereto.
3.
Exhibits. The following exhibits are included as part of this Form 10-K.
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- 94 -
- 95 -
(1)
Not filed herewith. In accordance with Rule 12b-32 promulgated pursuant to the Exchange Act, reference is made to the documents previously filed with the SEC, which are incorporated by reference herein.
(2)
Management contract or compensatory plan or arrangement.
(3)
These certifications are not “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any filing under the Securities Act or the Exchange Act.
(b) See (a)(3) above for all exhibits filed herewith and the Exhibit Index.
(c) Financial Statement Schedules. None.
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Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WASHINGTON TRUST BANCORP, INC.
(Registrant)
Date: March 15, 2006
By
/s/ John C. Warren
John C. Warren
Chairman, Chief Executive Officer and Director
(principal executive officer)
Date: March 15, 2006
By
/s/ David V. Devault
David V. Devault
Executive Vice President, Secretary,
Treasurer and Chief Financial Officer
(principal financial and principal accounting officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: March 15, 2006
/s/ Gary P. Bennett
Gary P. Bennett, Director
Date: March 15, 2006
/s/ Steven J. Crandall
Steven J. Crandall, Director
Date: March 15, 2006
/s/ Larry J. Hirsch
Larry J. Hirsch, Director
Date: March 15, 2006
/s/ Barry G. Hittner
Barry G. Hittner, Director
Date: March 15, 2006
/s/ Katherine W. Hoxsie
Katherine W. Hoxsie, Director
Date: March 15, 2006
/s/ Mary E. Kennard
Mary E. Kennard, Director
Date: March 15, 2006
/s/ Edward M. Mazze
Edward M. Mazze, Director
Date: March 15, 2006
/s/ Kathleen McKeough
Kathleen McKeough, Director
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Date: March 15, 2006
/s/ Victor J. Orsinger II
Victor J. Orsinger II, Director
Date: March 15, 2006
/s/ H. Douglas Randall III
H. Douglas Randall, III, Director
Date: March 15, 2006
/s/ Joyce Olson Resnikoff
Joyce Olson Resnikoff, Director
Date: March 15, 2006
/s/ Patrick J. Shanahan, Jr.
Patrick J. Shanahan, Jr., Director
Date: March 15, 2006
/s/ James P. Sullivan
James P. Sullivan, Director
Date: March 15, 2006
/s/ Neil H. Thorp
Neil H. Thorp, Director
Date: March 15, 2006
/s/ John F. Treanor
John F. Treanor, Director
Date: March 15, 2006
/s/ John C. Warren
John C. Warren, Director
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