UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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F O R M 10 - KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the Fiscal Year Ended December 31, 2003.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to ____________________
Commission file number 333-59824
SOUTHERN CONNECTICUT BANCORP, INC.
(Name of Small Business Issuer in Its Charter)
Connecticut 06-1594123
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
215 Church Street
New Haven, Connecticut 06510
(Address of Principal Executive Offices) (Zip Code)
Issuer's telephone number (203) 782-1100
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $.01 per share
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes __X__ No _____
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
State issuer's revenue for its most recent fiscal year: $3,008,418
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Aggregate market value of the voting stock held by nonaffiliates (assumes
directors and executive officers are nonaffiliates) of the registrant as of
February 27, 2004: $8,338,700
1
Number of shares of the registrant's Common Stock, par value $.01 per share,
outstanding as of February 27, 2004: 1,063,320
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for 2004 Annual Meeting of Incorporated into Part III
Shareholders. (A of this Form 10-KSB
definitive proxy statement will be filed
with the Securities and Exchange Commission
within 120 days after the close of the
fiscal year covered by this Form 10-KSB.)
Transitional Small Business Disclosure Format (check one):
Yes _____; No__X__
2
Table of Contents
Part I Page
Item 1. Description of Business 4
Item 2. Description of Property 13
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 15
Part II
Item 5. Market for Common Equity, Related Shareholder Matters, and Small 15
Business Issuer Purchases of Equity Securities
Item 6. Management's Discussion and Analysis or Plan of Operation 17
Item 7. Financial Statements 27
Item 8. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 27
Item 8a.Controls and Procedures 27
Part III
Item 9. Directors and Executive Officers of the Registrant 27
Item 10. Executive Compensation 28
Item 11. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 28
Item 12. Certain Relationships and Related Transactions 28
Item 13. Exhibits, Lists, and Reports on Form 8 - K 28
Item 14. Principal Accountants Fees and Services 30
Exhibit Index 32
3
PART I
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Item 1. Description of Business.
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Southern Connecticut Bancorp, Inc. ("Bancorp"), a Connecticut
corporation, was incorporated on November 8, 2000 to serve as a bank holding
company. Bancorp owns one hundred percent of the capital stock of The Bank of
Southern Connecticut (the "Bank"), a state chartered bank in New Haven,
Connecticut, which commenced operations on October 1, 2001 after receiving its
Final Certificate of Authority from the Connecticut Banking Commissioner and its
deposit insurance from the Federal Deposit Insurance Corporation ("FDIC").
Bancorp invested $10,000,000 of the net proceeds of its July 26, 2001 stock
offering to purchase the capital stock of the Bank and an additional $360,000 to
cover the Bank's pre-opening deficit. The $10,000,000 of initial equity capital
for the Bank required under The Bank of Southern Connecticut's Temporary
Certificate of Authority substantially exceeded the statutory minimum equity
capital for a new Connecticut bank of $5,000,000. Bancorp chose a holding
company structure because it provides flexibility that would not otherwise be
available. For example, Bancorp could acquire additional banks, establish de
novo banks and other businesses, including mortgage companies, leasing
companies, insurance agencies and small business investment companies. Bancorp
may in the future decide to engage in additional businesses permitted to bank
holding companies or financial holding companies. Before Bancorp could acquire
interests in other banks, establish de novo banks or expand into other
businesses, it may need to obtain regulatory approvals and might need additional
capital.
Bancorp has leased a free-standing building located at 215 Church
Street, New Haven, Connecticut, located in the central business and financial
district of New Haven. It has assigned this lease to The Bank of Southern
Connecticut, and the Bank has assumed all rights and obligations under this
lease. Both Bancorp and the Bank operate from this facility. On October 7, 2002
the Bank opened a branch office in Branford, Connecticut at West Main Street and
Summit Place. On August 15, 2002 the Bank also purchased a building at 1475
Whalley Avenue in the Westville section of New Haven for a new branch office
site which was opened March 24, 2003.
The following table sets forth the location of the Bank's branch
offices and other related information:
Office Location Status
------ -------- ------
Main Office 215 Church Street, New Haven, Connecticut Leased
Branford Office 445 West Main Street, Branford, Connecticut Leased
Amity Office 1475 Whalley Avenue, New Haven, Connecticut Owned
Bancorp has submitted an application to the Department of Banking of
the State of Connecticut to charter a bank to be located in New London,
Connecticut. The application is pending with the Department of Banking and a
decision is anticipated in the second quarter of 2004. Presuming approval by the
Department of Banking, Bancorp will proceed to file an application with the
Federal Deposit Insurance Corporation for deposit insurance approval and an
application with the Federal Reserve Bank of Boston for approval to acquire the
new state chartered bank. The New London based bank will be named The Bank of
Southeastern Connecticut and will be operated similarly to The Bank of Southern
Connecticut. Bancorp will provide certain management and operations support and
services to the two banks as well as certain infrastructure. Bancorp will seek
to raise additional capital in order to capitalize the new bank as well as for
other purposes. (See further discussion below and in Liquidity)
4
Bancorp entered into a lease on January 14, 2004 with the City of New
London for a facility located at 15 Mason Street, New London, Connecticut. This
facility is intended to be the main office of the proposed wholly owned state
chartered subsidiary bank to be named The Bank of Southeastern Connecticut. (See
Description of Property)
Bancorp anticipates, subject to regulatory approval of the proposed
bank, improving the leased building and purchasing furniture and equipment for
the proposed Bank of Southeastern Connecticut, which is expected to commence
operations in the fourth quarter of 2004 (See Description of Property).
Currently, there are no plans involving the significant purchase or sale of
property or equipment in the next twelve months. Bancorp intends to recruit a
majority of Directors, as well as the executive management and employees of The
Bank of Southeastern Connecticut from within the New London market area. Outside
of staffing the new bank, Bancorp does not anticipate a significant change in
the number of its employees.
Bancorp will seek to raise $10 to $15 million in new capital of which
approximately $6 million will be used to fund the start up of the new bank.
Bancorp expects the new bank to be operating by the end of 2004. The balance
will be retained by Bancorp for other business purposes including the likely
contribution of additional capital to The Bank of Southern Connecticut.
On November 17, 2003, SCB Capital, Inc., a wholly-owned subsidiary of
Bancorp, was incorporated. SCB Capital, Inc. will engage in a limited range of
investment banking, advisory and financial brokerage services primarily to small
to medium size business clients of Bancorp and the general public located in
Connecticut. SCB Capital, Inc. is in the process of applying for approval as and
membership with the National Association of Security Dealers as a broker-dealer.
SCB Capital, Inc. has not been capitalized nor has it commenced operations. The
amount to be invested in SCB Capital, Inc. will be determined by Bancorp's Board
of Directors following completion of the application process.
Bancorp's current and proposed bank subsidiaries are not expected to
compete with large institutions for the primary banking relationships of large
corporations, but to compete for niches in this business segment and for the
consumer business of employees of such entities. The Bank of Southern
Connecticut focuses on small to medium-sized businesses, professionals and
individuals and their employees. This focus includes retail, service, wholesale
distribution, manufacturing and international businesses. The Bank of Southern
Connecticut attracts these customers based on relationships and contacts which
the Bank's directors and management have within and beyond its primary service
area. It is anticipated that the proposed The Bank of Southeastern Connecticut
will pursue a similar strategy in the greater New London market. The strategy
includes, among other factors, substantial local bank board representation,
local credit decision authority, focus on the local business community, personal
service, and support of community interests. Additional employees will be
recruited to staff the new bank.
Greater New Haven, where The Bank of Southern Connecticut is located,
is currently served by approximately 70 offices of commercial banks, none of
which are headquartered in New Haven. In addition, New Haven Savings Bank, a
mutual savings bank, has 16 branches in the New Haven market. All of these banks
are substantially larger than The Bank of Southern Connecticut expects to be in
the near future and are able to offer products and services which may be
impracticable to provide at this time. The New Haven Savings Bank has approval
to convert to a stock state chartered savings bank charter and to acquire two
other bank holding companies located in the state of Connecticut during 2004.
There are numerous banks and other financial institutions serving the
communities surrounding New Haven which also draw customers from New Haven,
posing significant competition to attract deposits and loans. The Bank of
Southern Connecticut also experiences competition from out-of-state financial
institutions. The Bank will have to continue to obtain customers from the
customer base of such existing banks and financial institutions and from growth
in New Haven and the surrounding area. Many of such banks and financial
5
institutions are well established and well capitalized, allowing them to provide
a greater range of services (including trust services) than the Bank will be
able to offer in the near future.
Intense market demands, economic pressures and significant legislative
and regulatory actions have eroded banking industry classifications which were
once clearly defined and have increased competition among banks and other
financial institutions. Market dynamics and legislative and regulatory changes
impacting banks and other financial institutions have resulted in a number of
new competitors offering services historically offered only by commercial banks;
non-bank corporations offering services traditionally offered only by banks;
increased customer awareness of product and service differences among
competitors; and increased merger activity.
Additional legislative and regulatory changes may affect The Bank of
Southern Connecticut in the future; however, the nature of such changes and the
effect of their implementation cannot be assessed. New rules and regulations
may, among other things, revise limits on interest rates on various categories
of deposits and may limit or influence interest rates on loans. Monetary and
fiscal policies of the United States government and its instrumentalities,
including the Federal Reserve, significantly influence the growth of loans,
investments and deposits. The present bank regulatory scheme is undergoing
significant change both as it affects the banking industry itself and as it
affects competition between banks and non-bank financial institutions.
The Bank of Southern Connecticut currently offers products and services
described as "core" products and services which are more completely described
below. Through correspondent and other relationships, it is expected that the
Bank will be able to help our customers meet all of their banking needs,
including obtaining services which The Bank of Southern Connecticut may not
offer directly.
The Bank of Southern Connecticut continues to attract a sound base of
core deposits, including checking accounts, money market accounts, savings
accounts, sweep accounts, NOW accounts and a variety of certificates of deposits
and IRA accounts. To attract deposits, The Bank of Southern Connecticut is
employing an aggressive marketing plan in its service area and features a broad
product line and rates and services competitive with those offered in the New
Haven market. The primary sources of deposits have been and are expected to be,
residents of, and businesses and their employees located in, New Haven and the
surrounding communities. The Bank is obtaining these deposits through personal
solicitation by its officers and directors, outside programs and advertisements
published and / or broadcasted in the local media.
Deposits and The Bank of Southern Connecticut's equity capital are the
sources of funds for lending and investment activities. Repayments on loans,
investment income and proceeds from the sale and maturity of investment
securities also provide additional funds for these purposes. While scheduled
principal repayments on loans and investment securities are a relatively
predictable source of funds, deposit flows and loan prepayments are greatly
influenced by general interest rates, economic conditions and competition. The
Bank is expected to manage the pricing of deposits to maintain a desired deposit
balance. The Bank offers drive-in teller services, wire transfer, lock box and
safe deposit services.
The Bank of Southern Connecticut's loan strategy is to offer a broad
range of loans to businesses and individuals in its service area, including
commercial and business loans, personal loans, mortgage loans, home equity
loans, automobile loans and education loans. The Bank has received lending
approval status from the Small Business Administration ("SBA") to enable it to
make SBA loans to both the Greater New Haven business community and companies
throughout the State of Connecticut. The marketing focus on small to medium-size
businesses and professionals may result in an assumption of certain lending
risks that are different from or greater than those which would apply to loans
made to larger companies or consumers. Commercial loans generally entail certain
additional risks because repayment is usually dependent on the success of the
enterprise. The Bank seeks to manage the credit risk inherent in its loan
portfolio through credit controls, loan diversification and a loan review
program. Prior to approving a loan, the Bank evaluates: the credit histories of
6
potential borrowers; the value and liquidity of available collateral; the
purpose of the loan; the source and reliability of funds for repayment and other
factors considered relevant in the circumstances.
Loans are made on a variable or fixed rate basis with fixed rate loans
limited to five year terms. All loans are approved by The Bank of Southern
Connecticut's management and the Loan Committee of the Bank's Board of
Directors. At the present time, the Bank is not syndicating or securitizing
loans. The Bank, at times, participates in multi-bank loans to companies in its
service area. Commercial loans and commercial real estate loans may be written
for terms of up to twenty years. Loans to purchase or refinance commercial real
estate are supported by personal guarantees of the makers and related parties
and are collateralized by the subject real estate, which may in cases be
supplemented by additional collateral in the form of liquid assets. Loans to
local businesses are generally supported by the personal guarantees of the
principal owners and are carefully underwritten to determine appropriate
collateral and covenant requirements.
Other services currently provided include, cashier's checks, money
orders, travelers checks, bank by mail, direct deposit and U. S. Savings Bonds.
The Bank of Southern Connecticut is associated with a shared network of
automated teller machines that its customers are able to use throughout
Connecticut and other regions. The Bank does not currently expect to offer trust
services but may offer trust services through a joint venture with a larger
institution. To offer such services in the future, the Bank would need the
approval of the Connecticut Banking Commissioner.
Another significant activity for The Bank of Southern Connecticut is
maintaining an investment portfolio. Although granting a variety of loans to
generate interest income and loan fees is an important aspect of the Bank's
business plan, the aggregate amount of loans will be subject to maintaining a
satisfactory loan-to-deposit ratio. The Bank's overall portfolio objective is to
maximize the long-term total rate of return through active management of
portfolio holdings taking into consideration estimated asset/liability and
liquidity needs, tax equivalent yields and maturities. Permissible investments
include debt securities such as U. S. Government securities, government
sponsored agency securities, municipal bonds, domestic certificates of deposit
that are insured by the FDIC, mortgage-backed securities and collateralized
mortgage obligations. The Bank expects that investments in equity securities
will be very limited. The Bank's current investment portfolio is limited to U.
S. government agency obligations and agency issue collateralized mortgage
obligations which have been classified as available for sale. Accordingly, the
principal risk associated with the Bank's current investing activities is market
risk (variations in value resulting from general changes in interest rates)
rather than credit risk.
Overall, The Bank of Southern Connecticut's plan of operation is
focused on responsible growth and pricing of deposits and loans, and investment
in high quality U. S. government securities to achieve a net interest margin
sufficient to cover operating expenses, achieve profitable operations and
maintain liquidity. The Bank is seeking to develop additional fee income sources
to supplement the core bank product offerings.
Currently, The Bank of Southern Connecticut has 29 full-time and no
part-time employees. Most routine day-to-day banking transactions are performed
at the Bank by its employees. However, the Bank has entered into a number of
arrangements for banking services such as correspondent banking, data processing
and armored carriers.
Supervision and Regulation
Banks and bank holding companies are extensively regulated under both
federal and state law. The Bank has set forth below brief summaries of various
aspects of supervision and regulation which do not purport to be complete and
which are qualified in their entirety by reference to applicable laws, rules and
regulations.
7
Regulations to which Bancorp is subject
As a bank holding company, Bancorp is regulated by and subject to the
supervision of the Board of Governors of the Federal Reserve System (the "FRB")
and is required to file with the FRB an annual report and such other information
as may be required. The FRB has the authority to conduct examinations of Bancorp
as well.
The Bank Holding Company Act of 1956 (the "BHC Act") limits the types
of companies which Bancorp may acquire or organize and the activities in which
they may engage. In general, a bank holding company and its subsidiaries are
prohibited from engaging in or acquiring control of any company engaged in
non-banking activities unless such activities are so closely related to banking
or managing and controlling banks as to be a proper incident thereto. Activities
determined by the FRB to be so closely related to banking within the meaning of
the BHC Act include operating a mortgage company, finance company, credit card
company, factoring company, trust company or savings association; performing
certain data processing operations; providing limited securities brokerage
services; acting as an investment or financial advisor; acting as an insurance
agent for certain types of credit-related insurance; leasing personal property
on a full-payout, non-operating basis; providing tax planning and preparation
service; operating a collection agency; and providing certain courier services.
The FRB also had determined that certain other activities, including real estate
brokerage and syndication, land development, property management and
underwriting of life insurance unrelated to credit transactions, are not closely
related to banking and therefore are not a proper activity for a bank holding
company.
In November 1999, Congress amended certain provisions of the BHC Act
through passage of the Gramm-Leach-Bliley Act. Under this new legislation, a
bank holding company may elect to become a "financial holding company" and
thereby engage in a broader range of activities than would be permissible for
traditional bank holding companies. In order to qualify for the election, all of
the depository institution subsidiaries of the bank holding company must be well
capitalized and well managed, as defined under FRB regulations, and all such
subsidiaries must have achieved a rating of "satisfactory" or better with
respect to meeting community credit needs. Pursuant to the Gramm-Leach-Bliley
Act, financial holding companies are permitted to engage in activities that are
"financial in nature" or incidental or complementary thereto, as determined by
the FRB. The Gramm-Leach-Bliley Act identifies several activities as "financial
in nature", including, among others, insurance underwriting and agency
activities, investment advisory services, merchant bank and underwriting, and
dealing in or making a market in securities.
The Gramm-Leach-Bliley Act also makes it possible for entities engaged
in providing various other financial services to form financial holding
companies and form or acquire banks. Accordingly, the Gramm-Leach-Bliley Act
makes it possible for a variety of financial services firms to offer products
and services comparable to the products and services offered by the Bank.
There are various statutory and regulatory limitations regarding the
extent to which present and future banking subsidiaries of Bancorp can finance
or otherwise transfer funds to Bancorp or its non-banking subsidiaries, whether
in the form of loans, extensions of credit, investments or asset purchases,
including regulatory limitation on the payment of dividends directly or
indirectly to Bancorp from the Bank. Federal and state bank regulatory agencies
also have the authority to limit further the Bank's payment of dividends based
on such factors as the maintenance of adequate capital for such subsidiary bank,
which could reduce the amount of dividends otherwise payable. Under the policy
of the FRB, Bancorp is expected to act as a source of financial strength to the
Bank and to commit resources to support the Bank in circumstances where Bancorp
might not elect to do so absent such policy.
The FRB has established capital adequacy guidelines for bank holding
companies that are similar to the Federal Deposit Insurance Corporation ("FDIC")
capital requirements for the Bank described below.
8
Regulations to which the Bank is subject
The Bank of Southern Connecticut is organized under the Banking Law of
the State of Connecticut. Its operations are subject to federal and state laws
applicable to commercial banks and to extensive regulation, supervision and
examination by the Connecticut Banking Commissioner, as well as by the FDIC, as
its primary federal regulatory and insurer of deposits. While the Bank is not a
member of the Federal Reserve System, it is subject to certain regulations of
the FRB. In addition to banking laws, regulations and regulatory agencies, the
Bank is subject to various other laws, regulations and regulatory agencies, all
of which directly or indirectly affect the Bank's operations. The Connecticut
Banking Commissioner and the FDIC examine the affairs of the Bank for the
purpose of determining its financial condition and compliance with laws and
regulations.
The Connecticut Banking Commissioner and the FDIC have significant
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such policies whether by the FDIC, Congress, the
Connecticut Banking Commissioner or the Connecticut General Assembly could have
a material adverse impact on the Bank.
Federal laws and regulations also limit, with certain exceptions, the
ability of state banks to engage in activities or make equity investments that
are not permissible for national banks. Bancorp does not expect such provisions
to have a material adverse effect on Bancorp or the Bank.
Capital Standards
The FDIC has adopted risk-based capital guidelines to which
FDIC-insured, state-chartered banks that are not members of the Federal Reserve
System, such as the Bank, are subject. The guidelines establish a systematic
analytical framework that makes regulatory capital requirements more sensitive
to the differences in risk profiles among banking organizations. Banks are
required to maintain minimum levels of capital based upon their total assets and
total "risk-weighted assets." For purposes of these requirements, capital is
comprised of both Tier 1 and Tier 2 capital. Tier 1 capital consists primarily
of common stock and retained earnings. Tier 2 capital consists primarily of loan
loss reserves, subordinated debt, and convertible securities. In determining
total capital, the amount of Tier 2 capital may not exceed the amount of Tier 1
capital. A bank's total "risk-based assets" are determined by assigning the
bank's assets and off-balance sheet items (e.g., letters of credit) to one of
four risk categories based upon their relative credit risks. The greater the
risk associated with an asset, the greater the amount of such asset that will be
subject to capital requirements.
Safety and Soundness Standards
Federal law requires each federal banking agency to prescribe for
depository institutions under its jurisdiction standards relating to, among
other things: internal controls; information systems and audit systems; loan
documentation; credit underwriting; interest rate risk exposure; asset growth;
compensation; fees and benefits; and such other operational and managerial
standards as the agency deems appropriate. The federal banking agencies adopted
final regulations and Interagency Guidelines Establishing Standards for Safety
and Soundness (the "Guidelines") to implement these safety and soundness
standards. The Guidelines set forth the safety and soundness standards that the
federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. The Guidelines address
internal controls and information systems; internal audit system; credit
underwriting; loan documentation; interest rate risk exposure; asset quality;
earnings and compensation; fees and benefits. If the appropriate federal banking
agency determines that an institution fails to meet any standards prescribed by
the Guidelines, the agency may require the institution to submit to the agency
an acceptable plan to achieve compliance with the standard set by the Federal
Deposit Insurance Act. The final regulations establish deadlines for submission
and review of such safety and soundness compliance plans.
9
The federal banking agencies also have adopted final regulations for
real estate lending prescribing uniform guidelines for real estate lending. The
regulations require insured depository institutions to adopt written policies
establishing standards, consistent with such guidelines, for extensions of
credit secured by real estate. The policies must address loan portfolio
management, underwriting standards and loan to value limits that do not exceed
the supervisory limits prescribed by the regulations.
Prompt Corrective Action and Other Enforcement Mechanisms
Federal law requires each federal banking agency to take prompt
corrective action to resolve the problems of insured depository institutions,
including but not limited to those that fall below one or more prescribed
minimum capital ratios. The law requires each federal banking agency to
promulgate regulations defining the following five categories in which an
insured depository institution will be placed, based on the level of its capital
ratios: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. In September
1992, the federal banking agencies issued uniform final regulations implementing
the prompt corrective action provisions of federal law.
An institution that, based upon its capital levels, is classified as
"well capitalized," "adequately capitalized" or "undercapitalized" may be
treated as though it were in the next lower capital category if the appropriate
federal banking agency, after notice and opportunity for hearing, determines
that an unsafe or unsound condition or an unsafe or unsound practice warrants
such treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. The federal banking agencies,
however, may not treat an institution as "critically undercapitalized" unless
its capital ratio actually warrants such treatment.
In addition to restrictions and sanctions imposed under the prompt
corrective action provisions, commercial banking organizations may be subject to
potential enforcement actions by the federal regulators for unsafe or unsound
practices in conducting their businesses or for violations of any law, rule,
regulation or any condition imposed in writing by the agency or any written
agreement with the agency. Enforcement actions may include the imposition of a
conservator or receiver, the issuance of a cease and desist order that can be
judicially enforced, the termination of insurance of deposits (in the case of a
depository institution), the imposition of civil money penalties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the issuance of removal and prohibition orders against
institution-affiliated parties and the enforcement of such actions through
injunctions or restraining orders based upon a judicial determination that the
agency would be harmed if such equitable relief was not granted.
Premiums for Deposit Insurance
The FDIC has implemented a risk-based assessment system, under which an
institution's deposit insurance premium assessment is based on the probability
that the deposit insurance fund will incur a loss with respect to the
institution, the likely amount of any such loss, and the revenue needs of the
deposit insurance fund.
Under this risk-based assessment system, banks are categorized into one
of three capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three categories based on supervisory evaluations
by its primary federal regulatory. The three supervisory categories are:
financially sound with only a few minor weaknesses (Group A), demonstrates
weaknesses that could result in significant deterioration (Group B), and poses a
substantial probability of loss (Group C). The capital ratios used by the FDIC
to define well-capitalized, adequately capitalized and undercapitalized are the
same in the FDIC's prompt corrective action regulations. As of December 31,
2003, the most recent notification from the Federal Deposit Insurance
Corporation and the State of Connecticut Department of Banking categorized the
Bank as well capitalized under the regulatory framework for prompt corrective
10
action. There are no conditions or events that management believes have changed
the Bank's category.
FDIC insurance of deposits may be terminated by the FDIC, after notice
and hearing, upon finding by the FDIC that the insured institution has engaged
in unsafe or unsound practices, or is in an unsafe or unsound condition to
continue operations, or has violated any applicable law, regulation, rule or
order of, or conditions imposed by, the FDIC.
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), as implemented by FDIC
regulations, the Bank has a continuing and affirmative obligation consistent
with its safe and sound operation to help meet the credit needs of its entire
community, including law and moderate income neighborhoods. The CRA does not
prescribe specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the FDIC, in connection with its
examination of a savings institution, to assess the institution's record of
meeting the credit needs of its community and to take such record into account
in its evaluation of certain applications by such institution. The Financial
Institutions Reform, Recovery and Enforcement Act (FIRREA) amended the CRA to
require public disclosure of an institution's CRA rating and require the FDIC to
provide a written evaluation of an institution's CRA performance utilizing a
four-tiered descriptive rating system. Institutions are evaluated and rated by
the FDIC as "Outstanding", "Satisfactory", "Needs to Improve", or "Substantial
Non Compliance." Failure to receive at least a "Satisfactory" rating may inhibit
an institution from undertaking certain activities, including acquisitions or
other financial institutions, which require regulatory approval based, in part,
on CRA Compliance considerations.
Interstate Banking and Branching
Under the Riegel-Neal Interstate Banking and Branching Efficiency Act
of 1994, as amended (the "Interstate Act, a bank holding company that is
adequately capitalized and managed may obtain approval under the BHCA to acquire
an existing bank located in another state generally without regard to state law
prohibitions on such acquisitions. A bank holding company, however, can not be
permitted to make such an acquisition if, upon consummation, it would control
(a) more than 10% of the total amount of deposits of insured depository
institutions in the United States or (b) 30% or more of the deposits in the
state in which the bank is located. A state may limit the percentage of total
deposits that may be held in that state by any one bank or bank holding company
if application of such limitation does not discriminate against out of state
banks. An out of state bank holding company may not acquire a state bank in
existence for less than a minimum length of time that may be prescribed by state
law except that a state may not impose more than a five year existence
requirement. Since June 1, 1997 (and prior to that date in some instances),
banks have been able to expand across state lines where qualifying legislation
adopted by certain states prior to that date prohibits such interstate
expansion. Banks may also expand across state lines through the acquisition of
an individual branch of a bank located in another state or through the
establishment of a de novo branch in another state where the law of the state in
which the branch is to be acquired or established specifically authorizes such
acquisition or de novo branch establishment.
The USA PATRIOT Act
In response to the events of September 11, 2001, the Uniting and
Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, was signed into law on
October 26, 2001. The USA PATRIOT Act gives the federal government new powers to
address terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing and broadened anti-money
laundering requirements. By way of amendments to the Bank Secrecy Act, Title III
of the USA PATRIOT Act takes measures intended to encourage information sharing
among bank regulatory agencies and law enforcement bodies. Further, certain
provisions of Title III impose affirmative obligations on a broad range of
11
financial institutions, including banks, thrifts, brokers, dealers, credit
unions, money transfer agents and parties registered under the Commodity
Exchange Act.
Among other requirements, Title III of the USA PATRIOT Act imposes the
following requirements with respect to financial institutions:
o Pursuant to Section 352, all financial institutions must
establish anti-money laundering programs that include, at
minimum: (i) internal policies, procedures, and controls; (ii)
specific designation of an anti-money laundering compliance
officer; (iii) ongoing employee training programs; and (iv) an
independent audit function to test the anti-money laundering
program.
o Section 326 authorizes the Secretary of the Department of
Treasury, in conjunction with other bank regulators, to issue
regulations by October 26, 2002 that provide for minimum
standards with respect to customer identification at the time
new accounts are opened.
o Section 312 requires financial institutions that establish,
maintain, administer, or manage private banking accounts or
correspondence accounts in the United States for non-United
States persons or their representatives (including foreign
individuals visiting the United States) to establish
appropriate, specific, and, where necessary, enhanced due
diligence policies, procedures, and controls designed to
detect and report money laundering.
o Financial institutions are prohibited from establishing,
maintaining, administering or managing correspondent accounts
for foreign shell banks (foreign banks that do not have a
physical presence in any country), and will be subject to
certain record keeping obligations with respect to
correspondent accounts of foreign banks.
o Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on
Federal Reserve Act and Bank Merger Act applications.
The federal banking agencies have begun to propose and implement
regulations pursuant to the USA PATRIOT Act. These proposed and interim
regulations would require financial institutions to adopt the policies and
procedures contemplated by the USA PATRIOT Act.
Sarbanes-Oxley Act of 2002
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act
of 2002 ("Sarbanes-Oxley"), which implemented legislative reforms intended to
address corporate and accounting fraud. In addition to the establishment of a
new accounting oversight board that will enforce auditing, quality control and
independence standards and will be funded by fees from all publicly traded
companies, Sarbanes-Oxley places certain restrictions on the scope of services
that may be provided by accounting firms to their public company audit clients.
Any non-audit services being provided to a public company audit client will
require preapproval by the company's audit committee. In addition,
Sarbanes-Oxley makes certain changes to the requirements for audit partner
rotation after a period of time. Sarbanes-Oxley requires chief executive
officers and chief financial officers, or their equivalent, to certify to the
accuracy of periodic reports filed with the Securities and Exchange Commission,
subject to civil and criminal penalties if they knowingly or willingly violate
this certification requirement. The Company's Chief Executive Officer and Chief
Financial Officer, and the Bank's President, have signed certifications to this
Form 10-KSB as required by Sarbanes-Oxley. In addition, under Sarbanes-Oxley,
counsel will be required to report evidence of a material violation of the
securities laws or a breach of fiduciary duty by a company to its chief
executive officer or its chief legal officer, and, if such officer does not
appropriately respond, to report such evidence to the audit committee or other
similar committee of the board of directors or the board itself.
12
Under Sarbanes-Oxley, longer prison terms will apply to corporate
executives who violate federal securities laws; the period during which certain
types of suits can be brought against a company or its officers is extended; and
bonuses issued to top executives prior to restatement of a company's financial
statements are now subject to disgorgement if such restatement was due to
corporate misconduct. Executives are also prohibited from trading the company's
securities during retirement plan "blackout" periods, and loans to company
executives (other than loans by financial institutions permitted by federal
rules and regulations) are restricted. In addition, a provision directs that
civil penalties levied by the Securities and Exchange Commission as a result of
any judicial or administrative action under Sarbanes-Oxley be deposited to a
fund for the benefit of harmed investors. The Federal Accounts for Investor
Restitution provision also requires the Securities and Exchange Commission to
develop methods of improving collection rates. The legislation accelerates the
time frame for disclosures by public companies, as they must immediately
disclose any material changes in their financial condition or operations.
Directors and executive officers must also provide information for most changes
in ownership in a company's securities within two business days of the change.
Sarbanes-Oxley also increases the oversight of, and codifies certain
requirements relating to audit committees of public companies and how they
interact with the company's "registered public accounting firm." Audit Committee
members must be independent and are absolutely barred from accepting consulting,
advisory or other compensatory fees from the issuer. In addition, companies must
disclose whether at least one member of the committee is a "financial expert"
(as such term is defined by the Securities and Exchange Commission) and if not,
why not. Under Sarbanes-Oxley, a company's registered public accounting firm is
prohibited from performing statutorily mandated audit services for a company if
such company's chief executive officer, chief financial officer, comptroller,
chief accounting officer or any person serving in equivalent positions had been
employed by such firm and participated in the audit of such company during the
one-year period preceding the audit initiation date. Sarbanes-Oxley also
prohibits any officer or director of a company or any other person acting under
their direction from taking any action to fraudulently influence, coerce,
manipulate or mislead any independent accountant engaged in the audit of the
company's financial statements for the purpose of rendering the financial
statements materially misleading. Sarbanes-Oxley also requires the Securities
and Exchange Commission to prescribe rules requiring inclusion of any internal
control report and assessment by management in the annual report to
shareholders. Sarbanes-Oxley requires the company's registered public accounting
firm that issues the audit report to attest to and report on management's
assessment of the company's internal controls.
Factors Affecting Future Results
--------------------------------
In addition to historical information, this Form 10-KSB includes
certain forward looking statements that involve risks and uncertainties such as
statements of Bancorp's plans, expectations and unknown outcomes. Bancorp's
actual results could differ materially from management expectations. Factors
that could contribute to those differences include, but are not limited to,
general economic conditions, legislative and regulatory changes, monetary and
fiscal policies of the federal government, changes in tax policies, rates and
regulations of federal and local tax authorities, changes in interest rates,
deposit flows, the cost of funds, demand for loan products, demand for financial
services, competition, changes in the quality or composition of the Bank's loan
and investment portfolios, changes in ownership status resulting in, among other
things, change in accounting principles, policies or guidelines, and other
economic, competitive, governmental and technological factors affecting the
Company's operations, markets, products, services and prices.
Item 2. Description of Property.
-----------------------
Bancorp executed a lease for a free-standing building located at 215
Church Street, New Haven, Connecticut, in the central business and financial
district of New Haven. The lease was assigned to The Bank of Southern
Connecticut, and the Bank assumed, all obligations there under. The location is
a former bank branch, which has been renovated for use as the headquarters of
13
the Bank and Bancorp. The building has a drive-up teller, an automated teller
machine, two vaults and a night deposit drop.
The lease is for an initial term of five years and three months, with
an option to extend the lease for up to three additional terms of five years.
There was no base rent payable for the first three months of the initial term
and monthly rent was $4,117 until August 1, 2001. The annual base rent during
the balance of the initial term will be $107,400 for the first year and
increases each year to $125,500 for the fifth year. The base rent for the option
periods is also fixed in the lease. The Bank is responsible for all costs to
maintain the building, other than structural repairs, and for all real estate
taxes. The Bank, as Bancorp's assignee, will have a right of first refusal to
purchase the building.
To the extent that the building contains space not needed for
operations, the Bank expects to sublease such excess to the extent practicable.
The Bank of Southern Connecticut had subleased approximately 1,045 square feet
to Laydon and Company, LLC, an entity owned by Elmer A. Laydon, the son of Elmer
F. Laydon, one of Bancorp's directors.
The Bank of Southern Connecticut entered into a lease agreement on
August 7, 2002 to lease the facility at 445 West Main Street, Branford,
Connecticut, the site of the Branford branch which opened for business on
October 7, 2002.
The Branford branch lease is for an initial term of five years, with an
option to extend the lease for up to three additional terms of five years. The
base rent payable for the initial term and monthly rent is $3,095 until
September 30, 2007. The base rent for the option periods increases and is fixed
in the lease. The Bank is responsible for all costs to maintain the building,
other than structural repairs, and for all real estate taxes.
On August 15, 2002 the Bank also purchased an additional branch
facility at 1475 Whalley Avenue, New Haven, Connecticut, the site of the Amity
branch location which opened March 24, 2003.
On January 14, 2004 Bancorp entered into a lease agreement to lease the
facility at 15 Mason Street, New London, Connecticut, the site of the proposed
Bank of Southeastern Connecticut. Pending regulatory approval of The Bank of
Southeastern Connecticut, the facility will be improved to accommodate the new
bank. Improvements, furnishings and equipment are estimated to be $159,000. The
Bank of Southeastern Connecticut is expected to commence operations in the
fourth quarter of 2004. The Lease is for an initial term of five years, with
three successive five year option periods. Base rent is $45,580 annually until
January 14, 2009. The base rent for the option years is subject to increases.
Bancorp is responsible for pro rata allocations for taxes, utilities, common
charges and other customary expenses of the premises. Upon the commencement of
bank operations, it is Bancorp's intention to assign the lease to The Bank of
Southeastern Connecticut.
Item 3. Legal Proceedings.
-----------------
There are no legal proceedings currently pending or threatened against
Bancorp or The Bank of Southern Connecticut or their property. Bancorp is not
aware of any proceeding contemplated by a governmental entity involving Bancorp
or the Bank.
Bancorp's wholly-owned subsidiary, The Bank of Southern Connecticut,
was involved in litigation during 2003 with its former President and Chief
Operating Officer, Gary D. Mullin, for breach of contract in connection with Mr.
Mullin's dismissal for cause. Mr. Mullin notified the Bank of his claim in March
2003. The only parties to the dispute were the Bank and Mr. Mullin. The matter
has been settled satisfactorily with no material impact to Bancorp or the Bank.
14
Item 4. Submission of Matters to a Vote of Security Holders.
---------------------------------------------------
No matter was submitted to a vote of shareholders of Bancorp during the
fourth quarter of the fiscal year covered by this Form 10-KSB.
PART II
Item 5. Market for Common Equity, Related Stockholder Matters and Small
Business Issuer Purchases Of Equity Securities.
----------------------------------------------------------------
Bancorp's Common Stock is quoted on the Over the Counter Market System
under the symbol "SCNO."
The following table sets forth the high and low sales price* per share
of Bancorp's Common Stock, as reported on the Over the Counter Market as quoted
on Bloomberg Market Data System (TM) for the last two years:
(The prices listed may not reflect actual transactions.)
Quarter Ended High Low
-------------
March 31, 2003 $ 8.25 $ 7.80
June 30, 2003 $10.75 $ 7.70
September 30, 2003 $10.30 $ 8.65
December 31, 2003 $10.00 $ 8.65
March 31, 2002 $12.00 $ 8.50
June 30,2002 $11.00 $ 8.50
September 30, 2002 $10.00 $ 7.85
December 31, 2002 $ 9.50 $ 8.05
*Share price have not been adjusted to reflect the 10% stock dividend
declared January 13, 2004.
Holders
--------
There were approximately 100 registered shareholders of record of
Bancorp's Common Stock as of March 19, 2004.
Dividends
---------
No cash dividends have been declared to date by Bancorp. Management
expects that earnings, if any, will be retained and that no cash dividends will
be paid in the near future. Bancorp may, however, declare stock dividends at the
discretion of its Board of Directors. Bancorp declared a 10% stock dividend on
January 13, 2004 to shareholders of record as January 30, 2004. Bancorp issued
96,653 shares in connection with the stock dividend.
Bancorp's sole operating subsidiary is The Bank of Southern
Connecticut. Bancorp is dependent upon the ability of the Bank to declare and
pay dividends to Bancorp. The Bank's ability to declare dividends is dependent
unit the Bank's ability to earn profits and to maintain acceptable capital
ratios, as well as meet regulatory requirements and remain compliant with
banking law.
15
The policy of the Connecticut Banking Commissioner is to not permit
payment of any cash dividends prior to recapture of organization and
pre-operating expenses from operating profits. In addition, the Bank is
prohibited by Connecticut law from declaring a cash dividend on its Common Stock
without prior approval of the Connecticut Banking Commissioner except from its
net profits for that year and any retained net profits of the preceding two
years. "Net profits" is defined as the remainder of all earnings from current
operations. In some instances, further restrictions on dividends may be imposed
by the FDIC. However, during 2002, the Bank requested, and was granted,
permission from the State of Connecticut Department of Banking, to pay a special
cash dividend to Bancorp in the amount of $200,000. At December 31, 2003 and
2002, no cash dividends may be declared by the Bank without regulatory approval.
The payment of dividends by the Bank may also be affected by other
factors, such as the requirement to maintain capital in accordance with
regulatory guidelines. If, in the opinion of the Connecticut Banking
Commissioner, the Bank were engaged in or was about to engage in an unsafe or
unsound practice, the Commissioner could require, after notice and a hearing,
the Bank to cease and desist from the practice. The federal banking agencies
have indicated that paying dividends that deplete a depository institution's
capital base to an inadequate level would be an unsafe and unsound banking
practice. Under the Federal Deposit Insurance Corporation Improvements Act of
1991, a depository institution may not pay any dividend if payment would cause
it to become undercapitalized or if it already is undercapitalized. Moreover,
the federal banking agencies have issued policy statements that provide that
bank holding companies and insured banks should generally only pay dividends out
of current operating earnings.
Equity Compensation Plan Information
The following schedule provides information with respect to the
compensation plans (including individual compensation arrangements) under which
equity securities of Bancorp are authorized for issuance as of December 31,
2003:
----------------------------------------------------------------------------------------------------------------------
Plan Category Number of securities to be Weighted-average exercise Number of securities
issued upon exercise of price of outstanding remaining available for
outstanding options, options, warrants future issuance under
warrants and rights and rights equity compensation plans
(a) (b) (excluding securities
reflected in column (a))
----------------------------------------------------------------------------------------------------------------------
Equity compensation plan 228,811 $ 8.48 21,189
approved by security holders
----------------------------------------------------------------------------------------------------------------------
Equity compensation plans not 132,481 $12.00 0 1
approved by security holders
----------------------------------------------------------------------------------------------------------------------
Total 361,292 $ 9.77 21,189
----------------------------------------------------------------------------------------------------------------------
The 2001 option and warrant plans were not approved by security
holders.
*Numbers and dollars have not been adjusted to reflect the 10% stock
dividend declared January 13, 2004.
-----------------
1 The 2001 Option Plan was terminated on May 14,2002.
16
Recent Sales of Unregistered Securities
---------------------------------------
Bancorp has not sold unregistered securities.
Repurchase of Securities
------------------------
Bancorp has not repurchased any of its securities.
Item 6. Management's Discussion and Analysis and Results of Operations.
--------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
De Novo banks in Connecticut have reached profitability on average
within three to four years after commencement of operations. The Bank of
Southern Connecticut was profitable in the fourth quarter of 2003, the ninth
quarter of operation.
Southern Connecticut Bancorp, Inc.
Financial Highlights
As of and for the years ended December 31, 2003 and 2002:
2003 2002
---- ----
Operating Data
--------------
Interest income $ 2,512,086 $ 1,125,321
Interest expense 574,795 441,813
Net interest income 1,937,291 683,508
Provision for loan losses 213,100 220,000
Noninterest income 496,332 86,163
Noninterest expenses 2,818,450 1,933,684
Net loss (597,927) (1,384,013)
Basic and diluted loss per share (.56) (1.30)
Balance Sheet Data
------------------
Cash and due from banks $ 1,147,883 $ 1,245,010
Federal funds sold 966,000 1,144,000
Short-term investments 454,115 662,419
Investment securities 8,478,068 9,501,492
Loans, net 40,818,718 19,049,212
Total assets 56,386,040 35,500,115
Total deposits 47,273,875 24,992,931
Repurchase agreements 339,752 822,259
Total shareholders equity 7,314,302 8,274,679
Assets
------
Bancorp's total assets were $56.4 million as of December 31, 2003, an
increase of $20.9 million over December 31, 2002. Earning assets comprise $51.2
million of the total asset volume, and consist of Federal Funds sold, short-term
investments, securities and loans, a $20.6 million increase from 2002. Bancorp
has maintained liquidity by maintaining balances in overnight Federal Funds and
in Money Market Mutual Funds to provide funding for higher yielding loans as
17
they are approved. As of December 31, 2003, Federal Funds Sold balances were
$966,000 and Money Market Mutual Fund balances were $454,115. Bank investment
securities classified as available for sale were $8.5 million and $9.5 million
as of December 31, 2003 and 2002, respectively. The loan portfolio was $41.2
million and $19.3 million as of December 31, 2003 and 2002 respectively, a net
increase of $21.9 million.
The earning asset growth in 2003 has been funded by deposit growth
within the Bank's market area. Deposits were $47.3 million and $25.0 million as
of December 31, 2003 and 2002 respectively, a net increase of $22.3 million. The
mix of deposits as of December 31, 2003 includes non-interest bearing checking
accounts of $13.8 million, interest- bearing checking deposits of $3.5 million,
savings deposits of $2.6 million, money market deposits of $17.3 million, as
well as time certificates of deposit of $10.1 million. The deposit mix between
2003 and 2002 has not substantially changed. The Bank has not accepted any
brokered deposits.
The following table presents the maturity distribution of investment
securities at December 31, 2003 and the weighted average yield of such
securities. The weighted average yields were calculated based on the amortized
cost and effective yields to maturity of each security.
One Year After Five
One Year Through but Within Over No
Available for sale or Less Five Years Ten Years Ten Years Maturity Total
------------------ ------- ---------- --------- --------- -------- -----
U. S. Government
Agency obligations $ -- $2,501,421 $4,199,527 $ 500,000 $ -- $7,200,948
Mortgage-backed securities -- -- -- -- 1,576,878 1,576,878
------------------------------------------------------------------------------------------
Total $ -- $2,501,421 $4,199,527 $ 500,000 $1,576,878 $8,777,826
==========================================================================================
Weighted average yield 2.35% 2.77% 4.00% 3.82% 2.90%
The following table presents a summary of investments for any issuer that
exceeds 10% of shareholders' equity at December 31, 2003.
Amortized Fair
Cost Value
---- -----
U. S. Government agencies:
--------------------------
Federal Home Loan Mortgage Corp. $ 4,450,515 $ 4,317,460
Federal Home Loan Bank 2,798,665 2,713,760
Federal National Mortgage Association 1,528,646 1,446,848
Loans
The Bank's net loan portfolio was $40.8 million at December 31, 2003.
Loan demand has been robust throughout the year. The loan to deposit ratio as of
December 31, 2003 was 87.2%. In comparison, the loan to deposit ratio as of
December 31, 2002 was 77.1%. Bancorp's target for this ratio is 80% to 83%, and
attributes the year end 2003 ratio to the success of the Bank's loan business
development program to small to medium businesses, as well as an improving
economy, in generating loan demand. Management believes that the ratio will
decline to within the targeted band and will generally remain within the band
over time as the Bank's branch system deposit base grows. The deployment of new
deposit growth and Federal Funds Sold, money market mutual fund investments and
federal agency and other investments into the loan portfolio have produced a
positive impact on net interest spread - see the table depicting the
Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and
Interest Differential on Page 22 of this Form 10-KSB. There are no significant
loan concentrations in the loan portfolio.
18
The following table presents the maturities of loans in Bancorp's
portfolio at December 31, 2003 by type of loan, and the sensitivities of loans
to changes in interest rates:
Due after
Due in one year
one year through Due After
(Thousands of dollars) or less five years five years Total
---------------------------------------------------------------------------------------
Commercial loans secured
by real estate $ 3,699 $12,119 $ 2,226 $18,044
Residential real estate 81 867 -- 948
Construction loans 773 728 -- 1,501
Commercial loans 10,193 5,203 3,188 18,584
Consumer installment 671 534 -- 1,205
Consumer home equity 445 588 10 1,043
------- ------- ------- -------
Total $15,862 $20,039 $ 5,424 $41,325
======= ======= ======= =======
Fixed rate loans $ 2,156 $ 4,010 $ 3,887 $10,053
Variable rate loans 13,706 16,029 1,537 31,272
------- ------- ------- -------
Total $15,862 $20,039 $ 5,424 $41,325
======= ======= ======= =======
Critical Accounting Policy
In the ordinary course of business, Bancorp has made a number of
estimates and assumptions relating to reporting the results of operations and
financial condition in preparing its financial statements in conformity with
accounting principals generally accepted in the United States of America. Actual
results could differ significantly from those estimates under different
assumptions and conditions. Bancorp believes the following discussion addresses
Bancorp's only critical accounting policy, which is the policy that is most
important to the portrayal of Bancorp's financial condition and results and
requires management's most difficult, subjective and complex judgments, often as
a result of the need to make estimates about the effect of matters that are
inherently uncertain.
Allowance for Loan Losses
The allowance for loan losses, a material estimate susceptible to
significant change in the near-term, is established as losses are estimated to
have occurred through a provision for losses charged against operations, and is
maintained at a level that management considers adequate to absorb losses in the
loan portfolio. Management's judgment in determining the adequacy of the
allowance is inherently subjective and is based on the evaluation of individual
loans, pools of homogeneous loans, the known and inherent risk characteristics
and size of the loan portfolios, the assessment of current economic and real
estate market conditions, estimates of the current value of underlying
collateral, past loan loss experience, review of regulatory authority
examination reports and evaluations of specific loans and other relevant
factors. Loans, including impaired loans, are charged against the allowance for
loan losses when management believes that the uncollectibility of principal is
confirmed. Any subsequent recoveries are credited to the allowance for loan
losses when received. In connection with the determination of the allowance for
loan losses, management obtains appraisals for significant properties, when
considered necessary.
The reserve consists of specific, general and unallocated components.
The specific component relates to loans that are classified doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an
19
allowance is established when the discounted cash flows (or collateral value or
observable market price) of the impaired loan is lower than the carrying value
of that loan. The general component covers non-classified loans and is based on
historical loss experience adjusted for qualitative factors. An unallocated
component may be maintained to cover uncertainties that could affect
management's estimate of probably losses.The unallocated component of the
allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.
Based upon this evaluation, management believes the allowance for loan
losses of $421,144 or 1.02% of gross loans at December 31, 2003 is adequate,
under prevailing economic conditions, to absorb losses on existing loans.
The accrual of interest income on loans is discontinued whenever
reasonable doubt exists as to its collectibility and generally is discontinued
when loans are past due 90 days as to either principal or interest, or are
otherwise considered impaired. When the accrual of interest income is
discontinued, all previously accrued and uncollected interest is reversed
against interest income. The accrual of interest on loans past due 90 days or
more may be continued if the loan is well secured, and it is believed all
principal and accrued interest income due on the loan will be realized, and the
loan is in the process of collection. A non-accrual loan is restored to an
accrual status when it is no longer delinquent and collectibility of interest
and principal is no longer in doubt.
Management considers all non-accrual loans, other loans past due 90
days or more, based on contractual terms, and restructured loans to be impaired.
In most cases, loan payments that are past due less than 90 days and the related
loans are not considered to be impaired. Bancorp considers consumer installment
loans to be pools of smaller balance homogeneous loans, which are collectively
evaluated for impairment.
Analysis of Allowance for Loan Losses
2003 2002
--------- ---------
Balance at beginning of period $ 232,000 $ 12,000
Charge-offs (24,572) --
Recoveries 616 --
--------- ---------
Net (charge-offs) recoveries (23,956) --
Additions charged to operations 213,100 220,000
--------- ---------
Balance at end of period $ 421,144 $ 232,000
========= =========
Net charge-offs to average loans 0.08% --
========= =========
Allocation of the Allowance for Loan Losses at December 31:
2003 2002
--------------------------- -----------------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Balance Total Loans Balance Total Loans
------- ----------- ------- -----------
Commercial loans secured
by real estate $165,986 43.66% $ 88,083 45.56%
Construction loans 35,589 3.63% 8,538 2.94%
Residential 4,833 2.29% 3,828 7.92%
Commercial 192,075 44.98% 74,041 38.29%
Consumer Installment 21,361 2.92% 3,550 3.67%
Consumer Home Equity 1,300 2.52% 785 1.62%
Unallocated -- -- 53,175 --
-------- ------ -------- -----
$421,144 100.00% $232,000 100.0%
======== ====== ======== =====
20
Non-Accrual, Past Due and Restructured Loans
Non-accrual loans at December 31, 2003 totaled $94,063. There were no
restructured loans. There were no loans in 2003 considered as "troubled debt
restructurings."
Potential Problem Loans
Other than loans identified as non-accrual at December 31, 2003, the
Bank had no loans as to which management has significant doubts as to the
ability of the borrower to comply with the present repayment terms.
Deposits
Total deposits were $47.3 million at December 31, 2003, an increase of
$22.3 million in comparison to total deposits as of December 31, 2002 of $25.0
million. The deposit total at December 31, 2003 consists of non-interest bearing
checking of $13.8 million (29.1%), interest bearing checking and money market
deposits of $20.8 million (43.9%), savings of $2.6 million (5.6%) and
certificates of deposit of $10.1 million (21.4%). The Bank has not accepted any
brokered deposits and has no present plans to review this policy.
The Bank continues to offer competitive interest rates in the very
competitive New Haven County marketplace in order to fund expected loan growth.
As of December 31, 2003 the Bank's maturities of time deposits were:
$100,000 Less than
or greater $100,000 Totals
---------- -------- ------
(Thousands of dollars)
Three months or less $ 2,056 $ 796 $ 2,852
Over three months to one year 4,491 866 5,357
Over one year 505 1,395 1,900
------- ------- -------
$ 7,052 $ 3,057 $10,109
======= ======= =======
Other
The increase in premises and equipment is primarily due to the
improvements made to the building and related site used for the Amity branch of
the Bank.
In September, 2002, the Bank began offering securities sold under
agreements to repurchase, which are classified as secured borrowings, and
generally mature within one to three days from the transaction date. Securities
sold under agreements to repurchase are recorded at the amount of cash received
in connection with the transaction. The Bank may be required to provide
additional collateral based on the changes in fair value of the underlying
securities.
21
The following table presents average balance sheets (daily
averages), interest income, interest expense, and the corresponding annualized
rates on earning assets and rates paid on interest bearing liabilities for the
years ended December 31, 2003 and 2002.
Distribution of Assets, Liabilities and Shareholders'
Equity; Interest Rates and Interest Differential
2003 2002 Fluctuations in
-------------------------------------- ------------------------------------ interest
Interest Interest Annualized Income/Expense
Average Income/ Average Average Income/ Average ---------------
(Dollars in thousands) Balance Expense Rate Balance Expense Rate Total
---------------------- ------- ------- ---- ------- ------- ---- -----
Interest earning assets
Loans (1) $ 29,091 $ 2,224 7.64% $ 9,095 $ 744 8.18% $ 1,480
Short term investments 993 7 0.70% 3,642 59 1.62% (52)
Investments 8,747 256 2.93% 7,649 263 3.44% (7)
Federal funds sold 2,379 25 1.05% 3,692 59 1.60% (34)
-------- -------- -------- -------- --------
Total interest earning assets 41,210 2,512 6.10% 24,078 1,125 4.67% 1,387
-------- --------
Cash and due from banks 1,396 902
Premises and equipment, net 3,381 1,915
Allowance for loan losses (303) (70)
Other 1,068 756
-------- --------
Total assets $ 46,752 $ 27,581
======== ========
Interest bearing liabilities
Time certificates $ 6,534 166 2.54% $ 5,106 156 3.06% 10
Savings deposits 1,984 21 1.06% 625 10 1.60% 11
Money market / checking
deposits 18,381 211 1.15% 7,514 135 1.80% 76
Capital lease obligations 1,191 169 14.19% 936 137 14.64% 32
Repurchase agreements and other 914 8 0.88% 388 4 1.03% 4
-------- -------- -------- -------- --------
Total interest bearing
liabilities 29,004 575 1.98% 14,569 442 3.03% 133
-------- -------- --------
Non-interest bearing deposits 9,645 3,686
Accrued expenses and
other liabilities 357 210
Shareholder's equity 7,746 9,116
-------- --------
Total liabilities and equity $ 46,752 $ 27,581
======== ========
Net interest income $ 1,937 $ 683 $ 1,254
======== ======== ========
Interest margin 4.70% 2.84%
======= =======
Interest spread 4.12% 1.64%
======= =======
(1) Includes nonaccruing loans.
22
RATE VOLUME VARIANCE ANALYSIS
The following table summarizes the variance in interest income and
expense for 2003 and 2002 resulting from changes in assets and liabilities and
fluctuations in interest rates earned and paid. The change in interest
attributable to both rate and volume have been allocated to both rate and volume
on a pro rata basis.
2003 vs. 2002
Variance due to:
(Dollars in thousands) Volume Rate Total
---------------------- ------ ---- -----
Interest Earning Assets
Loans $ 1,532 ($ 52) $ 1,480
Short Term Investments (29) (23) (52)
Investments 35 (42) (7)
Federal Funds Sold (17) (17) (34)
------- ------- -------
1,521 (134) 1,387
------- ------- -------
Interest bearing liabilities
Time certificates $ 39 (29) $ 10
Savings deposits 15 (4) 11
Money market / checking deposits 139 (63) 76
Capital lease obligations 37 (5) 32
Repurchase agreements 5 (1) 4
------- ------- -------
235 (102) 133
------- ------- -------
Net Interest Income $ 1,286 ($ 32) $ 1,254
======= ======= =======
The improvements realized in net interest income during 2003 primarily
reflect substantial increased earning asset volume over 2002, as the average
earning assets in 2003 of $41.2 million were 71% greater than average earning
assets in 2002. Overall, interest income attributed to volume considerations
considerably outweighed rate considerations (increase of $1,521,000 verses a
decrease of $134,000). With respect to variances in the 2003 cost of interest
bearing liabilities in comparison to 2002, increased volume considerations of
$235,000 also outweighed decreased rate considerations of $102,000.
Loan growth has been the primary factor in improving net interest
income, as the net portfolio growth of $21.8 million in 2003 was accompanied by
a $1.3 million increase in net interest income. Bancorp intends for the Bank to
continue to emphasize lending to small to medium businesses in its market area
as its strategy to increase assets under management and to improve earnings. The
Bank will seek opportunities to increase its deposit base in order to support
its earning assets through marketing and by considering additional branch
locations and new product and service offerings.
23
The following are measurements of Bancorp's earnings (loss) in relation
to assets and equity, and average equity to average assets for the year ended
December 31, 2003 and 2002.
2003 2002
------- -------
Return on average assets (1.28)% (5.02)%
Return on average equity (7.72)% (15.18)%
Average equity to average assets 16.56 % 33.05 %
Results of Operations
Bancorp's net loss for fiscal year 2003 was $598,000, a decrease of
$786,000 from the net loss of $1,384,000 in fiscal year 2002. The decrease in
the 2003 loss was primarily due to increases in net interest income and
non-interest income, partly offset by an increase in non-interest expenses.
Net Interest Income
For the year December 30, 2003, net interest income was $1,937,000
versus $684,000 for the year ended December 31, 2002, a $1.3 million or 183%
increase. The 2003 increase was primarily the result of a $17.1 million increase
in average earning assets. The increase in average earning assets was comprised
of increases in average loans of $20.0 million and investments of $1.1 million,
partially offset by a decrease in lower yielding short term investments of $2.6
million and federal funds sold of $1.3 million.
The yield on average interest earning assets for the twelve months
ended December 31, 2003 was 6.10% versus 4.67% for same period in 2002, an
increase of 143 basis points. The increase in the yield on assets reflects the
increased ratio of loans to the total of earning assets over 2002.
The cost of average interest bearing liabilities was 1.98% for the
twelve months ended December 31, 2003 versus 3.03% for the same period in 2002,
a favorable decrease of 105 basis points. The decrease in the cost of interest
bearing liabilities was due to the $10.9 million increase in the average
outstanding balances of low rate money market and interest bearing checking
deposits in comparison to the total increase in interest bearing liabilities of
$14.4 million, as well as the generally lower interest rate environment
prevalent in 2003.
Due to the improvements in 2003 in the yield on average earning assets,
and the favorable decrease in the cost of interest bearing liabilities, the
interest spread improved to 4.12% for fiscal year 2003, an increase of 248 basis
points over the interest spread realized in 2002. Net interest margin improved
to 4.70% in 2003 from the 2.84% in 2002, a favorable change of 186 basis points.
Noninterest Income
The $410,000 increase in non-interest income for the twelve months
ended December 31, 2003 versus 2002 is the result of $177,000 referral fee
income and gains on sales of loan participations related to Small Business
Administration ("SBA") guaranteed loans in the fourth quarter of 2003, increased
deposit account service charges and fees of $42,000, other noninterest fee
income of $147,000 and $44,000 of gains on the sales of investment securities
for the year. The Bank of Southern Connecticut intends to originate SBA
guaranteed loans in the future and expects to continue to earn fee income from
SBA loan participation sales and referrals. The increase in other noninterest
fee income is attributable to volume growth in the loan and deposit portfolios,
as well as the receipt of an approximately $32,000 prepayment penalty on a loan.
24
Noninterest Expenses
Total noninterest expenses were $2.8 million for the year ended
December 31, 2003 versus $1.9 million for 2002, an increase of $900,000 or 47%.
The increase in expenses is due to the growth in Bancorp's loan and deposit
volume as well as the addition of the Amity office in March of 2003, requiring
additional staffing and other operating expenses. As a result, salaries and
benefits increased $548,000 to $1.5 million in fiscal year 2003 in comparison to
fiscal year 2002, and occupancy and equipment expenses increased by $184,000 in
fiscal year 2003 to $370,000.
Professional services decreased for the year ended December 31, 2003
versus the year ended December 31, 2002 by $61,000. The decrease is primarily
the result of hiring Michael M. Ciaburri as President and Chief Operating
Officer of the Bank as of February 12, 2003, who had worked up to that point as
a consultant to the bank developing new loan and deposit account volume.
Off-Balance-Sheet Arrangements
See Note 12 to the accompanying consolidated Financial Statements for
required disclosure regarding off-balance-sheet arrangements.
Liquidity
Bancorp's liquidity position as of December 31, 2003 and December 31,
2002 consisted of liquid assets totaling $11.1 million and $12.6 million,
respectively. This represents 19.6% and 35.5% of total assets at December 31,
2003 and 2002, respectively. The liquidity ratio is defined as the percentage of
liquid assets to total assets. The following categories of assets as described
in the accompanying balance sheet are considered liquid assets: Cash and due
from banks, federal funds sold, short-term investments and securities available
for sale. Liquidity is a measure of Bancorp's ability to generate adequate cash
to meet financial obligations. The principal cash requirements of a financial
institution are to cover downward fluctuations in deposits and increases in its
loan portfolio.
Management believes Bancorp's short-term assets have sufficient
liquidity to cover potential fluctuations in deposit accounts and loan demand
and to meet other anticipated operating cash requirements.
Capital
The following table illustrates the Bank's regulatory capital ratios at
December 31:
2003 2002
------- -------
Leverage Capital 14.16% 23.76 %
Tier 1 Risk - Based Capital 16.33% 31.52 %
Total Risk - Based Capital 17.24% 32.43 %
Capital adequacy is one of the most important factors used to determine
the safety and soundness of individual banks and the banking system. Based on
the above ratios, the Bank is considered to be "well capitalized" under
applicable regulations. To be considered "well capitalized" an institution must
generally have a leverage capital ratio of at least 5%, a Tier 1 risk-based
capital ratio of at least 6% and a total risk-based capital ratio of at least
10%.
Bancorp's actual and required ratios are not substantially different
from those shown above.
Subject to regulatory approval and completion of a public offering of
additional common shares during 2004, Bancorp has intentions to establish The
Bank of Southeastern Connecticut in the fourth quarter of 2004. Bancorp also
anticipates commencing the operations of SCB Capital, Inc. in the second half of
2004. Provided both regulatory approval of the new bank subsidiary and the
success of the public offering, Bancorp will capitalize both of these entities
in 2004. The application for the Bank of Southeastern Connecticut specifies that
25
the initial capitalization of The Bank of Southeastern Connecticut will be
approximately $6 million. The National Association of Security Dealers rules and
regulations require a minimum capitalization for SCB Capital, Inc. to be not
less than $25,000.
Market Risk
Market risk is defined as the sensitivity of income to fluctuations in
interest rates, foreign exchange rates, equity prices, commodity prices and
other market-driven rates or prices. Based upon on the nature of the Company's
business, market risk is primarily limited to interest rate risk, which is the
impact that changing interest rates have on current and future earnings.
Bancorp's goal is to maximize long-term profitability, while minimizing
its exposure to interest rate fluctuations. The first priority is to structure
and price Bancorp's assets and liabilities to maintain an acceptable interest
rate spread, while reducing the net effect of changes in interest rates. In
order to reach an acceptable interest rate spread, Bancorp must generate loans
and seek acceptable long-term investments to replace the lower yielding balances
in Federal Funds sold and short-term investments. The focus also must be on
maintaining a proper balance between the timing and volume of assets and
liabilities re-pricing within the balance sheet. One method of achieving this
balance is to originate variable loans for the portfolio to offset the
short-term re-pricing of the liabilities. In fact, a number of the interest
bearing deposit products have no contractual maturity. Customers may withdraw
funds from their accounts at any time and deposits balances may therefore run
off unexpectedly due to changing market conditions.
The exposure to interest rate risk is monitored by the Asset and
Liability Management Committee ("ALCO") consisting of senior management
personnel and selected members of the Board of Directors. ALCO reviews the
interrelationships within the balance sheet to maximize net interest income
within acceptable levels of risk. ALCO reports to the Board of Directors on a
quarterly basis regarding the status of ALCO activities within the Company.
Impact of Inflation and Changing Prices
Bancorp's financial statements have been prepared in terms of
historical dollars, without considering changes in relative purchasing power of
money over time due to inflation. Unlike most industrial companies, virtually
all of the assets and liabilities of a financial institution are monetary in
nature. As a result, interest rates have a more significant impact on a
financial institution's performance than the effect of general levels of
inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as the prices of goods and services. Notwithstanding this
fact, inflation can directly affect the value of loan collateral, in particular,
real estate. Inflation, or disinflation, could significantly affect Bancorp's
earnings in future periods.
"Safe Harbor" Statement Under Private Securities Litigation Reform Act of 1995.
Certain statements contained in Bancorp's public reports, including
this report, and in particular in this "Management's Discussion and Analysis or
Plan of Operation", may be forward looking and subject to a variety of risks and
uncertainties. These factors include, but are not limited to, (1) changes in
prevailing interest rates which would affect the interest earned on Bancorp's
interest earning assets and the interest paid on its bearing liabilities, (2)
the timing of re-pricing of Bancorp's interest earning assets and interest
bearing liabilities, (3) the effect of changes in governmental monetary policy,
(4) the effect of changes in regulations applicable to Bancorp and the conduct
of its business, (5) changes in competition among financial service companies,
including possible further encroachment of non-banks on services traditionally
provided by banks and the impact of recently enacted federal legislation, (6)
the ability of competitors which are larger than Bancorp to provide products and
services which it is impracticable for Bancorp to provide, (7) the effect of
Bancorp's opening of branches, (8) the effect of any decision by Bancorp to
engage in any business not historically permitted to it. Other such factors may
be described in Bancorp's filings with the SEC.
26
Although Bancorp believes that it offers the loan and deposit products
and has the resources needed for success, future revenues and interest spreads
and yields cannot be reliably predicted. These trends may cause Bancorp to
adjust its operations in the future. Because of the foregoing and other factors,
recent trends should not be considered reliable indicators of future financial
results or stock prices.
Item 7. Financial Statements
--------------------
The consolidated balance sheets of Bancorp as of December 31, 2003 and
2002, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years then ended, together with the report thereon
of McGladrey & Pullen, LLP dated March 5, 2004 are included as part of this Form
10-KSB in the "Financial Report" following page 33 hereof.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
-----------------------------------------------------------------------
Not applicable.
Item 8a. Controls and Procedures
-----------------------
(a) Evaluation of disclosure controls and procedures
Based upon an evaluation of the effectiveness of Bancorp's disclosure
controls and procedures performed by Bancorp's management, with participation of
Bancorp's Chief Executive Officer and its Chief Financial Officer as of the end
of the period covered by this report, Bancorp's Chief Executive Officer and
Chief Financial Officer concluded that Bancorp's disclosure controls have been
effective.
As used herein, "disclosure controls and procedures" mean controls and
other procedures of Bancorp that are designed to ensure that information
required to be disclosed by Bancorp in the reports that it files or submits
under the Securities Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Commissions rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by
Bancorp in the reports that it files or submits under the Securities Exchange
Act is accumulated and communicated to Bancorp's management, including its
principal executive, and principal financial officers, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure.
(b) Changes in Internal Controls
There have not been any significant changes in Bancorp's internal
controls or in other factors that occurred during Bancorp's fiscal year ended
December 31, 2003 that could significantly affect these controls subsequent to
the evaluation referenced in paragraph (a) above.
PART III
Item 9. Directors and Executive Officers of the Registrant
--------------------------------------------------
The information required by this Item 9 is incorporated into this Form
10-KSB by reference to Bancorp's definitive proxy statement for its 2004 Annual
Meeting of Shareholders (the "Definitive Proxy Statement").
27
Item 10. Executive Compensation
----------------------
The information required by this Item 10 is incorporated into this Form
10-KSB by reference to the Definitive Proxy Statement.
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
------------------------------------------------------------------
The information required by this Item 11 is incorporated into this Form
10-KSB by reference to the Definitive Proxy Statement.
Item 12. Certain Relationships and Related Transactions
----------------------------------------------
The information required by this Item 12 is incorporated into this Form
10-KSB by reference to the Definitive Proxy Statement.
Item 13. Exhibits, List and Reports on Form 8-K
--------------------------------------
(a) Exhibits
No. Description
--- -----------
3(i) Amended and Restated Certificate of Incorporation of the Issuer
(incorporated by reference to Exhibit 3(i) to Issuer's Quarterly Report
on Form 10-QSB dated June 30, 2002)
3(ii) By-Laws of the Issuer (incorporated by reference to Exhibit 3(ii) to
the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.1 Lease, dated as of August 17, 2000, between 215 Church Street, LLC and
the Issuer (incorporated by reference to Exhibit 10.1 to the Issuer's
Registration Statement on Form SB-2 (No. 333-59824))
10.2 Letter agreement dated January 3, 2001 amending the Lease between 215
Church Street, LLC and the Issuer (incorporated by reference to Exhibit
10.2 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.3 First Amendment to Lease dated March 30, 2001 between 215 Church
Street, LLC and the Issuer (incorporated by reference to Exhibit 10.3
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.4 Second Amendment to Lease dated March 31, 2001 between 215 Church
Street, LLC and the Issuer (incorporated by reference to Exhibit 10.4
to the Issuer's Registration Statement Form SB-2 (No. 333-59824))
10.5 Assignment of Lease dated April 11, 2001 between the Issuer and The
Bank of Southern Connecticut (incorporated by reference to Exhibit 10.5
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.6 Employment Agreement dated as of January 23, 2001, between The Bank of
Southern Connecticut, the Issuer and Joseph V. Ciaburri (incorporated
by reference to Exhibit 10.6 to the Issuer's Registration Statement on
Form SB-2 (No. 333-59824))
10.7 Employment Agreement dated as of March 29, 2001 between The Bank of
Southern Connecticut, and Gary D. Mullin (incorporated by reference to
Exhibit 10.7 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.8 Issuer's 2001 Stock Option Plan (incorporated by reference to Exhibit
10.8 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
28
10.9 Issuer's 2001 Warrant Plan (incorporated by reference to Exhibit 10.9
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.10 Sublease dated January 1, 2001 between Michael Ciaburri, d/b/a Ciaburri
Bank Strategies and The Bank of Southern Connecticut (incorporated by
reference to Exhibit 10.10 to the Issuer's Registration Statement on
Form SB-2 (No. 333-59824))
10.11 Sublease dated January 1, 2001 between Laydon and Company, LLC and The
Bank of Southern Connecticut (incorporated by reference to Exhibit
10.11 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.12 Issuer's 2001 Supplemental Warrant Plan (incorporated by reference to
Exhibit 10.12 to Issuer's Annual Report on Form 10-KSB dated March 29,
2002)
10.13 Issuer's 2002 Stock Option Plan (incorporated by reference to Appendix
B to Issuer's Definitive Proxy Statement dated April 18, 2002).
10.14 Employment Agreement dated as of February 12, 2003, between The Bank of
Southern Connecticut and Michael M. Ciaburri. (incorporated by
reference to Exhibit 10.14 to Issuer's Form 10-QSB dated May 14, 2003).
10.15 Amendment to Employment Agreement dated as of October 20, 2003, between
The Bank of Southern Connecticut and Southern Connecticut Bancorp, Inc.
and Joseph V. Ciaburri. (incorporated by reference to Exhibit 10.15 to
issuer's Form 10-QSB dated November 12, 2003)
10.16 Lease dated January 14, 2004 between The City of New London and the
Issuer (attached hereto)
10.17 Lease dated August 2, 2002, between 469 West Main Street LLC and The
Bank of Southern Connecticut (attached hereto)
14. Code of Ethics (attached hereto)
21. Subsidiaries (incorporated by reference to Exhibit 21 to Issuer's form
10-KSB dated March 31, 2003)
31.1 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by Chairman and
Chief Executive Officer.
31.2 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by President and
Chief Operating Officer.
31.3 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by Vice President
and Chief Financial Officer.
32.1 Section 1350 Certification by Chairman and Chief Executive Officer.
32.2 Section 1350 Certification by President and Chief Operating Officer.
32.3 Section 1350 Certification by Vice President and Chief Financial
Officer.
29
Item 14. Principal Accountant Fees and Services
--------------------------------------
Bancorp's Principal Accountants, McGladrey & Pullen, LLP provide audit,
audit related and tax advisory and tax return preparation services for Bancorp
and The Bank of Southern Connecticut. The following table summaries the fees
provided in 2003 and 2002 respectively:
2003 2002
---- ----
Audit Fees $81,583 $74,344
Audit Related Fees $ 6,235 $ 9,600
Tax Fees $ 7,565 $ 7,065
All Other Fees NONE NONE
Audit fees consist of fees for professional services rendered for the
audit of the consolidated financial statements, review of financial statements
included in quarterly reports included on Form 10-QSB, and services connected
with statutory and regulatory filings or engagements. Audit related fees are
principally for consultations on various accounting and reporting matters. Tax
service fees consist of fees for tax return preparation for Bancorp.
30
SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly
SOUTHERN CONNECTICUT BANCORP, INC.
(Registrant)
By: /S/ Joseph V. Ciaburri
-----------------------
Name: Joseph V. Ciaburri
Title: Chairman and Chief
Executive Officer
Date: March 30, 2004
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in capacities and
on the dates indicated.
/S/ Joseph V. Ciaburri March 30, 2004
------------------------------------ -----------------
Joseph V. Ciaburri Date
Chief Executive Officer and Director
/S/ Elmer F. Laydon March 30, 2004
------------------------------------ -----------------
Elmer F. Laydon Date
Vice Chairman and Director
/S/ Juan Jose Alvarez de Lugo March 30, 2004
------------------------------------ -----------------
Juan Jose Alvarez de Lugo Date
Director
/S/ G. Leon Jacobs March 30, 2004
------------------------------------ -----------------
G. Leon Jacobs Date
Director
/S/ Joshua H. Sandman March 30 2004
------------------------------------ -----------------
Joshua H. Sandman Date
Director
/S/ Alphonse F. Spadaro, Jr. March 30, 2004
------------------------------------ -----------------
Alphonse F. Spadaro, Jr. Date
Director
/S/ Carl R. Borrelli March 30, 2004
------------------------------------ -----------------
Carl R. Borrelli Date
Director
/S/ William F. Weaver March 30, 2004
------------------------------------ -----------------
William F. Weaver Date
Chief Financial Officer
31
Exhibit Index
No. Description
--- -----------
3(i) Amended and Restated Certificate of Incorporation of the Issuer
(incorporated by reference to Exhibit 3(i) to Issuer's Quarterly Report
on Form 10-QSB dated June 30, 2002)
3(ii) By-Laws of the Issuer (incorporated by reference to Exhibit 3(ii) to
the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.1 Lease, dated as of August 17, 2000, between 215 Church Street, LLC and
the Issuer (incorporated by reference to Exhibit 10.1 to the Issuer's
Registration Statement on Form SB-2 (No. 333-59824))
10.2 Letter agreement dated January 3, 2001 amending the Lease between 215
Church Street, LLC and the Issuer (incorporated by reference to Exhibit
10.2 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.3 First Amendment to Lease dated March 30, 2001 between 215 Church
Street, LLC and the Issuer (incorporated by reference to Exhibit 10.3
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.4 Second Amendment to Lease dated March 31, 2001 between 215 Church
Street, LLC and the Issuer (incorporated by reference to Exhibit 10.4
to the Issuer's Registration Statement Form SB-2 (No. 333-59824))
10.5 Assignment of Lease dated April 11, 2001 between the Issuer and The
Bank of Southern Connecticut (incorporated by reference to Exhibit 10.5
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.6 Employment Agreement dated as of January 23, 2001, between The Bank of
Southern Connecticut, the Issuer and Joseph V. Ciaburri (incorporated
by reference to Exhibit 10.6 to the Issuer's Registration Statement on
Form SB-2 (No. 333-59824))
10.7 Employment Agreement dated as of March 29, 2001 between The Bank of
Southern Connecticut, and Gary D. Mullin (incorporated by reference to
Exhibit 10.7 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.8 Issuer's 2001 Stock Option Plan (incorporated by reference to Exhibit
10.8 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.9 Issuer's 2001 Warrant Plan (incorporated by reference to Exhibit 10.9
to the Issuer's Registration Statement on Form SB-2 (No. 333-59824))
10.10 Sublease dated January 1, 2001 between Michael Ciaburri, d/b/a Ciaburri
Bank Strategies and The Bank of Southern Connecticut (incorporated by
reference to Exhibit 10.10 to the Issuer's Registration Statement on
Form SB-2 (No.
333-59824))
10.11 Sublease dated January 1, 2001 between Laydon and Company, LLC and The
Bank of Southern Connecticut (incorporated by reference to Exhibit
10.11 to the Issuer's Registration Statement on Form SB-2 (No.
333-59824))
10.12 Issuer's 2001 Supplemental Warrant Plan (incorporated by reference to
Exhibit 10.12 to Issuer's Annual Report on Form 10-KSB dated March 29,
2002)
10.13 Issuer's 2002 Stock Option Plan (incorporated by reference to Appendix
B to Issuer's Definitive Proxy Statement dated April 18, 2002).
10.14 Employment Agreement dated as of February 12, 2003, between The Bank of
Southern Connecticut and Michael M. Ciaburri. (incorporated by
reference to Exhibit 10.14 to Issuer's Form 10-QSB dated May 14, 2003).
32
10.15 Amendment to Employment Agreement dated as of October 20, 2003, between
The Bank of Southern Connecticut and Southern Connecticut Bancorp, Inc.
and Joseph V. Ciaburri. (incorporated by reference to Exhibit 10.15 to
issuer's Form 10-QSB dated November 12, 2003)
10.16 Lease dated January 14, 2004 between The City of New London and the
Issuer (attached hereto)
10.17 Lease dated August 2, 2002, between 469 West Main Street LLC and The
Bank of Southern Connecticut (attached hereto)
14. Code of Ethics (attached hereto)
21. Subsidiaries (incorporated by reference to Exhibit 21 to Issuer's form
10-KSB dated March 31, 2003)
31.1 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by Chairman and
Chief Executive Officer.
31.2 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by President and
Chief Operating Officer.
31.3 Section Rule 13(a)-14(a)/15(d)-14(a) Certification by Vice President
and Chief Financial Officer.
32.1 Section 1350 Certification by Chairman and Chief Executive Officer.
32.2 Section 1350 Certification by President and Chief Operating Officer.
32.4 Section 1350 Certification by Vice President and Chief Financial
Officer
33
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
FINANCIAL REPORT
December 31, 2003 and 2002
CONTENTS
--------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT 1
--------------------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets 2
Consolidated Statements of Operations 3
Consolidated Statements of Shareholders' Equity 4
Consolidated Statements of Cash Flows 5-6
Notes to Consolidated Financial Statements 7-33
--------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Southern Connecticut Bancorp, Inc. and Subsidiary
New Haven, Connecticut
We have audited the accompanying consolidated balance sheets of Southern
Connecticut Bancorp, Inc. and Subsidiary (the "Company") as of December 31, 2003
and 2002, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Southern Connecticut
Bancorp, Inc. and Subsidiary as of December 31, 2003 and 2002, and the results
of their operations and their cash flows for the years then ended, in conformity
with accounting principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
New Haven, Connecticut
March 5, 2004
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
-------------------------------------------------------------------------------
2003 2002
-------------------------------
ASSETS
Cash and due from banks (Note 2) $ 1,147,883 $ 1,245,010
Federal funds sold 966,000 1,144,000
Short-term investments (Note 2) 454,115 662,419
-------------------------------
Cash and cash equivalents 2,567,998 3,051,429
-------------------------------
Available for sale securities (at fair value) (Note 3) 8,478,068 9,501,492
Federal Home Loan Bank stock (Note 7) 21,500 500
Loans receivable (net of allowance for loan losses: 2003 $421,144;
2002 $232,000) (Note 4) 40,818,718 19,049,212
Accrued interest receivable 196,545 187,672
Premises and equipment, net (Note 5) 3,459,915 3,052,921
Other assets 843,296 656,889
-------------------------------
Total assets $ 56,386,040 $ 35,500,115
===============================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits (Note 6)
Noninterest bearing deposits $ 13,781,286 $ 6,401,759
Interest bearing deposits 33,492,589 18,591,172
-------------------------------
Total deposits 47,273,875 24,992,931
Repurchase agreements 339,752 822,259
Accrued expenses and other liabilities 267,232 178,489
Capital lease obligations (Note 8) 1,190,879 1,191,852
Deferred tax liability (Note 9) - 39,905
-------------------------------
Total liabilities 49,071,738 27,225,436
-------------------------------
Commitments and Contingencies (Notes 7, 8, 11, 12, 13, 16 and 17)
Shareholders' Equity (Notes 10 and 13)
Preferred stock, no par value; 500,000 shares authorized;
none issued - -
Common stock, par value $.01; shares authorized: 5,000,000;
shares issued and outstanding: 2003 1,063,320; 2002 966,667 10,633 9,667
Additional paid-in capital 10,704,269 10,705,382
Accumulated deficit (3,100,842) (2,502,915)
Accumulated other comprehensive income (loss) - net unrealized (loss) gain on
available for sale securities (299,758) 62,545
-------------------------------
Total shareholders' equity 7,314,302 8,274,679
-------------------------------
Total liabilities and shareholders' equity $ 56,386,040 $ 35,500,115
===============================
See Notes to Consolidated Financial Statements.
2
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2003 and 2002
--------------------------------------------------------------------------------
2003 2002
------------------------------
Interest Income:
Interest and fees on loans $ 2,224,547 $ 743,501
Interest on securities 255,545 262,986
Interest on Federal funds sold and short-term investments 31,994 118,834
------------------------------
Total interest income 2,512,086 1,125,321
------------------------------
Interest Expense:
Interest expense on deposits (Note 6) 397,993 300,694
Interest expense on capital lease obligations 168,767 137,402
Interest expense on repurchase agreements and other borrowings 8,035 3,717
------------------------------
Total interest expense 574,795 441,813
------------------------------
Net interest income 1,937,291 683,508
------------------------------
Provision for Loan Losses (Note 4) 213,100 220,000
------------------------------
Net interest income after
provision for loan losses 1,724,191 463,508
------------------------------
Noninterest Income:
Service charges and fees 128,251 86,163
Gains and fees from sales and referrals of SBA loans 177,018 -
Gains on sales of available for sale securities (Note 3) 44,505 -
Other noninterest income 146,558 -
------------------------------
Total noninterest income 496,332 86,163
------------------------------
Noninterest Expenses:
Salaries and benefits (Note 7) 1,462,085 913,853
Occupancy and equipment expense 369,794 185,902
Professional services 307,423 368,131
Data processing and other outside services 196,820 124,841
Advertising and promotional expenses 94,614 97,732
Forms, printing and supplies 59,828 42,981
Other operating expenses 327,886 200,244
------------------------------
Total noninterest expenses 2,818,450 1,933,684
------------------------------
Net loss $ (597,927) $ (1,384,013)
==============================
Basic and Diluted Loss per Share $ (0.56) $ (1.30)
==============================
Dividends per Share $ - $ -
==============================
See Notes to Consolidated Financial Statements.
3
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Years Ended December 31,
2003 and 2002
--------------------------------------------------------------------------------
Accumulated
Additional Other
Number Common Paid-In Accumulated Comprehensive
of Shares Stock Capital Deficit Income (Loss) Total
------------------------------------------------------------------------------------
Balance, December 31, 2001 966,667 $ 9,667 $ 10,705,382 $ (1,118,902) $ - $ 9,596,147
Comprehensive income:
Net loss - - - (1,384,013) - (1,384,013)
Unrealized holding gain on available for
sale securities (Note 15) - - - - 62,545 62,545
---------------
Total comprehensive loss (1,321,468)
------------------------------------------------------------------------------------
Balance, December 31, 2002 966,667 9,667 10,705,382 (2,502,915) 62,545 8,274,679
---------------
Comprehensive income (loss):
Net loss - - - (597,927) - (597,927)
Unrealized holding loss on available for
sale securities (Note 15) - - - - (362,303) (362,303)
---------------
Total comprehensive loss (960,230)
---------------
10% stock dividend declared January 13,
2004 - 96,653 shares 96,653 966 (966) - - -
Fractional shares to be paid in cash - - (147) - - (147)
------------------------------------------------------------------------------------
Balance, December 31, 2003 1,063,320 $10,633 $ 10,704,269 $ (3,100,842) $ (299,758) $ 7,314,302
==================================================================== ===============
See Notes to Consolidated Financial Statements.
4
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2003 and 2002
--------------------------------------------------------------------------------
2003 2002
-----------------------------------
Cash Flows From Operations
Net loss $ (597,927) $ (1,384,013)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization and accretion of premiums and discounts
on investments, net 34,071 47,441
Provision for loan losses 213,100 220,000
Gains on sales of available for sale securities (44,505) -
Gains on sales of SBA loans (122,269) -
Depreciation and amortization 219,853 117,498
Increase in cash surrender value of life insurance (38,344) -
Changes in assets and liabilities:
Increase in deferred loan fees 29,219 54,091
Increase in accrued interest receivable (8,873) (109,780)
(Increase) decrease in other assets (148,063) 1,895
Increase (decrease) in accrued expenses and other liabilities 88,596 (3,732)
-----------------------------------
Net cash used in operating activities (375,142) (1,056,600)
-----------------------------------
Cash Flows From Investing Activities
Purchases of available for sale securities (10,949,683) (1,890,699)
Principal repayments on available for sale securities 1,038,338 7,173
Proceeds from maturities of available for sale securities 6,185,000 -
Proceeds from sales of available for sale securities 4,357,995 -
Purchases of held to maturity securities - (6,277,529)
Maturities of held to maturity securities - 2,800,000
Purchase of FHLB stock (21,000) (500)
Proceeds from sales of SBA loans 1,295,122 -
Net increase in loans receivable (23,184,678) (18,127,959)
Purchase of life insurance policy - (521,000)
Purchases of premises and equipment (626,847) (1,348,763)
-----------------------------------
Net cash used in investing activities (21,905,753) (25,359,277)
-----------------------------------
Cash Flows From Financing Activities
Net increase in demand, savings and money market deposits 18,523,708 15,295,349
Net increase in time certificates of deposit 3,757,236 2,913,551
Net (decrease) increase in repurchase agreements (482,507) 822,259
Principal repayments on capital lease obligations (973) (184)
-----------------------------------
Net cash provided by financing activities 21,797,464 19,030,975
-----------------------------------
Net decrease in cash and cash equivalents (483,431) (7,384,902)
Cash and cash equivalents
Beginning 3,051,429 10,436,331
-----------------------------------
Ending $ 2,567,998 $ 3,051,429
===================================
5
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
For the Years Ended December 31, 2003 and 2002
--------------------------------------------------------------------------------
2003 2002
-----------------------------------
Supplemental Disclosures of Cash Flow Information:
Cash paid for:
Interest $ 551,398 $ 417,344
===================================
Income taxes $ - $ -
===================================
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
Transfer of held to maturity securities to available for sale securities (Note 3) $ - $ 7,517,682
===================================
Unrealized holding (losses) gains on available for sale securities arising
during the period $ (402,208) $ 102,450
===================================
Fractional stock dividend shares payable in cash $ 147 $ -
===================================
Capital lease incurred for acquisition of building $ - $ 342,036
===================================
See Notes to Consolidated Financial Statements.
6
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies
Southern Connecticut Bancorp, Inc. (the "Company"), a Connecticut corporation,
is a bank holding company incorporated on November 8, 2000 and is the sole
shareholder of the Bank of Southern Connecticut (the "Bank"). The Bank provides
a full range of banking services to commercial and consumer customers, primarily
concentrated in the New Haven County area of Connecticut, through its main
office in New Haven, Connecticut and two branch offices in New Haven and
Branford, Connecticut. In 2003, SCB Capital, Inc. was formed as a Connecticut
corporation, and in 2004, the Company plans to capitalize SCB Capital, Inc.,
which will become a subsidiary of the Company. SCB Capital, Inc. will engage in
a limited range of investment banking, advisory and brokerage services,
primarily with small and medium size business clients.
Principles of consolidation and basis of financial statement presentation
-------------------------------------------------------------------------
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, the Bank, and have been prepared in accordance with
accounting principles generally accepted in the United States of America and
general practices within the banking industry. All significant intercompany
balances and transactions have been eliminated. In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities, and disclosures of
contingent assets and liabilities as of the date of the balance sheet and the
reported amounts of income and expenses for the reporting period. Actual results
could differ from those estimates.
Significant group concentrations of credit risk
-----------------------------------------------
Most of the Company's activities are with customers located within the New Haven
County region of Connecticut. Note 3 discusses the types of securities that the
Company invests in and Note 4 discusses the types of lending that the Company
engages in. The Company does not have any significant concentrations in any one
industry or customer.
The following is a summary of the Company's significant accounting policies.
Cash and cash equivalents and statement of cash flows
-----------------------------------------------------
Cash and due from banks, Federal funds sold, and short-term investments are
recognized as cash equivalents in the statements of cash flows. Federal funds
sold generally mature in one day. For purposes of reporting cash flows, the
Company considers all highly liquid debt instruments purchased with an original
maturity of three months or less to be cash equivalents. Cash flows from
deposits are reported net. The Company maintains amounts due from banks and
Federal funds sold which, at times, may exceed Federally insured limits. The
Company has not experienced any losses from such concentrations.
7
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Investments in debt and marketable equity securities
----------------------------------------------------
Management determines the appropriate classification of securities at the date
individual investment securities are acquired, and the appropriateness of such
classification is reassessed at each balance sheet date.
Debt securities that management has the positive intent and ability to hold to
maturity are classified as "held to maturity" and recorded at amortized cost.
"Trading" securities, if any, are carried at fair value with unrealized gains
and losses recognized in earnings. Securities not classified as held to maturity
or trading, including equity securities with readily determinable fair values,
are classified as "available for sale" and recorded at fair value, with
unrealized gains and losses excluded from earnings and reported in other
comprehensive income, net of taxes.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the fair value of
held to maturity and available for sale securities below their cost that are
deemed to be other than temporary are reflected in earnings as realized losses.
In estimating other-than-temporary impairment losses, management considers (1)
the length of time and the extent to which the fair value has been less than
cost, (2) the financial condition and near-term prospects of the issuer, and (3)
the intent and ability of the Company to retain its investment in the issuer for
a period of time sufficient to allow for any anticipated recovery in fair value.
Gains and losses on the sale of securities are recorded on the trade date and
are determined using the specific identification method.
The sale of a held to maturity security within three months of its maturity date
or after collection of at least 85% of the principal outstanding at the time the
security was acquired is considered a maturity for purposes of classification
and disclosure.
Transfers of financial assets
-----------------------------
Transfers of financial assets are accounted for as sales when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right to pledge or exchange the transferred assets and no
condition both constrains the transferee from taking advantage of that right and
provides more than a trivial benefit for the transferor, and (3) the transferor
does not maintain effective control over the transferred assets through either
(a) an agreement that both entitles and obligates the transferor to repurchase
or redeem the assets before maturity or (b) the ability to unilaterally cause
the holder to return specific assets, other than through a cleanup call.
Servicing
---------
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of financial assets. Generally, purchased
servicing rights are capitalized at the cost to acquire the rights. For sales of
loans, a portion of the original cost of the loan is allocated to the servicing
right, and if the pass-through rate to the investor is less than the note rate,
to an interest-only strip, based on relative
8
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
fair value. Fair value is based on a valuation model that calculates the present
value of estimated future net servicing and interest income. The valuation model
incorporates assumptions that market participants would use in estimating future
net servicing and interest income, such as the cost to service, the discount
rate, the custodial earnings rate, an inflation rate, ancillary income,
prepayment speeds and default rates and losses. Capitalized servicing rights are
reported in other assets and are amortized into non-interest income in
proportion to, and over the period of, the estimated future net servicing income
of the underlying financial assets. Interest only strips are also reported in
other assets and are amortized into interest income under the same method as
servicing assets.
Servicing assets and interest-only strips are evaluated for impairment based
upon the fair value of the assets as compared to amortized cost. Impairment is
determined by stratifying the assets into tranches based on predominant risk
characteristics, such as interest rate, loan type and investor type. Impairment
is recognized through a valuation allowance for an individual tranche, to the
extent that fair value is less than the capitalized amount for the tranche. If
the Company later determines that all or a portion of the impairment no longer
exists for a particular tranche, a reduction of the allowance may be recorded as
an increase to income.
Servicing fee income is recorded for fees earned for servicing loans. The fees
are based on a contractual percentage of the outstanding principal; or a fixed
amount per loan and are recorded as income when earned. The amortization of
mortgage servicing rights is netted against loan servicing fee income, and the
amortization of interest-only strips is netted against interest income.
Loans receivable
----------------
Loans receivable are stated at their current unpaid principal balances, net of
the allowance for loan losses and net deferred loan origination fees and costs.
The Company has the ability and intent to hold its loans receivable for the
foreseeable future or until maturity or payoff.
Impaired loans, if any, are measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or, as a
practical expedient, at the loan's observable market price or the fair value of
the collateral, if the loan is collateral dependent. The amount of impairment,
if any, and any subsequent changes are recorded as adjustments to the allowance
for loan losses. A loan is impaired when it is probable the Company will be
unable to collect all contractual principal and interest payments due in
accordance with the terms of the loan agreement.
A loan is classified as a restructured loan when certain concessions have been
made to the original contractual terms, such as a reduction in interest rate or
deferral of interest or principal payments, due to the borrower's financial
condition.
Management considers all nonaccrual loans, other loans past due 90 days or more,
and restructured loans to be impaired. In most cases, loan payments that are
past due less than 90 days, based on contractual terms, are considered minor
collection delays, and the related loans are not considered to be impaired. The
9
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Company considers consumer installment loans to be pools of small balance
homogeneous loans, which are collectively evaluated for impairment.
Allowance for loan losses
-------------------------
The allowance for loan losses, a material estimate which could change
significantly in the near-term, is established as losses are estimated to have
occurred through a provision for losses charged against operations, and is
maintained at a level that management considers adequate to absorb losses in the
loan portfolio. Management's judgment in determining the adequacy of the
allowance is inherently subjective and is based on the evaluation of individual
loans, pools of homogeneous loans, the known and inherent risk characteristics
and size of the loan portfolios, the assessment of current economic and real
estate market conditions, estimates of the current value of underlying
collateral, past loan loss experience, review of regulatory authority
examination reports and evaluations of specific loans and other relevant
factors. Loans, including impaired loans, are charged against the allowance for
loan losses when management believes that the uncollectibility of principal is
confirmed. Any subsequent recoveries are credited to the allowance for loan
losses when received. In connection with the determination of the allowance for
loan losses, management obtains appraisals for significant properties, when
considered necessary.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower than
the carrying value of that loan. The general component covers non-classified
loans and is based on historical loss experience adjusted for qualitative
factors. An unallocated component may be maintained to cover uncertainties that
could affect management's estimate or probable losses. The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.
Management believes the allowance for loan losses is adequate. While management
uses available information to recognize losses on loans, future additions to the
allowance or write-downs may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Company's allowance for loan
losses. Such agencies have the authority to require the Company to recognize
additions to the allowance or charge-offs based on the agencies' judgments about
information available to them at the time of their examination.
Interest and fees on loans
--------------------------
Interest on loans is accrued and included in operating income based on
contractual rates applied to principal amounts outstanding. The accrual of
interest income is discontinued whenever reasonable doubt exists as to its
collectibility and generally is discontinued when loans are past due 90 days as
to either principal or interest, or are otherwise considered impaired. When the
accrual of interest income is discontinued, all previously accrued and
uncollected interest is reversed against interest income. The accrual of
10
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
interest on loans past due 90 days or more may be continued if the loan is well
secured, and it is believed all principal and accrued interest income due on the
loan will be realized, and the loan is in the process of collection. A
nonaccrual loan is restored to an accrual status when it is no longer delinquent
and collectibility of interest and principal is no longer in doubt.
Loan origination fees, net of direct loan origination costs, are deferred and
amortized as an adjustment to the loan's yield generally over the contractual
life of the loan, utilizing the interest method.
Premises and equipment
----------------------
Premises and equipment are stated at cost for purchased assets, and for assets
under capital lease, at the lower of fair value or the net present value of the
minimum lease payments required over the term of the lease, net of accumulated
depreciation and amortization. Leasehold improvements are capitalized and
amortized over the shorter of the terms of the related leases or the estimated
economic lives of the improvements. Depreciation is charged to operations using
the straight-line method over the estimated useful lives of the related assets
which range from 3 to 20 years. Gains and losses on dispositions are recognized
upon realization. Maintenance and repairs are expensed as incurred and
improvements are capitalized.
Impairment of long-lived assets
-------------------------------
Long-lived assets, including premises and equipment, which are held and used by
the Company, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If impairment is indicated by that review, the asset is written
down to its estimated fair value through a charge to noninterest expense.
Repurchase agreements
---------------------
Repurchase agreements, which are classified as secured borrowings, generally
mature within one to three days from the transaction date, and are reflected at
the amount of cash received in connection with the transaction. The Company may
be required to provide additional collateral based on the fair value of the
underlying securities.
Income taxes
------------
The Company recognizes income taxes under the asset and liability method. Under
this method, deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and loss carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized.
11
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Stock compensation plans
------------------------
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation", encourages all entities to adopt a fair value based
method of accounting for employee stock compensation plans, whereby compensation
cost is measured at the grant date based on the value of the award and is
recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date (or other measurement date) over the
amount an employee must pay to acquire the stock. Stock options issued to
employees and directors under the Company's stock option and warrant plans have
no intrinsic value at the grant date, and under Opinion No. 25 no compensation
cost is recognized for them. The Company has elected to continue with the
accounting methodology in Opinion No. 25 and, as a result, has provided pro
forma disclosures of net loss and earnings (loss) per share and other
disclosures, as if the fair value based method of accounting had been applied.
Had compensation cost for issuance of such options and warrants been recognized
based on the fair values of awards on the grant dates, in accordance with the
method described in SFAS No. 123, reported net loss and per share amounts for
2003 and 2002 would have been increased to the pro forma amounts shown below:
2003 2002
--------------------------------------
Net loss, as reported $ (597,927) $ (1,384,013)
Deduct: total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects (229,473) (138,009)
--------------------------------------
Pro forma net loss $ (827,400) $ (1,522,022)
======================================
Basic and diluted loss per share:
As reported $ (0.56) $ (1.30)
======================================
Pro forma $ (0.78) $ (1.43)
======================================
Related party transactions
--------------------------
Directors and officers of the Company and the Bank and their affiliates have
been customers of and have had transactions with the Bank, and it is expected
that such persons will continue to have such transactions in the future.
Management believes that all deposit accounts, loans, services and commitments
comprising such transactions were made in the ordinary course of business, and
on substantially the same terms, including interest rates, as those prevailing
at the time for comparable transactions with other customers who are not
12
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
directors or officers. In the opinion of management, the transactions with
related parties did not involve more than normal risks of collectibility or
favored treatment or terms, or present other unfavorable features. Notes 2, 8
and 14 contain details regarding related party transactions.
Comprehensive income
--------------------
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available for sale
securities, are reported as a separate component of the shareholders' equity
section of the balance sheets, such items, along with net income or loss, are
components of comprehensive income.
Fair value of financial instruments
-----------------------------------
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments.
Cash and due from banks, Federal funds sold, short-term investments,
accrued interest receivable and repurchase agreements
The carrying amount is a reasonable estimate of fair value.
Securities
Fair values, excluding restricted Federal Home Loan Bank stock, are based
on quoted market prices or dealer quotes, if available. If a quoted market
price is not available, fair value is estimated using quoted market prices
for similar securities. The carrying value of Federal Home Loan Bank stock
approximates fair value based on the redemption provisions of the stock.
Loans receivable
For variable rate loans which reprice frequently, and have no significant
changes in credit risk, fair value is based on the loan's carrying value.
The fair value of fixed rate loans is estimated by discounting the future
cash flows using the year-end rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining
maturities.
Servicing assets
The fair value is based on market prices for comparable servicing
contracts, when available, or alternatively, is based on a valuation model
that calculates the present value of estimated future net servicing
income.
Deposits
The fair value of demand deposits, regular savings and certain money
market deposits is the amount payable on demand at the reporting date. The
fair value of certificates of deposit and other time deposits is estimated
using a discounted cash flow calculation that applies interest rates
currently being offered for deposits of similar remaining maturities to a
schedule of aggregated expected maturities on such deposits.
13
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Off-balance-sheet instruments
Fair values for the Company's off-balance-sheet instruments (lending
commitments) are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and
the counterparties' credit standing.
Recent accounting pronouncements
--------------------------------
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," ("FIN 45"), which covers guarantees such as standby
letters of credit, performance guarantees, and direct or indirect guarantees of
the indebtedness of others, but not guarantees of funding. FIN 45 requires a
guarantor to recognize, at the inception of a guarantee, a liability in an
amount equal to the fair value of the obligation undertaken in issuing the
guarantee, and requires disclosure about the maximum potential payments that
might be required, as well as the collateral or other recourse obtainable. The
recognition and measurement provisions of FIN 45 were effective on a prospective
basis after December 31, 2002, and its adoption by the Company on January 1,
2003 has not had a significant effect on the Company's consolidated financial
statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," ("FIN 46"), which establishes guidance for
determining when an entity should consolidate another entity that meets the
definition of a variable interest entity. FIN 46 requires a variable interest
entity to be consolidated by a company if that company will absorb a majority of
the expected losses, will receive a majority of the expected residual returns,
or both. Transfers to qualified special-purpose entities ("QSPEs") and certain
other interests in a QSPE are not subject to the requirements of FIN 46. On
December 17, 2003, the FASB revised FIN 46 ("FIN 46R") and deferred the
effective date of FIN 46 to no later than the end of the first reporting period
that ends after March 15, 2004, however, for special-purpose entities, FIN 46
would be required to be applied as of December 31, 2003. This Interpretation did
not have a material effect on the Company's consolidated financial statements.
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. This Statement is effective for contracts entered into or modified
after June 30, 2003, except in certain circumstances, and for hedging
relationships designated after June 30, 2003. This Statement did not have a
material effect on the Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This Statement
provides new rules on the accounting for certain financial instruments that,
under previous guidance, issuers could account for as equity. Such financial
instruments include mandatorily redeemable shares, instruments that require the
issuer to buy back some of its share in exchange for cash or other assets, or
obligations that can be settled with shares, the monetary value of which is
fixed. Most of the guidance in SFAS No. 150 is effective for financial
14
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 30,
2003. This Statement had no effect on the Company's consolidated financial
statements.
Reclassifications
-----------------
Certain 2002 amounts have been reclassified to conform with the 2003
presentation, and such reclassifications had no effect on 2002 net loss or
shareholders' equity.
Note 2. Restrictions on Cash and Cash Equivalents
The Company is required to maintain reserves against its respective transaction
accounts and non-personal time deposits. At December 31, 2003, the Company was
required to have cash and liquid assets of approximately $208,000 to meet these
requirements. In addition, at December 31, 2003 and 2002, the Company was
required to maintain $125,000 and $25,000, respectively in the Federal Reserve
Bank for clearing purposes. Also, approximately $212,000 and $100,000,
respectively, of short-term investments are maintained at another financial
institution to secure available customer letters of credit with that
institution, and approximately $11,000 and $10,000, respectively, of short-term
investments are maintained with that institution to secure an available credit
card line of credit for a Company director.
Note 3. Available for Sale Securities
The amortized cost, gross unrealized gains, gross unrealized losses and
approximate fair values of available for sale securities at December 31, 2003
and 2002 are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
2003 Cost Gains Losses Value
-----------------------------------------------------------------
U.S. Government Agency obligations $ 7,200,948 $ - $ (269,550) $ 6,931,398
Mortgage-backed securities 1,576,878 - (30,208) 1,546,670
-----------------------------------------------------------------
$ 8,777,826 $ - $ (299,758) $ 8,478,068
=================================================================
At December 31, 2003, all securities above were in an unrealized loss position,
and there were no unrealized losses on securities that have existed for a period
of twelve months or more. Management believes that none of the unrealized losses
on these securities are other than temporary because all of the unrealized
losses relate to debt and mortgage-backed securities issued by U.S. Government
Agencies, which the Company has both the intent and the ability to hold until
maturity or until the fair value fully recovers. In addition, management
considers the issuers of the securities to be financially sound and the Company
will receive all contractual principal and interest related to these
investments.
15
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
2002 Cost Gains Losses Value
-------------------------------------------------------------------
U.S. Government Agency obligations $ 8,902,682 $ 110,252 $ (1,000) $ 9,011,934
Mortgage-backed securities 496,360 - (6,802) 489,558
-------------------------------------------------------------------
$ 9,399,042 $ 110,252 $ (7,802) $ 9,501,492
===================================================================
The amortized cost and fair value of available for sale debt securities at
December 31, 2003 by contractual maturity are presented below. Actual maturities
of mortgage-backed securities may differ from contractual maturities because the
mortgages underlying the securities may be called or repaid without any
penalties. Because mortgage-backed securities are not due at a single maturity
date, they are not included in the maturity categories in the following summary:
Amortized Fair
Cost Value
---------------------------------
Maturity:
Within one year $ - $ -
After 1 but within 5 years 2,501,421 2,447,405
After 5 but within 10 years 4,199,527 4,013,413
Over 10 years 500,000 470,580
Mortgage-backed securities 1,576,878 1,546,670
---------------------------------
$ 8,777,826 $ 8,478,068
=================================
At December 31, 2003 and 2002, available for sale securities with a carrying
value of $2,911,572 and $2,568,750, respectively, were pledged as collateral
under repurchase agreements with Bank customers and to secure public deposits.
During 2003, proceeds from sales of available for sale securities were
$4,357,995 and gross gains of $44,505 were recognized on such sales. During
2002, there were no sales of available for sale securities.
In December 2002, the Company transferred all of its held to maturity
securities, which had a carrying value of $7,517,682, to the available for sale
category. At the time of the transfer, the Company recognized an unrealized gain
of $66,973, net of taxes, as an adjustment to other comprehensive income. The
transfer of these securities resulted from a change in the Company's overall
investment strategies and for liquidity purposes.
16
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Note 4. Loans Receivable and Allowance for Loan Losses
A summary of the Company's loan portfolio at December 31, 2003 and 2002 is as
follows:
2003 2002
--------------------------------------
Commercial loans secured by real estate $ 18,043,588 $ 8,808,320
Commercial loans 18,584,292 7,404,050
Construction and land loans, net of undisbursed
portion of $729,220 in 2003 and $19,830 in 2002 1,500,891 569,229
Residential mortgages 948,258 1,531,186
Consumer home equity loans 1,042,717 314,082
Consumer installment loans 1,204,920 709,930
--------------------------------------
Total loans 41,324,666 19,336,797
Net deferred loan fees (84,804) (55,585)
Allowance for loan losses (421,144) (232,000)
--------------------------------------
Loans receivable, net $ 40,818,718 $ 19,049,212
======================================
The Company services certain loans that it has sold without recourse to third
parties. The aggregate of loans serviced for others approximated $1,174,000 and
$-0- as of December 31, 2003 and 2002, respectively.
The balance of capitalized servicing rights, included in other assets at
December 31, 2003 and 2002, was $20,798 and $-0-, respectively. No impairment
charges related to servicing rights were recognized during the years ended
December 31, 2003 and 2002.
The changes in the allowance for loan losses for the years ended December 31,
2003 and 2002 are as follows:
2003 2002
-------------------------------------
Balance, beginning of year $ 232,000 $ 12,000
Provision for loan losses 213,100 220,000
Recoveries of loans previously charged-off 616 -
Loans charged-off (24,572) -
-------------------------------------
Balance, end of year $ 421,144 $ 232,000
=====================================
17
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
At December 31, 2003, the unpaid principal balances of loans delinquent 90 days
or more and placed on nonaccrual status were $94,063. At December 31, 2002,
there were no loans delinquent 90 days or more or placed on nonaccrual status.
The following information relates to impaired loans as of and for the years
ended December 31, 2003 and 2002:
2003 2002
----------------------------------------
Loans receivable for which there is a related allowance for credit
losses $ 94,063 $ -
========================================
Loans receivable for which there is no related allowance for credit
losses $ - $ -
========================================
Allowance for credit losses related to impaired loans $ 21,381 $ -
========================================
Average recorded investment in impaired loans $ 13,317 $ -
========================================
There was no interest income on impaired loans collected or recognized in 2003
and 2002. If nonaccrual loans had been current throughout their terms,
additional interest income of approximately $4,800 would have been recognized in
2003. The Company has no commitments to lend additional funds to borrowers whose
loans are impaired.
The Company's lending activities are conducted principally in the New Haven
County section of Connecticut. The Company grants commercial and residential
real estate loans, commercial business loans and a variety of consumer loans. In
addition, the Company may grant loans for the construction of residential homes,
residential developments and for land development projects. All residential and
commercial mortgage loans are collateralized by first or second mortgages on
real estate. The ability and willingness of borrowers to satisfy their loan
obligations is dependent in large part upon the status of the regional economy
and regional real estate market. Accordingly, the ultimate collectibility of a
substantial portion of any resulting real estate acquired is susceptible to
changes in market conditions.
The Company has established credit policies applicable to each type of lending
activity in which it engages, evaluates the creditworthiness of each customer on
an individual basis and, when deemed appropriate, obtains collateral. Collateral
varies by each borrower and loan type. The market value of collateral is
monitored on an ongoing basis and additional collateral is obtained when
warranted. Important types of collateral include business assets, real estate,
automobiles, marketable securities and time deposits. While collateral provides
assurance as a secondary source of repayment, the Company ordinarily requires
the primary source of repayment to be based on the borrower's ability to
generate continuing cash flows.
18
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Note 5. Premises and Equipment
At December 31, 2003 and 2002, premises and equipment consisted of the
following:
2003 2002
-------------------------------------
Land $ 255,766 $ -
Premises under capital lease 1,192,036 1,192,036
Building and improvements 674,046 -
Leasehold improvements 817,366 816,268
Furniture and fixtures 399,032 201,134
Equipment 483,626 376,798
Construction in progress - 608,788
-------------------------------------
3,821,872 3,195,024
Less accumulated depreciation and amortization (361,957) (142,103)
-------------------------------------
$ 3,459,915 $ 3,052,921
=====================================
For the years ended December 31, 2003 and 2002, depreciation and amortization
expense related to premises and equipment totaled $219,853 and $117,498,
respectively.
Premises under capital lease of $1,192,036, and related accumulated amortization
of $67,939 and $57,489, as of December 31, 2003 and 2002, respectively, are
included in premises and equipment.
Note 6. Deposits
At December 31, 2003 and 2002, deposits consisted of the following:
2003 2002
-------------------------------------
Noninterest bearing $ 13,781,286 $ 6,401,759
-------------------------------------
Interest bearing:
Time certificates, less than $100,000 3,057,294 2,610,756
Time certificates, $100,000 or more 7,051,249 3,740,551
Savings 2,633,341 1,029,433
Money market 17,251,327 8,858,585
Checking 3,499,378 2,351,847
-------------------------------------
Total interest bearing 33,492,589 18,591,172
-------------------------------------
Total deposits $ 47,273,875 $ 24,992,931
=====================================
19
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Contractual maturities of time certificates of deposit as of December 31, 2003
are summarized below:
Due within:
1 year $ 8,208,163
1-2 years 1,028,318
2-3 years 140,000
3-4 years 557,020
4-5 years 175,042
----------------
$ 10,108,543
================
Interest expense on certificates of deposit in denominations of $100,000 or more
was $90,394 and $87,538 for the years ended December 31, 2003 and 2002,
respectively.
Note 7. Commitments
Federal Home Loan Bank borrowings and stock
-------------------------------------------
The Bank is a member of the Federal Home Loan Bank of Boston ("FHLB"). At
December 31, 2003 and 2002, the Bank had the ability to borrow from the FHLB
based on a certain percentage of the value of the Bank's qualified collateral,
as defined in the FHLB Statement of Products Policy, at the time of the
borrowing. In accordance with an agreement with the FHLB, the qualified
collateral must be free and clear of liens, pledges and encumbrances. There were
no borrowings outstanding with the FHLB at December 31, 2003 and 2002.
The Bank is required to maintain an investment in capital stock of the FHLB in
an amount equal to a percentage of its outstanding mortgage loans and contracts
secured by residential properties, including mortgage-backed securities. No
ready market exists for FHLB stock and it has no quoted market value. For
disclosure purposes, such stock is assumed to have a market value which is equal
to cost since the Bank can redeem the stock with FHLB at cost.
Other available borrowings
--------------------------
During 2003, the Company obtained secured and unsecured lines of credit with
other financial institutions with total available borrowings of $4,400,000.
There are no borrowings outstanding under these lines of credit as of December
31, 2003.
Employment agreements
---------------------
The Company and the Bank have entered into an employment agreement (the
"Chairman Agreement") with the Chairman and Chief Executive Officer of the
Company and the Bank with an initial term of five years beginning October 1,
2001, which may be extended for additional one-year terms at the end of the
initial term. In October 2003, the Company amended the Chairman Agreement to
extend the initial five-year term by one year. The Chairman Agreement provides
for a base salary with annual adjustments, and an annual bonus, as determined by
20
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
the Board of Directors. The Chairman Agreement also provides for vacation and
various insurance benefits and reimbursement for travel, entertainment and
bank-related education and convention expenses.
Also, under the Chairman Agreement, the Company issued to the Chairman options
to purchase 50,000 shares of the Company's stock under the terms of the
Company's 2001 Stock Option Plan (see Note 10).
In the event of the early termination of the Chairman for any reason other than
cause, the Company would be obligated to compensate the Chairman, in accordance
with the terms of the Chairman Agreement, through the full term of the Chairman
Agreement. Also upon termination of the Chairman, for reasons other than cause,
the Chairman Agreement provides that the Chairman will serve as a consultant to
the Company, on a year to year basis, and will be compensated at the rate of
$60,000 per year plus the employee benefits previously described. Further, in
the event the Chairman's position shall end or his responsibilities be
significantly reduced as a result of a business combination (as defined), the
Chairman will be entitled to a lump sum payment equal to three times his then
current annual compensation.
Also, the Company entered into an employment agreement (the "President
Agreement") with the new President of the Bank effective in February 2003, which
expires on December 31, 2004. The President Agreement provides for a base salary
and an annual bonus as determined by the Board of Directors. The President
Agreement also provides for vacation and various insurance benefits and
reimbursement for automobile, travel, entertainment, club dues and bank-related
education and convention expenses. Also, under the President Agreement, the
Company issued to the President options to purchase 20,000 shares of the
Company's stock under the terms of the Company's 2002 Stock Option Plan.
Note 8. Lease and Subleases
The Company leases the Bank's main office under a twenty-year capital lease that
expires in 2021. In addition, the Company leases its Branford branch office
under a twenty-year capital lease that expires in 2022. Under the terms of the
leases, the Bank will pay all executory costs including property taxes,
utilities and insurance. The Company has also entered into an operating lease
for the main office of its new bank subsidiary expected to be formed and become
operational in 2004 (see Note 17). The initial term of the lease expires in
2008, and the lease contains three five-year renewal options. The Company also
leases the driveway to its main office and certain equipment under
non-cancelable operating leases.
The Company has also entered into a five-year sublease agreement for excess
office space in its premises with a tenant, the principal of which is related to
the Company's Vice Chairman. During 2002, the Company also had a sublease with
another related party, which lease was terminated in early 2003 when such
related party became an officer of the Bank.
21
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
At December 31, 2003, future minimum lease payments to be made and received
under these leases by year and in the aggregate, are as follows:
Year Capital Leases Operating Leases Sublease Income
--------------------------------------------------------------------------------------------------------
2004 $ 156,984 $ 51,911 $ 13,690
2005 161,506 51,911 14,107
2006 166,028 50,555 14,526
2007 171,424 49,199 14,944
2008 178,564 49,199 15,361
2009 and thereafter 2,822,967 44,319 127,490
-------------------- --------------------------------------
3,657,473 $ 297,094 $ 200,118
======================================
Less amount representing interest (2,466,594)
--------------------
Present value of future minimum lease
payments - capital lease obligation $ 1,190,879
====================
Total rent expense charged to operations under the operating leases approximated
$3,200 and $3,000 for the years ended December 31, 2003 and 2002, respectively.
Rental income under the subleases approximated $17,200 and $17,800 for the years
ended December 31, 2003 and 2002, respectively.
Note 9. Income Taxes
A reconciliation of the anticipated income tax benefit (computed by applying the
statutory Federal income tax rate of 34% to the loss before income taxes) to the
amount reported in the statement of operations for the years ended December 31,
2003 and 2002 is as follows:
2003 2002
-------------------------------------
Benefit for income taxes at statutory Federal rate $ (203,295) $(470,564)
State tax benefit, net of Federal benefit (29,201) (68,179)
Increase in valuation allowance 253,878 526,329
Other (21,382) 12,414
-------------------------------------
$ - $ -
=====================================
22
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
At December 31, 2003 and 2002, the components of gross deferred tax assets and
liabilities are as follows:
2003 2002
-------------------------------------
Deferred tax assets:
Allowance for loan losses $ 164,036 $ 90,364
Net operating loss carryforwards 906,259 672,862
Start-up costs 142,401 194,183
Unrealized loss on available for sale securities 116,756 -
Other 66,796 36,681
-------------------------------------
Gross deferred tax assets 1,396,248 994,090
Less valuation allowance (1,304,609) (933,975)
-------------------------------------
Deferred tax assets - net of valuation allowance 91,639 60,115
-------------------------------------
Deferred tax liabilities:
Tax bad debt reserve 25,736 15,162
Depreciation 65,903 44,953
Unrealized gain on available for sale securities - 39,905
-------------------------------------
Gross deferred tax liabilities 91,639 100,020
-------------------------------------
Net deferred tax liability $ - $ (39,905)
=====================================
As of December 31, 2003, the Company had tax net operating loss carryforwards of
approximately $2,325,000 available to reduce future Federal and state taxable
income, which expire in 2021 through 2023.
The net changes in the valuation allowance for 2003 and 2002 were increases of
$370,634 and $526,329, respectively. The changes in the valuation allowance have
been allocated between operations and equity to adjust the deferred tax asset to
an amount considered by management more likely than not to be realized. The
portion of the change in the valuation allowance allocated to equity is to
eliminate the tax benefit related to the unrealized holding gains or losses on
available for sale securities.
Note 10. Shareholders' Equity
Stock dividend
--------------
On January 13, 2004, the Company declared a 10% stock dividend that was
distributed on February 16, 2004. As a result, the 2003 balance sheet and
statement of changes in shareholders' equity, and all per share amounts, have
been retroactively revised to reflect this dividend as if it were effective at
December 31, 2003. Generally accepted accounting principles require such
dividends to be recorded at fair value; however, when there is an accumulated
deficit, the Securities and Exchange Commission (SEC) advises that such stock
dividends be accounted for by capitalizing the stock issued at par value only,
through a reduction in additional paid-in capital.
23
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Income (loss) per share
-----------------------
The Company is required to present basic income (loss) per share and diluted
income (loss) per share in its statements of operations. Basic and fully diluted
income (loss) per share are computed by dividing net income (loss) by the
weighted average number of common shares outstanding. Diluted per share amounts
assume exercise of all potential common stock instruments unless the effect is
to reduce the loss or increase the income per share. For the periods presented,
the common stock equivalents described below have been excluded from the
computation of the net loss per share because the inclusion of such equivalents
is anti-dilutive. Weighted average shares outstanding were 1,063,320 for the
years ended December 31, 2003 and 2002, after giving effect to the stock
dividend declared in January 2004.
Stock options
-------------
The Company has adopted two stock option plans, the 2001 Stock Option Plan (the
"2001 Option Plan") and the 2002 Stock Option Plan (the "2002 Option Plan"),
under which an aggregate of 340,780 shares of the Company's common stock are
reserved for issuance upon the exercise of both incentive options and
nonqualified options granted under both option plans.
Under both option plans, the exercise price for each share covered by an option
may not be less than the fair market value of a share of the Company's common
stock on the date of grant. For incentive options granted to a person who owns
more than 10% of the combined voting power of the Company or any subsidiary
("ten percent shareholder"), the exercise price cannot be less than 110% of the
fair market value on the date of grant.
Options under both options plans have a term of ten years unless otherwise
determined at the time of grant, except that incentive options granted to any
ten percent shareholder will have a term of five years unless a shorter term is
fixed. Under both option plans, unless otherwise fixed at the time of grant, 40%
of the options become exercisable one year from the date of grant, and 30% of
the options become exercisable at each of the second and third anniversaries
from the date of grant.
Upon adoption of the 2002 Option Plan in May 2002, the Company determined that
no additional options will be granted under the 2001 Option Plan.
24
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
A summary of the status of the stock options at December 31, 2003 and 2002, and
changes during the years then ended, is as follows. The 2003 and 2002
information has been presented to give effect to the stock dividend declared in
January 2004.
2003 2002
------------------------------- ------------------------------
Weighted- Weighted-
Number Average Number Average
of Exercise of Exercise
Shares Price Shares Price
-----------------------------------------------------------------
Outstanding at beginning of year 74,140 $10.91 85,800 $10.91
Granted 255,110 7.66 16,280 10.91
Terminated (11,770) 9.08 (27,940) 10.91
------------ ------------
Outstanding at end of year 317,480 8.37 74,140 10.91
============ ============
Exercisable at end of year 44,814 $10.91 23,320 $10.91
============ ======== ============ =========
Weighted-average fair value per option
of options granted during the year $ 2.44 $ 1.90
============ ============
At December 31, 2003, the exercise prices on outstanding options ranged from
$7.27 to $10.91, and at December 31, 2002, the exercise price on all options
outstanding was $10.91. The weighted-average remaining contractual life for the
options outstanding at December 31, 2003 and 2002 is 9.2 and 8.7 years,
respectively.
Stock warrants
--------------
The Company adopted the 2001 Warrant Plan and the 2001 Supplemental Warrant Plan
(the "Warrant Plans"), under which an aggregate of 110,000 shares of the
Company's common stock were reserved for issuance upon the exercise of warrants
granted to non-employee directors of the Company and the Bank, and certain other
individuals involved in the organization of the Bank.
Warrants under the Warrant Plans have a term of ten years. Forty percent of the
warrants become exercisable one year from the date of grant, and 30% of the
warrants become exercisable at each of the second and third anniversaries from
the date of grant.
25
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
A summary of the status of the warrants at December 31, 2003 and 2002, and
changes during the years then ended, is as follows. The 2003 and 2002
information has been presented to give effect to the stock dividend declared in
January 2004.
2003 2002
------------------------------ ----------------------------
Weighted- Weighted-
Number Average Number Average
of Exercise of Exercise
Shares Price Shares Price
----------------------------------------------------------------
Outstanding at beginning of year 79,953 $10.91 79,953 $10.91
Granted - - - -
Exercised - - - -
---------- ----------
Outstanding at end of year 79,953 10.91 79,953 10.91
========== ==========
Exercisable at end of year 55,967 $10.91 31,981 $10.91
========== ========= ========== =========
Weighted-average fair value per
warrant of warrants granted during
the year N/A N/A
========== ==========
The weighted-average remaining contractual life for the warrants outstanding at
December 31, 2003 and 2002 is 7.7 and 8.7 years, respectively.
The fair value of options and warrants issued in 2003 and 2002 was estimated at
the grant date using the Black-Scholes option-pricing model with the following
assumptions:
2003 2002
--------------------------------------
Dividend rate - -
Risk free interest rate 2.88% to 4.02% 2.28%
Weighted-average expected lives 8 years 8 years
Volatility 20% 20%
Note 11. 401(k) Profit Sharing Plan
The Bank's employees are eligible to participate in the Bank of Southern
Connecticut 401(k) Profit Sharing Plan (the "Plan") under Section 401(k) of the
Internal Revenue Code. The Plan covers substantially all employees of the Bank.
Under the terms of the Plan, participants can contribute a discretionary
percentage of compensation, with total annual contributions subject to Federal
limitations. The Bank may make discretionary contributions to the Plan.
Participants are immediately vested in their contributions and become fully
vested in employer contributions after three years of service. There were no
discretionary contributions made by the Bank during 2003 and 2002.
26
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Note 12. Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amounts recognized in the financial statements. The contractual amounts
of these instruments reflect the extent of involvement the Company has in
particular classes of financial instruments.
The contractual amounts of commitments to extend credit represents the amounts
of potential accounting loss should: the contract be fully drawn upon; the
customer default; and the value of any existing collateral become worthless. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments and evaluates each
customer's creditworthiness on a case-by-case basis. Management believes that
the Company controls the credit risk of these financial instruments through
credit approvals, credit limits, monitoring procedures and the receipt of
collateral as deemed necessary.
Financial instruments whose contract amounts represent credit risk are as
follows at December 31, 2003:
2003 2002
----------------------------------------
Commitments to extend credit:
Future loan commitments $ 3,752,000 $ 2,890,000
Unused lines of credit 9,065,661 5,518,023
Undisbursed construction loans 729,220 19,830
Financial standby letters of credit 933,055 338,059
---------------------------------------
$ 14,479,936 $ 8,765,912
=======================================
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
to extend credit generally have fixed expiration dates or other termination
clauses and may require payment of a fee by the borrower. Since these
commitments could expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based
on management's credit evaluation of the counter party. Collateral held varies,
but may include residential and commercial property, deposits and securities.
Standby letters of credit are written commitments issued by the Company to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. As of January 1, 2003, newly issued
or modified guarantees that are not derivative contracts have been recorded on
the Company's consolidated balance sheet at their fair value at inception. The
liability related to guarantees recorded at December 31, 2003 was not
significant.
27
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Note 13. Regulatory Matters
The Company (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory -
and possibly additional discretionary - actions by regulators that, if
undertaken, could have a direct material effect on the Company's and the Bank's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and the Bank must meet
specific capital guidelines that involve quantitative measures of the assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2003, that the Company and the Bank meet all capital adequacy requirements to
which they are subject.
As of December 31, 2003, the most recent notification from the Federal Deposit
Insurance Corporation and the State of Connecticut Department of Banking
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the table. There are no conditions or events since then, that
management believes have changed the Bank's category.
The Bank's actual capital amounts and ratios at December 31, 2003 and 2002 were
(dollars in thousands):
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
2003 Actual Purposes Action Provisions
-----------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------
Total Capital to Risk-Weighted Assets $ 8,013 17.24% $ 3,718 8.00% $ 4,648 10.00%
Tier I Capital to Risk-Weighted Assets 7,592 16.33% 1,860 4.00% 2,789 6.00%
Tier I Capital to Average Assets 7,592 14.16% 2,145 4.00% 2,681 5.00%
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
2002 Actual Purposes Action Provisions
-----------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------
Total Capital to Risk-Weighted Assets $ 8,309 32.43% $ 2,050 8.00% $ 2,562 10.00%
Tier I Capital to Risk-Weighted Assets 8,077 31.52% 1,025 4.00% 1,537 6.00%
Tier I Capital to Average Assets 8,077 23.76% 1,360 4.00% 1,700 5.00%
28
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
The Company's actual and required ratios are not substantially different from
those shown above.
Restrictions on dividends, loans or advances
--------------------------------------------
The Company's ability to pay cash dividends is dependent on the Bank's ability
to pay dividends to the Company. However, certain restrictions exist regarding
the ability of the Bank to transfer funds to the Company in the form of cash
dividends, loans or advances. Regulatory approval is required to pay dividends
in excess of the Bank's net earnings retained in the current year plus retained
net earnings for the preceding two years. The Bank is also prohibited from
paying dividends that would reduce its capital ratios below minimum regulatory
requirements, and the Federal Reserve Board may impose further dividend
restrictions on the Company. During 2002, the Bank requested, and was granted,
permission from the State of Connecticut Department of Banking, to pay a special
dividend to the Company in the amount of $200,000. At December 31, 2003 and
2002, no dividends may be declared by the Bank without regulatory approval.
Under Federal Reserve regulation, the Bank is also limited to the amount it may
loan to the Company, unless such loans are collateralized by specified
obligations. Loans or advances to the Company by the Bank are limited to 10% of
the Bank's capital stock and surplus on a secured basis.
Note 14. Related Party Transactions
In the normal course of business, the Company may grant loans to executive
officers, directors and members of their immediate families, as defined, and to
entities in which these individuals have more than a 10% equity ownership. Such
loans are transacted at terms including interest rates, similar to those
available to unrelated customers.
Changes in loans outstanding to such related parties during 2003 and 2002 are as
follows:
2003 2002
--------------------------------------
Balance, beginning of year $ 534,637 $ -
Additional loans 1,225,195 726,139
Repayments (962,411) (201,502)
--------------------------------------
Balance, end of year $ 797,421 $ 534,637
======================================
Related party deposits aggregated approximately $7,108,000 and $3,999,000 as of
December 31, 2003 and 2002, respectively.
Included in professional services for the years ended December 31, 2003 and 2002
are approximately $4,800 and $7,900, respectively, in legal fees incurred for
services provided by law firms, principals of which are directors of the
Company. Included in consulting fees for the years ended December 31, 2003 and
2002 are $29,300 and $127,400, respectively, in consulting fees and expenses
paid to entities, the principals of which are related to Company directors.
29
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
In addition, during 2003 and 2002, the Company paid approximately $1,500 and
$46,900, respectively, for capital expenditures and maintenance to certain
companies, principals of which are directors of the Company.
Also during 2003 and 2002, the Company purchased investment securities,
including accrued interest and fees, of approximately $10,950,000 and
$8,176,000, respectively, through an investment brokerage firm, an employee of
which is related to the Company's Chairman and Chief Executive Officer.
Lastly, as described in Note 8, rental income and expense reimbursements of
approximately $16,500 and $14,800 were received in 2003 and 2002, respectively,
from tenants, the principals of which are related to the Company's Chairman and
Chief Executive Officer, and the Company's Vice Chairman.
Note 15. Other Comprehensive Income
Other comprehensive income, which is comprised solely of the change in
unrealized gains and losses on available for sale securities, is as follows:
2003
---------------------------------------------------
Before-Tax Taxes Net-of-Tax
Amount Amount
----------------------------------------------------
Unrealized holding losses arising during period $ (446,713) $ 44,321 $ (402,392)
Less reclassification adjustment for gains recognized
in income 44,505 (4,416) 40,089
---------------------------------------------------
Unrealized holding loss on available for sale
securities, net of taxes $ (402,208) $ 39,905 $ (362,303)
===================================================
2002
---------------------------------------------------
Before-Tax Taxes Net-of-Tax
Amount Amount
----------------------------------------------------
Unrealized holding losses arising during period $ (7,252) $ 2,824 $ (4,428)
Add adjustment for unrealized gains on held to maturity
securities transferred to available for sale
securities 109,702 (42,729) 66,973
---------------------------------------------------
Unrealized holding gain on available for sale
securities, net of taxes $ 102,450 $ (39,905) $ 62,545
===================================================
30
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Note 16. Fair Value of Financial Instruments and Interest Rate Risk
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments"
("Statement No. 107"), requires disclosure of fair value information about
financial instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rates and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparisons to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. Statement No. 107 excludes certain
financial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Company.
Management uses its best judgment in estimating the fair value of the Company's
financial instruments; however, there are inherent weaknesses in any estimation
technique. Therefore, for substantially all financial instruments, the fair
value estimates presented herein are not necessarily indicative of the amounts
the Company could have realized in a sales transaction at December 31, 2003 and
2002. The estimated fair value amounts for 2003 and 2002 have been measured as
of their respective year-ends, and have not been reevaluated or updated for
purposes of these consolidated financial statements subsequent to those
respective dates. As such, the fair values of these financial instruments
subsequent to the respective reporting dates may be different from the amounts
reported at each year-end.
The information presented should not be interpreted as an estimate of the fair
value of the entire Company since a fair value calculation is only required for
a limited portion of the Company's assets and liabilities. Due to the wide range
of valuation techniques and the degree of subjectivity used in making the
estimate, comparisons between the Company's disclosures and those of other bank
holding companies may not be meaningful.
31
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
As of December 31, 2003 and 2002, the recorded book balances and estimated fair
values of the Company's financial instruments were:
2003 2002
--------------------------------------------------------------
Recorded Recorded
Book Book
Balance Fair Value Balance Fair Value
--------------------------------------------------------------
Financial Assets:
Cash and due from banks $ 1,147,883 $ 1,147,883 $ 1,245,010 $ 1,245,010
Federal funds sold 966,000 966,000 1,144,000 1,144,000
Short-term investments 454,115 454,115 662,419 662,419
Available for sale securities 8,478,068 8,478,068 9,501,492 9,501,492
Federal Home Loan Bank stock 21,500 21,500 500 500
Loans receivable, net 40,818,718 40,818,116 19,049,212 19,029,150
Accrued interest receivable 196,545 196,545 187,672 187,672
Servicing rights 20,798 20,798 -- --
Financial Liabilities:
Noninterest-bearing deposits 13,781,286 13,781,256 6,401,759 6,401,759
Time certificates of deposits 10,108,543 10,197,429 6,351,307 6,383,715
Savings deposits 2,633,341 2,633,341 1,029,433 1,029,433
Money market deposits 17,251,327 17,251,327 8,858,585 8,858,585
Interest bearing checking accounts 3,499,378 3,499,378 2,351,847 2,351,847
Repurchase agreements 339,752 339,752 822,529 822,259
Unrecognized financial instruments
----------------------------------
Loan commitments on which the committed interest rate is less than the current
market rate are insignificant at December 31, 2003 and 2002.
The Company assumes interest rate risk (the risk that general interest rate
levels will change) as a result of its normal operations. As a result, the fair
values of the Company's financial instruments will change when interest rate
levels change and that change may be either favorable or unfavorable to the
Company. Management attempts to match maturities of assets and liabilities to
the extent believed necessary to minimize interest rate risk. However, borrowers
with fixed rate obligations are less likely to prepay in a rising rate
environment and more likely to prepay in a falling rate environment. Conversely,
depositors who are receiving fixed rates are more likely to withdraw funds
before maturity in a rising rate environment and less likely to do so in a
falling rate environment. Management monitors rates and maturities of assets and
liabilities and attempts to minimize interest rate risk by adjusting terms of
new loans and deposits and by investing in securities with terms that mitigate
the Company's overall interest rate risk.
32
SOUTHERN CONNECTICUT BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
December 31, 2003 and 2002
-------------------------------------------------------------------------------
Note 17. Business Developments
During 2003, the Company's Board of Directors approved the establishment of a
new commercial bank in New London, Connecticut and the Company plans to raise
between $10 million to $15 million in capital through a public offering of its
common stock to fund the establishment of the new bank and for other corporate
purposes. In October, the Company submitted its final application to the State
of Connecticut Department of Banking related to the establishment of the new
bank. Subject to regulatory approval and the successful raising of capital, the
Company plans to open the new bank in the fourth quarter of 2004.
33