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NFSB > SEC Filings for NFSB > Form 10-K on 22-Mar-2013All Recent SEC Filings

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Form 10-K for NEWPORT BANCORP INC


22-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Overview

Income. Newport Federal's primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that the Bank pays on deposits and borrowings. Other significant sources of pre-tax income are customer service fees (mostly from service charges on deposit accounts), loan servicing fees and income from bank-owned life insurance.

Allowance for Loan Losses.The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. The Bank evaluates the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.

Expenses. The non-interest expenses Newport Federal incurs in operating its business consist of salaries and employee benefits, occupancy and equipment, data processing and other expenses.

Salaries and employee benefits consist primarily of salaries and wages paid to the Bank's employees, stock-based compensation, payroll taxes, expenses for health insurance, retirement plans, and other employee benefits.

Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using the straight-line method based on the useful lives of the related assets, which range from three to forty years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the expected term of the lease. The expected term includes lease option periods to the extent that the exercise of such options is reasonably assured.

Data processing expenses are the fees paid to third parties for processing customer information, deposits and loans.

Other expenses include expenses for professional services, marketing, office supplies, postage, telephone, insurance, charitable contributions, FDIC deposit insurance and OCC assessments and other miscellaneous operating expenses.

Index

Critical Accounting Policies

Newport Bancorp considers accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on results of operations to be critical accounting policies. The Company considers the allowance for loan losses and the valuation of the net deferred tax asset to be our critical accounting policies.

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management evaluates the level of the allowance at least quarterly and establishes the provision for loan losses based upon a review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other factors related to the collectability of the loan portfolio. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Although management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the OCC, as an integral part of its examination process, periodically reviews Newport Federal's allowance for loan losses. Such agency may require the Bank to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings.

The allowance consists of general and allocated loss components. For loans that are classified as impaired, an allocated loss allowance is established when the discounted cash flows or the collateral value of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan by loan basis by the fair value of the collateral.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures.

Income Taxes. Management considers accounting for income taxes as a critical accounting policy due to the subjective nature of certain estimates that are involved in the calculation. The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance related to deferred tax assets is established when, in the judgment of management, it is more likely than not that all or a portion of such deferred tax assets will not be realized. The Company assesses the realizability of its deferred tax assets by (1) reviewing taxable income in allowable federal carry-back periods, and (2) assessing the likelihood of the Company generating federal and state taxable income, as applicable, in future periods in amounts sufficient to offset the deferred tax charges that are expected to reverse. Adjustments to increase or decrease the valuation allowance are generally charged or credited, respectively, to income tax expense.

Index

Merger Agreement With SI Financial Group, Inc.

On March 5, 2013, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with SI Financial Group, Inc. ("SI Financial"), the holding company of Savings Institute Bank and Trust Company, pursuant to which the Company will merge with and into SI Financial, with SI Financial as the surviving entity (the "Merger"). In addition, the Bank will merge with and into Savings Institute Bank and Trust Company, with Savings Institute Bank and Trust Company as the surviving entity.

Under the terms of the Merger Agreement, at the effective time of the Merger, each share of Company common stock will be converted into the right to receive either $17.55 in cash or 1.5129 shares of SI Financial common stock in exchange for each share of Company common stock held by them, subject to proration procedures to ensure that 50 percent of the outstanding shares of Company common stock is converted into SI Financial common stock and the balance is converted into the cash consideration.

The directors of the Company have agreed to vote their shares in favor of the approval of the Merger Agreement at the Company stockholders' meeting to be held to vote on the proposed transaction. Following the Merger, three members of the Company's board of directors, including Kevin M. McCarthy, the current President and Chief Executive Officer of the Company, will join SI Financial's board of directors. The Merger is currently expected to be completed in the third quarter of 2013.

The completion of the Merger is subject to customary closing conditions, including regulatory approval and approval by stockholders of the Company and SI Financial. The Company has also agreed not to (i) solicit proposals relating to alternative business combination transactions or (ii) subject to certain exceptions, enter into discussions concerning confidential information in connection with alternative business combination transactions. If the Merger Agreement is terminated under certain circumstances, the Company has agreed to pay SI Financial a termination fee of $2.45 million.

The Merger Agreement also contains usual and customary representations and warranties that the Company and SI Financial made to each other as of specific dates. The assertions embodied in those representations and warranties were made solely for purposes of the contract between the Company and SI Financial, and may be subject to important qualifications and limitations agreed to by the parties in connection with negotiating its terms. Moreover, the representations and warranties are subject to a contractual standard of materiality that may be different from what may be viewed as material to stockholders, and the representations and warranties may have been used to allocate risk between the Company and SI Financial rather than establishing matters as facts.

Balance Sheet Analysis

Overview. During the year ended December 31, 2012, the Company's assets decreased by $4.5 million, or 1.0%, to $449.4 million. The decrease in assets was primarily due to a $13.9 million, or 38.4%, decrease in securities and a $1.2 million, or 8.3%, decrease in premises and equipment, offset in part by a $5.0 million, or 16.0%, increase in cash and cash equivalents and a $6.5 million, or 1.9%, increase in net loans. The decrease in securities was attributable to principal payments received on the mortgage-backed securities, which contributed to the increase in cash and cash equivalents. The decrease in net premises and equipment is attributable to the sale of the former Westerly, Rhode Island branch and normal depreciation and amortization.

During the year ended December 31, 2012, liabilities decreased by $6.0 million, or 1.5%, due to a $30.9 million, or 23.1%, decrease in borrowings, offset by a $24.9 million, or 9.4%, increase in deposits.

Loans. Newport Federal's primary lending activity is the origination of loans secured by real estate. The Bank originates one-to-four family residential real estate loans, equity loans and lines of credit and commercial and multi-family mortgage loans. To a lesser extent, Newport Federal originates construction loans, commercial and consumer loans. Net loans increased 1.9% from $348.5 million at December 31, 2011 to $355.0 million at December 31, 2012. Net loans represented 79.0% of total assets at December 31, 2012.

Index

The largest segment of the Bank's loan portfolio is one-to-four family residential mortgage loans, which increased by $20.7 million in 2012. One-to-four family loans totaled $228.4 million, which represented 63.4% of total loans at December 31, 2012, compared to $207.8 million, which represented 58.8% of total loans at December 31, 2011. The Bank offers fixed and adjustable-rate one-to-four family residential loans. At December 31, 2012, the Bank had $218.3 million in fixed-rate and $10.1 million in adjustable-rate one-to-four family residential loans.

Equity loans and lines of credit totaled $17.0 million, representing 4.7% of total loans at December 31, 2012, a decrease of $2.6 million from $19.6 million at December 31, 2011.

Commercial and multi-family residential mortgage loans totaled $109.4 million and represented 30.4% of total loans at December 31, 2012, compared to $119.5 million, representing 33.8% of total loans at December 31, 2011. Construction loans totaled $4.1 million, representing 1.1% of total loans at December 31, 2012, compared to $5.0 million, representing 1.4% of total loans at December 31, 2011.

Commercial business loans, which consist of commercial loans not secured by real estate, totaled $998,000, representing 0.3% of total loans at December 31, 2012, compared to $1.1 million at December 31, 2011. The Bank also originates consumer loans secured by automobiles or passbook or certificate accounts. Consumer loans totaled $311,000 at December 31, 2012, compared to $399,000 at December 31, 2011.

Index

The following table sets forth the composition of the Bank's loan portfolio at the dates indicated.

                                                                                                   At December 31,
                                                   2012                       2011                       2010                       2009                       2008
                                           Percent       Amount       Percent       Amount       Percent       Amount       Percent       Amount       Percent
                                                                                                (Dollars in thousands)
Mortgage loans:
One-to-four family residential            $ 228,428        63.41 %   $ 207,773        58.79 %   $ 203,893        56.49 %   $ 191,154        53.67 %   $ 183,767        54.53 %
Equity loans and lines of credit             16,995         4.72        19,597         5.55        23,112         6.40        25,891         7.27        30,425         9.03
Commercial and multi-family residential     109,372        30.36       119,486        33.81       127,071        35.21       127,255        35.74       108,866        32.30
Construction                                  4,117         1.14         5,016         1.42         4,948         1.37         9,736         2.73        11,204         3.32
Total mortgage loans                        358,912        99.63       351,872        99.57       359,024        99.47       354,036        99.41       334,262        99.18

Other Loans:
Commercial loans                                998         0.28         1,116         0.32         1,638         0.45         1,885         0.53         2,145         0.64
Consumer loans                                  311         0.09           399         0.11           288         0.08           223         0.06           601         0.18
Total loans                                 360,221       100.00 %     353,387       100.00 %     360,950       100.00 %     356,144       100.00 %     337,008       100.00 %

Less:
Allowance for loan losses                    (4,031 )                   (3,709 )                   (3,672 )                   (3,467 )                   (2,924 )
Net deferred loan fees                       (1,152 )                   (1,186 )                   (1,229 )                   (1,178 )                   (1,055 )
Loans, net                                $ 355,038                  $ 348,492                  $ 356,049                  $ 351,499                  $ 333,029

Index

The following table sets forth certain information at December 31, 2012 regarding the dollar amount of loan principal repayments coming due during the periods indicated. The table does not include any estimate of prepayments, which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.

                                          One-to-Four                                 Commercial and
                                       Family Residential       Equity Loans &         Multi-family         Construction
                                         Mortgage Loans         Lines of Credit       Mortgage Loans       Mortgage Loans
                                                                         (In thousands)
Amounts due in:
One year or less                      $                122     $             607     $          6,215     $          1,343
More than one year to five years                     1,980                 4,338               35,909                2,774
More than five years to ten years                   25,297                 7,068               64,287                    -
More than ten years to twenty years                 87,624                 4,926                2,753                    -
More than twenty years                             113,405                    56                  208                    -
Total                                 $            228,428     $          16,995     $        109,372     $          4,117




                                       Commercial      Consumer        Total
                                         Loans           Loans         Loans
                                                   (In thousands)
Amounts due in:
One year or less                      $        231     $     273     $   8,791
More than one year to five years               337            38        45,376
More than five years to ten years              430             -        97,082
More than ten years to twenty years              -             -        95,303
More than twenty years                           -             -       113,669
Total                                 $        998     $     311     $ 360,221

The following table sets forth the dollar amount of all loans at December 31, 2012 that are due after December 31, 2013 and have either fixed interest rates or floating or adjustable interest rates. The amounts shown below exclude the allowance for loan losses and net deferred loan fees.

                                                               Floating or
                                           Fixed Rates       Adjustable Rates        Total
                                                            (In thousands)
Mortgage loans:
One-to-four family residential            $     218,182     $           10,124     $ 228,306
Equity loans and lines of credit                  5,140                 11,248        16,388
Commercial and multi-family residential          44,343                 58,814       103,157
Construction                                          -                  2,774         2,774
Other loans:
Commercial loans                                    428                    339           767
Consumer loans                                        -                     38            38
Total                                     $     268,093     $           83,337     $ 351,430

Index

Securities. The securities portfolio consists of the following:

                                                                At December 31,
                                         2012                         2011                         2010
                                Amortized        Fair        Amortized        Fair        Amortized        Fair
                                  Cost          Value          Cost          Value          Cost          Value
                                                                 (In thousands)

Securities held to maturity:
Mortgage-back securities $ 22,307 $ 24,506 $ 36,220 $ 39,248 $ 47,021 $ 49,314

All mortgage-backed securities are backed by residential mortgage loans and are issued by U.S. government-sponsored enterprises. Other than mortgage-backed securities issued by U.S. government-sponsored enterprises, the Company had no investments in one issuer that had an aggregate book value in excess of 10% of our equity at December 31, 2012.

There were no sales of securities during the years ended December 31, 2012 and 2011.

The following table sets forth the stated maturities and weighted average yields of debt securities at December 31, 2012. At December 31, 2012, we had no debt securities with maturities of ten years or less.

                                      More than Ten Years                        Total
                                 Carrying           Weighted         Carrying         Weighted
                                  Value           Average Yield        Value        Average Yield
                                                     (Dollars in thousands)
Securities held to maturity:
Mortgage-backed securities     $     22,307                 4.42 %   $  22,307                4.42 %

Deposits. Newport Federal's deposit base is comprised of demand deposits, money market and savings accounts and time deposits. The Bank considers demand deposits, money market and savings accounts to be core deposits. Deposits increased $24.9 million, or 9.4%, for the year ended December 31, 2012. The increase in deposits in 2012 resulted from an $18.1 million, or 16.0%, increase in NOW/Demand accounts, a $6.3 million, or 19.5%, increase in savings accounts and a $5.1 million, or 7.2%, increase in time deposits, offset by a $4.6 million, or 9.4%, decrease in money market accounts. Time deposits represented 26.1% of the Company's total deposit balances at December 31, 2012, compared to 26.6% at December 31, 2011. NOW/Demand accounts represented 45.3% and 42.7% of the Company's total deposit balances at December 31, 2012 and 2011, respectively.

The following table sets forth the balances of the Bank's deposit products at the dates indicated.

                                                 At December 31,
                                        2012          2011          2010
                                                 (In thousands)

Noninterest-bearing demand deposits   $  49,173     $  39,868     $  37,026
Interest-bearing demand deposits         82,059        73,233        72,842
Money market deposit accounts            44,404        48,986        51,778
Regular savings                          38,418        32,143        29,728
Certificates of deposit                  75,620        70,539        69,676

Total                                 $ 289,674     $ 264,769     $ 261,050

At December 31, 2012, certificates of deposit include $9.9 million of brokered certificates of deposit. Beginning in November 2013, and monthly thereafter, $5.0 million of these accounts become callable by the Bank.

Index

The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity as of December 31, 2012. Jumbo certificates of deposit require minimum deposits of $100,000. The Bank does not offer special rates for jumbo certificates.

Maturity Period                       Amount
                                 (In thousands)
Three months or less              $       3,083
Over three through six months             4,186
Over six through twelve months            5,705
Over twelve months                       10,079
Total                             $      23,053

Borrowings. Newport Federal utilizes borrowings from the Federal Home Loan Bank of Boston and repurchase agreements to supplement the Bank's supply of funds for loans and investments.

The Company's borrowings decreased by $30.9 million to $102.8 million at December 31, 2012, due to excess liquidity available as borrowings matured. For additional information regarding our borrowings, see Note 7 to the Notes to Consolidated Financial Statements included in this Annual Report.

Index

Results of Operations for the Years Ended December 31, 2012 and 2010

Overview. The following table provides selected performance, capital and asset
quality ratios for the years ended December 31, 2012 and 2011, expressed as
percentages.

                                                                              At or For the Years Ended
                                                                                    December 31,
                                                                              2012                2011
Performance Ratios:
Return on average assets                                                           0.34 %              0.32 %
Return on average equity                                                           2.96                2.83
Interest rate spread (1)                                                           3.21                3.49
Net interest margin (2)                                                            3.38                3.69
Non-interest expense to average assets                                             2.80                3.07
Efficiency ratio (3)                                                              79.98               80.64
Average interest-earning assets to average interest-bearing liabilities          112.81              112.26
Average equity to average assets                                                  11.36               11.25

Capital Ratios (Bank Only):
Tangible capital                                                                  10.00                9.50
Leverage capital                                                                  10.00                9.50
Total risk-based capital                                                          17.10               16.00

Asset Quality Ratios:
Allowance for loan losses as a percent of total loans (4)                          1.12                1.05
Allowance for loan losses as a percent of nonperforming loans                    186.62              194.19
Net charge-offs to average outstanding loans during the period                     0.19                0.31
Non-performing loans as a percent of total loans (4)                               0.60                0.54

(1) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities.

(2) Represents net interest income as a percent of average interest-earning assets.

(3) Represents non-interest expense divided by the sum of net interest income and non-interest income.

(4) Total loans are presented before the allowance for loan losses but include deferred costs/fees. Construction loans are included net of unadvanced funds.

Net income in 2012 was $1.6 million compared to $1.5 million in 2011. The increase was due to the $102,000 decrease in the provision for loan losses, the $71,000 increase in non-interest income, the $961,000 decrease in non-interest expenses and the $106,000 decrease in the tax provision, partially offset by the $1.1 million decrease in the Company's net interest income.

Index

Average Balances and Yields. The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. For purposes of this table, average balances have been calculated using daily average balances, nonaccrual loans are included in average balances only, and loan fees are included in interest income on loans. None of the income reflected in the following table is tax-exempt income.

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