10-K 1 form10-k2004.htm FORM 10-K 12312004 Form 10-K 12312004
 
  
 
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
 
For annual and transition reports pursuant to sections 13 or 15(d) of the Securities Exchange Act of 1934
(Mark One)
x  Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended DECEMBER 31, 2004 or
 
o  Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ____________ to ____________
 
Commission file number: 000-13091
 
WASHINGTON TRUST BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
RHODE ISLAND
  
05-0404671
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
  
Identification No.)
     
23 BROAD STREET
WESTERLY, RHODE ISLAND
 
 
02891
(Address of principal executive offices)
  
(Zip Code)

Registrant’s telephone number, including area code: 401-348-1200

Securities registered pursuant to Section 12(b) of the Act:

NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, $.0625 PAR VALUE PER SHARE
(Title of class)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. xYes  oNo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). xYes o No

The aggregate market value of voting stock held by non-affiliates of the registrant at June 30, 2004 was $295,027,178 based on a closing sales price of $25.99 per share as reported for the NASDAQ National Market, which includes $28,142,749 held by The Washington Trust Company under trust agreements and other instruments.

The number of shares of the registrant’s common stock, $.0625 par value per share, outstanding as of February 25, 2005 was 13,296,360.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement dated March 15, 2005 for the Annual Meeting of Shareholders to be held April 26, 2005 are incorporated by reference into Part III of this Form 10-K.
  
 
 

FORM 10-K
WASHINGTON TRUST BANCORP, INC.
For the Year Ended December 31, 2004


  
Description 
  
Page
Number
   
3
18
18
19
     
   
21
22
26
44
44
85
85
85
     
   
85
85
 
86
87
87
87
     
 
90
     
 Exhibit 10.t  Non-Qualified Deferred Compensation Plan  
 Exhibit 23  Independent Accountants' Consent  
 Exhibit 31.a  CEO Certification  
 Exhibit 31.b  CFO Certification  
 Exhibit 32  Certifications pursuant to 18 U.S.C. Section 1350  
 
This report contains certain statements that may be considered “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Corporation’s (as defined below) actual results, performance or achievements could differ materially from those projected in the forward-looking statements as a result, among other factors, of changes in general national or regional economic conditions, changes in interest rates, reductions in the market value of trust and investment assets under management, reductions in loan demand, reductions in deposit levels necessitating increased borrowing to fund loans and investments, changes in loan default and charge-off rates, changes in the size and nature of the Corporation’s competition, changes in legislation or regulation and accounting principles, policies and guidelines and changes in the assumptions used in making such forward-looking statements.
 
 

Washington Trust Bancorp, Inc.
Washington Trust Bancorp, Inc. (the “Bancorp”) is a publicly-owned, registered bank holding company, organized in 1984 under the laws of the state of Rhode Island, whose subsidiaries are permitted to engage in banking and other financial services and businesses. The Bancorp conducts its business through its wholly owned subsidiary, The Washington Trust Company (the “Bank”), a Rhode Island-chartered commercial bank. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”), subject to regulatory limits.

The Bancorp was formed in 1984 under a plan of reorganization in which outstanding common shares of the Bank were exchanged for common shares of the Bancorp.

The accounting and reporting policies of the Bancorp and the Bank (together, the “Corporation” or “Washington Trust”) are in accordance with accounting principles generally accepted in the United States of America and conform to general practices of the banking industry. At December 31, 2004, the Corporation had total assets of $2.3 billion, total deposits of $1.5 billion and total shareholders’ equity of $151.9 million.

The Corporation’s Internet address is www.washtrust.com. On the same day that the Bancorp files its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and exhibits and amendments thereto with the Securities and Exchange Commission (the “SEC”), the Bancorp makes such reports available free of charge through the Corporation’s website.

The Washington Trust Company
The Bank was originally chartered in 1800 as the Washington Bank and is the oldest banking institution headquartered in its market area and is among the oldest banks in the United States. Its current corporate charter dates to 1902. See the discussion under the caption “Market Area and Competition” for further information.

The Bank provides a broad range of financial services, including:

Residential mortgages
Internet banking services
Commercial loans
Commercial and consumer demand deposits
Construction loans
Savings, NOW and money market deposits
Consumer installment loans
Certificates of deposit
Home equity lines of credit
Retirement accounts
Merchant credit card services
Cash management services
Automated teller machines (ATMs)
Safe deposit boxes
Telephone banking services
Trust and investment management services

The Bank owns and operates ATMs located throughout its market area that provide an important customer delivery channel for banking transactions. Additionally, the Bank contracts with a third party vendor who supplies and supports ATMs that are branded with the Bank’s logo located in retail stores and other locations throughout Rhode Island and southeastern Connecticut. The Bank is a member of various ATM networks, including Cirrus, MasterCard, NYCE and PLUS. The Bank also has access to the American Express, Discover and Visa networks.

Data processing for most of the Bank’s deposit and loan accounts and other applications are conducted internally, using Bank-owned equipment. Application software is primarily obtained through purchase or licensing agreements.

The Bank’s primary source of income is net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing deposits and other borrowed funds. Sources of noninterest income include fees for management of customer investment portfolios, trusts and estates, service charges on deposit accounts, merchant processing fees, net gains on loan sales and other banking-related fees.
 
Noninterest expenses include the provision for loan losses, salaries and employee benefits, occupancy, equipment, merchant processing, outsourced services, advertising and promotion and other administrative expenses.
 
The Bank’s loan portfolio is concentrated among borrowers in southern New England, primarily Rhode Island, and to a lesser extent Connecticut and Massachusetts, as well as other states. The Bank provides a variety of commercial and retail lending products. The Bank generally underwrites its residential mortgages based upon secondary market standards. Loans are originated both for sale in the secondary market as well as for retention in the Bank’s loan portfolio. The Bank sells loans with servicing both released and retained. The Bank also purchases loans for its portfolio from various third parties.

The Bank provides trust and investment management services as a trustee under wills and trust agreements; as an executor or administrator of estates; as a provider of agency, custodial and management investment services to individuals and institutions; and as a trustee for employee benefit plans. The Bank also provides investment advisory services including asset allocation analysis and equity, fixed income and balanced portfolio management. The total market value of trust and investment management assets under administration amounted to $1.9 billion and $1.7 billion as of December 31, 2004 and 2003, respectively.

The following is a summary of recurring sources of income, which excludes net realized gains on securities, as a percentage of total income (net interest income plus recurring noninterest income) during the past five years:

   
2004
  
2003
  
2002
  
2001
  
2000
  
                                 
Net interest income
    
67
%
  
65
%
  
66
%
  
65
%
  
67
%
Trust and investment management fees
    
16
    
14
    
15
    
17
    
19
  
Other noninterest income
    
17
    
21
    
19
    
18
    
14
  
                                 
Total income
    
100
%
  
100
%
  
100
%
  
100
%
  
100
%

In April 2002, the Corporation completed the acquisition of First Financial Corp., the parent company of First Bank and Trust Company, a Rhode Island-chartered community bank. The results of First Financial Corp.’s operations have been included in the Corporation’s Consolidated Statements of Income since the acquisition date. First Financial Corp. was headquartered in Providence, Rhode Island and its subsidiary, First Bank and Trust Company, operated banking offices in Providence, Cranston, Richmond and North Kingstown, Rhode Island. The Corporation closed the Richmond and North Kingstown branches and consolidated them into existing Bank branches in May 2002.

Market Area and Competition
The Bank’s market area includes Washington County and portions of Providence and Kent Counties in Rhode Island, as well as a portion of New London County in Connecticut. The Bank operates seventeen banking offices in these Rhode Island and Connecticut counties. The locations of the banking offices are as follows:

Westerly, RI (three locations) (1)
Wakefield, RI (1)
Richmond, RI (1)
North Kingstown, RI (1)
Charlestown, RI (1)
Warwick, RI (2)
New Shoreham (Block Island), RI (1)
Cranston, RI (3)
Narragansett, RI (two locations) (1)
Providence, RI (two locations) (3) (4)
 
(1)  
Located in Washington County.
(2)  
Located in Kent County.
(3)  
Located in Providence County.
(4)  
The Bank has a full service branch as well as a trust/investment management office located in Providence, RI.

The Bank’s banking offices in Charlestown and on Block Island are the only bank facilities in those two Rhode Island communities.

The Bank faces strong competition from branches of major Rhode Island and regional commercial banks, local branches of certain Connecticut banks, as well as various credit unions, savings institutions and, to some extent,
 
mortgage and finance companies. The principal methods of competition are through interest rates, financing terms and other customer conveniences.
 
The Bank operates ten of its banking offices in Washington County, Rhode Island. As of June 30, 2004, based upon information reported in the FDIC’s Deposit Market Share Report, the Bank had 49% of total deposits reported by all financial institutions for Washington County. The closest competitor held 27%, and the second closest competitor held 11% of total deposits in Washington County. The Corporation believes that being the largest commercial banking institution headquartered within this market area provides a competitive advantage over other financial institutions. With the April 2002 acquisition of First Financial Corp., the Bank added two locations in Providence County. In addition, a full-service Bank branch office in Warwick, Rhode Island was opened in the second quarter of 2003, which expanded the Bank’s market area into Kent County.

The Bank has a marketing department that is responsible for reviewing existing products and services and the development and promotion of new products and services.

Employees
As of December 31, 2004 the Corporation had 442 employees, of which 393 were full-time and 49 were part-time.

Supervision and Regulation
The business in which the Corporation is engaged is subject to extensive supervision, regulation, and examination by various bank regulatory authorities and other governmental agencies. State and federal banking laws have as their principal objective either the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system or the protection of consumers or classes of consumers, and depositors, in particular, rather than the specific protection of shareholders of a bank or its parent company.

Set forth below is a brief description of certain laws and regulations that relate to the regulation of Washington Trust. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation. A change in applicable statutes, regulations or regulatory policy may have a material effect on our business.

Regulation of the Bancorp. As a registered bank holding company, the Bancorp is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), and the State of Rhode Island, Department of Business Regulation, Division of Banking (the “Rhode Island Division of Banking”).

The Federal Reserve Board has the authority to issue orders to bank holding companies to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the Federal Reserve Board. The Federal Reserve Board is also empowered to assess civil money penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of ownership and control of a non-banking subsidiary by a bank holding company. Under the BHCA, the Bancorp may not generally engage in activities or acquire more than 5% of any class of voting securities of any company engaged in activities other than banking or activities that are closely related to banking. However, a bank holding company that has elected to be treated as a financial holding company may engage in activities that are financial in nature or incidental or complementary to such financial activities, as determined by the Federal Reserve Board alone, or together with the Secretary of the Department of the Treasury. At this time, the Bancorp has not elected financial holding company status. Under certain circumstances, the Bancorp may be required to give notice or seek approval of the Federal Reserve Board before engaging in activities other than banking.

Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Act”). The Interstate Act permits adequately capitalized and adequately managed bank holding companies, as determined by the Federal Reserve Board, to acquire banks in any state subject to certain concentration limits and other conditions. The Interstate Act also authorizes the interstate merger of banks. In addition, among other things, the Interstate Act permits banks to establish new branches on an interstate basis provided that the law of the host state specifically authorizes such action. Rhode Island and Connecticut, the two states in which the Corporation conducts banking operations, have adopted legislation to "opt in" to interstate merger and branching provisions that effectively eliminated state law barriers. As a bank holding company, prior Federal Reserve Board approval is required
 
before acquiring more than 5% of a class of voting securities, or substantially all of the assets, of a bank holding company, bank or savings association.
 
Control Acquisitions. The Change in Bank Control Act prohibits a person or a group of persons from acquiring “control” of a bank holding company, such as the Bancorp, unless the Federal Reserve Board has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting securities of a bank holding company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), would, under the circumstances set forth in the presumption, constitute the acquisition of control of the bank holding company. In addition, a company is required to obtain the approval of the Federal Reserve Board under the BHCA before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of outstanding voting securities of a bank holding company, or otherwise obtaining control or a “controlling influence” over that bank holding company.

Bank Holding Company Dividends. The Federal Reserve Board and the Rhode Island Division of Banking have authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. The Federal Reserve Board has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the bank holding company’s net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization’s capital needs, asset quality and overall financial condition. Additionally, under Rhode Island law, distributions of dividends cannot be made if a bank holding company would not be able to pay its debts as they become due in the usual course of business or the bank holding company’s total assets would be less than the sum of its total liabilities. The Bancorp’s revenues consist of cash dividends paid to it by the Bank. As described below, the FDIC and the Rhode Island Division of Banking may also regulate the amount of dividends payable by the Bank. The inability of the Bank to pay dividends may have an adverse effect on the Bancorp.

Regulation of the Bank. The Bank is subject to the regulation, supervision and examination by the FDIC, the Rhode Island Division of Banking and the State of Connecticut, Department of Banking, in which the Bank has established branches. The Bank is also subject to various Rhode Island and Connecticut business and banking regulations.

Insurance of Accounts and FDIC Regulation. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund member institutions. The FDIC has established a risk-based assessment system under which the FDIC classifies institutions based on their capital ratios and on other relevant factors and generally assesses higher rates on those institutions that tend to pose greater risks to the federal deposit insurance funds. The Federal Deposit Insurance Act (“FDIA”) does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. The Corporation cannot predict whether the FDIC will be required to increase deposit insurance assessments above their current levels.

Bank Holding Company Support to Subsidiary Bank. Under the Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to its subsidiary bank and to commit resources to its support. This support may be required at times when the bank holding company may not have the resources to provide it. Similarly, under the cross-guarantee provisions of FDIA, the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (1) the “default” of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution “in danger of default.” The Bank is a FDIC-insured depository institution.

Regulatory Capital Requirements. The Federal Reserve Board and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to United States banking organizations. In addition, these regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels, whether because of its financial condition or actual or anticipated growth.
 
The Federal Reserve Board risk-based guidelines define a three-tier capital framework. Tier 1 capital includes common shareholders’ equity and qualifying preferred stock, less goodwill and other adjustments. Tier 2 capital consists of preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for loan losses up to 1.25% of risk-weighted assets. Tier 3 capital includes subordinated debt that is unsecured, fully paid, has an original maturity of at least two years, is not redeemable before maturity without prior approval by the Federal Reserve Board and includes a lock-in clause precluding payment of either interest or principal if the payment would cause the issuing bank’s risk-based capital ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier 2 capital less investments in unconsolidated subsidiaries represents qualifying total capital. Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk. The minimum Tier 1 capital ratio is 4% and the minimum total risk-based capital (Tier 1 and Tier 2) is 8%. At December 31, 2004, the Corporation’s net risk-weighted assets amounted to $1.3 billion, its Tier 1 capital ratio was 9.15% and its total risk-based capital ratio was 10.72%.

The leverage ratio is determined by dividing Tier 1 capital by adjusted average total assets. Although the stated minimum ratio is 100 to 200 basis points above three percent, banking organizations are required to maintain a ratio of at least five percent to be classified as well capitalized. The Corporation’s leverage ratio was 5.35% as of December 31, 2004.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, identifies five capital categories for insured depository institutions (well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the federal bank regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An “undercapitalized” bank must develop a capital restoration plan and its parent holding company must guarantee that bank’s compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the bank’s assets at the time it became “undercapitalized” or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards.

The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a “well-capitalized” institution must have a Tier 1 risk-based capital ratio of at least six percent, a total risk-based capital ratio of at least ten percent and a leverage ratio of at least five percent and not be subject to a capital directive order. Regulators also must take into consideration (a) concentrations of credit risk; (b) interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance sheet position); and (c) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the institution’s regular safety and soundness examination. In addition, the Bancorp, and any bank with significant trading activity, must incorporate a measure for market risk in their regulatory capital calculations. At December 31, 2004, the Bank’s capital ratios placed it in the well-capitalized category. Reference is made to Note 16 to the Corporation’s Consolidated Financial Statements for additional discussion of the Corporation’s regulatory capital requirements.

Limitations on Bank Dividends. The Bancorp’s revenues consist of cash dividends paid to it by the Bank. Such payments are restricted pursuant to various state and federal regulatory limitations. Reference is made to Note 16 to the Corporation’s Consolidated Financial Statements for additional discussion of the Corporation’s ability to pay dividends.
 
Gramm-Leach-Bliley Act of 1999 (“the GLBA”). The GLBA established a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework to permit bank holding companies that qualify and elect to be treated as financial holding companies to engage in a broader range of financial activities than would be permissible for traditional bank holding companies, such as the Bancorp, that have not elected to be treated as financial holding companies. Financial activities is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

Generally, the GLBA and its implementing regulations:

§  
repeal historical restrictions on, and eliminate many federal and state law barriers to, affiliations among banks, securities firms, insurance companies, and other financial service providers;
 
§  
permit investment in non-financial enterprises, subject to significant operational, holding period and other restrictions;
 
§  
provide a uniform framework for the functional regulation of the activities of banks, savings institutions, and their holding companies;
 
§  
broaden the activities that may be conducted by national banks (and derivatively state banks), banking subsidiaries of bank holding companies, and their financial subsidiaries;
 
§  
require all financial institutions to provide notice of their privacy policies at specified times to their retail customers and consumers of their financial products or services, and permit retail customers and consumers, under certain circumstances, to prohibit financial institutions from sharing certain nonpublic personal information pertaining to them by opting out of such sharing;
 
§  
establish guidelines for safeguarding the security, confidentiality and integrity of customer information;
 
§  
adopt a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank (“FHLB”) system;
 
§  
modify the laws governing the implementation of the Community Reinvestment Act of 1977 (“CRA”); and
 
§  
address a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.
 
In order to elect to become a financial holding company and engage in a broader array of activities, a bank holding company, such as the Bancorp, must meet certain tests and file an election form with the Federal Reserve Board. To qualify, all of a bank holding company's subsidiary banks must be well-capitalized and well-managed, as measured by regulatory guidelines. In addition, to engage in the new activities, each of the bank holding company's subsidiary banks must have been rated "satisfactory" or better in its most recent federal CRA evaluation. Furthermore, a bank holding company that elects to be treated as a financial holding company may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the Federal Reserve Board, which imposes limitations on its operations and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions. At this time, the Bancorp has not elected financial holding company status.

Customer Information Security. The Federal Reserve Board, the FDIC and other bank regulatory agencies have adopted final guidelines (the “Guidelines”) for safeguarding nonpublic personal customer information. The Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to create, implement and maintain a comprehensive written
 
information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
 
Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires the financial institution to explain to consumers its policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, the financial institution is prohibited from disclosing such information except as provided in its policies and procedures.

USA Patriot Act of 2001 (the “Patriot Act”). The Patriot Act, designed to deny terrorists and others the ability to obtain anonymous access to the United States financial system, has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act, together with the regulations implemented by various federal regulatory agencies, requires financial institutions, including the Bank, to implement new policies and procedures or amend existing policies or procedures with respect to, among other matters, anti-money laundering compliance, suspicious activity and currency transaction reporting and due diligence on customers. The Patriot Act and underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the Federal Reserve Board to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act.

The Community Reinvestment Act (the “CRA”). The CRA requires lenders to identify the communities served by the institution’s offices and other deposit taking facilities and to make loans and investments and provide services that meet the credit needs of these communities. Regulatory agencies examine each of the banks and rate such institutions’ compliance with CRA as “Outstanding”, “Satisfactory”, “Needs to Improve” or “Substantial Noncompliance”. Failure of an institution to receive at least a “Satisfactory” rating could inhibit an institution or its holding company from undertaking certain activities, including engaging in activities newly permitted as a financial holding company under GLBA and acquisitions of other financial institutions. The Federal Reserve Board must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low- and moderate-income neighborhoods. The Bank has achieved a rating of “Outstanding” on its most recent examination dated November 2003.

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). Sarbanes-Oxley implements a broad range of corporate governance and accounting measures for public companies (including publicly-held bank holding companies such as Bancorp) designed to promote honesty and transparency in corporate America. Sarbanes-Oxley’s principal provisions, many of which have been interpreted through regulations released in 2003, provide for and include, among other things:

§  
The creation of an independent accounting oversight board;
 
§  
Auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients;
 
§  
Additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer of a public company certify financial statements;
 
§  
The forfeiture of bonuses or other incentive-based compensation and profits from the sale of a public company’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
 
§  
An increase in the oversight of, and enhancement of certain requirements relating to, audit committees of public companies and how they interact with the company’s independent auditors;
 
§  
Requirements that audit committee members be independent and are barred from accepting consulting, advisory or other compensatory fees from public companies;
 
§  
Requirements that public companies disclose whether at least one member of the audit committee is a “financial expert” (as such term is defined by the SEC) and if not, why not;
 
§  
Expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;
 
§  
A prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions, such as the Bank, on nonpreferential terms and in compliance with other bank regulatory requirements;
 
§  
Disclosure of a code of ethics and filing a Form 8-K for a change to or waiver of such code; and
 
§  
A range of enhanced penalties for fraud and other violations.
 
The Corporation is monitoring the status of other related ongoing rulemaking by the SEC and other regulatory entities. Currently, management believes that the Corporation is in compliance with the rulemaking promulgated to date.

Risk Factors
In addition to the other information contained or incorporated by reference in this Annual Report on Form 10-K, you should consider the following factors relating to the business of the Corporation.

Interest Rate Volatility May Reduce Our Profitability
Significant changes in market interest rates may adversely affect both our profitability and our financial condition. Our profitability depends in part on the difference between rates earned on loans and investments and rates paid on deposits and other interest-bearing liabilities. Since market interest rates may change by differing magnitudes and at different times, significant changes in interest rates over an extended period of time could reduce overall net interest income. (See Item 7A, Quantitative and Qualitative Disclosures about Market Risk, for additional discussion on interest rate risk.)

Changes in the Market Value of Trust and Investment Management Assets under Administration May Reduce Our Profitability
Trust and investment management fees provide an important source of total revenues. These fees are primarily dependent on the market value of trust and investment management assets under administration. These assets primarily consist of marketable securities. Reductions in the market value of these assets could reduce the level of fees that we earn.

Reductions in Deposit Levels Necessitating Increased Borrowing to Fund Loans and Investments
The Bank’s principal source of funding is deposits and borrowings. As a general matter, deposits are a lower cost source of funds than borrowings because interest rates paid for deposits are typically less than interest rates charged for borrowings. If, as a result of general economic conditions, market interest rates, competitive pressures or otherwise, the level of the Bank’s deposits were to decline relative to the total sources of funds, the Bank may have to rely more heavily on higher cost borrowings in the future.

Our Allowance for Loan Losses May Not Be Adequate to Cover Actual Loan Losses
We make various assumptions and judgments about the collectibility of our loan portfolio and provide an allowance for potential losses based on a number of factors. If our assumptions are wrong, our allowance for loan losses may not be sufficient to cover our losses, which would have an adverse effect on our operating results, and may also cause us to increase the allowance in the future. Further, our net income would decrease if we had to add additional amounts to our allowance for loan losses. In addition to general real estate and economic factors, the following factors could affect our ability to collect our loans and require us to increase the allowance in the future:

·  
Regional credit concentration - We are exposed to real estate and economic factors in southern New England, primarily Rhode Island and to a lesser extent Connecticut and Massachusetts, because a significant portion of our loan portfolio is concentrated among borrowers in these markets. Further, because a substantial portion of our loan portfolio is secured by real estate in this area, including most consumer loans and those commercial loans not specifically classified as commercial mortgages, the value of our collateral is also subject to regional real estate market conditions.
 
·  
Industry concentration - A portion of our loan portfolio consists of loans to the hospitality and tourism industry. Loans to companies in this industry may have a somewhat higher risk of loss than some other industries because these businesses are seasonal, with a substantial portion of commerce concentrated in the summer season. Accordingly, the ability of borrowers to meet their repayment terms is more dependent on economic, climate and other conditions and may be subject to a higher degree of volatility from year to year.

For a more detailed discussion on the allowance for loan losses, see additional information disclosed in Item 7 under the caption “Application of Critical Accounting Policies and Estimates.”

We May Not Be Able to Compete Effectively Against Larger Financial Institutions in Our Increasingly Competitive Industry
The financial services industry in our market has experienced both significant concentration and deregulation. This means that we compete with larger bank and non-bank financial institutions for loans and deposits as well as other sources of funding in the communities we serve, and we will likely face even greater competition in the future as a result of recent federal legislative changes. Many of our competitors have significantly greater resources and lending limits than we have. As a result of those greater resources, the large financial institutions that we compete with may be able to provide a broader range of services to their customers and may be able to afford newer and more sophisticated technology. Our long-term success depends on the ability of the Bank to compete successfully with other financial institutions in the Bank’s service areas.

Changes in Legislation and/or Regulation and Accounting Principles, Policies and Guidelines
Changes in legislation and/or regulation governing financial holding companies and their subsidiaries could affect our operations. The Corporation is subject to extensive federal and state laws and regulations and is subject to supervision, regulation and examination by various federal and state bank regulatory agencies. The restrictions imposed by such laws and regulations limit the manner in which the Corporation may conduct business. There can be no assurance that any modification of these laws and regulations, or new legislation that may be enacted in the future, will not make compliance more difficult or expensive, or otherwise adversely affect the operations of the Corporation. See the section entitled "Supervision and Regulation" beginning on page 5 of this report.

Changes in accounting principles generally accepted in the United States applicable to the Corporation could have a material impact on the Corporation’s reported results of operations.

GUIDE 3 Statistical Disclosures
The following tables contain additional consolidated statistical data about the Corporation, to be read in conjunction with the Consolidated Financial Statements and the related Notes.

I.
Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential
 
A.  
Average balance sheets are presented under the caption “Average Balances/Net Interest Margin (Fully Taxable Equivalent Basis)” of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Nonaccrual loans are included in average loan balances. Average balances are based upon daily averages.
 
B.  
An analysis of net interest earnings, including interest earned and paid, average yields and costs, and net yield on interest-earning assets, is presented under the caption “Average Balances/Net Interest Margin (Fully Taxable Equivalent Basis)” of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Interest income is reported on a fully taxable-equivalent basis. Tax exempt income is converted to a fully taxable equivalent basis using the statutory federal income tax rate. For dividends on corporate stocks, the 70% federal dividends received deduction is also used in the calculation of tax equivalency. Interest on nonaccrual loans is included in the analysis of net interest earnings to the extent that such interest income has
-11-
 
been recognized in the Consolidated Statements of Income. See Guide 3 Statistical Disclosures - Item III.C.1.
 
C.  
An analysis of rate/volume changes in interest income and interest expense is presented under the caption “Volume/Rate Analysis - Interest Income and Expense (Fully Taxable Equivalent Basis)” of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. The net change attributable to both volume and rate has been allocated proportionately.
 
II.
Securities Available for Sale and Securities Held to Maturity
 
A.  
The carrying amounts of securities as of the dates indicated are presented in the following tables:
 
(Dollars in thousands)
                    
                     
December 31,
    
2004
    
2003
    
2002
  
                     
Securities Available for Sale:
                    
U.S. Treasury obligations and obligations
                    
of U.S. government-sponsored agencies
  
$
137,663
  
$
99,094
  
$
77,973
  
Mortgage-backed securities
    
491,847
    
464,825
    
386,747
  
Corporate bonds
    
78,834
    
79,938
    
66,435
  
Corporate stocks
    
27,322
    
29,988
    
22,401
  
                     
Total securities available for sale
  
$
735,666
  
$
673,845
  
$
553,556
  

(Dollars in thousands)
                    
                     
December 31,
    
2004
    
2003
    
2002
  
                     
Securities Held to Maturity:
                    
U.S. Treasury obligations and obligations
                    
of U.S. government-sponsored agencies
  
$
30,000
  
$
8,000
  
$
3,000
  
Mortgage-backed securities
    
105,753
    
143,162
    
220,711
  
States and political subdivisions
    
18,639
    
14,414
    
18,566
  
                     
Total securities held to maturity
  
$
154,392
  
$
165,576
  
$
242,277
  
 
B.  
Maturities of debt securities as of December 31, 2004 are presented in the following tables. Mortgage-backed securities are included based on their weighted average maturities, adjusted for anticipated prepayments. Yields on tax exempt obligations are not computed on a tax equivalent basis.
 
(Dollars in thousands)
  
Due in
  
After 1 Year
 
After 5 Years
         
   
1 Year
  
but within
  
but within
  
After
      
   
or Less
  
5 Years
  
10 Years
  
10 Years
  
Totals
  
Securities Available for Sale:
                                
U.S. Treasury obligations and obligations
                                
of U.S. government-sponsored agencies:
                                
Amortized cost
  
$
26,957
  
$
71,877
  
$
36,679
  
$
-
  
$
135,513
  
Weighted average yield
    
4.92
%
  
3.15
%
  
5.34
%
  
-
    
4.09
%
                                 
Mortgage-backed securities:
                                
Amortized cost
    
102,805
    
278,410
    
111,149
    
-
    
492,364
  
Weighted average yield
    
4.06
%
  
3.92
%
  
3.01
%
  
-
    
3.74
%
                                 
Corporate bonds:
                                
Amortized cost
    
4,001
    
33,467
    
9,170
    
31,726
    
78,364
  
Weighted average yield
    
3.37
%
  
3.81
%
  
5.19
%
  
3.08
%
  
3.65
%
                                 
Total debt securities:
                                
Amortized cost
  
$
133,763
  
$
383,754
  
$
156,998
  
$
31,726
  
$
706,241
  
Weighted average yield
    
4.21
%
  
3.76
%
  
3.68
%
  
3.08
%
  
3.80
%
                                 
Fair value
  
$
134,106
  
$
384,803
  
$
157,518
  
$
31,917
  
$
708,344
  


(Dollars in thousands)
  
Due in
  
After 1 Year
 
After 5 Years
         
   
1 Year
  
but within
  
but within
  
After
      
   
or Less
  
5 Years
  
10 Years
  
10 Years
  
Totals
  
Securities Held to Maturity:
                                
U.S. Treasury obligations and obligations
                                
of U.S. government-sponsored agencies:
                                
Amortized cost
  
$
10,000
  
$
20,000
  
$
-
  
$
-
  
$
30,000
  
Weighted average yield
    
2.97
%
  
3.07
%
  
-
    
-
    
3.04
%
                                 
Mortgage-backed securities:
                                
Amortized cost
    
22,886
    
63,693
    
19,174
    
-
    
105,753
  
Weighted average yield
    
5.30
%
  
4.86
%
  
2.85
%
  
-
    
4.59
%
                                 
States and political subdivisions:
                                
Amortized cost
    
4,073
    
7,650
    
6,131
    
785
    
18,639
  
Weighted average yield
    
4.30
%
  
3.99
%
  
3.50
%
  
3.52
%
  
3.88
%
                                 
Total debt securities:
                                
Amortized cost
  
$
36,959
  
$
91,343
  
$
25,305
  
$
785
  
$
154,392
  
Weighted average yield
    
4.56
%
  
4.40
%
  
3.01
%
  
3.52
%
  
4.20
%
                                 
Fair value
  
$
37,353
  
$
92,411
  
$
25,709
  
$
797
  
$
156,270
  
 
C.  
Not applicable.

III.
Loan Portfolio
 
A.  
The following table sets forth the composition of the Corporation’s loan portfolio for each of the past five years:
 
(Dollars in thousands)
                                
                                 
December 31,
   
2004
    
2003
    
2002
    
2001
    
2000
  
                                 
Commercial:
                                
Mortgages
  
$
266,670
  
$
227,334
  
$
197,814
  
$
118,999
  
$
121,817
  
Construction and development
    
29,263
    
12,486
    
10,337
    
1,930
    
2,809
  
Other (1)
    
211,778
    
168,657
    
174,018
    
139,704
    
115,202
  
                                 
Total commercial
    
507,711
    
408,477
    
382,169
    
260,633
    
239,828
  
                                 
Residential real estate:
                                
Mortgages
    
494,720
    
375,706
    
269,548
    
223,681
    
236,595
  
Homeowner construction
    
18,975
    
14,149
    
11,338
    
11,678
    
14,344
  
                                 
Total residential real estate
    
513,695
    
389,855
    
280,886
    
235,359
    
250,939
  
                                 
Consumer:
                                
Home equity lines
    
155,001
    
116,458
    
81,503
    
56,410
    
45,635
  
Other (2)
    
73,269
    
46,191
    
50,568
    
53,243
    
60,753
  
                                 
Total consumer loans
    
228,270
    
162,649
    
132,071
    
109,653
    
106,388
  
                                 
Total loans
  
$
1,249,676
  
$
960,981
  
$
795,126
  
$
605,645
  
$
597,155
  
 
(1)  
Loans to businesses and individuals, a substantial portion of which are fully or partially collateralized by real estate.
(2)  
Fixed rate home equity loans and other consumer installment loans.

B.  
An analysis of the maturity and interest rate sensitivity of Real Estate Construction and Other Commercial loans as of December 31, 2004 follows:
 
(Dollars in thousands)
                  
   
1 Year
  
1 to 5
  
After 5
      
Matures in:
  
or Less
  
Years
  
Years
  
Totals
  
                   
Construction and development (1)
  
$
4,999
  
$
17,325
  
$
25,914
  
$
48,238
  
Commercial - other
    
94,870
    
79,269
    
37,639
    
211,778
  
                           
   
$
99,869
  
$
96,594
  
$
63,553
  
$
260,016
  
 
(1)  
Includes homeowner construction and commercial construction and development. Maturities of homeowner construction loans are included based on their contractual conventional mortgage repayment terms following the completion of construction.
 
Sensitivity to changes in interest rates for all such loans due after one year is as follows:
 
(Dollars in thousands)
      
Floating or
      
   
Predetermined
  
Adjustable
      
   
Rates
  
Rates
  
Totals
  
               
Principal due after one year
  
$
97,784
  
$
62,363
  
$
160,147
  

C.  
Risk Elements
Reference is made to the caption “Asset Quality” included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Included therein is a discussion of the Corporation’s credit review and accounting practices, as well as information relevant to nonperforming assets at December 31, 2004.
 
1.  
Nonaccrual, Past Due and Restructured Loans
a)  
Nonaccrual loans as of the dates indicated were as follows:
 
(Dollars in thousands)
                                
                                 
December 31,
    
2004
    
2003
    
2002
    
2001
    
2000
  
                                 
   
$
4,731
  
$
2,743
  
$
4,177
  
$
3,827
  
$
3,434
  

Loans, with the exception of certain well-secured residential mortgage loans, are placed on nonaccrual status and interest recognition is suspended when such loans are 90 days or more overdue with respect to principal and/or interest. Well-secured residential mortgage loans are permitted to remain on accrual status provided that full collection of principal and interest is assured. Loans are also placed on nonaccrual status when, in the opinion of management, full collection of principal and interest is doubtful. Interest previously accrued, but not collected on such loans is reversed against current period income. Cash receipts on nonaccrual loans are recorded as interest income or as a reduction of principal if full collection of the loan is doubtful or if impairment of the collateral is identified. Loans are removed from nonaccrual status when they have been current as to principal and interest for a period of time, the borrower has demonstrated an ability to comply with repayment terms, and when, in management’s opinion, the loans are considered to be fully collectible.

For the year ended December 31, 2004, the gross interest income that would have been recognized if loans on nonaccrual status had been current in accordance with their original terms was approximately $371 thousand. Interest recognized on these loans amounted to approximately $297 thousand.

There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at December 31, 2004.

b)  
Loans contractually past due 90 days or more and still accruing for the dates indicated were as follows:
 
(Dollars in thousands)
                      
                       
December 31,
  
2004
  
2003
  
2002
  
2001
  
2000
  
                                 
   $
- 
  
$
-
  
$
-
  
$
-
  
$
393
  

c)  
Restructured accruing loans for the dates indicated were as follows:
 
(Dollars in thousands)
                      
                       
December 31,
  
2004
  
2003
  
2002
  
2001
  
2000
  
                                 
 
    $
- 
 
$
-
  
$
-
  
$
-
  
$
-
  

Restructured accruing loans include those for which concessions, such as reduction of interest rates other than normal market rate adjustments or deferral of principal or interest payments, have been granted due to a borrower’s financial condition. Interest on restructured loans is accrued at the reduced rate.

2.  
Potential Problem Loans
The Corporation classifies certain loans as “substandard,” “doubtful,” or “loss” based on criteria consistent with guidelines provided by banking regulators. Potential problem loans consist of classified accruing commercial loans that were less than 90 days past due at December 31, 2004. Such loans are characterized by weaknesses in the financial condition of borrowers or collateral deficiencies. Based on historical experience, the credit quality of some of these loans may improve as a result of collection
 
efforts, while the credit quality of other loans may deteriorate, resulting in some amount of losses. These loans are not included in the analysis of nonaccrual, past due and restructured loans in Section III.C.1 above. At December 31, 2004, potential problem loans amounted to approximately $2.2 million. The Corporation’s loan policy provides guidelines for the review of such loans in order to facilitate collection.

Depending on future events, these potential problem loans, and others not currently identified, could be classified as nonperforming in the future.

3.  
Foreign Outstandings - None.

4.  
Loan Concentrations
The Corporation has no concentration of loans that exceed 10% of its total loans except as disclosed by types of loan in Section III.A.

D.  
Other Interest-Bearing Assets
None.

IV. Summary of Loan Loss Experience
 
A.  
The allowance for loan losses is management’s best estimate of probable credit losses in the loan portfolio that have been incurred as of the balance sheet date. The level of the allowance is based on management’s ongoing review of the growth and composition of the loan portfolio, net charge-off experience, current and expected economic conditions, and other pertinent factors. Loans (or portions thereof) deemed to be uncollectible are charged against the allowance and recoveries of amounts previously charged off are added to the allowance. Loss experience on loans is presented in the following table for the years indicated:
 
(Dollars in thousands)
                      
December 31,
    
2004
    
2003
    
2002
    
2001
    
2000
  
                                 
Balance at beginning of year
  
$
15,914
  
$
15,487
  
$
13,593
  
$
13,135
  
$
12,349
  
Charge-offs:
                                
Commercial:
                                
Mortgages
    
215
    
-
    
27
    
122
    
61
  
Construction and development
    
-
    
-
    
-
    
-
    
-
  
Other
    
257
    
200
    
284
    
121
    
144
  
Residential:
                                
Mortgages
    
-
    
-
    
29
    
-
    
65
  
Homeowner construction
    
-
    
-
    
-
    
-
    
-
  
Consumer
    
95
    
94
    
157
    
190
    
413
  
                                 
Total charge-offs
    
567
    
294
    
497
    
433
    
683
  
                                 
Recoveries:
                                
Commercial:
                                
Mortgages
    
36
    
17
    
72
    
-
    
53
  
Construction and development
    
34
    
-
    
-
    
-
    
-
  
Other
    
569
    
177
    
-
    
273
    
157
  
Residential:
                                
Mortgages
    
-
    
-
    
-
    
15
    
46
  
Homeowner construction
    
-
    
-
    
-
    
-
    
-
  
Consumer
    
175
    
67
    
90
    
53
    
63
  
                                 
Total recoveries
    
814
    
261
    
162
    
341
    
319
  
                                 
Net (recoveries) charge-offs
    
(247
)
  
33
    
335
    
92
    
364
  
Allowance on acquired loans
    
-
    
-
    
1,829
    
-
    
-
  
Additions charged to earnings
    
610
    
460
    
400
    
550
    
1,150
  
                                 
Balance at end of year
  
$
16,771
  
$
15,914
  
$
15,487
  
$
13,593
  
$
13,135
  
                                 
Net (recoveries) charge-offs
                                
to average loans
    
(.02
)%
  
-
%
  
.05
%
  
.02
%
  
.06
%

B.  
The following table presents the allocation of the allowance for loan losses:
 
(Dollars in thousands)
                      
                       
December 31,
    
2004
    
2003
    
2002
    
2001
    
2000
  
                                 
Commercial:
                                
Mortgages
  
$
4,385
  
$
4,102
  
$
3,161
  
$
2,195
  
$
2,316
  
% of these loans to all loans
    
21.3
%
  
23.7
%
  
24.9
%
  
19.6
%
  
20.4
%
                                 
Construction and development
    
729
    
294
    
243
    
33
    
55
  
% of these loans to all loans
    
2.3
%
  
1.3
%
  
1.3
%
  
.3
%
  
.5
%
                                 
Other
    
3,633
    
3,248
    
2,832
    
3,024
    
2,250
  
% of these loans to all loans
    
16.9
%
  
17.6
%
  
21.9
%
  
23.1
%
  
19.3
%
                                 
Residential:
                                
Mortgages
    
1,447
    
1,965
    
1,457
    
1,230
    
1,286
  
% of these loans to all loans
    
39.7
%
  
39.0
%
  
33.9
%
  
36.9
%
  
39.6
%
                                 
Homeowner construction
    
47
    
74
    
61
    
64
    
78
  
% of these loans to all loans
    
1.5
%
  
1.5
%
  
1.4
%
  
2.0
%
  
2.4
%
                                 
Consumer
    
1,323
    
1,507
    
1,305
    
1,222
    
1,295
  
% of these loans to all loans
    
18.3
%
  
16.9
%
  
16.6
%
  
18.1
%
  
17.8
%
                                 
Unallocated
    
5,207
    
4,724
    
6,428
    
5,825
    
5,855
  
                                 
Balance at end of year
  
$
16,771
  
$
15,914
  
$
15,487
  
$
13,593
  
$
13,135
  
     
100.0
%
  
100.0
%
  
100.0
%
  
100.0
%
  
100.0
%

V.
Deposits
 
A.  
Average deposit balances outstanding and the average rates paid thereon are presented in the following table:
 
(Dollars in thousands)
  
2004
  
2003
  
2002
  
 
    
Average
 
 
Average
 
 
Average
 
 
Average
 
 
Average
 
 
Average
 
 
 
 
Amount
 
 
Rate Paid
 
 
Amount
 
 
Rate Paid
 
 
Amount
 
 
Rate Paid
  
                                       
Demand deposits
  
$
193,905
    
-
  
$
174,338
    
-
  
$
149,382
    
-
  
NOW accounts
    
162,714
    
.21
%
  
134,432
    
.24
%
  
106,188
    
.53
%
Money market accounts
    
152,664
    
1.44
%
  
74,435
    
.98
%
  
75,216
    
1.70
%
Savings accounts
    
257,274
    
.61
%
  
269,927
    
.80
%
  
218,144
    
1.72
%
Time deposits
    
575,877
    
3.14
%
  
485,126
    
3.16
%
  
454,239
    
3.69
%
                                       
Total deposits
  
$
1,342,434
    
1.65
%
$
1,138,258
    
1.63
%
$
1,003,169
    
2.23
%

B.  
Not Applicable.

C.  
Not Applicable.

D.  
The maturity schedule of time deposits in amounts of $100 thousand or more at December 31, 2004 was as follows:
 
(Dollars in thousands)
      
Over 3
  
Over 6
          
   
3 months
  
through
  
through
  
Over 12
      
Time remaining until maturity
  
or less
  
6 months
  
12 months
  
months
  
Totals
  
                       
   
$
38,093
  
$
33,366
  
$
21,444
  
$
217,480
  
$
310,383
  

E.  
Not Applicable
 
VI.
Return on Equity and Assets
 
   
2004
  
2003
  
2002
  
               
Return on average assets
    
0.97
%
  
1.03
%
  
1.07
%
Return on average shareholders’ equity
    
14.40
%
  
14.15
%
  
14.25
%
Dividend payout ratio (1)
    
44.16
%
  
43.97
%
  
43.08
%
Average equity to average total assets
    
6.73
%
  
7.24
%
  
7.50
%
 
(1)  
Represents the ratio of historical per share dividends declared by the Bancorp to diluted earnings per share.

VII.
Short-Term Borrowings
 
Not Applicable.

The Corporation conducts its business from its corporate headquarters and other properties listed below all of which are considered to be in good condition and adequate for the purposes for which they are used. The following table sets forth certain information relating to bank premises owned or used by the Corporation in conducting its business:

   
Own/Lease
Location
Description
Expiration Date
     
23 Broad Street, Westerly, RI
Corporate headquarters
Own
126 Franklin Street, Westerly, RI
Branch office
Own
1200 Main Street, Wyoming (Richmond), RI
Branch office
Own
4137 Old Post Road, Charlestown, RI
Branch office
Own
730 Kingstown Road, Wakefield, RI
Branch office
Lease / 2005 (1)
20 Point Judith Road, Narragansett, RI
Branch office
Own
885 Boston Neck Road, Narragansett, RI
Branch office
Own
Ocean Avenue, New Shoreham (Block Island), RI
Branch office
Lease / 2006 (1)
7625 Post Road, North Kingstown, RI
Branch office
Own
236 Centerville Road, Warwick, RI
Branch office
Own
645 Reservoir Avenue, Cranston, RI
Branch office
Own & Lease (2)
180 Washington Street, Providence RI
Branch office
Own
Olde Mistick Village, 27 Coogan Boulevard, Mystic, CT
Branch office
Lease / 2008 (1)
McQuades Marketplace, Main Street, Westerly, RI
Supermarket branch
Lease / 2007 (1)
McQuades Marketplace, 10 Clara Drive, Mystic, CT
Supermarket branch
Lease / 2007 (1)
A & P Super Market, Route 1, Mystic, CT
Supermarket branch
Lease / 2005 (1)
66 South Main Street, Providence, RI
Trust and investment services office
Lease / 2009 (1)
5 Ledward Avenue, Westerly, RI
Operations facility
Lease / 2005 (1)
2 Crosswind Road, Westerly, RI
Operations facility
Own
 
(1)  Lease may be extended by the Corporation beyond the indicated expiration date.
(2)  Owned building on leased land. Lease expiration date is May 2009.

In addition to the facilities listed in the previous table, the Bank has five owned offsite-ATMs in leased spaces. The terms of these leases are negotiated annually. The previous table does not include ATMs that are branded with the Bank’s logo under contracts with a third party vendor located in retail stores and other locations throughout Rhode Island and southeastern Connecticut.

On June 22, 2004 a suit was filed by Galilee Hotel Associates, LLC (“plaintiff”) in the United States Bankruptcy Court, District of Rhode Island (the “Court”) against Bank Rhode Island, The Washington Trust Company (the “Bank”), Kahn, Litwin, Renza & Co. Ltd. and Thomas Furey. The suit alleged that the actions of the defendants contributed to and culminated in the bankruptcy filing of the plaintiff. The plaintiff had applied to The Washington Trust Company in 2003 for a commercial real estate loan in the amount of $3.5 million. No loan was made by the Bank in connection with that application. The most significant count against the Bank alleged breach
 
of the covenant of good faith and fair dealing and sought damages in the amount of at least $3.5 million. Other counts against the Bank were contained in the suit relating to allegations and claims that were not material.

On September 2, 2004 the Court dismissed the count relating to the $3.5 million claim without prejudice, indicating that the plaintiff failed to state a claim upon which relief could be granted under the count. However, the plaintiff was permitted additional time to restate its claim. On October 20, 2004, the plaintiff was converted to Chapter 7 status under federal bankruptcy law. On December 9, 2004, a motion was filed whereby the Bank and the plaintiff’s Chapter 7 Bankruptcy Trustee agreed to resolve the suit without any liability on the part of the Bank. The motion was approved by the Court on January 3, 2005. The final agreement between the parties was executed in January 2005 and this matter is closed.

The Corporation is involved in various other claims and legal proceedings arising out of the ordinary course of business. Management is of the opinion, based on its review with counsel of the development of such matters to date, that the ultimate disposition of such other matters will not materially affect the consolidated financial position or results of operations of the Corporation.

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2004.

Executive Officers of the Registrant
The following is a list of all executive officers of the Bancorp and the Bank with their titles, ages, and length of service, followed by certain biographical information as of December 31, 2004.

     
Years of
Name
Title
Age
Service
       
John C. Warren
Chairman and Chief Executive Officer of the Bancorp and the Bank
59
9
       
John F. Treanor
President and Chief Operating Officer of the Bancorp and the Bank
57
6
       
David V. Devault
Executive Vice President, Treasurer and Chief Financial
50
18
 
Officer of the Bancorp and the Bank; Secretary of the Bank
    
       
Harvey C. Perry II
Senior Vice President and Secretary of the Bancorp;
55
30
 
Senior Vice President - Director of Non-Profit Resources of the Bank
    
       
Dennis L. Algiere
Senior Vice President - Chief Compliance Officer and Director of
44
10
 
Community Affairs of the Bank
    
       
Stephen M. Bessette
Senior Vice President - Retail Lending of the Bank
57
8
       
Vernon F. Bliven
Senior Vice President - Human Resources of the Bank
55
32
       
Elizabeth B. Eckel
Senior Vice President - Marketing of the Bank
44
13
       
William D. Gibson
Senior Vice President - Credit Administration of the Bank
58
6
       
Barbara J. Perino, CPA
Senior Vice President - Operations and Technology of the Bank
43
16
       
B. Michael Rauh, Jr.
Senior Vice President - Corporate Sales Planning and Delivery of the Bank
45
13
       
James M. Vesey
Senior Vice President and Chief Credit Officer of the Bank
57
6

John C. Warren joined the Bancorp and the Bank in 1996 as President and Chief Operating Officer. In 1997, he was elected President and Chief Executive Officer of the Bancorp and the Bank. In 1999, he was elected Chairman and Chief Executive Officer of the Bancorp and the Bank.
 
John F. Treanor joined the Bancorp and the Bank in April 1999 as President and Chief Operating Officer. He served as Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer of SIS Bancorp, Inc. from 1994 to 1999.

David V. Devault joined the Bank in 1986 as Controller. He was elected Vice President and Chief Financial Officer of the Bancorp and the Bank in 1987. He was elected Senior Vice President and Chief Financial Officer of the Bancorp and the Bank in 1990. In 1997, he was also elected Treasurer of the Bancorp and the Bank. In 1998, he was elected Executive Vice President, Treasurer and Chief Financial Officer of the Bancorp and the Bank. He was appointed to the position of Secretary of the Bank in 2002.

Harvey C. Perry II joined the Bank in 1974 and was elected Assistant Trust Officer in 1977, Trust Officer in 1981 and Secretary and Trust Officer in 1982. He was elected Vice President and Secretary of the Bancorp and the Bank in 1984, and Senior Vice President and Secretary of the Bancorp and the Bank in 1990. In 2002, he was appointed Senior Vice President - Director of Non-Profit Resources of the Bank.

Dennis L. Algiere joined the Bank in April 1995 as Compliance Officer. He was named Vice President -Compliance in December 1996 and was promoted to Senior Vice President - Compliance and Community Affairs in September 2001. He was named Senior Vice President - Chief Compliance Officer and Director of Community Affairs in 2003.

Stephen M. Bessette joined the Bank in February 1997 as Senior Vice President - Retail Lending. Prior to joining the Bank he held the position of Executive Vice President at Ameristone Mortgage Corporation since June 1995.

Vernon F. Bliven joined the Bank in 1972 and was elected Assistant Vice President in 1980, Vice President in 1986 and Senior Vice President - Human Resources in 1993.

Elizabeth B. Eckel joined the Bank in 1991 as Director of Advertising and Public Relations. In 1995, she was named Vice President - Marketing. She was promoted to Senior Vice President - Marketing in 2000.

William D. Gibson joined the Bank in March 1999 as Senior Vice President - Credit Administration. Prior to joining the Bank, he served as Senior Vice President of Credit Review and Senior Vice President of Credit and Loan Administration of Citizens Bank since October 1977.

Barbara J. Perino joined the Bank in 1988 as Financial Accounting Officer. She was named Controller in 1989 and Vice President - Controller in 1992. In 1998, she was promoted to Senior Vice President - Operations and Technology.

B. Michael Rauh, Jr. joined the Bank in 1991 as Vice President - Marketing and was promoted in 1993 to Senior Vice President - Retail Banking. He was named Senior Vice President - Corporate Sales Planning and Delivery in 2003.

James M. Vesey joined the Bank in 1998 as Senior Vice President - Commercial Lending. In 2000, he was named Senior Vice President and Chief Credit Officer. Prior to joining the Bank, he held the position of Senior Vice President and Director of Business Banking at Citizens Bank since December 1995.

 

The Bancorp’s common stock has traded on the Nasdaq National Market since May 1996. Previously, the Bancorp’s stock traded on the Nasdaq Small-Cap Market since June 1992, and had been listed on the Nasdaq Over-The-Counter Market system since June 1987.

The quarterly common stock price ranges and dividends paid per share for the years ended December 31, 2004 and 2003 are presented in the following table. The stock prices are based on the high and low sales prices during the respective quarter.

2004 Quarters
    
1
 
 
2
 
 
3
 
 
4
  
                           
Stock prices:
                          
High
  
$
27.60
  
$
27.56
  
$
26.81
  
$
30.50
  
Low
    
23.80
    
24.28
    
23.20
    
25.82
  
                           
Cash dividend declared per share
  
$
.17
  
$
.17
  
$
.17
  
$
.17
  
                           
2003 Quarters
    
1
 
 
2
 
 
3
 
 
4
  
                           
Stock prices:
                          
High
  
$
20.61
  
$
24.17
  
$
28.49
  
$
29.42
  
Low
    
19.36
    
19.80
    
22.60
    
23.94
  
                           
Cash dividend declared per share
  
$
.15
  
$
.15
  
$
.16
  
$
.16
  

The Bancorp will continue to review future common stock dividends based on profitability, financial resources and economic conditions. The Bancorp (including the Bank prior to 1984) has recorded consecutive quarterly dividends for over one hundred years.

The Bancorp’s primary source of funds for dividends paid to shareholders is the receipt of dividends from the Bank. A discussion of the restrictions on the advance of funds or payment of dividends to the Bancorp is included in Note 16 to the Consolidated Financial Statements.

At February 25, 2005 there were 2,158 holders of record of the Bancorp’s common stock.

See additional disclosures on Equity Compensation Plan Information in Part III, Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
 
The following tables represent selected consolidated financial data as of and for the years ended December 31, 2004, 2003, 2002, 2001 and 2000. The selected consolidated financial data is derived from the Corporation’s Consolidated Financial Statements. The selected consolidated financial data set forth below does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information including the Consolidated Financial Statements and related Notes, and the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” appearing elsewhere in this Annual Report on Form 10-K.

Selected Operating Data and Financial Ratios:
  
(Dollars in thousands)
  
   
At or for the years ended December 31,
    
2004
    
2003
    
2002
    
2001
    
2000
  
                                 
Financial Results:
                                
Interest income
  
$
96,853
  
$
86,245
  
$
87,339
  
$
87,527
  
$
85,099
  
Interest expense
    
42,412
    
37,446
    
43,057
    
48,160
    
47,231
  
                                 
Net interest income
    
54,441
    
48,799
    
44,282
    
39,367
    
37,868
  
Provision for loan losses
    
610
    
460
    
400
    
550
    
1,150
  
                                 
Net interest income after
                               
provision for loan losses
    
53,831
    
48,339
    
43,882
    
38,817
    
36,718
  
Noninterest income
    
26,905
    
26,735
    
23,258
    
21,485
    
19,712
  
                                 
Net interest and noninterest income
    
80,736
    
75,074
    
67,140
    
60,302
    
56,430
  
Noninterest expense
    
50,373
    
47,632
    
42,990
    
41,653
    
37,548
  
                                 
Income before income taxes
    
30,363
    
27,442
    
24,150
    
18,649
    
18,882
  
Income tax expense
    
9,534
    
8,519
    
7,393
    
5,541
    
5,673
  
                                 
Net income
  
$
20,829
  
$
18,923
  
$
16,757
  
$
13,108
  
$
13,209
  
                                 
Per share information ($):
                                
Earnings per share:
                                
Basic
    
1.57
    
1.44
    
1.32
    
1.09
    
1.10
  
Diluted
    
1.54
    
1.41
    
1.30
    
1.07
    
1.09
  
Cash dividends declared (1)
    
.68
    
.62
    
.56
    
.52
    
.48
  
Book value
    
11.44
    
10.46
    
9.87
    
8.15
    
7.43
  
Market value - closing stock price
    
29.31
    
26.20
    
19.53
    
19.00
    
14.00
  
                                 
Performance Ratios (%):
                                
Return on average assets
    
.97
    
1.03
    
1.07
    
1.01
    
1.14
  
Return on average shareholders’ equity
    
14.40
    
14.15
    
14.25
    
13.86
    
16.14
  
Dividend payout ratio (2)
    
44.16
    
43.97
    
43.08
    
48.60
    
44.04
  
                                 
Asset Quality Ratios (%):
                                
Nonperforming loans to total loans
    
.38
    
.29
    
.53
    
.63
    
.58
  
Nonperforming assets to total assets
    
.21
    
.14
    
.24
    
.28
    
.28
  
Allowance for loan losses to nonaccrual loans
    
354.49
    
580.17
    
370.78
    
355.20
    
382.50
  
Allowance for loan losses to total loans
    
1.34
    
1.66
    
1.95
    
2.24
    
2.20
  
Net charge-offs to average total loans
    
-
    
-
    
.05
    
.02
    
.06
  
                                 
Capital Ratios (%):
                                
Total equity to total assets
    
6.58
    
6.99
    
7.37
    
7.19
    
7.32
  
Tier 1 leverage capital ratio
    
5.35
    
5.65
    
5.63
    
6.84
    
7.08
  
Tier 1 risk-based capital ratio
    
9.15
    
10.00
    
10.13
    
12.63
    
12.70
  
Total risk-based capital ratio
    
10.72
    
11.57
    
11.55
    
14.22
    
14.35
  

(1)
Represents historical per share dividends declared by the Bancorp.
(2)
Represents the ratio of historical per share dividends declared by the Bancorp to diluted earnings per share, restated as a result of the 2000 acquisition of Phoenix Investment Management Company, Inc., which was accounted for under the pooling of interests method.
     
Selected Balance Sheet Data:
  
(Dollars in thousands)
   
December 31,
    
2004
    
2003
    
2002
    
2001
    
2000
  
                                 
Assets:
                                
Cash and cash equivalents
  
$
52,081
  
$
61,110
  
$
51,048
  
$
50,899
  
$
43,860
  
Total securities
    
890,058
    
839,421
    
795,833
    
629,061
    
511,526
  
FHLB stock
    
34,373
    
31,464
    
24,582
    
23,491
    
19,558
  
Loans:
                                
Commercial and other
    
507,711
    
408,477
    
382,169
    
260,633
    
239,828
  
Residential real estate
    
513,695
    
389,855
    
280,886
    
235,359
    
250,939
  
Consumer
    
228,270
    
162,649
    
132,071
    
109,653
    
106,388
  
                                 
Total loans
    
1,249,676
    
960,981
    
795,126
    
605,645
    
597,155
  
Less allowance for loan losses
    
16,771
    
15,914
    
15,487
    
13,593
    
13,135
  
                                 
Net loans
    
1,232,905
    
945,067
    
779,639
    
592,052
    
584,020
  
Goodwill and other intangibles
    
23,900
    
24,544
    
25,260
    
669
    
799
  
Other
    
74,503
    
72,201
    
69,299
    
66,057
    
58,304
  
                                 
Total assets
  
$
2,307,820
  
$
1,973,807
  
$
1,745,661
  
$
1,362,229
  
$
1,218,067
  
                                 
Liabilities:
                                
Deposits:
                                
Demand deposits
  
$
189,588
  
$
194,144
  
$
157,539
  
$
134,783
  
$
113,012
  
NOW accounts
    
174,727
    
153,344
    
120,092
    
96,288
    
83,088
  
Money market accounts
    
196,775
    
83,037
    
75,446
    
77,947
    
51,891
  
Savings accounts
    
251,920
    
257,497
    
275,816
    
142,718
    
124,330
  
Time deposits
    
644,875
    
518,119
    
481,600
    
365,140
    
363,363
  
                                 
Total deposits
    
1,457,885
    
1,206,141
    
1,110,493
    
816,876
    
735,684
  
FHLB advances
    
672,748
    
607,104
    
480,080
    
431,490
    
377,362
  
Other borrowings
    
3,417
    
2,311
    
9,183
    
2,087
    
3,227
  
Other liabilities
    
21,918
    
20,196
    
17,184
    
13,839
    
12,608
  
Shareholders' equity
    
151,852
    
138,055
    
128,721
    
97,937
    
89,186
  
                                 
Total liabilities and shareholders’ equity
  
$
2,307,820
  
$
1,973,807
  
$
1,745,661
  
$
1,362,229
  
$
1,218,067
  
                                 
                                 
Asset Quality:
                                
Nonaccrual loans
  
$
4,731
  
$
2,743
  
$
4,177
  
$
3,827
  
$
3,434
  
Other real estate owned, net
    
4
    
11
    
86
    
30
    
9
  
                                 
Total nonperforming assets
  
$
4,735
  
$
2,754
  
$
4,263
  
$
3,857
  
$
3,443
  

 
Selected Quarterly Financial Data
  
(Dollars in thousands)
  
                                 
2004
    
Q1
   
Q2
    
Q3
    
Q4
    
Year
  
                                 
Interest income:
                                
Interest and fees on loans
  
$
13,641
  
$
14,287
  
$
15,762
  
$
17,138
  
$
60,828
  
Income from securities
    
8,255
    
8,107
    
8,742
    
8,683
    
33,787
  
Dividends on corporate stock and FHLB stock
    
474
    
506
    
562
    
563
    
2,105
  
Interest on federal funds sold
                                
and other short-term investments
    
20
    
20
    
47
    
46
    
133
  
                                 
Total interest income
    
22,390
    
22,920
    
25,113
    
26,430
    
96,853
  
                                 
Interest expense:
                                
Savings deposits
    
729
    
894
    
1,180
    
1,324
    
4,127
  
Time deposits
    
4,018
    
4,130
    
4,756
    
5,166
    
18,070
  
FHLB advances
    
4,545
    
4,789
    
5,281
    
5,538
    
20,153
  
Other
    
15
    
15
    
14
    
18
    
62
  
                                 
Total interest expense
    
9,307
    
9,828
    
11,231
    
12,046
    
42,412
  
                                 
Net interest income
    
13,083
    
13,092
    
13,882
    
14,384
    
54,441
  
Provision for loan losses
    
120
    
120
    
120
    
250
    
610
  
                                 
Net interest income after provision for loan losses
    
12,963
    
12,972
    
13,762
    
14,134
    
53,831
  
                                 
Noninterest income:
                                
Trust and investment management
    
3,055
    
3,320
    
3,218
    
3,455
    
13,048
  
Service charges on deposit accounts
    
1,170
    
1,192
    
1,066
    
1,055
    
4,483
  
Merchant processing fees
    
597
    
1,095
    
1,643
    
924
    
4,259
  
Net gains on loan sales
    
349
    
560
    
348
    
644
    
1,901
  
Income from bank-owned life insurance
    
299
    
295
    
293
    
288
    
1,175
  
Net realized (losses) gains on securities
    
-
    
(240
)
  
101
    
387
    
248
  
Other income
    
470
    
702
    
398
    
221
    
1,791
  
                                 
Total noninterest income
    
5,940
    
6,924
    
7,067
    
6,974
    
26,905
  
                                 
Noninterest expense:
                                
Salaries and employee benefits
    
6,977
    
7,218
    
7,439
    
7,182
    
28,816
  
Net occupancy
    
816
    
796
    
770
    
819
    
3,201
  
Equipment
    
770
    
788
    
837
    
872
    
3,267
  
Merchant processing costs
    
466
    
882
    
1,398
    
788
    
3,534
  
Advertising and promotion
    
466
    
538
    
429
    
315
    
1,748
  
Outsourced services
    
376
    
467
    
357
    
416
    
1,616
  
Legal, audit and professional fees
    
258
    
245
    
379
    
653
    
1,535
  
Amortization of intangibles
    
161
    
161
    
161
    
161
    
644
  
Other
    
1,390
    
1,450
    
1,284
    
1,888
    
6,012
  
                                 
Total noninterest expense
    
11,680
    
12,545
    
13,054
    
13,094
    
50,373
  
                                 
Income before income taxes
    
7,223
    
7,351
    
7,775
    
8,014
    
30,363
  
Income tax expense
    
2,268
    
2,308
    
2,442
    
2,516
    
9,534
  
                                 
Net income
  
$
4,955
  
$
5,043
  
$
5,333
  
$
5,498
  
$
20,829
  
                                 
Weighted average shares outstanding - basic
    
13,202.6
    
13,216.1
    
13,235.7
    
13,259.7
    
13,227.8
  
Weighted average shares outstanding - diluted
    
13,513.3
    
13,517.0
    
13,514.0
    
13,605.1
    
13,542.7
  
Per share information:
                                
Basic earnings per share
  
$
.38
  
$
.38
  
$
.40
  
$
.41
  
$
1.57
  
Diluted earnings per share
  
$
.37
  
$
.37
  
$
.39
  
$
.40
  
$
1.54
  
Cash dividends declared per share
 
$
.17
  
$
.17
  
$
.17
  
$
.17
  
$
.68
  
 
   
Selected Quarterly Financial Data
(Dollars in thousands)
                                 
2003
    
Q1
   
Q2
    
Q3
    
Q4
    
Year
  
                                 
Interest income:
                                
Interest and fees on loans
  
$
12,646
  
$
12,853
  
$
12,568
  
$
13,536
  
$
51,603
  
Income from securities
    
8,555
    
8,333
    
7,592
    
7,950
    
32,430
  
Dividends on corporate stock and FHLB stock
    
487
    
531
    
528
    
535
    
2,081
  
Interest on federal funds sold
                                
and other short-term investments
    
37
    
39
    
35
    
20
    
131
  
                                 
Total interest income
    
21,725
    
21,756
    
20,723
    
22,041
    
86,245
  
                                 
Interest expense:
                                
Savings deposits
    
950
    
880
    
724
    
667
    
3,221
  
Time deposits
    
3,934
    
3,799
    
3,740
    
3,860
    
15,333
  
FHLB advances
    
4,893
    
4,777
    
4,514
    
4,635
    
18,819
  
Other
    
19
    
18
    
18
    
18
    
73
  
                                 
Total interest expense
    
9,796
    
9,474
    
8,996
    
9,180
    
37,446
  
                                 
Net interest income
    
11,929
    
12,282
    
11,727
    
12,861
    
48,799
  
Provision for loan losses
    
100
    
160
    
100
    
100
    
460
  
                                 
Net interest income after provision for loan losses
    
11,829
    
12,122
    
11,627
    
12,761
    
48,339
  
                                 
Noninterest income:
                                
Trust and investment management
    
2,533
    
2,744
    
2,692
    
2,800
    
10,769
  
Service charges on deposit accounts
    
1,100
    
1,348
    
1,242
    
1,230
    
4,920
  
Net gains on loan sales
    
1,238
    
1,441
    
1,383
    
628
    
4,690
  
Merchant processing fees
    
457
    
862
    
1,412
    
679
    
3,410
  
Income from bank-owned life insurance
    
284
    
263
    
298
    
316
    
1,161
  
Net realized gains on securities
    
230
    
400
    
-
    
-
    
630
  
Other income
    
191
    
297
    
420
    
247
    
1,155
  
                                 
Total noninterest income
    
6,033
    
7,355
    
7,447
    
5,900
    
26,735
  
                                 
Noninterest expense:
                                
Salaries and employee benefits
    
6,534
    
6,619
    
6,974
    
6,818
    
26,945
  
Net occupancy
    
762
    
736
    
671
    
810
    
2,979
  
Equipment
    
837
    
837
    
830
    
876
    
3,380
  
Merchant processing costs
    
362
    
683
    
1,139
    
532
    
2,716
  
Legal, audit and professional fees
    
305
    
281
    
394
    
252
    
1,242
  
Advertising and promotion
    
270
    
542
    
261
    
367
    
1,440
  
Outsourced services
    
371
    
325
    
328
    
309
    
1,333
  
Debt prepayment penalties
    
-
    
941
    
-
    
-
    
941
  
Amortization of intangibles
    
180
    
179
    
180
    
180
    
719
  
Other
    
1,357
    
1,705
    
1,413
    
1,472
    
5,937
  
                                 
Total noninterest expense
    
10,978
    
12,848
    
12,190
    
11,616
    
47,632
  
                                 
Income before income taxes
    
6,884
    
6,629
    
6,884
    
7,045
    
27,442
  
Income tax expense
    
2,134
    
2,055
    
2,144
    
2,186
    
8,519
  
                                 
Net income
  
$
4,750
  
$
4,574
  
$
4,740
  
$
4,859
  
$
18,923
  
                                 
Weighted average shares outstanding - basic
    
13,059.3
    
13,089.4
    
13,133.8
    
13,172.3
    
13,114.1
  
Weighted average shares outstanding - diluted
    
13,230.2
    
13,304.9
    
13,486.8
    
13,538.9
    
13,393.6
  
Per share information:
                                
Basic earnings per share
  
$
.36
  
$
.35
  
$
.36
  
$
.37
  
$
1.44
  
Diluted earnings per share
  
$
.36
  
$
.34
  
$
.35
  
$
.36
  
$
1.41
  
Cash dividends declared per share
 
$
.15
  
$
.15
  
$
.16
  
$
.16
  
$
.62
  

 

The following analysis is intended to provide the reader with a further understanding of the consolidated financial condition and results of operations of the Corporation for the periods shown. For a full understanding of this analysis, it should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 “Financial Statements and Supplementary Data.”

Overview
The Bancorp provides a broad range of banking and financial services through its subsidiary, the Bank. The Bank’s primary source of income is net interest income. The Bank’s lending business includes commercial, residential mortgage and consumer loans. The Bank’s loan portfolio is concentrated among borrowers in southern New England, primarily Rhode Island, and to a lesser extent Connecticut and Massachusetts as well as other states. The Bank also offers a full range of retail and commercial deposit products through its seventeen banking offices located in Rhode Island and southeastern Connecticut. Noninterest income is an important source of revenue for Washington Trust. Primary sources of noninterest income are trust and investment management revenues, servicing of deposit accounts, merchant credit card processing and net gains on loan sales. Revenue from trust and investment management services continues to be the largest component of noninterest income.

The Bank faces strong competition from branches of major Rhode Island and regional commercial banks, local branches of certain Connecticut banks, as well as various credit unions, savings institutions and, to some extent, mortgage and finance companies. The principal methods of competition are through interest rates, financing terms and other customer conveniences. Among the external factors affecting Washington Trust’s operating results are market rates of interest, the condition of the financial markets, and both national and regional economic conditions.

Forward-Looking Statements
This report contains statements that are “forward-looking statements.” We may also make written or oral forward-looking statements in other documents we file with the SEC, in our annual reports to shareholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “outlook,” “will,” “should,” and other expressions which predict or indicate future events and trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Corporation. These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Corporation to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements.

Some of the factors that might cause these differences include the following: changes in general national or regional economic conditions, changes in interest rates, reductions in the market value of trust and investment assets under management, reductions in loan demand, reductions in deposit levels necessitating increased borrowing to fund loans and investments, changes in loan defaults and charge-off rates, changes in the size and nature of the Corporation’s competition, changes in legislation or regulation and accounting principles, policies and guidelines and changes in the assumptions used in making such forward-looking statements. In addition, the factors described under “Risk Factors” in Item 1 of this Annual Report on Form 10-K may result in these differences. You should carefully review all of these factors, and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this report, and we do not promise to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

Application of Critical Accounting Policies and Estimates
Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on income and the carrying value of certain assets, are considered critical accounting policies. The Corporation considers the following to be its critical accounting policies: allowance for loan losses, review of goodwill and intangible assets for impairment, other-than-temporary impairment, interest income recognition and
 
tax estimates. There have been no significant changes in the methods or assumptions used in the accounting policies that require material estimates and assumptions.

Allowance for Loan Losses
Arriving at an appropriate level of allowance for loan losses necessarily involves a high degree of judgment. The Corporation uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: (1) identification of specific loan losses, (2) general loss allocations for certain loan types based on credit grade and loss experience factors, and (3) general loss allocations for other environmental factors. The methodology includes an analysis of individual loans deemed to be impaired in accordance with accounting principles generally accepted in the United States of America (SFAS 114, “Accounting by Creditors for Impairment of a Loan--an amendment of FASB Statements No. 5 and 15”). Other individual commercial loans and commercial mortgage loans are evaluated using an internal rating system and the application of loss allocation factors. The loan rating system and the related loss allocation factors take into consideration parameters including the borrower’s financial condition, the borrower’s performance with respect to loan terms and the adequacy of collateral. Portfolios of more homogenous populations of loans including residential mortgages and consumer loans are analyzed as groups taking into account delinquency ratios and other indicators, the Corporation’s historical loss experience and comparison to industry standards of loss allocation factors for each type of credit product. Finally, an additional unallocated allowance is maintained based on a judgmental process whereby management considers qualitative and quantitative assessments of other environmental factors. For example, a significant portion of our loan portfolio is concentrated among borrowers in southern New England, primarily Rhode Island and to a lesser extent Connecticut and Massachusetts, and a substantial portion of the portfolio is collateralized by real estate in this area, including most consumer loans and those commercial loans not specifically classified as commercial mortgages. A portion of the commercial loans and commercial mortgage loans are to borrowers in the hospitality and tourism industry. Further, economic conditions which may affect the ability of borrowers to meet debt service requirements are considered, including interest rates and energy costs. Results of regulatory examinations, historical loss ranges, portfolio composition including a trend toward somewhat larger credit relationships, and other changes in the portfolio are also considered.

The Corporation’s Audit Committee of the Board of Directors is responsible for oversight of the loan review process. This process includes review of the Bank’s procedures for determining the adequacy of the allowance for loan losses, administration of its internal credit rating systems and the reporting and monitoring of credit granting standards.

Accounting for Acquisitions and Review of Goodwill for Impairment
For acquisitions accounted for under the purchase method, the Corporation is required to record assets acquired and liabilities assumed at their fair value, which in many instances involve estimates based on third party, internal or other valuation techniques. In addition, purchase acquisitions typically result in goodwill or other intangible assets, which are subject to ongoing periodic impairment tests. Goodwill is evaluated for impairment using market value comparisons for similar institutions. The valuation technique contains estimates as to the comparability of the selected market information to the specifics of the Corporation. Furthermore, the determination of which intangible assets have finite lives is subjective, as is the determination of the amortization period for such intangible assets. In connection with the April 2002 acquisition of First Financial Corp., the Corporation has recorded $22.6 million of goodwill and $1.3 million of intangible assets as of December 31, 2004.

Other-Than-Temporary Impairment
The Corporation records an investment impairment charge at the point it believes an investment security has experienced a decline in value that is other-than-temporary. In determining whether an other-than-temporary impairment has occurred, the Corporation reviews information about the issuer of the security that is publicly available, analyst reports, applicable industry data, the magnitude of the impairment, the length of time the security has been impaired and other pertinent information. The investment is written down to its current fair value through a charge to earnings at the time the impairment is deemed to have occurred. Future adverse changes in market conditions, continued poor operating results of the issuer or other factors could result in further
 
losses that may not be reflected in an investment’s current carrying value, possibly requiring an additional impairment charge in the future.

Interest Income Recognition
Interest on loans is included in income as earned based upon rates applied to unpaid principal. Interest is not accrued on loans ninety days or more past due unless they are adequately secured and in the process of collection or on other loans when management believes collection is doubtful. All loans considered impaired are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all interest previously accrued is reversed against current-period interest income, therefore an increase in loans on nonaccrual status could have impact on interest income recognized in future periods.

Tax Estimates
The Corporation accounts for income taxes by deferring income taxes based on estimated future tax effects of differences between the tax and book basis of assets and liabilities considering the provisions of enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in the Corporation’s Consolidated Balance Sheets. The Corporation must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and establish a valuation allowance for those assets determined to not likely be recoverable. Management judgment is required in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income. The Corporation has determined that a valuation allowance is not required for any of the deferred tax assets since it is more likely than not that these assets will be realized primarily through carryback to taxable income in prior years and future reversals of existing taxable temporary differences.

Results of Operations
Comparison of 2004 to 2003
Net income for the year ended December 31, 2004 amounted to $20.8 million, up 10% from $18.9 million reported for 2003. On a diluted per share basis, the Corporation earned $1.54 for 2004, up 9%, from the $1.41 earned in 2003. The rates of return on average equity and average assets for 2004 were 14.40% and 0.97%, respectively. Comparable amounts for 2003 were 14.15% and 1.03%, respectively.

Net Interest Income
Net interest income is the difference between interest earned on loans and securities and interest paid on deposits and other borrowings, and continues to be the primary source of Washington Trust’s operating income. Net interest income is affected by the level of interest rates, changes in interest rates and by changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Net interest income totaled $54.4 million for 2004, an increase of 12% from the $48.8 million reported for 2003.

The following discussion presents net interest income on a fully taxable equivalent (FTE) basis by adjusting income and yields on tax-exempt loans and securities to be comparable to taxable loans and securities.

FTE net interest income for 2004 amounted to $55.4 million, up $5.6 million, or 11%, from the $49.8 million reported for 2003. The Corporation experienced strong balance sheet growth in 2004. Average interest-earning assets amounted to $2.023 billion for 2004, up 17% from $1.725 billion for 2003. This increase was mainly due to an increase in average balances of loans, resulting from purchases of residential mortgage loans as well as growth in commercial and consumer loans. Average interest-bearing liabilities increased $272.0 million, or 18%, in 2004, as deposit growth, along with additional borrowings, were utilized to fund the Corporation's asset growth.

The net interest margins (FTE net interest income as a percentage of average interest-earning assets) for 2004 and 2003 were 2.74% and 2.89%, respectively. The decline in the net interest margin reflects the decline in yields on loans and securities offset somewhat by lower funding costs. The interest rate spread decreased from 2.60% in 2003 to 2.48% in 2004. The yield on interest-earning assets declined 22 basis points during 2004, while the cost of interest-bearing liabilities decreased 10 basis points.
 
Average loans increased $243.0 million, or 28%, during 2004, while the FTE rate of return on total loans declined 49 basis points in 2004 and amounted to 5.52%. This decrease in the yield on total loans was primarily due to lower marginal yields on loans as compared to the prior year and a decline in yields on new loan originations. Average residential real estate loans increased $129.5 million, or 40%, in 2004, primarily due to purchases of loans from other institutions. The yield on residential real estate loans decreased 57 basis points from the prior year, and amounted to 5.04%. Average commercial loans rose $58.1 million, or 15%, in 2004, while the yield on commercial loans declined 38 basis points to 6.44%. Average consumer loans rose $55.5 million, or 39%, in 2004. The yield on consumer loans declined 16 basis points from the prior year to 4.52%, primarily due to a decline in the yield on home equity loans.

Total average securities increased $54.8 million, or 6%, in 2004, mainly due to purchases of taxable debt securities. The FTE rate of return on securities was 4.01% in 2004, down from 4.10% in 2003. The decrease in yields on securities reflects a combination of lower yields on variable rate securities tied to short-term interest rates and lower marginal rates on reinvestment of cash flows in 2004 relative to the prior year.

NOW account deposits and savings accounts continue to be the least costly sources of funding for the Bank. Average NOW account deposits increased $28.3 million, or 21%, in 2004. The rate paid on NOW account deposits was 0.21% in 2004, compared to 0.24% in 2003. Average savings deposits decreased $12.7 million, or 5%, with a decrease of 19 basis points in the rate paid in 2004. Average money market account deposits rose $78.2 million, or 105%, with an increase of 46 basis points in the rate paid in 2004. The increase in the rate paid on money market accounts was due in part to higher rates paid on larger balance, premium money market account balances. Average time deposits increased $90.8 million, or 19%, in 2004. The rate paid on time deposits for 2004 was 3.14%, compared to 3.16% in 2003. In addition, average demand deposits, an interest-free source of funding, amounted to $193.9 million in 2004, up $19.6 million, or 11%, from 2003.

Average FHLB advances increased by $87.8 million, or 16%, from 2003 and amounted to $644.5 million. The average rate paid on FHLB advances in 2004 was 3.13%, a decrease of 25 basis points from the rate paid in 2003.
 
Average Balances/Net Interest Margin (Fully Taxable Equivalent Basis)
The following table presents average balance and interest rate information. Tax-exempt income is converted to a fully taxable equivalent basis using the statutory federal income tax rate. For dividends on corporate stocks, the 70% federal dividends received deduction is also used in the calculation of tax equivalency. Nonaccrual and renegotiated loans, as well as interest earned on these loans (to the extent recognized in the Consolidated Statements of Income) are included in amounts presented for loans.

Years ended December 31,
      
2004
          
2003
          
2002
      
   
Average
      
Yield/
  
Average
      
Yield/
  
Average
      
Yield/
  
(Dollars in thousands)
  
Balance
  
Interest
  
Rate
  
Balance
  
Interest
  
Rate
  
Balance
  
Interest
  
Rate
  
Assets:
                                                        
Residential real estate loans
  
$
450,898
    
22,737
    
5.04
  
$
321,442
    
18,044
    
5.61
  
$
246,915
    
16,989
    
6.88
  
Commercial and other loans
    
454,251
    
29,266
    
6.44
    
396,148
    
27,009
    
6.82
    
341,434
    
25,632
    
7.51
  
Consumer loans
    
198,857
    
8,984
    
4.52
    
143,370
    
6,703
    
4.68
    
121,110
    
7,122
    
5.88
  
Total loans
    
1,104,006
    
60,987
    
5.52
    
860,960
    
51,756
    
6.01
    
709,459
    
49,743
    
7.01
  
                                                         
Federal funds sold and other
short-term investments
    
12,371
    
133
    
1.08
    
14,911
    
131
    
.88
    
14,477
    
219
    
1.52
  
Taxable debt securities
    
835,091
    
33,125
    
3.97
    
781,425
    
31,755
    
4.06
    
674,095
    
34,746
    
5.15
  
Nontaxable debt securities
    
16,430
    
1,018
    
6.20
    
16,079
    
1,038
    
6.46
    
19,544
    
1,267
    
6.48
  
Corporate stocks and FHLB stock
    
54,706
    
2,543
    
4.65
    
51,372
    
2,534
    
4.93
    
43,491
    
2,379
    
5.47
  
Total securities
    
918,598
    
36,819
    
4.01
    
863,787
    
35,458
    
4.10
    
751,607
    
38,611
    
5.14
  
                                                         
Total interest-earning assets
    
2,022,604
    
97,806
    
4.84
    
1,724,747
    
87,214
    
5.06
    
1,461,066
    
88,354
    
6.05
  
                                                         
Cash and due from banks
    
38,437
                
34,639
                
29,069
              
Allowance for loan losses
    
(16,332
)
              
(15,696
)
              
(15,016
)
            
Premises and equipment, net
    
24,836
                
25,270
                
23,741
              
Other
    
79,361
                
76,979
                
69,803
              
Total assets
  
$
2,148,906
              
$
1,845,939
              
$
1,568,663
              
                                                         
Liabilities and
                                                        
Shareholders’ Equity:
                                                        
NOW accounts
  
$
162,714
    
341
    
0.21
  
$
134,432
    
322
    
0.24
  
$
106,188
    
559
    
0.53
  
Money market accounts
    
152,664
    
2,205
    
1.44
    
74,435
    
731
    
0.98
    
75,216
    
1,280
    
1.70
  
Savings accounts
    
257,274
    
1,581
    
0.61
    
269,927
    
2,168
    
0.80
    
218,144
    
3,759
    
1.72
  
Time deposits
    
575,877
    
18,070
    
3.14
    
485,126
    
15,333
    
3.16
    
454,239
    
16,776
    
3.69
  
FHLB advances
    
644,520
    
20,153
    
3.13
    
556,689
    
18,819
    
3.38
    
431,000
    
20,596
    
4.78
  
Other
    
2,014
    
62
    
3.10
    
2,454
    
73
    
2.94
    
3,539
    
87
    
2.46
  
                                                         
Total interest-bearing liabilities
    
1,795,063
    
42,412
    
2.36
    
1,523,063
    
37,446
    
2.46
    
1,288,326
    
43,057
    
3.34
  
                                                         
Demand deposits
    
193,905
                
174,338
                
149,382
              
Other liabilities
    
15,281
                
14,813
                
13,364
              
Shareholders’ equity
    
144,657
                
133,725
                
117,591
              
Total liabilities and
shareholders’ equity
  
$
2,148,906
              
$
1,845,939
              
$
1,568,663
              
                                                         
Net interest income
        
$
55,394
              
$
49,768
              
$
45,297
        
                                                         
Interest rate spread
                
2.48
                
2.60
                
2.71
  
Net interest margin
                
2.74
                
2.89
                
3.10
  

Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency for the years indicated:
 
(Dollars in thousands)
              
Years ended December 31,
    
2004
    
2003
    
2002
  
Commercial and other loans
  
$
159
  
$
153
  
$
167
  
Nontaxable debt securities
    
356
    
363
    
442
  
Corporate stocks and FHLB stock
    
438
    
453
    
406
  
 
Volume/Rate Analysis - Interest Income and Expense (Fully Taxable Equivalent Basis)
The following table presents certain information on a fully taxable equivalent basis regarding changes in our interest income and interest expense for the periods indicated.
 
       
2004/2003
          
2003/2002
      
(Dollars in thousands)
  
Volume
 
Rate
 
Net Change
 
Volume
 
Rate
 
Net Change
 
                           
Interest on interest-earning assets:
                          
Residential real estate loans
  
$
6,674
    
(1,981
)
  
4,693
  
$
4,546
    
(3,491
)
  
1,055
  
Commercial and other loans
   
3,817
    
(1,560
)
  
2,257
    
3,870
    
(2,493
)
  
1,377
  
Consumer loans
    
2,518
    
(237
)
  
2,281
    
1,179
    
(1,598
)
  
(419
)
Federal funds sold and
                                      
other short-term investments
    
(25
)
  
27
    
2
    
6
    
(94
)
  
(88
)
Taxable debt securities
    
2,099
    
(729
)
  
1,370
    
5,025
    
(8,016
)
  
(2,991
)
Nontaxable debt securities
    
22
    
(42
)
  
(20
)
  
(225
)
  
(4
)
  
(229
)
Corporate stocks and FHLB stock
    
158
    
(149
)
  
9
    
405
    
(250
)
  
155
  
                                       
Total interest income
    
15,263
    
(4,671
)
  
10,592
    
14,806
    
(15,946
)
  
(1,140
)
                                       
Interest on interest-bearing liabilities:
                                      
NOW accounts
    
62
    
(43
)
  
19
    
124
    
(361
)
  
(237
)
Money market accounts
    
1,064
    
410
    
1,474
    
3
    
(552
)
  
(549
)
Savings accounts
    
(95
)
  
(492
)
  
(587
)
  
745
    
(2,336
)
  
(1,591
)
Time deposits
    
2,835
    
(98
)
  
2,737
    
1,083
    
(2,526
)
  
(1,443
)
FHLB advances
    
2,803
    
(1,469
)
  
1,334
    
5,135
    
(6,912
)
  
(1,777
)
Other
    
(14
)
  
3
    
(11
)
  
(30
)
  
16
    
(14
)
                                       
Total interest expense
    
6,655
    
(1,689
)
  
4,966
    
7,060
    
(12,671
)
  
(5,611
)
                                       
Net interest income
  
$
8,608
    
(2,982
)
  
5,626
  
$
7,746
    
(3,275
)
  
4,471
  

Provision and Allowance for Loan Losses
For the years ended December 31, 2004 and 2003, the Corporation’s provision for loan losses amounted to $610 thousand and $460 thousand, respectively. The allowance for loan losses is management’s best estimate of the probable loan losses incurred as of the balance sheet date. The allowance for loan losses increased from $15.9 million at December 31, 2003 to $16.8 million at December 31, 2004. See the additional discussion under the caption “Asset Quality” for further information on the Allowance for Loan Losses.

Noninterest Income
Noninterest income is an important source of revenue for Washington Trust. For the year ended December 31, 2004, recurring noninterest income, which excludes net realized gains on securities, accounted for 33% of total revenues (net interest income plus recurring noninterest income). Washington Trust’s primary sources of recurring noninterest income are trust and investment management fees, service charges on deposit accounts, net gains on loan sales and merchant credit card processing fees. Also included in noninterest income are earnings generated from bank-owned life insurance (“BOLI”). Noninterest income, excluding net realized gains on securities, amounted to $26.7 million for 2004, up $552 thousand from $26.1 million reported for 2003. The Corporation recognized net realized gains on securities amounting to $248 thousand and $630 thousand in 2004 and 2003, respectively.
 
The following table presents a noninterest income comparison for the years ended December 31, 2004 and 2003:
 
(Dollars in thousands)
    
2004
    
2003
  
 
$ Change
    
% Change
  
                           
Noninterest income:
                          
Trust and investment management fees
  
$
13,048
  
$
10,769
  
$
2,279
    
21
%
Service charges on deposit accounts
    
4,483
    
4,920
    
(437
)
  
(9
)%
Merchant processing fees
    
4,259
    
3,410
    
849
    
25
%
Net gains on loan sales
    
1,901
    
4,690
    
(2,789
)
  
(59
)%
Income from bank-owned life insurance
    
1,175
    
1,161
    
14
    
1
%
Other income
    
1,791
    
1,155
    
636
    
55
%
                           
Subtotal
    
26,657
    
26,105
    
552
    
2
%
                           
Net realized gains on securities
    
248
    
630
    
(382
)
  
(61
)%
                           
Total noninterest income
  
$
26,905
  
$
26,735
  
$
170
    
1
%

Revenue from trust and investment management services continues to be the largest component of noninterest income. This revenue is largely dependent on the value of assets under administration and is closely tied to the performance of the financial markets. Trust and investment management fees represented 49% of noninterest income (excluding net realized gains on securities). For the year 2004, trust and investment management fees totaled $13.0 million, up $2.3 million, or 21%, from 2003. The market value of trust and investment management assets under administration amounted to $1.871 billion and $1.742 billion at December 31, 2004 and 2003, respectively.

Service charges on deposit accounts declined 9% in 2004, due in part to deposit account pricing strategies utilized to attract new deposits in a highly competitive marketplace. “In-market” deposit balances (which exclude brokered certificates of deposit) rose 18% in 2004 partly as a result of such strategies.

Merchant processing fees increased 25% in 2004 due to increases in the volume of transactions processed. Merchant processing fees represents charges to merchants for credit card transactions processed.

Net gains on loan sales decreased $2.8 million, or 59%, in 2004, due to a decline in fixed rate residential mortgage origination and sales activity. Included in net gains on loan sales in 2004 and 2003 were approximately $789 thousand and $425 thousand, respectively, in net gains on sales of Small Business Administration (“SBA”) loans.

Income from bank-owned life insurance (“BOLI”) amounted to $1.2 million for the each of the years ended December 31, 2004 and 2003. BOLI represents life insurance on the lives of certain employees who have consented to allowing the Bank to be the beneficiary of such policies. The Corporation expects to benefit from the BOLI contracts as a result of the tax-free growth in cash surrender value and death benefits that are expected to be generated over time. The cash surrender value of BOLI was $29.2 million at December 31, 2004 compared to $28.1 million at December 31, 2003. BOLI is invested in the “general account” of quality insurance companies. Standard and Poors rated all such general account carriers “AA” or better at December 31, 2004. The BOLI investment provides a means to mitigate increasing employee benefit costs.

Loan servicing fees (which are included in other income) amounted to $234 thousand for the year ended December 31, 2004, up $108 thousand from 2003 primarily due a lower level of valuation adjustments on loan servicing rights recorded as reductions to servicing fees. Also, included in other income in 2004 was $280 thousand recovered as a result of a favorable litigation decision.

Noninterest Expense
For the year ended December 31, 2004, noninterest expense amounted to $50.4 million, up 6% from the $47.6 million reported in 2003. Exclusive of the debt prepayment penalty charge of $941 thousand in 2003, noninterest expenses increased 8% in 2004.
 
The following table presents a noninterest expense comparison for the years ended December 31, 2004 and 2003:
 
(Dollars in thousands)
    
2004
    
2003
  
 
$ Change
    
% Change
  
                           
Noninterest expense:
                          
Salaries and employee benefits
  
$
28,816
  
$
26,945
  
$
1,871
    
7
%
Net occupancy
    
3,201
    
2,979
    
222
    
7
%
Equipment
    
3,267
    
3,380
    
(113
)
  
(3
)%
Merchant processing costs
    
3,534
    
2,716
    
818
    
30
%
Advertising and promotion
    
1,748
    
1,440
    
308
    
21
%
Outsourced services
    
1,616
    
1,333
    
283
    
21
%
Legal, audit and professional fees
    
1,535
    
1,242
    
293
    
24
%
Amortization of intangibles
    
644
    
719
    
(75
)
  
(10
)%
Other
    
6,012
    
5,937
    
75
    
1
%
                           
Subtotal
    
50,373
    
46,691
    
3,682
    
8
%
                           
Debt prepayment penalties
    
-
    
941
    
(941
)
  
(100
)%
                           
Total noninterest expense
  
$
50,373
  
$
47,632
  
$
2,741
    
6
%

Salaries and employee benefit expense, the largest component of total noninterest expense, increased $1.9 million, or 7%, in 2004. The increase in salaries and employee benefit expense was mainly due to merit pay increases as well as higher defined benefit pension costs, performance-based compensation and health insurance premiums. Merit pay increases resulted in a $645 thousand, or 3%, increase in salaries and wages. Pension expense (which is included in salaries and employee benefits expense) was $1.5 million and $1.1 million for the years ended December 31, 2004 and 2003, respectively. Pension expense increased primarily due to higher service cost and a lower discount rate. Performance-based compensation expense increased $216 thousand, or 6%, in 2004. Health insurance premiums amounted to $2.5 million in 2004, up $165 thousand, or 7%, from 2003.

Also included in salaries and employee benefits expense was stock compensation expense associated with restricted stock and restricted stock units awarded under the Bancorp’s 1997 Equity Incentive Plan, as amended. Stock compensation expense amounted to $135 thousand and $31 thousand in 2004 and 2003, respectively. Stock options granted during 2004 and in prior years did not require the recognition of any expense in the Consolidated Statements of Income during those periods. In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revised Statement No. 123, “Share-Based Payment”, which requires that all companies expense the fair value of employee stock options in accordance with the Statement effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005.

Net occupancy expense in 2004 increased 7%. The increase was primarily due to higher rental expense for premises leased by the Bank. Equipment expense decreased 3% in 2004 primarily due to lower depreciation expense on furniture and equipment.

Merchant processing costs increased 30% in 2004 due to increases in the volume of transactions processed. Merchant processing costs represent third-party costs incurred that are directly attributable to handling merchant credit card transactions.

Advertising and promotion expense increased 21% in 2004. The increase was primarily attributable to stronger marketing and promotion efforts for products such as demand deposit accounts and home equity lines of credit.

Outsourced services increased 21% in 2004 due to higher costs for data processing services and third party vendor costs, including online banking.

Legal, audit and professional fees totaled $1.5 million in 2004, up from $1.2 million in 2003. Included in legal, audit and professional fees in 2004 were approximately $602 thousand of audit and professional fees incurred to comply with the internal control documentation and testing standards of Section 404 of the Sarbanes-Oxley Act. The Corporation expects that some portion of these costs will be incurred annually in future years.
 
Included in other noninterest expense for 2004 were contributions of appreciated equity securities to the Corporation’s charitable foundation amounting to $454 thousand and $433 thousand in 2004 and 2003, respectively. These transactions resulted in realized securities gains of $387 thousand and $400 thousand, respectively, for the same periods. Also included in other noninterest expenses for 2004 were costs of $307 thousand associated with the conversion of certain technology systems.

In the second quarter of 2003, the Corporation recorded debt prepayment penalties of $941 thousand ($649 thousand after tax, amounting to $.05 per diluted share), related to the prepayment of certain higher interest rate FHLB advances consummated to reduce future funding costs. No debt prepayment penalties were incurred in 2004.

Taxes
Income tax expense amounted to $9.5 million and $8.5 million in 2004 and 2003, respectively. The Corporation’s effective tax rate was 31.4% in 2004, compared to a rate of 31.0% in 2003. These rates differed from the federal rate of 35.0% due to the benefits of tax-exempt income, the dividends received deduction and income from BOLI.

The Corporation’s net deferred tax asset amounted to $3.2 million at December 31, 2004 and 2003. The Corporation has determined that a valuation allowance is not required for any of the deferred tax assets since it is more likely than not that these assets will be realized primarily through carryback to taxable income in prior years and future reversals of existing taxable temporary differences. (See Note 13 to the Consolidated Financial Statements for additional information regarding income taxes.)

Comparison of 2003 with 2002
Net income for the year ended December 31, 2003 amounted to $18.9 million, up 13% from the $16.8 million reported for 2002. Washington Trust earned $1.41 per diluted share for 2003, up 8% from the $1.30 earned in 2002. The rates of return on average equity and average assets for 2003 were 14.15% and 1.03%, respectively. Comparable amounts for the year 2002 were 14.25% and 1.07%, respectively.

In June 2003, the Corporation recorded debt prepayment penalties of $941 thousand ($649 thousand after tax, amounting to $.05 per diluted share), related to the prepayment of certain higher interest rate FHLB advances consummated to reduce future funding costs. As calculated at the time of restructuring, the Corporation expected that this debt restructuring would result in future interest expense savings of approximately $510 thousand on an annualized basis over the remaining term of the prepaid debt. In the second quarter of 2002, the Corporation completed the acquisition of First Financial Corp., and recorded acquisition-related expenses of $605 thousand ($417 thousand after tax, amounting to $.03 per diluted share).

For the year ended December 31, 2003, net interest income (the difference between interest earned on loans and securities and interest paid on deposits and other borrowings) amounted to $48.8 million, up 10% from $44.3 million for 2002. The increase in net interest income was due to growth in interest-earning assets including assets acquired through the April 2002 acquisition of First Financial Corp. Although net interest income increased, the net interest margin (FTE net interest income as a percentage of average interest-earning assets) for 2003 amounted to 2.89%, down 21 basis points from 3.10% for 2002. The decrease in the net interest margin reflected a decline in yields on loans and securities, which was offset somewhat by lower funding costs of interest-bearing deposits and FHLB advances. The interest rate spread decreased from 2.71% in 2002 to 2.60% in 2003. Earning asset yields declined 99 basis points during 2003, while the cost of interest-bearing liabilities decreased 88 basis points.

Other noninterest income (noninterest income excluding net realized gains on securities) amounted to $26.1 million for the year 2003, up 16% from the 2002 amount of $22.6 million. The growth in noninterest income in 2003 was primarily attributable to increases in net gains on loan sales and service charges on deposits.

Revenue from trust and investment management services continues to be the largest component of noninterest income. Trust and investment management fees represented 40% of noninterest income in 2003. For the year
 
ended December 31, 2003, trust and investment management fees, which are closely tied to the performance of the financial markets, totaled $10.8 million, up $598 thousand, or 6%, from the $10.2 million reported for 2002. The market value of trust and investment management assets under administration amounted to $1.742 billion and $1.524 billion at December 31, 2003 and 2002, respectively.

Net gains on loan sales totaled $4.7 million in 2003, up $1.8 million, or 63%, from 2002. As a result of the decline in interest rates during most of 2003, the Corporation experienced heavy residential mortgage activity, predominantly refinancing, which increased the amount of loans sold into the secondary market. Included in net gains on loan sales in 2003 and 2002 were approximately $425 thousand and $201 thousand, respectively, in net gains on sales of SBA loans.

Service charges on deposit accounts amounted to $4.9 million for the year ended December 31, 2003, up 30% from the $3.8 million earned in 2002. Growth in the Corporation’s total deposit base, as well as changes in the fee structures of various deposit products during 2003, were contributing factors in this increase.

The Corporation recognized net realized gains on securities amounting to $630 thousand and $678 thousand in 2003 and 2002, respectively. The Corporation’s 2002 net realized gains on securities included $459 thousand in loss write-downs on certain equity securities deemed to be other than temporarily impaired based on an analysis of the financial condition and operating outlook of the issuers. Information on other-than-temporary impairment can be found under the caption “Application of Critical Accounting Policies and Estimates.”

For the year ended December 31, 2003, noninterest expense amounted to $47.6 million, up $4.6 million, or 11%, from $43.0 million reported in 2002. Exclusive of the debt prepayment penalties in 2003 and the acquisition costs in 2002, the increase in noninterest expenses was primarily due to normal growth, costs associated with the opening of the Warwick branch in the second quarter of 2003 and higher operating costs resulting from the acquisition of First Financial Corp. Salaries and benefit expense, the largest component of total noninterest expense, amounted to $26.9 million for 2003, up 13% from the $23.8 million reported for 2001. Legal, audit and professional fees totaled $1.2 million for 2003, down from $1.9 million in 2002. Included in legal, audit and professional fees in 2002 were approximately $831 thousand in costs associated with a special consulting project in connection with trust and investment management services.

Total consolidated assets amounted to $1.974 billion at December 31, 2003, up 13% from the December 31, 2002 balance of $1.746 billion. Average assets rose 18% during 2003 and amounted to $1.846 billion.

During 2003, total loans increased $165.9 million to $961.0 million, with the largest increase in residential real estate loans. The Corporation purchased a total of $132.0 million of fixed and adjustable rate residential mortgages from other financial institutions in 2003. The purchases of loans were funded with FHLB advances and brokered certificates of deposit. Consumer loans increased $30.6 million, or 23%, from the balance at December 31, 2002, primarily due to growth in home equity lines. Commercial loans increased $26.3 million, or 7%, to $408.5 million at December 31, 2003.

Total securities were $839.4 million at December 31, 2003, up $43.6 million from the balance at December 31, 2002. The increase in securities was mainly due to purchases of mortgage-backed securities, U.S. government agency securities and corporate bonds.

Total deposits at December 31, 2003 amounted to $1.206 billion, up $95.6 million, or 9%, from the December 31, 2002 balance of $1.110 billion. Demand deposits increased $36.6 million, or 23%, in 2003 and totaled $194.1 million at December 31, 2003. The increase in demand deposits included a temporary placement of approximately $18.6 million in funds on deposit at December 31, 2003 that were withdrawn in January 2004. Savings deposits rose $22.5 million in 2003 and amounted to $493.9 million at December 31, 2003. Time deposits totaled $518.1 million at December 31, 2003, up $36.5 million from the 2002 balance, primarily due to increases in brokered certificates of deposit. Total brokered certificates of deposit amounted to $118.2 million at December 31, 2003, compared to $56.5 million at December 31, 2002. In 2003, FHLB advances increased $127.0 million to $607.1 million at December 31, 2003.
 
Nonaccrual loans as a percentage of total loans at December 31, 2003 were .29%, down from .53% at December 31, 2002. Similarly, nonperforming assets (nonaccrual loans and property acquired through foreclosure) as a percent of total assets at December 31, 2003 amounted to .14% as compared to .24% at December 31, 2002.

The allowance for loan losses amounted to $15.9 million, or 1.66% of total loans, at December 31, 2003, compared to $15.5 million, or 1.95% of total loans, at December 31, 2002. The Corporation incurred favorable loan loss experience in 2003 as indicated by a $33 thousand excess of actual charge-offs over loan loss recoveries. In 2002, charge-offs, net of recoveries, amounted to $335 thousand.

Total shareholders’ equity increased $9.3 million, or 7.3%, during 2003 and amounted to $138.1 million at December 31, 2003. The changes in shareholders’ equity included net income for the year 2003 of $18.9 million, partially offset by $2.5 million in net unrealized losses on securities available for sale and $8.1 million in dividends to shareholders. In addition, stock option exercises increased shareholders’ equity by $1.9 million in 2003. Common stock shares repurchased amounted to $209 thousand at December 31, 2003, compared to $851 thousand at December 31, 2002. The ratio of total equity to total assets amounted to 6.99% at December 31, 2003, compared to 7.37% at December 31, 2002. Book value per share at December 31, 2003 amounted to $10.46, a 6.0% increase from the year-earlier amount of $9.87 per share.

Liquidity and Capital Resources
Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. Washington Trust’s primary source of liquidity is deposits. Deposits (demand, NOW, money market, savings and time deposits) funded approximately 62.4% of total average assets in 2004. Other sources of funding include discretionary use of purchased liabilities (i.e., FHLB term advances and federal funds purchased), cash flows from the Corporation’s securities portfolios and loan repayments. In addition, securities designated as available for sale may be sold in response to short-term or long-term liquidity needs.

The Corporation’s Asset/Liability Committee (“ALCO”) establishes and monitors internal liquidity measures to manage liquidity exposure. Liquidity remained well within target ranges established by the ALCO during 2004. Net loans as a percentage of total assets amounted to 53% at December 31, 2004, compared to 48% at December 31, 2003. Total securities as a percentage of total assets amounted to 39% at December 31, 2004, down from 43% at December 31, 2003.

For the year ended December 31, 2004, net cash provided by financing activities amounted to $310.2 million and was generated primarily from the $251.8 million in overall growth in deposits. Additionally, proceeds from FHLB advances totaled $1.1 billion, while repayments of FHLB advances totaled $1.0 billion in 2004. Net cash used in investing activities was $346.0 million in 2004, the majority of which was used to fund internal loan growth and purchase residential mortgages and debt securities. In 2004, the Corporation purchased $119.8 million of mainly adjustable rate residential mortgages from other institutions. In addition, the Corporation purchased $2.9 million of FHLB stock based on its level of FHLB advances in 2004 and the Corporation expended $2.4 million to upgrade and expand equipment and premises to support its operations. Net cash provided by operating activities amounted to $26.8 million in 2004, $20.8 million of which was generated by net income. See the Consolidated Statements of Cash Flows for further information about sources and uses of cash.

At December 31, 2004 and 2003, total shareholders’ equity amounted to $151.9 million and $138.1 million, respectively. The increase of $13.8 million in shareholder’s equity in 2004 was primarily attributable to net income of $20.8 million, partially offset by $9.0 million in dividends to shareholders.

Accumulated other comprehensive income increased $836 thousand in 2004 due to increases in net unrealized gains on securities. In addition, shares issued (principally for stock option exercises) increased shareholders’ equity by $1.2 million in 2004.
 
The ratio of total equity to total assets amounted to 6.58% at December 31, 2004, compared to 6.99% at December 31, 2003. Book value per share at December 31, 2004 amounted to $11.44, a 9% increase from the year-earlier amount of $10.46 per share.

The Corporation is subject to various regulatory capital requirements. The Corporation is categorized as well-capitalized under the regulatory framework for prompt corrective action. See Note 16 to the Consolidated Financial Statements for additional discussion of capital requirements.

Contractual Obligations and Commitments
The Corporation has entered into numerous contractual obligations and commitments. The following table summarizes our contractual cash obligation and other commitments at December 31, 2004.

(Dollars in thousands)
  
Payments Due by Period
  
   
Total
  
Less Than
1 Year
  
1-3 Years
  
4-5 Years
  
After
5 Years
  
Contractual Obligations:
                                
FHLB advances (1)
  
$
672,748
  
$
222,137
  
$
209,123
  
$
170,309
  
$
71,179
  
Operating lease obligations
    
1,621
    
534
    
669
    
418
    
-
  
Software licensing arrangements
    
1,300
    
612
    
528
    
96
    
64
  
Treasury, tax and loan demand note
    
2,835
    
2,835
    
-
    
-
    
-
  
Other borrowings
    
582
    
71
    
128
    
58
    
325
  
                                 
Total contractual obligations
  
$
679,086
  
$
226,189
  
$
210,448
  
$
170,881
  
$
71,568
  
 
(1)  
All FHLB advances are shown in the period corresponding to their scheduled maturity.


(Dollars in thousands)
  
Amount of Commitment Expiration - Per Period
  
   
Total
 
Less Than
1 Year
 
1-3 Years
 
4-5 Years
 
After
5 Years
  
Other Commitments:
                      
Commercial loans
  
$
87,249
  
$
61,588
  
$
12,085
  
$
5,176
  
$
8,400
  
Home equity lines
    
150,175
    
3,697
    
4,785
    
8,870
    
132,823
  
Other loans
    
20,870
    
18,809
    
-
    
2,061
    
-
  
Standby letters of credit
    
9,737
    
1,712
    
7,675
    
350
    
-
  
Forward loan commitments to:
                                
Originate loans
    
2,846
    
2,846
    
-
    
-
    
-
  
Sell loans
    
3,947
    
3,947
    
-
    
-
    
-
  
                                 
Total commitments
  
$
274,824
  
$
92,599
  
$
24,545
  
$
16,457
  
$
141,223
  

See additional discussion under the caption “Off-Balance Sheet Arrangements” and Note 9 to the Consolidated Financial Statements for more information regarding the nature and business purpose of financial instruments with off-balance sheet risk and derivative financial instruments.

Asset/Liability Management and Interest Rate Risk
The ALCO is responsible for establishing policy guidelines on liquidity and acceptable exposure to interest rate risk. Interest rate risk is the risk of loss to future earnings due to changes in interest rates. The objective of the ALCO is to manage assets and funding sources to produce results that are consistent with Washington Trust’s liquidity, capital adequacy, growth, risk and profitability goals.

The ALCO manages the Corporation’s interest rate risk using income simulation to measure interest rate risk inherent in the Corporation’s on-balance sheet and off-balance sheet financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 12-month horizon, the month 13 to month 24 horizon and a 60-month horizon. The simulations assume that the size and general composition of the
 
Corporation’s balance sheet remain static over the simulation horizons and take into account the specific repricing, maturity, call options, and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios. The characteristics of financial instrument classes are reviewed periodically by the ALCO to ensure their accuracy and consistency.

The ALCO reviews simulation results to determine whether the Corporation’s exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. As of December 31, 2004 and 2003, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Corporation. The Corporation defines maximum unfavorable net interest income exposure to be a change of no more than 5% in net interest income over the first 12 months, no more than 10% over the second 12 months, and no more than 10% over the full 60 month simulation horizon.

The ALCO reviews a variety of interest rate shift scenario results to evaluate interest risk exposure, including scenarios showing the effect of steepening or flattening changes in yield curve shape as well as parallel changes in interest rates. Because income simulations assume that the Corporation’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.

The following table sets forth the estimated change in net interest income from a flat interest rate scenario over a 12-month period for parallel changes in market interest rates using the Corporation’s on and off-balance sheet financial instruments as of December 31, 2004 and 2003. Interest rates are assumed to shift by a parallel 100 or 200 basis points upward or 100 basis points downward over a 12-month period, except for core savings deposits, which are assumed to shift by lesser amounts due to their historical insensitivity to rate changes. Further, deposits are assumed to have certain minimum rate levels below which they will not fall. It should be noted that the rate scenarios shown do not necessarily reflect the ALCO’s view of the “most likely” change in interest rates over the next 12 months.

   
100 Basis Point
 
100 Basis Point
 
200 Basis Point
  
   
Rate Decrease
  
Rate Increase
  
Rate Increase
  
December 31, 2004
    
-1.31
%
  
1.26
%
  
2.26
%
December 31, 2003
    
-1.04
%
  
2.34
%
  
4.02
%

The ALCO estimates that the negative exposure of net interest income to falling rates results from the difficulty of reducing rates paid on core savings deposits significantly below current levels. If rates were to fall and remain low for a sustained period, core savings deposit rates would likely not fall as fast as other market rates, while asset yields would decline as current asset holdings mature or reprice. The pace of asset cash flows would also be likely to increase in a falling rate environment due to more rapid mortgage-related prepayments and redemption of callable securities. While the ALCO reviews simulation assumptions to ensure that they are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk since the repricing, maturity and prepayment characteristics of financial instruments may change to a different degree than estimated. Specifically, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income. Changes in prepayment speeds can also affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. The sensitivity of core savings deposits to fluctuations in interest rates could also differ from the ALCO’s simulation assumptions, and could result in changes in both liability mix and interest expense that differ from those used to estimate interest rate risk exposure. Income simulation results assume that changes in core savings deposit rates are related to changes in short-term interest rates. The assumed relationship and correlation between short-term interest rate changes and core deposit rate changes used in income simulation may fluctuate over time based on the ALCO’s assessment of market conditions.
 
The Corporation also monitors the potential change in market value of its available for sale debt securities in changing interest rate environments. The purpose is to determine market value exposure which may not be captured by income simulation, but which might result in changes to the Corporation’s capital position. Results are calculated using industry-standard analytical techniques and securities data. Available for sale equity securities are excluded from this analysis because the market value of such securities cannot be directly correlated with changes in interest rates. The following table summarizes the potential change in market value of the Corporation’s available for sale debt securities as of December 31, 2004 and 2003 resulting from immediate parallel rate shifts:

(Dollars in thousands)
  
Down 100
  
Up 200
  
   
Basis
  
Basis
  
Security Type
  
Points
  
Points
  
           
U.S. Treasury and government-sponsored agency securities (noncallable)
  
$
3,031
  
$
(5,399
)
U.S. government-sponsored agency securities (callable)
    
575
    
(3,025
)
Mortgage-backed securities
    
4,931
    
(26,794
)
Corporate securities
    
1,074
    
(2,029
)
               
Total change in market value as of December 31, 2004
  
$
9,611
  
$
(37,247
)
               
Total change in market value as of December 31, 2003
  
$
6,371
  
$
(27,507
)

See additional discussion under the caption “Off-Balance Sheet Arrangements” and Note 9 to the Consolidated Financial Statements for more information regarding the nature and business purpose of financial instruments with off-balance sheet risk and derivative financial instruments.

Financial Condition
Summary
Consolidated total assets increased $334.0 million, or 17%, in 2004. The growth in total assets was mainly attributable to internal loan growth and purchases of residential mortgages. Total liabilities increased $320.2 million in 2004, primarily due to growth in total deposits. Shareholders’ equity totaled $151.9 million at December 31, 2004, up 10% from 2003.

Securities
Securities are designated as either available for sale or held to maturity at the time of purchase. Securities available for sale may be sold in response to changes in market conditions, prepayment risk, rate fluctuations, liquidity, or capital requirements. Securities available for sale are reported at fair value, with any unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of tax, until realized. Securities designated as held to maturity are part of the Corporation’s portfolio of long-term interest-earning assets. These securities are classified as held to maturity because the Corporation has the intent and ability to hold them until maturity. Securities held to maturity are reported at amortized cost.

Securities Available for Sale
The carrying value of securities available for sale at December 31, 2004 amounted to $735.7 million, an increase of $61.8 million, or 9%, over the December 31, 2003 balance of $673.8 million. This increase was due primarily to purchases of mortgage-backed securities and U.S. government agency securities. At December 31, 2004 and 2003, the net unrealized gains on securities available for sale amounted to $11.5 million and $10.3 million, respectively. See Note 4 to the Consolidated Financial Statements for detail of unrealized gains and losses associated with securities available for sale.

Securities Held to Maturity
As a result of principal paydowns on mortgage-backed securities and a called FHLB security, the carrying value of securities held to maturity decreased $11.2 million in 2004, to $154.4 million at December 31, 2004. The expectation of rising interest rates in the second half of 2004 resulted in lower market values for the majority of
 
debt security holdings. As a result, the net unrealized gain on securities held to maturity amounted to $1.9 million at December 31, 2004, down from $3.8 million at December 31, 2003.

Federal Home Loan Bank Stock
The Corporation is required to maintain a level of investment in FHLB stock that currently is based on the level of its FHLB advances. As of December 31, 2004 and 2003, the Corporation’s investment in FHLB stock totaled $34.4 million and $31.5 million, respectively.

Loans
The Corporation experienced strong loan growth in 2004. Total loans increased 30% in 2004 and amounted to $1.250 billion at December 31, 2004. The increase was the result of both internal loan growth as well as loans purchased from other parties.

The Corporation originates residential mortgages for both portfolio and sale and purchases mortgages from other financial institutions. Residential real estate loans grew $123.8 million, or 32%, in 2004, including an increase of $71.7 million in purchased mortgages. Substantially all of the increase in purchased mortgages consisted of adjustable rate loans. Included in residential mortgages at December 31, 2004 were $19.0 million in homeowner construction loans, an increase of $4.8 million from December 31, 2003.

Commercial loans, including commercial real estate and construction loans, increased $99.2 million, or 24%, in 2004 to $507.7 million at year-end, substantially all of which was the result of internal growth. Approximately 40% of the growth occurred in the category of commercial real estate and 17% in construction loans.

Consumer loans amounted to $228.3 million at December 31, 2004, up $65.6 million, or 40% in 2004, primarily due to growth in home equity lines and loans. Home equity lines and loans amounted to approximately 92% and 94% of consumer loans at December 31, 2004 and 2003, respectively. Other consumer loans include personal installment loans and loans to individuals secured by general aviation aircraft and automobiles.

Investment in Bank-Owned Life Insurance (BOLI)
BOLI amounted to $29.2 million and $28.1 million at December 31, 2004 and 2003, respectively. BOLI provides a means to mitigate increasing employee benefit costs. The Corporation expects to benefit from the BOLI contracts as a result of the tax-free growth in cash surrender value and death benefits that are expected to be generated over time. The purchase of the life insurance policy results in an interest sensitive asset on the Corporation’s consolidated balance sheet that provides monthly tax-free income to the Corporation. The largest risk to the BOLI program is credit risk of the insurance carriers. To mitigate this risk, annual financial condition reviews are completed on all carriers. BOLI is included in the Corporation’s consolidated balance sheets at its cash surrender value. Increases in BOLI’s cash surrender value are reported as a component of noninterest income in the Corporation’s consolidated statements of income.

Deposits
Total deposits amounted to $1.458 billion at December 31, 2004, up 21% from the balance at December 31, 2003, with the largest increases in money market and time deposits. Money market deposits increased $113.7 million in 2004 and amounted to $196.8 million at December 31, 2004. Time deposits increased $126.8 million, or 24%, in 2004, primarily due to increases in consumer certificates of deposit and brokered certificates of deposit. The Corporation utilizes brokered time deposits as a funding source, generally with maturities ranging from three to five years. Total brokered certificates of deposit amounted to $169.6 million at December 31, 2004, up from $118.2 million at December 31, 2003. Demand deposits amounted to $189.6 million at December 31, 2004. Included in demand deposits at December 31, 2003 was a temporary placement of approximately $18.6 million in funds on deposit that were withdrawn in January 2004. Excluding this temporary placement of funds at December 31, 2003, demand deposits increased $14.0 million, or 8%, in 2004.

Borrowings
Washington Trust uses advances from the Federal Home Loan Bank of Boston as well as other borrowings as part of its overall funding strategy. The additional FHLB advances and other borrowings were used to meet short-term
 
liquidity needs, to fund loan growth and to purchase loans and securities. FHLB advances increased $65.6 million in 2004 and totaled $672.7 million at December 31, 2004. See Note 11 to the Consolidated Financial Statements for additional information about borrowings.

Asset Quality
The Board of Directors of the Bank monitors credit risk management through two committees, the Finance Committee and the Audit Committee. The Finance Committee reviews and approves large exposure credit requests, monitors asset quality on a regular basis and has approval authority for credit granting policies. The Audit Committee oversees management’s system and procedures to monitor the credit quality of the loan portfolio, conduct a loan review program, maintain the integrity of the loan rating system and determine the adequacy of the allowance for loan losses. The Bank’s practice is to identify problem credits early and take charge-offs as promptly as practicable.

Nonperforming Assets
Nonperforming assets include nonaccrual loans and other real estate owned. Nonperforming assets were .21% of total assets at December 31, 2004, compared to .14% at December 31, 2003. The increase was largely due to a single commercial lending relationship classified as nonaccrual during 2004 with a carrying value of $1.9 million at December 31, 2004. Nonaccrual loans as a percentage of total loans increased from .29% at the end of 2003 to .38% at December 31, 2004. Approximately $1.2 million, or 26% of total nonaccrual loans, were less than 90 days past due at December 31, 2004.

The following table presents nonperforming assets and related ratios:
 
(Dollars in thousands)
          
           
December 31,
    
2004
    
2003
  
               
Nonaccrual loans:
              
Residential real estate
  
$
1,027
  
$
946
  
Commercial and other:
              
Mortgages
    
2,357
    
342
  
Construction and development
    
390
    
-
  
Other
    
730
    
1,236
  
Consumer
    
227
    
219
  
               
Total nonaccrual loans
    
4,731
    
2,743
  
               
Other real estate owned, net
    
4
    
11
  
               
Total nonperforming assets
  
$
4,735
  
$
2,754
  
               
Nonaccrual loans as a percentage of total loans
    
.38
%
  
.29
%
Nonperforming assets as a percentage of total assets
    
.21
%
  
.14
%

Nonaccrual Loans
Loans, with the exception of certain well-secured residential mortgage loans, are placed on nonaccrual status and interest recognition is suspended when such loans are 90 days or more past due with respect to principal and/or interest. Well-secured residential mortgage loans are permitted to remain on accrual status provided that full collection of principal and interest is assured. Loans are also placed on nonaccrual status when, in the opinion of management, full collection of principal and interest is doubtful. Interest previously accrued, but uncollected, is reversed against current period income. Subsequent cash receipts on nonaccrual loans are recognized as interest income, or recorded as a reduction of principal if full collection of the loan is doubtful or if impairment of the collateral is identified.

Nonaccrual loans are returned to accrual status when the obligation has performed in accordance with the contract terms for a reasonable period of time and the ultimate collectibility of the contractual principal and interest is no longer doubtful.
 
There were no accruing loans 90 days or more past due at December 31, 2004 and 2003.

(Dollars in thousands)
          
           
December 31,
    
2004
    
2003
  
               
Nonaccrual loans 90 days or more past due
  
$
3,498
  
$
1,721
  
Nonaccrual loans less than 90 days past due
    
1,233
    
1,022
  
               
Total nonaccrual loans
  
$
4,731
  
$
2,743
  

Restructured Loans
Loans are considered restructured when the Corporation has granted concessions to a borrower due to the borrower’s financial condition that it otherwise would not have considered. These concessions include modifications of the terms of the debt such as reduction of the stated interest rate other than normal market rate adjustments, extension of maturity dates, or reduction of principal balance or accrued interest. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit the Corporation by increasing the ultimate probability of collection. At December 31, 2004, there were no restructured loans included in nonaccrual loans. Included in nonaccrual loans at December 31, 2003, was a loan with a carrying value of $33 thousand whose terms had been restructured. There were no significant commitments to lend additional funds to borrowers whose loans had been restructured.

Other Real Estate Owned and Repossessed Assets
Other real estate owned and repossessed assets is comprised of properties acquired through foreclosure and other legal means, and loans determined to be substantively repossessed. A loan is considered to be substantively repossessed when the Corporation has taken possession of the collateral, but has not completed legal foreclosure proceedings. These assets are carried at the lower of cost or fair value minus estimated costs to sell. A valuation allowance is maintained for declines in market value and estimated selling costs.

At December 31, 2004 and 2003, the balance of other real estate owned and repossessed assets was insignificant and was reported in other assets in the Corporations’ Consolidated Balance Sheets. Washington Trust occasionally provides financing to facilitate the sales of some of these properties. Financing is generally provided at market rates with credit terms similar to those available to other borrowers.

Allowance for Loan Losses
The Corporation uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient allowance for loan losses. See additional discussion regarding the allowance for loan losses under the caption “Critical Accounting Policies”.

The allowance for loan losses is management’s best estimate of the probable loan losses incurred as of the balance sheet date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans.

The allowance for loan losses amounted to $16.8 million, or 1.34% of total loans, at December 31, 2004, compared to $15.9 million, or 1.66%, at December 31, 2003.
 
The following table reflects the activity in the allowance for loan losses:
 
(Dollars in thousands)
          
           
Years ended December 31,
    
2004
    
2003
  
               
Beginning balance
  
$
15,914
  
$
15,487
  
Charge-offs, net of recoveries:
              
Residential:
              
Mortgages
    
-
    
-
  
Homeowner construction
    
-
    
-
  
Commercial:
              
Mortgages
    
(179
)
  
17
  
Construction and development
    
34
    
-
  
Other
    
312
    
(23
)
Consumer
    
80
    
(27
)
               
Net recoveries (charge-offs)
    
247
    
(33
)
Provision for loan losses
    
610
    
460
  
               
Ending balance
  
$
16,771
  
$
15,914
  
               
Allowance for loan losses to nonaccrual loans
    
354.49
%
  
580.17
%
Allowance for loan losses to total loans
    
1.34
%
  
1.66
%
 

Information regarding quantitative and qualitative disclosures about market risk appears under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Asset/Liability Management and Interest Rate Risk”.


The financial statements and supplementary data are contained herein.

Description
  
Page
     
Management’s Report on Internal Control Over Financial Reporting
  
45
     
Reports of Independent Registered Public Accounting Firm
 
46
     
Consolidated Balance Sheets
December 31, 2004 and 2003
  
48
     
Consolidated Statements of Income
For the Years Ended December 31, 2004, 2003 and 2002
  
49
     
Consolidated Statements of Changes in Shareholders’ Equity
For the Years Ended December 31, 2004, 2003 and 2002
  
50
     
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2004, 2003 and 2002
  
51
     
Notes to Consolidated Financial Statements
  
52
     

 

The management of Washington Trust Bancorp, Inc. and subsidiary (the “Corporation” or “Washington Trust”) is responsible for establishing and maintaining adequate internal control over financial reporting for the Corporation. Washington Trust’s internal control system was designed to provide reasonable assurance to management and the Board of Directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Washington Trust’s management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2004. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on our assessment, we believe that, as of December 31, 2004, the Corporation’s internal control over financial reporting is effective based on those criteria.

Washington Trust’s independent registered public accounting firm has issued an attestation report on our assessment of the Corporation’s internal control over financial reporting. This report appears on page 46 of this Annual Report on Form 10-K.
                                               
                                                 
/s/ John C. Warren
/s/ David V. Devault
John C. Warren
Chairman and
Chief Executive Officer
David V. Devault
Executive Vice President,
Treasurer and Chief Financial Officer

 
[Graphic Omitted]
 

The Board of Directors and Shareholders
Washington Trust Bancorp, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Washington Trust Bancorp, Inc. and subsidiary (the “Corporation”) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Corporation’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the COSO. Also, in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Corporation as of December 31, 2004 and 2003, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 15, 2005 expressed an unqualified opinion on those consolidated financial statements.


 
/s/ KPMG LLP
Providence, Rhode Island
March 15, 2005


 
[Graphic Omitted]
Report of Independent Registered Public Accounting Firm



The Board of Directors and Shareholders
Washington Trust Bancorp, Inc.:

We have audited the consolidated financial statements of Washington Trust Bancorp, Inc. and subsidiary (the “Corporation”) as listed in the accompanying index. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Washington Trust Bancorp, Inc. and subsidiary as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 15, 2005 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting.

 

/s/ KPMG LLP
Providence, Rhode Island
March 15, 2005
 
 
   
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
(Dollars in thousands)
 
 
December 31,
  
2004
  
2003
  
Assets:
              
Cash and due from banks
  
$
34,801
  
$
40,710
  
Federal funds sold and other short-term investments
    
17,280
    
20,400
  
Mortgage loans held for sale
    
1,095
    
2,486
  
Securities:
              
Available for sale, at fair value; amortized cost $724,209 in 2004 and $663,529 in 2003
    
735,666
    
673,845
  
Held to maturity, at cost; fair value $156,270 in 2004 and $169,401 in 2003
    
154,392
    
165,576
  
Total securities
    
890,058
    
839,421
  
               
Federal Home Loan Bank stock, at cost
    
34,373
    
31,464
  
               
Loans:
              
Commercial and other
    
507,711
    
408,477
  
Residential real estate
    
513,695
    
389,855
  
Consumer
    
228,270
    
162,649
  
Total loans
    
1,249,676
    
960,981
  
Less allowance for loan losses
    
16,771
    
15,914
  
Net loans
    
1,232,905
    
945,067
  
               
Premises and equipment, net
    
24,248
    
24,941
  
Accrued interest receivable
    
9,367
    
7,911
  
Investment in bank-owned life insurance
    
29,249
    
28,074
  
Goodwill
    
22,591
    
22,591
  
Identifiable intangible assets
    
1,309
    
1,953
  
Other assets
    
10,544
    
8,789
  
Total assets
  
$
2,307,820
  
$
1,973,807
  
               
Liabilities:
              
Deposits:
              
Demand deposits
  
$
189,588
  
$
194,144
  
NOW accounts
    
174,727
    
153,344
  
Money market accounts
    
196,775
    
83,037
  
Savings accounts
    
251,920
    
257,497
  
Time deposits
    
644,875
    
518,119
  
Total deposits
    
1,457,885
    
1,206,141
  
               
Dividends payable
    
2,257
    
2,113
  
Federal Home Loan Bank advances
    
672,748
    
607,104
  
Other borrowings
   
3,417
    
2,311
  
Accrued expenses and other liabilities
    
19,661
    
18,083
  
Total liabilities
    
2,155,968
    
1,835,752
  
               
Commitments and contingencies
              
               
Shareholders’ Equity:
              
Common stock of $.0625 par value; authorized 30 million shares in 2004 and 2003;
              
issued 13,278,685 shares in 2004 and 13,204,024 shares in 2003
    
830
    
825
  
Paid-in capital
    
31,718
    
29,868
  
Retained earnings
    
113,314
    
101,492
  
Unearned stock-based compensation
    
(737
)
  
(22
)
Accumulated other comprehensive income
   
6,937
    
6,101
  
Treasury stock, at cost; 9,309 shares in 2004 and 9,463 shares in 2003
    
(210
)
  
(209
)
Total shareholders’ equity
    
151,852
    
138,055
  
               
Total liabilities and shareholders’ equity
  
$
2,307,820
  
$
1,973,807
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
(Dollars and shares in thousands,
except per share amounts)

Years ended December 31,
  
2004
  
2003
  
2002
  
Interest income:
                    
Interest and fees on loans
  
$
60,828
  
$
51,603
  
$
49,576
  
Interest on securities
    
33,787
    
32,430
    
35,571
  
Dividends on corporate stock and Federal Home Loan Bank stock
    
2,105
    
2,081
    
1,973
  
Interest on federal funds sold and other short-term investments
    
133
    
131
    
219
  
                     
Total interest income
    
96,853
    
86,245
    
87,339
  
                     
Interest expense:
                    
Deposits
    
22,197
    
18,554
    
22,374
  
Federal Home Loan Bank advances
    
20,153
    
18,819
    
20,596
  
Other
    
62
    
73
    
87
  
                     
Total interest expense
    
42,412
    
37,446
    
43,057
  
                     
Net interest income
    
54,441
    
48,799
    
44,282
  
Provision for loan losses
    
610
    
460
    
400
  
                     
Net interest income after provision for loan losses
    
53,831
    
48,339
    
43,882
  
                     
Noninterest income:
                    
Trust and investment management fees
    
13,048
    
10,769
    
10,171
  
Service charges on deposit accounts
    
4,483
    
4,920
    
3,787
  
Merchant processing fees
    
4,259
    
3,410
    
3,002
  
Net gains on loan sales
    
1,901
    
4,690
    
2,884
  
Income from bank-owned life insurance
    
1,175
    
1,161
    
1,155
  
Net realized gains on securities
    
248
    
630
    
678
  
Other income
    
1,791
    
1,155
    
1,581
  
                     
Total noninterest income
    
26,905
    
26,735
    
23,258
  
                     
Noninterest expense:
                    
Salaries and employee benefits
    
28,816
    
26,945
    
23,793
  
Net occupancy
    
3,201
    
2,979
    
2,694
  
Equipment
    
3,267
    
3,380
    
3,333
  
Merchant processing costs
    
3,534
    
2,716
    
2,391
  
Advertising and promotion
    
1,748
    
1,440
    
1,180
  
Outsourced services
    
1,616
    
1,333
    
1,077
  
Legal, audit and professional fees
    
1,535
    
1,242
    
1,893
  
Amortization of intangibles
    
644
    
719
    
651
  
Debt prepayment penalties
    
-
    
941
    
-
  
Acquisition related expenses
    
-
    
-
    
605
  
Other
   
6,012
    
5,937
    
5,373
  
                     
Total noninterest expense
    
50,373
    
47,632
    
42,990
  
                     
Income before income taxes
    
30,363
    
27,442
    
24,150
  
Income tax expense
    
9,534
    
8,519
    
7,393
  
                     
Net income
  
$
20,829
  
$
18,923
  
$
16,757
  
Weighted average shares outstanding - basic
    
13,227.8
    
13,114.1
    
12,737.3
  
Weighted average shares outstanding - diluted
    
13,542.7
    
13,393.6
    
12,932.4
  
Per share information:
                    
Basic earnings per share
  
$
1.57
  
$
1.44
  
$
1.32
  
Diluted earnings per share
  
$
1.54
  
$
1.41
  
$
1.30
  
Cash dividends declared per share
  
$
.68
  
$
.62
  
$
.56
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 

WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
(Dollars in thousands)
 
 
                   
Accumulated
          
               
Unearned
  
Other
          
   
Common
  
Paid-in
  
Retained
  
Stock-Based
  
Comprehensive
  
Treasury
      
   
Stock
  
Capital
  
Earnings
  
Compensation
  
Income
  
Stock
  
Total
  
Balance at January 1, 2002
  
$
754
  
$
10,696
  
$
81,114
  
$
-
  
$
6,416
  
$
(1,043
)
$
97,937
  
Net income
                
16,757
                      
16,757
  
Unrealized gains on securities, net
                                            
of $1,629 income tax expense
                            
3,310
          
3,310
  
Reclassification adjustments, net of tax
                            
(432
)
        
(432
)
Comprehensive income
                                        
19,635
  
Cash dividends declared
                
(7,154
)
                    
(7,154
)
Restricted stock award
          
1
          
(25
)
        
24
    
-
  
Amortization of restricted stock
                      
1
                
1
  
Shares issued
          
(185
)
                    
704
    
519
  
Shares issued for acquisition
    
64
    
18,255
                            
18,319
  
Shares repurchased
                                  
(536
)
  
(536
)
                                             
Balance at December 31, 2002
  
$
818
  
$
28,767
  
$
90,717
  
$
(24
)
$
9,294
  
$
(851
)
$
128,721
  
                                             
Net income
                
18,923
                      
18,923
  
Unrealized losses on securities, net
                                            
of $1,002 income tax benefit
                            
(2,499
)
        
(2,499
)
Reclassification adjustments, net of tax
                            
(410
)
        
(410
)
Minimum pension liability adjustment,
                                            
net of $153 income tax benefit
                            
(284
)
        
(284
)
Comprehensive income
                                        
15,730
  
Cash dividends declared
                
(8,148
)
                    
(8,148
)
Restricted stock award
          
29
          
(29
)
              
-
  
Amortization of restricted stock
                      
31
                
31
  
Shares issued
   
7
    
1,072
                      
851
    
1,930
  
Shares repurchased
                                  
(209
)
  
(209
)
                                             
Balance at December 31, 2003
  
$
825
  
$
29,868
  
$
101,492
  
$
(22
)
$
6,101
  
$
(209
)
$
138,055
  
   
 
 
  
 
 
  
 
 
  
 
 
 
 
 
  
 
 
 
 
 
  
Net income
                
20,829
                      
20,829
  
Unrealized gains on securities, net
                                            
of $383 income tax expense
                            
1,006
          
1,006
  
Reclassification adjustments, net of tax
                            
(161
)
        
(161
)
Minimum pension liability adjustment,
                                            
net of $5 income tax benefit
                            
(9
)
        
(9
)
Comprehensive income
                                        
21,665
  
Cash dividends declared
                
(9,007
)
                    
(9,007
)
Restricted stock award
          
850
          
(850
)
              
-
  
Amortization of restricted stock
                      
135
                
135
  
Shares issued
   
5
    
1,000
                      
154
    
1,159
  
Shares repurchased
                                  
(155
)
  
(155
)
                                             
Balance at December 31, 2004
  
$
830
  
$
31,718
  
$
113,314
  
$
(737
)
$
6,937
  
$
(210
)
$
151,852
  
 
Disclosure of Reclassification Amount:
              
Years ended December 31,
    
2004
    
2003
    
2002
  
Reclassification adjustment for net gains included in net income
  
$
(248
)
$
(630
)
$
(678
)
Income tax effect on net gains
    
87
    
220
    
237
  
Reclassification adjustment for amortization of unrealized loss
                    
on interest rate floor contract included in net income
    
-
    
-
    
13
  
Income tax effect on interest rate floor contract amortization
    
-
    
-
    
(4
)
Net reclassification adjustments
  
$
(161
)
$
(410
)
$
(432
)

The accompanying notes are an integral part of these consolidated financial statements.
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
(Dollars in thousands)
 

Years ended December 31,
  
2004
  
2003
  
2002
  
Cash flows from operating activities:
                    
Net income
  
$
20,829
  
$
18,923
  
$
16,757
  
Adjustments to reconcile net income to net cash provided by operating activities:
                    
Provision for loan losses
    
610
    
460
    
400
  
Depreciation of premises and equipment
    
3,124
    
3,162
    
2,988
  
Net amortization of premium and discount
    
2,758
    
5,355
    
3,342
  
Net amortization of intangibles
    
644
    
719
    
510
  
Depreciation of interest rate floor contract
    
-
    
-
    
229
  
Amortization of restricted stock
    
135
    
31
    
1
  
Deferred income tax benefit
    
(296
)
  
(701
)
  
(1,262
)
Net realized gains on securities
    
(248
)
  
(630
)
  
(678
)
Net gains on loan sales
    
(1,901
)
  
(4,690
)
  
(2,884
)
Earnings from bank-owned life insurance
    
(1,175
)
  
(1,161
)
  
(1,155
)
Proceeds from sales of loans
    
67,426
    
185,214
    
126,382
  
Loans originated for sale
    
(64,456
)
  
(178,979
)
  
(120,587
)
(Increase) decrease in accrued interest receivable, excluding purchased interest
    
(1,075
)
  
222
    
(175
)
(Increase) decrease in other assets
    
(1,755
)
  
2,081
    
(1,589
)
Increase (decrease) in accrued expenses and other liabilities
    
1,578
    
2,042
    
(733
)
Other, net
    
557
    
(260
)
  
(1,112
)
Net cash provided by operating activities
    
26,755
    
31,788
    
20,434
  
Cash flows from investing activities:
                    
Securities available for sale: Purchases
    
(297,287
)
  
(456,596
)
  
(307,083
)
Proceeds from sales
    
4,604
    
42,858
    
29,964
  
Maturities and principal repayments
    
230,396
    
289,901
    
187,549
  
Securities held to maturity: Purchases
    
(44,537
)
  
(62,347
)
  
(152,157
)
Maturities and principal repayments
    
55,190
    
137,416
    
84,447
  
Purchases of Federal Home Loan Bank stock
    
(2,909
)
  
(6,882
)
  
-
  
Principal collected on loans under loan originations
    
(169,228
)
  
(34,534
)
  
(12,507
)
Purchases of loans, including purchased interest
    
(119,796
)
  
(132,317
)
  
(62,433
)
Proceeds from sales of other real estate owned
    
6
    
87
    
61
  
Purchases of premises and equipment
    
(2,431
)
  
(3,687
)
  
(3,400
)
Proceeds from sale of premises and equipment
    
-
    
-
    
638
  
Purchases of bank-owned life insurance
    
-
    
(4,900
)
  
-
  
Cash acquired, net of payment made for acquisition
    
-
    
-
    
34,506
  
Net cash used in investing activities
    
(345,992
)
  
(231,001
)
  
(200,415
)
Cash flows from financing activities:
                    
Net increase in deposits
    
251,767
    
95,855
    
156,420
  
Net increase (decrease) in other borrowings
   
1,106
    
(6,872
)
  
4,242
  
Proceeds from Federal Home Loan Bank advances
    
1,077,228
    
1,395,331
    
717,200
  
Repayment of Federal Home Loan Bank advances
    
(1,011,465
)
  
(1,268,143
)
  
(690,695
)
Purchase of treasury stock
   
(155
)
  
(209
)
  
(536
)
Proceeds from the issuance of common stock
    
590
    
1,174
    
397
  
Cash dividends paid
    
(8,863
)
  
(7,861
)
  
(6,898
)
Net cash provided by financing activities
    
310,208
    
209,275
    
180,130
  
Net (decrease) increase in cash and cash equivalents
    
(9,029
)
  
10,062
    
149
  
Cash and cash equivalents at beginning of year
    
61,110
    
51,048
    
50,899
  
Cash and cash equivalents at end of year
  
$
52,081
  
$
61,110
  
$
51,048
  
Noncash Investing and Financing Activities:
                    
Fair value of assets acquired
  
$
-
  
$
-
  
$
204,762
  
Fair value of liabilities assumed
    
-
    
-
    
166,708
  
Net transfers from loans to other real estate owned
    
4
    
266
    
84
  
Loans charged off
    
567
    
294
    
497
  
Loans made to facilitate the sale of other real estate owned
    
-
    
322
    
-
  
Supplemental Disclosures: Interest payments
    
41,305
    
37,311
    
42,955
  
Income tax payments
    
9,731
    
7,834
    
8,607
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
 
December 31, 2004 and 2003
  
 
General
The Bancorp is a publicly owned, registered bank holding company, organized under the laws of the State of Rhode Island. The Bancorp provides a complete product line of financial services through the Bank. The Bank was originally chartered in 1800 and provides a variety of financial services including commercial, residential and consumer lending, retail and commercial deposit products and trust and investment management services through its branch offices in Rhode Island and Connecticut. The deposits of the Bank are insured by the FDIC, subject to regulatory limits.

The activities of the Bancorp and the Bank are subject to the regulatory supervision of the Federal Reserve Board and the FDIC, respectively. Both companies are also subject to various Rhode Island business and banking regulations. The Bank is subject to various Connecticut business and banking regulations.

(1) Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Bancorp and the Bank. All significant intercompany transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year classification.

The accounting and reporting policies of the Corporation conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices of the banking industry. The Corporation has one reportable operating segment. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change are the determination of the allowance for loan losses and the review of goodwill for impairment.

Securities
Investments in debt securities that management has the positive intent to hold to maturity are classified as held to maturity and carried at amortized cost. Management determines the appropriate classification of securities at the time of purchase.

Investments not classified as held to maturity are classified as available for sale. Securities available for sale consist of debt and equity securities that are available for sale to respond to changes in market interest rates, liquidity needs, changes in funding sources and other similar factors. These assets are specifically identified and are carried at fair value. Changes in fair value of available for sale securities, net of applicable income taxes, are reported as a separate component of shareholders’ equity.

When a decline in market value of a security is considered other than temporary, the cost basis of the individual security is written down to fair value as the new cost basis and the write-down is charged to net realized securities gains (losses) in the consolidated statements of income as a loss. Washington Trust does not have a trading portfolio.

Premiums and discounts are amortized and accreted over the term of the securities on a method that approximates the interest method.  Realized gains or losses from sales of equity securities are determined using the average cost method, while other realized gains and losses are determined using the specific identification method.

Federal Home Loan Bank Stock
The Bank is a member of the FHLB of Boston. As a requirement of membership, the Bank must own a minimum amount of FHLB stock, calculated periodically based primarily on its level of borrowings from the FHLB. The Bank may redeem FHLB stock in excess of the minimum required. In addition, the FHLB may require members to redeem stock in excess of the requirement. FHLB stock is redeemable at par value, which equals cost. Since no market exists for these shares, they are carried at par value.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
Mortgage Banking Activities
Mortgage Loans Held for Sale - Residential mortgage loans originated for sale are classified as held for sale. These loans are specifically identified and are carried at the lower of aggregate cost, net of unamortized deferred loan origination fees and costs, or market. Gains or losses on sales of loans are included in noninterest income and are recognized at the time of sale.

Loan Servicing Rights - Rights to service loans for others are recognized as an asset, including rights acquired through both purchases and originations. The total cost of originated loans that are sold with servicing rights retained is allocated between the loan servicing rights and the loans without servicing rights based on their relative fair values. Capitalized loan servicing rights are included in other assets and are amortized as an offset to other income over the period of estimated net servicing income. They are periodically evaluated for impairment based on their fair value. Impairment is measured on an aggregated basis according to interest rate band and period of origination. The fair value is estimated based on the present value of expected cash flows, incorporating assumptions for discount rate, prepayment speed and servicing cost. Any impairment is recognized as a charge to earnings through a valuation allowance.

Loans
Portfolio Loans - Loans held in the portfolio are stated at the principal amount outstanding, net of unamortized deferred loan origination fees and costs. Interest income is accrued on a level yield basis based on principal amounts outstanding. Deferred loan origination fees and costs are amortized as an adjustment to yield over the life of the related loans.

Nonaccrual Loans - Loans, with the exception of certain well-secured residential mortgage loans, are placed on nonaccrual status and interest recognition is suspended when such loans are 90 days or more overdue with respect to principal and/or interest. Well-secured residential mortgage loans are permitted to remain on accrual status provided that full collection of principal and interest is assured. Loans are also placed on nonaccrual status when, in the opinion of management, full collection of principal and interest is doubtful. Interest previously accrued but not collected on such loans is reversed against current period income. Subsequent cash receipts on nonaccrual loans are applied to the outstanding principal balance of the loan or recognized as interest income depending on management’s assessment of the ultimate collectibility of the loan. Loans are removed from nonaccrual status when they have been current as to principal and interest for a period of time, the borrower has demonstrated an ability to comply with repayment terms, and when, in management’s opinion, the loans are considered to be fully collectible.

Impaired Loans - A loan is impaired when it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Corporation considers all nonaccrual commercial loans to be impaired. Impairment is measured on a discounted cash flow method, or at the loan’s observable market price, or at the fair value of the collateral if the loan is collateral dependent. Impairment is measured based on the fair value of the collateral if it is determined that foreclosure is probable.

Restructured Loans - Restructured loans include those for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments have been granted due to a borrower’s financial condition. Subsequent cash receipts on restructured loans are applied to the outstanding principal balance of the loan, or recognized as interest income depending on management’s assessment of the ultimate collectibility of the loan.

Allowance for Loan Losses
The Corporation uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: (1) identification of specific loan losses, (2) general loss allocations for certain loan types based on credit grade and loss experience factors, and (3) general loss allocations for other environmental factors.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
The methodology includes an analysis of individual loans deemed to be impaired in accordance with accounting principles generally accepted in the United States of America (SFAS 114, “Accounting by Creditors for Impairment of a Loan--an amendment of FASB Statements No. 5 and 15”). Other individual commercial and commercial mortgage loans are evaluated using an internal rating system and the application of loss allocation factors. The loan rating system and the related loss allocation factors take into consideration parameters including the borrower’s financial condition, the borrower’s performance with respect to loan terms and the adequacy of collateral. Portfolios of more homogenous populations of loans including residential mortgages and consumer loans are analyzed as groups taking into account delinquency ratios and other indicators, the Corporation’s historical loss experience and comparison to industry standards of loss allocation factors for each type of credit product. Finally, an additional allowance is maintained based on a judgmental process whereby management considers qualitative and quantitative assessments of other factors including regional credit concentration, industry concentration, results of regulatory examinations, historical loss ranges, portfolio composition, economic conditions such as interest rates and energy costs and other changes in the portfolio. The allowance for loan losses is management’s best estimate of the probable loan losses incurred as of the balance sheet date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans (or portions thereof) deemed to be uncollectible.
 
While management believes that the allowance for loan losses is adequate, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies periodically review the Corporation’s allowance for loan losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination.

Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation for financial reporting purposes is calculated on the straight-line method over the estimated useful lives of assets. Expenditures for major additions and improvements are capitalized while the costs of current maintenance and repairs are charged to operating expenses. The estimated useful lives of premises and improvements range from three to fifty years. For furniture, fixtures and equipment, the estimated useful lives range from two to twenty years.

Goodwill and Other Intangibles
Goodwill represents the excess of the purchase price over the fair value of net assets acquired for transactions accounted for using purchase accounting. Goodwill and intangible assets that are not amortized are tested for impairment, based on their fair values, at least annually. Identifiable intangible assets that are subject to amortization are also reviewed for impairment based on their fair value. Any impairment is recognized as a charge to earnings and the adjusted carrying amount of the intangible asset becomes its new accounting basis. The remaining useful life of an intangible asset that is being amortized is also evaluated each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization.

Impairment of Long-Lived Assets Other than Goodwill 
The Corporation reviews long-lived assets and other intangible assets for impairment at least annually or whenever events or changes in business circumstances indicate that the remaining useful life may warrant revision or that the carrying amount of the long-lived asset may not be fully recoverable. If impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.

Other Real Estate Owned (OREO)
OREO consists of property acquired through foreclosure and loans determined to be substantively repossessed. Real estate loans that are substantively repossessed include only those loans for which the Corporation has taken possession of the collateral, but has not completed legal foreclosure proceedings.

OREO is stated at the lower of cost or fair value minus estimated costs to sell at the date of acquisition or classification to OREO status. Fair value of such assets is determined based on independent appraisals and other
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
relevant factors. Any write-down to fair value at the time of foreclosure is charged to the allowance for loan losses. A valuation allowance is maintained for declines in market value and for estimated selling expenses. Increases to the valuation allowance, expenses associated with ownership of these properties, and gains and losses from their sale are included in foreclosed property costs.

Bank-Owned Life Insurance (BOLI)
BOLI represents life insurance on the lives of certain Bank employees who have provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received, are recorded in other noninterest income, and are not subject to income taxes. The cash value is included in assets. Washington Trust reviews the financial strength of the insurance carrier prior to the purchase of BOLI and annually thereafter.

Transfers and Servicing of Assets and Extinguishments of Liabilities
The Corporation accounts and reports for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial components approach that focuses on control. This approach distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. After a transfer of financial assets, the Corporation recognizes all financial and servicing assets it controls and liabilities it has incurred and derecognizes financial assets it no longer controls and liabilities that have been extinguished. This financial components approach focuses on the assets and liabilities that exist after the transfer. Many of these assets and liabilities are components of financial assets that existed prior to the transfer. If a transfer does not meet the criteria for a sale, the Corporation accounts for a transfer as a secured borrowing with a pledge of collateral.

Fee Revenue
Trust and investment management revenue is primarily accrued as earned based upon a percentage of asset values under administration. Certain trust related fee revenue is recognized to the extent that services have been completed. Fee revenue from deposit service charges is generally recognized when earned. Fee revenue for merchant processing services is generally accrued as earned.

Pension Costs
The Corporation accounts for pension benefits using the net periodic benefit cost method, which recognizes the compensation cost of an employee’s pension benefit over that employee’s approximate service period.

Stock-Based Compensation
The Corporation measures compensation cost for stock-based compensation plans using the intrinsic value based method prescribed by Accounting Principles Board (“APB”) Opinion No. 25. In addition, the Corporation discloses pro forma net income and earnings per share computed using the fair value based method of accounting for these plans as required by Statement of Financial Accounting Standards (“SFAS”) No. 123 and SFAS No. 148.

In determining the pro forma disclosures required by SFAS No. 123 and SFAS No. 148, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following table presents pro forma net income and earnings per share assuming the stock option plan was accounted for using the fair value method prescribed by SFAS No. 123 and SFAS No. 148, the weighted average assumptions used and the grant date fair value of options granted in 2004, 2003 and 2002:
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(Dollars in thousands, except per share amounts)
              
               
Years ended December 31,
    
2004
    
2003
    
2002
  
                     
Net income, as reported
  
$
20,829
  
$
18,923
  
$
16,757
  
Less:
                    
Total stock-based compensation expense
                    
determined under fair value based method
                    
for all awards, net of related tax effects
    
(776
)
  
(1,033
)
  
(1,143
)
                     
Pro forma net income
  
$
20,053
  
$
17,890
  
$
15,614
  
                     
Earnings per share:
                    
Basic - as reported
  
$
1.57
  
$
1.44
  
$
1.32
  
Basic - pro forma
  
$
1.52
  
$
1.36
  
$
1.23
  
Diluted - as reported
  
$
1.54
  
$
1.41
  
$
1.30
  
Diluted - pro forma
  
$
1.48
  
$
1.34
  
$
1.21
  
                     
Weighted average fair value
  
$
8.95
  
$
6.56
  
$
6.92
  
Expected life
    
6.3 years
    
6.3 years
    
6.4 years
  
Risk-free interest rate
    
3.97
%
  
3.13
%
  
4.98
%
Expected volatility
    
35.4
%
  
39.8
%
  
36.2
%
Expected dividend yield
    
2.8
%
  
2.8
%
  
2.7
%

The pro forma effect on net income and earnings per share for 2004, 2003 and 2002 is not representative of the pro forma effect on net income and earnings per share for future years.

Income Taxes
Income tax expense is determined based on the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

Earnings Per Share (EPS)
Diluted EPS is computed by dividing net income by the average number of common shares and common stock equivalents outstanding. Common stock equivalents arise from the assumed exercise of outstanding stock options, if dilutive. The computation of basic EPS excludes common stock equivalents from the denominator.

Comprehensive Income
Comprehensive income is defined as all changes in equity, except for those resulting from investments by and distribution to shareholders. Net income is a component of comprehensive income, with all other components referred to in the aggregate as other comprehensive income.

Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and other short-term investments. Generally, federal funds are sold on an overnight basis.

Guarantees
FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” considers standby letters of credit a guarantee of the Corporation. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Under the standby letters of credit, the Corporation is required to make payments to the beneficiary of the letters of credit upon request by the beneficiary contingent upon the customer’s failure to perform under the terms of the underlying contract with the beneficiary.

Derivative Instruments and Hedging Activities
Derivatives are accounted for in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS Nos. 137, 138 and 149. The Corporation recognizes all derivatives as either assets or liabilities in the balance sheet and measures those instruments at fair value. Changes in the fair value of the derivatives are reported in either earnings or other comprehensive income (loss), depending on the use of the derivative and whether or not it qualifies for hedge accounting. Hedge accounting treatment is permitted only if specific criteria are met, including a requirement that the hedging relationship be highly effective both at inception and on an ongoing basis. Accounting for hedges varies based on the type of hedge — fair value or cash flow. Results of effective hedges are recognized in current earnings for fair value hedges and in other comprehensive income (loss) for cash flow hedges. Ineffective portions of hedges are recognized immediately in earnings and are not deferred. There may be increased volatility in net income and other comprehensive income (loss) on an ongoing basis as a result of accounting for derivative instruments in accordance with SFAS No. 133, as amended.

Interest rate lock commitments are extended to borrowers that relate to the origination of readily marketable mortgage loans held for sale (“rate locks”). To mitigate the interest rate risk inherent in these rate locks, as well as closed mortgage loans held for sale (“loans held for sale”), best efforts forward commitments are established to sell individual mortgage loans (“forward commitments”). Rate locks and forward commitments are considered to be derivatives under SFAS No. 133, as amended. The estimated fair value of the rate locks and forward commitments are recorded on the balance sheet in other assets, with the offset to net gains on sales of loans included in noninterest income. Market value is estimated based on outstanding investor commitments or, in the absence of such information, current investor yield requirements.

From time to time, the Corporation uses interest rate contracts (swaps and floors) as part of its interest rate risk management strategy. Interest rate swap and floor agreements are entered into as hedges against future interest rate fluctuations on specifically identified assets or liabilities.

By using derivative financial instruments to hedge exposures to changes in interest rates, the Corporation exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Corporation, which creates credit risk for the Corporation. When the fair value of a derivative contract is negative, the Corporation owes the counterparty and, therefore, it does not possess credit risk. The Corporation minimizes the credit risk in derivative instruments by entering into transactions with highly rated counterparties that management believes to be creditworthy.

Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. The market risk associated with interest rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

The net amounts to be paid or received on outstanding interest rate contracts are recognized on the accrual basis as an adjustment to the related interest income or expense over the life of the agreements. Changes in fair value of interest rate contracts are recorded in current earnings. Gains or losses resulting from the termination of interest rate swap and floor agreements on qualifying hedges of existing assets or liabilities are deferred and amortized over the remaining lives of the related assets/liabilities as an adjustment to the yield. Unamortized deferred gains/losses on terminated interest rate swap and floor agreements are included in the underlying assets/liabilities hedged.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(2) New Accounting Pronouncements
In December 2003, the FASB issued a revised SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” This Statement requires additional disclosures to those in the original Statement No. 132 about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. Except as noted below, this Statement is effective for financial statements with fiscal years ending after December 15, 2003. The interim period disclosures required by this Statement are effective for interim periods beginning after December 15, 2003. Disclosure of estimated future benefit payments required by this Statement is effective for fiscal years ending after June 15, 2004. The Corporation has provided the disclosure required under revised SFAS No. 132 in Note 12 to the Consolidated Financial Statements.

In December 2003, the FASB issued a revised Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (“ARB”) No. 51.” This Interpretation addresses consolidation by business enterprises of variable interest entities having certain characteristics as detailed in the Interpretation. ARB No. 51 requires that an enterprise’s consolidated financial statements include subsidiaries in which the enterprise has a controlling financial interest. The voting interest approach is not effective in identifying controlling financial interests in entities that are not controllable through voting interests or in which the equity investors do not bear the residual economic risks. The objective of this Interpretation is not to restrict the use of variable interest entities but to improve financial reporting by enterprises involved with variable interest entities. The application of this Interpretation is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities for all other types of entities is required in financial statements for periods ending after March 15, 2004. The adoption of this Interpretation did not have any impact on the Corporation’s financial statements.

In December 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” SOP 03-3 requires loans acquired through a transfer, such as a business combination where there are differences in expected cash flows and contractual cash flows due in part to credit quality, to be recognized at their fair value. The yield that may be accreted is limited to the excess of the investor’s estimate of undiscounted expected principal, interest and other cash flows over the investor’s initial investment in the loan. The excess of contractual cash flows over expected cash flows is not to be recognized as an adjustment of yield, loss accrual or valuation allowance. Valuation allowances cannot be created nor “carried over” in the initial accounting for loans acquired in a transfer of loans with evidence of deterioration of credit quality since origination. However, valuation allowances for non-impaired loans acquired in a business combination can be carried over. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. The Corporation does not believe the adoption of SOP 03-3 will have a material impact on the Corporation’s financial position or results of operations.

In March 2004, the SEC issued SEC Staff Accounting Bulletin (“SAB”) No. 105, “Application of Accounting Principles to Loan Commitments”, which summarizes the views of the SEC regarding the application of GAAP to loan commitments accounted for as derivatives. The guidance requires the measurement of the fair value of the loan commitment to include only the differences between the guaranteed interest rate and the market interest rate. SAB No. 105 prohibits recognizing expected future cash flows related to the servicing of a loan. Servicing assets are to be recognized only once the servicing asset has been contractually separated from the underlying loan by sale or securitization of the loan with servicing retained. SAB No. 105 was effective for loan commitments accounted for as derivatives entered into after March 31, 2004. The adoption of this SAB did not have a material impact on the Corporation’s financial statements.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment.” The Statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” This Statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. Revised
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
SFAS No. 123 requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Compensation cost would be recognized in the financial statement over the requisite service period. This Statement is effective for any interim or annual period beginning after June 15, 2005. For those option awards outstanding as of December 31, 2004 with requisite service periods remaining subsequent to the implementation date of this Statement, the Corporation expects that the cost associated with such awards to be recognized in the financial statements will not be significant.

In 2003, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on EITF 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. EITF 03-1 provided application guidance to assess whether there have been any events or economic circumstance to indicate that a security is impaired on an other-than-temporary basis. Factors to consider include the length of time the security has had a market value less than the cost basis, the intent and ability of the company to hold the security for a period time sufficient for a recover in value, recent events specific to the issuer or industry and for debt securities, external credit rating and recent downgrades. Securities on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss. In December 2004, the FASB announced that it will reconsider in its entirety all guidance on disclosing, measuring and recognizing other-than-temporary impairments of debt and equity securities. Until new guidance is issued, companies must continue to comply with the disclosure requirements of EITF 03-1 and all relevant measurement and recognition requirements in other accounting literature. Companies evaluating whether an impairment is other-than-temporary under existing requirements should continue to consider the length of time a security has been impaired, the severity of the impairment and the financial condition and near-term prospects of the issue of the security.

(3) Cash and Due From Banks
The Bank is required to maintain certain average reserve balances with the Federal Reserve Board. Such reserve balances amounted to $17.3 million and $13.0 million at December 31, 2004 and 2003, respectively.

(4) Securities
Securities are summarized as follows:
 
(Dollars in thousands)
                  
   
Amortized
  
Unrealized
  
Unrealized
  
Fair
  
December 31, 2004
  
Cost
  
Gains
  
Losses
  
Value
  
                   
Securities Available for Sale:
                  
U.S. Treasury obligations and obligations of U.S.
government-sponsored agencies
  
$
135,513
  
$
2,771
  
$
(621
)
$
137,663
  
Mortgage-backed securities
    
492,364
    
2,944
    
(3,461
)
  
491,847
  
Corporate bonds
    
78,364
    
953
    
(483
)
  
78,834
  
Corporate stocks
    
17,968
    
9,443
    
(89
)
  
27,322
  
                           
Total securities available for sale
    
724,209
    
16,111
    
(4,654
)
  
735,666
  
                           
Securities Held to Maturity:
                          
U.S. Treasury obligations and obligations of U.S.
government-sponsored agencies
    
30,000
    
3
    
(127
)
  
29,876
  
Mortgage-backed securities
    
105,753
    
1,927
    
(208
)
  
107,472
  
States and political subdivisions
    
18,639
    
348
    
(65
)
  
18,922
  
                           
Total securities held to maturity
    
154,392
    
2,278
    
(400
)
  
156,270
  
                           
Total securities
  
$
878,601
  
$
18,389
  
$
(5,054
)
$
891,936
  
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(Dollars in thousands)
                  
   
Amortized
  
Unrealized
  
Unrealized
  
Fair
  
December 31, 2003
  
Cost
  
Gains
  
Losses
  
Value
  
                   
Securities Available for Sale:
                  
U.S. Treasury obligations and obligations of U.S. government-sponsored agencies
  
$
97,876
  
$
1,480
  
$
(262
)
$
99,094
  
Mortgage-backed securities
    
464,138
    
3,964
    
(3,277
)
  
464,825
  
Corporate bonds
    
79,175
    
1,487
    
(724
)
  
79,938
  
Corporate stocks
    
22,340
    
8,262
    
(614
)
  
29,988
  
                           
Total securities available for sale
    
663,529
    
15,193
    
(4,877
)
  
673,845
  
                           
Securities Held to Maturity:
                          
U.S. Treasury obligations and obligations of U.S. government-sponsored agencies
    
8,000
    
13
    
-
    
8,013
  
Mortgage-backed securities
    
143,162
    
3,256
    
(118
)
  
146,300
  
States and political subdivisions
    
14,414
    
674
    
-
    
15,088
  
                           
Total securities held to maturity
    
165,576
    
3,943
    
(118
)
  
169,401
  
                           
Total securities
  
$
829,105
  
$
19,136
  
$
(4,995
)
$
843,246
  

Included in corporate stocks at December 31, 2004 are preferred stocks, which are callable at the discretion of the issuer, with an amortized cost of $7.2 million and a fair value of $7.5 million. Call features on these stocks range from one month to four years.

At December 31, 2004 and 2003, the Corporation’s securities portfolio included $13.3 million and $14.1 million of net pretax unrealized gains, respectively. Included in these net amounts were gross unrealized losses amounting to $5.1 million and $5.0 million at December 31, 2004 and 2003, respectively.

The following table summarizes, for all securities in an unrealized loss position at December 31, 2004, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position.

   
Less than 12 Months
  
12 Months or Longer
  
Total
  
   
Fair
  
Unrealized
  
Fair
  
Unrealized
  
Fair
  
Unrealized
  
At December 31, 2004
  
Value
  
Losses
  
Value
  
Losses
  
Value
  
Losses
  
                           
U.S. Treasury obligations and obligations of U.S.government-sponsored agencies
  
$
73,436
  
$
497
  
$
11,749
  
$
251
  
$
85,185
  
$
748
  
Mortgage-backed securities
    
271,485
    
2,310
    
88,313
    
1,359
    
359,798
    
3,669
  
States and political subdivisions
    
3,982
    
65
    
-
    
-
    
3,982
    
65
  
Corporate bonds
    
20,183
    
182
    
11,737
    
301
    
31,920
    
483
  
Subtotal, debt securities
    
369,086
    
3,054
    
111,799
    
1,911
    
480,885
    
4,965
  
Corporate stocks
    
2,207
    
68
    
479
    
21
    
2,686
    
89
  
                                       
Total temporarily impaired securities
  
$
371,293
  
$
3,122
  
$
112,278
  
$
1,932
  
$
483,571
  
$
5,054
  

For those debt securities whose amortized cost exceeds fair value, the primary cause is related to interest rates. The majority of debt securities reported in an unrealized loss position at December 31, 2004 were purchased during 2004 and 2003, during which interest rates were at or near historical lows. The relative increase in short and medium term interest rates towards the end of 2004 resulted in a decline in market value for these debt securities. Other contributing factors for debt securities reported in an unrealized loss position at December 31, 2004 include widening of investment spreads on certain variable rate asset classes, which have resulted in relative declines in market value compared to amortized cost. The Corporation believes that the nature and duration of
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
impairment on its debt security holdings are primarily a function of future interest rate movements and changes in investment spreads, and does not consider full repayment of principal on the reported debt obligations to be at risk. The debt securities in an unrealized loss position at December 31, 2004 consisted of eighty-eight debt security holdings. The largest loss percentage of any single holding was 4.4% of its amortized cost.

Causes of conditions whereby the fair value of corporate stock equity securities is less than cost include the timing of purchases and changes in valuation specific to individual industries or issuers. The relationship between the level of market interest rates and the dividend rates paid on individual equity securities may also be a contributing factor. The Corporation believes that the nature and duration of impairment on its equity securities holdings are a function of general financial market movements and industry conditions. The equity securities in an unrealized loss position at December 31, 2004 consisted of five holdings of financial and commercial entities. The largest loss percentage position of any single holding was 5.1% of its cost.

The maturities of debt securities are presented below. Mortgage-backed securities are included based on weighted average maturities, adjusted for anticipated prepayments. All other securities are included based on contractual maturities. Actual maturities may differ from amounts presented because certain issuers have the right to call or prepay obligations with or without call or prepayment penalties. At December 31, 2004, the Corporation owned debt securities with an aggregate carrying value of $143.8 million that are callable at the discretion of the issuers. Final maturities of the callable securities range from ten months to twenty-six years with call features ranging from one month to ten years.

(Dollars in thousands)
          
   
Amortized
  
Fair
  
December 31, 2004
  
Cost
  
Value
  
           
Securities Available for Sale:
          
Due in 1 year or less
  
$
133,763
  
$
134,106
  
After 1 but within 5 years
    
383,754
    
384,803
  
After 5 but within 10 years
    
156,998
    
157,518
  
After 10 years
    
31,726
    
31,917
  
               
Total debt securities available for sale
    
706,241
    
708,344
  
               
Securities Held to Maturity:
              
Due in 1 year or less
    
36,959
    
37,353
  
After 1 but within 5 years
    
91,343
    
92,411
  
After 5 but within 10 years
    
25,305
    
25,709
  
After 10 years
    
785
    
797
  
               
Total debt securities held to maturity
    
154,392
    
156,270
  
               
Total debt securities
  
$
860,633
  
$
864,614
  
 
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
The following is a summary of amounts relating to sales of securities available for sale:
 
(Dollars in thousands)
              
               
Years ended December 31,
    
2004
    
2003
    
2002
  
                     
Proceeds from sales
  
$
4,604
  
$
42,858
  
$
29,964
  
                     
Gross realized gains
  
$
937
  
$
630
  
$
1,137
  
Gross realized losses
    
(689
)
  
-
    
-
  
Other than temporary write-downs
    
-
    
-
    
(459
)
                     
Net realized gains
  
$
248
  
$
630
  
$
678
  

Included in net realized gains on securities in 2002 were $459 thousand in loss write-downs on certain equity securities deemed to be other than temporarily impaired based on an analysis of the financial condition and operating outlook of the issuers.

Included in other noninterest expense for the twelve months ended December 31, 2004, 2003 and 2002 were contributions of appreciated equity securities to the Corporation’s charitable foundation amounting to $454 thousand, $433 thousand and $403 thousand, respectively. These transactions resulted in realized securities gains of $387 thousand, $400 thousand and $381 thousand, respectively, for the same periods.

Securities available for sale and held to maturity with a fair value of $574.7 million and $548.4 million were pledged in compliance with state regulations concerning trust powers and to secure Treasury Tax and Loan deposits, borrowings and certain public deposits at December 31, 2004 and 2003, respectively. (See Note 11 to the Consolidated Financial Statements for additional discussion of FHLB borrowings). In addition, securities available for sale and held to maturity with a fair value of $20.9 million and $23.0 million were collateralized for the discount window at the Federal Reserve Bank at December 31, 2004 and 2003, respectively. There were no borrowings with the Federal Reserve Bank at either date. Securities available for sale with a fair value of $2.4 million and $2.8 million were designated in a rabbi trust for a nonqualified retirement plan at December 31, 2004 and 2003, respectively.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(5) Loans
The following is a summary of loans:
 
(Dollars in thousands)
          
           
December 31,
    
2004
    
2003
  
               
Commercial and other:
              
Mortgages (1)
  
$
266,670
  
$
227,334
  
Construction and development (2)
    
29,263
    
12,486
  
Other (3)
    
211,778
    
168,657
  
               
Total commercial and other
    
507,711
    
408,477
  
               
Residential real estate:
              
Mortgages (4)
    
494,720
    
375,706
  
Homeowner construction
    
18,975
    
14,149
  
               
Total residential real estate
    
513,695
    
389,855
  
               
Consumer:
              
Home equity lines
    
155,001
    
116,458
  
Other (5)
    
73,269
    
46,191
  
               
Total Consumer
    
228,270
    
162,649
  
               
Total loans (6)
  
$
1,249,676
  
$
960,981
  
 
(1)  
Amortizing mortgages, primarily secured by income producing property
(2)  
Loans for construction of residential and commercial properties and for land development
(3)  
Loans to businesses and individuals, a substantial portion of which are fully or partially collateralized by real estate
(4)  
A substantial portion of these loans is used as qualified collateral for FHLB borrowings (See Note 11 for additional discussion of FHLB borrowings)
(5)  
Fixed rate home equity loans and other consumer installment loans
(6)  
Net of unearned income and unamortized loan origination fees, net of costs totaling $507 thousand and $687 thousand at December 31, 2004 and 2003, respectively. Includes $729 thousand and $685 thousand of net purchased premium at December 31, 2004 and 2003, respectively.

Concentrations of Credit Risk
A significant portion of the Corporation’s loan portfolio is concentrated among borrowers in southern New England, primarily Rhode Island, and to a lesser extent Connecticut and Massachusetts. The Corporation grants single family and multi-family residential loans, commercial real estate loans, commercial loans, and a variety of consumer loans. In addition, loans are granted for the construction of residential homes, commercial real estate properties, and for land development. The ability of single family residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the market area and real estate values. The ability of commercial borrowers to honor their repayment commitments is dependent on the general economy as well as the health of the real estate economic sector in the Corporation’s market area

Nonaccrual Loans
The balance of loans on nonaccrual status as of December 31, 2004 and 2003 was $4.7 million and $2.7 million, respectively. Interest income that would have been recognized had these loans been current in accordance with their original terms was approximately $371 thousand in 2004 and $232 thousand in 2003. Interest income attributable to these loans included in the Consolidated Statements of Income amounted to approximately $297 thousand in 2004 and $196 thousand in 2003.

There were no accruing loans 90 days or more past due at December 31, 2004 and 2003.

WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
At December 31, 2004, there were no restructured loans included in nonaccrual loans. Included in nonaccrual loans at December 31, 2003, was a loan with a carrying value of $33 thousand whose terms had been restructured.

Impaired Loans
Impaired loans consist of all nonaccrual commercial loans. The following is a summary of impaired loans:
 
(Dollars in thousands)
          
           
December 31,
    
2004
    
2003
  
               
Impaired loans requiring an allowance
  
$
589
  
$
815
  
Impaired loans not requiring an allowance
    
2,888
    
762
  
               
Total recorded investment in impaired loans
  
$
3,477
  
$
1,577
  

(Dollars in thousands)
              
               
Years ended December 31,
    
2004
    
2003
    
2002
  
                     
Average recorded investment in impaired loans
  
$
3,300
  
$
2,274
  
$
2,219
  
                     
Interest income recognized on impaired loans
  
$
222
  
$
111
  
$
100
  


Loan Servicing Activities
An analysis of loan servicing rights for the years ended December 31, 2004, 2003 and 2002 follows:
 
(Dollars in thousands)
  
Loan
          
   
Servicing
  
Valuation
      
   
Rights
  
Allowance
  
Total
  
Balance as of December 31, 2001
  
$
830
  
$
(320
)
$
510
  
Loan servicing rights capitalized
    
152
    
-
    
152
  
Acquired loan servicing rights (1)
    
453
    
-
    
453
  
Amortization (2)
    
(176
)
  
-
    
(176
)
Increase in impairment reserve (2)
    
-
    
(177
)
  
(177
)
                     
Balance at December 31, 2002
    
1,259
    
(497
)
  
762
  
Loan servicing rights capitalized
    
302
    
-
    
302
  
Amortization (2)
    
(261
)
  
-
    
(261
)
Increase in impairment reserve (2)
    
-
    
(82
)
  
(82
)
                     
Balance at December 31, 2003
    
1,300
    
(579
)
  
721
  
Loan servicing rights capitalized
    
487
    
-
    
487
  
Amortization (2)
    
(311
)
  
-
    
(311
)
Direct write-down
    
(146
)
  
146
    
-
  
Decrease in impairment reserve (2)
    
-
    
102
    
102
  
                     
Balance at December 31, 2004
  
$
1,330
  
$
(331
)
$
999
  
 
(1)  
The acquired loan servicing rights have a weighted average amortization period of 15 years.
(2)  
Both amortization and increases in the impairment reserve are recorded as reductions in loan servicing fees.
 
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
Estimated aggregate amortization expense related to loan servicing assets is as follows:
 
(Dollars in thousands)
          
           
Years ending December 31:
    
2005
  
$
263
  
     
2006
    
213
  
     
2007
    
172
  
     
2008
    
139
  
     
2009
    
112
  

The Corporation services mortgage loans and other loans sold to others on a fee basis under various agreements. Loans serviced for others are not included in the Consolidated Balance Sheets. Balance of loans serviced for others, by type of loan:
 
(Dollars in thousands)
          
           
December 31,
   
2004
    
2003
  
               
Residential mortgages
  
$
63,709
  
$
74,353
  
Commercial loans
    
29,316
    
25,477
  
               
Total
  
$
93,025
  
$
99,830
  

Loans to Related Parties
The Corporation has made loans in the ordinary course of business to certain directors and executive officers including their immediate families and their affiliated companies. Such loans were made under normal interest rate and collateralization terms. Activity related to these loans in 2004 was as follows:

(Dollars in thousands)
      
     
2004
  
         
Balance at beginning of year
  
$
10,994
  
Additions
    
18,561
  
Reductions
    
(11,513
)
         
Balance at end of year
  
$
18,042
  

(6) Allowance for Loan Losses
The following is an analysis of the allowance for loan losses:
 
(Dollars in thousands)
              
               
Years ended December 31,
    
2004
    
2003
    
2002
  
                     
Balance at beginning of year
  
$
15,914
  
$
15,487
  
$
13,593
  
Allowance on acquired loans
    
-
    
-
    
1,829
  
Provision charged to expense
    
610
    
460
    
400
  
Recoveries of loans previously charged off
    
814
    
261
    
162
  
Loans charged off
    
(567
)
  
(294
)
  
(497
)
                     
Balance at end of year
  
$
16,771
  
$
15,914
  
$
15,487
  

Included in the allowance for loan losses at December 31, 2004, 2003 and 2002 was an allowance for impaired loans amounting to $236 thousand, $134 thousand and $29 thousand, respectively.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(7) Premises and Equipment
The following is a summary of premises and equipment:
 
(Dollars in thousands)
          
           
December 31,
    
2004
    
2003
  
               
Land and improvements
  
$
4,014
  
$
4,009
  
Premises and improvements
    
27,956
    
29,001
  
Furniture, fixtures and equipment
    
19,145
    
23,368
  
     
51,115
    
56,378
  
Less accumulated depreciation
    
26,867
    
31,437
  
               
Total premises and equipment, net
  
$
24,248
  
$
24,941
  

Depreciation of premises and equipment amounted to $3.1 million, $3.2 million and $3.0 million of expense for the years ended December 31, 2004, 2003 and 2002, respectively.

(8) Goodwill and Other Intangibles
The changes in the carrying value of goodwill and other intangible assets for the years ended December 31, 2004 and 2003 are as follows:
 
(Dollars in thousands)
      
Core Deposit
  
Other
  
Total
  
   
Goodwill
  
Intangibles
  
Intangibles
  
Intangibles
  
                   
Balance at December 31, 2002
  
$
22,588
  
$
2,009
  
$
663
  
$
25,260
  
Recorded during the period
    
3
    
-
    
-
    
3
  
Amortization expense
    
-
    
(435
)
  
(284
)
  
(719
)
Impairment recognized
    
-
    
-
    
-
    
-
  
                           
Balance at December 31, 2003
  
$
22,591
  
$
1,574
  
$
379
  
$
24,544
  
Recorded during the period
    
-
    
-
    
-
    
-
  
Amortization expense
    
-
    
(360
)
  
(284
)
  
(644
)
Impairment recognized
    
-
    
-
    
-
    
-
  
 
Balance at December 31, 2004
  
$
22,591
  
$
1,214
  
$
95
  
$
23,900
  

At December 31, 2004 and December 31, 2003, the Corporation had unamortized identifiable intangible assets consisting of core deposit intangibles and a noncompete agreement.

Estimated annual amortization expense is as follows:
 
(Dollars in thousands)
              
   
Core Deposit
  
Other
  
Total
  
Estimated amortization expense
  
Intangibles
  
Intangibles
  
Intangibles
  
               
2005
  
$
303
  
$
95
  
$
398
  
2006
    
261
    
-
    
261
  
2007
    
140
    
-
    
140
  
2008
    
120
    
-
    
120
  
2009
    
120
    
-
    
120
  
 
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
The components of intangible assets at December 31, 2004 are as follows:
 
(Dollars in thousands)                    
 
    
Gross Carrying
 
 
Accumulated
 
 
Net
  
Intangible assets
    
Amount
 
 
Amortization
 
 
Amount
  
                     
Core deposit intangibles
  
$
2,997
  
$
(1,783
)
$
1,214
  
Other intangibles
    
852
    
(757
)
  
95
  
                     
Total
  
$
3,849
  
$
(2,540
)
$
1,309
  

(9) Financial Instruments With Off-Balance Sheet Risk and Derivative Financial Instruments
The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage the Corporation’s exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, financial guarantees, interest rate swaps and floors and commitments to originate and commitments to sell fixed rate mortgage loans. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Consolidated Balance Sheets. The contract or notional amounts of these instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The contractual and notional amounts of financial instruments with off-balance sheet risk are as follows:

(Dollars in thousands)
          
           
December 31,
   
2004
    
2003
  
               
Financial instruments whose contract amounts represent credit risk:
              
Commitments to extend credit:
              
Commercial loans
  
$
87,249
  
$
78,555
  
Home equity lines
    
150,175
    
109,182
  
Other loans
    
20,870
    
14,965
  
Standby letters of credit
    
9,737
    
9,448
  
Financial instruments whose notional amounts exceed the amount of credit risk:
              
Forward loan commitments:
              
Commitments to originate fixed rate mortgage loans to be sold
    
2,846
    
1,328
  
Commitments to sell fixed rate mortgage loans
    
3,947
    
3,340
  

Commitments to Extend Credit
Commitments to extend credit are agreements to lend to a customer as long as there are no violations of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each borrower’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the borrower.

Standby Letters of Credit
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Under the standby letters of credit, the Corporation is required to make payments to the beneficiary of the letters of credit upon request by the beneficiary contingent upon the customer’s failure to perform under the terms of the underlying contract with the beneficiary. Standby letters of credit extend up to five years. At December 31, 2004 and 2003, the maximum potential amount of undiscounted future payments,
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
not reduced by amounts that may be recovered totaled $9.7 million and $9.4 million, respectively. At December 31, 2004 and 2003, there was no liability to beneficiaries resulting from standby letters of credit.
 
At December 31, 2004, a substantial portion of the standby letters of credit were supported by pledged collateral. The collateral obtained is determined based on management’s credit evaluation of the customer. Should the Corporation be required to make payments to the beneficiary, repayment from the customer to the Corporation is required.

Interest Rate Risk Management Agreements
The Corporation uses interest rate swaps and floors from time to time as part of its interest rate risk management strategy. Swaps are agreements in which the Corporation and another party agree to exchange interest payments (e.g., fixed-rate for variable-rate payments) computed on a notional principal amount. A floor is a purchased contract that entitles the Corporation to receive payment from a counterparty if a rate index falls below a contractual rate. The amount of the payment is the difference between the contractual floor rate and the rate index multiplied by the notional principal amount of the contract. If the rate index does not fall below the contractual floor rate, no payment is received. The credit risk associated with swap and floor transactions is the risk of default by the counterparty. To minimize this risk, the Corporation enters into interest rate agreements only with highly rated counterparties that management believes to be creditworthy. The notional amounts of these agreements do not represent amounts exchanged by the parties and thus, are not a measure of the Corporation’s potential loss exposure.

The Corporation was party to a five-year interest rate floor contract with a notional amount of $20.0 million that was to mature in February 2003. The floor contract entitled the Corporation to receive payment from a counterparty if the three-month LIBOR rate fell below 5.50%. The Corporation and the counterparty agreed to an early termination date of May 7, 2002 and the Corporation received a final payment from the counterparty of $606 thousand.

The Corporation recognized the fair value of this derivative as an asset on the balance sheet and changes in fair value were recorded in current earnings. Included in interest income for the year ended December 31, 2002, was $229 thousand of depreciation in value through the termination date.

The Corporation has not terminated any interest rate swap agreements or floor contracts, other than disclosed above.

Forward Loan Commitments
Commitments to originate and commitments to sell fixed rate mortgage loans are derivative financial instruments. Accordingly, the Corporation recognizes the fair value of these commitments as an asset on the balance sheet. At December 31, 2004 and 2003, the carrying value of these commitments amounted to $(3) thousand and $(15) thousand, respectively, and was reported in other assets. Changes in the fair value were recorded in current earnings and amounted to income of $8 thousand for the year ended December 31, 2004 compared to income of $52 thousand for the year ended December 31, 2003.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(10) Time Certificates of Deposit
Scheduled maturities of time certificates of deposit at December 31, 2004 were as follows:
 
(Dollars in thousands)
          
               
Years ending December 31:
    
2005
  
$
214,888
  
   
2006
    
135,991
  
     
2007
    
103,894
  
     
2008
    
112,101
  
     
2009
    
67,972
  
 
    
2010 and thereafter 
    
10,029
  
               
Balance at December 31, 2004
        
$
644,875
  

The aggregate amount of time certificates of deposit in denominations of $100 thousand or more was $310.4 million and $215.4 million at December 31, 2004 and 2003, respectively.

(11) Borrowings
Federal Home Loan Bank Advances
The following table presents maturities and weighted average interest rates paid on FHLB advances outstanding at December 31, 2004 and 2003:
 
(Dollars in thousands)  
December 31, 2004
  
December 31, 2003
  
   
 
  
Redeemed
  
 
  
 
  
Redeemed
  
 
  
   
 
  
at 
 
 Weighted
 
 
 
at 
 
Weighted
 
 
 
 Scheduled
 
Call
 
Average 
 
 Scheduled
 
Call 
 
 Average
 
 
 
Maturity
 
Date (1)
 
Rate (2)
 
Maturity
 
Date (1)
 
Rate (2)
  
                           
2005
  
$
222,137
  
$
272,637
    
2.52
%
$
         291,297
  
$
336,797
    
2.06
%
2006
    
106,810
    
111,810
    
3.02
%
  
78,371
    
83,371
    
2.98
%
2007
    
102,313
    
112,313
    
3.48
%
  
84,962
    
84,962
    
3.23
%
2008
    
90,796
    
90,796
    
3.64
%
  
44,902
    
54,902
    
3.87
%
2009
    
79,513
    
67,513
    
4.21
%
  
30,456
    
30,456
    
3.81
%
2010 and after
    
71,179
    
17,679
    
4.90
%
  
77,116
    
16,616
    
5.18
%
                                       
   
$
672,748
  
$
672,748
        
$
607,104
  
$
607,104
        
 
(1)  
Callable FHLB advances are shown in the respective periods assuming that the callable debt is redeemed at the call date while all other advances are shown in the periods corresponding to their scheduled maturity date.
(2)  
Weighted average rate based on scheduled maturity dates.

In addition to the outstanding advances, the Bank also has access to an unused line of credit amounting to $8.0 million at December 31, 2004. Under agreement with the FHLB, the Bank is required to maintain qualified collateral, free and clear of liens, pledges, or encumbrances that, based on certain percentages of book and market values, has a value equal to the aggregate amount of the line of credit and outstanding advances. The FHLB maintains a security interest in various assets of the Bank including, but not limited to, residential mortgage loans, U.S. government or agency securities, U.S. government-sponsored agency securities, and amounts maintained on deposit at the FHLB. The Bank maintains qualified collateral in excess of the amount required to collateralize the line of credit and outstanding advances at December 31, 2004. Included in the collateral were securities available for sale and held to maturity with a fair value of $515.8 million and $526.0 million that were specifically pledged to secure FHLB borrowings at December 31, 2004 and December 31, 2003, respectively. Unless there is an event of default under the agreement, the Corporation may use, encumber or dispose any portion of the collateral in excess of the amount required to secure FHLB borrowings, except for that collateral which has been specifically pledged.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
In June 2003, the Corporation incurred $941 thousand in prepayment penalty charges associated with the prepayment of certain FHLB advances totaling $23 million. The prepayment penalty charges were reported in noninterest expenses in the Corporation’s Consolidated Statements of Income.

Other Borrowings
The following is a summary of other borrowings:
 
(Dollars in thousands)
          
           
December 31,
  
2004
  
2003
  
           
Treasury, Tax and Loan demand note balance
  
$
2,835
  
$
1,567
  
Other
    
582
    
744
  
               
Other borrowings
  
$
3,417
  
$
2,311
  
 
There were no securities sold under repurchase agreements outstanding at December 31, 2004 and 2003. Securities sold under repurchase agreements generally mature within 90 days. The securities underlying the agreements are held in safekeeping by the counterparty in the name of the Corporation and are repurchased when the agreement matures. Accordingly, these underlying securities are included in securities available for sale and the obligations to repurchase such securities are reflected as a liability. The following is a summary of amounts relating to securities sold under repurchase agreements:

(Dollars in thousands)
              
               
Years ended December 31,
  
2004
  
2003
  
2002
  
               
Maximum amount outstanding at any month-end
  
$
-
  
$
-
  
$
2,864
  
Average amount outstanding
  
$
-
  
$
-
  
$
783
  
Weighted average rate
    
-
    
-
    
1.47
%

(12) Employee Benefits
Defined Benefit Pension Plans
The Corporation’s noncontributory tax-qualified defined benefit pension plan covers substantially all employees. Benefits are based on an employee’s years of service and highest 3-year compensation. The plan is funded on a current basis, in compliance with the requirements of the Employee Retirement Income Security Act of 1974, as amended. At December 31, 2004 and 2003, the accrued benefit costs relating to the defined benefit pension plan amounted to $1.3 million and $1.4 million, respectively.

The Corporation has a non-qualified retirement plan to provide supplemental retirement benefits to certain employees, as defined in the plan. The primary purpose of this plan is to restore benefits which would otherwise be provided by the level of the tax-qualified defined benefit pension plan but which are limited by the Internal Revenue Code of 1986, as amended. The accrued pension liability related to this plan amounted to $2.0 million and $1.7 million at December 31, 2004 and 2003, respectively. The actuarial assumptions used for this supplemental plan are the same as those used for the Corporation’s tax-qualified pension plan. The projected benefit obligation for this plan amounted to $2.6 million at December 31, 2004 and $2.3 million at December 31, 2003.

The Corporation has a non-qualified retirement plan to provide supplemental retirement benefits to certain executives, as defined by the plan. The accrued pension liability of this plan amounted to $611 thousand at December 31, 2004 and $433 thousand at December 31, 2003. Using the same actuarial assumptions as the other aforementioned pension plans, the projected benefit obligation of this plan amounted to $1.6 million and $1.0 million at December 31, 2004 and 2003, respectively.
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
As a result of the second quarter 2002 acquisition of First Financial Corp., the Corporation assumed a non-qualified executive retirement plan to provide supplemental retirement benefits to a former First Financial Corp. executive. The accrued pension liability of this plan amounted to $3.2 million at December 31, 2004 and 2003. Using the same assumptions as the other aforementioned pension plans, the projected benefit obligation amounted to $3.2 million at December 31, 2004 and 2003.

The non-qualified retirement plans provide for the designation of assets in rabbi trusts. Securities available for sale designated for this purpose, with the carrying value of $3.0 million and $3.2 million, are included in the Corporation’s Consolidated Balance Sheets at December 31, 2004 and 2003, respectively.
 
Obligations And Funded Status:
 
(Dollars in thousands)
  
Qualified
  
Non-Qualified
  
   
Pension Plan
  
Retirement Plans
  
At December 31,
  
2004
  
2003
  
2004
  
2003
  
                   
Change in Benefit Obligation:
                  
Benefit obligation at beginning of period
  
$
22,785
  
$
18,512
  
$
6,538
  
$
5,621
  
Service cost
    
1,592
    
1,273
    
292
    
184
  
Interest cost
    
1,367
    
1,226
    
390
    
369
  
Actuarial loss (gain)
    
920
    
2,560
    
497
    
678
  
Benefits paid
    
(777
)
  
(700
)
  
(321
)
  
(314
)
Administrative expenses
    
(110
)
  
(86
)
  
-
    
-
  
                           
Benefit obligation at end of period
  
$
25,777
  
$
22,785
  
$
7,396
  
$
6,538
  
                           
Change in Plan Assets:
                          
Fair value of plan assets at beginning of period
  
$
18,818
  
$
16,902
  
$
-
  
$
-
  
Actual return on plan assets
    
1,870
    
2,225
    
-
    
-
  
Employer contribution
    
1,500
    
477
    
321
    
314
  
Benefits paid
    
(777
)
  
(700
)
  
(321
)
  
(314
)
Administrative expenses
    
(110
)
  
(86
)
  
-
    
-
  
                           
Fair value of plan assets at end of period
  
$
21,301
  
$
18,818
  
$
-
  
$
-
  
                           
Funded status
  
$
(4,476
)
$
(3,967
)
$
(7,396
)
$
(6,538
)
Unrecognized transition asset
    
(19
)
  
(25
)
  
-
    
-
  
Unrecognized prior service cost
    
122
    
152
    
525
    
600
  
Unrecognized net actuarial loss
    
3,051
    
2,474
    
1,770
    
1,336
  
                           
Net amount recognized
  
$
(1,322
)
$
(1,366
)
$
(5,101
)
$
(4,602
)

Amounts recognized in the Corporation’s Consolidated Balance Sheets consist of:
 
(Dollars in thousands)
  
Qualified
  
Non-Qualified
  
   
Pension Plan
  
Retirement Plans
  
December 31,
  
2004
  
2003
  
2004
  
2003
  
                   
Accrued benefit cost
  
$
(1,322
)
$
(1,366
)
$
(5,802
)
$
(5,285
)
Intangible asset
    
-
    
-
    
250
    
246
  
Deferred tax asset
    
-
    
-
    
158
    
153
  
Accumulated other comprehensive income
    
-
    
-
    
293
    
284
  
                           
Net amount recognized
  
$
(1,322
)
$
(1,366
)
$
(5,101
)
$
(4,602
)

 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
The accumulated benefit obligation for the qualified pension plan was $19.7 million and $17.4 million at December 31, 2004 and 2003, respectively. The accumulated benefit obligation for the non-qualified pension plans amounted to $5.8 million and $5.3 million at December 31, 2004 and 2003, respectively.
 
Information For Pension Plans With An Accumulated Benefit Obligation In Excess Of Plan Assets:
(Dollars in thousands)
  
Non-Qualified
  
   
Retirement Plans
  
December 31,
  
2004
  
2003
  
           
Projected benefit obligation
  
$
7,396
  
$
6,538
  
Accumulated benefit obligation
    
5,802
    
5,285
  
Fair value of plan assets
    
-
    
-
  

Components of Net Periodic Benefit Cost:
(Dollars in thousands)
  
Qualified
  
Non-Qualified
  
   
Pension Plan
  
Retirement Plans
  
Years ended December 31,
  
2004
  
2003
  
2002
  
2004
  
2003
  
2002
  
                   
Service cost
  
$
1,592
  
$
1,273
  
$
1,029
  
$
292
  
$
184
  
$
174
  
Interest cost
    
1,367
    
1,226
    
1,119
    
390
    
369
    
287
  
Expected return on plan assets
    
(1,564
)
  
(1,416
)
  
(1,446
)
  
-
    
-
    
-
  
Amortization of transition asset
    
(6
)
  
(6
)
  
(6
)
  
-
    
-
    
-
  
Amortization of prior service cost
    
30
    
33
    
33
    
76
    
111
    
118
  
Recognized net actuarial (gain) loss
   
37
    
-
    
(14
)
  
63
    
28
    
19
  
                                       
Net periodic benefit cost
  
$
1,456
  
$
1,110
  
$
715
  
$
821
  
$
692
  
$
598
  

Additional Information:
(Dollars in thousands)
  
Qualified
  
Non-Qualified
  
   
Pension Plan
  
Retirement Plans
  
Years ended December 31,
  
2004
  
2003
  
2002
  
2004
  
2003
  
2002
  
                   
Increase in minimum liability included
                          
in other comprehensive income
  
$
-
  
$
-
  
$
-
  
$
9
  
$
284
  
$
-
  

Assumptions:
The measurement date and weighted-average assumptions used to determine benefit obligations at December 31, 2004 and 2003 were as follows:
 
   
Qualified Pension Plan
  
Non-Qualified Retirement Plans
  
   
2004
 
2003
 
2004
 
2003
  
                   
Measurement date
    
Sept. 30, 2004
    
Sept. 30, 2003
    
Sept. 30, 2004
    
Sept. 30, 2003
  
Discount rate
    
6.00
%
  
6.10
%
  
6.00
%
  
6.10
%
Rate of compensation increase
    
4.25
%
  
4.25
%
  
4.25
%
  
4.25
%

 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
The measurement date and weighted-average assumptions used to determine net periodic benefit cost for the years ended December 31, 2004, 2003 and 2002 were as follows:
 
   
Qualified Pension Plan
  
Non-Qualified Retirement Plans
  
   
2004
 
2003
 
2002
 
2004
 
2003
  
2002
  
                           
Measurement date
    
Sept. 30, 2003
    
Sept. 30, 2002
    
Sept. 30, 2001
    
Sept. 30, 2003
    
Sept. 30, 2002
    
Sept. 30, 2001
  
Discount rate
    
6.10
%
  
6.75
%
  
7.25
%
  
6.10
%
  
6.75
%
  
7.25
%
Expected long-term
                                     
return on plan assets
    
8.25
%
  
8.00
%
  
8.50
%
  
-
    
-
    
-
  
Rate of compensation
                                      
increase
    
4.25
%
  
4.25
%
  
4.75
%
  
4.25
%
  
4.25
%
  
4.75
%
 
The expected long-term rate of return on plan assets is based on what the Corporation believes is realistically achievable based on the types of assets held by the plan and the plan's investment practices. The assumption is updated at least annually, taking into account the asset allocation, historical asset return trends on the types of assets held and the current and expected economic conditions. At September 30, 2003, the measurement date used in the determination of net periodic benefit cost for 2004, the Corporation determined that a revision to the assumption was necessary based upon expected market performance and the expected long-term rate of return assumption was increased from 8.00% to 8.25%.

Plan Assets:
The asset allocations of the qualified pension plan at December 31, 2004 and 2003, by asset category were as follows:
 
December 31,
  
2004
  
2003
  
           
Asset Category:
          
Equity securities
    
57.2
%
  
54.0
%
Debt securities
    
41.4
%
  
45.9
%
Other
    
1.4
%
  
0.1
%
               
Total
    
100.0
%
  
100.0
%

The assets of the qualified defined benefit pension plan trust (the “Pension Trust”) are managed to balance the needs of cash flow requirements and long-term rate of return. Cash inflow is typically comprised of invested income from portfolio holdings and Bank contributions, while cash outflow is for the purpose of paying plan benefits. As early as possible each year, the trustee is advised of the projected schedule of employer contributions and estimations of benefit payments. As a general rule, the trustee shall invest the funds so as to produce sufficient income to cover benefit payments and maintain a funded status that exceeds the regulatory requirements for tax-qualified defined benefit plans.

The investment philosophy used for the Pension Trust emphasizes consistency of results over an extended market cycle, while reducing the impact of the volatility of the security markets upon investment results. The assets of the Pension Trust should be protected by substantial diversification of investments, providing exposure to a wide range of quality investment opportunities in various asset classes.

The investment objective with respect to the Pension Trust assets is to secure a balanced mix of current income with capital appreciation. At any time, the portfolio will typically be invested in the following ranges: 40% to 60% in equities; 40% to 60% in fixed income; and 0% to 25% in cash and cash equivalents. The trustee investment manager will have authorization to invest within these ranges, making decisions based upon market conditions. Investments in real estate or derivatives are not permitted.

Fixed income bond investments should be limited to those in the top four categories used by the major credit rating agencies.  In order to reduce the volatility of the annual rate of return of the bond portfolio, attention will be
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
given to the maturity structure of the portfolio in light of money market conditions and interest rate forecasts.  Generally, the Pension Trust shall not purchase bonds with a maturity of more than twelve years and the maturity schedule will have a lddered character avoiding large concentrations in any single year. 
 
Common stock and equity holdings provide opportunities for dividend and capital appreciation returns. Holdings will typically consist of large-cap companies. Diversification of equity holdings should be influenced by forecasts of economic activity, corporate profits and allocation among different segments of the economy. The fair value of equity securities of any one issuer will not be permitted to exceed 10% of the total fair value of equity holdings of the Pension Trust.
 
Cash Flows:
 
Contributions
The Internal Revenue Code permits flexibility in plan contributions so that normally a range of contributions is possible. The Corporation’s current funding policy has been generally to contribute the minimum required contribution and additional amounts up to the maximum deductible contribution. The Corporation expects to contribute $1.3 million to the qualified pension plan in 2005. In addition, the Corporation expects to contribute $326 thousand in benefit payments to the non-qualified retirement plans in 2005.

Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:
 
(Dollars in thousands)
  
Qualified
Pension Plan
  
Non-Qualified
Plans
  
2005
  
$
835
  
$
326
  
2006
    
805
    
359
  
2007
    
864
    
407
  
2008
    
917
    
405
  
2009
    
916
    
412
  
Years 2010 - 2014
    
7,394
    
3,366
  

401(k) Plan
The Corporation’s 401(k) Plan provides a specified match of employee contributions for substantially all employees. Total employer matching contributions under this plan amounted to $504 thousand, $463 thousand and $425 thousand in 2004, 2003 and 2002, respectively.

Other Incentive Plans
The Corporation maintains several non-qualified incentive compensation plans. Substantially all employees participate in one of the incentive compensation plans. Incentive plans provide for annual or more frequent payments based on a combination of individual performance targets and the achievement of target levels of net income, earnings per share and return on equity, or for certain employees, solely on the achievement of individual performance targets. Total incentive based compensation amounted to $3.8 million, $3.6 million and $3.0 million in 2004, 2003 and 2002, respectively. In general, the terms of incentive plans are subject to annual renewal and may be terminated at any time by the Board of Directors.

Deferred Compensation Plan
The Nonqualified Deferred Compensation Plan provides supplemental retirement and tax benefits to directors and certain officers. The plan is funded primarily through pre-tax contributions made by the participants. The Corporation has recorded the assets and liabilities for the deferred compensation plan at fair value in the consolidated balance sheets. The participants in the plan bear the risk of market fluctuations of the underlying assets. The accrued liability related to this plan amounted to $1.9 million and $1.6 million at December 31, 2004 and 2003, respectively, and is included in other liabilities on the accompanying consolidated balance sheets.  The corresponding invested assets are reported in other assets. 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(13) Income Taxes
The components of income tax expense were as follows:
 
(Dollars in thousands)
              
               
Years ended December 31,
  
2004
  
2003
  
2002
  
               
Current tax expense:
              
Federal
  
$
9,826
  
$
9,206
  
$
8,636
  
State
    
4
    
14
    
19
  
                     
Total current tax expense
    
9,830
    
9,220
    
8,655
  
                     
Deferred tax benefit:
                    
Federal
    
(296
)
  
(701
)
  
(1,262
)
State
    
-
    
-
    
-
  
                     
Total deferred tax benefit
    
(296
)
  
(701
)
  
(1,262
)
                     
Total income tax expense
 
$
9,534
  
$
8,519
  
$
7,393
  
 
Total income tax expense varied from the amount determined by applying the Federal income tax rate to income before income taxes. The reasons for the differences were as follows:

(Dollars in thousands)
              
               
Years ended December 31,
  
2004
  
2003
  
2002
  
               
Tax expense at Federal statutory rate
  
$
10,627
  
$
9,605
  
$
8,453
  
(Decrease) increase in taxes resulting from:
                    
Tax-exempt income
    
(305
)
  
(306
)
  
(349
)
Dividends received deduction
    
(288
)
  
(300
)
  
(271
)
Bank-owned life insurance
    
(411
)
  
(406
)
  
(404
)
State tax, net of Federal income tax benefit
    
3
    
9
    
12
  
Other
    
(92
)
  
(83
)
  
(48
)
                     
Total income tax expense
  
$
9,534
  
$
8,519
  
$
7,393
  
 
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
The approximate tax effects of temporary differences that give rise to gross deferred tax assets and gross deferred tax liabilities at December 31, 2004 and 2003 are as follows:

(Dollars in thousands)
          
           
December 31,
 
2004
  
2003
  
           
Gross deferred tax assets:
          
Allowance for loan losses
  
$
5,813
  
$
5,327
  
Supplemental retirement benefits
    
2,031
    
1,850
  
Deferred compensation
    
671
    
562
  
Deferred loan origination fees
    
801
    
626
  
Pension
    
621
    
478
  
Net operating loss carryover from acquired bank
    
81
    
123
  
Other
    
665
    
754
  
               
Gross deferred tax assets
    
10,683
    
9,720
  
               
Gross deferred tax liabilities:
              
Securities available for sale
    
(4,226
)
  
(3,778
)
Deferred loan origination costs
    
(1,629
)
  
(1,312
)
Premises and equipment
    
(990
)
  
(636
)
Amortization of intangibles
    
(209
)
  
(304
)
Other
    
(468
)
  
(535
)
               
Gross deferred tax liabilities
    
(7,522
)
  
(6,565
)
               
Net deferred tax asset
  
$
3,161
  
$
3,155
  

The Corporation has determined that a valuation allowance is not required for any of the deferred tax assets since it is more likely than not that these assets will be realized primarily through carryback to taxable income in prior years and future reversals of existing taxable temporary differences.

(14) Operating Leases
At December 31, 2004, the Corporation was committed to rent premises used in banking operations under noncancellable operating leases. Rental expense under the operating leases amounted to $569 thousand, $464 thousand and $525 thousand for 2004, 2003 and 2002, respectively. The minimum annual lease payments under the terms of these leases, exclusive of renewal provisions, are as follows:

(Dollars in thousands)
          
           
Years ending December 31:
    
2005
  
$
534
  
     
2006
    
387
  
     
2007
    
282
  
     
2008
    
232
  
     
2009
    
186
  
               
Total minimum lease payments
        
$
1,621
  

(15) Litigation
The Corporation is involved in various claims and legal proceedings arising out of the ordinary course of business. Management is of the opinion, based on its review with counsel of the development of such matters to date, that the ultimate disposition of such matters will not materially affect the consolidated financial position or results of operations of the Corporation.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(16) Shareholders' Equity
Stock Repurchase Plan
In September 2001, the Bancorp’s Board of Directors approved a stock repurchase plan authorizing up to 250,000, or 2.1%, of its outstanding common shares to be repurchased. The Bancorp plans to hold the repurchased shares as treasury stock to be used for general corporate purposes. During 2004, the Bancorp purchased 5,000 shares at a total cost of $125 thousand. No shares were repurchased under this plan for the year ended December 31, 2003. In addition, from time to time shares are acquired pursuant to the Nonqualified Deferred Compensation Plan.

Rights
In August 1996, the Bancorp declared a dividend of one common share purchase right (a “Right”) for each share of common stock payable on September 3, 1996 to shareholders of record on that date. Such Rights also apply to new issuances of shares after that date. Each Right entitles the registered holder to purchase from the Corporation one share of its common stock at a price of $35.56 per share, subject to adjustment.

The Rights are not exercisable or separable from the common stock until the earlier of 10 days after a person or group (an “Acquiring Person”) acquires beneficial ownership of 15% or more of the outstanding common shares or announces a tender offer to do so. The Rights, which expire on August 31, 2006, may be redeemed by the Bancorp at any time prior to the acquisition by an Acquiring Person of beneficial ownership of 15% or more of the common stock at a price of $.001 per Right. In the event that any party becomes an Acquiring Person, each holder of a Right, other than Rights owned by the Acquiring Person, will have the right to receive upon exercise that number of common shares having a market value of two times the purchase price of the Right. In the event that, at any time after any party becomes an Acquiring Person, the Corporation is acquired in a merger or other business combination transaction or 50% or more of its assets or earning power are sold, each holder of a Right will have the right to purchase that number of shares of the acquiring company having a market value of two times the purchase price of the Right.

Dividends
The primary source of funds for dividends paid by the Bancorp is dividends received from the Bank. The Bancorp and the Bank are regulated enterprises and their abilities to pay dividends are subject to regulatory review and restriction. Certain regulatory and statutory restrictions exist regarding dividends, loans, and advances from the Bank to the Bancorp. Generally the Bank has the ability to pay dividends to the Bancorp subject to minimum regulatory capital requirements. The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. In addition, the Rhode Island Division of Banking may also restrict the declaration of dividends if a bank would not be able to pay its debts as they become due in the usual course of business or the bank’s total assets would be less than the sum of its total liabilities. Under the most restrictive of these requirements, the Bank could have declared aggregate additional dividends of $28.4 million as of December 31, 2004.

Stock Incentive Plans
The Bancorp’s 2003 Stock Incentive Plan, as amended (the “2003” Plan) permits the granting of options and other equity incentives to officers, employees, directors, and other key persons. Up to 600,000 shares of the Bancorp’s common stock may be used from authorized but unissued shares or shares reacquired from the Corporation. No more than 200,000 shares may be issued in the form of awards other than Stock Options or Stock Appreciation Rights. Options are designated either as non-qualified or as incentive options. The exercise price of each option may not be less than fair market value of the common stock on the date of the grant. In general, the option price is payable in cash, by the delivery of shares of common stock already owned by the grantee, or a combination thereof. Incentive stock option awards may be granted at any time until February 20, 2013.

The Bancorp’s 1997 Equity Incentive Plan, as amended (the “1997 Plan”) permits the granting of options and other equity incentives to key employees, directors, advisors, and consultants. Up to 1,012,500 shares of the Bancorp’s common stock may be used from authorized but unissued shares, treasury stock, or shares available
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
from expired awards. Options are designated either as non-qualified or as incentive options. The exercise price of each option may not be less than fair market value of the common stock on the date of the grant. In general, the option price is payable in cash, by the delivery of shares of common stock already owned by the grantee, or a combination thereof. Incentive stock option awards may be granted at any time until April 29, 2007.

The Bancorp has also granted restricted stock unit and restricted stock awards under the 1997 Plan. Such awards are valued at the fair market value of common stock as of the award date and the associated cost is recognized in salaries and benefits expense over the vesting period of each award. Corresponding additions to paid-in-capital are recognized over the vesting period. In 2004, 36,000 restricted stock units were awarded which will vest on the third anniversary date of the award at which time, a share of common stock will be issued for each unit. The total unearned stock-based compensation for these awards amounted to $850 thousand at the award date. During 2003, 2,460 restricted stock share awards were issued which vest over a three-year period. For the years ended December 31, 2004 and 2003, compensation expense related to restricted stock unit and restricted stock awards amounted to $135 thousand, and $31 thousand, respectively.

The Amended and Restated 1988 Stock Option Plan (the “1988 Plan”) provided for the granting of options to directors, officers and key employees. The 1988 Plan permitted options to be granted at any time until December 31, 1997. The 1988 Plan provided for shares of the Bancorp’s common stock to be used from authorized but unissued shares, treasury stock, or shares available from expired options. Options were designated either as non-qualified or as incentive options. The exercise price of options granted was equal to the fair market value on the date of grant. In general, the option price is payable in cash, by the delivery of shares of the Bancorp’s common stock already owned by the grantee, or a combination thereof.

The 1997 Plan and the 1988 Plan permit options to be granted with stock appreciation rights ("SARs"), however, no options have been granted with SARs.

Options granted under the plans vest according to various terms at the end of ten years. The following table presents changes in options outstanding during 2004, 2003 and 2002:

Years ended December 31,
  
2004
  
2003
  
2002
  
       
Weighted
      
Weighted
      
Weighted
  
   
Number
  
Average
  
Number
  
Average
  
Number
  
Average
  
   
of
  
Exercise
  
of
  
Exercise
  
of
  
Exercise
  
   
Shares
  
Price
  
Shares
  
Price
  
Shares
  
Price
  
                           
Outstanding at January 1
    
1,133,600
  
$
17.07
    
1,149,739
  
$
15.61
    
980,059
  
$
14.47
  
Granted
    
32,050
  
$
27.42
    
235,755
  
$
20.18
    
219,610
  
$
20.07
  
Exercised
    
(110,171
)
$
12.38
    
(234,784
)
$
12.87
    
(40,769
)
$
11.68
  
Cancelled
    
(6,404
)
$
21.04
    
(17,110
)
$
19.31
    
(9,161
)
$
18.21
  
                                       
Outstanding at December 31
    
1,049,075
  
$
17.86
    
1,133,600
  
$
17.07
    
1,149,739
  
$
15.61
  
                                       
Exercisable at December 31
    
814,113
  
$
16.91
    
767,588
  
$
15.74
    
849,739
  
$
14.52
  
 
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
The weighted average exercise price and remaining contractual life for options outstanding at December 31, 2004 were as follows:

   
Options Outstanding
  
Options Exercisable
  
       
Weighted
  
 
      
 
  
       
Average
  
Weighted
      
Weighted
  
 
  
 
  
Remaining
  
Average
  
 
  
Average
  
Range of   Number     Contractual    Exercise   Number   
Exercise 
  
Exercise Prices
  
Outstanding
  
Life
  
Price
  
Exercisable
  
Price
  
                       
$6.74 to $8.27
    
31,255
    
0.4 years
  
$
7.56
    
31,255
  
$
7.56
  
$8.28 to $11.02
    
36,377
    
1.4 years
  
$
9.73
    
36,377
  
$
9.73
  
$11.03 to $13.78
    
48,124
    
2.3 years
  
$
11.68
    
48,124
  
$
11.68
  
$13.79 to $16.54
    
160,563
    
5.2 years
  
$
15.36
    
160,563
  
$
15.36
  
$16.55 to $19.29
    
294,860
    
5.0 years
  
$
17.82
    
294,860
  
$
17.82
  
$19.30 to $22.05
    
442,896
    
7.5 years
  
$
20.10
    
241,602
  
$
20.11
  
$22.06 to $27.56
    
35,000
    
9.2 years
  
$
27.38
    
1,332
  
$
26.90
  
                                 
Total
    
1,049,075
    
5.8 years
  
$
17.86
    
814,113
  
$
16.91
  

As discussed in Note 1, the Corporation accounts for its stock option plan using the intrinsic value based method prescribed by APB Opinion No. 25, and in addition, is required to disclose pro forma net income and earnings per share using the fair value based method prescribed by SFAS No. 123 and SFAS No. 148. Accordingly, no compensation cost for these plans has been recognized in the Consolidated Statements of Income for 2004, 2003 and 2002.

Dividend Reinvestment
Under the Amended and Restated Dividend Reinvestment and Stock Purchase Plan, 607,500 shares of common stock were originally reserved to be issued for dividends reinvested and cash payments to the plan.

Reserved Shares
As of December 31, 2004, a total of 1,902,866 common stock shares were reserved for issuance under the 1988 Plan, 1997 Plan, 2003 Plan and the Amended and Restated Dividend Reinvestment and Stock Purchase Plan.

Regulatory Capital Requirements
The Bancorp and the Bank are subject to various regulatory capital requirements administered by the Federal Reserve Board and the FDIC, respectively. These requirements were established to more accurately assess the credit risk inherent in the assets and off-balance sheet activities of financial institutions. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2004 that the Corporation meets all capital adequacy requirements to which it is subject.

As of December 2004, the most recent notification from the FDIC categorized the Bank as “well-capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized,” the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios. There are no conditions or events since that notification that management believes have changed the Bank’s category.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
The following table presents the Corporation’s and the Bank’s actual capital amounts and ratios at December 31, 2004 and 2003, as well as the corresponding minimum regulatory amounts and ratios:
 
 
(Dollars in thousands)
  
 
 
Actual
  
 
For Capital Adequacy Purposes
  
To Be Well Capitalized Under Prompt Corrective Action Provisions
  
   
Amount
  
Ratio
  
Amount
  
Ratio
  
Amount
  
Ratio
  
As of December 31, 2004:
                          
Total Capital (to Risk-Weighted Assets):
                          
Consolidated
  
$
141,312
    
10.72
%
$
105,453
    
8.00
%
$
131,816
    
10.00
%
Bank
  
$
139,389
    
10.57
%
$
105,453
    
8.00
%
$
131,816
    
10.00
%
Tier 1 Capital (to Risk-Weighted Assets):
                                      
Consolidated
  
$
120,622
    
9.15
%
$
52,726
    
4.00
%
$
79,090
    
6.00
%
Bank
  
$
118,699
    
9.00
%
$
52,726
    
4.00
%
$
79,090
    
6.00
%
Tier 1 Capital (to Average Assets): (1)
                                      
Consolidated
  
$
120,622
    
5.35
%
$
90,234
    
4.00
%
$
112,792
    
5.00
%
Bank
  
$
118,699
    
5.26
%
$
90,237
    
4.00
%
$
112,796
    
5.00
%
                                       
As of December 31, 2003:
                                      
Total Capital (to Risk-Weighted Assets):
                                      
Consolidated
  
$
124,229
    
11.57
%
$
85,867
    
8.00
%
$
107,334
    
10.00
%
Bank
  
$
122,763
    
11.44
%
$
85,867
    
8.00
%
$
107,334
    
10.00
%
Tier 1 Capital (to Risk-Weighted Assets):
                                      
Consolidated
  
$
107,339
    
10.00
%
$
42,933
    
4.00
%
$
64,400
    
6.00
%
Bank
  
$
105,873
    
9.86
%
$
42,933
    
4.00
%
$
64,400
    
6.00
%
Tier 1 Capital (to Average Assets): (1)
                                      
Consolidated
  
$
107,339
    
5.65
%
$
75,982
    
4.00
%
$
94,978
    
5.00
%
Bank
  
$
105,873
    
5.57
%
$
75,995
    
4.00
%
$
94,993
    
5.00
%
 
(1)  
Leverage ratio

(17) Earnings per Share
(Dollars in thousands, except per share amounts)
              
               
Years ended December 31,
  
2004
  
2003
  
2002
  
   
Basic
  
Diluted
  
Basic
  
Diluted
  
Basic
  
Diluted
  
Net income
  
$
20,829
  
$
20,829
  
$
18,923
  
$
18,923
  
$
16,757
  
$
16,757
  
                                       
Share amounts, in thousands:
                                      
Average outstanding
    
13,227.8
    
13,227.8
    
13,114.1
    
13,114.1
    
12,737.3
    
12,737.3
  
Common stock equivalents
    
-
    
314.9
    
-
    
279.5
    
-
    
195.1
  
                                       
Weighted average outstanding
    
13,227.8
    
13,542.7
    
13,114.1
    
13,393.6
    
12,737.3
    
12,932.4
  
                                       
Earnings per share
  
$
1.57
  
$
1.54
  
$
1.44
  
$
1.41
  
$
1.32
  
$
1.30
  

(18) Fair Value of Financial Instruments
SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, requires that the Corporation disclose estimated fair values of its financial instruments. Fair value estimates are made as of a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any pricing adjustments that could result from the sale of the Corporation’s entire holding of a particular financial instrument. Because no quoted market exists for a portion of the financial instruments, fair value estimates are based on subjective judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. Changes in assumptions could
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
significantly affect the estimates of fair value. Fair value estimates, methods, and assumptions are set forth as follows:

Cash and Securities
The carrying amount of short-term instruments such as cash and federal funds sold is used as an estimate of fair value.

The fair value of securities available for sale and held to maturity is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. No market exists for shares of the FHLB of Boston. Such stock may be redeemed at par upon termination of FHLB membership and is therefore valued at par, which equals cost.

Mortgage Loans Held for Sale
The fair value of mortgage loans held for sale is the estimated value to sell the loans using the quoted market prices for sales of similar loans on the secondary market.

Bank-Owned Life Insurance
The carrying amount of BOLI represents its cash surrender value and approximates fair value.

Loans
Fair values are estimated for categories of loans with similar financial characteristics. Loans are segregated by type and are then further segmented into fixed rate and adjustable rate interest terms to determine their fair value. The fair value of fixed rate commercial and consumer loans is calculated by discounting scheduled cash flows through the estimated maturity of the loan using interest rates offered at December 31, 2004 and 2003 that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Corporation’s historical repayment experience. For residential mortgages, fair value is estimated by using quoted market prices for sales of similar loans on the secondary market, adjusted for servicing costs. The fair value of floating rate commercial and consumer loans approximates carrying value. The fair value of nonaccrual loans is calculated by discounting estimated cash flows, using a rate commensurate with the risk associated with the loan type or by other methods that give consideration to the value of the underlying collateral.

Deposit Liabilities
The fair value of demand deposits, NOW accounts, money market accounts and savings accounts is equal to the amount payable on demand as of December 31, 2004 and 2003. The discounted values of cash flows using the rates currently offered for deposits of similar remaining maturities were used to estimate the fair value of certificates of deposit.

Securities Sold Under Agreements to Repurchase
The carrying amount of securities sold under repurchase agreements approximates fair value.

Federal Home Loan Bank Advances
Rates currently available to the Corporation for advances with similar terms and remaining maturities are used to estimate fair value of existing advances.

Derivative Financial Instruments
Forward Loan Commitments to Sell Loans Held for Sale - The fair value of forward loan commitments to sell loans reflects the estimated amounts that the Corporation would receive or pay to terminate the commitment at the reporting date. It also considers the difference between current levels of interest rates and the committed rates.

Letters of Credit - The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. Letters of credit contain provisions for fees, conditions and term periods that are consistent with customary market practices.
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
Accordingly, the fair value amounts (considered to be the discounted present value of the remaining contractual fees over the unexpired commitment period) would not be material and therefore are not disclosed.

The following table presents the fair values of the Corporation’s financial instruments:

December 31,
  
2004
  
2003
  
   
Carrying
  
Estimated
  
Carrying
  
Estimated
  
(Dollars in thousands)
  
Amount
  
Fair Value
  
Amount
  
Fair Value
  
                           
Financial Assets:
                          
Cash and cash equivalents
  
$
52,081
  
$
52,081
  
$
61,110
  
$
61,110
  
Mortgage loans held for sale
    
1,095
    
1,108
    
2,486
    
2,541
  
Securities available for sale
    
735,666
    
735,666
    
673,845
    
673,845
  
Securities held to maturity
    
154,392
    
156,270
    
165,576
    
169,401
  
FHLB stock
    
34,373
    
34,373
    
31,464
    
31,464
  
Loans, net of allowance for loan losses
    
1,232,905
    
1,251,977
    
945,067
    
972,481
  
Bank-owned life insurance
    
29,249
    
29,249
    
28,074
    
28,074
  
Derivative financial instruments relating to assets:
                          
Forward loan commitments
    
(8
)
  
(8
)
  
(16
)
  
(16
)
                           
Financial Liabilities:
                          
Noninterest bearing demand deposits
  
$
189,588
  
$
189,588
  
$
194,144
  
$
194,144
  
NOW accounts
    
174,727
    
174,727
    
153,344
    
153,344
  
Money market accounts
    
196,775
    
196,775
    
83,037
    
83,037
  
Savings accounts
    
251,920
    
251,920
    
257,497
    
257,497
  
Certificates of deposit
    
644,875
    
658,996
    
518,119
    
531,207
  
FHLB advances
    
672,748
    
683,668
    
607,104
    
623,399
  
Other borrowings
    
3,417
    
3,417
    
2,311
    
2,311
  
 
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
(19) Parent Company Financial Statements
The following are parent company only financial statements of the Washington Trust Bancorp, Inc. reflecting the investment in the Bank on the equity basis of accounting. The Statements of Changes in Shareholders’ Equity for the parent company only are identical to the Consolidated Statements of Changes in Shareholders’ Equity and are therefore not presented.

Balance Sheets
  
(Dollars in thousands)
  
           
December 31,
 
2004
  
2003
  
           
Assets:
          
Cash on deposit with bank subsidiary
  
$
1,931
  
$
1,779
  
Investment in bank subsidiary at equity value
    
149,928
    
136,589
  
Dividend receivable from bank subsidiary
    
2,250
    
1,800
  
               
Total assets
  
$
154,109
  
$
140,168
  
               
Liabilities:
              
Dividends payable
  
$
2,257
  
$
2,113
  
               
Total liabilities
    
2,257
    
2,113
  
               
Shareholders’ Equity:
              
Common stock of $.0625 par value; authorized 30 million shares
              
in 2004 and 2003; issued 13,278,685 shares in 2004
              
and 13,204,024 shares in 2003
    
830
    
825
  
Paid-in capital
    
31,718
    
29,868
  
Retained earnings
    
113,314
    
101,492
  
Unearned stock-based compensation
   
(737
)
  
(22
)
Accumulated other comprehensive income
    
6,937
    
6,101
  
Treasury stock, at cost; 9,309 shares in 2004 and 9,463 shares in 2003
    
(210
)
  
(209
)
               
Total shareholders’ equity
    
151,852
    
138,055
  
               
Total liabilities and shareholders’ equity
  
$
154,109
  
$
140,168
  


Statements of Income
  
(Dollars in thousands)
  
               
Years ended December 31,
  
2004
  
2003
  
2002
  
               
Dividends from bank subsidiary
  
$
9,000
  
$
6,300
  
$
26,742
  
Equity in undistributed earnings of subsidiary
    
11,829
    
12,623
    
(9,985
)
                     
Net income
  
$
20,829
  
$
18,923
  
$
16,757
  
 
 
WASHINGTON TRUST BANCORP, INC. AND SUBSIDIARY
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
  
December 31, 2004 and 2003
  
 
Statements of Cash Flows
  
(Dollars in thousands)
  
               
Years ended December 31,
  
2004
  
2003
  
2002
  
               
Cash flow from operating activities:
              
Net income
  
$
20,829
  
$
18,923
  
$
16,757
  
Adjustments to reconcile net income
                   
to net cash provided by operating activities:
                    
Equity effect of undistributed earnings of subsidiary
    
(11,829
)
  
(12,623
)
  
9,985
  
(Increase) decrease in dividend receivable
    
(450
)
  
(300
)
  
1,380
  
Other
    
-
    
-
    
(390
)
                     
Net cash provided by operating activities
    
8,550
    
6,000
    
27,732
  
                     
Cash flows from investing activities:
                    
Proceeds from the sale of securities available for sale
    
-
    
-
    
521
  
Cash paid for acquisition
    
-
    
-
    
(19,648
)
                     
Net cash used in investing activities
    
-
    
-
    
(19,127
)
                     
Cash flows from financing activities:
                    
Purchase of treasury stock
    
(125
)
  
-
    
(536
)
Proceeds from the issuance of common stock
    
590
    
1,174
    
397
  
Cash dividends paid
    
(8,863
)
  
(7,861
)
  
(6,898
)
                     
Net cash used in financing activities
    
(8,398
)
  
(6,687
)
  
(7,037
)
                     
Net increase (decrease) in cash
    
152
    
(687
)
  
1,568
  
Cash at beginning of year
    
1,779
    
2,466
    
898
  
                     
Cash at end of year
  
$
1,931
  
$
1,779
  
$
2,466
  
 

None.


As required by Rule 13a-15 under the Exchange Act, the Corporation carried out an evaluation under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures as of the end of the period ended December 31, 2004. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are adequate and designed to ensure that information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. The Corporation will continue to review and document its disclosure controls and procedures and consider such changes in future evaluations of the effectiveness of such controls and procedures, as it deems appropriate. There has been no change in our internal control over financial reporting during the period ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


None.



Required information regarding directors is presented under the caption “Nominee and Director Information” in the Bancorp’s Proxy Statement dated March 15, 2005 prepared for the Annual Meeting of Shareholders to be held April 26, 2005 and incorporated herein by reference.

Required information regarding audit committee financial experts is included under the caption “Audit Committee” in the Bancorp’s Proxy Statement dated March 15, 2005 prepared for the Annual Meeting of Shareholders to be held April 26, 2005 and incorporated herein by reference.

Required information regarding executive officers of the Corporation is included in Part I of this Annual Report under the caption “Executive Officers of the Registrant.”

Information required with respect to compliance with Section 16(a) of the Exchange Act appears under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Bancorp’s Proxy Statement dated March 15, 2005 prepared for the Annual Meeting of Shareholders to be held April 26, 2005, which is incorporated herein by reference.

The Corporation adopted a code of ethics that applies to all of the Corporation’s directors, officers and employees. This code of ethics is available on the Corporation’s website at www.washtrust.com, under the heading Investor Relations.


The information required by this Item appears under the caption “Compensation of Directors and Executive Officers - Executive Compensation” in the Bancorp’s Proxy Statement dated March 15, 2005 prepared for the Annual Meeting of Shareholders to be held April 26, 2005, which is incorporated herein by reference.

Required information regarding security ownership of certain beneficial owners and management appears under the caption “Nominee and Director Information” in the Bancorp’s Proxy Statement dated March 15, 2005 prepared for the Annual Meeting of Shareholders to be held April 26, 2005, which is incorporated herein by reference.

Equity Compensation Plan Information
The following table provides information as of December 31, 2004 regarding shares of common stock of the Bancorp that may be issued under our existing equity compensation plans, including the 1988 Plan, the 1997 Plan, the 2003 Plan and the Nonqualified Deferred Compensation Plan (the “Deferred Compensation Plan”).

Equity Compensation Plan Information
  
Plan category
  
Number of securities to be issued upon exercise of outstanding options, warrants and rights (1)
  
Weighted Average exercise price of outstanding options, warrants and rights
  
Number of securities remaining available for future issuance under equity compensation plan (excluding securities referenced in column (a))
  
   
(a)
  
(b)
  
(c)
  
               
Equity compensation plans
approved by security holders (2)
    
1,049,075
  
$
17.86
    
504,816(3
)
                     
Equity compensation plans not
approved by security holders (4)
    
11,027
    
N/A(5
)
  
13,973
  
                     
Total
    
1,060,102
  
$
17.86
    
518,789
  

(1)  
Does not include any restricted stock as such shares are already reflected in the Bancorp’s outstanding shares.
(2)  
Consists of the 1988 Plan, the 1997 Plan and the 2003 Plan.
(3)  
Includes up to 324,673 securities that may be issued in the form of restricted stock under the 1997 Plan and the 2003 Plan.
(4)  
Consists of the Deferred Compensation Plan, which is described below.
(5)  
Does not include information about the phantom stock units outstanding under the Deferred Compensation Plan as such units do not have any exercise price.

The Deferred Compensation Plan
The Deferred Compensation Plan was established as of January 1, 1999. The Deferred Compensation Plan has not been approved by our shareholders.

The Deferred Compensation Plan allows our directors and officers to defer a portion of their compensation. The deferred compensation is contributed to a rabbi trust. The trustee of the rabbi trust invests the assets of the trust in shares of selected mutual funds as well as shares of the Bancorp’s common stock pursuant to the directions of the plan participants. All shares of the Bancorp’s common stock are purchased in the open market.

The Deferred Compensation Plan was included as part of Exhibit 4.4 to the Bancorp’s Form S-8 Registration Statement filed with the SEC on February 12, 1999.
 

The information required by this Item is incorporated herein by reference to the caption “Indebtedness and Other Transactions” in the Bancorp’s Proxy Statement dated March 15, 2005 prepared for the Annual Meeting of Shareholders to be held April 26, 2005.


The information required by this Item is incorporated herein by reference to the caption “Independent Auditors” in the Bancorp’s Proxy Statement dated March 15, 2005 prepared for the Annual Meeting of Shareholders to be held April 26, 2005.


(a)
1.
Financial Statements. The financial statements of the Corporation required in response to this Item are listed in response to Part II, Item 8 of this Annual Report.
     
 
2.
Financial Statement Schedules. All schedules normally required by Article 9 of Regulation S-X and all other schedules to the consolidated financial statements of the Corporation have been omitted because the required information is either not required, not applicable, or is included in the consolidated financial statements or notes thereto.
     
 
3.
Exhibits. The following exhibits are included as part of this Form 10-K.

   
Exhibit Number
  
   
3.a
Restated Articles of Incorporation of the Registrant - Filed as Exhibit 3.a to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (1)
   
3.b
Amendment to Restated Articles of Incorporation - Filed as Exhibit 3.b to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. (1)
   
3.c
Amended and Restated By-Laws of the Registrant - Filed as Exhibit 3.c to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. (1)
   
4.a
Amended and Restated Agreement, between the Registrant and Mellon Investor Services LLC, dated March 1, 2002 - Filed as Exhibit 4.a to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002. (1)
   
10.a
Supplemental Pension Benefit and Profit Sharing Plan - Filed as Exhibit 10.a to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (1) (2)
   
10.b
Annual Performance Plan - Filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated January 20, 2005. (1) (2)
   
10.c
Amended and Restated Nonqualified Deferred Compensation Plan - Filed as Exhibit 4.4 to the Registrant’s Registration Statement on Form S-8 (File No. 333-72277) filed with the Commission on February 12, 1999. (1) (2)
   
10.d
Amended and Restated 1988 Stock Option Plan - Filed as Exhibit 10.d to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (1) (2)
   
10.e
Vote of the Board of Directors of the Registrant which constitutes the 1996 Directors’ Stock Plan - Filed as Exhibit 10.e to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. (1) (2)
 
Exhibit Number
  
10.f
The Registrant’s 1997 Equity Incentive Plan - Filed as Exhibit 10.f to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. (1) (2)
   
10.g
Revised Change in Control Agreements with Executive Officers - Filed as Exhibit 10 to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000. (1) (2)
   
10.h
Change in Control Agreement with an Executive Officer - Filed as Exhibit 10.a to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2000. (1) (2)
   
10.i
Amendment to the Registrant’s 1997 Equity Incentive Plan - Filed as Exhibit 10.b to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2000. (1) (2)
   
10.j
Amendment to the Registrant’s Supplemental Pension Benefit and Profit Sharing Plan - Filed as Exhibit 10.j to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (1) (2)
   
10.k
July 2000 Amendment to the Registrant’s Supplemental Pension Benefit and Profit Sharing Plan - Filed as Exhibit 10.k to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (1) (2)
   
10.l
Amendment to the Registrant’s Nonqualified Deferred Compensation Plan - Filed as Exhibit 10.l to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (1) (2)
   
10.m
Amendment to Change in Control Agreement with an Executive Officer - Filed as Exhibit 10.a to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2001. (1) (2)
   
10.n
Supplemental Executive Retirement Plan - Filed as Exhibit 10.b to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2001. (1) (2)
   
10.o
Amendment to Change in Control Agreement with an Executive Officer - Filed as Exhibit 10.a to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002. (1) (2)
   
10.p
Amendment to the Registrant’s Trust Agreement Under The Washington Trust Company’s Supplemental Pension Benefit and Profit Sharing Plan - Filed as Exhibit 10.b to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002. (1) (2)
   
10.q
Noncompetition Agreement - Filed as Exhibit 10.a to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002. (1) (2)
   
10.r
2003 Stock Incentive Plan - Filed as Exhibit 10 to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003. (1) (2)
   
10.s
First Amendment to 2003 Stock Incentive Plan - Filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated December 16, 2004. (1) (2)
   
10.t
Amendment to the Registrant’s Nonqualified Deferred Compensation Plan - Filed herewith. (2)
   
14
Code of Ethics - Filed as Exhibit 99.1 to the Registrant’s Current Report on Form 8-K dated December 16, 2004. (1)
   
21
Subsidiaries of the Registrant - Filed as Exhibit 21 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. (1)
   
23
Consent of Independent Accountants - Filed herewith.
   
31.a
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Filed herewith.
   
31.b
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Filed herewith.
 
Exhibit Number
  
   
32
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - Filed herewith. (3)
   
   
(1)
 
Not filed herewith. In accordance with Rule 12b-32 promulgated pursuant to the Exchange Act, reference is made to the documents previously filed with the SEC, which are incorporated by reference herein.
 
(2)
 
Management contract or compensatory plan or arrangement.
 
(3)
These certifications are not “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any filing under the Securities Act or the Exchange Act.

(c) See (a)(3) above for all exhibits filed herewith and the Exhibit Index.
(d) Financial Statement Schedules. None.
 


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


   
WASHINGTON TRUST BANCORP, INC.
   
(Registrant)
     
Date: March 4, 2005
By
/s/ John C. Warren
   
John C. Warren
   
Chairman, Chief Executive Officer and Director
(principal executive officer)
     
Date: March 4, 2005
By
/s/ David V. Devault
   
David V. Devault
Executive Vice President, Treasurer and
   
Chief Financial Officer
   
(principal financial and principal accounting officer)


Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Date: March 4, 2005
  
/s/ Gary P. Bennett
   
Gary P. Bennett, Director
     
Date: March 4, 2005
  
/s/ Steven J. Crandall
   
Steven J. Crandall, Director
     
Date: March 4, 2005
  
/s/ Larry J. Hirsch
   
Larry J. Hirsch, Director
     
Date: March 4, 2005
  
/s/ Barry G. Hittner
   
Barry G. Hittner, Director
     
Date: March 4, 2005
  
/s/ Katherine W. Hoxsie
   
Katherine W. Hoxsie, Director
     
Date: March 4, 2005
  
/s/ Mary E. Kennard
   
Mary E. Kennard, Director
     
Date: March 4, 2005
  
/s/ Edward M. Mazze
   
Edward M. Mazze, Director
     
Date: March 4, 2005
  
/s/ Kathleen McKeough
   
Kathleen McKeough, Director
     
 

 
Date: March 4, 2005
  
/s/ Victor J. Orsinger II
   
Victor J. Orsinger II, Director
     
Date: March 4, 2005
  
/s/ H. Douglas Randall III
   
H. Douglas Randall, III, Director
     
Date: March 9, 2005
  
/s/ Joyce Olson Resnikoff
   
Joyce Olson Resnikoff, Director
     
Date: March 4, 2005
  
/s/ Patrick J. Shanahan, Jr.
   
Patrick J. Shanahan, Jr., Director
     
Date: March 4, 2005
  
/s/ James P. Sullivan
   
James P. Sullivan, Director
     
Date: March 4, 2005
  
/s/ Neil H. Thorp
   
Neil H. Thorp, Director
     
Date: March 4, 2005
  
/s/ John F. Treanor
   
John F. Treanor, Director
     
Date: March 4, 2005
  
/s/ John C. Warren
   
John C. Warren, Director
     

-91-