Item 1.
BUSINESS
General
Newport Bancorp, Inc. (“Newport Bancorp” or the “Company”) is a Maryland chartered company established in March 2006 to become the holding company for Newport Federal Savings Bank (“Newport Federal” or the “Bank”). Newport Bancorp’s business activity is the ownership of the outstanding capital stock of Newport Federal. Newport Bancorp does not own or lease any property but instead uses the premises, equipment and other property of Newport Federal with the payment of appropriate rental fees, as required by applicable law and regulations, under the terms of an expense allocation agreement. In the future, Newport Bancorp may acquire or organize other operating subsidiaries; however, there are no current plans, arrangements, agreements or understandings, written or oral, to do so.
Newport Federal is a federally chartered savings bank originally founded as a Rhode Island institution in 1888. In October 2005, Newport Federal merged with Westerly Savings Bank, a Rhode Island mutual financial institution with two branch locations in Westerly, Rhode Island. The Bank operates as a community-oriented financial institution offering traditional financial services to consumers and businesses in the Bank’s market area. Newport Federal attracts deposits from the general public and uses those funds to originate one-to-four family residential loans, multi-family loans, commercial real estate loans, construction loans and consumer loans.
In connection with the conversion on July 6, 2006, the Company established and funded the Newportfed Charitable Foundation (the “Foundation”) with shares of Company common stock equal to 7.4% of the shares sold in the stock offering. The Foundation provides funding to support charitable causes and community development activities in the communities served by the Company.
Available Information
The Bank’s website address is www.newportfederal.com. Information on this website should not be considered a part of this Form 10-K.
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Market Area
Newport Federal is headquartered in Newport, Rhode Island. In addition to the Bank’s main office in Newport, the Bank operates five other full-service branch offices in Rhode Island: one each in Middletown and in Wakefield, two in Westerly, and our new branch location in Portsmouth, which we opened on January 23, 2009. On November, 21, 2007, the Bank entered into a twenty-year lease agreement for land in Stonington, Connecticut to construct a new branch. We expect that this branch will open in May 2009. The Bank considers Newport and Washington Counties, Rhode Island to be its primary market area. The economy in our market area is primarily oriented to the retail and hospitality industries.
Competition
Newport Federal faces significant competition for the attraction of deposits and origination of loans. The Bank’s most direct competition for deposits has historically come from the several financial institutions operating in its market area and, to a lesser extent, from other financial service companies such as brokerage firms, credit unions and insurance companies. Newport Federal also faces competition for investors’ funds, from money market funds, mutual funds and other corporate and government securities. At June 30, 2008, which is the most recent date for which data is available from the FDIC, the Bank held approximately 11.46% of the deposits in Newport County, Rhode Island and approximately 4.02% of the deposits in Washington County, Rhode Island. In addition, banks owned by large holding companies such as Bank of America, Citizens and Sovereign also operate in our market area. These institutions are significantly larger than the Bank and, therefore, have significantly greater resources.
The Bank’s competition for loans comes primarily from financial institutions in our market area and, to a lesser extent, from other financial service providers, such as mortgage companies, credit unions and mortgage brokers. Competition for loans also comes from the increasing number of non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies.
Newport Federal expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Changes in federal law permit affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in the financial services industry. Competition for deposits and the origination of loans could limit our growth in the future.
Lending Activities
General. The largest segment of the Bank’s loan portfolio is real estate mortgage loans, primarily one-to-four family residential loans. The other significant segment of the Bank’s loan portfolio is commercial real estate loans. To a lesser degree, Newport Federal also originates multi-family and construction loans, as well as consumer loans. The Bank originates loans for investment purposes, although the Bank occasionally may sell a portion of its one-to-four family residential loans into the secondary market.
One-to-Four Family Residential Loans. The Bank’s origination of mortgage loans enables borrowers to purchase or refinance existing homes located in Rhode Island, Southeastern Connecticut and, to a lesser extent, Southeastern Massachusetts, although our primary lending market is Newport and Washington Counties, Rhode Island.
Newport Federal’s residential lending policies and procedures conform to the secondary market guidelines as we occasionally sell qualifying fixed-rate loans into the secondary market. The Bank offers fixed-rate mortgage loans with terms of 10 to 30 years, and to a lesser extent, 40 years. Newport Federal also offers adjustable-rate mortgage loans. Borrower demand for adjustable-rate loans compared to fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans as compared to an initially discounted interest rate and loan fees for multi-year adjustable-rate mortgages (“ARMs”). The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment. The loan fees, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.
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Interest rates and payments on the Bank’s adjustable-rate mortgage loans generally adjust annually after an initial fixed period that typically ranges from one to three years. Interest rates and payments on the Bank’s adjustable-rate loans generally are adjusted to a rate typically equal to a percentage above the one-year U.S. Treasury index. The maximum amount by which the interest rate may be increased or decreased is generally 2% per adjustment period and the lifetime interest rate cap is generally 6% over the initial interest rate of the loan.
While one-to-four family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans. Newport Federal does not offer loans with negative amortization and generally does not offer interest-only loans.
The Bank generally does not make conventional loans with loan-to-value ratios exceeding 95%. Loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance. Newport Federal requires all properties securing first mortgage loans to be appraised by an independent appraiser, who is approved by the Board of Directors. The Bank generally requires title insurance on all first mortgage loans. Borrowers must obtain hazard insurance, and flood insurance is required for loans on properties located in a flood zone.
Multi-Family and Commercial Real Estate Loans. Newport Federal offers fixed- and adjustable-rate mortgage loans secured by commercial and multi-family real estate. The Bank’s commercial and multi-family real estate loans are generally secured by five to ten unit apartment buildings, small office buildings, two to four unit mixed-use retail and residential properties and hospitality establishments. These properties are primarily located in Newport and Washington Counties in Rhode Island, and to a lesser extent other cities and towns in Rhode Island and New London County, Connecticut.
Newport Federal originates a variety of fixed- and adjustable-rate commercial real estate and multi-family real estate loans generally for terms up to 10 years. These adjustable-rate loans include loans that adjust based on the five-year FHLB Classic Rate Advance Index, adjustable every five years. Loans are secured by first mortgages, and amounts generally do not exceed 75% of the property’s appraised value.
As of December 31, 2008, the Bank’s largest commercial loan was $2.3 million. This loan is secured by three non-residential real estate properties. This loan was performing in accordance with its original terms at December 31, 2008.
Home Equity Loans and Lines. Newport Federal offers home equity loans with a maximum combined loan to value ratio of 80% or less. Home equity lines of credit have adjustable rates of interest that are indexed to the Prime Rate as published by The Wall Street Journal. Home equity loans have fixed interest rates and terms that typically range from five to 15 years, but may have terms as long as 20 years.
Construction Loans. Newport Federal originates construction loans for one-to-four family homes and commercial, multi-family and other nonresidential purposes. The Bank’s residential construction loans generally provide for the payment of only interest during the construction phase, which is usually six to twelve months. At the end of the construction phase, the loan converts to a permanent mortgage loan. One-to-four family residential construction loans are made with a maximum loan to value ratio of 80% of the market value of the real estate and improvements. Commercial, multi-family and other nonresidential loans can be made with a maximum loan to value ratio of 75% of the upon completion market value of the real estate and improvements. At December 31, 2008, the largest construction loan was for $4.0 million, of which $601,000 was advanced. This loan was performing according to its original terms at December 31, 2008. Construction loans to individuals are generally made on the same terms as Newport Federal’s one-to-four family mortgage loans.
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Consumer Loans. The Bank offers a variety of consumer and other loans, including auto loans and loans secured by passbook savings or certificate accounts.
The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.
Loan Underwriting Risks.
Adjustable-Rate Loans. While Newport Federal anticipates that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate mortgages, an increased monthly mortgage payment required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property also may be adversely affected in a high interest rate environment. In addition, although adjustable-rate mortgage loans make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.
Multi-family and Commercial Real Estate Loans. Loans secured by multi-family and commercial real estate generally have larger balances and involve a greater degree of risk than one-to-four family residential mortgage loans. Of primary concern in multi-family and commercial real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy. To monitor cash flows on income properties, the Bank requires borrowers and loan guarantors, if any, to provide annual financial statements on multi-family and commercial real estate loans. In reaching a decision on whether to make a multi-family or commercial real estate loan, Newport Federal considers and reviews a global cash flow analysis of the borrower and considers the net operating income of the property, the borrower’s expertise, credit history and profitability and the value of the underlying property. The Bank has generally required that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.25. An environmental survey or environmental risk insurance is obtained when the possibility exists that hazardous materials may have existed on the site, or the site may have been impacted by adjoining properties that handled hazardous materials.
Construction Loans. Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost of construction. During the construction phase, a number of factors could result in delays and/or cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the building. Also, the Bank may be confronted, at or before the maturity of the loan, with a building having a value that is insufficient to assure full repayment. If Newport Federal is forced to foreclose on such a building before or at completion due to a default, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
Consumer Loans. Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as motor vehicles. In the latter case, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Loan Originations, Purchases and Sales. Loan originations come from a number of sources. The primary source of loan originations are existing customers, walk-in traffic, advertising and referrals from customers.
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Occasionally, Newport Federal sells loans that the Bank has originated. The decision to sell loans is based on prevailing market interest rate conditions and interest rate management. Newport Federal did not sell any loans in 2008.
From time to time, Newport Federal will purchase whole loans or participation loans to supplement its lending portfolio. Whole loans purchased totaled $926,000 at December 31, 2008. The Bank performs its own underwriting analysis on each loan purchased using the same standards used for loans originated. The Bank does not service purchased loans.
Loan participations, purchased and sold, totaled $2.1 million at December 31, 2008. Loan participations are also subject to the same credit analysis and loan approvals as loans Newport Federal originates. The Bank is permitted to review all of the documentation relating to any loan in which Newport Federal participates. However, in a purchased participation loan, the Bank does not service the loan and thus is subject to the policies and practices of the lead lender with regard to monitoring delinquencies, pursuing collections and instituting foreclosure proceedings.
Loan Approval Procedures and Authority. Newport Federal’s lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by the Board of Directors and management. The President, Chief Lending Officer and Chief Operating Officer have authority to approve secured loans in amounts up to $2.8 million and unsecured loans up to $300,000. Secured loans from $2.8 million to $3.2 million must be approved by four of the following persons: recommending loan officer, Chief Lending Officer, President, Chief Operating Officer and one non-employee member of the Board of Directors. Secured loans from $3.2 million to $3.6 million must be approved by a majority of the Executive Committee of the Board of Directors. Unsecured loans over $600,000 and secured loans greater than $3.6 million up to the legal lending limit must be approved by a majority vote of the Board of Directors. Smaller loans may be approved by individual loan officers; however, the Chief Lending Officer oversees the origination of all loans.
Loans to One Borrower. The maximum amount the Bank may lend to one borrower and the borrower’s related entities is limited, by regulation, to generally 15% of its stated capital and reserves. At December 31, 2008, Newport Federal’s regulatory limit on loans to one borrower was $6.4 million. At that date, the Bank’s largest lending relationship was $4.0 million and was secured by a commercial property located in Medfield, Massachusetts. This loan was performing in accordance with its original terms at December 31, 2008.
Loan Commitments. The Bank issues commitments for fixed- and adjustable-rate mortgage loans conditioned upon the occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers. Generally, these loan commitments expire after 60 days.
Investment Activities
Newport Federal has legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various Government-sponsored enterprises and of state and municipal governments, mortgage-backed securities and certificates of deposit of federally insured institutions. Within certain regulatory limits, the Bank also may invest a portion of its assets in corporate securities and mutual funds. Newport Federal also is required to maintain an investment in Federal Home Loan Bank of Boston stock.
At December 31, 2008, the Bank’s investment portfolio consisted of mortgage-backed securities issued primarily by Fannie Mae and mutual funds, the underlying assets of which consist of short-term agency securities and mortgage-backed securities.
Newport Federal’s investment objectives are to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. The Bank’s Board of Directors has the overall responsibility for the investment portfolio, including approval of the investment policy. The Chief Executive Officer and Chief Financial Officer are responsible for implementation of the investment policy and monitoring the Bank’s investment performance. The Board of Directors of Newport Federal reviews the status of the investment portfolio on a quarterly basis, or more frequently if warranted.
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Deposit Activities and Other Sources of Funds
General. Deposits, borrowings and loan repayments are the major sources of Newport Federal’s funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions.
Deposit Accounts. Substantially all of the Bank’s depositors are residents of Rhode Island. Deposits are attracted from within our market area through the offering of a broad selection of deposit instruments, including non-interest-bearing demand deposits (such as checking accounts), interest-bearing demand accounts (such as NOW and money market accounts), regular savings accounts and certificates of deposit. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of Newport Federal’s deposit accounts, the Bank considers the rates offered by the Bank’s competition, Newport Federal’s liquidity needs, profitability to the Bank, matching deposit and loan products and customer preferences and concerns. Newport Federal generally reviews the deposit mix and pricing weekly. The Bank’s current strategy is to offer competitive rates and to be in the middle of the market for rates on all types of deposit products; however, the Bank selectively competes for various certificates of deposit.
In addition to accounts for individuals, Newport Federal also offers deposit accounts designed for the businesses operating in our market area. The Bank’s business banking deposit products include commercial checking accounts and money market accounts.
Borrowings. Newport Federal utilizes advances from the Federal Home Loan Bank of Boston to supplement the Bank’s investable funds. The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a member, the Bank is required to own capital stock in the Federal Home Loan Bank and is authorized to apply for advances on the security of such stock and certain of the Bank’s mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness.
Personnel
At December 31, 2008, the Bank had 68 full-time employees and 20 part-time employees, none of whom is represented by a collective bargaining unit. Newport Federal believes that its relationship with its employees is good.
Subsidiaries
Newport Bancorp conducts its principal business activities through its wholly-owned subsidiary, Newport Federal Savings Bank. The Newport Federal Savings Bank has one wholly-owned subsidiary, NewportFed Investments, Inc., which was established to hold certain investments, consisting primarily of commercial mortgages and loans.
REGULATION AND SUPERVISION
General
As a savings and loan holding company, the Company is required by federal law to report to, and otherwise comply with the rules and regulations of, the Office of Thrift Supervision. The Bank is subject to extensive regulation, examination and supervision by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Deposit Insurance Fund managed by the Federal Deposit Insurance Corporation. The Bank must file reports with the Office of Thrift Supervision and the Federal Deposit Insurance Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals
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prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The Office of Thrift Supervision and/or the Federal Deposit Insurance Corporation conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation or Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth below and elsewhere in this document does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company and is qualified in its entirety by reference to the actual laws and regulations.
Holding Company Regulation
The Company is a non-diversified unitary savings and loan holding company within the meaning of federal law. Under prior law, a unitary savings and loan holding company, such as the Company, was not generally restricted as to the types of business activities in which it may engage, provided that the Bank continued to be a qualified thrift lender. See “Federal Savings Institution Regulation - QTL Test.” The Gramm-Leach-Bliley Act of 1999 provided that no company may acquire control of a savings institution after May 4, 1999 unless the company engages only in the financial activities permitted for financial holding companies under law or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specified that existing savings and loan holding companies may only engage in such activities. The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for activities with respect to unitary savings and loan holding companies existing prior to May 4, 1999, so long as the holding company’s savings institution subsidiary continues to comply with the QTL Test. The Company does not qualify for the grandfathering. Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the qualified thrift lender test and is deemed to be a savings institution by the Office of Thrift Supervision, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain activities authorized by Office of Thrift Supervision regulation. However, the OTS has issued an interpretation concluding that multiple savings and loan holding companies may also engage in activities permitted for financial holding companies.
A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company, without prior written approval of the Office of Thrift Supervision and from acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision considers factors such as the financial and managerial resources and future prospects of the Company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive effects.
The Office of Thrift Supervision may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Although savings and loan holding companies are not currently subject to specific regulatory capital requirements or specific restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions. The Bank must notify the Office of Thrift Supervision thirty days before declaring any dividend to the Company, and comply with the additional restrictions described below. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is
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evaluated by the Office of Thrift Supervision and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.
In addition, Maryland law prohibits the Company from making a distribution to its stockholders if, after giving effect to the distribution: (1) the Company would not be able to pay indebtedness of the Company as the indebtedness becomes due in the usual course of business; or (2) the Company’s total assets would be less than the sum of the Company’s total liabilities plus the amount that would be needed, if the Company were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution.
Acquisition of the Company. Under the Federal Change in Control Act, a notice must be submitted to the Office of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire “control” of a savings and loan holding company or savings association. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the Company’s outstanding voting stock, unless the Office of Thrift Supervision has found that the acquisition will not result in control of the Company. Under the Change in Control Act, the Office of Thrift Supervision generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition. Any company that acquires control would then be subject to regulation as a savings and loan holding company.
Federal Savings Institution Regulation
Business Activities. The activities of federal savings banks are governed by federal laws and regulations. Those laws and regulations delineate the nature and extent of the business activities in which federal savings banks may engage. In particular, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.
Capital Requirements. The Office of Thrift Supervision capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio; a 4% Tier 1 capital to total assets leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system); and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The Office of Thrift Supervision regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total risk based capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments), to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet activities, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital is generally defined as common stockholders’ equity (including retained earnings), certain non-cumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital (Tier 2 Capital) currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible debt securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets, and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
The Office of Thrift Supervision also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular circumstances. At December 31, 2008, the Bank met each of its capital requirements.
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In October 2008, the United States Department of Treasury announced a voluntary Capital Purchase Program to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. The Bank chose not to participate in the Department of Treasury’s Capital Purchase Program.
Prompt Corrective Regulatory Action. The Office of Thrift Supervision is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be “undercapitalized.” A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be “significantly undercapitalized” and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be “critically undercapitalized.” Subject to a narrow exception, the Office of Thrift Supervision is required to appoint a receiver or conservator within specified time frames for an institution that is “critically undercapitalized.” The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a savings institution is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by any parent holding company in the amount of up to the lesser of 5% of the savings association’s total assets when it was deemed to be undercapitalized or the amount necessary to achieve compliance with applicable capital requirements. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The Office of Thrift Supervision could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.
Insurance of Deposit Accounts. Deposit accounts in the Bank are insured by the Federal Deposit Insurance Corporation, generally up to a maximum of $100,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. However, pursuant to its statutory authority, the Board of Directors of the Federal Deposit Insurance Corporation recently increased the deposit insurance available on deposit accounts to $250,000 effective until December 31, 2009.
In addition, in October 2008, the FDIC announced the Temporary Liquidity Guarantee Program, part of which allows any participating depository institution to provide full deposit insurance coverage for non-interest bearing transaction accounts, regardless of the dollar amount. The Bank has opted to participate in this part of the Temporary Liquidity Guarantee Program. See “-FDIC Temporary Liquidity Guarantee Program” below.
The FDIC imposes an assessment on all depository institutions for deposit insurance. This assessment is based on the risk category of the institution and, prior to 2009, ranged from five to 43 basis points of the institution’s deposits. On December 22, 2008, the FDIC published a final rule that raises the current deposit insurance assessment rates uniformly for all institutions by 7 basis points (to a range from 12 to 50 basis points) effective for the first quarter of 2009. On February 27, 2009, the FDIC also issued a final rule that revises the way the FDIC calculates federal deposit insurance assessment rates beginning in the second quarter of 2009. Under the new rule, the FDIC will first establish an institution’s initial base assessment rate. This initial base assessment rate will range, depending on the risk category of the institution, from 12 to 45 basis points. The FDIC will then adjust the initial base assessment (higher or lower) to obtain the total base assessment rate. The adjustments to the initial base assessment rate will be based upon an institution’s levels of unsecured debt, secured liabilities and brokered deposits. The total base assessment rate will range from 7 to 77.5 basis points of the institution’s deposits. Additionally, the FDIC issued an interim rule that would impose a special 20 basis points assessment on June 30, 2009, which would be collected on September 30, 2009. The interim rule also allows for additional special assessments.
Based upon the Bank’s review of the Federal Deposit Insurance Corporation’s rule, its Federal Deposit Insurance Corporation assessment for the first quarter of 2009 will increase by approximately $35,000. Thereafter,
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because of adjustments to the initial base assessment rate, we believe the rule will have a negative effect on our earnings.
In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended September 30, 2008, the annualized FICO assessment was equal to 1.12 basis points on domestic deposits maintained at an institution.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of Newport Bancorp and the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
FDIC-Temporary Liquidity Guarantee Program. On October 14, 2008, the FDIC announced a new program - the Temporary Liquidity Guarantee Program (“TLGP”). This program has two components. One guarantees newly issued senior unsecured debt of the participating organizations, up to certain limits established for each institution, issued between October 14, 2008 and June 30, 2009. The FDIC will pay the unpaid principal and interest on an FDIC-guaranteed debt instrument upon the uncured failure of the participating entity to make a timely payment of principal or interest in accordance with the terms of the instrument. The guarantee will remain in effect until June 30, 2012. On February 27, 2009, the FDIC issued an interim rule allowing participants to apply to have the FDIC guarantee newly issued senior unsecured debt that mandatorily converts into common shares on a specified date that is on or before June 30, 2012. In return for the FDIC’s guarantee, participating institutions will pay the FDIC a fee based on the amount and maturity of the debt. The Bank has opted to participate in this component of the TLGP.
The other component of the program provides full FDIC insurance coverage for non-interest bearing transaction deposit accounts, regardless of dollar amount, until December 31, 2009. An annualized 10 basis point assessment on balances in noninterest-bearing transaction accounts that exceed the existing deposit insurance limit of $250,000 will be assessed on a quarterly basis to insured depository institutions that have not opted out of this component of the TLGP. The Bank chose to participate in this component of the program, and therefore is providing the full FDIC insurance coverage on the related transaction deposit accounts until year-end 2009.
Loans to One Borrower. Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. Generally, subject to certain exceptions, a savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral.
QTL Test. Federal law requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities, but also including education, credit card and small business loans) in at least 9 months out of each 12 month period.
A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. At December 31, 2008, the Bank maintained 96.79% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.
Limitation on Capital Distributions. Office of Thrift Supervision regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and
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prior approval of the Office of Thrift Supervision is required prior to any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under Office of Thrift Supervision regulations (i.e., generally, examination and Community Reinvestment Act ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the Office of Thrift Supervision. If an application is not required, the institution must still provide prior notice to the Office of Thrift Supervision of the capital distribution if, like the Bank, it is a subsidiary of a holding company. In the event the Bank’s capital fell below its regulatory requirements or the Office of Thrift Supervision notified it that it was in need of increased supervision, the Bank’s ability to make capital distributions could be restricted. In addition, the Office of Thrift Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision determines that such distribution would constitute an unsafe or unsound practice.
Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness in various areas such as internal controls and information systems, internal audit, loan documentation and credit underwriting, interest rate exposure, asset growth and quality, earnings and compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the Office of Thrift Supervision determines that a savings institution fails to meet any standard prescribed by the guidelines, the Office of Thrift Supervision may require the institution to submit an acceptable plan to achieve compliance with the standard.
Transactions with Related Parties. The Bank’s authority to engage in transactions with “affiliates” (e.g., any entity that controls or is under common control with an institution, including the Company and its other subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must generally be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
The Sarbanes-Oxley Act of 2002 generally prohibits loans by the Company to its executive officers and directors. However, the law contains a specific exception for loans by the Bank to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital level and requires that certain board approval procedures be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional limitations based on the type of loan involved. (See Note 13 “Related Party Transactions” in the attached Financial Statement Schedules).
Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over savings institutions and has authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The Federal Deposit Insurance Corporation has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director,
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the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
Assessments. Savings institutions are required to pay assessments to the Office of Thrift Supervision to fund the agency’s operations. The general assessments, paid on a semi-annual basis, are computed based upon the savings institution’s (including consolidated subsidiaries) total assets, financial condition and complexity of its portfolio. The OTS assessments paid by the Company for the year ended December 31, 2008 totaled $101,000.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank System, which consists of (12) regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. The Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at December 31, 2008 of $5.6 million.
The Federal Home Loan Banks are required to provide funds for certain purposes including the resolution of insolvent thrifts in the late 1980s and to contributing funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, the Bank’s net interest income would likely also be reduced.
On February 26, 2009, the Federal Home Loan Bank of Boston announced to their members that it has suspended its dividend payment for the first quarter of 2009 and it is unlikely that it will pay dividends in 2009. In addition, the Federal Home Loan Bank of Boston also stated the moratorium on excess stock repurchases declared in December 2008 will continue during 2009.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily Negotiable Order of Withdrawal (NOW) and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $44.4 million; a 10% reserve ratio is applied above $44.4 million. The first $10.3 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The amounts are adjusted annually. The Bank complies with the foregoing requirements.
Federal Securities Laws
Newport Bancorp’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. Newport Bancorp is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
Other Regulations
Troubled Assets Relief Program. On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. The EESA provides the U.S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. One of the programs resulting from the legislation is the Troubled Asset Relief Program Capital Purchase Program (“CPP”), which provides direct equity investment in perpetual preferred stock by the U.S. Treasury Department in qualified financial institutions. The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends. The CPP provides for a minimum investment of one percent of total risk-weighted assets and a maximum investment equal to the lesser of three percent of total risk-weighted assets or $25 billion. The Bank opted not to participate in the CPP.
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On February 10, 2009, the U.S. Department of the Treasury announced its Capital Assistance Program (“CAP”) under which Treasury will make capital available to financial institutions through Treasury’s purchase of cumulative mandatorily convertible preferred stock. The preferred shares will mandatorily convert to common stock after seven years. Prior to that time, the preferred shares are convertible in whole or in part at the option of the institution, subject to the approval of the institution’s primary federal regulator. The minimum investment is an amount equal to 1% of risk-weighted assets and the maximum is an amount equal to 2% of risk-weighted assets. Institutions may receive additional capital to the extent such funds are used to redeem preferred shares issued in the CPP, effectively exchanging the CAP convertible preferred stock for the preferred stock sold under the CPP. The Bank has not yet determined whether it will participate in the CAP, or the amount of any investment it would apply for if it does decide to participate. The deadline for applying for participation in the CAP is May 25, 2009.
ITEM 1A.
ITEM 1A. RISK FACTORS
Our business may be adversely affected by conditions in the financial markets and economic conditions generally.
Since December 2007, the United States has been in a recession. Business activity across a wide range of industries and regions is greatly reduced and local governments and many businesses are in serious difficulty due declines in revenues, the lack of consumer spending and the lack of liquidity in the credit markets. Unemployment has increased significantly. During 2008 and early 2009, the business environment has been adverse for many households and businesses in the United States and worldwide. It is expected that the business environment in the Company’s markets, the United States and worldwide may continue to weaken for the near future. There can be no assurance that these conditions will improve in the near term. Such conditions could adversely affect the credit quality of the Company’s loans, results of operations and financial condition.
Market conditions have also led to the failure or merger of a number of prominent financial institutions. Financial institution failures or near-failures have resulted in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties. Furthermore, declining asset values, defaults on mortgages and consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to increase the cost and decrease the availability of liquidity, despite very significant declines in Federal Reserve borrowing rates and other government actions. Some banks and other lenders have suffered significant losses and have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining asset values on the value of collateral. The foregoing has significantly weakened the strength and liquidity of some financial institutions worldwide.
A continued decline in real estate values could impact our profits.
Nearly all of Newport Federal’s loans are secured by real estate in the State of Rhode Island. As a result of this concentration, a downturn in the local economy could cause significant increases in nonperforming loans, which would impact the Bank’s profits. According to the Rhode Island State-Wide Multiple Listing Service, the median price of a single family home sold in 2008 was 14.58% lower than it was in 2007 ($234,900 versus $275,000). A continued decline in real estate values could cause some of Newport Federal’s mortgage loans to become inadequately collateralized, which would expose the Bank to a greater risk of loss. Additionally, a decline in real estate values could adversely impact the Bank’s portfolio of commercial real estate loans and could result in a decline in the origination of such loans.
Changes in interest rates may reduce our profits.
Net interest income is our largest source of income. Changes in interest rates can affect the level of net interest income. The Company’s interest rate sensitivity is discussed in more detail in Item 7 of this report. We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed. Changes in interest rates can also affect the demand for our products and services, and the supply conditions in the U.S. financial and capital markets. Changes in the level of interest rates may negatively affect our
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ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings.
If we do not achieve profitability on new branches, they may negatively impact our earnings.
We opened our Portsmouth, Rhode Island branch office in January 2009, and we expect to open another new branch in Stonington, Connecticut in May 2009. Numerous factors contribute to the performance of a new branch, such as a suitable location, qualified personnel and an effective marketing strategy. Additionally, it takes time for a new branch to generate significant deposits and make sufficient loans to produce enough income to offset expenses, some of which, like salaries and occupancy expense, are relatively fixed costs. We expect that it may take a period of time before the new branch offices can become profitable. During this period, operating these new branch offices may negatively impact our net income.
Strong competition within our market area could affect our profits and slow growth.
Newport Federal faces intense competition both in making loans and attracting deposits. This competition has made it more difficult for the Bank to make new loans and attract deposits. Price competition for loans and deposits might result in the Bank earning less on the Bank’s loans and paying more on the Bank’s deposits, which would reduce net interest income. Competition also makes it more difficult to grow loans and deposits. At June 30, 2008, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation (“FDIC”), Newport Federal held approximately 11.46% of the deposits in Newport County, Rhode Island and approximately 4.02% of the deposits in Washington County, Rhode Island. Some of the institutions with which the Bank competes have substantially greater resources and lending limits than Newport Federal has and may offer services that the Bank does not provide. Newport Federal expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry.
Due to the interventions of the federal government, some of the institutions that we compete with are receiving substantial federal financial support which may not be available to our Company. Many institutions have been allowed to convert to banking charters and to offer insured deposits for the first time. The federal government has guaranteed money market funds which traditionally compete with bank deposits. The federal government has offered significant guarantees of new debt issuances to some of the Company’s competitors to help them fund their operations. The federal government now controls Fannie Mae and Freddie Mac and may operate directly as a competitor in some lending markets in the future. Emergency measures designed to support some of the Company’s competitors may provide no advantage to the Company or place it at a disadvantage. Emergency changes in deposit insurance, financial market regulation, bank regulation, and policy of the Federal Home Loan Bank system may all affect the competitive environment for the Company and other market participants. Our profitability depends upon our continued ability to compete successfully in our market area.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially and adversely affect our operating results. The accounting measurements related to impairment and the loan loss allowance require significant estimates which are subject to uncertainty and changes relating to new information and changing circumstances. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates.
Our regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of
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recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.
Our expenses will increase as a result of increases in Federal Deposit Insurance Corporation insurance premiums.
The FDIC imposes an assessment against financial institutions for deposit insurance. This assessment is based on the risk category of the institution and currently ranges from 5 to 43 basis points of the institution’s deposits. The FDIC has issued final rules that increase the current deposit insurance assessment rates to a range from 12 to 45 basis points beginning April 1, 2009. Additionally, the FDIC has issued an interim rule that would impose a special 20 basis points assessment on deposits as of June 30, 2009, which would be paid on September 30, 2009. The increase in the assessment rates and the special assessment will increase our expenses.
Continued or further declines in the value of certain investment securities could require write-downs, which would reduce our earnings.
At December 31, 2008, the Company recognized a $706,000 impairment charge for the Bank’s holding in the AMF Ultra Short Mortgage Fund. The AMF Ultra Short Mortgage Fund has invested in private label mortgage-backed securities and US Government Agency and government sponsored agency securities. Although management believes it is possible that all principal and interest payments will be received, general market concerns over these and similar types of securities has caused the fair value to decline severely enough to warrant an other-than-temporary impairment charge. Given the significant uncertainty and illiquidity in the markets for such securities, the Bank cannot be certain that future impairment charges will not be required against this investment, which had a remaining book value of $2.0 million at December 31, 2008 (net of impairment charges), or on other investment securities held by the Bank.
If dividends paid on our investment in the Federal Home Loan Bank of Boston continue to be suspended, or if our investment is classified as other-than-temporarily impaired or as permanently impaired, our earnings and/or stockholders’ equity could decrease.
We own common stock of the Federal Home Loan Bank of Boston (“FHLBB”) to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLBB’s advance program. There is no market for our FHLBB common stock. On February 26, 2009, the FHLBB reported a net annual loss of $73.2 million. The loss was primarily due to a other-than-temporary impairment charge of $339.1 million on its private-label mortgage backed securities portfolio. The FHLBB believes that it will recover a substantial portion of the impairment losses over time and expects to hold the securities until maturity. As a result of the loss, the FHLBB also announced that the dividend paid on its common stock has been suspended indefinitely and that the payment of any dividend in 2009 is unlikely. The continued suspension of the dividend will decrease our income. In an extreme situation, it is possible that the capitalization of a Federal Home Loan Bank, including the FHLBB, could be substantially diminished or reduced to zero. Consequently, we believe that there is a risk that our investment in FHLBB common stock could be deemed other-than-temporarily impaired at some time in the future, and if this occurs, it would cause our earnings and stockholders’ equity to decrease by the after-tax amount of the impairment charge. We have been notified by the FHLBB that future dividend levels may be different from past levels, and a reduction or elimination of this dividend would reduce our earnings.
Economic conditions may adversely affect our liquidity.
In the past year, significant declines in the values of mortgage-backed securities and derivative securities issued by financial institutions, government sponsored entities, and major commercial and investment banks has led to decreased confidence in financial markets among borrowers, lenders, and depositors, as well as disruption and extreme volatility in the capital and credit markets and the failure of some entities in the financial sector. As a result, many lenders and institutional investors have reduced or ceased to provide funding to borrowers. Continued turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.
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Future legislative or regulatory actions responding to perceived financial and market problems could impair our rights against borrowers.
As a result of the recent financial crisis, the potential exists for the promulgation of new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, which are expected to result in the issuance of many formal enforcement orders. Negative developments in the financial services industry and the credit markets, and the impact of new legislation in response to these developments, may negatively affect our operations by restricting our business operations, including our ability to originate or sell loans and pursue business opportunities. Compliance with such regulation also will likely increase our costs.
There have been proposals made by members of Congress and others that would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral. Were proposals such as these, or other proposals limiting our rights as a creditor, to be implemented, we could experience increased credit losses or increased expense in pursuing our remedies as a creditor.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
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ITEM 2.
ITEM 2.
PROPERTIES
We conduct our business through our main office and branch offices. The following table sets forth certain information relating to these facilities as of December 31, 2008.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. Newport Federal is not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market and Dividend Information.
The Company’s common stock is listed on the Nasdaq Global Market (“NASDAQ”) under the trading symbol “NFSB.”
The following table sets forth the high and low sales prices of the Company’s common stock since trading commenced, as reported by NASDAQ. The Company has not paid any dividends to stockholders to date. See “Dividends” below.
Holders.
As of March 12, 2009, there were approximately 612 holders of record of the Company’s common stock.
Dividends.
The Company has not paid any dividends to its stockholders to date. The payment of dividends in the future will depend upon a number of factors, including capital requirements, the Company’s financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. In addition, the Company’s ability to pay dividends is dependent on dividends received from Newport Federal. For more information regarding restrictions on the payment of cash dividends by the Company and by Newport Federal, see “Business-Regulation and Supervision-Holding Company Regulation” and “- Regulation and Supervision-Federal Savings Institution Regulation-Limitation on Capital Distributions” and Note 10 to the Consolidated Financial Statements included in this Annual Report. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in the future.
Securities Authorized for Issuance under Equity Compensation Plans.
See Part III, Item 12(d) Equity Compensation Plan Information, in this Annual Report on Form 10-K, for the table providing information as of December 31, 2008 about Company common stock that may be issued upon the exercise of options under the Newport Bancorp, Inc. 2007 Equity Incentive Plan. The plan was approved by the Company’s shareholders at the August 16, 2007 Annual Meeting of Stockholders.
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Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities.
Not applicable.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers.
The following table provides certain information with regard to shares repurchased by the Company in the fourth quarter of 2008.
(1) On July 25, 2008, the Company announced the commencement of a stock repurchase program to acquire up to 440,270 shares, or 10%, of the Company’s then outstanding common stock. At December 31, 2008, the Company has purchased 214,900 shares under this program, at an average cost of $11.56. Repurchases, which are conducted through open market purchases or privately negotiated transactions, are made from time to time depending on market conditions and other factors. On March 12, 2009, the Company announced it had completed this stock repurchase program, acquiring 440,270 shares at an average cost of $11.54 per share.
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ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
(1)
Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities.
(2)
Represents net interest income as a percent of average interest-earning assets.
(3)
Represents non-interest expense minus the expense related to the contribution to the NewportFed Charitable Foundation in 2006 divided by the sum of net interest income and non-interest income. The December 31, 2008 ratio represents non-interest expense divided by the sum of net interest income and non-interest income, excluding the $706,000 impairment charge incurred in 2008.
(4)
Loans are presented before the allowance for loan losses but include deferred costs/fees. Construction loans are included net of loans in process. Loans held for sale are included.
N/M
Not meaningful because there are no nonperforming loans and, consequently, the denominator in the ratio was zero.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Overview
Income. Newport Federal’s primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that the Bank pays on deposits and borrowings. Other significant sources of
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pre-tax income are service charges (mostly from service charges on deposit accounts, loan servicing fees and income from bank-owned life insurance). In some years, Newport Federal recognizes income from the sale of loans and securities.
Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. The Bank evaluates the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
Expenses. The non-interest expenses Newport Federal incurs in operating the Bank’s business consist of compensation and employee benefits expenses, occupancy expenses, data processing expenses and other miscellaneous expenses.
Compensation and employee benefits consist primarily of salaries and wages paid to the Bank’s employees, stock-based compensation, payroll taxes, expenses for health insurance, retirement plans, and other employee benefits.
Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using the straight-line method based on the useful lives of the related assets, which range from three to forty years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the expected term of the lease. The expected term includes lease option periods to the extent that the exercise of such options is reasonably assured.
Data processing expenses are the fees paid to third parties for processing customer information, deposits and loans.
Other expenses include expenses for professional services, advertising, office supplies, postage, telephone, insurance, charitable contributions, regulatory assessments, FDIC deposit insurance and other miscellaneous operating expenses.
Critical Accounting Policies
Newport Bancorp considers accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on results of operations to be critical accounting policies. The Company considers the allowance for loan losses, other-than-temporary impairment of securities and the valuation of the net deferred tax asset to be our critical accounting policies.
Allowance for Loan Losses.
The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management evaluates the level of the allowance at least quarterly and establishes the provision for loan losses based upon a review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other factors related to the collectability of the loan portfolio. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Although management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews Newport Federal’s allowance for loan losses. Such agency may require the Bank to recognize adjustments to the allowance based on its judgments about information available to it
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at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings.
The allowance consists of general and unallocated loss components. For loans that are classified as impaired, an allowance is established when the collateral value of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating the general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan by loan basis by the fair value of the collateral.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.
Other-Than-Temporary Impairment.
In estimating other than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition of the issuer, and (3) the intent and ability of the Bank to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Income Taxes.
Management considers accounting for income taxes as a critical accounting policy due to the subjective nature of certain estimates that are involved in the calculation. Newport Federal uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance related to deferred tax assets is established when, in the judgment of management, it is more likely than not that all or a portion of such deferred tax assets will not be realized. The Bank assesses the realizability of its deferred tax assets by (1) reviewing taxable income in allowable federal carry-back periods, and (2) assessing the likelihood of the Bank generating federal and state taxable income, as applicable, in future periods in amounts sufficient to offset the deferred tax charges they are expected to reverse. Adjustments to increase or decrease the valuation allowance are generally charged or credited, respectively, to income tax expense.
Balance Sheet Analysis
Overview. During 2008, the Company’s assets increased by $71.1 million, or 19.7%, to $432.3 million. The majority of the asset growth was concentrated in net loans, which increased by $39.9 million, and securities held to maturity, which increased by $21.3 million. The asset growth was principally funded by a $40.1 million, or 38.0%, increase in borrowings, of which $15.0 million was used to purchase securities, and deposit growth of $35.8 million.
Loans. Newport Federal’s primary lending activity is the origination of loans secured by real estate. The Bank originates one-to-four family residential loans, commercial real estate and multi-family loans and home equity loans. To a lesser extent, Newport Federal originates construction loans and consumer loans. Net loans increased from $293.1 million at December 31, 2007 to $333.0 million at December 31, 2008, or 13.6%. Net loans represented 77.03% of total assets at December 31, 2008.
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The largest segment of the Bank’s loan portfolio is one-to-four family residential loans, but the percentage of one-to-four family loans as a percentage of total loans decreased in both 2008 and 2007 due to increases in other lending, particularly, multi-family and commercial real estate lending.
One-to-four family loans totaled $183.8 million and represented 54.5% of total loans at December 31, 2008, compared to $169.2 million, or 57.1% of total loans at December 31, 2007. The Bank offers fixed and adjustable rate one-to-four family residential loans. At December 31, 2008, the Bank had $164.5 million in fixed rate and $19.3 million in adjustable rate one-to-four family loans.
Commercial real estate loans totaled $93.6 million and represented 27.8% of total loans at December 31, 2008, compared to $76.9 million, or 26.0% of total loans at December 31, 2007. The increase of $16.7 million, or 21.7%, was a result of the Company’s concerted efforts to expand its commercial loan portfolio.
Multi-family loans totaled $17.4 million, or 5.2% of total loans at December 31, 2008, compared to $9.5 million, or 3.2% of total loans at December 31, 2007. Construction loans totaled $11.2 million, representing 3.3% of total loans at December 31, 2008, compared to $9.4 million or 3.2% of total loans at December 31, 2007.
Home equity loans and lines totaled $30.4 million, representing 9.0% of total loans at December 31, 2008, compared to $30.9 million at December 31, 2007.
The Bank also originates consumer loans secured by automobiles or passbook or certificate accounts. Consumer loans totaled $601,000 at December 31, 2008, compared to $442,000 at December 31, 2007.
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The following table sets forth the composition of the Bank’s loan portfolio at the dates indicated.
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The following table sets forth certain information at December 31, 2008 regarding the dollar amount of loan principal repayments coming due during the periods indicated. The table does not include any estimate of prepayments, which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
The following table sets forth the dollar amount of all loans at December 31, 2008 that are due after December 31, 2009 and have either fixed interest rates or floating or adjustable interest rates. The amounts shown below exclude the allowance for loan losses and net deferred loan fees.
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Securities. The securities portfolio consists of mutual funds and mortgage-backed securities.
All mortgage-backed securities are from government sponsored enterprises. Newport Federal had no investments that had an aggregate book value in excess of 10% of our equity at December 31, 2008.
At December 31, 2008, the Company recognized a $706,000 impairment charge for the Bank’s holding in the AMF Ultra Short Mortgage Fund. The AMF Ultra Short Mortgage Fund has invested in private label mortgage-backed securities and US Government Agency and government sponsored agency securities. Although management believes it is possible that all principal and interest payments will be received, general market concerns over these and similar types of securities has caused the fair value to decline severely enough to warrant an other-than-temporary impairment charge. Given the significant uncertainty and illiquidity in the markets for such securities, the Bank cannot be certain that future impairment charges will not be required against this investment, which had a remaining book value of $2.0 million at December 31, 2008 (net of impairment charges).
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The following table sets forth the stated maturities and weighted average yields of debt securities at December 31, 2008.
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Deposits. Newport Federal’s deposit base is comprised of demand deposits, money market and savings accounts and time deposits. The Bank considers demand deposits, money market and savings accounts to be core deposits. Deposits increased $35.8 million, or 18.5%, for the year ended December 31, 2008. Deposit growth was focused in NOW/Demand accounts, which increased by $31.5 million, or 53.2%, and money market accounts, which increased $10.8 million, or 37.5%. These increases were partially offset by a decrease in time deposit accounts of $6.1 million, or 7.7%, and a decrease in savings accounts of $372,000, or 1.4%.
The following table sets forth the balances of the Bank’s deposit products at the dates indicated.
The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity as of December 31, 2008. Jumbo certificates of deposit require minimum deposits of $100,000. The Bank does not offer special rates for jumbo certificates.
Borrowings. Newport Federal utilizes borrowings from the Federal Home Loan Bank of Boston and repurchase agreements to supplement the Bank’s supply of funds for loans and investments.
Federal Home Loan Bank advances increased by $25.0 million to $105.4 million at December 31, 2008. During 2008, the Bank borrowed $15.0 million using a repurchase agreement. These borrowings were used to help fund loan originations and to purchase securities held to maturity during 2008. During 2007, the Bank borrowed $25.0 million using a repurchase agreement.
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Results of Operations for the Years Ended December 31, 2008 and 2007
Overview.
Net loss in 2008 was $848,000 compared to the net income of $757,000 in 2007. The decrease in non-interest income of $743,000, the increase in non-interest expenses of $2.1 million and the increase in the tax provision of $400,000, partially offset by increases in the Bank’s net interest income of $1.8 million, contributed towards the net loss in 2008. The $1.8 million increase in net interest income was primarily the result of higher levels of interest-earning assets and an increase in the interest rate spread, partially offset by expense from borrowings utilized to fund the year’s asset growth. The $743,000 decrease in non-interest income is primarily a result of the $706,000 impairment charge recorded for the Bank’s holding in the AMF Ultra Short Mortgage Fund. Non-interest expense for 2008 increased to $12.9 million from $10.8 million in 2007, an increase of 19.2%. The increase in non-interest expense between the two years is primarily due to an increase of $1.7 million in salaries and employee benefits, an increase of $160,000 in marketing costs, an increase of $99,000 in data processing fees, and an overall increase in FDIC insurance costs and other general operating costs. The increase in salaries and benefits is due to the stock-based compensation expense associated with stock options and restricted stock awards granted on October 1, 2007. There was no stock-based compensation expense incurred during the first nine months of 2007. Effective tax rates were 673.0% and 44.1% for 2008 and 2007, respectively. The higher effective tax rate in 2008, was primarily due to an increase in the valuation reserve against deferred tax assets and the write-down of the state deferred tax assets in conjunction with the formation of a passive investment company subsidiary.
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Average Balances and Yields. The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. For purposes of this table, average balances have been calculated using month-end balances, and nonaccrual loans are included in average balances only. Management does not believe that use of month-end balances instead of daily average balances has caused any material differences in the information presented. None of the income reflected in the following table is tax-exempt income.
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Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
Net Interest Income. Net interest income for the year ended December 31, 2008 was $12.1 million, compared to $10.3 million for year December 31, 2007, an increase of 17.1%. The increase in net interest income is due to the increase in interest-earning assets and an increase in interest rate spread, partially offset by increased expense from borrowings utilized to fund the year’s asset growth. The yield on interest-earning assets decreased to 5.96% in 2008 from 6.21% in 2007, a decrease of 25 basis points. The cost of interest-bearing liabilities decreased to 3.19% in 2008 from 3.52% in 2007, a decrease of 33 basis points. The average cost of interest-bearing demand deposits increased by 189 basis points due to the new rewards checking product, launced late in 2007. While, the total cost of other interest-bearing deposits decreased by 200 basis points from 2007 to 2008. With decreases in short-term market interest rates, customers have increasingly shown a preference for higher-yielding core accounts, rather than the longer-term time deposit accounts. The low short-term market interest rate environment has also contributed towards the 95 basis points decrease in total cost of borrowings from 2007 to 2008. The interest rate spread increased to 2.77% for 2008 from 2.69% in 2007, up 8 basis points.
Provision for Loan Losses. The loan loss provision for the years ended December 31, 2008 and December 31, 2007 was $568,000 and $426,000, respectively. The provision was increased primarily due to the growth and changes in the composition of the loan portfolio, including the increase in commercial mortgages and changes in general economic conditions including the slowing economy and falling housing prices.
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Non-Interest Income. The following table shows the components of non-interest income and the percentage changes from year to year.
Non-interest income for 2008 totaled $1.6 million, a decrease of $743,000, or 32.0%, compared to 2007. The decrease in non-interest income is primarily due to the $706,000 impairment charge recorded for the Bank’s holdings in the AMF Ultra Short Mortgage Fund.
Non-Interest Expense. The following table shows the components of non-interest expense and the percentage changes for the years indicated.
Total non-interest expenses for 2008 increased to $12.9 million from $10.8 million for 2007, an increase of 19.2%. Non-interest expenses increased due to an increase in salaries and employee benefits, marketing, data processing fees, increased FDIC insurance costs and overall other operating costs. The increase in salaries and benefits is due to the stock-based compensation expense associated with stock options and restricted stock awards granted on October 1, 2007. There was no stock-based compensation expense incurred during the first nine months of 2007. Data processings costs increased as a direct result of the increase in number of deposit and loan accounts maintained by the Bank’s computer systems. Marketing expense increased primarily due to the strategic efforts devoted to marketing and advertising projects throughout the year, in addition to a strong promotional effort during the fourth quarter of 2008 for the Company’s grand opening of its new Portsmouth, Rhode Island branch in January 2009. A decrease in professional fees during 2008 was primarily due to a reduction in professional services associated with Sarbanes-Oxley section 404 reporting. All other expenses increased due to an overall increase in costs and FDIC insurance premiums as a result of the FDIC’s increase in rates and insurance coverage limits. Management expects FDIC insurance costs to continue to increase in 2009, due to rate increases and special assessments declared by the FDIC.
Income Tax Expense. The income tax expense for 2008 was $996,000 compared to an income tax expense of $596,000 for 2007. The effective tax rates were 673.0% and 44.1% in 2008 and 2007, respectively. The effective tax rate in 2008 includes the non-deductible compensation expense recorded for a portion of the incentive stock options and additional valuation reserves against the Company’s deferred tax assets (discussed below), and the write-down of state deferred tax assets in conjunction with the formation of a passive investment company subsidiary, which were partially offset by non-taxable BOLI income.
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The deferred tax assets applicable to loss carry forwards relating to the deduction for the donation to the charitable foundation in 2006 are recoverable, only to the extent that 10% pre-tax of income exceeds the deduction during the five-year carry forward period. Newport Bancorp had previously recognized a valuation allowance of $492,000 against the deferred tax asset related to this loss carry forward at December 31, 2007. This valuation allowance is assessed quarterly for recoverability. Based on management’s assessment in the fourth quarter of 2008, the valuation allowance on this asset was increased by $250,000 due to changes in projected future taxable income. At December 31, 2008, the valuation allowance for this deferred tax asset amounted to $742,000.
In addition, a valuation reserve of $240,000 was established against the deferred tax asset resulting from the 2008 securities impairment loss, as the Bank has no history of capital gains to carryback.
On December 31, 2008, the Bank established NewportFed Investments, Inc., a passive investment company subsidiary allowed under Rhode Island state law to hold certain investments consisting primarily of commercial mortgages and loans. Such assets were transferred from Newport Federal Savings Bank to this subsidiary, and as of December 31, 2008, the subsidiary had $119.8 million of assets. Based on current Rhode Island state law, it is expected that future income from assets held by this subsidiary will not be taxable to the Company for state income tax purposes. As a result, the Company incurred additional income tax provision of $300,000 during this quarter in connection with a revaluation of the Company’s deferred state tax asset.
Risk Management
Overview. Managing risk is an essential part of successfully managing a financial institution. Newport Bancorp’s most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are accounted for on a mark-to-market basis. Other risks that the Company faces are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue.
Credit Risk Management. Newport Federal’s strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans.
When a borrower fails to make a required loan payment, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status. When the loan becomes 15 days past due a late notice is sent to the borrower. When the loan becomes 18 days past due, a more formal letter is sent. When a loan becomes 25 days past due, the borrower is typically called. After 30 days, the Bank regards the borrower as in default. The borrower is promptly sent a letter from the Bank’s attorney and the Bank may commence collection proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. Generally, when a consumer loan becomes 60 days past due, the Bank institutes collection proceedings and attempts to repossess any personal property that secures the loan. Management informs the board of directors monthly of the amount of loans delinquent more than 30 days, all loans in foreclosure and repossessed property that it owns.
Analysis of Nonperforming and Classified Assets. Newport Bancorp considers repossessed assets and loans that are 90 days or more past due to be nonperforming assets. Loans are generally placed on nonaccrual status when they become 90 days delinquent at which time the accrual of interest ceases and the allowance for any uncollectible accrued interest is established and charged against operations. Typically, payments received on a nonaccrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan.
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The following table provides information with respect to the Bank’s nonperforming assets at the dates indicated.
Federal regulations require the Newport Federal to review and classify the Bank’s assets on a regular basis. In addition, the Office of Thrift Supervision has the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified “loss” is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations also provide for a “special mention” category, described as assets which do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving our close attention. When the Bank classifies an asset as substandard or doubtful, the asset is assessed for impairment, and a specific allowance for loan losses is established when appropriate. If Newport Federal classifies an asset as loss, it is charged off at an amount equal to 100% of the portion of the asset classified loss.
The following table shows the aggregate amounts of our classified assets at the dates indicated.
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Delinquencies. The following table provides information about delinquencies in our loan portfolio at the dates indicated.
Analysis and Determination of the Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. Newport Federal evaluates the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
Our methodology for assessing the appropriateness of the allowance for loan losses consists of: (1) a specific valuation allowance on identified impaired loans; and (2) a general valuation allowance on the remainder of the loan portfolio. Although the Bank determines the amount of each element of the allowance separately, the entire allowance for loan losses is available to absorb losses in the loan portfolio.
Specific Valuation Allowance on Identified Impaired Loans. Newport Federal identifies loans that may need to be charged off as a loss, or need a specific reserve in accordance with SFAS 114, by reviewing all delinquent loans, classified loans and other loans that management may have concerns about collectability. All identified impaired loans are reviewed to assess the borrower’s inability to make payments under the terms of the loan and/or a shortfall in collateral value that would result in charging off the loan or the portion of the loan that was impaired.
General Valuation Allowance on the Remainder of the Loan Portfolio. Newport Federal establishes a general allowance for loans that are not problem loans, to recognize the inherent losses associated with lending activities. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages to each category. The percentages are adjusted for significant changes in factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are reevaluated periodically to ensure their relevance in the current economic environment.
The Bank engages an independent third party to conduct an annual review of its commercial real estate portfolio. This loan review, which typically includes a 50% penetration of the commercial real estate portfolio, provides a credit evaluation of individual loans to determine whether the risk ratings assigned are appropriate.
The Office of Thrift Supervision, as an integral part of its examination process, periodically reviews our allowance for loan losses. The Office of Thrift Supervision may require the Bank to make additional provisions for loan losses based on judgments different from ours.
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At December 31, 2008 and 2007, the allowance for loan losses represented 0.87% and 0.81% of total loans, respectively. No portion of the allowance was allocated to impaired loans at December 31, 2008 or 2007. The allowance for loan losses increased from $2,399,000 at December 31, 2007, to $2,924,000 at December 31, 2008, or 21.9%. The increase in 2008, was primarily due to the growth, changes in the composition of the loan portfolio and changes in general economic conditions. The increase in the allowance for loan losses as a percentage of the loan portfolio was primarily due to an increase in the proportion of commercial loans in the portfolio and the increase in the percentage used to calculate the allowance on such loans due to general economic conditions.
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.
Although management believes the best information available was used to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while management believes it has established the allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that regulators, in reviewing the loan portfolio, will not require an increase in the allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.
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Analysis of Loan Loss Experience. The following table sets forth an analysis of the allowance for loan losses for the periods indicated. Where specific loan loss allowances have been established, any difference between the loss allowance and the amount of loss realized has been charged or credited to current income.
Qualitative Aspects of Market Risk. The Company’s most significant form of market risk is interest rate risk. Newport Bancorp manages the interest rate sensitivity of its interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect earnings while decreases in interest rates may beneficially affect earnings. To reduce the potential volatility of our earnings, the Company has sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Newport Bancorp’s strategy for managing interest rate risk emphasizes: adjusting the maturities of borrowings; adjusting the investment portfolio mix and duration; and periodically selling fixed-rate mortgage loans and available-for-sale investment securities.
The Company has an Asset Liability Management Committee to communicate, coordinate and control all aspects involving asset/liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.
Quantitative Aspects of Market Risk. The Company uses an interest rate sensitivity analysis prepared by the Office of Thrift Supervision to review our level of interest rate risk. This analysis measures interest rate risk by computing changes in net portfolio value of our cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. Net portfolio value represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 300 basis point increase or 100 basis point decrease in market interest rates with no effect given to any steps that we might take to counter the effect of that interest rate movement. Newport
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Bancorp measures interest rate risk by modeling the changes in net portfolio value over a variety of interest rate scenarios.
The following table presents the change in the net portfolio value at September 30, 2008 (the most current information available), that would occur in the event of an immediate change in interest rates based on Office of Thrift Supervision assumptions, with no effect given to any steps that we might take to counteract that change. The Bank expects that its net portfolio value at December 31, 2008 is consistent with the table below.
The Office of Thrift Supervision uses certain assumptions in assessing the interest rate risk of savings associations. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.
The Committee also measures and evaluates interest rate risk using income simulation analysis. This analysis considers the maturity and repricing characteristics of assets and liabilities, as well as the relative sensitivities of these balance sheet components over a range of interest rate scenarios. Interest rate scenarios tested generally include instantaneous rate shocks, rate ramps over a one-year period, and static (or flat) rates. The simulation analysis is used to measure the exposure of net interest income to changes in interest rates over a specified time horizon, usually a two-year period.
The table below sets forth, as of November 30, 2008, the estimated changes in Newport Bancorp’s net interest income that would result from the designated instantaneous changes in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. The Bank expects that its percentage change in estimated net interest income over the next 12 months and from months 13-24 at December 31, 2008 is consistent with the table below.
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As indicated in the table above, the result of an immediate 200 basis point parallel increase in interest rates is estimated to increase net interest income by 0.1% over a 12-month horizon, and decrease net interest income by 13.8% for months 13-24, when compared to the flat rate scenario, which assumes no increase in interest-bearing checking rates except for high balance interest bearing checking which increase 75 basis points (BP), an increase in savings rates of 50-75 (BP) and an increase in money market rates of 150 basis points. These assumptions are based on the Bank’s past experience with the changes in rates paid on these non-maturity deposits coincident with changes in market interest rates. The estimated change in net interest income from the flat rate scenario for a 100 basis point parallel decline in the level of interest rates is an increase of 0.6% over the 12 month horizon and a decrease of 5.5% for months 13-24, which assumes no decrease in interest-bearing checking rates, except for high balance accounts which decrease 30-50 BP, savings rates decreasing 20-33 BP and a decrease in money market rates of 100 basis points. These assumptions are based on the Bank’s past experience with the changes in rates paid on these non-maturity deposits coincident with changes in market interest rates.
There are inherent shortcomings in income simulation, given the number and variety of assumptions that must be made in performing the analysis. The assumptions relied upon in making these calculations of interest rate sensitivity include the level of market interest rates, the shape of the yield curve, the degree to which certain assets and liabilities with similar maturities or periods to repricing react to changes in market interest rates, the degree to which non-maturity deposits react to changes in market rates, the expected prepayment rates on loans and mortgage-backed securities, the degree to which early withdrawals occur on certificates of deposit and the volume of other deposit flows. As such, although the analysis shown above provides an indication of Newport Bancorp’s sensitivity to interest rate changes at a point in time, these estimates are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on Newport Bancorp’s net interest income and will differ from actual results.
The table below shows Newport Bancorp’s interest sensitivity gap position at December 31, 2008, indicating the amount of interest-earning assets and interest-bearing liabilities that are anticipated to mature or reprice in each of the future time periods shown. Generally, these assets and liabilities are shown in the table based on the earlier of the time remaining to repricing or contractual maturity. However, savings, money market deposit and interest bearing deposit accounts are assumed to have annual rates of withdrawal (decay rates) of 26%, 32% and 10%, respectively.
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Liquidity Management. Liquidity is the ability to meet current and future financial obligations of a short-term nature. The primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the Federal Home Loan Bank of Boston. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
The Bank regularly adjusts our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy.
The most liquid assets are cash and cash equivalents and interest-bearing deposits. The levels of these assets depend on the operating, financing, lending and investing activities during any given period. At December 31, 2008, cash and cash equivalents totaled $9.7 million. Securities classified as available for sale and whose market value exceeds their cost provide an additional source of liquidity. Securities classified as available for sale totaled $6.4 million at December 31, 2008. In addition, at December 31, 2008, we had the ability to borrow a total of approximately $28.9 million of additional advances from the Federal Home Loan Bank of Boston. On December 31, 2008, we had $105.4 million of advances outstanding.
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At December 31, 2008, the Bank had $36.3 million in loan commitments outstanding, which consisted of $8.9 million of real estate loan commitments, $14.9 million in unused home equity lines of credit, $9.0 million in construction loan commitments and $3.5 million in commercial lines of credit commitments. Certificates of deposit due within one year of December 31, 2008 totaled $66.8 million, or 91.2% of certificates of deposit. The large percentage of certificates of deposit that mature within one year reflects customer’s hesitancy to invest their funds for long periods in the recent low interest rate environment. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, Newport Federal may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before December 31, 2008. The Bank believes, however, based on past experience, that a significant portion of our certificates of deposit will remain with the Bank. Newport Federal has the ability to attract and retain deposits by adjusting the interest rates offered.
The Bank’s primary investing activities are the origination and purchase of loans and the purchase of securities. The primary financing activities consist of activity in deposit accounts and Federal Home Loan Bank advances. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by Newport Federal and our local competitors and other factors. The Bank generally manages the pricing of our deposits to be competitive. Occasionally, promotional rates are offered on certain deposit products to attract deposits.
Capital Resources. The Bank is subject to various regulatory capital requirements administered by the Office of Thrift Supervision, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2008, we exceeded all of our regulatory capital requirements. We are considered “well capitalized” under regulatory guidelines.
The initial public stock offering increased the Company’s equity by approximately $43.6 million, which significantly increased liquidity and capital resources. The financial condition and results of operations were enhanced by the capital from the offering, resulting in increased net interest-earning assets and net income. However, the large increase in equity resulting from the capital raised in the offering will, initially, have an adverse impact on our return on equity. The Company may use capital management tools such as cash dividends and common share repurchases. However, under Office of Thrift Supervision regulations, we are not allowed to repurchase any shares during the first year following our initial stock offering, except: (1) in extraordinary circumstances, we may make open market repurchases of up to 5% of our outstanding stock if we receive the prior non-objection of the OTS of such repurchases; (2) repurchases of qualifying shares of a director or if we conduct an OTS-approved offer to repurchase made to all shareholders; (3) if we repurchase to fund a restricted stock award plan that has been approved by shareholders; or (4) if we repurchase stock to fund a tax-qualified employee stock benefit plan. All repurchases are prohibited, however, if the repurchase would reduce Newport Federal’s regulatory capital below regulatory required levels.
Off-Balance Sheet Arrangements. In the normal course of operations, Newport Federal engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For information about the Company’s loan commitments and unused lines of credit, see Note 12 to the Consolidated Financial Statements included in this Annual Report.
For the year ended December 31, 2008, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
Effect of Inflation and Changing Prices
The financial statements and related financial data presented in this Form 10-K have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of
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money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated herein by reference to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, including supplemental data, of Newport Bancorp, Inc. begin on page of this Annual Report.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(T).
ITEM 9A(T).
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures.
The Company’s President and Chief Executive Officer, its Chief Financial Officer, and other members of its senior management team have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) or 15d-15(e)), as of December 31, 2008. Based on such evaluation, the President and Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures, as of the end of the period covered by this report, were adequate and effective to provide reasonable assurance that information required to be disclosed by the Company, including Newport Federal, in reports that are filed or submitted under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms.
Changes in Internal Controls Over Financial Reporting.
There have been no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting.
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008, utilizing the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2008 is effective.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets;
Index
and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America; (2) receipts and expenditures are being made only in accordance with authorizations of management and the 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 Company’s 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. 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.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information relating to the directors and officers of the Company, information regarding compliance with Section 16(a) of the Exchange Act and information regarding the audit committee and audit committee financial expert is incorporated herein by reference to the Company’s Proxy Statement for the 2009 Annual Meeting of Stockholders (the “Proxy Statement”).
The Company has adopted a code of ethics that applies to its principal executive officer, the principal financial officer and principal accounting officer. The Code of Ethics is posted on the Company’s Internet Web site at www.newportfederal.com.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information regarding executive compensation, compensation committee interlocks and insider participation is incorporated herein by reference to the Proxy Statement.
Index
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
(a)
Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.
(b)
Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.
(c)
Changes in Control
Management of the Company knows of no arrangements, including any pledge by any person or securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.
(d)
Equity Compensation Plan Information
The following table sets forth information as of December 31, 2008 about Company common stock that may be issued upon the exercise of options under the Newport Bancorp, Inc. 2007 Equity Incentive Plan. The plan was approved by the Company’s stockholders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information relating to certain relationships and related transactions and director independence is incorporated herein by reference to the Proxy Statement.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information relating to the principal accounting fees and expenses is incorporated herein by reference to the Proxy Statement.
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PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1)
The financial statements required in response to this item are incorporated by reference from Item 8 of this report.
(2)
All financial statement schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.
(3)
Exhibits
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______________________________
(1)
Incorporated by reference to the Company’s Registration Statement on Form S-1, as amended, initially filed with the SEC on March 20, 2006.
(2)
Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007.
(3)
Incorporated by reference to Exhibit 21.0 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
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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.
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.
Name
Title
Date
/s/ Kevin M. McCarthy
President, Chief Executive Officer,
March 27, 2009
Kevin M. McCarthy
and Director
(principal executive officer)
/s/ Bruce A. Walsh
Senior Vice President and Chief
March 27, 2009
Bruce A. Walsh
Financial Officer
(principal accounting and
financial officer)
/s/ John N. Conti
Director
March 27, 2009
John N. Conti
/s/ Peter T. Crowley
Director
March 27, 2009
Peter T. Crowley
/s/ William R. Harvey
Director
March 27, 2009
William R. Harvey
/s/ Michael J. Hayes
Director
March 27, 2009
Michael J. Hayes
/s/ Donald N. Kaull
Director
March 27, 2009
Donald N. Kaull
/s/ Arthur H. Lathrop
Director
March 27, 2009
Arthur H. Lathrop
/s/ Robert S. Lazar
Director
March 27, 2009
Robert S. Lazar
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/s/ Arthur P. Macauley
Director
March 27, 2009
Arthur P. Macauley
/s/ Nino Moscardi
Director
March 27, 2009
Nino Moscardi
/s/ Kathleen A. Nealon
Director
March 27, 2009
Kathleen A. Nealon
/s/ Michael S. Pinto
Director
March 27, 2009
Michael S. Pinto
/s/ Alicia S. Quirk
Director
March 27, 2009
Alicia S. Quirk
/s/ Peter W. Rector
Director
March 27, 2009
Peter W. Rector
/s/ Barbara Saccucci Radebach
Director
March 27, 2009
Barbara Saccucci Radebach
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NEWPORT BANCORP, INC.
CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Index
Report of Independent Registered Public Accounting Firm
The Board of Directors
Newport Bancorp, Inc.
Newport, Rhode Island
We have audited the accompanying consolidated balance sheets of Newport Bancorp, Inc. and subsidiary as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the 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 Newport Bancorp, Inc. and subsidiary as of December 31, 2008 and 2007, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
March 19,
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NEWPORT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2008 and 2007
(continued)
See accompanying notes to consolidated financial statements.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded)
Years Ended December 31, 2008 and 2007
See accompanying notes to consolidated financial statements.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008 and 2007
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Newport Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, Newport Federal Savings Bank (the “Bank”). The Bank has one wholly-owned subsidiary, Newport Federal Investments, Inc., which was established in December 2008 to hold certain investments, consisting primarily of commercial mortgages and loans. All significant intercompany balances and transactions have been eliminated in consolidation.
Nature of Operations
The Company provides a variety of financial services to individuals and small businesses through its offices in Newport and Washington County, Rhode Island. Its primary deposit products are savings, checking and term certificate accounts, and its primary lending products are residential and commercial mortgage loans.
Segment Reporting
Management evaluates the Company’s performance and allocates resources based on a single segment concept. Accordingly, there are no separately identified operating segments for which discrete financial information is available. The Company does not derive revenues from, or have assets located in, foreign countries, nor does it derive revenues from any single customer that represents 10% or more of the Company’s total revenues.
Use of Estimates
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan losses, other-than-temporary impairment of securities and the valuation of deferred tax assets.
Reclassification
Certain amounts in the 2007 consolidated financial statements have been reclassified to conform to the 2008 presentation.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Cash and Cash Equivalents
Cash and cash equivalents include cash and balances due from banks and short-term investments consisting of federal funds and interest-bearing deposits, all of which mature within ninety days.
Securities
Securities available for sale are carried at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of comprehensive income/loss. Securities held to maturity are reflected at amortized cost.
Purchase premiums and discounts are amortized to earnings by the interest method over the terms of the securities. Declines in the value of securities that are deemed to be other than temporary are reflected in earnings when identified. Gains and losses on disposition of securities are recorded on the trade date and are computed by the specific identification method.
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
Federal Home Loan Bank Stock
The Bank, as a member of the Federal Home Loan Bank (“FHLB”) system, is required to maintain an investment in capital stock of the FHLB. Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost. At its discretion, the FHLB may declare dividends on the stock. The Bank reviews for impairment based on the ultimate recoverability of the cost basis in the FHLB stock. As of December 31, 2008, no impairment has been recognized.
Loans
The Bank grants mortgage, commercial and consumer loans to customers and a substantial portion of the loan portfolio consists of mortgage loans in Newport and Washington County, Rhode Island. The ability of the Company’s debtors to honor their contracts is dependent upon the economy in general and the real estate and construction economic sectors.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Loans (concluded)
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method over the contractual terms of the loan.
The accrual of interest on mortgage loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of allocated and general loss components. For loans that are classified as impaired, an allowance is established when the collateral value of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for Loan Losses (concluded)
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan by loan basis by the fair value of the collateral.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Bank-owned Life Insurance
Bank-owned life insurance policies are reflected on the consolidated balance sheets at cash surrender value. Changes in cash surrender value are reflected in non-interest income on the consolidated statements of income.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation and amortization, computed on a straight-line method over the estimated useful lives of the assets or the expected terms of the leases, if shorter. Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured.
Marketing Costs
Marketing costs are expensed as incurred.
Pension Plan
It is the Company’s policy to fund pension costs in the year of accrual.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock Compensation Plans
The Company measures and recognizes compensation cost relating to stock-based compensation transactions based on the grant-date fair value of the equity instruments issued. Stock-based compensation is recognized over the period the employee is required to provide services for the award. The Company uses the Black-Scholes option-pricing model to determine the fair value of stock options granted.
Employee Stock Ownership Plan
Compensation expense for the Employee Stock Ownership Plan (“ESOP”) is recorded at an amount equal to the shares allocated by the ESOP multiplied by the average fair market value of the shares during the period. The Company recognizes compensation expense ratably over the year based upon the Company’s estimate of the number of shares expected to be allocated by the ESOP. Unearned compensation applicable to the ESOP is reflected as a reduction of stockholders’ equity in the consolidated balance sheet. The difference between the average fair market value and the cost of the shares allocated by the ESOP is recorded as an adjustment to additional paid-in capital.
Treasury Stock
Common stock shares repurchased are recorded as treasury stock at cost.
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted accordingly through the provision for income taxes. The Bank’s base amount of its federal income tax reserve for loan losses is a permanent difference for which there is no recognition of a deferred tax liability. However, the loan loss allowance maintained for financial reporting purposes is a temporary difference with allowable recognition of a related deferred tax asset, if it is deemed realizable.
A valuation allowance related to deferred tax assets is established when, in the judgment of management, it is more likely than not that all or a portion of such deferred tax assets will not be realized.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Earnings per Share
Basic earnings per share (“EPS”) excludes dilution and is calculated by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted EPS reflects additional common shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents (stock options and unvested restricted stock) were issued during the period. Common stock equivalents of 594,006 and 633,033 that could potentially dilute basic EPS in the future were not included in the computation of diluted EPS because they were anti-dilutive for the years ended December 31, 2008 and 2007, respectively. Treasury shares and unallocated ESOP shares are not deemed outstanding for earnings per share calculations.
Comprehensive Income/Loss
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the retained earnings section of the balance sheet, such items, along with net income, are components of comprehensive income/loss. There is no tax benefit available on the unrealized losses on the securities available for sale as the losses represent capital losses for which the Company has no capital gain history to offset such losses.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, “Fair Value Measurements.” This Statement defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. Emphasis is placed on fair value being a market-based measurement, not an entity-specific measurement, and therefore a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering these market participant assumptions, a fair value hierarchy has been established to distinguish between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Recent Accounting Pronouncements (continued)
In February 2008, the FASB issued a Staff Position which delays the effective date of Statement No. 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis, to fiscal years beginning after November 15, 2008. The Company adopted this Statement, except for items covered by the Staff Position, as of January 1, 2008 and the adoption did not have a material impact on the consolidated financial statements. See Note 13.
In October 2008, the FASB issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”). FSP 157-3 clarifies the application of Statement No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP 157-3 was effective immediately upon issuance, and includes prior periods for which financial statements have not been issued. FSP 157-3 did not have an impact on the consolidated financial statements.
In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115.” This Statement permits entities to choose to measure many financial instruments and certain other items at fair value, with the objective of improving financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions, and is expected to expand the use of fair value measurement. An entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may generally be applied instrument by instrument and is irrevocable. This Statement was adopted by the Company on January 1, 2008 and did not have an impact on the Company’s consolidated financial statements.
Effective January 1, 2008, the Company adopted Emerging Issues Task Force (“EITF”) Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”, which addresses accounting for split-dollar life insurance arrangements whereby the employer purchases a policy to insure the life of an employee, and separately enters into an agreement to split the policy benefits between the employer and the employee. This EITF states that an obligation arises as a result of a substantive agreement with an employee to provide future postretirement benefits. Under EITF 06-4, the obligation is not settled upon entering into an insurance arrangement. Since the obligation is not settled, a liability should be recognized in accordance with applicable authoritative guidance. The result of adopting this EITF on January 1, 2008 was a decrease to retained earnings in the amount of $62,000.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Recent Accounting Pronouncements (concluded)
In December 2007, the FASB issued Statement No. 141 (revised), “Business Combinations”, which replaces FASB Statement No. 141, and applies to all business entities, including mutual entities that previously used the pooling-of-interests method of accounting for certain business combinations. This Statement makes significant amendments to other Statements and other authoritative guidance, and applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. This Statement is not expected to have a material impact on the Company’s consolidated financial statements.
In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”, which changes the disclosure requirements for derivative instruments and hedging activities. This Statement is intended to enhance the current disclosure framework in Statement 133. The Statement requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. This Statement is effective for the Company’s consolidated financial statements issued for fiscal years and interim periods beginning on January 1, 2009 and is not expected to have a material impact on the Company’s consolidated financial statements.
2.
RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS
The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2008 and 2007, these reserve balances amounted to $5,451,000 and $2,904,000, respectively.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3.
SECURITIES
The amortized cost and estimated fair value of securities, with gross unrealized gains and losses, follows:
Mortgage-backed securities consist primarily of participation certificates guaranteed by the Federal National Mortgage Association.
At December 31, 2008 and 2007, mortgage-backed securities were pledged to secure repurchase agreements (see Note 7).
There were no sales of securities for the years ended December 31, 2008 and 2007.
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NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (continued)
Information pertaining to securities with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
At December 31, 2008, two mutual funds have unrealized losses with aggregate depreciation of 5.6% from the Company’s cost basis. Neither of the funds have reduced or eliminated their dividend payments. The Company has determined that these unrealized losses relate primarily to illiquidity in the market for the securities underlying these funds and not to credit issues. The Company has the intent and ability to hold the securities for a period of time sufficient to allow for an anticipated recovery of the fair value. The effective duration of these funds range from 1.5 years to 2.7 years. The Company has reviewed the financial condition of the issuers and has determined that none of the declines are other than temporary.
At December 31, 2008, one mortgage-backed security is in an unrealized loss position which relates primarily to changes in interest rates and as the Company has the intent and ability to hold this security until maturity, the decline is deemed not to be other than temporary.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (concluded)
At December 31, 2008, the Company recognized a $706,000 impairment charge for the Bank’s holding in the AMF Ultra Short Mortgage Fund. This fund has invested in private-label mortgage-backed securities and U.S. Government agency and government-sponsored enterprise securities. Although management believes it is possible that all principal and interest payments will be received, general market concerns over these and similar types of securities has caused the fair value to decline severely enough to warrant an other-than-temporary impairment charge. Given the significant uncertainty and illiquidity in the markets for such securities, the Bank cannot be certain that future impairment charges will not be required against this investment, which had a remaining book value of $2.0 million at December 31, 2008 (net of impairment charges).
In February 2008, the redemption-in-kind provisions of two of the Company’s mutual fund investments, with an aggregate carrying value of $4,074,000 at December 31, 2008, were activated as a result of current market conditions. In addition, cash redemptions for these funds have been restricted to $250,000 over any ninety day period. Redemptions in excess of this amount may be done in-kind. Management does not intend to redeem these funds.
4.
LOANS
A summary of the balances of loans follows:
Loans sold and serviced for others amounted to $13,775,000 and $15,231,000 at December 31, 2008 and 2007, respectively, which are primarily sold without recourse.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
LOANS (concluded)
An analysis of the allowance for loan losses follows:
There were no non-accrual or impaired loans at December 31, 2008. At December 31, 2007, non-accrual and impaired loans amounted to $908,000, with no related valuation allowance. There were no additional funds committed to be advanced in connection with impaired loans. For the years ended December 31, 2008 and 2007, the average recorded investment in impaired loans amounted to $378,000 and $326,000, respectively. There was $19,000 of interest income recognized on impaired loans during 2008, on the cash basis. The Bank recognized no interest income on impaired loans during 2007. At December 31, 2008 and 2007, there were no loans greater than ninety days past due and still accruing interest.
5.
PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation and amortization and estimated useful lives of premises and equipment follows:
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
PREMISES AND EQUIPMENT (concluded)
Depreciation and amortization expense for each of the years ended December 31, 2008 and 2007 amounted to $608,000 and $619,000, respectively.
Construction in progress primarily represents costs incurred to date in connection with proposed new branches in Portsmouth, RI, and Stonington, CT, and renovations to the main office in Newport, RI. At December 31, 2008, total commitments related to the construction in progress total $5,085,000. The Portsmouth, RI branch was completed in January 2009 at a total cost of $7,760,000.
6.
DEPOSITS
A summary of deposit balances, by type, is as follows:
The aggregate amount of time deposit accounts with balances over $100,000 amounted to $21,966,000 and $23,916,000 at December 31, 2008 and 2007, respectively.
A summary of certificate accounts is as follows:
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7.
BORROWINGS
Short-term Borrowings
Short-term borrowings consist of Federal Home Loan Bank of Boston (“FHLB”) advances, which mature within one year at a weighted average rate of 0.46% and 4.41% at December 31, 2008 and 2007, respectively.
The Bank also has an available line of credit with the FHLB at an interest rate that adjusts daily. Borrowings under the line are limited to 2% of the Bank’s total assets. At December 31, 2008 and 2007, this line of credit amounted to $3,000,000. There were no amounts outstanding at December 31, 2008. At December 31, 2007, $1,809,000 was outstanding and is included in short-term borrowings.
Long-term Borrowings
FHLB Advances
Long-term borrowings include the following FHLB advances:
*
Includes advances callable within one year aggregating $36,500,000 with a weighted average rate of 3.47% at December 31, 2008.
All FHLB borrowings are secured by a blanket lien on certain qualified collateral, defined principally as 75% of the carrying value of first mortgage loans on owner-occupied residential property, 50% of the carrying value of certain pledged commercial mortgages and 65% of the carrying value of certain pledged multi-family real estate loans. At December 31, 2008 and 2007, the carrying amount of assets qualifying as collateral for FHLB advances amounted to $194,185,000 and $143,520,000, respectively.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
BORROWINGS (concluded)
Long-term Borrowings (concluded)
Repurchase Agreements
During 2008, the Company entered into a repurchase agreement for $15,000,000 at a rate of 2.58%. This agreement matures on November 21, 2013, and is callable on November 21, 2010 and each quarter thereafter.
During 2007, the Company entered into a repurchase agreement for $25,000,000 at a rate of 3.36%, subject to adjustment if 3-month LIBOR exceeds 5.05%. On November 29, 2009 the rate becomes fixed at 3.36%. This agreement matures on November 29, 2012, and is callable on November 29, 2009 and each quarter thereafter.
The amount of securities collateralizing these agreements to repurchase remains in securities and the obligation to repurchase securities sold is reflected as a liability in the consolidated balance sheets. Mortgage-backed securities pledged to secure these agreements have a carrying value of $52,121,000 and $29,804,000 and a fair value of $54,154,000 and $29,124,000 at December 31, 2008 and 2007, respectively.
8.
INCOME TAXES
Allocation of federal and state income taxes between current and deferred portions is as follows:
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (continued)
The reasons for the differences between the statutory federal income tax provision and the actual income tax provision are summarized as follows:
The components of the net deferred tax asset are as follows:
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (concluded)
The tax effects of each item that gives rise to deferred taxes are as follows:
At December 31, 2008, the Company has a charitable contribution carryforward in the amount of $2,935,000, which will expire in 2011, if not fully utilized. The Company reduces deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company assesses the realizability of its deferred tax assets by (1) reviewing taxable income in allowable federal carry-back periods, and (2) assessing the likelihood of the Company generating federal and state taxable income, as applicable, in future periods in amounts sufficient to offset the deferred tax charges in the periods they are expected to reverse. Based on this assessment, management concluded that a valuation allowance of $742,000 and $492,000 was required for the years ended December 31, 2008 and 2007, respectively, due to the possible limitation of the charitable contribution deduction.
In addition, as a result of an impairment loss recognized during 2008 and no history of capital gains, an additional valuation reserve of $240,000 was established.
The federal income tax reserve for loan losses at the Bank’s base year amounted to $1,032,000. If any portion of the reserve is used for purposes other than to absorb loan losses, approximately 150% of the amount actually used, limited to the amount of the reserve, would be subject to taxation in the year in which used. As the Bank intends to use the reserve only to absorb loan losses, a deferred income tax liability of $412,000 has not been provided.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9.
STOCKHOLDERS’ EQUITY
Minimum Regulatory Capital Requirement
The Bank is subject to various regulatory capital requirements administered by the Office of Thrift Supervision. 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 Bank’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of 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. Federal Savings and Loan Holding Companies are not subject to any regulatory capital requirements by the Office of Thrift Supervision.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Tier 1 and tangible capital (as defined) to adjusted total assets (as defined) and of total and Tier 1 capital to risk-weighted assets (as defined). Management believes, as of December 31, 2008 and 2007, that the Bank met all capital adequacy requirements to which it was subject.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS’ EQUITY (continued)
Minimum Regulatory Capital Requirement (concluded)
As of December 31, 2008, the most recent notification from the Office of Thrift Supervision 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, Tier 1 leverage and tangible ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s category. The Bank’s actual capital amounts and ratios as of December 31, 2008 and 2007 are also presented in the table.
Other Capital Restrictions
Federal banking regulations place certain restrictions on dividends paid, stock repurchases and other transactions charged to the capital accounts of the Bank. Capital distributions in the form of dividends paid to the Bank’s stockholder for any one year may not exceed the Bank’s net income for the year to date plus the Bank’s retained earnings for the preceding two years, without regulatory approval. Loans or advances are limited to 10 percent of the Bank’s capital stock and surplus on a secured basis.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS’ EQUITY (concluded)
Other Capital Restrictions (concluded)
At December 31, 2008 and 2007, the Bank’s retained net income available for the payment of dividends was $1,354,000 and $2,039,000, respectively. Accordingly, $36,911,000 and $36,774,000 of the Company’s equity in the net assets of the Bank was restricted at December 31, 2008 and 2007, respectively. At December 31, 2008 and 2007, funds available for loans or advances by the Bank to the Company amounted to $1,947,000 and $2,022,000, respectively. In addition, dividends paid would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements.
Liquidation Account
As part of the Conversion, the Bank established a liquidation account which was equal to the net worth of the Bank as of the date of the latest consolidated balance sheet appearing in the final prospectus distributed in connection with the Conversion. The liquidation account will be maintained for the benefit of eligible account holders and supplemental eligible account holders who maintain their accounts at the Bank after the Conversion. The liquidation account will be reduced annually to the extent that such account holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases will not restore an account holder’s interest in the liquidation account. In the event of a complete liquidation, each eligible account holder will be entitled to receive balances for accounts then held. At December 31, 2008, the balance remaining in the liquidation account amounted to $11,588,000.
Share Repurchase Plan
In 2007, the Board of Directors approved a stock repurchase program to acquire up to 243,917 shares, or 5%, of its outstanding common stock. This repurchase program was completed on January 31, 2008. In addition, in February 2008, the Board of Directors approved a second stock repurchase program to acquire up to 5% of the Company’s outstanding common stock. This stock repurchase program was completed in July 2008 upon acquiring 231,721 shares at an average cost of $12.45 per share. In July 2008, the Board of Directors approved a third stock repurchase program to acquire up to 440,270 shares, or 10%, of its outstanding common stock. As of December 31, 2008, 214,900 shares have been purchased under this program at an average cost of $11.56, leaving 225,370 shares available for possible future repurchases. Repurchases, which will be conducted through open market purchases or privately negotiated transactions, will be made from time to time depending on market conditions and other factors.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10.
EMPLOYEE BENEFIT PLANS
Defined Benefit Plan
The Bank is a participant in the defined benefit plan of the Financial Institutions Retirement Fund. The Plan is a multi-employer plan whereas the contributions by each bank are not restricted to provide benefits to the employees of the contributing bank. Each employee reaching the age of 21 and having completed at least 1,000 hours of service in one consecutive twelve-month period, beginning with such employee’s date of employment, automatically becomes a participant in the Plan. Participants become vested after completion of five years of service measured from their date of hire. Pension expense under this Plan amounted to $296,000 and $318,000 for the years ended December 31, 2008 and 2007, respectively.
401(k) Plan
The Bank offers a 401(k) plan for eligible employees that provides for voluntary contributions by participating employees up to fifty percent of their annual compensation subject to certain limits based on federal tax laws. Each employee reaching the age of 21 and having completed at least 500 hours of service in one six-month period beginning with such employee’s date of employment, or anniversary thereof, becomes eligible to be a participant in the plan. The Bank matches the employees’ voluntary contribution up to 3% of their compensation and will match one-half of the next 2%. The Bank’s total contribution for the years ended December 31, 2008 and 2007 amounted to $206,000 and $222,000, respectively.
Incentive Plan
The Company has an Incentive Plan (the “Plan”) whereby officers and employees are eligible to receive cash bonuses based upon Company performance against annual established performance targets, including financial measures and other factors, including individual performance. The structure of the Plan is to be reviewed on an annual basis by the Board of Directors and individual awards are adjusted based on recommendations from the Compensation Committee. Incentive compensation expense for the years ended December 31, 2008 and 2007 amounted to $211,000 and $322,000, respectively.
Supplemental Executive and Director Retirement Plans
The Bank has a Supplemental Executive Retirement Plan, which provides for certain executives of the Bank to receive monthly benefits upon retirement, subject to certain limitations as set forth in the Plan. The present value of these future benefits is accrued over the executive’s term of service, taking into consideration vesting provisions in these agreements. The related expense for the years ended December 31, 2008 and 2007 amounted to $168,000 and $180,000, respectively.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (continued)
Supplemental Executive and Director Retirement Plans (concluded)
In addition, the Bank has a Supplemental Director Retirement Plan, which provides for certain directors to receive annual benefits upon retirement, subject to certain limitations set forth in the Plan. The present value of these benefits is accrued over the directors’ required service periods, and the expense for the years ended December 31, 2008 and 2007 amounted to $41,000 and $45,000, respectively.
The accrued liability for these Plans is included in accrued expenses and other liabilities on the consolidated balance sheets and amounted to $822,000 and $613,000 at December 31, 2008 and 2007, respectively.
Endorsement Split-Dollar Life Insurance Arrangements
The Company is the sole owner of life insurance policies pertaining to certain executives and directors of the Company. The Company has entered into agreements with these executives whereby the Company will pay to the executives’ estates or beneficiaries a portion of the death benefit that the Company will receive as beneficiary of such policies. Prior to January 1, 2008, no liability had been recognized on the consolidated balance sheet for such death benefits. On January 1, 2008, the Company adopted EITF 06-4 (see Note 1). As a result, the Company recognized a liability for future death benefits in the amount of $62,000 by cumulatively adjusting retained earnings as of January 1, 2008 and recognized related expense of $31,000 for the year ended December 31, 2008.
Employee Stock Ownership Plan
The Company maintains an Employee Stock Ownership Plan (“ESOP”) to provide eligible employees the opportunity to own Company stock. The Company provided a loan to the Newport Federal Savings Bank Employee Stock Ownership Trust of $3,903,000, which was used to purchase 390,268 shares of the Company’s common stock at a price of $10.00 per share. The loan bears interest equal to 8.25% and provides for annual payments of interest and principal over the 15-year term of the loan.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (continued)
Employee Stock Ownership Plan (continued)
At December 31, 2008, the remaining principal balance on the ESOP debt is payable as follows:
The Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased, which are held in a suspense account until released for allocation to participants, as principal and interest payments are made by the ESOP to the Company.
Shares released are allocated to each eligible participant based on the ratio of each such participant’s compensation, as defined in the ESOP, to the total compensation of all eligible plan participants. Cash dividends paid on allocated shares will be distributed, at the direction of the Bank, to participants’ accounts or used to repay the principal and interest on the ESOP loan used to acquire Company stock on which dividends were paid. Cash dividends on unallocated shares will be used to repay the outstanding debt of the ESOP.
Shares held by the ESOP include the following:
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (continued)
Employee Stock Ownership Plan (concluded)
The fair value of unallocated ESOP shares was $3,587,000 and $3,991,000 at December 31, 2008 and 2007, respectively.
As ESOP shares are earned by the participants, the Company recognizes compensation expense equal to the fair value of the earned ESOP shares during the periods in which they become committed to be released. Total compensation expense recognized in connection with the ESOP was $309,000 and $340,000 for the years ended December 31, 2008 and 2007, respectively.
Stock Compensation Plans
In accordance with the Company’s 2007 Equity Incentive Plan (the “2007 Plan”), the Company awarded 437,900 stock options and 195,133 shares of restricted stock to eligible participants on October 1, 2007. The 2007 Plan provides for total awards of 487,834 stock options and 195,133 shares of restricted stock, leaving 49,934 stock options available for future awards. The shares of common stock underlying any awards that are forfeited, cancelled or otherwise terminated (other than by exercise), shares that are tendered or withheld in payment of the exercise price of any award, and shares that are tendered or withheld for tax withholding obligations will be added back to the shares of common stock with respect to which new awards may be granted under the plan. The exercise price of options granted under the plan is equal to the market value of the underlying common stock on the date of grant. Stock options and restricted stock granted under the 2007 Plan vest over five years and options expire no later than ten years from the date of grant. Upon a change in control (as defined in the plan) or the death or disability of the individual to whom options or shares were awarded, all options and restricted shares awarded immediately vest.
The fair value of the stock options granted in 2007 were estimated on the date of grant using a Black-Scholes option valuation model with the following weighted-average assumptions:
There were no stock options granted during 2008.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (continued)
Stock Compensation Plans (continued)
The expected volatility was determined based on the review of the experience of peer companies who are similar in size. The volatility is calculated over the expected term of the grant. The expected term is determined using the average of the mathematical mean of the vesting period and the full term of the option rather than estimating based on historical experience. The risk-free interest rate for a period equal to the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.
The following table presents the activity for the 2007 Plan as of and for the year ended December 31, 2008:
The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $11.49 as of December 31, 2008 which would have been received by the option holders had all option holders exercised their options as of that date. There were no in-the-money options exercisable as of December 31, 2008, therefore the options have no intrinsic value. The weighted-average grant-date fair values of options granted during the year ended December 31, 2007 was $4.82.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EMPLOYEE BENEFIT PLANS (concluded)
Stock Compensation Plans (concluded)
For the years ended December 31, 2008 and 2007, the Company recognized compensation cost for stock options of $858,000 and $241,000, respectively, with a related tax benefit of $82,000 and $27,000, respectively. For the years ended December 31, 2008 and 2007, the Company recognized compensation cost for restricted stock awards of $994,000 and $279,000, respectively, with a related tax benefit of $338,000 and $111,000, respectively. The Company is employing an accelerated method of expense recognition for options and restricted stock awards. The estimated amount and timing of future compensation cost (pre-tax) to be recognized for awards to date under the plan is as follows:
11. OTHER COMMITMENTS AND CONTINGENCIES
In the normal course of business there are outstanding commitments and contingencies which are not reflected in the accompanying financial statements.
Loan Commitments
The Bank 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. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying balance sheets.
The Bank’s exposure to credit loss is represented by the contractual amount of these commitments. The Bank uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
OTHER COMMITMENTS AND CONTINGENCIES (continued)
Loan Commitments (concluded)
At December 31, 2008 and 2007, the following financial instruments were outstanding whose contract amounts represent credit risk:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit worthiness on a case-by-case basis and the commitments are collateralized by real estate.
Operating Lease Commitments
Pursuant to the terms of noncancelable lease agreements in effect pertaining to banking premises, future minimum rent commitments are as follows:
The leases contain options to extend for periods from five to fifty years. The cost of such rentals is not included above. Total rent expense for the years ended December 31, 2008 and 2007 amounted to $104,000 and $97,000, respectively.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
OTHER COMMITMENTS AND CONTINGENCIES (concluded)
Employment and Change in Control Agreements
The Company and the Bank have entered into employment agreements with certain executive officers which provide for a specific salary and continuation of benefits in the event the executive is terminated without cause. However, such employment may be terminated for cause, as defined, without incurring any continuing obligations. The agreements also provide for a lump sum severance payment, subject to certain conditions, following a “change in control” as defined in the agreement. In addition, the Bank has entered into change in control agreements with certain other executive officers which provide for a lump sum severance payment, subject to certain conditions.
Other Contingencies
Various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company’s financial position.
12.
RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to its directors and officers and affiliates. Activity is as follows:
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with FASB Statement No. 157, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
Fair Value Hierarchy
In accordance with Statement No. 157, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 - Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. For example, Level 2 assets and liabilities may include debt securities with quoted prices that are traded less frequently than exchange-traded instruments or mortgage loans held for sale, for which the fair value is based on what the securitization market is currently offering for mortgage loans with similar characteristics.
Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain asset-backed securities, certain private equity investments, residential mortgage servicing rights, and long-term derivative contracts.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
Fair Value Hierarchy (continued)
The following methods and assumptions were used by the Company in estimating fair value disclosures:
Cash and cash equivalents: The carrying amounts of cash and cash equivalents approximate fair values.
Securities available for sale: Fair values are based on the net asset values (“NAV”) of the mutual funds. The NAV is determined based on the fair values of the individual securities within the fund divided by the number of shares outstanding. The funds’ debt securities are valued at market quotations obtained from independent pricing services, or, for certain securities, a fixed income pricing methodology using factors such as 1) information obtained with respect to market transactions in such securities or comparable securities; (2) the price and extent of public trading in similar securities of the issuer or comparable securities; (3) the fundamental analytical data relating to the investment and; (4) quotations from broker/dealers, yields, maturities, ratings and various relationships between securities. The valuation process also takes into consideration factors such as interest rate changes, movements in credit spreads, default rate assumptions, prepayment assumptions, type and quality of collateral, and security seasoning.
Securities held to maturity: Fair values are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.
FHLB stock: The carrying value of FHLB stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank of Boston.
Loans: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms, adjusted for credit risk.
Accrued interest: The carrying amounts of accrued interest approximate fair values.
Deposits: The fair values for non-certificate accounts are, by definition, equal to the amount payable on demand at the reporting date which is the carrying amount. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
Fair Value Hierarchy (concluded)
Short-term borrowings: The carrying amounts of short-term borrowings approximate fair value.
Long-term borrowings: Fair values of long-term debt are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.
Off-balance-sheet instruments: Fair values for off-balance-sheet lending com-mitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The estimated fair values of off-balance-sheet instruments are immaterial.
Assets Measured at Fair Value on a Recurring Basis
Assets measured at fair value on a recurring basis are summarized below:
The Company’s assets measured at fair value are grouped in the Level 2 category because the valuation technique used is based on the net asset values of the funds which use observable inputs that can be corroborated by observable market data for substantially the full term of the assets.
The Company does not measure any liabilities at fair value on a recurring basis and does not measure any assets or liabilities at fair value on a non-recurring basis.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)
Summary of Fair Value of Financial Instruments
As required under FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments,” the estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14.
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial information pertaining only to Newport Bancorp, Inc. is as follows:
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (Concluded)
Index
NEWPORT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
15.
QUARTERLY DATA (UNAUDITED)
(1)
The increase in the fourth quarter of 2008 is due to a $250,000 increase in the valuation reserve against deferred tax assets for a change in projected profitability and a $300,000 write-down of the net deferred state tax asset in connection with the formation of a passive investment company subsidiary.