Southern CT 10QSB

 

 
U. S. SECURITIES AND EXCHANGE COMMISSION
 
WASHINGTON, D.C. 20549
 
___________________
 
F O R M 10 - QSB
 
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended March 31, 2006
 

Commission file number 0-49784


SOUTHERN CONNECTICUT BANCORP, INC.
(Name of Small Business Issuer as Specified in Its Charter)

Connecticut
(State or Other Jurisdiction of Incorporation or Organization)
 
06-1609692
(I.R.S. Employer Identification Number)
215 Church Street
New Haven, Connecticut 06510
(Address of Principal Executive Offices)
 
(203) 782-1100
(Issuer’s Telephone Number)
 
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, and (2) has been subject to such filing requirements for the past 90 days. YES [X] No [  ]

 
The number of shares of the issuer’s Common Stock, par value $.01 per share, outstanding as of May 12, 2006: 2,937,525

Transitional Small Business Disclosure Format

Yes __   No X

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes___   No X





Table of Contents
Part I
Financial Information
   
Page
 
     
   
 
     
   
   
 
     
   
   
 
     
   
 
     
 
     
     
     
Part II
Other Information
     
     
     
     
     
     
     





1

 
 
 
 
 
CONSOLIDATED BALANCE SHEETS
 
 
 
 
 
March 31, 2006 (unaudited) and December 31, 2005
          
   
2006
 
2005
 
Assets
          
Cash and due from banks
  
$
1,319,959
  
$
966,732
  
Federal funds sold
    
7,845,000
   
9,579,000
 
Short-term investments
    
6,115,164
   
6,023,555
 
Cash and cash equivalents
    
15,280,123
   
16,569,287
 
               
Available for sale securities, at fair value
    
9,926,377
   
9,973,488
 
Federal Home Loan Bank Stock
   
60,000
   
60,000
 
Loans receivable (net of allowance for loan losses of
              
$776,790 in 2006 and $778,051 in 2005)
    
58,284,390
   
55,881,508
 
Loans held for sale, at fair value
    
212,061
   
401,503
 
Accrued interest receivable
    
402,185
   
324,346
 
Premises and equipment, net
    
4,382,420
   
4,457,715
 
Other assets
    
942,940
   
906,387
 
Total assets
  
$
89,490,496
  
$
88,574,234
  
               
Liabilities and Shareholders’ Equity
              
               
Liabilities
              
Deposits
              
Noninterest bearing deposits
  
$
18,070,864
  
$
18,091,849
  
Interest bearing deposits
   
48,769,957
   
47,187,667
 
Total deposits
    
66,840,821
   
65,279,516
 
               
Repurchase agreements
    
518,505
   
1,363,368
 
Accrued expenses and other liabilities
    
611,714
   
445,295
 
Capital lease obligations
    
1,188,952
   
1,189,212
 
Total liabilities
    
69,159,992
   
68,277,391
 
               
Commitments and Contingencies
    
-
   
-
 
               
Shareholders’ Equity
              
Preferred stock, no par value; 500,000 shares authorized;
              
none issued
              
Common stock, par value $.01; 5,000,000, shares authorized;
              
shares issued and outstanding: 2006 2,937,525; 2005 2,937,525
    
29,375
   
29,375
 
Additional paid-in capital
    
24,083,638
   
24,083,638
 
Accumulated deficit
    
(3,398,683
)
  
(3,477,576
)
Accumulated other comprehensive loss – net unrealized
             
loss on available for sale securities
   
(383,826
)
  
(338,594
)
Total shareholders' equity
   
20,330,504
   
20,296,843
 
 
              
Total liabilities and shareholders' equity
  
$
89,490,496
  
$
88,574,234
  
               
See Notes to Consolidated Financial Statements.
              
 
2

          
CONSOLIDATED STATEMENTS OF OPERATIONS
           
For the Three Months Ended March 31, 2006 and 2005 (unaudited)
           
            
   
 Three Months Ended
  
   
 March
  
   
 2006
  
2005
  
Interest Income
              
Interest and fees on loans
  
$
1,270,140
  
$
988,078
  
Interest on securities
    
78,721
   
86,660
 
Interest on federal funds sold and short-term investments
    
143,496
   
89,328
 
Total interest income
    
1,492,357
   
1,164,066
 
               
Interest Expense
              
Interest on deposits
    
366,430
   
190,627
 
Interest on capital lease obligations
    
43,541
   
43,147
 
Interest on repurchase agreements
    
3,296
   
2,780
 
Total interest expense
    
413,267
   
236,554
 
               
Net interest income
    
1,079,090
   
927,512
 
               
Provision for Loan Losses
    
(58,032
)
  
17,000
 
Net interest income after
              
provision for loan losses
    
1,137,122
   
910,512
 
 
              
Noninterest Income
              
Service charges and fees
    
86,359
   
80,796
 
Gains and fees from sales and referrals of loans
    
36,566
   
13,273
 
Other noninterest income
    
61,483
   
43,660
 
Total noninterest income
    
184,408
   
137,729
 
               
Noninterest Expense
              
Salaries and benefits
    
683,782
   
557,433
 
Occupancy and equipment
    
159,227
   
143,339
 
Professional services
    
101,667
   
94,140
 
Data processing and other outside services
    
81,180
   
76,484
 
Advertising and promotional expense
    
44,425
   
27,534
 
Forms, printing and supplies
    
32,303
   
17,275
 
Other operating expenses
    
140,053
   
147,603
 
Total noninterest expense
    
1,242,637
   
1,063,808
 
               
Net income (loss)
  
$
78,893
  
$
(15,567
)
               
Basic Income (loss) per Share
  
$
0.03
  
$
(0.01
)
Diluted Income (loss) per Share
  
$
0.03
  
$
(0.01
)
               
Dividends per Share
  
$
-
  
$
-
  
               
See Notes to Consolidated Financial Statements.
              
3

 
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
  
For the Three Months Ended March 31, 2006 and 2005 (unaudited)
                           
   
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
Additional
 
 
 
Other
 
 
 
 
 
Number
 
Common
 
Paid-in
 
Accumulated
 
Comprehensive
 
 
 
 
 
of Shares
 
Stock
 
Capital
 
Deficit
 
Loss
 
Total
  
                           
Balance December 31, 2004
    
2,797,711
 
$
27,977
  
$
24,085,612
  
$
(3,199,126
)
$
(216,736
)
$
20,697,727
  
                                       
Comprehensive Loss:
                                      
Net Loss
    
-
   
-
   
-
   
(15,567
)
  
-
   
(15,567
)
Unrealized holding loss on available
                                     
for sale securities
    
-
   
-
   
-
   
-
   
(146,395
)
  
(146,395
)
Total comprehensive loss
                                  
(161,962
)
                                       
5% stock dividend declared
                                      
April 12, 2005
    
139,814
   
1,398
   
(1,398
)
  
-
   
-
   
-
 
                                       
Balance March, 31, 2005
    
2,937,525
 
$
29,375
  
$
24,084,214
  
$
(3,214,693
)
$
(363,131
)
$
20,535,765
  
                                       
Balance December 31, 2005
    
2,937,525
 
$
29,375
  
$
24,083,638
  
$
(3,477,576
)
$
(338,594
)
$
20,296,843
  
                                       
Comprehensive Income:
                                      
Net Income
    
-
   
-
   
-
   
78,893
   
-
   
78,893
 
Unrealized holding loss on available
                                     
for sale securities
    
-
   
-
   
-
   
-
   
(45,232
)
  
(45,232
)
Total comprehensive income
                                  
33,661
 
                                       
Balance March 31, 2006
    
2,937,525
 
$
29,375
  
$
24,083,638
  
$
(3,398,683
)
$
(383,826
)
$
20,330,504
  
                                       
See Notes to Consolidated Financial Statements.
                                      
4
 
         
CONSOLIDATED STATEMENTS OF CASH FLOWS
          
For the Three Months Ended March 31, 2006 and 2005 (unaudited)
          
           
Cash Flows From Operations
  
2006
  
2005
  
Net income (loss)
  
$
78,893
  
$
(15,567
)
Adjustments to reconcile net income (loss) to net cash
              
provided by (used in) operating activities:
              
Amortization and accretion of premiums and discounts on investments, net
    
(729
)
  
(510
)
Provision for loan losses
    
(58,032
)
  
17,000
 
Loans originated for sale, net of principal payments received
    
(202,000
)
  
(538,179
)
Proceeds from sales of loans
    
276,375
   
-
 
Gains on sales of loans
    
(30,772
)
  
-
 
Depreciation and amortization
    
86,211
   
72,739
 
Increase in cash surrender value of life insurance
    
(8,250
)
  
(9,000
)
Changes in assets and liabilities:
              
( Decrease) increase in deferred loan fees
   
(8,674
)
  
1,257
 
Increase in accrued interest receivable
    
(77,839
)
  
(61,558
)
Increase in other assets
    
(28,303
)
  
(94,126
)
Increase in accrued expenses and other liabilities
    
166,419
   
86,995
 
Net cash provided by (used in) operating activities
    
193,299
   
(540,949
)
               
Cash Flows From Investing Activities
              
Principal repayments on available for sale securities
   
2,608
   
97,584
 
Net increase in loans receivable
    
(2,190,337
)
  
(3,210,199
)
Purchases of premises and equipment
    
(10,916
)
  
(260,772
)
Net cash used in investing activities
    
(2,198,645
)
  
(3,373,387
)
               
Cash Flows From Financing Activities
              
Net (decrease) increase in demand, savings and money market deposits
    
(1,781,210
)
  
3,903,469
 
Net increase in certificates of deposit
    
3,342,515
   
2,746,110
 
Net decrease in repurchase agreements
    
(844,863
)
  
(234,109
)
Principal payments on capital lease obligations
    
(260
)
  
(233
)
Net cash provided by financing activities
    
716,182
   
6,415,237
 
               
Net (decrease) increase in cash and cash equivalents
    
(1,289,164
)
  
2,500,901
 
               
Cash and cash equivalents
              
Beginning
    
16,569,287
   
15,743,882
 
Ending
  
$
15,280,123
  
$
18,244,783
  
               
See Notes to Consolidated Financial Statements.
              
5

         
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
          
For the Three Months Ended March 31, 2006 and 2005 (unaudited)
          
           
   
2006
  
2005
  
Supplemental disclosures of cash flow information:
          
Cash paid during the period for:
              
Interest
 
$
394,318
  
$
226,233
  
               
Income taxes
  
$
-
  
$
-
  
               
Supplemental disclosures of noncash investing activities:
              
Unrealized holding losses on available for sale securities arising
              
during the period
  
$
(45,232
)
$
(146,395
)
               
Transfer of Loans Held for Sale to Loans Receivable
  
$
(102,216
)
$
-
  
               
               
See Notes to Consolidated Financial Statements.
  
6

Southern Connecticut Bancorp, Inc.
Notes to Consolidated Financial Statements
(Unaudited)

Note 1.
Nature of Operations

Southern Connecticut Bancorp, Inc. (“Bancorp”), is a bank holding company headquartered in New Haven, Connecticut that was incorporated on November 8, 2000. Bancorp’s strategic objective is to serve as a bank holding company for a community-based commercial bank serving the greater New Haven and greater New London markets, as well as the approximately 62 miles of coastal towns and communities located between these two cities and extending to Rhode Island. Bancorp owns 100% of the capital stock of The Bank of Southern Connecticut (the “Bank”) a Connecticut-chartered bank with its headquarters in New Haven, Connecticut. The Bank operates through four offices, three offices in the greater New Haven area, including the main office in downtown New Haven, a branch in the Westville/Amity section of New Haven, a branch in Branford, Connecticut, as well as a branch in New London, Connecticut. The New London branch is the headquarters of The Bank of Southeastern Connecticut, a division of The Bank of Southern Connecticut, which opened March 6, 2006. An application has been approved by the FDIC and the Connecticut Department of Banking to open a new branch in North Haven, Connecticut, which will operate as The Bank of North Haven, a division of The Bank of Southern Connecticut. The expected opening date of this branch is the summer of 2006. Bancorp owns a property in Clinton, Connecticut that is suitable for a branch location. A portion of the property has been rented. Management is considering opening a branch of The Bank of Southern Connecticut at that location at some point in the future. The Bank focuses on serving the banking needs of small to medium-sized businesses, professionals and professional corporations, and their owners and employees in the greater New Haven and greater New London markets. The Bank has been successful in winning business by offering a combination of competitive pricing for its services, quick decision making processes and a high level of personalized, “high touch” customer service.

Note 2.
Basis of Financial Statement Presentation

The consolidated balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements of Bancorp at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

The accompanying consolidated unaudited financial statements as of and for the three months ended March 31, 2006 and 2005 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The accompanying consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements of Bancorp and notes thereto as of December 31, 2005, filed with the Securities and Exchange Commission on Form 10-KSB on March 22, 2006.

The accompanying unaudited consolidated financial information reflects, in the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the interim periods presented. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results of operations that may be expected for all of 2006.


7

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 March 31, 2006 and December 31, 2005 are as follows:

   
 
 
Gross
 
Gross
 
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
March 31, 2006
Cost
 
Gains
 
Losses
 
Value
  
U.S. Government Sponsored Agency Obligations
  
$
10,198,437
  
$
-
  
$
(381,933
)
$
9,816,504
  
Mortgage Backed Securities
    
111,766
   
-
   
(1,893
)
  
109,873
 
   
$
10,310,203
  
$
-
  
$
(383,826
)
$
9,926,377
  
 
   
 
 
Gross
 
Gross
 
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
December 31, 2005
Cost
 
Gains
 
Losses
 
Value
  
U.S. Government Sponsored Agency Obligations
  
$
10,197,667
  
$
-
  
$
(337,415
)
$
9,860,252
  
Mortgage Backed Securities
    
114,415
   
-
   
(1,179
)
  
113,236
 
   
$
10,312,082
  
$
-
  
$
(338,594
)
$
9,973,488
  
 
At March 31, 2006, gross unrealized holding losses on available for sale securities totaled $383,826. All such unrealized losses have existed for a period of twelve months or longer. Management does not believe that any of the unrealized losses as of March 31, 2006 are other than temporary, as they relate to debt and mortgage-backed securities issued by U.S. Government sponsored agencies resulting from changes in the interest rate environment. Bancorp has the intent and ability to hold these securities to maturity if necessary and expects to receive all contractual principal and interest related to these investments. As a result, management believes that these unrealized losses will not have a negative impact on future earnings or a permanent effect on capital.

At December 31, 2005, gross unrealized holding losses on available for sale securities totaled $338,594. Of the securities with unrealized losses, the total unrealized losses on securities that existed for a period of twelve months or longer amounted to $287,729.
 

8

Note 4.
Loans Receivable

A summary of Bancorp’s loan portfolio at March 31, 2006 and December 31, 2005 is as follows:

   
March 31, 2006
  
 December 31, 2005
  
            
Commercial loans secured by real estate
  
$
26,439,923
  
$
26,724,972
  
Commercial loans
    
27,051,599
   
25,852,655
 
Construction and land loans
    
3,758,648
   
2,573,809
 
Residential mortgage loans
    
154,314
   
155,909
 
Consumer home equity loans
    
744,408
   
750,114
 
Consumer installment loans
    
1,008,583
   
707,069
 
Total loans
    
59,157,475
   
56,764,528
 
Net deferred loan fees
    
(96,295
)
  
(104,969
)
Allowance for loan losses
    
(776,790
)
  
(778,051
)
Loans receivable, net
  
$
58,284,390
  
$
55,881,508
  

Allowance for Loan Losses
          
The following represents the activity in the allowance for loan losses for the three
         
months ended March 31, 2006 and 2005:
          
           
   
For the Period Ended March 31,
  
   
2006
  
2005
  
Balance at beginning of period
  
$
778,051
  
$
752,394
  
Charge-offs
    
(2,568
)
  
-
 
Recoveries
    
59,339
   
750
 
Provision charged to operations
    
(58,032
)
  
17,000
 
Balance at end of period
  
$
776,790
  
$
770,144
  
               
               
Net charge-offs to average loans
    
-0.10
%
  
0.00
%

Non-Accrual, Past Due and Restructured Loans
          
           
The following is a summary of non-accruing and past due loans:
          
           
   
March 31, 2006
  
December 31, 2005
  
Loans delinquent over 90 days and still accruing
  
$
-
  
$
-
  
Non-accruing loans
    
215,661
   
578,826
 
Total
  
$
215,661
  
$
578,826
  
% of Total Loans
    
0.37
%
  
1.02
%
% of Total Assets
    
0.24
%
  
0.65
%

9
 
Note 5.
Deposits

At March 31, 2006 and December 31, 2005, deposits consisted of the following:

   
March 31, 2006
  
 December 31, 2005
  
Noninterest bearing deposits
  
$
18,070,864
  
$
18,091,849
  
               
Interest bearing deposits
              
Checking
    
6,891,825
   
6,175,953
 
Money Market
    
24,628,833
   
27,001,393
 
Savings
    
2,586,699
   
2,690,236
 
Checking, money market & savings
    
34,107,357
   
35,867,582
 
               
Time Certificates under $100,000
    
6,072,820
   
4,498,286
 
Time Certificates of $100,000 or more
    
8,589,780
   
6,821,799
 
Time deposits
    
14,662,600
   
11,320,085
 
 
    
48,769,957
   
47,187,667
 
Total deposits
  
$
66,840,821
  
$
65,279,516
  
 
 
Note 6.
Available Borrowings

The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). At March 31, 2006, 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 March 31, 2006.

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.

Note 7.
Stock Dividend and Income (Loss) Per Share

On April 12, 2005, Bancorp declared a 5% stock dividend to shareholders of record as of April 26, 2005. The stock dividend was distributed on May 9, 2005. Payment of this dividend resulted in the issuance of 139,885 additional common shares. As a result, the March 31, 2005 balance sheet and statement of changes in shareholders’ equity, and all per share amounts, were retroactively revised to reflect this dividend as if it were effective at January 1, 2005. Generally accepted accounting principals 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. Fractional shares were payable in cash on an equivalent share basis of $8.05. Weighted-average shares and per share data were restated to give effect to the stock dividend.

Bancorp is required to present basic income (loss) per share and diluted income (loss) per share in its statements of operations. Basic per share amounts 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 equivalents in weighted average shares outstanding, unless the effect is antidilutive. Bancorp is also required to provide a reconciliation of the numerator and denominator used in the computation of both basic and diluted income (loss) per share. The following is information about the computation of income (loss) per share for the three month periods ended March 31, 2006 and 2005.

10

Income (Loss) per Share
                          
                           
Three Months Ended March 31,
                          
   
2006
 
2005
 
 
 
 
 
Weighted
 
 
 
 
 
Weighted
 
 
 
 
 
Net
 
Average
 
Amount
 
Net
 
Average
 
Amount
 
 
 
Income
 
Shares
 
Per Share
 
Loss
 
Shares
 
Per Share
  
Basic Income (Loss) Per Share
                          
Income (Loss ) available to common shareholders
  
$
78,893
    
2,937,525
 
$
0.03
  
$
(15,567
)
  
2,937,525
 
$
(0.01
)
Effect of Dilutive Securities
                                      
Warrants/Stock Options outstanding
    
-
   
2,171
   
-
   
-
   
-
   
-
 
Diluted Income (Loss) Per Share
                                      
Income (Loss) available to common
                                      
shareholders plus assumed conversions
  
$
78,893
    
2,939,696
 
$
0.03
  
$
(15,567
)
  
2,937,525
 
$
(0.01
)

For the three months ended March 31, 2005, common stock equivalents have been excluded from the computation of the net loss per share because the inclusion of such equivalents is antidilutive.

11

Note 8.
Other Comprehensive Loss

Other comprehensive loss, which is comprised solely of the change in unrealized losses on available for sale securities, is as follows:

   
Three Months Ended
 
 
 
March 31, 2006
 
 
 
Before-Tax
 
 
 
Net-of-Tax
 
 
 
Amount
 
Taxes
 
Amount
  
Unrealized holding losses arising during the period
  
$
(45,232
)
$
-
    
($45,232
)
                     
Add: Reclassification adjustment for amounts
                    
recognized in net income
    
-
   
-
   
-
 
                     
Unrealized holding loss on available for sale
                    
securities
  
$
(45,232
)
$
-
  
$
(45,232
)
                     
 
 
Three Months Ended
 
  
March 31, 2005
 
    
Before-Tax 
    
 
    
Net-of-Tax
  
 
    
Amount 
    
Taxes
    
Amount
  
Unrealized holding losses arising during the period
  
$
(146,395
)
$
-
    
($146,395
)
                     
Add: Reclassification adjustment for losses
                    
recognized in net loss
    
-
   
-
   
-
 
                     
Unrealized holding loss on available for sale
                    
securities
  
$
(146,395
)
$
-
  
$
(146,395
)
                     
 
There is no tax effect relating to other comprehensive income because there is a full valuation allowance recorded against the deferred tax asset.

Note 9.
Stock Based Compensation

Bancorp has adopted three share-based plans, the 2001 Stock Option Plan (the “2001 Plan”), the 2002 Stock Option Plan (the “2002 Plan”), and the 2005 Stock Option and Award Plan (the “2005 Plan”), under which an aggregate of 582,914 shares of Bancorp’s common stock are reserved for issuance of Bancorp’s common stock, or upon the exercise of both incentive options and nonqualified options, granted under the share-based plans.

Under all three plans, the exercise price for each share covered by an option may not be less than the fair market value of a share of Bancorp’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 Bancorp or any subsidiary (“ten percent shareholder”), the exercise price cannot be less than 110% of the fair market value on the date of grant.

Options under all three plans have a term of ten years unless otherwise determined at the time of grant, except that incentive options granted to any ten percent shareholder will have a term of five years unless a shorter term is fixed. Under the 2001 and 2002 plans, unless otherwise fixed at the time of grant, 40% of the options become exercisable one year from the date of grant, and 30% of the options become exercisable at each of the second and third anniversaries from the date of grant. Under the 2005 plan, the vesting terms of the awards is determined at the date of grant.

Upon adoption of the 2002 Option Plan in May 2002, Bancorp determined that no additional options will be granted under the 2001 Option Plan.

12

A summary of the status of stock options at March 31, 2006 and 2005, and changes during the three months then ended is as follows:
  
                           
   
2006
 
2005
 
 
 
 
 
Weighted-
 
 
 
 
 
Weighted-
 
 
 
 
 
Number
 
Average
 
Aggregate
 
Number
 
Average
 
Aggregate
 
 
 
of
 
Exercise
 
Intrinsic
 
of
 
Exercise
 
Intrinsic
 
 
 
Shares
 
Price
 
Value
 
Shares
 
Price
 
Value
  
Outstanding at beginning of year
    
431,068
 
$
8.03
          
363,827
 
$
8.03
        
Granted
    
-
               
13,671
   
8.09
       
Exercised
    
-
               
-
             
Terminated
    
(8,118
)
  
7.74
         
(100
)
  
8.03
       
Outstanding at end of period
    
422,950
   
7.98
 
$
40,014
    
377,398
   
8.03
 
$
212,958
  
                                       
Exercisable at end of period
    
422,950
 
$
7.98
  
$
40,014
    
175,188
 
$
8.53
  
$
89,298
  
                                       
Weighted-average fair value per option
                                      
of options granted during the year
  
$
-
              
$
2.43
              
 
The fair value of options issued in the three months ended March 31, 2005 was estimated at the grant date using the Black-Sholes option-pricing model with the following assumptions:
                         
           
2005
           
Dividend Rate
          
-
           
Risk free interest rate
          
3.80% TO 4.39%
           
Weighted-average expected lives
          
8 Years
           
Volatility
          
20%
           

On December 22, 2005, the Compensation Committee of the Board of Directors approved the acceleration of all unvested options, outstanding as of December 31, 2005, granted under Bancorp’s 2002 Stock Option Plan, held by 48 employees and directors. The decision to accelerate the vesting of all unvested options was made primarily to reduce compensation expense that would have been recognized in future periods once Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) issued by the Financial Accounting Standards Board, became effective for reporting periods beginning after December 31, 2005. Pursuant to the acceleration of all unvested options, options to purchase 197,571 shares of Bancorp’s common stock became immediately exercisable as of December 31, 2005. The exercise prices for such accelerated options range from $6.90 to $10.39 per share. As a result of accelerating the vesting of these options, approximately $300,000 of compensation expense, before taxes, that would have been recorded in 2006 through 2008 under SFAS 123(R), was reflected as 2005 pro forma compensation expense in Note 1 of the audited financial statements of Bancorp and notes thereto as of December 31, 2005, filed with the Securities and Exchange Commission on Form 10-KSB on March 22, 2006. There was no impact to the 2005 financial statements resulting from this action.

Effective January 1, 2006, Bancorp adopted SFAS 123(R) utilizing the modified prospective transition approach. Prior to the adoption of SFAS 123(R), Bancorp accounted for stock option grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees (the intrinsic value method), and accordingly, recognized no compensation expense for stock option grants for the years ended December 31, 2005 or 2004. Because there were no unvested share-based awards at January 1, 2006, the adoption of this statement had no effect on Bancorp’s financial statements. The impact of FAS 123(R) on Bancorp during 2006 and beyond will depend upon various factors, among them being Bancorp’s future compensation strategy. The pro forma compensation costs presented in the table below and in prior filings for Bancorp have been calculated using a Black-Scholes option pricing model and may not be indicative of amounts which should be expected in future years, however, Bancorp anticipates using the Black-Scholes option-pricing model for future awards.

13
As of January 1, 2006, Board Member compensation is paid fifty percent in cash and fifty percent in stock, versus one hundred percent in options as is done in prior years. The fair market value of the stock used to calculate the shares to be paid, is the average of the closing price of the common stock on the first and the fifteenth day of the third month of the quarter, or the following business day. The total director fees to be settled in stock charged to noninterest expense for the three months ended March 31, 2006 was $9,750.

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(R), reported net loss and per share amounts for 2005 would have been increased to the pro forma amounts shown below:

For the Three months ended March 31, 2005
       
        
   
 Three Months Ended
 
 
 
 March 31, 2005
  
Net loss as reported
  
$
(15,567
)
Add: total stock based employee
       
compensation expense included in reported net loss
    
-
 
         
Deduct: total stock based employee
        
compensation expense determined under fair value based
        
method for all awards
    
(61,196
)
         
Pro forma net loss
 
$
(76,763
)
         
Basic loss per share:
        
As reported
  
$
(0.01
)
Pro forma
  
$
(0.03
)
Diluted income (loss) per share:
        
As reported
  
$
(0.01
)
Pro forma
  
$
(0.03
)

For the three months ended March 31, 2005 common stock equivalents have been excluded from the computation of the pro forma net loss per share because the inclusion of such equivalents is antidilutive. Because no stock options vested during the three months ended March 31, 2006, no proforma information is disclosed.

Stock warrants

Bancorp adopted the 2001 Warrant Plan and the 2001 Supplemental Warrant Plan (the “Warrant Plans”), under which an aggregate of 77,184 shares of Bancorp’s common stock are reserved for issuance upon the exercise of warrants granted to non-employee directors of Bancorp’s and the Bank, and certain other individuals involved in the organization of the Bank.

Warrants under the Warrant Plans have a term of ten years. Forty percent of the warrants became exercisable one year from the date of grant, and 30% of the warrants became exercisable at each of the second and third anniversaries from the date of grant.

14

A summary of the status of the warrants at March 31, 2006 and 2005, and changes during the three months then ended, is as follows.
  
                   
   
2006
 
2005
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-
 
 
 
Weighted-
 
 
 
Number
 
Average
 
Number
 
Average
 
 
 
of
 
Exercise
 
of
 
Exercise
 
 
 
Shares
 
Price
 
Shares
 
Price
  
Outstanding at beginning of year
    
77,184
 
$
10.39
    
77,184
 
$
10.39
  
Granted
    
-
         
-
       
Exercised
    
-
         
-
       
Terminated
    
-
         
-
       
Outstanding at end of period
    
77,184
   
10.39
   
77,184
   
10.39
 
                           
Exercisable at end of period
    
77,184
 
$
10.39
    
77,184
 
$
10.39
  

Note 10.
Business Developments
 
On March 6, 2006, Bancorp opened The Bank of Southeastern Connecticut, a division of The Bank of Southern Connecticut, headquartered in New London, Connecticut. This opening has broadened Bancorp’s market position and demonstrated enhanced capabilities for increasing total loans and deposits.

In April 2006, the Bank received regulatory approval from both the Connecticut State Department of Banking and the Federal Deposit Insurance Corporation to open The Bank of North Haven, a division of The Bank of Southern Connecticut. It is anticipated that the branch will open for business during the summer of 2006, and will be located at 24 Washington Avenue, North Haven, Connecticut.

Note 11.
Financial Instruments with Off-Balance-Sheet Risk

In the normal course of business, Bancorp 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 Bancorp has in particular classes of financial instruments.

The contractual amounts of commitments to extend credit represent 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. Bancorp 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 Bancorp controls the credit risk of these financial instruments through credit approvals, credit limits, monitoring procedures and the receipt of collateral as deemed necessary.

15

Financial instruments whose contract amounts represent credit risk are as follows at March 31, 2006 and December 31, 2005:
  
           
   
March 31,
  
December 31,
  
   
2006
  
2005
  
Commitments to extend credit
              
Future loan commitments
  
$
6,665,000
  
$
3,982,679
  
Unused lines of credit
    
13,073,260
   
8,561,405
 
Undisbursed construction loans
    
482,000
   
437,825
 
Financial standby letters of credit
    
1,933,188
   
1,908,888
 
   
$
22,153,448
  
$
14,890,797
  
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by Bancorp upon extension of credit, is based upon 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 Bancorp 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 Bancorp’s books at their fair value at inception. The liability related to guarantees recorded at March 31, 2006 and December 31, 2005 was not significant.


Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to assist you in understanding the financial condition and results of operations of Bancorp. This discussion should be read in conjunction with the accompanying unaudited financial statements as of and for the three months ended March 31, 2006 and 2005, along with the audited financial statements as of and for the year ended December 31, 2005, included in Bancorp’s Form 10-KSB filed with the Securities and Exchange Commission on March 22, 2006.

Summary

As of March 31, 2006, Bancorp had $89.5 million of total assets, $58.3 million of total loans, and $66.8 million of total deposits. Total equity capital at March 31, 2006 was $20.3 million, representing a Tier I Leverage Capital Ratio of 23.77%. Net interest margin for the three months ended March 31, 2006 was 5.41%. Bancorp had net income of $78,893 (or basic and diluted earnings per share of $0.03) for the three months ended March 31, 2006, compared to a net loss of $15,567 (or basic and diluted loss per share of $0.01) for the three months ended March 31, 2005. The results for the three months ended March 31, 2006 reflect: i) the one time collection of interest income related to the settlement and collection of past due interest on a loan, and ii) the recovery of a loan that had previously been charged off, which resulted in a credit to the provision for loan losses for the three months ended March 31, 2006, in comparison to the three months ended March 31, 2005, in which neither of such items were recognized.

16
 
Critical Accounting Policy

In the ordinary course of business, Bancorp has made a number of estimates and assumptions relating to reporting 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. Bancorp has reviewed this critical accounting policy and estimates with its audit committee. Refer to the discussion below under “Allowance for Loan Losses” and Note 1 to the audited financial statements as of and for the year ended December 31, 2005, included in Bancorp’s Form 10-KSB filed with the Securities and Exchange Commission on March 22, 2006.

Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loans are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general, and unallocated components. The specific component relates to loans that are classified loss, doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component may be maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Based upon this evaluation, management believes the allowance for loan losses of $777,000 or 1.31% of gross loans at March 31, 2006 is adequate, under prevailing economic conditions, to absorb losses on existing loans. At December 31, 2005, the allowance for loan losses was $778,000 or 1.37% of gross loans outstanding.

The 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, 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. The Bank considers consumer installment loans to be pools of smaller balance homogeneous loans, which are collectively evaluated for impairment.

17
Based on its evaluation, management believes the allowance for loan losses of $777,000 at March 31, 2006, which represents 1.31% of gross loan receivables outstanding, is adequate, under prevailing economic conditions, to absorb probable losses on existing loans. At December 31, 2005, the allowance for loan losses was $778,000 or 1.37% of gross loans outstanding.

Recent Accounting Changes

Effective January 1, 2006, Bancorp adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-base payment awards to employees and directors based on the grant-date fair value of the awards. Information regarding Bancorp’s adoption of SFAS 123(R) and its effect upon the consolidated financial statements and the financial condition of Bancorp is provided in Note 9 to the consolidated financial statements of this Form 10-QSB.

Comparison of Financial Condition as of March 31, 2006 versus December 31, 2005

General
Bancorp’s total assets were $89.5 million at March 31, 2006, an increase of $900,000 (1.0%) from $88.6 million in assets as of December 31, 2005. Earning assets as of March 31, 2006 were $83.2 million, an increase of $.5 million (.6%) from $82.7 million at December 31, 2005.


Investments
Available for sale securities totaled $9.9 million as of March 31, 2006, a decrease of $100,000 from December 31, 2005. The portfolio is invested in U.S. government sponsored agency and sponsored agency issued mortgage backed securities.

As of March 31, 2006, gross unrealized losses on the available for sale securities portfolio totaled $384,000. Management believes that none of the unrealized losses on available for sale securities are other than temporary because all of the unrealized losses in Bancorp’s investment portfolio are due to market interest rate changes related to debt and mortgage-backed securities issued by U.S. Government sponsored agencies, which Bancorp 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 Bancorp will receive all contractual principal and interest related to these investments.


Loans
Net loans receivable increased $2.4 million (4.3%) from $55.9 million at December 31, 2005 to $58.3 million at March 31, 2006. The increase in loans is due to commercial demand in the greater New Haven and Connecticut markets. The increase in the loans receivable portfolio was funded primarily by increased deposits. The ratio of loans receivable to deposits as of March 31, 2006 was 87%, within Bancorp’s target ratio of loans receivable to deposits of 80% to 90%. Bancorp’s and the Bank’s Boards of Directors may elect from time to time to review Bancorp’s policy regarding this ratio.

18
 
Allowance for Loan Losses and Non-Accrual, Past Due and Restructured Loans

The following represents the activity in the allowance for loan losses for the three months ended March 31, 2006 and 2005:
          
           
   
For the Period Ended March 31,
  
   
2006
  
2005
  
Balance at beginning of period
  
$
778,051
  
$
752,394
  
Charge-offs
    
(2,568
)
  
-
 
Recoveries
    
59,339
   
750
 
Provision charged to operations
    
(58,032
)
  
17,000
 
Balance at end of period
  
$
776,790
  
$
770,144
  

Non-Accrual, Past Due and Restructured Loans
          
           
The following is a summary of non-accruing and past due loans:
          
           
   
March 31, 2006
  
December 31, 2005
  
Loans delinquent over 90 days and still accruing
  
$
-
  
$
-
  
Non-accruing loans
    
215,661
   
578,826
 
Total
  
$
215,661
  
$
578,826
  
% of Total Loans
    
0.37
%
  
1.02
%
% of Total Assets
    
0.24
%
  
0.65
%

Potential Problem Loans
At March 31, 2006, the Bank had no other loans, other than those disclosed in the table above, as to which management has significant doubts as to the ability of the borrower to comply with the present repayment terms.

Deposits
Deposits were $66.8 million at March 31, 2006, an increase of $1.5 million (2.3%) from $65.3 million as of December 31, 2005. Interest bearing checking and money market accounts were $31.5 million at March 31, 2006, a decrease of $1.7 million (5.1%) from $33.2 million. Time certificates were $14.7 million at March 31, 2006, an increase of $3.4 million, or 30.1% from December 31, 2005. Savings accounts decreased $100,000 from year-end 2005. Non-interest bearing checking accounts remained flat at $18.1 million from December 31, 2005. The increase in the total deposit portfolio reflects the ongoing marketing efforts of the Bank. The Bank does not have any brokered deposits.

Other
Repurchase agreement balances decreased $845,000 from December 31, 2005 to $519,000 as of March 31, 2006, due to normal customer activity.

Results of Operations - Comparison of Results for the Three Months Ended March 31, 2006 and March 31, 2005

General
Bancorp had net income of $78,893 for the three months ended March 31, 2006 versus a net loss of $15,567 for the three months ended March 31, 2005. The results for the three months ended March 31, 2006 reflect the one time collection of interest income related to the settlement and collection of past due interest on a loan, and the recovery of a loan that had previously been charged off, which resulted in a credit to the provision for loan losses for the quarter, in comparison to the three months ended March 31, 2005, in which neither of such items were recognized.

19
Net Interest Income
The principal source of revenue is net interest income. Bancorp’s net interest income is dependent primarily upon the difference or spread between the average yield earned on loans receivable and securities and the average rate paid on deposits and borrowings, as well as the relative amounts of such assets and liabilities. Bancorp, like other banking institutions, is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different times, or on a different basis, than its interest-earning assets.

For the three months ended March 31, 2006, net interest income was $1.1 million versus $900,000 for the three months ended March 31, 2005, a $200,000 or 22% increase. This was primarily the result of increases in the yields on interest earning assets, net of the increased cost of funds on interest bearing liabilities, and to a lesser extent by a $1.6 million increase in average earning assets. The increase in average interest earnings assets was comprised of increases in average loans of $6.2 million, decreases in short term investments of $2.4 million, decreases in investments of $1.3 million, and decreases in federal funds of $900,000.

The cost of average interest bearing liabilities was 3.50% for the three months ended March 31, 2006 versus 2.01% for the three months ended March 31, 2005, an increase of 149 basis points, reflecting a general increase in market interest rates. The increase in the cost of interest bearing liabilities was due principally to an increase in rates paid on deposit accounts. The average rate on interest paid on money market and interest bearing checking deposits increased 174 basis points for the three months ended March 31, 2006 versus the three months ended March 31, 2005. Also, the Bank’s average cost of funds for time deposits increased 114 basis for the three months ended March 31, 2006 versus the three months ended March 31, 2005.

Due to the change in the mix of assets and the resulting increase in the average yield on earning assets for the three months ended March 31, 2006, partially offset by the increase in the cost of interest bearing liabilities, the interest spread increased to 3.98% for three months ended March 31, 2006, an increase of 4 basis points versus the three months ended March 31, 2005. Net interest margin increased to 5.41% for the three months ended March 31, 2006 from 4.74% for the three months ended March 31, 2005, an increase of 67 basis points which largely reflects the change in the mix of assets and increasing rates during 2006.

Average Balances, Yields, and Rates
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 three months ended March 31, 2006 and March 31, 2005.

20

Distribution of Assets, Liabilities and Shareholders' Equity;
Interest Rates and Interest Differential
                               
   
Three months Ended
 
Three months Ended
     
   
March 31, 2006
  
March 31, 2005
      
       
Interest
         
Interest
     
Fluctuations in Interest
 
 
 
Average
 
Income/
 
Average
 
Average
 
Income/
 
Average
 
 
 
(Dollars in thousands)
 
Balance
 
Expense
 
Rate
 
Balance
 
Expense
 
Rate
 
Total
  
                               
Interest earning assets
                              
Loans (1)
  
$
57,625
  
$
1,270
    
8.94
%
$
51,468
  
$
988
    
7.79
%
$
282
  
Short-term investments
    
6,062
   
65
   
4.35
%
  
8,422
   
41
   
1.97
%
  
24
 
Investments
    
10,028
   
79
   
3.19
%
  
11,341
   
87
   
3.11
%
  
(8
)
Federal funds sold
    
7,227
   
78
   
4.38
%
  
8,126
   
48
   
2.40
%
  
30
 
Total interest earning assets
    
80,942
   
1,492
   
7.48
%
  
79,357
   
1,164
   
5.95
%
  
328
 
                                             
Cash and due from banks
    
1,319
               
812
                   
Premises and equipment, net
    
4,434
               
3,619
                   
Allowance for loan losses
    
(780
)
              
(757
)
                  
Other
    
1,243
                
1,327
                    
Total assets
  
$
87,158
              
$
84,358
                    
                                             
Interest bearing liabilities
                                            
Time certificates
  
$
13,385
    
121
   
3.67
%
$
10,110
    
63
   
2.53
%
  
58
 
Savings deposits
    
2,794
   
10
   
1.45
%
  
3,814
   
12
   
1.28
%
  
(2
)
Money market / checking deposits
    
29,561
   
235
   
3.22
%
  
31,472
   
115
   
1.48
%
  
120
 
Capital lease obligations
   
1,189
   
44
   
15.01
%
  
1,190
   
43
   
14.65
%
  
1
 
Repurchase agreements
    
891
   
3
   
1.37
%
  
1,016
   
3
   
1.20
%
  
-
 
                                             
Total interest bearing liabilities
    
47,820
   
413
   
3.50
%
  
47,602
   
236
   
2.01
%
  
177
 
                                             
Non-interest bearing deposits
    
18,498
               
15,788
                   
Accrued expenses and
                                            
other liabilities
    
460
               
274
                   
Shareholder's equity
    
20,380
               
20,694
                   
Total liabilities and equity
  
$
87,158
              
$
84,358
                    
                                             
Net interest income
        
$
1,079
              
$
928
        
$
151
  
                                             
Interest spread
                
3.98
%
              
3.94
%
      
Interest margin
                
5.41
%
              
4.74
%
      
                                             
(1) Includes nonaccruing loans.
                                            

21


Changes in Assets and Liabilities and Fluctuations in Interest Rates
The following tables summarize the variance in interest income and interest expense for the three months ended March 31, 2006 and 2005 resulting from changes in assets and liabilities and fluctuations in interest rates earned and paid. The changes in interest attributable to both rate and volume have been allocated to both rate and volume on a pro rata basis.

   
Three months Ended
 
 
 
March 31, 2006 v. 2005
 
 
 
Increase
 
Due to Change in
 
 
 
Or
 
Average
 
(Dollars in thousands)
 
(Decrease)
 
Volume
 
Rate
 
 
 
(Dollars in thousands)
 
Interest earning assets
                    
Loans
  
$
282
  
$
126
  
$
156
  
Short-term investments
    
24
   
(22
)
  
46
 
Investments
    
(8
)
  
(21
)
  
13
 
Federal funds sold
    
30
   
(9
)
  
39
 
Total interest earning assets
    
328
   
74
   
254
 
                     
Interest bearing liabilities
                    
Time certificates
    
58
   
24
   
34
 
Savings deposits
    
(2
)
  
(10
)
  
8
 
Money market / checking deposits
    
120
   
(9
)
  
129
 
Capital lease obligations
   
1
   
-
   
1
 
Repurchase agreements
    
-
   
(2
)
  
2
 
Total interest bearing liabilities
    
177
   
3
   
174
 
Net interest income
  
$
151
  
$
71
  
$
80
  

22


Provision for Loan Losses
The $58,000 loan loss provision credited to operations for the three months ended March 31, 2006 reflects the recovery of a loan that had previously been charged off, which resulted in a credit to the provision for loan losses for the quarter, in comparison to the provision for the three months ended March 31, 2005.

Noninterest Income
The $47,000 increase in total noninterest income for the three months ended March 31, 2006 versus the three months ended March 31, 2005 is due to $31,000 in Small Business Administration (“SBA”) guaranteed loan participation sales gains during the three months ended March 31, 2006 versus no gains during the three months ended March 31, 2005. Through the Bank, Bancorp intends to continue to originate SBA guaranteed loans in the future and expects to continue to earn income from SBA loan participation sales and referrals. The Bank retains the servicing rights of the SBA loans, which generated $21,000 in servicing income during the three months ended March 31, 2006 versus $6,000 during the three months ended March 31, 2005. Noninterest income also reflects a $14,000 prepayment penalty during the three months ended March 31, 2006. Separately, service charges and fees derived from deposits increased by $6,000.

Noninterest Expense
Total noninterest expense was approximately $1.2 million for the three months ended March 31, 2006 versus $1.1 million for the same period in 2005, an increase of $100,000 or 9%. The primary factor contributing to the increase in non-interest expense year-over-year was the opening of The Bank of Southeastern Connecticut, a division of The Bank of Southern Connecticut, which opened on March 6, 2006. During the three months ended March 31, 2006, additional staff was hired to support the new branch, extensive advertising took place to promote the new branch, and branch supplies were purchased.
 
Salaries and benefits for the first quarter of 2006 of $684,000 increased by $126,000, or 23%, from the first quarter of 2005. The increase is due to staff compensation and benefits increases in 2006 in comparison to the comparable period a year ago, primarily arising from the hiring of additional personnel for the New London branch.
  
Occupancy and equipment for the first quarter of 2006 increased by $16,000, or 11%, due primarily to the opening of the New London branch and the related depreciation of buildings, equipment and furniture, and property taxes.

Professional fees for the first quarter of 2006 increased by $8,000, or 8%, due primarily to fees related to the filing of a registration statement on Form S-8 to register the securities issuable under Bancorp’s 2005 Stock Option and Award Plan.

Data processing and other outside services for the first quarter of 2006 increased by $5,000, or 6%, primarily due to the opening of the New London branch.

Advertising and promotional expense for the first quarter of 2006 increased $17,000, or 61% due to marketing initiatives, primarily related to the opening of the New London branch.

Forms, printing and supplies expense for the first quarter of 2006 increased by $15,000, or 87%, primarily due to the printing of forms and the purchasing of supplies for the New London branch.

Off-Balance Sheet Arrangements

See Note 11 to the Financial Statements for information regarding Bancorp’s off-balance sheet arrangements.

23

Liquidity

Management believes that 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.  

Bancorp’s liquidity position as of March 31, 2006 and December 31, 2005 consisted of liquid assets totaling $25.2 million and $26.5 million, respectively. This represents 28.2% and 29.9% of total assets at March 31, 2006 and December 31, 2005, respectively. The liquidity ratio is defined as the percentage of liquid assets to total assets. The following categories of assets as described in the accompanying balance sheet are considered liquid assets: cash and due from banks, federal funds sold, short-term investments, and securities available for sale. Liquidity is a measure of Bancorp’s ability to generate adequate cash to meet financial obligations. The principal cash requirements of a financial institution are to cover downward fluctuations in deposits and increases in its loan portfolio.

Management believes Bancorp’s short-term assets provide sufficient liquidity to cover potential fluctuations in deposit accounts and loan demand and to meet other anticipated operating cash and investment requirements.

Capital
           
The following Table illustrates Bancorp's regulatory capital ratios at:
           
     
March 31,
  
December 31,
     
2006
  
2005
Tier 1 (Leverage) Capital to Average Assets
    
23.77%
  
24.17%
Tier 1 Capital to Risk-Weighted Assets
    
28.73%
  
29.17%
Total Capital to Risk-Weighted Assets
    
29.84%
  
30.30%
           
           
The following Table illustrates the Bank's regulatory capital ratios at:
           
     
March 31,
  
December 31,
     
2006
  
2005
Tier 1 (Leverage) Capital to Average Assets
    
19.23%
  
20.38%
Tier 1 Capital to Risk-Weighted Assets
    
23.41%
  
23.96%
Total Capital to Risk-Weighted Assets
    
24.58%
  
25.17%

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, Bancorp is considered to be “well capitalized” under applicable regulations specified by the Federal Reserve. The Bank also 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%.

24
 
Market Risk

Market risk is defined as the sensitivity of income to fluctuations in interest rates, foreign exchange rates, equity prices, commodity prices and other market-driven rates or prices. Based upon the nature of Bancorp’s business, market risk is primarily limited to interest rate risk, defined as the impact of changing interest rates on current and future earnings.

Bancorp’s goal is to maximize long-term profitability, while minimizing its exposure to interest rate fluctuations. The first priority is to structure and price Bancorp’s assets and liabilities to maintain an acceptable interest rate spread, while reducing the net effect of changes in interest rates. In order to reach an acceptable interest rate spread, Bancorp must generate loans and seek acceptable long-term investments to replace the lower yielding balances in Federal Funds sold and short-term investments. The focus also must be on maintaining a proper balance between the timing and volume of assets and liabilities re-pricing within the balance sheet. One method of achieving this balance is to originate variable rate loans for the portfolio to offset the short-term re-pricing of the liabilities. In fact, a number of the interest bearing deposit products have no contractual maturity. Customers may withdraw funds from their accounts at any time and deposits balances may therefore run off unexpectedly due to changing market conditions.

The exposure to interest rate risk is monitored by Senior Management of the Bank and reported quarterly to the Asset and Liability Management Committee and the Board of Directors of the Bank and Bancorp. Management reviews the interrelationships within the balance sheet to maximize net interest income within acceptable levels of risk.


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

Some of the statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and elsewhere in this Report on Form 10-QSB may include forward-looking statements which reflect our current views with respect to future events and financial performance. Statements which include the words “expect,” “intend,” “plan,” “believe,” “project,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise. All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in these statements or that could adversely affect the holders of our common stock. These factors include, but are not limited to, (1) changes in prevailing interest rates which would affect the interest earned on Bancorp’s interest earning assets and the interest paid on its interest bearing liabilities, (2) the timing of re-pricing of Bancorp’s interest earning assets and interest bearing liabilities, (3) the effect of changes in governmental monetary policy, (4) the effect of changes in regulations applicable to Bancorp and the conduct of its business, (5) changes in competition among financial service companies, including possible further encroachment of non-banks on services traditionally provided by banks and the impact of recently enacted federal legislation, (6) the ability of competitors which are larger than Bancorp to provide products and services which are impractical for Bancorp to provide, (7) the volatility of quarterly earnings, due in part to the variation in the number, dollar volume and profit realized from SBA guaranteed loan participation sales in different quarters, (8) the effect of a loss of any executive officer, key personnel, or directors, (9) the effect of Bancorp’s opening of branches and the receipt of regulatory approval to complete such actions, (10) concentration of Bancorp’s business in southern Connecticut, (11) the concentration of Bancorp’s loan portfolio in commercial loans to small-to-medium sized businesses, which may be impacted more severely than larger businesses during periods of economic weakness, (12) lack of seasoning in Bancorp’s loan portfolio, which may increase the risk of future credit defaults, and (13) the effect of any decision by Bancorp to engage in any business not historically permitted to it. Other such factors may be described in other filings made by Bancorp with the SEC.

25
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.

Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.


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, its Chief Operating Officer, and its Chief Financial Officer as of the end of the period covered by this report, Bancorp’s Chief Executive Officer, Chief Operating Officer and 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 Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by Bancorp in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to Bancorp’s management, including its principal executive, and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 
(b)
Changes in Internal Controls

There have not been any significant changes in Bancorp’s internal controls or in other factors that occurred during Bancorp’s quarter ended March 31, 2006 that could significantly affect these controls subsequent to the evaluation referenced in paragraph (a) above.


26



PART II
Other Information


Item 1. Legal Proceedings

Not applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders
 
Not applicable.
 
Item 5. Other Information
 
Not applicable.

Item 6. Exhibits

(a) Exhibits

No.
Description
   
3(i)
Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3(i) to Bancorp’s Quarterly Report on Form 10-QSB for the quarter ended June 30, 2002, as filed with the Securities and Exchange Commission on August 14, 2002)
   
3(ii)
By-Laws (incorporated by reference to Exhibit 3(ii) to Bancorp’s Registration Statement on Form SB-2, as filed with the Securities and Exchange Commission on April 30, 2001 (No. 333-59824))
   
   
   
   
   
   


27

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


 
SOUTHERN CONNECTICUT BANCORP, INC.
   
   
 
By: /s/ Joseph V. Ciaburri
 
Name: Joseph V. Ciaburri
Date: May 12, 2006
Title: Chairman & Chief Executive Officer
   
 
By: /s/ Michael M. Ciaburri
 
Name: Michael M. Ciaburri
Date: May 12, 2006
Title: President & Chief Operating Officer
   
 
By: /s/ Carlota I. Grate
 
Name: Carlota I. Grate
Date: May 12, 2006
Title: Senior Vice President & Chief Financial Officer
   
 
By: /s/ Anthony M. Avellani
 
Name: Anthony M. Avellani
Date: May 12, 2006
Title: Vice President & Chief Accounting Officer






28

Exhibit Index

No.
Description
3(i)
Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3(i) to Bancorp’s Quarterly Report on Form 10-QSB for the quarter ended June 30, 2002, as filed with the Securities and Exchange Commission on August 14, 2002)
   
3(ii)
By-Laws (incorporated by reference to Exhibit 3(ii) to Bancorp’s Registration Statement on Form SB-2, as filed with the Securities and Exchange Commission on April 30, 2001 (No. 333-59824))
   
   
   
   
   
   


29