UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-K





x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the fiscal year ended December 31, 2010 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: 0-51856





NEWPORT BANCORP, INC.


(Exact name of registrant as specified in its charter)





MARYLAND
20-4465271(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)100 Bellevue Avenue, Newport, Rhode Island
02840(Address of principal executive offices)
(Zip Code)





(401) 847-5500


(Registrant’s telephone number, including area code)





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




Title of each class
Name of each exchange on which registeredCommon Stock, par value $0.01 per share
Nasdaq Global Market





Securities registered pursuant to Section 12(g) of the Act:  None







Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  x




Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o    No  x




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.  Yes  x       No  o




Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  o     No   o




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 the 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. x




Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.




Large accelerated filer  o
Accelerated filer  oNon-accelerated filer  o
Smaller reporting company  x





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


Yes  o   No  x





The aggregate market value of the voting and non-voting common equity held by nonaffiliates as of June 30, 2010 was approximately $27,840,179.




The number of shares outstanding of the registrant’s common stock as of March 1, 2011 was 3,488,777.




DOCUMENTS INCORPORATED BY REFERENCE:




Portions of the Proxy Statement for the  Registrant’s Annual Meeting of Stockholders to be held on May 19, 2011 are incorporated by reference in Part III of this Form 10-K.













INDEX





Part IPageItem 1.
Business
2-15Item 1A.
Risk Factors
16-18Item 1B.
Unresolved Staff Comments
19Item 2.
Properties
19Item 3.
Legal ProceedingsItem 4.
(Removed and Reserved)Part IIItem 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities
20-21Item 6.
Selected Financial Data
21Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22-41Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
41Item 8.
Financial Statements and Supplementary Data
41Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
42Item 9A.
Controls and Procedures
42-43Item 9B.
Other Information
43Part IIIItem 10.
Directors, Executive Officers and Corporate Governance
43Item 11.
Executive Compensation
43Item 12.
Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters
43-44Item 13.
Certain Relationships and Related Transactions, and Director Independence
44Item 14.
Principal Accounting Fees and Services
44Part IVItem 15.
Exhibits and Financial Statement Schedules
45SIGNATURES
46-47




Index


This report contains certain “forward-looking statements” within the meaning of the federal securities laws.  These statements are not historical facts; rather, they are statements based on Newport Bancorp, Inc.’s current expectations regarding its business strategies, intended results and future performance.  Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.




Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain.  Factors which could affect actual results include interest rate trends, the general economic climate in the market area in which Newport Bancorp, Inc. operates, as well as nationwide, Newport Bancorp, Inc.’s ability to control costs and expenses, competitive products and pricing, loan delinquency rates and changes in federal and state legislation and regulation.  For further discussion of factors that may affect the results, see “Item 1A. Risk Factors” in this Annual Report on Form 10-K (“Form 10-K”). These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements




PART I




Item 1.
BUSINESS




General




Newport Bancorp, Inc. (“Newport Bancorp” or the “Company”) is a Maryland chartered company established in March 2006 to become the holding company for Newport Federal Savings Bank (“Newport Federal” or the “Bank”).  Newport Bancorp’s business activity is the ownership of the outstanding capital stock of Newport Federal.  Newport Bancorp does not own or lease any property but instead uses the premises, equipment and other property of Newport Federal with the payment of appropriate rental fees, as required by applicable law and regulations, under the terms of an expense allocation agreement.  In the future, Newport Bancorp may acquire or organize other operating subsidiaries; however, there are no current plans, arrangements, agreements or understandings, written or oral, to do so.




Newport Federal is a federally chartered savings bank originally founded as a Rhode Island institution in 1888.  In October 2005, Newport Federal merged with Westerly Savings Bank, a Rhode Island mutual financial institution that had two branch locations in Westerly, Rhode Island. The Bank operates as a community-oriented financial institution offering financial services to consumers and businesses in the Bank’s market area.  Newport Federal attracts deposits from the general public and uses those funds to originate one-to-four family residential loans, commercial real estate loans, home equity loans and lines of credit, multi-family loans, construction loans, commercial loans and consumer loans. At December 31, 2010, 99.5% of the loans in our portfolio were collateralized by real estate.




In connection with the initial stock offering, in July 2006, the Company established and funded the Newportfed Charitable Foundation (the “Foundation”) with shares of Company common stock equal to 7.4% of the shares sold in the stock offering.  The Foundation provides funding to support charitable causes and community development activities in the communities served by the Company.




Available Information




The Bank’s website address is www.newportfederal.com.  Information on this website should not be considered a part of this Form 10-K.




Market Area




Newport Federal is headquartered in Newport, Rhode Island.  In addition to its main office located in Newport, the Bank operates five full-service branch offices located in Middletown, Wakefield, Westerly and Portsmouth, Rhode Island, and Stonington, Connecticut.  In January 2011, the Bank opened a new branch in Westerly, Rhode Island, and closed its previous Westerly branch location. The Bank opened its Portsmouth, Rhode Island branch in January 2009 and its Stonington, Connecticut branch in May 2009.  The Bank considers Newport




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 Index


and Washington Counties, Rhode Island to be its primary market area.  The economy in our market area is primarily oriented to the retail and hospitality industries.




Competition




Newport Federal faces significant competition for the attraction of deposits and origination of loans.  The Bank’s competition for loans comes primarily from financial institutions and credit unions in our market area.




The Bank’s most direct competition for deposits has historically come from the several financial institutions operating in its market area and, to a lesser extent, from other financial service companies such as brokerage firms, credit unions and insurance companies.  Newport Federal also faces competition for investors’ funds, from money market funds, mutual funds and other corporate and government securities.  At June 30, 2010, which is the most recent date for which data is available from the FDIC, the Bank held approximately 11.71% of the deposits in Newport County, Rhode Island and approximately 2.47% of the deposits in Washington County, Rhode Island.  In addition, banks owned by large holding companies such as Bank of America, Citizens and Sovereign also operate in our market area.  These institutions are significantly larger than the Bank and, therefore, have significantly greater resources.




Newport Federal expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry.  Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks.  Changes in federal law permit affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in the financial services industry.  Competition for deposits and the origination of loans could limit our growth in the future.




Lending Activities




General.  The largest segment of the Bank’s loan portfolio is real estate mortgage loans, primarily one-to-four family residential loans. The other significant segment of the Bank’s loan portfolio is commercial real estate loans.  To a lesser degree, Newport Federal also originates home equity loans and lines of credit, multi-family loans and construction loans.  The Bank also offers commercial and consumer loans, which constituted 0.45% and 0.08%, respecitively, of total loans at December 31, 2010. The Bank originates loans for investment purposes, although the Bank occasionally may sell a portion of its one-to-four family residential loans into the secondary market.




One-to-Four Family Residential Real Estate Loans.  The Bank’s origination of mortgage loans enables borrowers to purchase or refinance existing homes located in Rhode Island, Southeastern Connecticut and, to a lesser extent, Southeastern Massachusetts, although our primary lending market is Newport and Washington Counties, Rhode Island.




Newport Federal’s residential lending policies and procedures conform to the secondary market guidelines as we occasionally sell qualifying fixed-rate loans into the secondary market.  The Bank offers fixed-rate mortgage loans with terms of 10 to 30 years, and to a lesser extent, 40 years.  Newport Federal also offers adjustable-rate mortgage loans.  Borrower demand for adjustable-rate loans compared to fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans as compared to an initially discounted interest rate and loan fees for multi-year adjustable-rate mortgages (“ARMs”).  The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment.  The loan fees, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.




Interest rates and payments on the Bank’s adjustable-rate mortgage loans generally adjust annually after an initial fixed period that typically ranges from one to three years.  Interest rates and payments on the Bank’s adjustable-rate loans generally are adjusted to a rate typically equal to a percentage above the one-year U.S.




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 Index


Treasury index.  The maximum amount by which the interest rate may be increased or decreased is generally 2% per adjustment period and the lifetime interest rate cap is generally 6% over the initial interest rate of the loan.




While one-to-four family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan.  Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.  Newport Federal does not offer loans with negative amortization and generally does not offer interest-only loans.




The Bank generally does not make conventional loans with loan-to-value ratios exceeding 95%.  Loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance.  Newport Federal requires all properties securing first mortgage loans to be appraised by an independent appraiser, who is approved by the Board of Directors.  The Bank generally requires title insurance on all first mortgage loans.  Borrowers must obtain hazard insurance, and flood insurance is required for loans on properties located in a flood zone.




Multi-Family and Commercial Real Estate Loans.  Newport Federal offers fixed- and adjustable-rate mortgage loans secured by commercial and multi-family real estate.  The Bank’s commercial and multi-family real estate loans are generally secured by five to ten unit apartment buildings, small office buildings, two to four unit mixed-use retail and residential properties and hospitality establishments.  These properties are primarily located in Newport and Washington Counties in Rhode Island, and to a lesser extent other cities and towns in Rhode Island, Connecticut and Massachusetts.




Newport Federal originates a variety of fixed- and adjustable-rate commercial real estate and multi-family real estate loans generally for terms up to 10 years, and to a lesser extent, 20 years.  These adjustable-rate loans include loans that adjust based on the five-year FHLB Classic Rate Advance Index, adjustable every five years.  Loans are secured by first mortgages, and amounts generally do not exceed 75% of the property’s appraised value.




As of December 31, 2010, the Bank’s largest loan secured by commercial real estate was $3.9 million.  This loan is secured by retail commercial property.  This loan was performing in accordance with its original terms at December 31, 2010.




Home Equity Loans and Lines.Newport Federal offers home equity loans with a maximum combined loan to value ratio of 80% or less.  Home equity lines of credit have adjustable rates of interest that are indexed to the Prime Rate as published by The Wall Street Journal.  Home equity loans have fixed interest rates and terms that typically range from five to 15 years, but may have terms as long as 20 years.




Construction Loans.Newport Federal originates construction loans for one-to-four family homes and commercial, multi-family and other nonresidential purposes. The Bank’s residential construction loans generally provide for the payment of only interest during the construction phase, which is usually six to twelve months.  At the end of the construction phase, the loan converts to a permanent mortgage loan. One-to-four family residential construction loans are made with a maximum loan to value ratio of 80% of the market value of the real estate and improvements.  Commercial, multi-family and other nonresidential loans can be made with a maximum loan to value ratio of 75% of the upon completion market value of the real estate and improvements.  At December 31, 2010, the largest construction loan was for $2.9 million, of which $2.1 million was advanced.  This loan was performing according to its original terms at December 31, 2010.  Construction loans to individuals are generally made on the same terms as Newport Federal’s one-to-four family mortgage loans.




Commercial Loans.  The Bank occasionally offers commercial loans, which are secured by business assets or are unsecured.  At December 31, 2010, commercial loans totaled $1.6 million, or 0.45% of total loans.




Consumer Loans.  The Bank offers a variety of consumer and other loans, including auto loans and loans secured by passbook savings or certificate accounts.  At December 31, 2010, consumer loans totaled $288,000, or 0.08% of total loans.




4
 Index


The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan.  Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.




Loan Underwriting Risks.




Adjustable-Rate Loans.  While Newport Federal anticipates that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate mortgages, an increased monthly mortgage payment required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults.  The marketability of the underlying property also may be adversely affected in a high interest rate environment.  In addition, although adjustable-rate mortgage loans make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.




Multi-family and Commercial Real Estate Loans.  Loans secured by multi-family and commercial real estate generally have larger balances and involve a greater degree of risk than one-to-four family residential real estate loans.  Of primary concern in multi-family and commercial real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project.  Payments on loans secured by income properties often depend on successful operation and management of the properties.  As a result, repayment of such loans may be subject to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy.  To monitor cash flows on income properties, the Bank requires borrowers and loan guarantors, if any, to provide annual financial statements on multi-family and commercial real estate loans.  In reaching a decision on whether to make a multi-family or commercial real estate loan, Newport Federal considers and reviews a global cash flow analysis of the borrower and considers the net operating income of the property, the borrower’s expertise, credit history and profitability and the value of the underlying property.  The Bank has generally required that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.25.  An environmental survey or environmental risk insurance is obtained when the possibility exists that hazardous materials may have existed on the site, or the site may have been impacted by adjoining properties that handled hazardous materials.




Construction Loans.  Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate.  Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost of construction.  During the construction phase, a number of factors could result in delays and/or cost overruns.  If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the building.  Also, the Bank may be confronted, at or before the maturity of the loan, with a building having a value that is insufficient to assure full repayment.  If Newport Federal is forced to foreclose on such a building before or at completion due to a default, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.




Commercial and Consumer Loans.  Commercial and consumer loans may entail greater risk than do residential real estate loans, particularly in the case when these loans are unsecured or secured by assets that depreciate rapidly, such as inventory or motor vehicles.  In the latter case, repossessed collateral for a defaulted commercial or consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower.  Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.




Loan Originations, Purchases and Sales.  Loan originations come from a number of sources.  The primary source of loan originations are existing customers, walk-in traffic, advertising and referrals from customers.  Occasionally, Newport Federal sells loans that the Bank has originated.  The decision to sell loans is based on




5
 Index


prevailing market interest rate conditions and interest rate management.  Newport Federal did not sell any loans in 2010 or 2009.




From time to time, Newport Federal will purchase whole loans or participation loans to supplement its lending portfolio.Whole loans purchased totaled $777,000 at December 31, 2010. The Bank performs its own underwriting analysis on each loan purchased using the same standards used for loans originated.




Loan participations, purchased and sold, totaled $2.0 million at December 31, 2010.  Loan participations are also subject to the same credit analysis and loan approvals as loans Newport Federal originates. The Bank is permitted to review all of the documentation relating to any loan in which Newport Federal participates.  However, as with purchased loans, the Bank does not service purchased participation loans.  Thus, with respect to purchased loans and participations, the Bank is subject to the policies and practices of the lead lender with regard to monitoring delinquencies, pursuing collections and instituting foreclosure proceedings.




Loan Approval Procedures and Authority.  Newport Federal’s lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by the Board of Directors and management.  The President, Chief Lending Officer and Chief Operating Officer have authority to approve secured loans in amounts up to $2.8 million and unsecured loans up to $300,000.  Secured loans from $2.8 million to $3.2 million must be approved by four of the following persons: Commercial Loan Manager, Retail Loan Manager, Chief Lending Officer, President, Chief Operating Officer or one non-employee member of the Board of Directors.  Secured loans from $3.2 million to $3.6 million must be approved by a majority of the Executive Committee of the Board of Directors.  Unsecured loans over $600,000 and secured loans greater than $3.6 million up to the legal lending limit must be approved by a majority vote of the Board of Directors.  Smaller loans may be approved by individual loan officers.




Loans to One Borrower.  The maximum amount the Bank may lend to one borrower and the borrower’s related entities is limited, by regulation, to generally 15% of its unimpaired capital and surplus.  At December 31, 2010, Newport Federal’s regulatory limit on loans to one borrower was $6.8 million.  At that date, the Bank’s largest lending relationship was $4.1 million and was secured by real property.  This relationship consists of three commercial real estate loans, which were performing in accordance with their original terms at December 31, 2010.




Loan Commitments.  The Bank issues commitments for fixed- and adjustable-rate mortgage loans conditioned upon the occurrence of certain events.  Commitments to originate mortgage loans are legally binding agreements to lend to our customers.  Generally, these loan commitments expire after 60 days.




Investment Activities




Newport Federal has legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various Government-sponsored enterprises and of state and municipal governments, mortgage-backed securities and certificates of deposit of federally insured institutions.  Within certain regulatory limits, the Bank also may invest a portion of its assets in corporate securities and mutual funds.  Newport Federal also is required to maintain an investment in Federal Home Loan Bank of Boston stock.




At December 31, 2010, the Bank’s investment portfolio consisted of mortgage-backed securities issued primarily by Fannie Mae.




Newport Federal’s investment objectives are to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return.  The Bank’s Board of Directors has the overall responsibility for the investment portfolio, including approval of the investment policy.  The Chief Executive Officer and Chief Financial Officer are responsible for implementation of the investment policy and monitoring the Bank’s investment performance.The Board of Directors of Newport Federal reviews the status of the investment portfolio on a quarterly basis, or more frequently if warranted.




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 Index


Deposit Activities and Other Sources of Funds




General.  Deposits, borrowings and loan repayments are the major sources of Newport Federal’s funds for lending and other investment purposes.  Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions.




Deposit Accounts.  The majority of the Bank’s depositors are residents of Rhode Island.  Deposits are attracted from within our market area through the offering of a broad selection of deposit instruments, including non-interest-bearing demand deposits (such as checking accounts), interest-bearing demand accounts (such as NOW and money market accounts), regular savings accounts and certificates of deposit. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors.  In determining the terms of Newport Federal’s deposit accounts, the Bank considers the rates offered by the Bank’s competition, Newport Federal’s liquidity needs, profitability to the Bank, matching deposit and loan products and customer preferences and concerns.  Newport Federal generally reviews the deposit mix and pricing weekly.  The Bank’s current strategy is to offer competitive rates and to be in the middle of the market for rates on all types of deposit products; however, the Bank selectively competes for various certificates of deposit.




In addition to deposit accounts for individuals, Newport Federal also offers deposit accounts designed for the businesses operating in our market area.  The Bank’s business banking deposit products include commercial checking accounts and money market accounts.




Borrowings.  Newport Federal utilizes advances from the Federal Home Loan Bank of Boston to supplement the Bank’s investable funds.  The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions.  As a member, the Bank is required to own capital stock in the Federal Home Loan Bank and is authorized to apply for advances on the security of such stock and certain of the Bank’s mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met.  Advances are made under several different programs, each having its own interest rate and range of maturities.  Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness.




Personnel




At December 31, 2010, the Bank had 70 full-time employees and 19 part-time employees, none of whom is represented by a collective bargaining unit.  Newport Federal believes that its relationship with its employees is good.




Subsidiaries




Newport Bancorp conducts its principal business activities through its wholly-owned subsidiary, Newport Federal Savings Bank.  The Newport Federal Savings Bank has one wholly-owned subsidiary, NewportFed Investments, Inc., which was established to hold certain investments, consisting primarily of commercial mortgages and loans.




REGULATION AND SUPERVISION




General




As a savings and loan holding company, Newport Bancorp is subject to regulation, examination and supervision by the Office of Thrift Supervision.  Newport Bancorp must file reports with the Office of Thrift Supervision concerning its activities and financial condition, and must also obtain regulatory approval of the Office of Thrift Supervision prior to entering into certain activities and transactions.  As further described below under “The Dodd-Frank Act”, as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), the powers and duties of the Office of Thrift Supervision with respect to savings and loan and mutual




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 Index


holding companies will be transferred to the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) by July 21, 2011, unless extended by up to six months.  At that time, Newport Bancorp will be subject to the rules and regulations, as well as supervision, of the Federal Reserve Board.  Newport Bancorp is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.




Newport Federal is subject to extensive regulation, examination and supervision by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation (“FDIC”) as its deposit insurer.  As a result of the Dodd-Frank Act, the powers and duties of the Office of Thrift Supervision with respect to savings associations, such as Newport Federal, will be transferred to the Office of the Comptroller of the Currency.  At that time, Newport Federal will be subject to the rules and regulations, as well as the supervision, of the Comptroller of the Currency.




Newport Federal must file reports with the Office of Thrift Supervision and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions.  The Office of Thrift Supervision and the FDIC conduct periodic examinations to test Newport Federal’s safety and soundness with various regulatory requirements.  Newport Federal is also regulated, to a lesser extent, by the Federal Reserve Board, which governs reserves to be maintained against deposits and other matters.  Newport Federal is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Deposit Insurance Fund managed by the FDIC.  This regulation and supervision establishes a comprehensive framework of activities in which Newport Federal may engage and is intended primarily for the protection of the Deposit Insurance Fund and depositors.  The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes.




Any future change in these regulatory requirements and policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, the Federal Reserve Board, the Comptroller of the Currency or Congress, could have a material adverse impact on Newport Bancorp, Newport Federal and their operations.




Set forth below is a brief description of certain regulatory requirements applicable to Newport Bancorp and Newport Federal.  The description below is limited to certain material aspects of the statutes and regulations addressed, and is not a complete description of such statutes and regulations and their effects on Newport Bancorp and Newport Federal.




The Dodd-Frank Act




The Dodd-Frank Act will significantly change the current bank regulatory structure and affect the lending, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act will eliminate our current primary federal regulator, the Office of Thrift Supervision, and require Newport Federal to be regulated by the Office of the Comptroller of the Currency (the primary federal regulator for national banks). The Dodd-Frank Act also authorizes the Federal Reserve Board to supervise and regulate all savings and loan holding companies, such as Newport Bancorp, in addition to bank holding companies, which it currently regulates.   These capital requirements are substantially similar to the capital requirements currently applicable to Newport Federal, as described in “Supervision and Regulation—Federal Banking Regulation—Capital Requirements.”  The Dodd-Frank Act also requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository institutions, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  Bank holding companies and savings and loan holding companies with assets of less than $500 million are exempt from these capital requirements.  Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets.  Savings and loan holding companies are subject to a five year transition period before the holding company capital requirements will become applicable.  The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage




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 Index


and capital requirements within 18 months.  These new leverage and capital requirements must take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.




The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Newport Federal, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives the state attorneys general the ability to enforce applicable federal consumer protection laws.




The Dodd Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.  The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012.  The Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate and solicit votes for their own candidates using a company’s proxy materials.  The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.  Further, the legislation requires that originators of securitized loans retain a percentage of the risk for transferred loans, directs the Federal Reserve Board to regulate pricing of certain debit card interchange fees and contains a number of reforms related to mortgage origination.  Many of the provisions of the Dodd-Frank Act involve delayed effective dates and/or require implementing regulations.  Accordingly, it will be some time before management can assess the full impact on operations.  However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in an increased regulatory burden and compliance, operating and interest expense for the Newport Federal and Newport Bancorp.




It is difficult to predict at this time what impact the new legislation and implementing regulations will have on community banks, such as Newport Federal, including the lending and credit practices of such banks.  Moreover, many of the provisions of the Dodd-Frank Act are not yet in effect, and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years.  Although the substance and scope of these regulations cannot be determined at this time, it is expected that the legislation and implementing regulations, particularly those provisions relating to the new Consumer Financial Protection Bureau and mutual holding company dividend waivers, will increase our operating and compliance costs and restrict our ability to pay dividends in the future.




Federal Banking Regulation




Business Activities.A federal savings bank derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and the regulations of the Office of Thrift Supervision.  Under these laws and regulations, Newport Federal may invest in mortgage loans secured by residential and nonresidential real estate, commercial business loans and consumer loans, certain types of debt securities and certain other assets, subject to applicable limits.  Newport Federal also may establish subsidiaries that may engage in activities not otherwise permissible for Newport Federal, including real estate investment and securities and insurance brokerage. The Dodd-Frank Act authorizes, for the first time, the payment of interest on commercial checking accounts effective July 1, 2011.




Capital Requirements.  Office of Thrift Supervision regulations require savings banks to meet four minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for savings banks receiving the highest rating on the CAMELS rating system), a 4% Tier 1 risk-based capital ratio, and an 8% total risk-based capital ratio.




9
 Index


The risk-based capital standard for savings banks requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively.  In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision, based on the risks believed inherent in the type of asset.  Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships.  The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair values.  Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.  Additionally, a savings bank that retains credit risk in connection with an asset sale may be required to maintain additional regulatory capital because of the recourse back to the savings bank.  Newport Federal does not typically engage in asset sales.  At December 31, 2010, Newport Federal’s capital exceeded all applicable requirements.




Loans-to-One Borrower. Generally, a federal savings bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus.  An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate.  As of December 31, 2010, Newport Federal was in compliance with its loans-to-one borrower limitations.




Qualified Thrift Lender Test.As a federal savings bank, Newport Federal must satisfy the qualified thrift lender, or “QTL,” test.  Under the QTL test, Newport Federal must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine months of the most recent 12 months.  “Portfolio assets” generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings bank’s business.




“Qualified thrift investments” include various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets.  “Qualified thrift investments” also include 100% of an institution’s credit card loans, education loans and small business loans.  Newport Federal also may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code.




A savings bank that fails the qualified thrift lender test must operate under specified restrictions.  The Dodd-Frank Act makes noncompliance with the QTL test subject to agency enforcement action for a violation of law.  At December 31, 2010, Newport Federal satisfied the QTL test.




Capital Distributions.Office of Thrift Supervision regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the capital account.  A savings bank must file an application for approval of a capital distribution if:




·
the total capital distributions for the applicable calendar year exceed the sum of the bank’s net income for that year to date plus the bank’s retained net income for the preceding two years;




·
the bank would not be at least adequately capitalized following the distribution;




·
the distribution would violate any applicable statute, regulation, agreement or Office of Thrift Supervision-imposed condition; or




·
the bank is not eligible for expedited treatment of its filings.




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 Index


Even if an application is not otherwise required, every savings bank that is a subsidiary of a holding company must still file a notice with the Office of Thrift Supervision at least 30 days before the Board of Directors declares a dividend or approves a capital distribution.




The Office of Thrift Supervision may disapprove a notice or application if:




·
the bank would be undercapitalized following the distribution;




·
the proposed capital distribution raises safety and soundness concerns; or




·
the capital distribution would violate a prohibition contained in any statute, regulation or agreement.




In addition, the Federal Deposit Insurance Act provides that an insured depository institution may not make any capital distribution, if after making such distribution the institution would be undercapitalized.




Liquidity.  A federal savings bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.




Community Reinvestment Act and Fair Lending Laws.  All savings banks have a responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a federal savings bank, the Office of Thrift Supervision is required to assess the bank’s record of compliance with the Community Reinvestment Act.  In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes.  A bank’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities.  The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice.  Newport Federal received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.




Transactions with Related Parties.  A federal savings bank’s authority to engage in transactions with its affiliates is limited by Office of Thrift Supervision regulations and by Sections 23A and 23B of the Federal Reserve Act and its implementing Regulation W.  An affiliate is a company that controls, is controlled by, or is under common control with an insured depository institution such as Newport Federal.  Newport Bancorp is an affiliate of Newport Federal.  In general, loan transactions between an insured depository institution and its affiliate are subject to certain quantitative and collateral requirements.  In addition, Office of Thrift Supervision regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.  Finally, transactions with affiliates must be consistent with safe and sound banking practices, not involve low-quality assets and be on terms that are as favorable to the institution as comparable transactions with non-affiliates.  The Office of Thrift Supervision requires savings banks to maintain detailed records of all transactions with affiliates.




Newport Federal’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve Board.  Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Newport Federal’s capital.  In addition, extensions of credit in excess of certain limits must be approved by Newport Federal’s Board of Directors.




Enforcement.  The Office of Thrift Supervision has primary enforcement responsibility over federal savings banks and has the authority to bring enforcement action against all “institution-affiliated parties,” including




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 Index


stockholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured federal savings bank.  Formal enforcement action by the Office of Thrift Supervision may range from the issuance of a capital directive or cease and desist order, to removal of officers and/or directors of the institution and the appointment of a receiver or conservator.  Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day.  The Federal Deposit Insurance Corporation also has the authority to terminate deposit insurance or to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings institution.  If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances.




The Comptroller of the Currency will assume the Office of Thrift Supervision’s enforcement authority over federal savings banks pursuant to the Dodd-Frank Act.




Standards for Safety and Soundness.  Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions.  These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate.  The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law.  The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired.  The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits.  If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.  If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.




Regulatory Guidance to Subprime Lending.  The federal bank regulatory agencies have issued regulatory guidance relating to the examination of financial institutions that are engaged in significant subprime lending activities.  The regulatory guidance emphasizes that the federal banking agencies believe that responsible subprime lending can expand credit access for consumers and offer attractive returns for the savings institution.  The guidance is applicable to savings institutions that have subprime lending programs greater than or equal to 25% of core capital.  As part of the regulatory guidance, examiners must provide greater scrutiny of (i) an institution’s ability to administer its higher risk subprime portfolio, (ii) the allowance for loan losses to ensure that the portion of the allowance allocated to the subprime portfolio is sufficient to absorb the estimated credit losses for the portfolio, and (iii) the level of risk-based capital that the savings institution has to ensure that such capital levels are adequate to support the savings institution’s subprime lending activities.  We do not offer subprime loans.




Prompt Corrective Action Regulations.  Under the prompt corrective action regulations, the Office of Thrift Supervision is required and authorized to take supervisory actions against undercapitalized savings banks.  For this purpose, a savings bank is generally placed in one of the following five categories based on the savings bank’s capital:




·
well-capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital);




·
adequately capitalized (at least 4% leverage capital, 4% Tier 1 risk-based capital and 8% total risk-based capital);




·
undercapitalized (less than 8% total risk-based capital, 4% Tier 1 risk-based capital or 4% leverage capital);




·
significantly undercapitalized (less than 6% total risk-based capital, 3% Tier 1 risk-based capital or 3% leverage capital); and




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 Index


·
critically undercapitalized (less than 2% tangible capital).




Generally, the Office of Thrift Supervision is required to appoint a receiver or conservator for a savings bank that is “critically undercapitalized” within specific time frames.  The regulations also provide that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a savings bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.”  Any holding company for the savings bank required to submit a capital restoration plan must guarantee the lesser of: an amount equal to 5% of a savings bank’s assets at the time it was notified or deemed to be undercapitalized by the Office of Thrift Supervision, or the amount necessary to restore the savings bank to adequately capitalized status.  This guarantee remains in place until the Office of Thrift Supervision notifies the savings bank that it has maintained adequately capitalized status for each of four consecutive calendar quarters, and the Office of Thrift Supervision has the authority to require payment and collect payment under the guarantee.  Failure by a holding company to provide the required guarantee will result in certain operating restrictions on the savings bank, such as restrictions on the ability to declare and pay dividends, pay executive compensation and management fees, and increase assets or expand operations. The Office of Thrift Supervision may also take any one of a number of discretionary supervisory actions against undercapitalized savings banks, including the issuance of a capital directive and the replacement of senior executive officers and directors.  At December 31, 2010, Newport Federal met the criteria for being considered “well-capitalized.”




Insurance of Deposit Accounts.The Federal Deposit Insurance Corporation, or FDIC, insures deposits at FDIC insured financial institutions such as Newport Federal. Deposit accounts in Newport Federal are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts.  The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund.




Under the FDIC’s current risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. The rates for nearly all of the financial institutions industry vary between five and seven cents for every $100 of domestic deposits.




As part of its plan to restore the Deposit Insurance Fund in the wake of the large number of bank failures following the financial crisis, the FDIC imposed a special assessment of 5 basis points for the second quarter of 2009.  In addition, the FDIC has required all insured institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012.   As part of this prepayment, the FDIC assumed a 5% annual growth in the assessment base and applied a 3 basis point increase in assessment rates effective January 1, 2011.  On December 31, 2009, Newport Federal prepaid $1.5 million in estimated fees for 2010 through 2012.  During the year ended December 31, 2010, $420,000 of this prepaid expense was amortized into expense, representing 2010 actual assessments.




In February 2011, the FDIC published a final rule under the Dodd-Frank Act to reform the deposit insurance assessment system.  The rule redefines the assessment base used for calculating deposit insurance assessments effective April 1, 2011.  Under the new rule, assessments will be based on an institution’s average consolidated total assets minus average tangible equity, as opposed to total deposits.  In addition, the final rule eliminates the adjustment for secured borrowings and makes certain other changes to the impact of unsecured borrowings and brokered deposits on an institution’s deposit insurance assessment. The proposed rule also revises the assessment rate schedule to provide assessments ranging from five to 45 basis points.




The Dodd-Frank Act also extended the unlimited deposit insurance on non-interest bearing transaction accounts through December 31, 2012.  Unlike the FDIC’s Temporary Liquidity Guarantee Program, the insurance provided under the Dodd-Frank Act does not extend to low-interest NOW accounts, and there is no separate assessment on covered accounts.




In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation.




13
 Index


The bonds issued by the FICO are due to mature in 2017 through 2019. During the year ended December 31, 2010, Newport Federal paid $28,000 in fees related to the FICO.




Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.




Prohibitions Against Tying Arrangements.  Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.




Federal Home Loan Bank System.  Newport Federal is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks.  The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending.  As a member of the Federal Home Loan Bank of Boston, Newport Federal is required to acquire and hold shares of capital stock in the Federal Home Loan Bank.  As of December 31, 2010, Newport Federal was in compliance with this requirement.




The Federal Home Loan Bank of Boston suspended its dividend payment for the first quarter of 2009 up until the fourth quarter of 2010, when they reintroduced a modest dividend payment.  In addition, the Federal Home Loan Bank of Boston declared a moratorium on excess stock repurchases in December 2008, which continues.




Federal Reserve System




Federal Reserve Board regulations require savings banks to maintain noninterest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts.  At December 31, 2010, Newport Federal was in compliance with these reserve requirements.




Other Regulations




Interest and other charges collected or contracted for by Newport Federal are subject to state usury laws and federal laws concerning interest rates.  Newport Federal’s operations are also subject to federal laws applicable to credit transactions and rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.  In addition, the operations of Newport Federal are subject to statutes and regulations relating to the privacy of consumer financial records, customers’ rights arising from the use of automated teller machines and other electronic banking services, and anti-money laundering compliance programs.




Holding Company Regulation




General.  Newport Bancorp is a non-diversified savings and loan holding company within the meaning of the Home Owners’ Loan Act.  As such, Newport Bancorp is registered with the Office of Thrift Supervision and is subject to Office of Thrift Supervision regulations, examinations, supervision and reporting requirements.  In addition, the Office of Thrift Supervision has enforcement authority over Newport Bancorp and its subsidiaries.  Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.  Unlike bank holding companies, federal savings and loan holding companies are not currently subject to any regulatory capital requirements or to supervision by the Federal Reserve Board.




Permissible Activities. Under present law, the business activities of Newport Bancorp is generally limited to those activities permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended, or for multiple savings and loan holding companies.  A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity.  A multiple savings and




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 Index


loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain additional activities authorized by Office of Thrift Supervision regulations.




Federal law prohibits a savings and loan holding company, including Newport Bancorp, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Office of Thrift Supervision.  It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured.  In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.




The Office of Thrift Supervision is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions:




(i)
the approval of interstate supervisory acquisitions by savings and loan holding companies; and




(ii)
the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisition.




The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.




Capital.  Savings and loan holding companies are not currently subject to specific regulatory capital requirements.  The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves.  Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital as is currently the case with bank holding companies. Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less.  There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements will apply to savings and loan holding companies.




Source of Strength.The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies.  The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.




Dividends.  The Bank must notify the Office of Thrift Supervision thirty days before declaring any dividend to the Company.  The financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the Office of Thrift Supervision and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.




Federal Securities Laws




Newport Bancorp’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934.  Newport Bancorp is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.




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 Index


ITEM 1A.
RISK FACTORS




Changes in interest rates may reduce our profits.




Net interest income is our largest source of income.  Changes in interest rates can affect the level of net interest income. The Company’s interest rate sensitivity is discussed in more detail in Item 7 of this report.  We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed.  Changes in interest rates can also affect the demand for our products and services, and the supply conditions in the U.S. financial and capital markets.  Changes in the level of interest rates may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings.




Financial reform legislation recently enacted by Congress will, among other things, eliminate the Office of Thrift Supervision, tighten capital standards, create a new Consumer Financial Protection Bureau and result in new laws and regulations that are expected to increase our costs of operations.




The recently enacted Dodd-Frank Act will significantly change the current bank regulatory structure and affect the lending, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act will eliminate our current primary federal regulator, the Office of Thrift Supervision, and require Newport Federal to be regulated by the Office of the Comptroller of the Currency (the primary federal regulator for national banks). The Dodd-Frank Act also authorizes the Board of Governors of the Federal Reserve System to supervise and regulate all savings and loan holding companies, like Newport Bancorp, in addition to bank holding companies which it currently regulates.  Bank holding companies with assets of less than $500 million are exempt from these capital requirements.  These capital requirements are substantially similar to the capital requirements currently applicable to Newport Federal, as described in “Supervision and Regulation—Federal Banking Regulation—Capital Requirements.”  The Dodd-Frank Act also requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository institutions, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets.  Savings and loan holding companies are subject to a five year transition period before the holding company capital requirements will become applicable.  The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.




The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Newport Federal, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.




In addition, the Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate and solicit votes for their own candidates using a company’s proxy materials.  The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.




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 Index


It is difficult to predict at this time what impact the new legislation and implementing regulations will have on community banks, including the lending and credit practices of such banks.  Moreover, many of the provisions of the Dodd-Frank Act are not yet in effect, and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years.  Although the substance and scope of these regulations cannot be determined at this time, it is expected that the legislation and implementing regulations, particularly those provisions relating to the new Consumer Financial Protection Bureau and mutual holding company dividend waivers, will increase our operating and compliance costs and restrict our ability to pay dividends, respectively.




Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely affect our operations and our income.




Government responses to economic conditions may adversely affect our operations, financial condition and earnings.




New financial reform legislation has been enacted by Congress that will change the bank regulatory framework, create an independent consumer protection bureau that will assume the consumer protection responsibilities of the various federal banking agencies, and establish more stringent capital standards for banks and bank holding companies.  The legislation will also result in new regulations affecting the lending, funding, trading and investment activities of banks and bank holding companies.  Bank regulatory agencies also have been responding aggressively to concerns and adverse trends identified in examinations.  Ongoing uncertainty and adverse developments in the financial services industry and the domestic and international credit markets, and the effect of new legislation and regulatory actions in response to these conditions, may adversely affect our operations by restricting our business activities, including our ability to originate or sell loans, modify loan terms, or foreclose on property securing loans.  These measures are likely to increase our costs of doing business and may have a significant adverse effect on our lending activities, financial performance and operating flexibility.  In addition, these risks could affect the performance and value of our loan and investment securities portfolios, which also would negatively affect our financial performance.




Furthermore, the Board of Governors of the Federal Reserve System, in an attempt to help stabilize the economy, has, among other things, kept interest rates low through its targeted federal funds rate and the purchase of mortgage-backed securities.  If the Federal Reserve increases the federal funds rate, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery.




If we do not achieve profitability on new branches, they may negatively impact our earnings.




We opened our Portsmouth, Rhode Island branch office in January 2009, and our Stonington, Connecticut branch office in May 2009.   Numerous factors contribute to the performance of a new branch, such as a suitable location, qualified personnel and an effective marketing strategy.  Additionally, it takes time for a new branch to generate significant deposits and make sufficient loans to produce enough income to offset expenses, some of which, like salaries and occupancy expense, are relatively fixed costs. We expect that it may take a period of time before the new branch offices can become profitable.  During this period, operating these new branch offices may negatively impact our net income.




Strong competition within our market area could affect our profits and slow growth.




Newport Federal faces intense competition both in making loans and attracting deposits.  This competition has made it more difficult for the Bank to make new loans and attract deposits.  Price competition for loans and deposits might result in the Bank earning less on the Bank’s loans and paying more on the Bank’s deposits, which would reduce net interest income.  Competition also makes it more difficult to grow loans and deposits.  At June 30, 2010, which is the most recent date for which data is available from the FDIC, Newport Federal held approximately 11.71% of the deposits in Newport County, Rhode Island and approximately 2.47% of the deposits in Washington County, Rhode Island.  Some of the institutions with which the Bank competes have substantially greater resources and lending limits than Newport Federal has and may offer services that the Bank does not provide.  Newport Federal expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry.




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 Index


Due to the interventions of the federal government, some of the institutions that we compete with are receiving substantial federal financial support which may not be available to our Company.  Many institutions have been allowed to convert to banking charters and to offer insured deposits for the first time.  The federal government has guaranteed money market funds which traditionally compete with bank deposits.  The federal government has offered significant guarantees of new debt issuances to some of the Company’s competitors to help them fund their operations.  The federal government now controls Fannie Mae and Freddie Mac and may operate directly as a competitor in some lending markets in the future.  Emergency measures designed to support some of the Company’s competitors may provide no advantage to the Company or place it at a disadvantage.   Emergency changes in deposit insurance, financial market regulation, bank regulation, and policy of the Federal Home Loan Bank system may all affect the competitive environment for the Company and other market participants.  Our profitability depends upon our continued ability to compete successfully in our market area.




A decline in real estate values could impact our profits.




Nearly all of Newport Federal’s loans are secured by real estate in the State of Rhode Island.  As a result of this concentration, a downturn in the local economy could cause significant increases in nonperforming loans, which would impact the Bank’s profits.  A continued decline in real estate values could also cause some of Newport Federal’s mortgage loans to become inadequately collateralized, which would expose the Bank to a greater risk of loss and could require additions to our allowance for loan losses through increased provisions for loan losses.  Additionally, a decline in real estate values could adversely impact the Bank’s portfolio of commercial real estate loans and could result in a decline in the origination of such loans.




Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.




Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially and adversely affect our operating results.  The accounting measurements related to impairment and the loan loss allowance require significant estimates which are subject to uncertainty and changes relating to new information and changing circumstances.  Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates.




Our regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.




If dividends paid on our investment in the Federal Home Loan Bank of Boston continue to be suspended, or if our investment is classified as other-than-temporarily impaired or as permanently impaired, our earnings and/or stockholders’ equity could decrease.




The Bank owns common stock of the Federal Home Loan Bank of Boston (“FHLBB”) to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLBB’s advance program.  As a result of losses, the FHLBB has not paid a dividend since the fourth quarter of 2008, which has decreased our earnings.  In addition, future dividend levels paid by the FHLBB may be different from past levels, and a reduction or elimination of this dividend would reduce our earnings.  Based on redemption provisions of the FHLBB common stock, the stock has no quoted market value and is carried at cost. The Bank reviews for impairment based on the ultimate recoverability of the cost basis in the FHLBB stock.  As of December 31, 2010, no impairment has been recognized on the FHLBB common stock.




18
 Index


ITEM 1B.
UNRESOLVED STAFF COMMENTS




None.




ITEM 2.
PROPERTIES




We conduct our business through our main office and branch offices.  The following table sets forth certain information relating to these facilities as of December 31, 2010.




Location

Year

Opened

Square

Footage


Date of Lease

Expiration

Owned/

Leased

Net Book Value(Dollars in thousands)Main Office:100 Bellevue Avenue

1964


12,000


N/A

Owned

$
3,330Newport, RI  02840Branches:165 East Main Road

1978


3,000


05/30/2020

Leased

$
489Middletown, RI  028421430 East Main Road

2009


6,754


N/A

Owned

$
3,417Portsmouth, RI  02871121 Old Tower Hill Road

1996


3,000


05/14/2011

Leased

$
264Wakefield, RI  028792 Wilder Avenue (1)

2001


1,200


N/A

Owned

$
472Westerly, RI  02891445 Liberty Street

2009


3,500


4/30/2029

Leased

$
1,881Stonington, CT 0637918 Post Road (1)

2011


3,800


12/31/2041

Leased

$
1,531Westerly, RI  02891





(1)  The Bank opened its new branch on 18 Post Road in Westerly in January, 2011, and closed its branch at 2 Wilder Avenue, Westerly at the same time.  Currently, the Bank plans to hold onto the 2 Wilder Avenue property and it is being used as a storage facility.





ITEM 3.
LEGAL PROCEEDINGS




Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business.  We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.




19
 Index


PART II




ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES




Market and Dividend Information.




The Company’s common stock is listed on the Nasdaq Global Market (“NASDAQ”) under the trading symbol “NFSB.”




The following table sets forth the high and low sales prices of the Company’s common stock as reported by NASDAQ.  The Company has not paid any dividends to stockholders to date.  See “Dividends” below.




High


Low2010:First Quarter

$
12.50


$
11.24Second Quarter

$
12.25


$
11.05Third Quarter

$
12.52


$
11.35Fourth Quarter

$
12.14


$
11.592009:First Quarter

$
11.96


$
11.00Second Quarter

$
12.25


$
11.00Third Quarter

$
12.99


$
11.80Fourth Quarter

$
12.80


$
11.08





Holders.




As of March 1, 2011, there were approximately 566 holders of record of the Company’s common stock.




Dividends.




The Company has not paid any dividends to its stockholders to date.  The payment of dividends in the future will depend upon a number of factors, including capital requirements, the Company’s financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions.  In addition, the Company’s ability to pay dividends is dependent on dividends received from Newport Federal.  For more information regarding restrictions on the payment of cash dividends by the Company and by Newport Federal, see “Business—Regulation and Supervision—Holding Company Regulation” and “— Regulation and Supervision—Federal Savings Institution Regulation—Limitation on Capital Distributions” and Note 9 to the Consolidated Financial Statements included in this Annual Report.  No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in the future.




Securities Authorized for Issuance under Equity Compensation Plans.




See Part III,  Item 12(d) Equity Compensation Plan Information, in this Annual Report on Form 10-K, for the table providing information as of December 31, 2010 about Company common stock that may be issued upon the exercise of options under the Newport Bancorp, Inc. 2007 Equity Incentive Plan.




Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities.




Not applicable.
  20
 Index


Purchases of Equity Securities by the Issuer and Affiliated Purchasers.


The Company did not repurchase any of its outstanding shares of common stock during the three-month period ended December 31, 2010.





ITEM 6.
SELECTED FINANCIAL DATA





At or For the Years Ended December 31,2010


2009


2008Performance Ratios:Return on average assets


0.40
%


0.16
%


(0.22
)%Return on average equity


3.57



1.34



(1.47
)Interest rate spread (1)


3.50



2.95



2.76Net interest margin (2)


3.72



3.27



3.32Non-interest expense to average assets


3.02



2.99



3.29Efficiency ratio (3)


78.41



85.97



90.08Average interest-earning assets to average interest-bearing liabilities


112.22



114.07



121.01Average equity to average assets


11.15



11.77



14.66Capital Ratios (Bank Only):Tangible capital


9.30



8.60



8.90Leverage capital


9.30



8.60



8.90Total risk-based capital


15.20



14.10



14.30Asset Quality Ratios:Allowance for loan losses as a percent of total loans (4)


1.02



0.98



0.87Allowance for loan losses as a percent of nonperforming loans


3,400.00



403.14



N/MNet charge-offs to average outstanding loans during the period


0.21



0.01



0.01Non-performing loans as a percent of total loans (4)


0.03



0.24



0.00





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


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


(3)
Represents non-interest expense divided by the sum of net interest income and non-interest income, excluding gains (losses) on sales of securities and impairment charges incurred.


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


N/M
Not meaningful because there were no nonperforming loans and, consequently, the denominator in the ratio was zero.


21
 Index


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




Overview




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




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




Expenses.  The non-interest expenses Newport Federal incurs in operating the Bank’s business consist of compensation and employee benefits expenses, occupancy expenses, data processing expenses and other miscellaneous expenses.




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




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




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




Other expenses include expenses for professional services, advertising, office supplies, postage, telephone, insurance, charitable contributions, FDIC Deposit Insurance and semi-annual OTS assessments and other miscellaneous operating expenses.




Critical Accounting Policies




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




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




Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management evaluates the level of the allowance at least quarterly and establishes the provision for loan losses based upon a review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying




22
 Index


collateral, prevailing economic conditions and other factors related to the collectability of the loan portfolio. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Although management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews Newport Federal’s allowance for loan losses. Such agency may require the Bank to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings.




The allowance consists of general and unallocated loss components.  For loans that are classified as impaired, an allowance is established when the collateral value of the impaired loan is lower than the carrying value of that loan.  The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating the general losses in the portfolio.




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




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




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




Balance Sheet Analysis




Overview.During 2010, the Company’s assets decreased by $9.2 million, or 2.0%, to $449.7 million.  The majority of the decrease in assets was concentrated in cash and cash equivalents, which decreased by $10.0 million, and securities, which decreased by $4.1 million, partially offset by an increase of $4.6 million in net loans.  The decrease in securities was attributable to sales of securities available for sale and principal payments of mortgage-backed securities held to maturity, partially offset by purchases of mortgage-backed securities held to maturity.  The decrease in cash and cash equivalents resulted primarily from a $6.2 million decrease in Federal Home Loan Bank borrowings, a $896,000 decrease in deposit balances and the increase in net loans.




Loans.Newport Federal’s primary lending activity is the origination of loans secured by real estate.  The Bank originates one-to-four family residential real estate loans, commercial real estate and multi-family real estate loans and home equity loans and lines of credit.  To a lesser extent, Newport Federal originates construction loans, commercial and consumer loans.  Net loans increased from $351.5 million at December 31, 2009 to $356.0 million at December 31, 2010, or 1.3%.  Net loans represented 79.18% of total assets at December 31, 2010.




23
 Index


The largest segment of the Bank’s loan portfolio is one-to-four family residential real estate loans, which increased by $12.7 million in 2010.  One-to-four family loans totaled $203.9 million, which represented 56.5% of total loans at December 31, 2010, compared to $191.2 million, which represented 53.7% of total loans at December 31, 2009.  The Bank offers fixed and adjustable rate one-to-four family residential loans. At December 31, 2010, the Bank had $191.5 million in fixed rate and $12.4 million in adjustable rate one-to-four family loans.




Commercial real estate loans totaled $104.5 million and represented 29.0% of total loans at December 31, 2010, compared to $104.7 million, representing 29.4% of total loans at December 31, 2009.  Multi-family real estate loans totaled $22.5 million, or 6.2% of total loans at December 31, 2010, compared to $22.5 million, or 6.3% of total loans at December 31, 2009.  Construction loans totaled $4.9 million, representing 1.4% of total loans at December 31, 2010, compared to $9.7 million, representing 2.7% of total loans at December 31, 2009.




Home equity loans and lines of credit totaled $23.1 million, representing 6.4% of total loans at December 31, 2010, a decrease of $2.8 million from $25.9 million at December 31, 2009.




Commercial loans, which consist of loans not secured by real estate, totaled $1.6 million, representing 0.5% of total loans at December 31, 2010, compared to $1.9 million at December 31, 2009.  The Bank also originates consumer loans secured by automobiles or passbook or certificate accounts.  Consumer loans totaled $288,000 at December 31, 2010, compared to $223,000 at December 31, 2009.




24
 Index


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




At December 31,2010


2009


2008


2007


2006Amount


Percent


Amount


Percent


Amount


Percent


Amount


Percent


Amount


Percent(Dollars in thousands)Real estate mortgage loans:ResidentialOne-to-four family

$
203,893



56.49
%

$
191,154



53.67
%

$
183,767



54.53
%

$
169,179



57.08
%

$
157,448



60.67
%Multi-family


22,540



6.25



22,535



6.33



17,379



5.16



9,494



3.20



9,360



3.61Home equity loans and lines


23,112



6.40



25,891



7.27



30,425



9.03



30,934



10.44



29,275



11.28Commercial


104,531



28.96



104,720



29.42



91,487



27.14



75,623



25.51



57,008



21.96Construction


4,948



1.37



9,736



2.73



11,204



3.32



9,427



3.18



4,685



1.80Total real estate loans


359,024



99.47



354,036



99.42



334,262



99.18



294,657



99.41



257,776



99.32Commercial


1,638



0.45



1,885



0.52



2,145



0.64



1,296



0.44



642



0.25Consumer


288



0.08



223



0.06



601



0.18



442



0.15



1,112



0.43Total loans


360,950



100.00
%


356,144



100.00
%


337,008



100.00
%


296,395



100.00
%


259,530



100.00
%Allowance for losses


(3,672
)






(3,467
)






(2,924
)






(2,399
)






(1,973
)Net deferred loan fees


(1.229
)






(1,178
)






(1,055
)






(912
)






(791
)Loans, net

$
356,049






$
351,499






$
333,029






$
293,084






$
256,766




25
 Index


The following table sets forth certain information at December 31, 2010 regarding the dollar amount of loan principal repayments coming due during the periods indicated.  The table does not include any estimate of prepayments, which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below.  Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.




One-to-Four

Family Residential

Mortgage Loans


Multi-Family

Mortgage Loans


Home Equity Loans &

Lines


Commercial Mortgage

Loans(Dollars in thousands)Amounts due in:One year or less

$
16


$
-


$
94


$
5,098More than one year to five years


2,933



3,508



3,684



18,058More than five years to ten years


19,455



18,083



9,299



76,601More than ten years to twenty years


59,051



729



10,035



4,526More than twenty years


122,438



220



-



248Total

$
203,893


$
22,540


$
23,112


$
104,531





Construction Mortgage Loans


Commercial

Loans


Consumer

Loans


Total

Loans(Dollars in thousands)Amounts due in:One year or less

$
2,024


$
303


$
189


$
7,724More than one year to five years


2,548



583



99



31,413More than five years to ten years


376



752



-



124,566More than ten years to twenty years


-



-



-



74,341More than twenty years


-



-



-



122,906Total

$
4,948


$
1,638


$
288


$
360,950





The following table sets forth the dollar amount of all loans at December 31, 2010 that are due after December 31, 2011 and have either fixed interest rates or floating or adjustable interest rates.  The amounts shown below exclude the allowance for loan losses and net deferred loan fees.




Fixed Rates


Floating or Adjustable

Rates


Total(Dollars in thousands)Real estate mortgages:ResidentialOne-to-four family

$
191,460


$
12,417


$
203,877Multi-family


4,236



18,304



22,540Home equity loans and lines


10,374



12,644



23,018Commercial


40,520



58,913



99,433Construction


-



2,924



2,924Commercial loans


752



583



1,335Consumer loans


18



81



99Total

$
247,360


$
105,866


$
353,226


26
 Index


Securities.The securities portfolio consists of the following:




At December 31,2010


2009


2008Amortized

Cost


Fair

Value


Amortized

Cost


Fair

Value


Amortized

Cost


Fair

Value(Dollars in thousands)Securities available for sale:Mutual funds

$
-


$
-


$
6,388


$
6,249


$
6,651


$
6,390Securities held to maturity:Mortgage-backed securities

$
47,021


$
49,314


$
44,898


$
46,940


$
52,162


$
54,198





All mortgage-backed securities are backed by residential mortgage loans and are issued by government-sponsored enterprises.  The Company had no investments in one issuer that had an aggregate book value in excess of 10% of our equity at December 31, 2010.




For the year ended December 31, 2010, proceeds from the sale of securities available for sale amounted to $6,275,000, which realized a gross loss of $267,000 and gross gains of $146,000.  For the year ended December 31, 2009, proceeds from the sale of securities available for sale amounted to $250,000, which realized gross gains of $10,000.  During the years ended December 31, 2009 and 2008, the Company recognized impairment charges of $76,000 and $706,000, respectively, for the Bank’s holding in a mutual fund, which had invested in private-label mortgage-backed securities and U.S. Government Agency and government-sponsored agency securities.  All of the Company’s investments in mutual funds were sold in 2010.




The following table sets forth the stated maturities and weighted average yields of debt securities at December 31, 2010.




More than Ten Years


TotalCarrying

Value


Weighted

Average Yield


Carrying

Value


Weighted

Average Yield(Dollars in thousands)Securities held to maturity:Mortgage-backed securities

$
47,021



4.49
%

$
47,021



4.49
%




27
 Index


Deposits.  Newport Federal’s deposit base is comprised of demand deposits, money market and savings accounts and time deposits.  The Bank considers demand deposits, money market and savings accounts to be core deposits.  Deposits decreased$896,000, or 0.3%, for the year ended December 31, 2010.  The decrease in deposits in 2010 resulted from a $9.4 million, or 11.9%, decrease in time deposits, offset by an increase of $4.8 million, or 10.2%, in money market accounts, an increase of $2.9 million, or 11.0%, in savings accounts and an increase of $759,000, or 0.7%, in NOW/Demand accounts.  Time deposits represented 26.7% of the Company’s total deposit balances at December 31, 2010, compared to 30.2% at December 31, 2009.  NOW/Demand accounts represented 42.1% and 41.7% of the Company’s total deposit balances at December 31, 2010 and 2009, respectively.




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




At December 31,2010


2009


2008(Dollars in thousands)Noninterest-bearing demand deposits

$
37,026


$
34,520


$
32,776Interest-bearing demand deposits


72,842



74,589



57,982Money market deposit accounts


51,778



46,991



39,540Regular savings


29,728



26,793



25,591Certificates of deposit


69,676



79,053



73,234Total

$
261,050


$
261,946


$
229,123





The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity as of December 31, 2010.  Jumbo certificates of deposit require minimum deposits of $100,000.  The Bank does not offer special rates for jumbo certificates.




Maturity Period

Certificates of

Deposit(Dollars in thousands)Three months or less

$
4,799Over three through six months


3,109Over six through twelve months


6,192Over twelve months


8,324Total

$
22,424





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




Federal Home Loan Bank advances decreased by $6.2 million to $135.2 million at December 31, 2010, due to excess liquidity available as borrowings matured.  Federal Home Loan Bank advancesdecreased by $4.0 million to $141.5 million during 2009.  During 2007 and 2008, the Bank borrowed $40.0 million using repurchase agreements.  These borrowings were used to help fund loan originations and to purchase securities held to maturity.  For additional information regarding our borrowings, see Note 7 to the notes to Consolidated Financial Statements included in this Annual Report.




28
 Index


Results of Operations for the Years Ended December 31, 2010 and 2009




Overview.




Years Ended December 31,2010


2009(Dollars in thousands)Net income

$
1,800


$
708Return on average assets


0.40
%


0.16
%Return on average equity


3.57
%


1.34
%Average equity to average assets


11.15
%


11.77
%





Net income in 2010 was $1.8 million compared to $708,000 in 2009. The $1.7 million increase in the Bank’s net interest income and the $53,000 increase in non-interest income, partially offset by the $226,000 increase in non-interest expenses and the $63,000 increase in the tax provision, contributed to the increase in net income in 2010.  The $1.7 million increase in net interest income was primarily the result of an increase in the interest rate spread.  The $53,000 increase in non-interest income is primarily a result of anincrease in fees earned on checking accounts and no impairment charge recorded on the Bank’s mutual fund holdings in 2010, compared to a $76,000 impairment charge recorded in 2009, partially offset by a $121,000 increase in net realized loss on sales of securities available for sale in 2010, compared to 2009.  The loss on sales of securities available for sale in 2010 is due to the sale of the Bank’s entire holdings in one mutual fund, which resulted in a $267,000 realized loss, partially offset by gains on sales of other securities available for sale.  Non-interest expense for 2010 increased to $13.7 million from $13.5 million in 2009, an increase of 1.7%.  The increase in non-interest expense between the two years is attributable to an increase in salaries and employee benefits, occupancy and equipment expense, data processing fees, marketing expense and foreclosed real estate, offset by decreases in professional fees, FDIC insurance costs and other general and administrative costs.   The increase in salaries and benefits is primarily due to an increase in retirement and incentive compensation expenses, partially offset by a reduction in the stock-based compensation expense associated with option grants and restricted stock awards.  The accelerated method of expense recognition was adopted at the inception of the equity incentive plan on October 1, 2007, resulting in a higher stock-based compensation expense in 2009 compared to 2010. The increase in occupancy and equipment expense and data processing fees is due to the overall increase in operating and maintenance costs associated with the branches and with an increase in the number of checking accounts in 2010.  The decrease in FDIC insurance is due to the FDIC special assessment of $205,000 incurred in 2009.  Effective tax rates were 33.1% and 53.9% for 2010 and 2009, respectively.




29
 Index


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




Years Ended December 31,2010


2009


2008Average

Balance


Interest

and

Dividends


Yield/

Cost


Average

Balance


Interest

and

Dividends


Yield/

Cost


Average

Balance


Interest

and

Dividends


Yield/

Cost(Dollars in thousands)Assets:Interest-earning assets:Loans

$
350,613


$
20,100



5.73
%

$
346,022


$
20,287



5.86
%

$
313,126


$
19,296



6.16
%Securities


47,260



2,383



5.04



55,054



2,709



4.92



40,778



2,079



5.10Other interest-earning assets


8,992



23



0.26



10,043



12



0.12



9,467



269



2.84Total interest-earning assets


406,865



22,506



5.53



411,119



23,008



5.60



363,371



21,644



5.96Bank-owned life insurance


10,504











10,105











9,667Noninterest-earning assets


35,340











28,329











19,549Total assets

$
452,709










$
449,553










$
392,587Liabilities and equity:Interest-bearing liabilities:Interest-bearing demand deposits

$
72,972



850



1.16


$
67,691



1,347



1.99


$
43,333



983



2.27Savings accounts


28,244



62



0.22



25,783



69



0.27



25,527



83



0.33Money market accounts


49,958



494



0.99



44,517



694



1.56



34,655



1,004



2.90Certificates of deposit


75,000



1,114



1.49



82,807



2,199



2.66



78,232



2,751



3.52Total interest-bearing deposits


226,174



2,520



1.11



220,798



4,309



1.95



181,747



4,821



2.65Borrowings


136,378



4,834



3.54



139,601



5,238



3.75



118,538



4,767



4.02Total interest-bearing liabilities


362,552



7,354



2.03



360,399



9,547



2.65



300,285



9,588



3.19Demand deposits


35,387











31,954











32,258Noninterest-bearing liabilities


4,299











4,309











2,479Total liabilities


402,238











396,662











335,022Equity


50,471











52,891











57,565Total liabilities and equity

$
452,709










$
449,553










$
392,587Net interest income





$
15,152










$
13,461










$
12,056Interest rate spread










3.50
%










2.95
%










2.77
%Net interest margin










3.72
%










3.27
%










3.32
%Average interest-earning assets to average interest-bearing liabilities










112.22
%










114.07
%










121.01
%


30
 Index


Rate/Volume Analysis.  The following table sets forth the effects of changing rates and volumes on our net interest income.  The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume).  The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate).  The net column represents the sum of the prior columns.  For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.




2010 Compared to 2009Increase (Decrease) Due toVolume


Rate


Net(Dollars in thousands)Interest income:Loans

$
267


$
(454
)

$
(187
)Securities


(392
)


66



(326
)Other interest-earning assets


(1
)


12



11Total interest-earning assets


(126
)


(376
)


(502
)Interest expense:Deposits


103



(1,892
)


(1,789
)Borrowings


(119
)


(285
)


(404
)Total interest-bearing liabilities


(16
)


(2,177
)


(2,193
)Change in net interest income

$
(110
)

$
1,801


$
1,691





Net Interest Income.Net interest income for the year ended December 31, 2010 was $15.2 million, compared to $13.5 million for year December 31, 2009, an increase of 12.6%.  The increase in net interest income during 2010 was primarily due to a decrease in expense from deposits and borrowings, partially offset by a decrease in the interest earned on loans and securities.  The yield on interest-earning assets decreased to 5.53% in 2010 from 5.60% in 2009, a decrease of 7 basis points.  The cost of interest-bearing liabilities decreased to 2.03% in 2010 from 2.65% in 2009, a decrease of 62 basis points.  The average cost of interest-bearing deposits decreased by 84 basis points, as a result of the continued low interest rate environment in 2010.  With decreases in short-term market interest rates, customers have increasingly shown a preference for higher-yielding core accounts and short-term time deposits, rather than the longer-term time deposit accounts. The average balance of borrowings decreased $3.2 million in 2010 and the low interest rate environment has also contributed towards the 21 basis points decrease in total cost of borrowings from 2009 to 2010.  When older and higher-cost borrowings matured, newer and lower-cost borrowings were purchased, which contributed towards the decrease in cost of borrowings in 2010. The Company’s interest rate spread increased 55 basis points to 3.50% at December 31, 2010 from 2.95% at December 31, 2009.





Provision for Loan Losses.The loan loss provision for the years ended December 31, 2010 and December 31, 2009 was $956,000 and $593,000, respectively.  The provision increased primarily due to loan charge-offs and the impact of general economic conditions, including the slowing economy and decreasing housing prices on the Company’s loan portfolio.





Non-Interest Income.The following table shows the components of non-interest income and the percentage changes from year to year.




Years Ended December 31,2010


2009


% Change(Dollars in thousands)Customer service fees

$
1,868


$
1,740



7.4
%Gain (loss) on sale of available-for-sale securities


(121
)


10



(1,310.0
)Impairment loss on available-for-sale securities


-



(76
)


100.0Bank-owned life insurance


387



400



(3.3
)Other


49



56



(12.5
)Total

$
2,183


$
2,130



2.5
%




31
 Index


Non-interest income for 2010 totaled $2.2 million, an increase of $53,000, or 2.5%, compared to 2009.  The increase in non-interest income is primarily due to higher fees earned on checking accounts and no impairment charge recorded in 2010, offset by the loss on sale of securities available for sale recorded in 2010.




Non-Interest Expense.The following table shows the components of non-interest expense and the percentage changes for the years indicated.




Years Ended December 31,2010


2009


% Change(Dollars in thousands)Salaries and employee benefits

$
7,651


$
7,560



1.2
%Occupancy and equipment


1,873



1,798



4.2Data processing


1,503



1,388



8.3Professional fees


458



476



(3.8
)Marketing


959



898



6.8Foreclosed real estate


64



-



-FDIC insurance


459



597



(23.1
)All other


720



744



(3.2
)Total

$
13,687


$
13,461



1.7Efficiency ratio


78.96
%


85.92
%


(8.1
)%





Total  non-interest expenses for 2010 increased to $13.7 million from $13.5 million for 2009, an increase of 1.7%.  The increase between the two years is attributable to an increase in salaries and employee benefits, occupancy and equipment expense, data processing fees, marketing expense and foreclosed real estate, offset by decreases in professional fees, FDIC insurance costs and other general and administrative costs.   The increase in salaries and benefits is primarily due to an increase in retirement and incentive compensation expenses, partially offset by a reduction in the stock-based compensation expense associated with option grants and restricted stock awards.  The accelerated method of expense recognition was adopted at the inception of the equity incentive plan on October 1, 2007, resulting in a higher stock-based compensation expense in 2009 compared to 2010. The increase in occupancy and equipment expense and data processing fees is due to the overall increase in operating and maintenance costs associated with the branches and with an increase in the number of checking accounts in 2010.   Marketing costs were higher due to more marketing campaigns in 2010 than in 2009. The decrease in FDIC insurance is due to the FDIC special assessment of $205,000 incurred in 2009.




Income Tax Expense. The incometax expense for 2010 was $892,000 compared to the income tax expense of $829,000 for 2009.  The effective tax rates were 33.1% and 53.9% in 2010 and 2009, respectively.  The effective tax rate decrease is due primarily to an increase in the valuation reserve against the Company’s deferred tax assets in 2009 compared to a decrease in this valuation allowance in 2010. The effective tax rates in 2010 and 2009 also include the non-deductible compensation expense recorded for a portion of the incentive stock options, partially offset by non-taxable BOLI income.




The deferred tax assets applicable to loss carry forwards relating to the deduction for the donation to the charitable foundation in 2006 are recoverable, only to the extent that 10% pre-tax of income exceeds the deduction during the five-year carry forward period.  At December 31, 2010, Newport Bancorp had recognized a valuation allowance of $868,000 against the deferred tax asset related to this loss carry forward.  In addition, securities available for sale that were previously impaired were sold in 2010, creating a capital loss carryover and a related valuation allowance of $304,000 at December 31, 2010.  For additional information regarding deferred tax assets, see Note 8 to the notes to Consolidated Financial Statements included in this Annual Report.


32
 Index





Risk Management




Overview.  Managing risk is an essential part of successfully managing a financial institution.  Newport Bancorp’s most prominent risk exposures are credit risk, interest rate risk and market risk.  Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due.  Interest rate risk is the potential reduction of interest income as a result of changes in interest rates.  Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are accounted for on a mark-to-market basis.  Other risks that the Company faces are operational risks, liquidity risks and reputation risk.  Operational risks include risks related to fraud, regulatory compliance, processing errors, technology and disaster recovery.  Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers.  Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue.




Credit Risk Management.  Newport Federal’s strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans.




When a borrower fails to make a required loan payment, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status.  When the loan becomes 15 days past due a late notice is sent to the borrower.  When the loan becomes 18 days past due, a more formal letter is sent.  When a loan becomes 25 days past due, the borrower is typically called.  After 30 days, the Bank regards the borrower as in default.  The borrower is promptly sent a letter from the Bank’s attorney and the Bank may commence collection proceedings.  If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure.  Generally, when a consumer loan becomes 60 days past due, the Bank institutes collection proceedings and attempts to repossess any personal property that secures the loan.  Management informs the board of directors monthly of the amount of loans delinquent more than 30 days, all loans in foreclosure and repossessed property that it owns.




Analysis of Nonperforming and Classified Assets.  Newport Bancorp considers repossessed assets and loans that are 90 days or more past due to be nonperforming assets.  Loans are generally placed on nonaccrual status when they become 90 days delinquent at which time the accrual of interest ceases and the allowance for any uncollectible accrued interest is established and charged against operations.  Typically, payments received on a nonaccrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan.




The following table provides information with respect to the Bank’s nonperforming assets at the dates indicated.




At December 31,2010


2009


2008


2007


2006(Dollars in thousands)Nonaccrual loans:One-to-four family real estate

$
108


$
-


$
-


$
-


$
-Commercial real estate


-



860



-



908



-Total


108



860



-



908



-Accruing loans past due 90 days or more


-



-



-



-



-Total nonperforming loans


108



860



-



908



-Real estate owned


100



-



-



-



-Other nonperforming assets


-



-



-



-



-Total nonperforming assets

$
208


$
860


$
-


$
908


$
-Total nonperforming loans to total loans


0.03
%


0.24
%


0.00
%


0.31
%


0.00
%Total nonperforming loans to total assets


0.02
%


0.19
%


0.00
%


0.25
%


0.00
%Total nonperforming assets to total assets


0.05
%


0.19
%


0.00
%


0.25
%


0.00
%




33
 Index


Gross interest income that would have been recorded for 2010 had nonaccruing loans been current according to their original terms, amounted to $3,000. The amount of interest income on such loans that was included in net income in 2010 was $32,000.




The Bank did not have any troubled debt restructurings at any of the dates presented.




Nonaccrual loans at December 31, 2010, consist of a one-to-four family residential mortgage and there is no loss expected on this loan.




Federal regulations require the Newport Federal to review and classify the Bank’s assets on a regular basis.  In addition, the Office of Thrift Supervision has the authority to identify problem assets and, if appropriate, require them to be classified.  There are three classifications for problem assets:  substandard, doubtful and loss.  “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss.  An asset classified “loss” is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.  The regulations also provide for a “special mention” category, described as assets which do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving our close attention.  When the Bank classifies an asset as substandard or doubtful, the asset is assessed for impairment, and if impaired, a specific valuation allowance for loan losses is established.  If classified loans are not deemed to be impaired, the Bank applies a general reserve as further described below.  If Newport Federal classifies an asset as loss, it is charged off at an amount equal to 100% of the portion of the asset classified loss.




The following table shows the aggregate amounts of our classified assets at the dates indicated.




At December 31,2010


2009


2008(Dollars in thousands)Special mention loans

$
10,030


$
6,242


$
73Substandard loans


3,204



4,570



-Substandard securities


-



3,582



-Doubtful assets


-



-



-Loss assets


-



-



-Total classified assets

$
13,234


$
14,394


$
73





At December 31, 2010, loans classified as substandard, which the Company considers to be potential problem loans, consist of five commercial real estate mortgages and one one-to-four family residential mortgage.




Delinquencies.  The following table provides information about delinquencies under 90 days in our loan portfolio at the dates indicated.




At December 31,2010


2009


200830-59

Days

Past Due


60-89

Days

Past Due


30-59

Days

Past Due


60-89

Days

Past Due


30-59

Days

Past Due


60-89

Days

Past Due(Dollars in thousands)Real estate mortgage loans:ResidentialOne-to-four family

$
220


$
-


$
229


$
-


$
688


$
118Home equity loans and lines


-



-



146



-



-



-Commercial


618



-



-



-



336



-Total

$
838


$
-


$
375


$
-


$
1,024


$
118Delinquent loans to total loans


0.23
%


0.00
%


0.11
%


0.00
%


0.31
%


0.04
%




34
 Index


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




Our methodology for assessing the appropriateness of the allowance for loan losses consists of:  (1) a specific valuation allowance on identified impaired loans; and (2) a general valuation allowance on the remainder of the loan portfolio.  Although the Bank determines the amount of each element of the allowance separately, the entire allowance for loan losses is available to absorb losses in the loan portfolio.




Specific Valuation Allowance on Identified Impaired Loans.  Newport Federal identifies impaired loans by reviewing all delinquent loans, classified loans and other loans that management may have concerns about collectability.  A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.




General Valuation Allowance on the Remainder of the Loan Portfolio.  Newport Federal establishes a general allowance for loans that are not impaired loans, to recognize the inherent losses associated with lending activities.  This general valuation allowance is determined by segregating the loans by loan type and risk classification and assigning allowance percentages to each category.  The percentages are adjusted for significant changes in factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.  These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results.  The applied loss factors are reevaluated quarterly to ensure their relevance in the current economic environment.




The Bank engages an independent third party to conduct an annual review of its commercial real estate portfolio.  This loan review, which typically includes a 50% penetration of the commercial real estate portfolio, provides a credit evaluation of individual loans to determine whether the risk ratings assigned are appropriate.




The Office of Thrift Supervision, as an integral part of its examination process, periodically reviews our allowance for loan losses.  The Office of Thrift Supervision may require the Bank to make additional provisions for loan losses based on judgments different from ours.




At December 31, 2010 and 2009, the allowance for loan losses represented 1.02% and 0.98% of total loans, respectively.  No portion of the allowance was allocated to impaired loans at December 31, 2010 or 2009.  The allowance for loan losses increased from $3.5 million at December 31, 2009, to $3.7 million at December 31, 2010, or 5.9%.  The increase in 2010, was primarily due to the growth and changes in the composition of the loan portfolio and changes in economic conditions.  The increase in the allowance for loan losses as a percentage of the loan portfolio was primarily due to additional general reserves provided for an increase in classified loans that, although currently performing, represent increased risk. The Bank currently does not originate sub-prime residential mortgage loans. There are $13.3 million of classified and criticized loans that are under watch by management.  Total classified and criticized loans consist of $3.3 million in the substandard category and $10.0 million in the special mention category.  The special mention category consists of $7.4 million of commercial real estate loans, $2.2 million of multi-family real estate loans, $398,000 of construction loans and one $61,000 commercial loan.  The substandard category consists of five commercial real estate loans totaling $3.1 million and one one-to-four family residential real estate loan totaling $92,000. Total classified and criticized loans represent 3.7% of the Company’s total gross loans.




35
 Index


The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.




At December 31,2010


2009Amount


% of

Allowance

to Total

Allowance


% of

Loans in

Category

To Total

Loans


Amount


% of

Allowance

to Total

Allowance


% of

Loans in

Category

To Total

Loans(Dollars in thousands)Real estate mortgage:ResidentialOne-to-four family

$
1,028



28.00
%


56.49
%

$
956



27.57
%


53.67
%Multi-family


377



10.27



6.25



338



9.75



6.33Home equity loans and lines


173



4.71



6.40



142



4.10



7.27Commercial


1,976



53.81



28.96



1,833



52.87



29.42Construction


89



2.42



1.37



167



4.82



2.73Commercial


25



0.68



0.45



28



0.81



0.52Consumer


4



0.11



0.08



3



0.08



0.06Total allowance for loan losses

$
3,672



100.00
%


100.00
%

$
3,467



100.00
%


100.00
%





At December 31,2008


2007Amount


% of

Allowance

to Total

Allowance


% of

Loans in

Category

To Total

Loans


Amount


% of

Allowance

to Total

Allowance


% of

Loans in

Category

To Total

Loans(Dollars in thousands)Real estate mortgage:ResidentialOne-to-four family

$
916



31.33
%


54.53
%

$
835



34.80
%


57.08
%Multi-family


260



8.89



5.16



137



5.71



3.20Home equity loans and lines


167



5.71



9.03



170



7.09



10.44Commercial


1,372



46.92



27.14



1,096



45.69



25.51Construction


168



5.75



3.32



136



5.67



3.18Commercial


32



1.09



0.64



19



0.79



0.44Consumer


9



0.31



0.18



6



0.25



0.15Total allowance for loan losses

$
2,924



100.00
%


100.00
%

$
2,399



100.00
%


100.00
%





At December 31,2006Amount


% of

Allowance

to Total

Allowance


% of

Loans in

Category

To Total

Loans(Dollars in thousands)Real estate mortgage:ResidentialOne-to-four family

$
787



39.89
%


60.67
%Multi-family


121



6.13



3.61Home equity loans and lines


241



12.21



11.28Commercial


741



37.56



21.96Construction


61



3.09



1.80Commercial


8



0.41



0.25Consumer


14



0.71



0.43Total allowance for loan losses

$
1,973



100.00
%


100.00
%




36
 Index


Although management believes the best information available was used to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations.  Furthermore, while management believes it has established the allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that regulators, in reviewing the loan portfolio, will not require an increase in the allowance for loan losses.  In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above.  Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.




Analysis of Loan Loss Experience.  The following table sets forth an analysis of the allowance for loan losses for the periods indicated.  Where specific loan loss allowances have been established, any difference between the loss allowance and the amount of loss realized has been charged or credited to current income.




Years Ended December 31,2010


2009


2008


2007


2006(Dollars in thousands)Balance at beginning of year

$
3,467


$
2,924


$
2,399


$
1,973


$
1,853Provision for loan losses


956



593



568



426



120Charge offs:Real estate mortgage:ResidentialOne-to-four family


-



-



-



-



-Multi-family


170



-



-



-



-Home equity loans and lines


124



50



40



-



-Commercial


469



-



-



-



-Commercial loans


6



-



-



-



-Consumer loans


3



-



7



-



-Total charge-offs


772



50



47



-



-Recoveries:Real estate mortgage:ResidentialOne-to-four family


-



-



-



-



-Multi-family


-



-



-



-



-Home equity loans and lines


21



-



-



-



-Commercial


-



-



-



-



-Commercial loans


-



-



-



-



-Consumer loans


-



-



4



-



-Total recoveries


21



-



4



-



-Net charge-offs


751



50



43



-



-Balance at end of year

$
3,672


$
3,467


$
2,924


$
2,399


$
1,973Net charge-offs to average loans outstanding during the year


0.22
%


0.01
%


0.01
%


0.00
%


0.00
%





Qualitative Aspects of Market Risk.The Company’s most significant form of market risk is interest rate risk.  Newport Bancorp manages the interest rate sensitivity of its interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment.  Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits.  As a result, sharp increases in interest rates may adversely affect earnings while decreases in interest rates may beneficially affect earnings.  To reduce the potential volatility of our earnings, the Company has sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread.  Newport Bancorp’s strategy for managing interest rate risk emphasizes:  adjusting the maturities of borrowings; adjusting the investment portfolio mix and duration; and periodically selling fixed-rate mortgage loans and available-for-sale investment securities.




37
 Index


The Company has an Asset Liability Management Committee to communicate, coordinate and control all aspects involving asset/liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.




Quantitative Aspects of Market Risk.The Company uses an interest rate sensitivity analysis prepared by the Office of Thrift Supervision to review our level of interest rate risk.  This analysis measures interest rate risk by computing changes in net portfolio value of our cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates.  Net portfolio value represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items.  This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 300 basis point increase or 100 basis point decrease in market interest rates with no effect given to any steps that we might take to counter the effect of that interest rate movement.  Newport Bancorp measures interest rate risk by modeling the changes in net portfolio value over a variety of interest rate scenarios.




The following table presents the change in the net portfolio value at September 30, 2010 (the most current information available), that would occur in the event of an immediate change in interest rates based on Office of Thrift Supervision assumptions, with no effect given to any steps that we might take to counteract that change. The Bank expects that its net portfolio value at December 31, 2010 is consistent with the table below.




Basis Point

(“bp”)


Net Portfolio Value


Net Portfolio Value as % of Portfolio Value of AssetsChange in Rates


Amount


Change


% Change


NPV Ratio


Change (bp)(Dollars in thousands)300


$
36,505


$
-19,446



-35



8.17
%


-354200



44,777



-11,174



-20



9.77



-391100



51,671



-4,280



-8



11.01



-6950



54,031



-1,920



-3



11.40



-310



55,951



0



0



11.71



0(50)



56,386



435



1



11.73



2(100)



56,956



1,005



2



11.79



8





The Office of Thrift Supervision uses certain assumptions in assessing the interest rate risk of savings associations.  These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others.  As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates.  Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset.  Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.




The Committee also measures and evaluates interest rate risk using income simulation analysis. This analysis considers the maturity and repricing characteristics of assets and liabilities, as well as the relative sensitivities of these balance sheet components over a range of interest rate scenarios. Interest rate scenarios tested generally include instantaneous rate shocks, rate ramps over a one-year period, and static (or flat) rates. The simulation analysis is used to measure the exposure of net interest income to changes in interest rates over a specified time horizon, usually a two-year period.




38
 Index


The table below sets forth, as of November 30, 2010, the estimated changes in Newport Bancorp’s net interest income that would result from the designated instantaneous changes in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. The Bank expects that its percentage change in estimated net interest income over the next 12 months and from months 13-24 at December 31, 2010 is consistent with the table below.




% Change in Estimated

Net Interest Income Over

the Next 12 Months


% Change in Estimated

Net Interest Income Over

Months 13-24200 basis point increase in rates


(0.6
)%


(4.4
)%Flat interest rates


0.0
%


(0.2
)%100 basis point decrease in rates


0.6
%


(1.9
)%





As indicated in the table above, the result of an immediate 200 basis point parallel increase in interest rates is estimated to decrease net interest income by 0.6% over a 12-month horizon, and decrease net interest income by 4.4% for months 13-24, when compared to the flat rate scenario, which assumes no increase in interest-bearing checking rates except for high balance interest bearing checking which increase 75 basis points (BP), an increase in savings rates of 50-75 BP and an increase in money market rates of 150 basis points.  These assumptions are based on the Bank’s past experience with the changes in rates paid on these non-maturity deposits coincident with changes in market interest rates.  The estimated change in net interest income from the flat rate scenario for a 100 basis point parallel decline in the level of interest rates is an increase of 0.6% over the 12 month horizon and a decrease of 1.9% for months 13-24, which assumes no decrease in interest-bearing checking rates, except for high balance accounts which decrease 30-50 BP, savings rates decreasing 20-33 BP and a decrease in money market rates of 100 basis points. These assumptions are based on the Bank’s past experience with the changes in rates paid on these non-maturity deposits coincident with changes in market interest rates.
  There are inherent shortcomings in income simulation, given the number and variety of assumptions that must be made in performing the analysis. The assumptions relied upon in making these calculations of interest rate sensitivity include the level of market interest rates, the shape of the yield curve, the degree to which certain assets and liabilities with similar maturities or periods to repricing react to changes in market interest rates, the degree to which non-maturity deposits react to changes in market rates, the expected prepayment rates on loans and mortgage-backed securities, the degree to which early withdrawals occur on certificates of deposit and the volume of other deposit flows. As such, although the analysis shown above provides an indication of Newport Bancorp’s sensitivity to interest rate changes at a point in time, these estimates are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on Newport Bancorp’s net interest income and will differ from actual results.
 39
 Index


The table below shows Newport Bancorp’s interest rate sensitivity gap position at December 31, 2010, indicating the amount of interest-earning assets and interest-bearing liabilities that are anticipated to mature or reprice in each of the future time periods shown. Generally, these assets and liabilities are shown in the table based on the earlier of the time remaining to repricing or contractual maturity. However, savings, money market deposit and interest bearing deposit accounts are assumed to have an annual rate of withdrawal (decay rate) of 10%.




At December 31, 2010Up to

One Year


More than

One Year to Two Years


More than Two Years to Three Years


More than Three Years to Five Years


More than Five Years


Total(Dollars in thousands)Interest-earning assets:Loans

$
7,723


$
7,195


$
9,587


$
14,630


$
321,815


$
360,950Securities


-



27



-



-



46,994



47,021Short-term investments


1,181



-



-



-



-



1,181Total interest-earning assets


8,904



7,222



9,587



14,630



368,809



409,152Interest-bearing liabilities:Savings deposits


2,973



2,675



2,408



2,168



19,504



29,728Money market deposits


5,178



4,660



4,194



3,774



33,972



51,778Interest-bearing demand deposits


10,987



9,888



8,899



8,009



72,085



109,868Certificates of deposits


48,216



10,343



1,707



203



9,207



69,676Borrowings


86,566



11,170



7,000



10,500



20,000



135,236Total interest-bearing liabilities


153,920



38,736



24,208



24,654



154,768



396,286Interest rate sensitivity gap

$
(145,016
)

$
(31,514
)

$
(14,621
)

$
(10,024
)

$
214,041


$
12,866Interest rate sensitivity gap as a % of total assets


(32.25
%)


(7.01
%)


(3.25
%)


(2.23
%)


47.60
%Cum. interest rate sensitivity gap

$
(145,016
)

$
(176,530
)

$
(191,151
)

$
(201,175
)

$
12,866Cum. interest rate sensitivity gap as a % of total assets


(32.25
%)


(39.26
%)


(42.51
%)


(44.74
%)


2.86
%





Liquidity Management.  Liquidity is the ability to meet current and future financial obligations of a short-term nature. The primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the Federal Home Loan Bank of Boston.  While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.




The Bank regularly adjusts our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy.




The most liquid assets are cash and cash equivalents and interest-bearing deposits.  The levels of these assets depend on the operating, financing, lending and investing activities during any given period.  At December 31, 2010, cash and cash equivalents totaled $9.4 million.  At December 31, 2010, we had the ability to borrow a total of approximately $48.0 million of additional advances from the Federal Home Loan Bank of Boston.  On December 31, 2010, we had $95.2 million of advances outstanding.




At December 31, 2010, the Bank had $23.8 million in loan commitments outstanding, which consisted of $2.6 million of real estate loan commitments, $15.1 million in unused home equity lines of credit, $2.5 million in construction loan commitments and $3.6 million in commercial lines of credit commitments.  Certificates of deposit due within one year of December 31, 2010 totaled $48.2 million, or 69.0% of certificates of deposit.  The large percentage of certificates of deposit that mature within one year reflects customer’s hesitancy to invest their funds for long periods in the recent low interest rate environment.  If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings.  Depending on market conditions, Newport Federal may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before December 31, 2011.  The Bank believes,




40
 Index


however, based on past experience, that a significant portion of our certificates of deposit will remain with the Bank.  Newport Federal has the ability to attract and retain deposits by adjusting the interest rates offered.




The Bank’s primary investing activities are the origination and purchase of loans and the purchase of securities.  The primary financing activities consist of activity in deposit accounts and Federal Home Loan Bank advances.  Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by Newport Federal and our local competitors and other factors.  The Bank generally manages the pricing of our deposits to be competitive.  Occasionally, promotional rates are offered on certain deposit products to attract deposits.




Capital Resources.  The Bank is subject to various regulatory capital requirements administered by the Office of Thrift Supervision, including a risk-based capital measure.  The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.  At December 31, 2010, we exceeded all of our regulatory capital requirements.  We are considered “well capitalized” under regulatory guidelines.




The initial public stock offering in 2006 increased the Company’s equity by approximately $43.6 million, which significantly increased liquidity and capital resources.  The financial condition and results of operations were enhanced by the capital from the offering, resulting in increased net interest-earning assets and net income.  However, the large increase in equity resulting from the capital raised in the offering will, initially, have an adverse impact on our return on equity.  The Company may use capital management tools such as cash dividends and common share repurchases.   All repurchases are prohibited, however, if the repurchase would reduce Newport Federal’s regulatory capital below regulatory required levels.




Off-Balance Sheet Arrangements.  In the normal course of operations, Newport Federal engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.  For information about the Company’s loan commitments and unused lines of credit, see Note 11 to the Consolidated Financial Statements included in this Annual Report.




For the year ended December 31, 2010, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.




Effect of Inflation and Changing Prices




The financial statements and related financial data presented in this Form 10-K have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation.  Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.




ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK




The information required by this item is incorporated herein by reference to Part II, Item 7,  “Management’s Discussion and Analysis of Financial Condition and Results of Operation.”




ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA




The Consolidated Financial Statements, including supplemental data, of Newport Bancorp, Inc. begin on page F-1 of this Annual Report.




41
 Index


ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE




None.




ITEM 9A.
CONTROLS AND PROCEDURES




Evaluation of Disclosure Controls and Procedures.




The Company’s President and Chief Executive Officer, its Chief Financial Officer, and other members of its senior management team have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) or 15d-15(e)), as of December 31, 2010. Based on such evaluation, the President and Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures, as of the end of the period covered by this report, were adequate and effective to provide reasonable assurance that information required to be disclosed by the Company, including Newport Federal, in reports that are filed or submitted under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms.




Changes in Internal Controls Over Financial Reporting.




There have been no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.




Management’s Report on Internal Control Over Financial Reporting.




The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.




Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010, utilizing the framework established in Internal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2010 is effective.




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




All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.




This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to




42
 Index


attestation by the Company’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.




ITEM9B.
OTHER INFORMATION




Not applicable.




PART III




ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE




The information relating to the directors and officers of the Company, information regarding compliance with Section 16(a) of the Exchange Act and information regarding the audit committee and audit committee financial expert is incorporated herein by reference to the Company’s Proxy Statement for the Registrant’s Annual Meeting of Stockholders, to be held on May 19, 2011 (the “Proxy Statement”).




The Company has adopted a code of ethics that applies to its principal executive officer, the principal financial officer and principal accounting officer.  The Code of Ethics is posted on the Company’s Internet Web site at www.newportfederal.com.




ITEM 11.
EXECUTIVE COMPENSATION




The information regarding executive compensation, compensation committee interlocks and insider participation is incorporated herein by reference to the Proxy Statement.




ITEM12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS




(a)
Security Ownership of Certain Beneficial Owners




Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.




(b)
Security Ownership of Management




Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.




(c)
Changes in Control




Management of the Company knows of no arrangements, including any pledge by any person or securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.




(d)
Equity Compensation Plan Information




43
 Index


The following table sets forth information as of December 31, 2010 about Company common stock that may be issued upon the exercise of options under the Newport Bancorp, Inc. 2007 Equity Incentive Plan.  The plan was approved by the Company’s stockholders.




Plan Category

Number of securities

to be issued upon

the exercise of outstanding options, warrants and rights


Weighted-average exercise price of outstanding options, warrants and rights


Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column)Equity compensation plans approved by security holders


487,834


$
12.50



-Equity compensation plans not approved by security holders


N/A



N/A



N/ATotal


487,834


$
12.50



-





ITEM13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE




The information relating to certain relationships and related transactions and director independence is incorporated herein by reference to the Proxy Statement.




ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES




The information relating to the principal accounting fees and expenses is incorporated herein by reference to the Proxy Statement.




44
 Index


PART IV




ITEM15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES




(1)
The financial statements required in response to this item are incorporated by reference from Item 8 of this report.




(2)
All financial statement schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.




(3)
Exhibits




3.1
Articles of Incorporation of Newport Bancorp, Inc. (1)


3.2
Bylaws of Newport Bancorp, Inc. (2)


4.1
Specimen Stock Certificate of Newport Bancorp, Inc. (1)


10.1
Amended and Restated Supplemental Executive Retirement Plan (3)


10.2
First Amendment to Form of Newport Federal Savings Bank Supplemental Director Retirement Agreement


10.3
Form of Amended and Restated Employment Agreement between Newport Federal Savings Bank and Executives


10.4
Form of Amended and Restated Employment Agreement between Newport Bancorp, Inc. and Executives


10.5
Form of First Amendment to Supplemental Executive Retirement Agreement between Newport Federal Savings Bank and Carol R. Silven, Kevin M. McCarthy, Nino Moscardi, Bruce A. Walsh and Ray D. Gilmore, II (3)


10.6
Executive Split Dollar Life Insurance Agreements between Newport Federal Savings Bank and Kevin M. McCarthy, Nino Moscardi and Bruce A. Walsh (3)


10.7
Director Split Dollar Life Insurance Agreements between Newport Federal Savings Bank and Peter W. Rector, Donald N. Kaull, Robert S. Lazar, Michael J. Hayes, Barbara Saccucci Radebach, Alicia S. Quirk, Peter T. Crowley, Arthur H. Lathrop, Arthur H. Macauley and Kathleen A. Nealon (3)


10.8
Form of Supplemental Director Retirement Agreements between Newport Federal Savings Bank and Peter W. Rector, William R. Harvey, Donald N. Kaull, Robert S. Lazar, Michael J. Hayes, Barbara Saccucci Radebach, Alicia S. Quirk, Peter T. Crowley, Arthur H. Lathrop, Arthur H. Macauley and Kathleen A. Nealon (3)


21.0
List of Subsidiaries


23.0
Consent of Wolf & Company, P.C.


31.1
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer


31.2
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer


32.0
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer





(1)
Incorporated by reference to the Company’s Registration Statement on Form S-1, as amended, initially filed with the SEC on March 20, 2006.


(2)
Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.


(3)
Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007.


45
 Index


SIGNATURES





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





NEWPORT BANCORP, INC.Date: March 18, 2011
By:
/s/ Kevin M. McCarthyKevin M. McCarthyPresident and Chief Executive 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.





Name

Title
Date/s/ Kevin M. McCarthy

President, Chief Executive Officer
March 18, 2011Kevin M. McCarthy

and Director(principal executive officer)/s/ Bruce A. Walsh

Senior Vice President and
March 18, 2011Bruce A. Walsh

Chief Financial Officer(principal accounting andfinancial officer)/s/ Peter T. Crowley

Director
March 18, 2011Peter T. Crowley/s/ William R. Harvey

Director
March 18, 2011William R. Harvey/s/ Michael J. Hayes

Director
March 18, 2011Michael J. Hayes/s/ Donald N. Kaull

Director
March 18, 2011Donald N. Kaull/s/ Arthur H. Lathrop

Director
March 18, 2011Arthur H. Lathrop/s/ Robert S. Lazar

Director
March 18, 2011Robert S. Lazar


46
 Index





Name

Title
Date/s/ Arthur P. Macauley

Director
March 18, 2011Arthur P. Macauley/s/ Nino Moscardi

Director
March 18, 2011Nino Moscardi/s/ Kathleen A. Nealon

Director
March 18, 2011Kathleen A. Nealon/s/ Alicia S. Quirk

Director
March 18, 2011Alicia S. Quirk/s/ Peter W. Rector

Director
March 18, 2011Peter W. Rector/s/ Barbara Saccucci Radebach

Director
March 18, 2011Barbara Saccucci Radebach


47
 Index




Newport Bancorp, Inc.
 Consolidated Financial Statements
 Years Ended December 31, 2010 and 2009
  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
  Report of Independent Registered Public Accounting Firm
F-2Consolidated Balance Sheets
F-3Consolidated Statements of Income
F-4Consolidated Statements of Changes in Stockholders’ Equity
F-5Consolidated Statements of Cash Flows
F-6 - F-7Notes to Consolidated Financial Statements
F-8 - F-47
  F-1
 Index
  Report of Independent Registered Public Accounting Firm
 
 To the Board of Directors of Newport Bancorp, Inc.:
  We have audited the accompanying consolidated balance sheets of Newport Bancorp, Inc. and subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the years then ended.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.
 
 We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
 
 In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Newport Bancorp, Inc. and subsidiary as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
 
 /s/ Wolf & Company, P.C.
 
 Boston, Massachusetts
 March 17, 2011
  F-2
 Index
  Newport Bancorp, Inc. and Subsidiary
  Consolidated Balance Sheets
  December 31, 2010 and 2009
  Assets2010


2009(In thousands)Cash and due from banks

$
8,194


$
7,618Short-term investments


1,181



11,750Cash and cash equivalents


9,375



19,368Securities available for sale, at fair value


-



6,249Securities held to maturity, at amortized cost


47,021



44,898Federal Home Loan Bank stock, at cost


5,730



5,730Loans


359,721



354,966Allowance for loan losses


(3,672
)


(3,467
)Loans, net


356,049



351,499Premises and equipment, net


14,477



13,393Accrued interest receivable


1,413



1,478Net deferred tax asset


2,600



2,538Bank-owned life insurance


10,705



10,318Foreclosed real estate


100



-Prepaid FDIC insurance


1,052



1,472Other assets


1,163



1,936Total assets

$
449,685


$
458,879Liabilities and Stockholders' EquityDeposits

$
261,050


$
261,946Short-term borrowings


3,000



-Long-term borrowings


132,236



141,468Accrued expenses and other liabilities


3,696



4,074Total liabilities


399,982



407,488Commitments and contingencies (Notes 5, 10 and 11)Stockholders' equity:Preferred stock, $.01 par value; 1,000,000 sharesauthorized; none issued


-



-Common stock, $.01 par value; 19,000,000 sharesauthorized; 4,878,349 shares issued


49



49Additional paid-in capital


50,435



50,504Retained earnings


18,832



17,032Unearned compensation (338,030 and 402,975 sharesat December 31, 2010 and 2009, respectively)


(2,864
)


(3,465
)Treasury stock (1,389,572 and 1,048,172 shares atat December 31, 2010 and 2009, respectively)


(16,749
)


(12,590
)Accumulated other comprehensive loss


-



(139
)Total stockholders' equity


49,703



51,391Total liabilities and stockholders' equity

$
449,685


$
458,879
 
 See accompanying notes to consolidated financial statements.
  F-3
 Index
  Newport Bancorp, Inc. and Subsidiary
  Consolidated Statements of Income
  Years Ended December 31, 2010 and 2009
  2010


2009(Dollars in thousands, except share data)Interest and dividend income:Loans

$
20,100


$
20,287Securities


2,383



2,709Other interest-earning assets


23



12Total interest and dividend income


22,506



23,008Interest expense:Deposits


2,520



4,309Short-term borrowings


2



9Long-term borrowings


4,832



5,229Total interest expense


7,354



9,547Net interest income


15,152



13,461Provision for loan losses


956



593Net interest income, after provisionfor loan losses


14,196



12,868Non-interest income:Customer service fees


1,868



1,740Impairment loss on securities available for sale


-



(76
)Net gain (loss) on sale of securities available for sale


(121
)


10Bank-owned life insurance


387



400Miscellaneous


49



56Total non-interest income


2,183



2,130Non-interest expenses:Salaries and employee benefits


7,651



7,560Occupancy and equipment


1,873



1,798Data processing


1,503



1,388Professional fees


458



476Marketing


959



898Foreclosed real estate


64



-FDIC insurance


459



597Other general and administrative


720



744Total non-interest expenses


13,687



13,461Income before income taxes


2,692



1,537Provision for income taxes


892



829Net income

$
1,800


$
708Weighted average shares outstanding:Basic


3,458,212



3,847,009Diluted


3,458,212



3,847,009Earnings per share:Basic

$
0.52


$
0.18Diluted

$
0.52


$
0.18
  See accompanying notes to consolidated financial statements.
  F-4
 Index
  Newport Bancorp, Inc. and Subsidiary
 
 Consolidated Statements of Changes in Stockholders' Equity
 
 Years Ended December 31, 2010 and 2009
  AccumulatedAdditional











OtherCommon Stock


Paid-in


Retained


Unearned


Treasury


ComprehensiveShares


Amount


Capital


Earnings


Compensation


Stock


Loss


Total(Dollars in thousands)Balance at December 31, 2008


4,878,349


$
49


$
50,438


$
16,324


$
(4,294
)

$
(7,943
)

$
(261
)

$
54,313Comprehensive income:Net income


-



-



-



708



-



-



-



708Net unrealized gain on securities available for sale,net of reclassification adjustment of $66,000


-



-



-



-



-



-



122



122Total comprehensive income






























830Share-based compensation - restricted stock


-



-



-



-



567



-



-



567Share-based compensation - options


-



-



490



-



-



-



-



490Release of ESOP shares (26,018 shares)


-



-



45



-



260



-



-



305Issuance of treasury stock in connection withrestricted stock plan (38,927 shares)


-



-



(467
)


-



-



467



-



-Forfeiture of restricted stock (400 shares)


-



-



(2
)


-



2



-



-



-Purchase of treasury shares (431,164 shares)


-



-



-



-



-



(5,114
)


-



(5,114
)Balance at December 31, 2009


4,878,349



49



50,504



17,032



(3,465
)


(12,590
)


(139
)


51,391Comprehensive income:Net income


-



-



-



1,800



-



-



-



1,800Net unrealized gain on securities available for sale,net of reclassification adjustment of $121,000


-



-



-



-



-



-



139



139Total comprehensive income






























1,939Share-based compensation - restricted stock


-



-



-



-



341



-



-



341Share-based compensation - options


-



-



350



-



-



-



-



350Release of ESOP shares (26,018 shares)


-



-



50



-



260



-



-



310Issuance of treasury stock in connection withrestricted stock plan (38,927 shares)


-



-



(469
)


-



-



469



-



-Purchase of treasury shares (380,327 shares)


-



-



-



-



-



(4,628
)


-



(4,628
)Balance at December 31, 2010


4,878,349


$
49


$
50,435


$
18,832


$
(2,864
)

$
(16,749
)

$
-


$
49,703
 
 See accompanying notes to consolidated financial statements.
  F-5
 Index
  Newport Bancorp, Inc. and Subsidiary
  Consolidated Statements of Cash Flows
  Years Ended December 31, 2010 and 2009
  2010


2009(In thousands)Cash flows from operating activities:Net income

$
1,800


$
708Adjustments to reconcile net income tonet cash provided by operating activities:Provision for loan losses


956



593Accretion of securities held to maturity


(199
)


(102
)Net loss (gain) on sale of securities available for sale


121



(10
)Impairment loss on securities available for sale


-



76Loss on sale of foreclosed real estate


17



-Amortization of net deferred loan fees


(416
)


(281
)Depreciation and amortization of premisesand equipment


849



808Share-based compensation and ESOP allocation


1,001



1,362Deferred income tax benefit


(62
)


(196
)Income from bank-owned life insurance


(387
)


(400
)Net change in:Accrued interest receivable


65



(49
)Prepaid FDIC insurance


420



(1,472
)Other assets


773



(814
)Accrued expenses and other liabilities


(378
)


613Net cash provided by operating activities


4,560



836Cash flows from investing activities:Proceeds from sales of securities available for sale


6,275



250Purchase of securities held to maturity


(15,767
)


(2,957
)Reinvested dividends on mutual funds


(8
)


(53
)Principal payments received on securities held to maturity


13,843



10,323Purchase of Federal Home Loan Bank stock


-



(174
)Loan originations, net of principal payments


(5,315
)


(18,782
)Proceeds from sale of foreclosed real estate


108



-Additions to premises and equipment


(1,933
)


(4,271
)Proceeds from sales of premises and equipment


-



792Net cash used by investing activities


(2,797
)


(14,872
)
  (continued)
 See accompanying notes to consolidated financial statements.
  F-6
 Index
  Newport Bancorp, Inc. and Subsidiary
  Consolidated Statements of Cash Flows (Concluded)
  Years Ended December 31, 2010 and 2009
  2010


2009(In thousands)Cash flows from financing activities:Net (decrease) increase in deposits


(896
)


32,823Net increase (decrease) in borrowings withmaturities of three months or less


3,000



(4,000
)Proceeds from borrowings with maturities inexcess of three months


8,000



11,500Repayment of borrowings with maturities inexcess of three months


(17,232
)


(11,470
)Purchase of treasury stock


(4,628
)


(5,114
)Net cash (used) provided by financing activities


(11,756
)


23,739Net change in cash and cash equivalents


(9,993
)


9,703Cash and cash equivalents at beginning of year


19,368



9,665Cash and cash equivalents at end of year

$
9,375


$
19,368Supplemental cash flow information:Interest paid on deposit accounts

$
2,606


$
4,274Interest paid on borrowings


4,874



5,274Income taxes paid, net of refunds


1,166



1,102Transfers from loans to foreclosed real estate


225



-
  See accompanying notes to consolidated financial statements.
  F-7
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements
  Years Ended December 31, 2010 and 2009
  1.           SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  Principles of Consolidation
  The consolidated financial statements include the accounts of Newport Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, Newport Federal Savings Bank (the “Bank”).  The Bank has one wholly-owned subsidiary, NewportFed Investments, Inc., which was established to hold certain investments, consisting primarily of commercial mortgages and loans.  All significant intercompany balances and transactions have been eliminated in consolidation.
  Nature of Operations
  The Company provides a variety of financial services to individuals and small businesses through its offices in Newport and Washington County, Rhode Island and Stonington Connecticut.  Its primary deposit products are savings, checking and term certificate accounts, and its primary lending products are residential and commercial mortgage loans.
  Segment Reporting
  Management evaluates the Company’s performance and allocates resources based on a single segment concept.  Accordingly, there are no separately identified operating segments for which discrete financial information is available.  The Company does not derive revenues from, or have assets located in, foreign countries, nor does it derive revenues from any single customer that represents 10% or more of the Company’s total revenues.
  Use of Estimates
  In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of deferred tax assets.
  Reclassification
  Certain amounts in the 2009 consolidated financial statements have been reclassified to conform to the 2010 presentation.
  F-8
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Fair Value Hierarchy
  The Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
  Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
  Level 2 – Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
  Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
  Cash and Cash Equivalents
  Cash and cash equivalents include cash and balances due from banks and short-term investments consisting of federal funds and interest-bearing deposits, all of which mature within ninety days.
  Securities
  Debt securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost.  All other securities are classified as available for sale and recorded at fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income/loss.
  Purchase premiums and discounts are amortized to earnings by the interest method over the terms of the securities.  Gains and losses on disposition of securities are recorded on the trade date and are computed by the weighted average cost method for mutual funds and the specific identification method for other securities.
  F-9
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Securities (concluded)
  Each reporting period, the Company evaluates all securities classified as available-for-sale or held-to-maturity, with a decline in fair value below the amortized cost of the investment to determine whether or not the impairment is deemed to be other-than-temporary (“OTTI”).
  Marketable equity securities are evaluated for OTTI based on the severity and duration of the impairment and, if deemed to be other than temporary, the declines in fair value are reflected in earnings as realized losses.  OTTI is required to be recognized (1) if the Company intends to sell the security; (2) if it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, if the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For impaired debt securities that the Company intends to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI through earnings. Credit-related OTTI for all other impaired debt securities is recognized through earnings. Non-credit related OTTI for such debt securities is recognized in other comprehensive income/loss, net of applicable taxes.
  Federal Home Loan Bank Stock
  The Bank, as a member of the Federal Home Loan Bank (“FHLB”) system, is required to maintain an investment in capital stock of the FHLB.  Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost.  At its discretion, the FHLB may declare dividends on the stock.  The Bank reviews for impairment based on the ultimate recoverability of the cost basis in the FHLB stock.  As of December 31, 2010, no impairment has been recognized.
  Loans
  The Company’s loan portfolio includes residential mortgage, commercial mortgage, construction, commercial and consumer segments.  Residential real estate loans include classes for one-to-four family, multi-family and home equity loans and equity lines of credit.  The Company grants mortgage, commercial and consumer loans to customers.  A substantial portion of the loan portfolio consists of mortgage loans in Newport and Washington County, Rhode Island.  The ability of the Company’s debtors to honor their contracts is dependent upon the economy in general and the real estate and construction economic sectors.
  F-10
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Loans (concluded)
  Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans.  Interest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method over the contractual terms of the loan.
  The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection.  Past due status is based on contractual terms of the loan.  In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
  All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income.  The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
  Allowance for Loan Losses
  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.
  The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
  F-11
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Allowance for Loan Losses (continued)
  The allowance consists of general and allocated loss components, as further described below.
  General component
  The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, construction, commercial and consumer.  Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment.  This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; national and local economic trends and conditions; and risk ratings assigned to loans.  There were no changes in the Company’s policies or methodology pertaining to the general component of the allowance for loan losses during 2010.
  The qualitative factors are determined based on the various risk characteristics of each loan segment.  Risk characteristics relevant to each portfolio segment are as follows:
  Residential mortgage loans – The Company generally does not originate loans with a loan-to-value ratio greater than 95 percent and does not grant subprime loans.  Loans with loan-to-value ratios in excess of 80 percent generally require private mortgage insurance.  All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower.  The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.
  Commercial mortgage loans – Loans in this segment are primarily income-producing properties throughout Newport and Washington County, Rhode Island, and to a lesser extent, other cities and towns in Rhode Island, Connecticut and Massachusetts.  The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment.  Management obtains rent rolls annually and continually monitors the cash flows of these loans.  In addition, for owner-occupied commercial real estate loans, repayment is expected from the cash flows of the owner’s business.  A weakened economy will have an effect on the credit quality of this segment.
  F-12
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Allowance for Loan Losses (continued)
  General component (concluded)
  Construction loans – The Company originates construction loans for one-to-four family homes and commercial, multi-family and other nonresidential purposes. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.
  Commercial loans – Loans in this segment are made to businesses and are generally secured by assets of the business.  Repayment is expected from the cash flows of the business.  A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.
  Consumer loans – The Company offers a variety of consumer and other loans, including auto loans and loans secured by passbook savings or certificate accounts.  Repayment is dependent on the credit quality of the individual borrower.
  Allocated component
  The allocated component relates to loans that are classified as impaired.  Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows (or collateral value, if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan.  Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement.
  A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
  F-13
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Allowance for Loan Losses (concluded)
  Allocated component (concluded)
  The Company periodically may agree to modify the contractual terms of loans.  When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (“TDR”).  All TDRs are initially classified as impaired.
  Transfers of Financial Assets
  Transfers of an entire asset, a group of entire financial assets, or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
  Bank-owned Life Insurance
  Bank-owned life insurance policies are reflected on the consolidated balance sheets at cash surrender value.  Changes in cash surrender value are reflected in non-interest income on the consolidated statements of income and are not subject to income taxes.
  Premises and Equipment
  Land is carried at cost.  Premises and equipment are stated at cost, less accumulated depreciation and amortization, computed on a straight-line method over the estimated useful lives of the assets or the expected terms of the leases, if shorter.  Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured.
  Marketing Costs
  Marketing costs are expensed as incurred.
  Pension Plan
  It is the Company’s policy to fund pension costs in the year of accrual.
  F-14
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Share-based Compensation Plans
  The Company measures and recognizes compensation cost relating to share-based compensation transactions based on the grant-date fair value of the equity instruments issued.  Share-based compensation is recognized over the period the employee is required to provide services for the award.  Reductions in compensation expense associated with forfeited options are estimated at the date of grant, and this estimated forfeiture rate is adjusted quarterly based on actual forfeiture experience.  The Company uses the Black-Scholes option-pricing model to determine the fair value of stock options granted.
  Employee Stock Ownership Plan
  Compensation expense for the Employee Stock Ownership Plan (“ESOP”) is recorded at an amount equal to the shares allocated by the ESOP multiplied by the average fair market value of the shares during the period.  The Company recognizes compensation expense ratably over the year based upon the Company’s estimate of the number of shares expected to be allocated by the ESOP.  Unearned compensation applicable to the ESOP is reflected as a reduction of stockholders’ equity in the consolidated balance sheet.  The difference between the average fair market value and the cost of the shares allocated by the ESOP is recorded as an adjustment to additional paid-in capital.
  Treasury Stock
  Common stock shares repurchased are recorded as treasury stock at cost.
  Income Taxes
  Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method.  Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.  A valuation allowance is established against deferred tax assets when, based upon the available evidence including historical and projected taxable income, it is more likely than not that some or all of the deferred tax assets will not be realized.
  The Company does not have any uncertain tax positions at December 31, 2010 that require accrual or disclosure.  The Company records interest and penalties as part of the income tax provision.  No interest and penalties were recorded for the years ended December 31, 2010 and 2009.
  F-15
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  Income Taxes (concluded)
  Income tax benefits related to stock compensation in excess of grant date fair value less any proceeds on exercise are recognized as an increase to additional paid-in capital upon vesting or exercising and delivery of the stock.  Any income tax effects related to stock compensation that are less than grant date fair value less any proceeds on exercise would be recognized as a reduction of additional paid in capital to the extent of previously recognized income tax benefits and then through income tax expense for the remaining amount.
  Earnings Per Share
  Basic earnings per share (“EPS”) represents net income available to common stockholders divided by the weighted-average number of shares of common stock outstanding during the period.  If rights to dividends on unvested options/awards are non-forfeitable, these unvested awards/options are considered outstanding in the computation of basic earnings per share.  Diluted EPS reflects additional common shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents (stock options and unvested restricted stock with forfeitable dividend rights) were issued during the period.  Treasury shares and unallocated ESOP shares are not deemed outstanding for earnings per share calculations.
  Earnings per common share have been computed based on the following:
  Years Ended December 31,2010


2009(In thousands)Net income applicable to common stock

$
1,800


$
708Weighted average number of common shares issued


4,878



4,878Less:  Weighted average treasury shares


(1,254
)


(878
)Less:  Weighted average unallocated ESOP shares


(273
)


(299
)Add:  Weighted average unvested restricted stockplan shares with non-forfeitable dividend rights


107



146Weighted average number of common shares outstandingused to calculate basic earnings per common share


3,458



3,847Effect of dilutive common stock equivalents


-



-Weighted average number of common shares outstandingused to calculate diluted earnings per common share


3,458



3,847
  F-16
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
  Earnings Per Share (concluded)
  Options for 487,834 and 437,900 shares of common stock were not included in the computation of diluted EPS because they were anti-dilutive for the years ended December 31, 2010 and 2009, respectively.
  Comprehensive Income/Loss
  Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income.  Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income/loss.  There was no tax benefit available on the unrealized losses on the securities available for sale as the losses represented capital losses for which the Company had no capital gain history to offset such losses.
  Recent Accounting Pronouncement
  In July 2010, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2010-20, Receivables (Topic 310), Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  This Update requires an entity to provide disclosures that facilitate financial statement users’ evaluation of (1) the nature of credit risk inherent in the entity’s loan portfolio (2) how that risk is analyzed and assessed in arriving at the allowance for loan and lease losses and (3) the changes and reasons for those changes in the allowance for loan and lease losses.  The Company adopted this Update at December 31, 2010 for the disclosures required as of the end of a reporting period.  The disclosures about activity that occurs during a reporting period are effective for the Company beginning in the quarter ending March 31, 2011.
  2.           RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS
  The Bank is required to maintain average balances on hand or with the Federal Reserve Bank.  At December 31, 2010 and 2009, these reserve balances amounted to $6,410,000 and $6,278,000, respectively.
  F-17
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  3.           SECURITIES
  The amortized cost and estimated fair value of securities, with gross unrealized gains and losses, follows:
  Amortized

Cost


Gross

Unrealized

Gains


Gross

Unrealized

Losses


Fair

Value(In thousands)December 31, 2010Securities Held to MaturityGovernment-sponsoredenterprise residentialmortgage-backed securities

$
47,021


$
2,300


$
(7
)

$
49,314December 31, 2009Securities Available for SaleMutual funds - bond funds

$
6,388


$
104


$
(243
)

$
6,249Securities Held to MaturityGovernment-sponsoredenterprise residentialmortgage-backed securities

$
44,898


$
2,076


$
(34
)

$
46,940
  At December 31, 2010 and 2009, certain mortgage-backed securities were pledged to secure repurchase agreements (see Note 7).
  For the year ended December 31, 2010, proceeds from the sale of securities available for sale amounted to $6,275,000, which realized a gross loss of $267,000 and gross gains of $146,000.  For the year ended December 31, 2009, proceeds from the sale of securities available for sale amounted to $250,000, which realized gross gains of $10,000.
  F-18
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  SECURITIES (concluded)
  Information pertaining to securities with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
  Less Than Twelve Months


Over Twelve MonthsGross





GrossUnrealized


Fair


Unrealized


FairLosses


Value


Losses


Value(In thousands)December 31, 2010Securities Held to MaturityGovernment-sponsoredenterprise residentialmortgage-backed securities

$
7


$
9,785


$
-


$
-December 31, 2009Securities Available for SaleMutual funds - bond funds

$
-


$
-


$
243


$
1,846Securities Held to MaturityGovernment-sponsoredenterprise residentialmortgage-backed securities


34



2,862



-



-Total temporarilyimpaired securities

$
34


$
2,862


$
243


$
1,846
 
 At December 31, 2010, one mortgage-backed security had an unrealized loss with aggregate depreciation of 0.1% from the Company’s amortized cost basis.  Because the decline in fair value is attributable to changes in interest rates and not to credit quality, and because the Company does not intend to sell the investment and it is more likely than not that the Company will not be required to sell the investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider this investment to be other-than-temporarily impaired at December 31, 2010.
  F-19
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  4.           LOANS
  A summary of the balances of loans follows:
  December 31,2010


2009(In thousands)Mortgage loans:Residential:One-to-four family

$
203,893


$
191,154Multi-family


22,540



22,535Equity loans and lines of credit


23,112



25,891Commercial


104,531



104,720Construction


4,948



9,736359,024



354,036Commercial loans


1,638



1,885Consumer loans


288



223Total loans


360,950



356,144Less:  Allowance for loan losses


(3,672
)


(3,467
)Net deferred loan fees


(1,229
)


(1,178
)Loans, net

$
356,049


$
351,499
 
 Loans sold and serviced for others amounted to $6,509,000 and $9,518,000 at December 31, 2010 and 2009, respectively, and have been sold without recourse.
  An analysis of the allowance for loan losses follows:
  Years Ended December 31,2010


2009(In thousands)Balance at beginning of year

$
3,467


$
2,924Provision for loan losses


956



593Loans charged-off


(772
)


(50
)Recoveries of loans previously charged-off


21



-Balance at end of year

$
3,672


$
3,467
  F-20
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  LOANS (continued)
 
 Further information pertaining to the allowance for loan losses and impaired loans at December 31, 2010 follows:
  Residential Mortgages


Commercial Mortgages


Construction


Commercial


Consumer


Total(In thousands)Amount of allowance forloan losses for loansdeemed to be impaired

$
-


$
-


$
-


$
-


$
-


$
-Amount of allowance forloan losses for loans notdeemed to be impaired


1,578



1,976



89



25



4



3,672Loans deemed to be impairedas of December 31, 2010


108



-



-



-



-



108Loans not deemed to be impairedas of December 31, 2010


249,437



104,531



4,948



1,638



288



360,842
 
 The following is a summary of past due and non-accrual loans at December 31, 2010:
 
 30-59 Days Past Due


60-89 Days Past Due


Greater than 90 Days


Total Past Due


Loans on Non-accrual(In thousands)Residential mortgages:One-to-four family

$
220


$
-


$
108


$
328


$
108Multi-family


-



-



-



-



-Equity loans and lines of credit


-



-



-



-



-Commercial mortgages


618



-



-



618



-Construction


-



-



-



-



-Commercial


-



-



-



-



-Consumer


-



-



-



-



-Total

$
838


$
-


$
108


$
946


$
108
  F-21
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  LOANS (continued)
 
 At December 31, 2010 and 2009, the recorded investment and unpaid principal balance of both non-accrual and impaired loans amounted to $108,000 and $860,000, respectively, representing one residential real estate loan and one commercial real estate loan, respectively.  There was no related valuation allowance at December 31, 2010 or 2009.  There were no additional funds committed to be advanced in connection with impaired loans.  For the years ended December 31, 2010 and 2009, the average recorded investment in impaired loans amounted to $980,000 and $72,000, respectively.  There was $32,000 of interest income recognized on impaired loans on the cash basis during 2010.  The Company recognized no interest income on impaired loans during 2009.  At December 31, 2010 and 2009, there were no loans greater than ninety days past due and still accruing interest.
 
 Credit Quality Information:
 
 The Company utilizes a nine grade internal loan rating system for multi-family mortgages, commercial mortgages, construction mortgages and commercial loans as follows:
  Loans rated 1 – 4: Loans in these categories are considered “pass” rated loans with low to average risk.
  Loans rated 5: Loans in this category are considered “watch” loans.  Loans classified as watch are pass rated loans that management is monitoring more closely but remain acceptable credit.
  Loans rated 6: Loans in this category are considered “special mention.”  These loans are starting to show signs of potential weakness and are being closely monitored by management.
  Loans rated 7: Loans in this category are considered “substandard.”  Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged.  There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.
  Loans rated 8: Loans in this category are considered “doubtful.”  Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.
  Loans rated 9: Loans in this category are considered uncollectible (“loss”) and of such little value that their continuance as loans is not warranted.
  F-22
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  LOANS (concluded)
  On a quarterly basis, or more often if needed, the Company formally reviews the ratings on all multi-family residential real estate, commercial real estate, construction and commercial loans. Annually, the Company engages an independent third-party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its review process.
  The following table presents the Company’s loans by risk rating at December 31, 2010:
  Multi-family


Commercial





CommercialMortgages


Mortgages


Construction


Loans(In thousands)Loans rated 1-4

$
18,271


$
80,961


$
1,168


$
1,577Loans rated 5


2,053



13,103



3,382



-Loans rated 6


2,216



7,355



398



61Loans rated 7


-



3,112



-



-Loans rated 8


-



-



-



-Loans rated 9


-



-



-



-
  The Company utilizes a rating scale of pass, special mention, substandard or doubtful for one-to-four family mortgages and equity loans and lines of credit.  On a quarterly basis, or more often if needed, the Company reviews the ratings of these loans and makes adjustments as deemed necessary.  At December 31, 2010, one residential mortgage loan was rated substandard and amounted to $92,000.  All other residential real estate and equity loans and lines of credit were classified as pass at December 31, 2010.
  F-23
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  5.            PREMISES AND EQUIPMENT
  A summary of the cost and accumulated depreciation and amortization and estimated useful lives of premises and equipment follows:
  December 31,


Estimated2010


2009


Useful Life(In thousands)Land

$
3,093


$
3,093



N/ABuilding and improvements


10,019



8,254


20-40 yearsLeasehold improvements


1,244



3,009


10-20 yearsFurniture, fixtures and equipment


3,148



3,254


3-10 yearsConstruction in progress


1,733



35



N/A19,237



17,645Less accumulated depreciationand amortization


(4,760
)


(4,252
)$
14,477


$
13,393
 
 Depreciation and amortization expense for the years ended December 31, 2010 and 2009 amounted to $849,000 and $808,000, respectively.
  At December 31, 2010 and 2009, construction in progress primarily represented costs incurred to date in connection with the re-location of the Westerly, Rhode Island branch, and renovations to the branch office in Wakefield, Rhode Island, which were completed in January 2011.  At December 31, 2010, commitments for construction in progress amounted to $360,000.
  6.            DEPOSITS
  A summary of deposit balances, by type, is as follows:
  December 31,2010


2009(In thousands)Demand

$
37,026


$
34,520NOW


72,842



74,589Money market


51,778



46,991Regular


29,728



26,793Total non-certificate accounts


191,374



182,893Term deposit certificates


69,676



79,053Total deposits

$
261,050


$
261,946
  F-24
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  DEPOSITS (concluded)
  The aggregate amount of time deposit accounts with balances of $100,000 or more amounted to $22,424,000 and $27,392,000 at December 31, 2010 and 2009, respectively.  There were no brokered deposits at December 31, 2010.  Brokered deposits at December 31, 2009 amounted to $1,300,000 and are included in term deposit certificates.
  A summary of certificate accounts is as follows:
  December 31, 2010


December 31, 2009Weighted





WeightedAverage





AverageAmount


Rate


Amount


Rate(Dollars in thousands)Maturing in:2010

$
-



-
%

$
72,569



1.66
%2011


48,216



1.00



3,592



3.252012


10,343



1.65



2,208



3.162013


1,707



2.32



618



3.352014


203



2.35



66



1.842015


9,207



3.00



-



-$
69,676



1.39
%

$
79,053



1.79
%
  7.             BORROWINGS
  Short-term Borrowings
  At December 31, 2010, short-term borrowings consisted of FHLB advances, which mature within one year at a weighted average rate of 0.32%.  There were no short-term borrowings at December 31, 2009.
  The Bank also has an available line of credit with the FHLB at an interest rate that adjusts daily.  Borrowings under the line are limited to 2% of the Bank’s total assets.  At December 31, 2010 and 2009, this line of credit amounted to $3,000,000 and there were no amounts outstanding.
  F-25
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  BORROWINGS (continued)
  Long-term Borrowings
  FHLB Advances:
  Long-term borrowings include the following FHLB advances:
  December 31, 2010


December 31, 2009Weighted





WeightedAverage





AverageAmount


Rate


Amount


Rate(Dollars in thousands)Fixed-rate advances maturing:2010

$
-



-
%

$
17,000



4.44
%2011


8,566



3.54



17,644



3.792012


11,170



4.61



14,324



4.762013*


23,500



3.22



23,500



3.222014


10,500



3.37



10,500



3.372015


20,000



3.37



-



-Thereafter*


18,500



3.81



18,500



3.81$
92,236



3.59
%

$
101,468



3.86
%
 
 * At December 31, 2010, includes advances callable by the FHLB within one year aggregating $35,000,000 with a weighted average rate of 3.34%.
  All FHLB borrowings are secured by a blanket lien on certain qualified collateral, defined principally as 75% of the carrying value of first mortgage loans on owner-occupied residential property, 50% of the carrying value of certain pledged commercial mortgages and 65% of the carrying value of certain pledged multi-family real estate loans.  At December 31, 2010 and 2009, the carrying amount of assets qualifying as collateral for FHLB advances amounted to $204,031,000 and $198,886,000, respectively.
  Repurchase Agreements:
  During 2008, the Company entered into a repurchase agreement for $15,000,000 at a rate of 2.58%.  This agreement matures in November 2013 and is callable on a quarterly basis.
  During 2007, the Company entered into a repurchase agreement for $25,000,000 at a rate of 3.36%, subject to adjustment if 3-month LIBOR exceeds 5.05%.  In November 2009 the rate became fixed at 3.36%.  This agreement matures in November 2012 and is callable on a quarterly basis.
  F-26
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  BORROWINGS (concluded)
  Long-term Borrowings (concluded)
  The amount of securities collateralizing these repurchase agreements remains in securities and the obligation to repurchase securities sold is reflected as a liability in the consolidated balance sheets.  Mortgage-backed securities pledged to secure these agreements have a carrying value of $46,994,000 and $44,865,000 and a fair value of $49,283,000 and $46,902,000 at December 31, 2010 and 2009, respectively.
  8.             INCOME TAXES
  Allocation of federal and state income taxes between current and deferred portions is as follows:
  Years Ended December 31,2010


2009(In thousands)Current tax provision:Federal

$
953


$
903State


1



122954



1,025Deferred tax benefit:Federal


(70
)


(420
)State


45



(3
)(25
)


(423
)Change in valuation allowance


(37
)


227(62
)


(196
)Total tax provision

$
892


$
829
  F-27
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  INCOME TAXES (continued)
  The reasons for the differences between the statutory federal income tax provision and the actual income tax provision are summarized as follows:
  Years Ended December 31,2010


2009(In thousands)Statutory tax provision at 34%

$
915


$
523Increase (decrease) resulting from:State taxes, net of federal tax benefit


30



56Change in valuation allowance


(37
)


227Bank-owned life insurance


(131
)


(136
)Share-based compensation and ESOP Plan


91



120Other


24



39Total tax provision

$
892


$
829
 
 The components of the net deferred tax asset are as follows:
  December 31,2010


2009(In thousands)Deferred tax asset:Federal

$
3,676


$
3,605State


226



2723,902



3,877Valuation allowance


(1,172
)


(1,209
)2,730



2,668Deferred tax liability:Federal


(130
)


(130
)Net deferred tax asset

$
2,600


$
2,538
  F-28
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  INCOME TAXES (continued)
  The tax effects of each item that gives rise to deferred taxes are as follows:
  December 31,2010


2009(In thousands)Allowance for loan losses

$
1,118


$
1,048Depreciation and amortization


54



54Net deferred loan fees


418



401Charitable contribution carryover


965



1,171Stock options and awards


464



451Employee benefit plans


434



339Impairment loss on securities available for sale


-



266Capital loss carryover


304



-Other, net


15



173,772



3,747Valuation allowance


(1,172
)


(1,209
)Net deferred tax asset

$
2,600


$
2,538
 
 At December 31, 2009, the Company has a charitable contribution carryforward in the amount of $2,416,000, which will expire in 2011, if not fully utilized.
  The Company reduces deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  The Company assesses the realizability of its deferred tax assets by (1) reviewing taxable income in allowable federal carry-back periods, and (2) assessing the likelihood of the Company generating federal and state taxable income, as applicable, in future periods in amounts sufficient to offset the deferred tax charges in the periods they are expected to reverse.  Based on this assessment, management concluded that a valuation allowance of $868,000, $943,000 and $742,000 was required at December 31, 2010, 2009 and 2008, respectively, due to the limitation of the charitable contribution deduction.  In addition, as a result of impairment losses on securities available for sale, a valuation allowance of $266,000 and $240,000 was required at December 31, 2009 and 2008, respectively.  The related impaired securities were sold in 2010, creating a capital loss carryover and a related valuation allowance of $304,000 was required at December 31, 2010 as a result of the capital loss carryover.
  F-29
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  INCOME TAXES (concluded)
  The federal income tax reserve for loan losses at the Bank’s base year amounted to $1,032,000.  If any portion of the reserve is used for purposes other than to absorb loan losses, approximately 150% of the amount actually used, limited to the amount of the reserve, would be subject to taxation in the year in which used.  As the Bank intends to use the reserve only to absorb loan losses, a deferred income tax liability of $412,000 has not been provided.
  The Company’s income tax returns are subject to review and examination by federal and state taxing authorities.  The Company is currently open to audit under the applicable statutes of limitations by the Internal Revenue Service for the years ended December 31, 2007 through 2010.  The years open to examination by state taxing authorities vary by jurisdiction; no years prior to 2007 are open.
  9.            STOCKHOLDERS’ EQUITY
  Minimum Regulatory Capital Requirement
  The Bank is subject to various regulatory capital requirements administered by the Office of Thrift Supervision.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s consolidated financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices.  The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.  Federal Savings and Loan Holding Companies are not subject to any regulatory capital requirements by the Office of Thrift Supervision.
  Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Tier 1 and tangible capital (as defined) to adjusted total assets (as defined) and of total and Tier 1 capital to risk-weighted assets (as defined).  Management believes, as of December 31, 2010 and 2009, that the Bank met all capital adequacy requirements to which it was subject.
  F-30
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  STOCKHOLDERS’ EQUITY (continued)
  Minimum Regulatory Capital Requirement (concluded)
  As of December 31, 2010, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage and tangible ratios as set forth in the following table.  There are no conditions or events since that notification that management believes have changed the Bank’s category.  The Bank’s actual capital amounts and ratios as of December 31, 2010 and 2009 are also presented in the table.
  Actual


Minimum

Capital

Requirement


Minimum

To Be Well

Capitalized Under

Prompt Corrective

Action ProvisionsAmount


Ratio


Amount


Ratio


Amount


Ratio(Dollars in thousands)December 31, 2010Total capital to risk weighted assets

$
45,265



15.2
%

$
23,838



8.0
%

$
29,797



10.0
%Tier 1 capital to risk weighted assets


41,654



14.0



11,919



4.0



17,848



6.0Tier 1 capital to adjusted total assets


41,654



9.3



17,964



4.0



22,455



5.0Tangible capital to adjusted total assets


41,654



9.3



6,737



1.5



N/A



N/ADecember 31, 2009Total capital to risk weighted assets

$
42,967



14.1
%

$
24,397



8.0
%

$
30,497



10.0
%Tier 1 capital to risk weighted assets


39,561



13.0



12,199



4.0



18,298



6.0Tier 1 capital to adjusted total assets


39,561



8.6



18,299



4.0



22,873



5.0Tangible capital to adjusted total assets


39,561



8.6



6,862



1.5



N/A



N/A
 
 Other Capital Restrictions
  Federal banking regulations place certain restrictions on dividends paid, stock repurchases and other transactions charged to the capital accounts of the Bank.  Capital distributions in the form of dividends paid to the Bank’s stockholder for any one year may not exceed the Bank’s net income for the year to date plus the Bank’s retained earnings for the preceding two years, without regulatory approval.  Loans or advances are limited to 10 percent of the Bank’s capital stock and surplus on a secured basis.
  F-31
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  STOCKHOLDERS’ EQUITY (concluded)
  Other Capital Restrictions (concluded)
  At December 31, 2010 and 2009, the Bank’s retained net income available for the payment of dividends was $1,826,000 and $1,168,000, respectively.  Accordingly, $39,828,000 and $38,393,000 of the Company’s equity in the net assets of the Bank was restricted at December 31, 2010 and 2009, respectively.  At December 31, 2010 and 2009, funds available for loans or advances by the Bank to the Company amounted to $2,198,000 and $2,034,000, respectively.  In addition, dividends paid would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements.
  Liquidation Account
  As part of the Conversion, the Bank established a liquidation account which was equal to the net worth of the Bank as of the date of the latest consolidated balance sheet appearing in the final prospectus distributed in connection with the Conversion.  The liquidation account will be maintained for the benefit of eligible account holders and supplemental eligible account holders who maintain their accounts at the Bank after the Conversion.  The liquidation account will be reduced annually to the extent that such account holders have reduced their qualifying deposits as of each anniversary date.  Subsequent increases will not restore an account holder’s interest in the liquidation account.  In the event of a complete liquidation, each eligible account holder will be entitled to receive balances for accounts then held.  At December 31, 2010, the balance remaining in the liquidation account amounted to $10,504,000.
  10.           EMPLOYEE BENEFIT PLANS
  Defined Benefit Plan
  The Bank is a participant in the defined benefit plan of the Financial Institutions Retirement Fund.  The Plan is a multi-employer plan whereas the contributions by each bank are not restricted to provide benefits to the employees of the contributing bank.  Each employee reaching the age of 21 and having completed at least 1,000 hours of service in one consecutive twelve-month period, beginning with such employee’s date of employment, automatically becomes a participant in the Plan.  Participants become vested after completion of five years of service measured from their date of hire.  Pension expense under this Plan amounted to $436,000 and $273,000 for the years ended December 31, 2010 and 2009, respectively.
  F-32
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  EMPLOYEE BENEFIT PLANS (continued)
  401(k) Plan
  The Bank offers a 401(k) plan for eligible employees that provides for voluntary contributions by participating employees up to fifty percent of their annual compensation subject to certain limits based on federal tax laws.  Each employee reaching the age of 21 and having completed at least 500 hours of service in one six-month period beginning with such employee’s date of employment, or anniversary thereof, becomes eligible to be a participant in the plan.  The Bank matches the employees’ voluntary contribution up to 3% of their compensation and will match one-half of the next 2%. The Bank’s total contribution for the years ended December 31, 2010 and 2009 amounted to $268,000 and $174,000, respectively.
  Incentive Plan
  The Company has an Incentive Plan (the “Plan”) whereby officers and employees are eligible to receive cash bonuses based upon Company performance against annual established performance targets, including financial measures and other factors, including individual performance.  The structure of the Plan is to be reviewed on an annual basis by the Board of Directors and individual awards are adjusted based on recommendations from the Compensation Committee.  Incentive compensation expense for the years ended December 31, 2010 and 2009 amounted to $351,000 and $210,000, respectively.
  Supplemental Executive and Director Retirement Plans
  The Bank has a Supplemental Executive Retirement Plan, which provides for certain executives of the Bank to receive monthly benefits upon retirement, subject to certain limitations as set forth in the Plan.  The present value of these future benefits is accrued over the executive’s term of service, taking into consideration vesting provisions in these agreements.  The related expense for the years ended December 31, 2010 and 2009 amounted to $143,000 and $228,000, respectively.
  In addition, the Bank has a Supplemental Director Retirement Plan, which provides for certain directors to receive annual benefits upon retirement, subject to certain limitations set forth in the Plan.  The present value of these benefits is accrued over the directors’ required service periods, and the expense for the years ended December 31, 2010 and 2009 amounted to $39,000 and $44,000, respectively.
  The accrued liability for these Plans is included in accrued expenses and other liabilities on the consolidated balance sheets and amounted to $1,273,000 and $1,094,000 at December 31, 2010 and 2009, respectively.
  F-33
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  EMPLOYEE BENEFIT PLANS (continued)
  Endorsement Split-Dollar Life Insurance Arrangements
  The Company is the sole owner of life insurance policies pertaining to certain executives and directors of the Company.  The Company has entered into agreements with these executives whereby the Company will pay to the executives’ estates or beneficiaries a portion of the death benefit that the Company will receive as beneficiary of such policies.  The Company recognized related expense for the years ended December 31, 2010 and 2009 of $45,000 and $29,000, respectively.
  Employee Stock Ownership Plan
  The Company maintains an Employee Stock Ownership Plan (“ESOP”) to provide eligible employees the opportunity to own Company stock.  The Company provided a loan to the Newport Federal Savings Bank Employee Stock Ownership Trust of $3,903,000, which was used to purchase 390,268 shares of the Company’s common stock at a price of $10.00 per share.  The loan bears interest equal to 8.25% and provides for annual payments of interest and principal over the 15-year term of the loan.
  At December 31, 2010, the remaining principal balance on the ESOP debt is payable as follows:
  Years EndingDecember 31,

Amount(In thousands)2011

$
2012012


2182013


2362014


2552015


276Thereafter


1,765$
2,951
 
 The Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loan.  The loan is secured by the shares purchased, which are held in a suspense account until released for allocation to participants, as principal and interest payments are made by the ESOP to the Company.
  F-34
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  EMPLOYEE BENEFIT PLANS (continued)
  Employee Stock Ownership Plan (concluded)
  Shares released are allocated to each eligible participant based on the ratio of each such participant’s compensation, as defined in the ESOP, to the total compensation of all eligible plan participants.  Forfeited shares shall be reallocated among other participants in the Plan.  Cash dividends paid on allocated shares will be distributed, at the direction of the Bank, to participants’ accounts or used to repay the principal and interest on the ESOP loan used to acquire Company stock on which dividends were paid.  Cash dividends on unallocated shares will be used to repay the outstanding debt of the ESOP.
  Shares held by the ESOP include the following:
  December 31,2010


2009Allocated


102,432



78,054Committed to be allocated


26,018



26,018Unallocated


260,178



286,196388,628



390,268
 
 The fair value of unallocated ESOP shares was $3,122,000 and $3,506,000 at December 31, 2010 and 2009, respectively.
  As ESOP shares are earned by the participants, the Company recognizes compensation expense equal to the fair value of the earned ESOP shares during the periods in which they become committed to be released.  Total compensation expense recognized in connection with the ESOP was $310,000 and $305,000 for the years ended December 31, 2010 and 2009, respectively.
  F-35
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  EMPLOYEE BENEFIT PLANS (continued)
  Share-based Compensation Plans
  In accordance with the Company’s 2007 Equity Incentive Plan (the “2007 Plan”), the Company awarded 437,900 stock options and 195,133 shares of restricted stock to eligible participants on October 1, 2007.  The 2007 Plan provides for total awards of 487,834 stock options and 195,133 shares of restricted stock, which left 49,934 stock options available for future awards.  On January 4, 2010, the Company issued the 49,934 remaining stock options to eligible participants. The shares of common stock underlying any awards that are forfeited, cancelled or otherwise terminated (other than by exercise), shares that are tendered or withheld in payment of the exercise price of any award, and shares that are tendered or withheld for tax withholding obligations will be added back to the shares of common stock with respect to which new awards may be granted under the plan.  The exercise price of options granted under the plan is equal to the market value of the underlying common stock on the date of grant.  Stock options and restricted stock granted under the 2007 Plan vest over five years, with the exception of the options granted in 2010, which vest over three years.  The stock options expire no later than ten years from the date of grant.  Upon a change in control (as defined in the plan) or the death or disability of the individual to whom options or shares were awarded, all options and restricted shares awarded immediately vest.
  The fair value of the stock options granted in 2010 was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
  Expected dividends


0.0%Expected term

6 yearsExpected volatility


28.26%Risk-free interest rate


1.35%
 
 The expected volatility is based on historical volatility.  The risk-free interest rate is consistent with the expected term of the awards and is based on the U.S. Treasury yield curve in effect at the time of the grant.  The expected term is based on the average of the vesting period and the full term of the option.  The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.
  F-36
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  EMPLOYEE BENEFIT PLANS (continued)
  Share-based Compensation Plans (continued)
  The following table presents the activity for the 2007 Plan as of and for the year ended December 31, 2010:
  Non-vestedStock Options


Restricted StockNumber

of Shares


Weighted

Average

Exercise

Price


Weighted

Average

Remaining

Contractual

Term

(Years)


Aggregate

Intrinsic

Value


Number

of Shares


Weighted

Average

Grant Date

Fair ValueOutstanding at beginning of year


437,900


$
12.53



6.75


$
-



116,779


$
12.53Granted


49,934



12.25



9.00



-



-



-Vesting of restricted stock


-



-



-



-



(38,927
)


12.53Cancelled (forfeited and expired)


-



-



-



-



-



-Outstanding at end of year


487,834


$
12.50



6.98


$
-



77,852


$
12.53Options exercisable atend of year


279,385


$
12.51



6.88


$
-
  The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $12.00 as of December 31, 2010 which would have been received by the option holders had all option holders exercised their options as of that date.  There were no in-the-money options exercisable as of December 31, 2010, therefore the options have no intrinsic value.  The weighted-average grant date fair value of options granted during the year ended December 31, 2010 was $3.69.  There were no stock options granted during the year ended December 31, 2009.
  F-37
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  EMPLOYEE BENEFIT PLANS (concluded)
  Share-based Compensation Plans (concluded)
  For the years ended December 31, 2010 and 2009, the Company recognized compensation cost for stock options of $350,000 and $490,000, respectively, with a related tax benefit of $28,000 and $47,000, respectively.  For the years ended December 31, 2010 and 2009, the Company recognized compensation cost for restricted stock awards of $341,000 and $567,000, respectively, with a related tax benefit of $116,000 and $192,000, respectively.  The Company is employing an accelerated method of expense recognition for options and restricted stock awards awarded in 2007 and the straight line method for options awarded in 2010.  The estimated amount and timing of future compensation cost (pre-tax) to be recognized for awards to date under the plan is as follows:
  2011


2012


2013


Total(In thousands)Stock options

$
225


$
125


$
6


$
356Restricted stock


189



73



-



262$
414


$
198


$
6


$
618
 
 11.           OTHER COMMITMENTS AND CONTINGENCIES
  In the normal course of business there are outstanding commitments and contingencies which are not reflected in the accompanying financial statements.
  Loan Commitments
  The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit.  Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying balance sheets.
 
 The Company’s exposure to credit loss is represented by the contractual amount of these commitments.  The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
  F-38
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  OTHER COMMITMENTS AND CONTINGENCIES (continued)
  Loan Commitments (concluded)
  At December 31, 2010 and 2009, the following financial instruments were outstanding whose contract amounts represent credit risk:
  2010


2009(In thousands)Commitments to grant loans

$
2,555


$
2,867Unadvanced funds on equity lines of credit


15,143



14,479Unadvanced funds on construction loans


2,510



4,433Unadvanced funds on commercial lines of credit


3,602



3,810
 
 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  The commitments for lines of credit may expire without being drawn upon.  Therefore, the total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each customer’s credit worthiness on a case-by-case basis and the commitments are generally collateralized by real estate, except for commercial lines of credit which are generally secured by business assets or are unsecured.
  Operating Lease Commitments
  Pursuant to the terms of noncancelable lease agreements in effect pertaining to premises, future minimum rent commitments are as follows:
  Years EndingDecember 31,

Amount(In thousands)2011

$
3252012


3482013


3482014


3622015


349Thereafter


5,300$
7,032
 
 The leases contain options to extend for periods from five to fifty years.  The cost of such rentals is not included above.  Total rent expense for the years ended December 31, 2010 and 2009 amounted to $249,000 and $178,000, respectively.
  F-39
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  OTHER COMMITMENTS AND CONTINGENCIES (concluded)
  Employment and Change in Control Agreements
  The Company and the Bank have entered into employment agreements with certain executive officers which provide for a specific salary and continuation of benefits in the event the executive is terminated without cause.  However, such employment may be terminated for cause, as defined, without incurring any continuing obligations.  The agreements also provide for a lump sum severance payment, subject to certain conditions, following a “change in control” as defined in the agreement.  In addition, the Bank has entered into change in control agreements with certain other executive officers which provide for a lump sum severance payment, subject to certain conditions.
  Other Contingencies
  Various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company’s financial position.
  12.           RELATED PARTY TRANSACTIONS
  In the ordinary course of business, the Bank has granted loans to its directors and officers and affiliates.  Activity is as follows:
  Years Ended December 31,2010


2009(In thousands)Balance at beginning of year

$
5,582


$
5,205Originations


362



1,287Principal payments


(751
)


(910
)Balance at end of year

$
5,193


$
5,582
  F-40
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  13.           FAIR VALUE OF ASSETS AND LIABILITIES
  Determination of Fair Value
  The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various assets and liabilities.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the asset or liability.
  The following methods and assumptions were used by the Company in estimating fair value disclosures:
  Cash and cash equivalents:  The carrying amounts of cash and cash equivalents approximate fair values.
  Securities available for sale:  All fair value measurements are obtained from a third party pricing service and are not adjusted by management.  Fair values are based on the net asset values (“NAV”) of the mutual funds.  The NAV is determined based on the fair values of the individual securities within the fund divided by the number of shares outstanding.  The funds’ debt securities are valued at market quotations obtained from independent pricing services, or, for certain securities, a fixed income pricing methodology using factors such as 1) information obtained with respect to market transactions in such securities or comparable securities; (2) the price and extent of public trading in similar securities of the issuer or comparable securities; (3) the fundamental analytical data relating to the investment and; (4) quotations from broker/dealers, yields, maturities, ratings and various relationships between securities.  The valuation process also takes into consideration factors such as interest rate changes, movements in credit spreads, default rate assumptions, prepayment assumptions, type and quality of collateral, and security seasoning.
  Securities held to maturity:  All fair value measurements are obtained from a third party pricing service and are not adjusted by management.  Fair values are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.
  F-41
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  FAIR VALUE OF ASSETS AND LIABILITIES (continued)
  FHLB stock:  The carrying value of FHLB stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank of Boston.
  Loans:  For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  Fair values for other loans are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms, adjusted for credit risk.
  Accrued interest:  The carrying amounts of accrued interest approximate fair values.
  Deposits:  The fair values for non-certificate accounts are, by definition, equal to the amount payable on demand at the reporting date which is the carrying amount.  Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
  Short-term borrowings:  The carrying amounts of short-term borrowings approximate fair value.
  Long-term borrowings:  Fair values of long-term debt are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.
  Off-balance-sheet instruments:  Fair values for off-balance-sheet lending com-mitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  The estimated fair values of off-balance-sheet instruments at December 31, 2010 are immaterial.
  Assets Measured at Fair Value on a Recurring Basis
  There are no assets or liabilities measured at fair value on a recurring basis at December 31, 2010.  There are no liabilities measured at fair value on a recurring basis at December 31, 2009.  Assets measured at fair value on a recurring basis at December 31, 2009 are as follows:
 TotalLevel 1


Level 2


Level 3


Fair Value(In thousands)Securities available for sale

$
-


$
6,249


$
-


$
6,249
  F-42
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  FAIR VALUE OF ASSETS AND LIABILITIES (continued)
  Assets Measured at Fair Value on a Non-recurring Basis
  The Company may also be required, from time to time, to measure certain other assets on a non-recurring basis in accordance with generally accepted accounting principles.  These adjustments to fair value usually result from application of lower-cost-or-market accounting or write-downs of individual assets.  There are no liabilities measured at fair value on a non-recurring basis at December 31, 2010 and 2009.  The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets carried at fair value on a non-recurring basis as of December 31, 2010.  There are no assets recorded on a non-recurring basis at December 31, 2009.  The losses represent the amount of charge-offs recorded during 2010 on the assets held at December 31, 2010.
  
 Level 1


Level 2


Level 3


Total Losses(In thousands)Foreclosed real estate

$
-


$
-


$
100


$
140
 
 Losses on foreclosed real estate are based on the appraised value of the underlying collateral, adjusted for selling costs, and may be discounted based on management's estimates of changes in market conditions from time of valuation.
  F-43
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  FAIR VALUE OF ASSETS AND LIABILITIES (concluded)
  Summary of Fair Value of Financial Instruments
  The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows.  Certain financial instruments and all nonfinancial instruments are exempt from disclosure requirements.  Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.
  December 31,2010


2009Carrying


Fair


Carrying


FairAmount


Value


Amount


Value(In thousands)Financial assets:Cash and cash equivalents

$
9,375


$
9,375


$
19,368


$
19,368Securities available for sale


-



-



6,249



6,249Securities held to maturity


47,021



49,314



44,898



46,940FHLB stock


5,730



5,730



5,730



5,730Loans, net


356,049



364,968



351,499



366,686Accrued interest receivable


1,413



1,413



1,478



1,478Financial liabilities:Deposits


261,050



261,851



261,946



262,584Short-term borrowings


3,000



3,000



-



-Long-term borrowings


132,236



133,866



141,468



142,917Accrued interest payable


535



535



661



661
  F-44
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  14.          CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
  Financial information pertaining only to Newport Bancorp, Inc. is as follows:
  December 31,BALANCE SHEETS

2010


2009(In thousands)ASSETSCash and cash equivalents due from subsidiary

$
2,377


$
7,291Investment in common stock of subsidiary


41,654



39,561Loan to Newport Federal Savings Bank ESOP


2,951



3,137Net deferred tax asset


139



266Other assets


2,597



1,143Total assets

$
49,718


$
51,398LIABILITIES AND STOCKHOLDERS' EQUITYAccrued expenses and other liabilities

$
15


$
7Stockholders' equity


49,703



51,391Total liabilities and stockholders' equity

$
49,718


$
51,398
  Years Ended December 31,STATEMENTS OF INCOME

2010


2009(In thousands)Income:Interest and fees on loans

$
259


$
273Interest on cash and cash equivalents


47



150Total income


306



423Total non-interest expenses


320



339(Loss) income before income taxes and equity inundistributed net income of subsidiary


(14
)


84Applicable income tax (benefit) provision


(169
)


245155



(161
)Equity in undistributed net income of subsidiary


1,645



869Net income

$
1,800


$
708
  F-45
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Continued)
  CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (Concluded)
  Years Ended December 31,STATEMENTS OF CASH FLOWS

2010


2009(In thousands)Cash flows from operating activities:Net income

$
1,800


$
708Adjustments to reconcile net income to net cash (used)provided by operating activities:Equity in undistributed net income of subsidiary


(1,645
)


(869
)Repayment of ESOP loan


186



172Stock-based compensation


34



57Repayment of stock-based compensation by subsidiary


658



1,000Deferred income tax provision


127



189Increase in other assets


(1,454
)


(697
)Increase (decrease) in other liabilities


8



(84
)Net cash (used) provided by operating activities


(286
)


476Cash flows from financing activities:Treasury stock purchased


(4,628
)


(5,114
)Net cash used by financing activities


(4,628
)


(5,114
)Net change in cash and cash equivalents


(4,914
)


(4,638
)Cash and cash equivalents at beginning of year


7,291



11,929Cash and cash equivalents at end of year

$
2,377


$
7,291
  F-46
 Index
  Newport Bancorp, Inc. and Subsidiary
  Notes to Consolidated Financial Statements (Concluded)
  15.          QUARTERLY DATA (UNAUDITED)
 
  Years Ended December 31,2010


2009Fourth


Third


Second


First


Fourth


Third


Second


FirstQuarter


Quarter


Quarter


Quarter


Quarter


Quarter


Quarter


Quarter(In thousands, except per share data)Interest and dividend income

$
5,589


$
5,625


$
5,627


$
5,665


$
5,718


$
5,736


$
5,836


$
5,718Interest expense


1,690



1,811



1,854



1,999



2,106



2,322



2,560



2,559Net interest income


3,899



3,814



3,773



3,666



3,612



3,414



3,276



3,159Provision for loan losses


175



387



80



314



146



160



101



186Net interest income, after provisionfor loan losses


3,724



3,427



3,693



3,352



3,466



3,254



3,175



2,973Impairment loss on available-for-salesecurities


-



-



-



-



-



-



-



(76
)Net gain (loss) on sale ofsecurities available for sale


67



16



13



(217
)


-



10



-



-Other non-interest income


567



590



609



538



589



551



545



511Non-interest expenses (1)


3,278



3,426



3,566



3,417



3,044



3,473



3,574



3,370Income before income taxes


1,080



607



749



256



1,011



342



146



38Provision for income taxes (2)


293



196



248



155



612



117



55



45Net income (loss)

$
787


$
411


$
501


$
101


$
399


$
225


$
91


$
(7
)Earnings per common share:Basic and diluted (3)

$
0.24


$
0.12


$
0.14


$
0.03


$
0.11


$
0.06


$
0.02


$
0.00
 
 (1)
The decrease in the fourth quarter of 2010 and 2009 is due to the decrease in stock-based compensation due to the accelerated method of expense recognition adopted at the inception of the plan on October 1, 2007.
  (2)
The increase in the fourth quarter of 2009 is due to a $200,000 increase in the valuation reserve against deferred tax assets, primarily the charitable contribution carryover, for a change in projected profitability.
  (3)
The total of the four quarters’ earnings per share does not agree to the year-to-date earnings per share due to rounding.




F-47