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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

 

    [X]      

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2010

OR

 

    [    ]        

Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                          to                         

Commission File Number 000-52947

United Financial Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland    74-3242562

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification Number)

95 Elm Street, West Springfield, Massachusetts 01089

(Address of principal executive offices)

Registrant’s telephone number, including area code: (413) 787-1700

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  ¨.

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  ¨    No  ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨

 

Accelerated filer  x

Non-accelerated filer  ¨ (Do not check if a smaller reporting company)  

Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  x.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common stock, $0.01 par value

16,126,308 shares outstanding as of November 3, 2010


Table of Contents

 

United Financial Bancorp, Inc.

INDEX

 

     Page  
PART I. FINANCIAL INFORMATION   

Item 1.

 

Financial Statements

  
  Consolidated Statements of Condition
September 30, 2010 (unaudited) and December 31, 2009
     1   
  Consolidated Statements of Earnings
Three and Nine Months Ended September 30, 2010 and 2009 (unaudited)
     2   
  Consolidated Statements of Stockholders’ Equity and Comprehensive Income
Nine Months Ended September 30, 2010 and 2009 (unaudited)
     3   
  Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2010 and 2009 (unaudited)
     4   
  Notes to Unaudited Consolidated Financial Statements      6   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      21   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      38   

Item 4.

  Controls and Procedures      38   
PART II. OTHER INFORMATION   

Item 1.

  Legal Proceedings      38   

Item 1A.

  Risk Factors      38   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      39   

Item 3.

  Defaults Upon Senior Securities      39   

Item 4.

  [Removed and Reserved]      39   

Item 5.

  Other Information      39   

Item 6.

  Exhibits      40   
SIGNATURES      41   


Table of Contents

 

PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements

UNITED FINANCIAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CONDITION

(Dollars in thousands, except per share amounts)

 

 

     September 30,
2010
     December 31,
2009
 
     (unaudited)      (audited)  

ASSETS

     

Cash and due from banks

     $ 17,273            $ 14,565      

Interest-bearing deposits

     36,349            7,312      
                 

Total cash and cash equivalents

     53,622            21,877      

Short-term investments

     -                1,096      

Securities available for sale, at fair value

     204,451            243,304      

Securities held to maturity, at amortized cost (fair value of $100,438 at September 30, 2010 and $63,063 at December 31, 2009)

     98,752            63,174      

Loans held for sale

     1,020            -          

Loans, net of allowance for loan losses of $9,945 at September 30, 2010 and $9,180 at December 31, 2009

     1,090,779            1,115,416      

Other real estate owned

     1,200            1,545      

Accrued interest receivable

     5,092            5,209      

Deferred tax asset, net

     11,732            11,295      

Stock in the Federal Home Loan Bank of Boston

     15,365            15,365      

Banking premises and equipment, net

     15,454            15,935      

Bank-owned life insurance

     28,844            28,476      

Goodwill

     7,981            7,844      

Other intangible assets

     531            613      

Other assets

     10,070            9,891      
                 

TOTAL ASSETS

     $ 1,544,893            $ 1,541,040      
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

     

Liabilities:

     

Deposits:

     

Interest-bearing

     $ 938,595            $ 884,553      

Non-interest-bearing

     171,022            154,374      
                 

Total deposits

     1,109,617            1,038,927      

Short-term borrowings

     62,127            75,488      

Long-term debt

     129,003            179,988      

Subordinated debentures

     5,425            5,357      

Escrow funds held for borrowers

     2,025            1,977      

Capitalized lease obligations

     5,044            5,141      

Accrued expenses and other liabilities

     9,617            8,916      
                 

Total liabilities

       1,322,858              1,315,794      
                 

Stockholders’ equity:

     

Preferred stock, par value $0.01 per share, authorized 50,000,000 shares; none issued

     -                -          

Common stock, par value $0.01 per share, authorized 100,000,000 shares; 18,706,933 shares issued at September 30, 2010 and December 31, 2009

     187            187      

Paid-in capital

     179,731            178,666      

Retained earnings

     81,425            77,456      

Unearned compensation

     (10,923)           (11,441)     

Treasury stock, at cost (2,536,789 shares at September 30, 2010 and 1,868,335 shares at December 31, 2009)

     (34,105)           (24,980)     

Accumulated other comprehensive income, net of taxes

     5,720            5,358      
                 

Total stockholders’ equity

     222,035            225,246      
                 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

     $ 1,544,893            $ 1,541,040      
                 

See notes to unaudited consolidated financial statements

 

1


Table of Contents

 

UNITED FINANCIAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF EARNINGS (unaudited)

(Dollars in thousands, except per share amounts)

 

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2010     2009     2010     2009  

Interest and dividend income:

       

Loans

    $ 15,406         $ 12,036           $ 46,267           $ 35,808      

Investments

    2,972           3,282           9,386           10,543      

Other interest-earning assets

    17           7           35           24      
                               

Total interest and dividend income

    18,395           15,325           55,688           46,375      

Interest expense:

       

Deposits

    3,501           3,454           10,383           10,923      

Borrowings

    1,727           1,897           5,355           5,780      
                               

Total interest expense

    5,228           5,351           15,738           16,703      

Net interest income before provision for loan losses

    13,167           9,974           39,950           29,672      

Provision for loan losses

    750           800           1,933           2,015      
                               

Net interest income after provision for loan losses

    12,417           9,174           38,017           27,657      

Non-interest income:

       

Fee income on depositors’ accounts

    1,295           1,257           4,006           3,526      

Net gain on sale of loans

    212           -               409           363      

Net (loss) gain on sale of securities

    (189)          -               (189)          461      

Impairment charge on security

    -               -               (145)          -          

Wealth management income

    198           136           503           480      

Income from bank-owned life insurance

    340           372           1,026           1,026      

Other income

    247           220           749           575      
                               

Total non-interest income

    2,103           1,985           6,359           6,431      

Non-interest expense:

       

Salaries and benefits

    6,121           4,625           18,167           13,904      

Occupancy expenses

    830           598           2,557           1,904      

Marketing expenses

    399           337           1,581           1,093      

Data processing expenses

    1,023           877           3,049           2,518      

Professional fees

    431           211           1,330           929      

Merger related expenses

    -               270           1,148           1,431      

FDIC insurance assessments

    365           83           1,105           1,313      

Amortization of intangible assets

    28           6           83           17      

Other expenses

    1,259           1,086           4,085           3,169      
                               

Total non-interest expense

    10,456           8,093           33,105           26,278      

Income before income taxes

    4,064           3,066           11,271           7,810      

Income tax expense

    1,387           1,165           3,910           3,226      
                               

Net income

    $ 2,677           $ 1,901           $ 7,361           $ 4,584      
                               

Earnings per share:

       

Basic

    $ 0.18           $ 0.13           $ 0.48           $ 0.30      

Diluted

    $ 0.18           $ 0.13           $ 0.48           $ 0.30      

Weighted average shares outstanding:

       

Basic

    15,131,682           14,997,836           15,395,113           15,293,117      

Diluted

    15,223,597           15,004,694           15,466,693           15,303,060      

Dividends paid per share

    $ 0.08           $ 0.07           $ 0.22           $ 0.21      

See notes to unaudited consolidated financial statements.

 

2


Table of Contents

 

UNITED FINANCIAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME (unaudited)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 and 2009

(Dollars in thousands, except per share amounts)

 

 

    Common
Shares
Outstanding
    Common
Stock
    Paid-In
Capital
    Retained
Earnings
    Unearned
Compensation
    Treasury
Stock
    Accumulated
Other
Comprehensive
Income
    Total  

Balances at December 31, 2008

    17,501,949           $ 178             $ 164,358           $ 75,888           $ (12,144)          $ (3,497)           $ 2,931          $ 227,714     

Noncredit-related OTTI (1)

    -               -               -               337           -              -              (337)          -           

Net income

    -               -               -               4,584           -              -              -              4,584      

Other comprehensive income

    -               -               -               -             -              -              2,800           2,800      
                     

Total comprehensive income

                  7,384      
                     

Cash dividends paid ($0.21 per share)

    -              -               -               (3,200)        -              -              -              (3,200)     

Treasury stock purchases

    (1,311,979)          -               -               -             -              (17,697)           -              (17,697)     

Shares repurchased in connection with restricted stock forfeited for tax purposes

    (20,923)          -               -               -             -              (271)           -              (271)     

Tax benefit from MRP vesting

    -               -               33           -             -              -              -              33      

Reissuance of treasury shares in connection with restricted stock grants

    398            -               (5)          -             -              5            -              -          

Stock-based compensation

    -               -               1,753           -             -              -              -              1,753      

ESOP shares committed to be released

    -               -               187           -             531           -              -              718      
                                                               

Balances at September 30, 2009

    16,169,445           $ 178           $ 166,326           $ 77,609           $ (11,613)          $ (21,460)           $ 5,394          $ 216,434      
                                                               

Balances at December 31, 2009

    16,838,598           $ 187           $ 178,666           $ 77,456           $ (11,441)          $ (24,980)           $ 5,358           $ 225,246     

Net income

    -               -               -               7,361           -             -             -              7,361      

Other comprehensive income

    -               -               -               -              -             -             641           641      

Prior service costs on pension and other post retirement benefit plans

    -               -               -               -              -             -             (279)          (279)     
                     

Total comprehensive income

                  7,723      
                     

Cash dividends paid ($0.22 per share)

    -               -               -               (3,392)          -             -             -              (3,392)     

Treasury stock purchases

    (718,450)          -               -               -              -             (9,747)           -              (9,747)     

Shares repurchased in connection with restricted stock forfeited for tax purposes

    (26,958)          -               -               -              -             (384)           -              (384)     

Tax benefit from MRP vesting

    -               -               107           -              -             -             -              107      

Tax withheld on options exercised

    -               -               (29)          -              -             -             -              (29)     

Reissuance of treasury shares in connection with restricted stock grants

    76,954           -               (1,006)          -              -             1,006           -              -          

Stock-based compensation

    -               -               1,810           -              -             -             -              1,810      

ESOP shares committed to be released

    -               -               183           -              518           -             -              701      
                                                               

Balances at September 30, 2010

      16,170,144           $ 187           $ 179,731           $   81,425           $ (10,923)          $   (34,105)           $ 5,720          $   222,035     
                                                               

 

  (1)

As required by the Recognition and Presentation of Other-Than-Temporary Impairments (“OTTI”) Topic of FASB ASC, reflects noncredit-related OTTI on securities not expected to be sold in other comprehensive income (loss), effective April 1, 2009.

The components of other comprehensive income and related tax effects are as follows:

 

     Nine Months Ended September 30,  
     2010      2009  

Change in unrealized holding gains on available-for-sale securities

     $ 744         $ 5,002   

Reclassification adjustment for losses (gains) realized in income

     334         (461)   
                 

Net change in unrealized gains

     1,078         4,541   

Tax effect

     (437)         (1,741)   
                 
     641         2,800   
                 

Pension liability for retirement plans

     (332)         -   

Pension liability adjustment

     (44)         -   
                 

Net change in pension liability

     (376)         -   

Tax effect

     97         -   
                 
     (279)         -   
                 

Other comprehensive income

     $ 362         $ 2,800   
                 

See notes to unaudited consolidated financial statements.

 

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UNITED FINANCIAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 and 2009

(Dollars in thousands)

 

 

     2010      2009  

Cash flows from operating activities:

     

Net income

     $ 7,361         $ 4,584   

Adjustments to reconcile net income to net cash provided by operating activities:

     

Provision for loan losses

       1,933         2,015   

ESOP expense

       701         718   

Stock-based compensation

       1,810         1,753   

Tax benefit from MRP vesting

     (107)         (33)   

Amortization of premiums and discounts

     891         262   

Depreciation and amortization

     1,049         793   

Amortization of intangible assets

     83         17   

Provision for other real estate owned

     -         55   

Net (gain) loss on sale of other real estate owned

     (121)         27   

Impairment charges on securities

     145         -   

Net loss (gain) on sale of securities

     189         (461)   

Loans originated for sale

     (11,978)         (16,018)   

Proceeds from sales of loans held for sale

     11,278         16,381   

Net gain on sale of loans

     (409)         (363)   

Net increase in cash surrender value of bank-owned life insurance

     (368)         (970)   

Decrease in accrued interest receivable

     117         222   

Increase in other assets

     (1,141)         (4,982)   

Increase (decrease) in accrued expenses and other liabilities

     631         (3,135)   
                 

Net cash provided by operating activities

     12,064         865   

Cash flows from investing activities:

     

Purchases of securities available for sale

     (20,634)         (4,599)   

Proceeds from sales of securities available for sale

     2,871         24,386   

Proceeds from maturities, calls and principal repayments of securities available for sale

     57,119         57,897   

Purchases of securities held to maturity

     (48,140)         (38,856)   

Proceeds from maturities, calls and principal repayments of securities held to maturity

     12,055         1,472   

Decrease (increase) in investment in short term time deposits

     1,096         (20)   

Proceeds from sales of other real estate owned

     1,680         514   

Net loan originations, purchases and principal repayments

     11,768         (30,828)   

Proceeds from sales of loans

     9,725         13,637   

Purchases of property and equipment

     (569)         (586)   

Cash paid to acquire Levine Financial Group

     -         (92)   
                 

Net cash provided by investing activities

     26,971         22,925   

(Continued)

 

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UNITED FINANCIAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 and 2009 (Concluded)

(Dollars in thousands)

 

 

     2010      2009  

Cash flows from financing activities:

     

Net increase in deposits

     70,690         57,662   

Net change in short-term borrowings

     (41,757)         (39,912)   

Repayment of long-term debt

     (22,521)         (21,222)   

Net increase in escrow funds held for borrowers

     48         463   

Payments on capitalized lease obligations

     (305)         (240)   

Tax benefit from MRP vesting

     107         33   

Tax withheld on options exercised

     (29)         -   

Treasury stock purchases

     (10,131)         (17,968)   

Cash dividends paid

     (3,392)         (3,200)   
                 

Net cash used in financing activities

     (7,290)         (24,384)   
                 

Increase (decrease) in cash and cash equivalents

     31,745         (594)   

Cash and cash equivalents at beginning of period

     21,877         13,572   
                 

Cash and cash equivalents at end of period

     $ 53,622         $ 12,978   
                 

Supplemental Disclosure of Cash Flow Information:

     

Cash paid during the period:

     

Interest on deposits, borrowings and other interest bearing liabilities

     $ 17,014         $ 11,341   

Income taxes – net

     3,786         9,680   

Non-cash items:

     

Capitalized lease assets and obligations

     -         2,119   

Transfer of loans to other real estate owned

     1,161         123   

See notes to unaudited consolidated financial statements.

 

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UNITED FINANCIAL BANCORP, INC. AND SUBSIDIARY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

Dollars in Thousands (except per share amounts)

 

 

NOTE A – BASIS OF PRESENTATION

The consolidated financial statements include the accounts of United Financial Bancorp, Inc. and its wholly-owned subsidiary, United Bank (the “Bank”). UCB Securities, Inc. is a subsidiary of the Bank and is engaged in the buying, selling and holding of securities. UB Properties, LLC is a subsidiary of the Bank formed to hold real estate assets acquired through foreclosure. All significant intercompany accounts and transactions have been eliminated in consolidation. These entities are collectively referred to herein as the “Company”.

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices within the banking industry. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, which are necessary for the fair presentation of the Company’s financial condition as of September 30, 2010 and the results of operations for the three and nine months ended September 30, 2010 and 2009. The interim results of operations presented herein are not necessarily indicative of the results to be expected for the entire year or any other period. These financial statements should be read in conjunction with the consolidated financial statements and the notes thereto for the year ended December 31, 2009 included in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 12, 2010.

NOTE B – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In August 2009, the FASB issued Accounting Standard Update 2009-05 (ASU 2009-05) “Measuring Liabilities at Fair Value”, in accordance with and as required by the Fair Value Measurements and Disclosures Topic of FASB ASC. This ASU was issued in response to the credit crisis and will reduce potential differences in measuring liabilities at fair value and thus promote comparability of companies’ financial statements. This update is effective for interim and fiscal periods beginning after October 1, 2009. The adoption of ASU 2009-05 on January 1, 2010 had no material effect on the Company’s Consolidated Financial Statements.

In January 2010, the FASB issued Accounting Standard Update 2010-06 (ASU 2010-06) “Improving Disclosures about Fair Value Measurements”, in accordance with and as required by the Fair Value Measurements and Disclosures Topic of FASB ASC. This ASU was issued in response to the recommendations of a number of constituents that the FASB improve disclosure requirements related to Fair Value Measurements and Disclosures. This update is effective for interim and fiscal periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. The adoption of this new guidance has been applied to the Company’s Consolidated Financial Statements as disclosed in Note M. The disclosure exceptions are effective for fiscal years beginning after December 15, 2010, and for the interim periods within those fiscal years. The adoption of ASU 2010-06 disclosure provisions effective for the Company on January 1, 2010 had no material effect on the Company’s Consolidated Financial Statements.

 

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In February 2010, the FASB issued Accounting Standard Update 2010-09 (ASU 2010-09) “Amendments to Certain Recognition and Disclosure Requirements”, in accordance with and as required by the Subsequent Events Topic of FASB ASC 855. This ASU was issued in response to a number of constituents informing the FASB that the requirements to disclose the date that the financial statements are issued potentially conflict with existing Securities and Exchange Commission’s (SEC) guidance. This update provides that an entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This change alleviates potential conflicts between FASB ASC 855 and the SEC’s requirements. The adoption of this new guidance has been applied to the Company’s Consolidated Financial Statements as disclosed in Note O.

In July 2010, the FASB issued Accounting Standard Update 2010-20 (ASU 2010-20) “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”, which amends the authoritative accounting guidance in accordance with and as required by the Receivables Topic of FASB ASC 310. The ASU is intended to provide financial statement users with greater transparency about an entity’s allowance for loan losses and the credit quality of its loan portfolio. Under the new guidelines, the allowance for loan losses and fair value are to be disclosed by portfolio segment, while credit quality information, impaired loans and non-accrual status are to be presented by class of loans. Disclosure of the nature and extent, the financial impact and segment information of troubled debt restructurings will also be required. The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the loan portfolio’s risk and performance. This guidance is effective for interim and annual reporting periods ending on or after December 15, 2010. The Company is evaluating the impact the adoption of ASU 2010-20 will have on its financial statements.

NOTE C – CRITICAL ACCOUNTING POLICIES

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses, the evaluation of the investment portfolio for other-than-temporary impairment (“OTTI”), income taxes, goodwill and identifiable intangible assets and fair value of financial instruments.

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover credit losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for changes in the economic environment that could result in adjustments to the amount of the recorded allowance for loan losses.

As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties. Inaccurate assumptions could significantly affect the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans.

Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, loss experience, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change based on, among other things, changes in economic and real estate market conditions.

 

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The allowance has a specific and general component. The specific component relates to loans that are delinquent or otherwise identified as potential problem loans through the application of our loan review process and our loan grading system. All such loans are evaluated individually, with principal consideration given to the value of the collateral securing the loans. Specific allowances are established as required by this analysis. The general component is determined by segregating the remaining loans by type of loan, credit grade and payment history. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations in establishing factors that are applied to the loan groups to determine the amount of the general component of the allowance for loan losses.

Although management uses available information to establish the appropriate level of the allowance for loan losses, future additions or reductions to the allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. As a result, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect the Company’s operating results. In addition, the Office of Thrift Supervision, our primary federal regulator, as an integral part of its examination process, periodically reviews the Company’s allowance for loan losses. Such an agency may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination.

Evaluation of the Investment Portfolio for Other-Than-Temporary Impairment. The evaluation of the investment portfolio for other-than-temporary impairment is also a critical accounting estimate. In evaluating the investment portfolio for other-than-temporary impairment, management considers the issuer’s credit rating, credit outlook, payment status and financial condition, the length of time the security has been in a loss position, the size of the loss position, our intent and ability to hold the securities to expected recovery of value and other meaningful information. If a decline in the fair value of an investment security below its cost is judged to be other-than-temporary, the cost basis of the investment security is written down to fair value as a new cost basis and the amount of the credit related impairment write-down is included in the results of operations and the non-credit related impairment for securities not expected to be sold is recognized in other comprehensive income (loss). A number of factors or combinations of factors could cause us to conclude in one or more future reporting periods that an unrealized loss that exists with respect to these securities constitutes an impairment that is other than temporary. These factors include, but are not limited to, failure to make scheduled principal and/or interest payments, an increase in the severity of the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions and/or industry or issuer specific factors that would render us unable to forecast a full recovery in value.

Income Taxes. The Company uses the asset and liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax bases of the Company’s asset and liabilities. The realization of the net deferred tax asset generally depends upon future levels of taxable income and the existence of prior years’ taxable income, to which “carry back” refund claims could be made. A valuation allowance is maintained for deferred tax assets that management estimates are more likely than not to be unrealizable based on available evidence at the time the estimate is made. At September 30, 2010 and December 31, 2009, the Company has not recorded a valuation allowance. Significant management judgment is required in determining income tax expense and deferred tax assets and liabilities. In determining the need for a valuation allowance, the Company uses historical and forecasted future operating results, based upon approved business plans, including a review of the eligible carryforward periods, tax planning opportunities and other relevant considerations. These underlying assumptions can change from period to period. For example, tax law changes or variances in future projected operating performance could result in a change in the valuation allowance. Should actual factors and conditions differ materially from those considered by management, the actual realization of the net deferred tax asset could differ materially from the amounts recorded in the financial statements. If the Company is not able to realize all or part of our net deferred tax asset in the future, any establishment of a deferred tax asset valuation allowance would be charged to income tax expense in the period such determination was made.

 

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Goodwill and Identifiable Intangible Assets. Goodwill and identifiable intangible assets are recorded as a result of business acquisitions and combinations. These assets are evaluated for impairment annually or whenever events or changes in circumstances indicate the carrying value of these assets may not be recoverable. If the carrying amount exceeds fair value, an impairment charge is recorded to income. The fair value is based on observable market prices, when practicable. Other valuation techniques may be used when market prices are unavailable, including estimated discounted cash flows and market multiples analyses. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies. In the event of future changes in fair value, the Company may be exposed to an impairment charge that could be material.

Fair Valuation of Financial Instruments. The Company uses fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, or to establish a loss allowance or write-down based on the fair value of impaired assets. Further, the notes to financial statements include information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. Additionally, for financial instruments not recorded at fair value, the notes to financial statements disclose the estimate of their fair value. Due to the judgments and uncertainties involved in the estimation process, the estimates could result in materially different results under different assumptions and conditions.

NOTE D – EARNINGS PER SHARE

Earnings per share (“EPS”) have been computed as required by the Earnings Per Share Topic of FASB ASC. Basic earnings per share have been calculated by dividing net income by weighted average shares outstanding before any dilution and are adjusted to exclude the weighted average number of unallocated shares held by the Bank’s employee stock ownership plan (the “ESOP”). Diluted earnings per share have been calculated by dividing net income by weighted average shares outstanding after giving effect to the potential dilution that could occur if potential common shares were converted into common stock using the treasury stock method because there is no difference under the two-class method.

The calculation of basic and diluted earnings per common share for the periods indicated is presented below.

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2010     2009     2010     2009  

Net income (in thousands)

    $ 2,677          $ 1,901          $ 7,361          $ 4,584     
                               

Weighted average common shares applicable to basic EPS

      15,131,682            14,997,836            15,395,113            15,293,117     

Effect of dilutive potential common shares (1) (2)

      91,915            6,858            71,580            9,943     
                               

Weighted average common shares applicable to diluted EPS

      15,223,597            15,004,694            15,466,693            15,303,060     
                               

Earnings per share:

       

Basic

    $ 0.18          $ 0.13          $ 0.48          $ 0.30     

Diluted

    $ 0.18          $ 0.13          $ 0.48          $ 0.30     

 

(1)

Options to purchase 1,443,222 and 1,302,863 shares for three months ended September 30, 2010 and 2009, respectively, and 1,436,457 and 1,302,863 shares for nine months ended September 30, 2010 and 2009, respectively, were outstanding but not included in the computation of earnings per share because they were antidilutive.

(2)

Includes incremental shares related to dilutive stock options.

 

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NOTE E – INVESTMENT SECURITIES

The amortized cost and fair value of securities classified as available for sale and held to maturity are as follows:

 

       Amortized  
Cost
     Unrealized        Fair Value    
        Gains          Losses         

Securities Available for Sale

           

September 30, 2010:

           

Debt Securities:

           

Government-sponsored enterprises

     $ 10,270           $ 43           $ -             $ 10,313     

Government-sponsored and government-guaranteed mortgage-backed securities

     170,950           9,719           (1)           180,668     

Private label mortgage-backed securities

     3,350           113           (15)           3,448     

Municipal bonds

     7,760           446           (23)           8,183     

Corporate bonds

     1,450           389           -             1,839     
                                   

Total

     $ 193,780           $     10,710           $ (39)           $     204,451     
                                   

December 31, 2009:

           

Debt Securities:

           

Government-sponsored enterprises

     $ 342           $ 11           $ -             $ 353     

Government-sponsored and government-guaranteed mortgage-backed securities

     215,819           9,216           (199)           224,836     

Private label mortgage-backed securities

     4,999           97           (60)           5,036     

Municipal bonds

     11,004           189           (260)           10,933     

Corporate bonds

     1,449           279           (16)           1,712     
                                   

Subtotal

     233,613           9,792           (535)           242,870     

Marketable equity securities

     97           337           -             434     
                                   

Total

     $ 233,710           $ 10,129           $ (535)           $ 243,304     
                                   
     Amortized
Cost
     Unrealized      Fair Value  
        Gains      Losses     

Securities Held to Maturity

           

September 30, 2010:

           

Government-sponsored and government-guaranteed mortgage-backed securities

     $ 89,370           $ 1,478           $ (58)           $ 90,790     

Private label mortgage-backed securities

     494           5           -             499     

IRB

     1,026           -             -             1,026     

State of Israel bonds

     150           -             -             150     

Municipal bonds

     7,712           261           -             7,973     
                                   

Total

     $ 98,752           $ 1,744           $ (58)           $ 100,438     
                                   

December 31, 2009:

           

Government-sponsored and government-guaranteed mortgage-backed securities

     $ 53,769           $ 180           $ (418)           $ 53,531     

Private label mortgage-backed securities

     737           13           -             750     

IRB

     1,039           -             -             1,039     

State of Israel bonds

     150           -             -             150     

Municipal bonds

     7,479           114           -             7,593     
                                   

Total

     $ 63,174           $ 307           $ (418)           $ 63,063     
                                   

 

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The scheduled maturities of debt securities available for sale and held to maturity at September 30, 2010 are shown below. Actual maturities will differ from contractual maturities because issuers generally have the right to call or prepay obligations with or without call or prepayment penalties.

 

     At September 30, 2010  
     Securities
Available for Sale
     Securities
Held to Maturity
 
       Amortized  
Cost
     Fair Value      Amortized
Cost
       Fair Value    

Due in one year or less

     $ 123           $ 124           $ 130           $ 130     

Due from one year to five years

     7,858           8,094           940           987     

Due from five years to ten years

     29,383           30,766           16,032           16,512     

Due after ten years

     156,416           165,467           81,650           82,809     
                                   
     $ 193,780           $   204,451           $   98,752           $ 100,438     
                                   

The Company’s portfolio of mortgage-backed securities, which represent interests in pools of residential mortgage loans, consists primarily of securities issued by the Federal Home Loan Mortgage Corporation (Freddie Mac), the Federal National Mortgage Association (Fannie Mae), and the Government National Mortgage Association (Ginnie Mae), all of which are federal government owned or sponsored enterprises. The Company also owns $3.9 million of private label residential mortgage-backed securities as a result of its acquisition of CNB Financial Corp. on November 30, 2009.

Gross unrealized losses and fair values at September 30, 2010 and December 31, 2009 aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position follow:

 

    Less than 12 months     12 months or longer     Total  
    Fair Value     Unrealized
Losses
    Fair Value     Unrealized
Losses
    Number of
Securities
    Fair Value     Unrealized
Losses
 

At September 30, 2010:

             

Securities Available for Sale

  

           

Debt Securities:

             

Government-sponsored and government-guaranteed mortgage-backed securities

    $ 3,091          $ (1)         $ -            $ -            2          $ 3,091          $ (1)    

Private label mortgage-backed securities

    957          (15)         -            -            1          957          (15)    

Municipal bonds

    -            -            267          (23)         1          267          (23)    
                                                       

Total

    $ 4,048          $ (16)         $ 267          $ (23)         4          $ 4,315          $ (39)    
                                                       

Securities Held to Maturity

  

           

Government-sponsored and government-guaranteed mortgage-backed securities

    $ 19,637          $ (58)         $ -            $ -            5          $ 19,637          $ (58)    
                                                       

Total

    $     19,637          $ (58)         $ -            $ -            5          $ 19,637          $ (58)    
                                                       

 

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    Less than 12 months     12 months or longer     Total  
    Fair Value     Unrealized
Losses
    Fair Value     Unrealized
Losses
    Number  of
Securities
    Fair Value     Unrealized
Losses
 

At December 31, 2009:

             

Securities Available for Sale

             

Debt Securities:

             

Government-sponsored and government-guaranteed mortgage- backed securities

   $ 14,428        $ (197)        $ 1,068        $ (2)         16        $ 15,496        $ (199)    

Private label mortgage-backed securities

    2,301         (60)         -           -                   2,301         (60)    

Municipal bonds

    2,076         (166)         935         (94)                3,011         (260)    

Corporate bonds

    -             -             308         (16)                308         (16)    
                                                       

Total

   $ 18,805        $ (423)        $   2,311        $     (112)         28        $ 21,116        $ (535)    
                                                       

Securities Held to Maturity

             

Government-sponsored and government-guaranteed mortgage- backed securities

   $   36,742        $     (418)        $ -          $ -            15        $   36,742        $ (418)    
                                                       

Total

   $ 36,742        $ (418)        $ -          $ -            15        $ 36,742        $     (418)    
                                                       

Management has determined that no declines in the fair value of the Company’s securities portfolio are deemed to represent an other-than temporary impairment as of September 30, 2010. In its evaluation, management considered the types of securities, including if the securities were U.S. Government issued, the credit rating on the securities, credit outlook, payment status and financial condition, the length of time the security has been in a loss position, the size of the loss position, our intent and ability to hold the securities to expected recovery of value and other meaningful information. The Company does not intend to sell any debt securities and is unlikely to be required to sell any security before its maturity or market price recovery.

NOTE F – LOANS

The components of the loan portfolio were as follows at September 30, 2010 and December 31, 2009:

 

         September 30,    
2010
         December 31,    
2009
 

Residential mortgages

     $ 307,467           $ 343,300     

Commercial mortgages

     433,250           409,680     

Construction

     35,522           48,808     

Home equity

     140,382           137,371     

Commercial and industrial

     161,482           159,437     

Automobile

     11,960           14,729     

Consumer

     8,353           8,916     
                 

Total loans

     1,098,416           1,122,241     

Net deferred loan costs and fees

     2,308           2,355     

Allowance for loan losses

     (9,945)          (9,180)    
                 

Loans, net

     $       1,090,779           $       1,115,416     
                 

 

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NOTE G – NON-PERFORMING ASSETS

The table below sets forth the amounts and categories of non-performing assets at September 30, 2010 and December 31, 2009:

 

       September 30,  
2010
      December 31,  
2009
 

Non-accrual loans:

    

Residential mortgages

     $ 1,491          $ 1,190     

Commercial mortgages

     2,764   (1)      10,717     

Construction

     4,299          3,280     

Home equity

     301          492     

Commercial and industrial

     2,772          571     

Automobile

     -              4     

Other consumer

     32          33     
                

Total non-accrual loans

     11,659          16,287     

Other real estate owned

     1,200          1,545     
                

Total non-performing assets

     $ 12,859          $ 17,832     
                

Accruing troubled debt restructuring

     $ 3,487   (2)      $ -           

Ratios:

    

Total non-accrual loans to total loans

     1.06%         1.45%    

Total non-performing assets to total assets

     0.83%         1.16%    

(1) Includes an $860,000 troubled debt restructure commercial mortgage loan which was restructured in the second quarter of 2010. There were no additional commitments to this borrower. There were no troubled debt restructured loans added during the third quarter of 2010.

(2) Represents a commercial mortgage loan which was restructured in the first quarter of 2010 and was returned to accrual status at June 30, 2010 as the customer has been current on the new payments for six months.

NOTE H – FAIR VALUE OF IMPAIRED LOANS ACQUIRED

Loans acquired with evidence of credit quality deterioration since origination and for which it is probable at purchase that the Company will be unable to collect all contractually required payments are accounted for as required by and in accordance with the Receivables Topic of FASB ASC, “Loans and Debt Securities Acquired with Deteriorating Credit Quality” (ASC 310). Evidence of credit quality deterioration as of the purchase date may include statistics such as past due status, refreshed borrower credit scores and refreshed loan-to-value (LTV), some of which are not immediately available as of the purchase date. The Company continues to evaluate this information and other credit-related information as it becomes available. ASC 310 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from the Company’s initial investment in loans if those differences are attributable, at least in part, to credit quality.

 

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The initial fair values for loans within the scope of ASC 310 are determined by discounting both principal and interest cash flows expected to be collected using an observable discount rate for similar instruments with adjustments that management believes a market participant would consider in determining fair value. The Company estimates the cash flows expected to be collected at acquisition using internal credit risk, interest rate and prepayment risk models that incorporate management’s best estimate of current key assumptions, such as default rates, loss severity and payment speeds.

As of November 30, 2009, the CNB Financial Corp. commercial loans acquired by the Company within the scope of ASC 310 had an unpaid principal balance of $5.2 million and a fair value of $3.1 million. At September 30, 2010, the unpaid principal balance on these commercial loans was $4.7 million and the carrying value on these loans was $2.4 million. During the third quarter of 2010, the Company increased its non-accretable difference, with a corresponding increase to goodwill, by $250,000 to $2.3 million based upon recently obtained information about conditions existing at the acquisition date. As a result, the Company’s estimated fair value of impaired loans at acquisition was adjusted to $2.8 million. The following table provides details on loans obtained in connection with the CNB Financial acquisition within the scope of ASC 310.

 

Acquired loan information for CNB Financial:

  

As of November 30, 2009:

  

Contractually required payments

     $             5,178     

Less: Nonaccretable difference

     (2,099)    
        

Cash flows expected to be collected (1)

     3,079     

Less: Accretable yield

     (13)    
        

Fair value of loans acquired

     $ 3,066     
        

 

  (1)  

The Bank has not factored any prepayments into the expected cash flows.

Under ASC 310, the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. Changes in the expected cash flows from the date of acquisition will either impact the accretable yield or result in a charge to the provision for credit losses. Subsequent decreases to expected principal cash flows will result in a charge to provision for credit losses and a corresponding increase to allowance for loan losses. Subsequent increases in expected principal cash flows will result in recovery of any previously recorded allowance for loan losses, to the extent applicable, and a reclassification from nonaccretable difference to accretable yield for any remaining increase. All changes in expected interest cash flows will result in reclassifications to/from nonaccretable differences. There were no changes in expected cash flows from the date of acquisition that resulted in adjustments to the accretable or nonaccretable differences or provision for credit losses.

Loans in the ASC 310 population that are modified subsequent to acquisition are reviewed to compare modified contractual cash flows to the ASC 310 carrying value. If modified cash flows are lower than the carrying value, the loan is removed from the ASC 310 pool at its carrying value, as well as the related allowance for loan losses, and classified as a troubled debt restructure. At September 30, 2010 the Company did not have any troubled debt restructured acquired loans.

 

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NOTE I – ALLOWANCE FOR LOAN LOSSES

A summary of the activity in the allowance for loan losses is as follows:

 

     For the Nine Months Ended
September 30,
 
     2010      2009  

Balance at beginning of period

     $ 9,180           $ 8,250     

Provision for loan losses

     1,933           2,015     

Charge-offs:

     

Residential mortgages

     (1)          (21)     

Commercial mortgages

     (458)          (442)     

Construction

     (203)          (135)    

Home equity

     (101)          -          

Commercial and industrial

     (494)          (243)     

Automobile

     (3)          (5)     

Other consumer

     (15)          (1)     
                 

Total charge-offs

     (1,275)          (847)     

Recoveries:

     

Commercial mortgages

     96           5     

Commercial and industrial

     11           71     

Automobile

     -               3     
                 

Total recoveries

     107           79     

Net charge-offs

     (1,168)          (768)    
                 

Balance at end of period

     $ 9,945           $ 9,497     
                 

Ratios:

     

Net charge-offs to average loans outstanding (annualized)

     0.14%         0.12%   

Allowance for loan losses to non-accrual loans at end of period

     85.30%         86.73%   

Allowance for loan losses to total loans at end of period

     0.90%         1.07%   

NOTE J – COMMITMENTS

Financial instruments with off-balance sheet risk at September 30, 2010 and December 31, 2009 were as follows:

 

       September 30,  
2010
       December 31,  
2009
 

Unused lines of credit

     $ 233,821           $ 226,543     

Amounts due mortgagors

     23,282           30,225     

Standby letters of credit

     4,467           6,155     

Commitments to originate loans

     39,823           16,120     

The Company also has a commitment to invest up to $1.0 million in a venture capital fund. As of September 30, 2010, the Company has contributed $500,000 to the fund.

 

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The Company has also committed to invest up to $10 million, representing 25% of the Class A or senior investor balance, in a low income housing tax credits fund by the end of 2014. At September 30, 2010 the Company has invested $1.1 million in the fund, which is included in other assets on the consolidated statement of condition. As a Class A investor, the Company has the right to transfer its investment to the fund’s Class B investor at the end of 10 years at which time the Company would have no compliance requirements or interest in the fund. The fund structure contemplates that the Class A investors will receive 95% of the tax credits and tax benefits from net operating losses for a period of eight years or until the minimum investment return has been met.

NOTE K – DEPOSITS

Deposit accounts, by type, are summarized as follows at September 30, 2010 and December 31, 2009:

 

     September 30,
2010
     December 31,
2009
 

Demand

      $ 171,022             $ 154,374     

NOW

     39,361           42,262     

Savings

     193,868           174,270     

Money market

     257,184           189,763     

Certificates of deposit

     448,182           478,258     
                 
      $         1,109,617             $         1,038,927     
                 

NOTE L – CONTINGENCIES

United Bank, as successor in interest to Commonwealth National Bank, is involved in litigation relating to its foreclosure on a certain loan property. The litigants are claiming that Commonwealth National Bank acted in bad faith and in violation of applicable law and that their actions resulted in a sale of the underlying property for less than it should have thereby causing damage to the parties. United Bank believes these claims are without merit and is vigorously defending the litigation. The parties are scheduled to go to trial in the first quarter of 2011. No estimate of the any reasonably possible loss or range of loss to United Bank can be made at this time.

In addition, the Company is a defendant in other claims and legal action arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

NOTE M - FAIR VALUES OF ASSETS AND LIABILITIES

In accordance with and as required by the Fair Value Measurements and Disclosures Topic of FASB ASC, the Company groups its financial assets and financial 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, as follows:

Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. Treasury, other U.S. government and government-sponsored enterprises and agency mortgage-backed securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

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Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.

Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker-traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities.

Assets measured at fair value on a recurring basis, are summarized below:

 

         Level 1              Level 2              Level 3          Total
 Fair Value 
 

At September 30, 2010

           

Securities available for sale:

           

Government-sponsored enterprises

     $     10,313           $ -             $ -             $ 10,313     

Government-sponsored and government-guaranteed mortgage-backed securities

     -             180,668           -             180,668     

Private label mortgage-backed securities

     -             3,448           -             3,448     

Municipal bonds

     -             8,183           -             8,183     

Corporate bonds

     -             -             1,839           1,839     

Mortgage servicing rights

     -             -             456           456     
                                   

Total

     $ 10,313           $   192,299           $ 2,295           $ 204,907     
                                   

At December 31, 2009

           

Securities available for sale

           

Government-sponsored enterprises

     $ 353           $ -             $ -             $ 353     

Government-sponsored and government-guaranteed mortgage-backed securities

     -             224,836           -             224,836     

Private label mortgage-backed securities

     -             5,036           -             5,036     

Municipal bonds

     -             10,631           302           10,933     

Corporate bonds

     -             -             1,712           1,712     

Marketable equity securities

     434             -             -             434     

Mortgage servicing rights

     -             -             313           313     
                                   

Total

     $ 787           $ 240,503           $     2,327           $   243,617     
                                   

The Company had no liabilities measured at fair value on a recurring basis at September 30, 2010 or December 31, 2009.

The table below presents the changes in Level 3 assets measured at fair value on a recurring basis for the nine months ended September 30, 2010.

 

Balance at December 31, 2009

     $ 2,327      

Total realized/unrealized losses included in net income

     (119)     

Change in unrealized gain

     127      

Purchases, sales, issuances and settlements

     (40)     

Transfers in and out of Level 3

     -        
        

Balance at September 30, 2010

     $     2,295      
        

The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. If a quoted market price is available for an instrument, the fair value to be disclosed for that instrument is the product of the number of trading units of the instrument times that market price.

 

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Also, the Company may be required, from time to time, to measure at fair value certain other financial and non-financial assets on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-fair value accounting or write-downs of individual assets. The following table summarizes the fair value hierarchy used to determine the adjustment and the carrying value of the related individual assets for the three and nine months ended September 30, 2010.

 

                          Three Months Ended
September 30,

2010
     Nine Months Ended
September 30,

2010
 
     At September 30, 2010      Total
Gains/(Losses)
     Total
Gains/(Losses)
 
         Level 1              Level 2              Level 3            

Assets:

              

Loans

     $ -             $ 11,659           $ -             $ (544)           $ (1,055)     

Other real estate owned

     -             1,200           -             21            119      

Other assets

     -             -             545           -              (145)     
                                            

Total assets

     $             -             $       12,859           $ 545           $ (523)           $ (1,081)     
                                            

The amount of loans represents the carrying value of impaired loans net of related write-downs and valuation allowances for which adjustments are based on the estimated fair value of the underlying collateral. The other real estate owned amount represents the carrying value for which adjustments are also based on the estimated fair value of the property. Included in other assets is private company stock which is carried at cost. Management determined that several impairment indicators exist and that the investment is impaired. In its evaluation, management considered the investee’s earnings performance, credit rating, asset quality, regulatory, economic, or technological environment operating environment, and the investee’s ability to continue as a going concern. The cost basis of the individual security was written down to fair value as a new cost basis and the amount of the write-down is accounted for as a realized loss and is included in earnings. As a result, management recorded an impairment charge of $145,000 in the first quarter of 2010. There were no additional indicators of impairment in the third quarter of 2010.

The Company is required to provide supplemental financial statement disclosures of the estimated fair value of its financial instruments. Financial instruments include cash and cash equivalents, investment and mortgage-backed securities, loans, deposits, borrowings and certain off-balance sheet items such as loan commitments. Other assets significant to the Company, including bank premises and equipment, deferred tax assets, as well as core deposit and other intangible assets are not considered financial instruments and are excluded from the fair value disclosures. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because a market may not readily exist for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The following methods and assumptions were used by the Company in estimating fair values of its financial instruments:

Cash and Cash Equivalents and Short-term Investments. For cash and short term investments having maturities of 90 days or less, the carrying amounts reported in the balance sheets approximate fair values. The carrying amount of short-term investments held at September 30, 2010 and at December 31, 2009 also approximates fair value.

 

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Investment Securities and FHLBB Stock. The fair value of securities to be held to maturity and securities available for sale is estimated based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Ownership of Federal Home Loan Bank of Boston (“FHLBB”) stock is restricted to member banks; therefore, the stock is not traded. The estimated fair value of FHLBB stock is equal to its carrying value, which represents the price at which the FHLBB is obligated to redeem its stock.

Loans. For valuation purposes, the loan portfolio was segregated into its significant categories, which are residential mortgage, commercial real estate, commercial and consumer loans. These categories were further segregated, where appropriate, into components based on significant financial characteristics such as type of interest rate (fixed or adjustable). Fair values were estimated for each component using a valuation method selected by management. The fair values of residential mortgage, commercial real estate, commercial and consumer loans were estimated by discounting the anticipated cash flows from the respective portfolios. Estimates of the timing and amount of these cash flows were based on factors such as future loan prepayments. The discount rates reflected current market rates for loans with similar terms to borrowers of similar credit quality. The fair value of home equity lines of credit was based on the outstanding loan balances, as required by the Financial Instruments Topic of FASB ASC.

Deposits. The fair value of deposits with no stated maturity, such as demand deposits, NOW, regular savings, and money market deposit accounts, is equal to the amount payable on demand. The fair value estimates do not include the benefit that results from the generally lower cost of funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. The fair value estimate of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

Federal Home Loan Bank of Boston Advances. The fair value estimate of the borrowings from the FHLBB is determined by discounting the anticipated future cash payments by using the rates currently available to the Bank for debt with similar terms and remaining maturities.

Repurchase Agreements. The Company enters into overnight repurchase agreements with its customers. Since these agreements are short-term instruments, the fair value of these agreements approximates their recorded balance. The Company also secures term repurchase agreements through other financial institutions. The fair value of these agreements are determined by discounting the anticipated future cash payments using rates currently available to the Bank for debt with similar terms and remaining maturities.

Subordinated Debentures. The Company has outstanding subordinated debt in the form of trust preferred securities issued through a private placement offering. The fair value estimate is determined by discounting the anticipated future cash payments by using the rates currently available to the Company for debt with similar terms and remaining maturities.

Off-Balance Sheet Instruments. The fair value of off-balance-sheet mortgage lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. In the case of the commitments discussed in Note J, the fair value equals the carrying amounts which are not significant.

 

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The fair value of the Company’s financial instruments is as follows at dates indicated:

 

     At September 30, 2010      At December 31, 2009  
     Carrying
Value
     Estimated
Fair Value
     Carrying
Value
     Estimated
Fair Value
 

Financial Assets:

           

Cash and cash equivalents

     $ 53,622           $ 53,622           $ 21,877           $ 21,877     

Short-term investments

     -             -             1,096           1,096     

Securities available for sale

     204,451           204,451           243,304           243,304     

Securities held to maturity

     98,752           100,438           63,174           63,063     

Stock in Federal Home Loan Bank of Boston

     15,365           15,365           15,365           15,365     

Net loans

       1,090,779             1,100,019             1,115,416             1,109,232     

Financial Liabilities:

           

Deposits (with no stated maturity)

     661,435           661,435           560,669           560,669     

Time deposits

     448,182           455,527           478,258           483,843     

Federal Home Loan Bank of Boston advances

     155,137           160,863           208,173           211,954     

Repurchase agreements

     35,993           35,553           47,303           46,068     

Subordinated debentures

     5,425           5,425           5,357           5,357     

NOTE N – PENSION AND POSTRETIREMENT BENEFIT PLANS

The Company maintains a Senior Executive Retirement Plan (SERP) and a Director Retirement Plan. These plans had no assets at September 30, 2010 and 2009. The following table presents the components of the net periodic benefit cost for the indicated periods:

 

     For the Three Months Ended September 30,      For the Nine Months Ended September 30,  
     2010      2009      2010      2009  
     SERP      Director
Retirement
Plan
     SERP      Director
Retirement
Plan
     SERP      Director
Retirement
Plan
     SERP      Director
Retirement
Plan
 

Periodic benefit cost:

                       

Service cost

     $ 80           $         17           $ 69           $ 15           $ 239           $ 51           $ 207           $ 44     

Interest cost

     44           10           35           9           132           31           105           27     
                                                                       

Total pension cost

     124           27           104           24           371           82           312           71     

Prior service cost amortization

     29           9           19           9           86           27           57           27     
                                                                       

Net periodic benefit cost

     $   153           $ 36           $   123           $         33           $   457           $         109           $   369           $         98     
                                                                       

Benefits expected to be paid over the next five years as presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 have not changed. These plans are funded on a pay-as-you-go-basis and the Company does not expect to make any contributions to these plans in 2010.

NOTE O – SUBSEQUENT EVENTS

In connection with the preparation of these financial statements, the Company has evaluated events and transactions through the date the financial statements were issued.

Cash dividend declared. On October 21, 2010, the Company’s Board of Directors announced a quarterly cash dividend of $0.08 per share. The dividend is payable on December 7, 2010 to stockholders of record as of November 15, 2010.

Share repurchase plan. On October 26, 2010, the Company announced the completion of its stock repurchase plan, which was previously announced on October 16, 2009 and commenced on December 2, 2009. In connection with this plan, the Company purchased 798,055 shares at an average price of $13.51. The Company also announced that its Board of Directors approved a new plan under which the Company plans to repurchase up to an additional 5%, or approximately 807,803 shares, of the Company’s common stock.

 

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ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This report may contain, and from time to time, the Company may disclose, forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, and similar matters. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends” or similar expressions. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements provided that the Company notes that a variety of factors could cause the Company’s actual results to differ materially from the anticipated results expressed in the Company’s forward-looking statements. Factors that may cause actual results to differ materially from those projected in the forward-looking statements include, but are not limited to, general economic conditions, changes in market interest rates, changes in size, composition or risks in the loan portfolio, loan or deposit demand, legislative or regulatory changes, and significant increases in competitive pressures. Additional factors are discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 under “Item 1A. Risk Factors” and in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 under “Item 1A. Risk Factors”. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Forward-looking statements speak only as of the date they are made and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date of the forward-looking statements or to reflect the occurrence of unanticipated events. Accordingly, past results and trends should not be used by investors to anticipate future results or trends.

Comparison of Financial Condition at September 30, 2010 and December 31, 2009

Total assets increased $3.9 million, or 0.3%, to $1.545 billion at September 30, 2010 from $1.541 billion at December 31, 2009 mainly due to growth in interest-bearing deposits and held to maturity investment securities, partially offset by decreases in net loans and available for sale investment securities. Interest-bearing deposits increased $29.0 million reflecting excess cash on deposit at the Federal Reserve Bank. Securities held to maturity increased $35.6 million, or 56.3%, to $98.8 million at September 30, 2010 due to purchases of government-sponsored and guaranteed mortgage-backed securities totaling $47.6 million, partially offset by repayments of $12.1 million. Net loans decreased $24.6 million, or 2.2%, to $1.091 billion at September 30, 2010 from $1.115 billion at December 31, 2009 reflecting the sale of $20.7 million in lower coupon, fixed rate residential mortgages. The residential real estate, construction and automobile loan portfolios were also affected by slower origination volume, loan prepayments and normal amortization. These items were partially offset by growth of $23.6 million, or 5.8%, in commercial mortgages and $2.0 million, or 1.3%, in commercial loans as a result of economic activity in our primary market areas and successful business development efforts. Securities available for sale decreased $38.9 million, or 16.0%, to $204.5 million at September 30, 2010 from $243.3 million at December 31, 2009, as a result of repayments of government-sponsored and guaranteed mortgage-backed securities and sales of $3.1 million in municipal bonds and $97,000 in marketable equity securities.

Total deposits increased $70.7 million, or 6.8%, to $1.110 billion at September 30, 2010 compared to $1.039 billion at December 31, 2009 primarily due to growth in core deposits accounts of $100.8 million, or 18.0%, to $661.4 million at September 30, 2010 from $560.7 million at December 31, 2009. The strong growth in core deposit account balances was driven by the success of sales and marketing initiatives in our new Worcester market, competitive products and pricing, attention to excellence in customer service and targeted promotional activities. The increase in core deposits was partially offset by a decrease in certificates of deposit of $30.1 million, or 6.3%, to $448.2 million at September 30, 2010 compared to $478.3 million at December 31, 2009 in connection with planned runoff in the brokered deposit portfolio. FHLBB advances were reduced by $53.0 million, or 25.5%, to $155.1 million at September 30, 2010 compared to $208.2 million at December 31, 2009 as a result of paydowns of using cash flows from the sales of loans and investment securities and

 

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increased deposit levels. At September 30, 2010, the Company continued to have considerable liquidity including significant unused borrowing capacity at the FHLBB and the Federal Reserve Bank and access to funding through the repurchase agreement and brokered deposit markets.

Total stockholders’ equity decreased $3.2 million, or 1.4%, to $222.0 million at September 30, 2010 from $225.2 million at December 31, 2009 as a result of repurchases of our common stock totaling $10.1 million and cash dividend payments amounting to $3.4 million. These decreases were partially offset by net income of $7.4 million for the nine months ended September 30, 2010, an increase of $362,000 in other comprehensive income, stock-based compensation totaling $1.8 million and employee stock ownership plan (“ESOP”) compensation of $701,000.

Credit Quality

The Company actively manages credit risk through its underwriting practices and collection operations and it does not offer nor has it historically offered residential mortgage and other consumer loans to subprime or Alt-A borrowers. Non-accrual loans totaled $11.7 million, or 1.06% of total loans, at September 30, 2010 compared to $16.3 million, or 1.45% of total loans, at December 31, 2009. The non-accrual loan total for September 30, 2010 includes an $860,000 commercial real estate loan which was impaired at March 31, 2010 and was restructured during the second quarter of 2010. The non-accrual loan total for December 31, 2009 includes a $3.5 million commercial real estate loan which was impaired at December 31, 2009 and was restructured during the first quarter of 2010. This loan was classified as a troubled debt restructure and was placed on non-accrual status as of March 31, 2010. As of September 30, 2010, this loan has been returned to accruing status as the customer has been current on the new payments for more than six months. See also “Note G – Non-Performing Assets” in the Notes to the Unaudited Consolidated Financial Statements in this report.

 

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Delinquent Loans. The following table sets forth our loan delinquencies by type and by amount at the dates indicated.

 

     Loans Delinquent For  
     60 - 89 Days      90 Days and Over     Total  
         Number              Amount              Number              Amount             Number              Amount      
     (Dollars in thousands)  

At September 30, 2010

                

Residential mortgages

     19           $ 2,406           6           $ 1,491          25           $ 3,897     

Commercial mortgages

     12           2,496           12           1,904   (1)      24           4,400     

Construction

     -             -             9           4,299          9           4,299     

Home equity

     2           85           5           301          7           386     

Commercial and industrial

     4           81           12           2,772          16           2,853     

Automobile

     -             -             -             -            -             -       

Other consumer

     3           3           1           32          4           35     
                                                    

Total

     40           $     5,071           45           $     10,799          85           $ 15,870     
                                                    

At December 31, 2009

                

Residential mortgages

     13           $ 1,355           5           $ 1,190          18           $ 2,545     

Commercial mortgages

     8           2,298           13           10,717          21           13,015     

Construction

     3           424           5           3,280          8           3,704     

Home equity

     3           157           4           492          7           649     

Commercial and industrial

     3           54           15           571          18           625     

Automobile

     -             -             3           4          3           4     

Other consumer

     3           11           1           33          4           44     
                                                    

Total

     33           $ 4,299           46           $ 16,287          79           $     20,586     
                                                    

(1) Does not include an $860,000 commercial mortgage loan which was restructured in the second quarter of 2010 and was placed on non-accrual status. Although this loan is reported as a non-performing asset, the borrower is current with respect to the restructured payment terms

Classified Assets. The following table shows the aggregate amount of our classified assets at the dates indicated for both loans and foreclosed assets. The total amount of loans in the table below at September 30, 2010 includes twenty relationships which represent 57% of the classified loans. Construction loans for one- to-four family home or condominium development represent 16% of total classified assets, a decrease from 24% at December 31, 2009. Of the $1.2 million in other real estate owned, $450,000 is under a sales contract with a closing expected in the first quarter of 2011.

 

     At September 30,
2010
     At December 31,
2009
 
     (In thousands)  

Classified Loans:

     

Special mention

     $ 25,334           $ 33,507     

Substandard

     50,813           45,354     

Doubtful

     238           136     

Loss

     -             -       
                 

Total classified loans

     $ 76,385           $ 78,997     

Foreclosed Assets:

     

Other real estate owned

     1,200           1,545     
                 

Total classified assets

     $         77,585           $         80,542     
                 

 

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Comparison of Operating Results for the Three Months Ended September 30, 2010 and 2009

Overview

Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income earned on interest-earning assets, consisting primarily of loans, investment securities and other interest-earning assets, and the interest paid on interest-bearing liabilities, consisting primarily of deposits, FHLBB advances and repurchase agreements.

Our results of operations also are affected by provisions for loan losses, non-interest income and non-interest expense. Non-interest income consists primarily of deposit account fees, gain (loss) on sale of loans and securities, wealth management fees, increases in the cash surrender value of bank-owned life insurance and miscellaneous other income. Non-interest expense consists primarily of salaries and benefits, data processing, occupancy, marketing, professional fees, FDIC insurance assessment, merger-related expenses and other operating expenses. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.

Net Income. Net income was $2.7 million, or $0.18 per diluted share, for the third quarter of 2010 compared to net income of $1.9 million, or $0.13 per diluted share, for the same period in 2009. Excluding merger related non-deductible expenses related to our acquisition of CNB Financial Corp. totaling $270,000 for the 2009 period, net income would have been $2.2 million, or $0.14 per diluted share. The improved quarterly operating results were primarily due to growth in net interest income, driven by net interest margin expansion and an increase in average interest earning assets and, to a lesser extent, a reduction in the provision for loan losses, gains from sales of loans and growth in fee income. These items were partially offset by losses from sales of securities and an increase in non-interest expense. The improvement in earnings per share was influenced by growth in earnings and the positive impact of Company stock repurchases.

 

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Average Balances and Yields. The following table sets forth average balances, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield.

 

     Three Months Ended September 30,  
     2010     2009  
     Average      Interest
and
     Yield/     Average      Interest
and
     Yield/  
    

Balance

    

Dividends

    

Cost

   

Balance

    

Dividends

    

Cost

 
            (Dollars in thousands)         

Interest-earning assets:

                

Loans:

                

Residential real estate(1)

     $ 316,354           $ 4,219           5.33     $ 330,943           $ 4,545           5.49

Commercial real estate

     461,793           7,461           6.46     312,799           4,643           5.94

Home equity

     140,273           1,426           4.07     122,292           1,356           4.44

Commercial and industrial

     151,786           1,992           5.25     86,646           1,120           5.17

Consumer and other

     21,653           308           5.69     26,003           372           5.72
                                        

Total loans

     1,091,859           15,406           5.64     878,683           12,036           5.48

Investment securities

     298,335           2,972           3.98     279,442           3,282           4.70

Other interest-earning assets

     56,953           17           0.12     23,522           7           0.12
                                        

Total interest-earning assets

     1,447,147           18,395           5.08     1,181,647           15,325           5.19

Noninterest-earning assets(2)

     86,342                62,259           
                            

Total assets

     $ 1,533,489                $ 1,243,906           
                            

Interest-bearing liabilities:

                

Savings accounts

     $ 191,965           415           0.86     $ 127,949           347           1.08

Money market accounts

     247,178           564           0.91     189,243           531           1.12

NOW accounts

     37,194           48           0.52     29,871           36           0.48

Certificates of deposit

     447,010           2,474           2.21     364,061           2,540           2.79
                                        

Total interest-bearing deposits

     923,347           3,501           1.52     711,124           3,454           1.94

FHLB advances

     155,987           1,408           3.61     155,946           1,644           4.22

Other interest-bearing liabilities

     48,626           319           2.62     36,471           253           2.77
                                        

Total interest-bearing liabilities

     1,127,960           5,228           1.85     903,541           5,351           2.37

Demand deposits

     172,417                117,029           

Other noninterest-bearing liabilities

     10,117                9,036           
                            

Total liabilities

     1,310,494                1,029,606           

Stockholders’ equity

     222,995                214,300           
                            

Total liabilities and stockholders' equity

     $ 1,533,489                $ 1,243,906           
                            

Net interest income

        $   13,167                $     9,974        
                            

Interest rate spread(3)

           3.23           2.82

Net interest-earning assets(4)

     $ 319,187                $ 278,106           
                            

Net interest margin(5)

           3.64           3.38

Average interest-earning assets to average interest-bearing liabilities

           128.30           130.78

 

 

(1)

Includes loans held for sale.

(2)

Includes bank-owned life insurance, the income on which is classified as non-interest income.

(3)

Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4)

Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(5)

Net interest margin represents annualized net interest income divided by average total interest-earning assets.

 

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Rate/Volume Analysis. The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. 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 both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.

 

     Three Months Ended September 30,
2010 vs. 2009
 
     Increase (Decrease) Due to      Net  
     Volume      Rate     
     (In thousands)  

Interest-earning assets:

        

Loans:

        

Residential real estate(1)

     $ (196)           $ (130)           $ (326)     

Commercial real estate

         2,377            441            2,818      

Home equity

     188            (118)           70      

Commercial and industrial

     855            17            872      

Consumer and other

     (62)           (2)           (64)     
                          

Total loans

     3,162            208                  3,370      

Investment securities

     212            (522)           (310)     

Other interest-earning assets

     10            -               10      
                          

Total interest-earning assets

     3,384            (314)           3,070      

Interest-bearing liabilities:

        

Savings accounts

     149            (81)           68      

Money market accounts

     144            (111)           33      

NOW accounts

     10            2            12      

Certificates of deposit

     516            (582)           (66)     
                          

Total interest-bearing deposits

     819            (772)           47      

FHLB advances

     -                (236)           (236)     

Other interest-bearing liabilities

     80            (14)           66      
                          

Total interest-bearing liabilities

     899                (1,022)           (123)     
                          

Change in net interest income

     $ 2,485            $ 708            $ 3,193      
                          

 

  (1)

Includes loans held for sale.

Net Interest Income Before Provision for Loan Losses. Net interest income before provision for loan losses increased $3.2 million, or 32.0%, to $13.2 million for the third quarter of 2010 from $10.0 million for the same period in 2009 as a result of an increase in average interest earning assets and net interest margin expansion. Net interest margin increased 26 basis points to 3.64% for the three months ended September 30, 2010, from 3.38% for the same period in 2009 due to amortization of certain acquisition accounting adjustments totaling $434,000 and improved spreads, primarily due to a lower cost of funds. These items were partially offset by an increased cost to fund share repurchases and growth in excess cash balances held in low yielding Federal Reserve Bank and FHLBB accounts.

 

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Table of Contents

 

Interest Income. Interest income increased $3.1 million, or 20.0%, to $18.4 million for the three months ended September 30, 2010 from $15.3 million for the prior year period due to an increase in average interest-earning assets, partially offset by a decrease in the yield on earning assets. Total average interest-earning asset balances increased $265.5 million, or 22.5%, to $1.447 billion for the third quarter of 2010, due in large part to the Company’s acquisition of CNB Financial Corp. in the fourth quarter of 2009 and, to a lesser extent, organic loan origination activity and an increase in excess cash balances. These items were partially offset by loan and investment security sales and prepayments and normal amortization of the existing loan and mortgage-backed securities portfolio. The yield on average interest-earning assets decreased by 11 basis points to 5.08% for the third quarter of 2010 in connection with the lower interest rate environment, partially offset by accretion of certain loan fair value accounting adjustments totaling $248,000 in the third quarter of 2010. The decrease in market rates contributed to the downward repricing of a portion of the Company’s existing assets and to lower rates for new assets.

Interest Expense. Interest expense decreased $123,000, or 2.3%, to $5.2 million for the three months ended September 30, 2010 from $5.4 million for the prior year period reflecting a decrease in the average rate paid on interest-bearing liabilities, partially offset by an increase in average interest-bearing liabilities. The average rate paid on interest-bearing liabilities declined 52 basis points to 1.85% for the three months ended September 30, 2010 reflecting the repricing of savings, money market and certificate of deposit balances in response to the lower interest rate environment as well as a $186,000 reduction in interest expense associated with the amortization of certain fair value accounting adjustments relating to deposits and borrowings. Average interest-bearing liabilities increased $224.4 million, or 24.8%, to $1.128 billion for the three months ended September 30, 2010 from $903.5 million for the prior year period reflecting growth in interest-bearing deposits and other interest-bearing liabilities due in large part to the Company’s acquisition of CNB Financial Corp. in the fourth quarter of 2009 and organic growth in the Springfield and Worcester markets.

Provision for Loan Losses. The provision for loan losses decreased $50,000, or 6.3%, to $750,000 for the three months ended September 30, 2010 compared to $800,000 for the same period in 2009. The decrease in the provision for the third quarter of 2010 was driven by improvement in credit quality, a decrease in net loan originations and loan sales. The allowance for loan losses is based on management’s estimate of the probable losses inherent in the portfolio, considering the impact of certain factors. Among the factors management considers are prior loss experience, current economic conditions and their effect on borrowers, the composition and size of the portfolio, trends in nonperforming loans and delinquency rates and the performance of individual loans in relation to contractual terms. The provision for loan losses reflects adjustments to the allowance based on management’s review of the loan portfolio in light of those conditions. The allowance for loan losses was $9.9 million, or 0.90% of loans outstanding at September 30, 2010. In accordance with generally accepted accounting principles, the Company recorded the loans acquired from CNB Financial Corp. at fair value and recognized the credit mark on loans purchased from other financial institutions as a component of fair value. At September 30, 2010, the remaining balance of the loan fair value adjustments was $6.0 million, or 2.5% of the total $241.6 million in outstanding purchased loans. Excluding the $219.9 million outstanding balance of loans acquired from CNB Financial Corp. and $21.8 million outstanding balance of loans purchased from other financial institutions, the ratio of the allowance for loan losses to total loans would have been 1.16%.

 

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Table of Contents

 

Non-interest Income. Non-interest income increased $118,000, or 5.9%, to $2.1 million for the three months ended September 30, 2010, reflecting growth of $62,000, or 45.6%, in wealth management income as a result of increases in commissions from annuity sales and fees from assets under management and $38,000, or 3.0%, in fee income on deposit accounts due to increased deposits. The third quarter results include gains of $212,000 on sales of $6.4 million in lower coupon fixed rate residential mortgages and losses totaling $189,000 from sales of $3.2 million in substandard municipal securities as well as Fannie Mae and Freddie Mac stock.

Non-interest Expense. Non-interest expense increased $2.4 million, or 29.2%, to $10.5 million for the third quarter of 2010 from $8.1 million for the same period in 2009. Excluding acquisition related costs of $270,000 in 2009, non-interest expense would have increased $2.6 million, or 33.7% for the third quarter of 2010. Salaries and benefits increased $1.5 million, or 32.3%, mainly due to costs incurred to support our new Worcester operations and, to a lesser extent, annual wage increases and a larger incentive accrual due to improved operating performance. Occupancy costs grew $232,000, or 38.8%, principally attributable to expenses incurred to operate our new Worcester facilities. Professional fees increased $220,000, or 104.3%, primarily due to additional legal and consulting costs associated with our Worcester operations and increased expenses related to loan workout activities and third party loan reviews. FDIC insurance assessment expense increased $282,000 primarily attributable to an adjustment in the third quarter of 2009 to reduce expense recorded earlier in 2009. Other expenses increased $173,000, or 15.9%, largely related to additional costs for the Worcester operations including equipment maintenance and depreciation, supplies, postage, courier service, protection and security, telephone and business development, as well as an increase in the amortization of mortgage servicing rights due to accelerated prepayments of sold loans and the amortization of the core deposit intangible recorded in connection with the acquisition of CNB Financial in November 2009. Data processing costs increased $146,000, or 16.6%, reflecting expenses for our new Worcester accounts and a larger loan and deposit account base in our Springfield market. Marketing expenses increased $62,000, or 18.4%, in connection with advertising and promotional expenses focused on our Worcester market.

Income Tax Expense. Income tax expense increased $222,000 to $1.4 million for three months ended September 30, 2010 from the comparable 2009 period as a result of an increase in taxable income, partially offset by a decrease in the effective tax rate from 38.0% in 2009 to 34.1% in 2010. The higher effective tax rate for 2009 was driven primarily by non-deductible merger expenses.

Comparison of Operating Results for the Nine Months Ended September 30, 2010 and 2009

Net Income. Net income for the nine months ended September 30, 2010 amounted to $7.4 million, or $0.48 per diluted share, compared to $4.6 million, or $0.30 per diluted share, for the same period in 2009. Excluding acquisition-related expenses totaling $1.1 million, losses from sales of securities totaling $189,000, impairment charges on securities of $145,000 and the related tax benefit of $446,000, net income would have been $8.4 million, or $0.54 per diluted share, for the nine months ended September 30, 2010. Excluding non-deductible acquisition-related expenses totaling $1.4 million and a special FDIC insurance assessment of $538,000 ($312,000 net of taxes) for the same period in 2009, net income would have been $6.3 million, or $0.41 per diluted share. The improved operating results for the nine months were primarily due in large part to growth in net interest income, driven by net interest margin expansion and an increase in average interest earning assets, and, to a lesser extent, increases in fee income and gains from sales of residential mortgages and a reduction in the provision for loan losses. These items were partially offset by an increase in non-interest expense, losses on sales of securities in 2010 compared to gains from sales of securities realized in the 2009 period and a $145,000 non-cash, non-deductible charge for other-than-temporary-impairment of an investment security recognized in the first quarter of 2010. The improvement in earnings per share was influenced by growth in earnings and the positive impact of Company stock repurchases.

 

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Table of Contents

 

Average balances and yields. The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield.

 

     Nine Months Ended September 30,  
     2010     2009  
     Average      Interest
and
     Yield/     Average      Interest
and
     Yield/  
    

Balance

    

Dividends

    

Cost

   

Balance

    

Dividends

    

Cost

 
            (Dollars in thousands)         

Interest-earning assets:

                

Loans:

                

Residential real estate(1)

    $ 327,801         $ 13,272          5.40    $ 342,312         $ 14,168          5.52

Commercial real estate

     459,642          21,486          6.23     295,305          13,027          5.88

Home equity loans

     139,236          4,308          4.13     121,459          4,139          4.54

Commercial and industrial

     151,948          6,236          5.47     83,900          3,344          5.31

Consumer and other

     22,831          965          5.64     26,772          1,130          5.63
                                        

Total loans

     1,101,458          46,267          5.60     869,748          35,808          5.49

Investment securities

     298,684          9,386          4.19     291,956          10,543          4.81

Other interest-earning assets

     43,146          35          0.11     20,900          24          0.15
                                        

Total interest-earning assets

     1,443,288          55,688          5.14     1,182,604          46,375          5.23

Noninterest-earning assets(2)

     86,345               57,816          
                            

Total assets

    $ 1,529,633              $ 1,240,420          
                            

Interest-bearing liabilities:

                

Savings accounts

    $ 181,289          1,248          0.92    $ 116,645          965          1.10

Money market accounts

     231,683          1,568          0.90     180,891          1,760          1.30

NOW accounts

     37,795          147          0.52     29,941          104          0.46

Certificates of deposit

     458,314          7,420          2.16     364,138          8,094          2.96
                                        

Total interest-bearing deposits

     909,081          10,383          1.52     691,615          10,923          2.11

FHLB advances

     172,151          4,371          3.39     174,956          5,084          3.87

Other interest-bearing liabilities

     50,785          984          2.58     33,814          696          2.74
                                        

Total interest-bearing liabilities

     1,132,017          15,738          1.85     900,385          16,703          2.47

Demand deposits

     164,137               114,172          

Other noninterest-bearing liabilities

     9,583               8,725          
                            

Total liabilities

     1,305,737               1,023,282          

Stockholders’ equity

     223,896               217,138          
                            

Total liabilities and stockholders’ equity

    $ 1,529,633              $ 1,240,420          
                            

Net interest income

       $ 39,950              $ 29,672       
                            

Interest rate spread(3)

           3.29           2.76

Net interest-earning assets(4)

    $ 311,271              $ 282,219          
                            

Net interest margin(5)

           3.69           3.35

Average interest-bearing assets to average interest-bearing liabilities

           127.50           131.34

 

 

(1)

Includes loans held for sale.

(2)

Includes bank-owned life insurance, the income on which is classified as non-interest income.

(3)

Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4)

Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(5)

Net interest margin represents annualized net interest income divided by average total interest-earning assets.

 

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Rate/Volume Analysis. The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. 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 both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.

 

     Nine Months Ended September 30,
2010 vs. 2009
 
     Increase (Decrease) Due to        
     Volume      Rate         Net      
     (In thousands)  

Interest-earning assets:

       

Loans:

       

Residential real estate(1)

    $ (592)         $ (304)        $ (896)    

Commercial real estate

     7,640           819          8,459     

Home equity loans

     572           (403)         169     

Commercial and industrial

     2,790           102          2,892     

Consumer and other

     (166)          1          (165)    
                         

Total loans

     10,244           215          10,459     

Investment securities

     238           (1,395)         (1,157)    

Other interest-earning assets

     21           (10)         11     
                         

Total interest-earning assets

     10,503           (1,190)         9,313     

Interest-bearing liabilities:

       

Savings accounts

     466           (183)         283     

Money market accounts

     422           (614)         (192)    

NOW accounts

     29           14          43     

Certificates of deposit

     1,815           (2,489)         (674)    
                         

Total interest-bearing deposits

     2,732           (3,272)         (540)    

FHLB advances

     (81)          (632)         (713)    

Other interest-bearing liabilities

     331           (43)         288     
                         

Total interest-bearing liabilities

     2,982           (3,947)         (965)    
                         

Change in net interest income

    $     7,521          $     2,757         $   10,278     
                         

 

  (1)

 Includes loans held for sale.

Net Interest Income Before Provision for Loan Losses. Net interest income before provision for loan losses increased $10.3 million, or 34.6%, to $40.0 million for the nine months ended September 30, 2010 from $29.7 million for the comparable 2009 period as a result of net interest margin expansion and an increase in average interest earning assets. Net interest margin increased 34 basis points to 3.69% for the nine months ended September 30, 2010 from 3.35% for the prior year period due to amortization of certain acquisition accounting adjustments totaling $1.9 million and improved spreads. Average interest earning assets increased $260.7 million, or 22.0%, to $1.443 billion, mainly due to the Company’s acquisition of CNB Financial Corp. in the fourth quarter of 2009 and organic loan growth in our Springfield and Worcester markets. These items were partially offset by an increased cost to fund share repurchases and growth in excess cash balances held in low yielding Federal Reserve Bank and FHLBB accounts.

 

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Interest Income. Interest income increased $9.3 million, or 20.1%, to $55.7 million for the nine months ended September 30, 2010 from $46.4 million for the prior year period due to an increase in average interest-earning assets, partially offset by a decrease in the yield on earning assets. Total average interest-earning asset balances increased $260.7 million, or 22.0%, to $1.443 billion for the third quarter of 2010, due in large part to the Company’s acquisition of CNB Financial Corp. in the fourth quarter of 2009 and, to a lesser extent, organic loan origination activity and an increase in excess cash balances. These items were partially offset by loan and investment security sales, as well as prepayments and normal amortization of the existing loan and mortgage-backed securities portfolio. The yield on average interest-earning assets decreased by 9 basis points to 5.14% for the third quarter of 2010 in connection with the lower interest rate environment and excess cash balances held in low yielding Federal Reserve Bank and FHLBB accounts, partially offset by accretion of certain loan fair value accounting adjustments totaling $925,000 for the nine months ended September 30, 2010. The decrease in market rates contributed to the downward repricing of a portion of the Company’s existing assets and to lower rates for new assets.

Interest Expense. Interest expense decreased $965,000, or 5.8%, to $15.7 million for the nine months ended September 30, 2010 from $16.7 million for the prior year period due to a decrease in the average rate paid on interest-bearing liabilities, partially offset by growth in average interest-bearing liabilities. The average rate paid on interest-bearing liabilities declined 62 basis points to 1.85% for the nine months ended September 30, 2010 reflecting the repricing of savings, money market and certificate of deposit balances in response to the lower interest rate environment as well as a $947,000 reduction in interest expense associated with the amortization of certain deposits and borrowings fair value accounting adjustments. Average interest-bearing liabilities increased $231.6 million, or 25.7%, to $1.132 billion for the nine months ended September 30, 2010 from $900.4 million for the prior year period reflecting growth in interest-bearing deposits and other interest-bearing liabilities due in large part to the Company’s acquisition of CNB Financial Corp. in the fourth quarter of 2009.

Provision for Loan Losses. The provision for loan losses decreased $82,000, or 4.1%, to $1.9 million for the nine months ended September 30, 2010 driven by improvement in credit quality, a decrease in net loan originations and loan sales.

Non-interest Income. Non-interest income decreased $72,000, or 1.1%, to $6.4 million for the nine months ended September 30, 2010 mainly attributable to losses totaling $189,000 from sales of substandard municipal securities as well as Fannie Mae and Freddie Mac stock in 2010 compared to gains of $461,000 from sales of securities in the 2009 period and an other-than-temporary impairment charge of an equity security of $145,000 in the first quarter of 2010. These items were partially offset by growth in deposit service charges of $480,000, or 13.6%, as a result of growth in accounts and transactions, an increase of $174,000, or 30.3%, in other income reflecting higher prepayment penalties, loan late charges and mortgage servicing income, and an increase of $46,000, or 12.7%, on gains from sales of lower coupon fixed rate residential mortgages.

 

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Non-interest Expense. Non-interest expense increased $6.8 million, or 26.0%, to $33.1 million for the nine months ended September 30, 2010 from $26.3 million for the prior year period. Excluding acquisition related costs of $1.1 million in 2010 and $1.4 million in 2009, non-interest expense would have increased $7.1 million, or 28.6%, for the nine months ended September 30, 2010. Total salaries and benefits increased $4.3 million, or 30.7%, mainly due to costs incurred to support our new Worcester operations and, to a lesser extent, annual wage increases and a larger incentive accrual due to improved operating performance. Other expenses increased $916,000, or 28.9%, largely related to additional costs for the Worcester operations including equipment maintenance and depreciation, supplies, postage, courier service, protection and security, telephone and business development, as well as an increase in the amortization of mortgage servicing rights due to accelerated prepayments of sold loans and the amortization of the core deposit intangible recorded in connection with the acquisition of CNB Financial in November 2009. Occupancy costs grew $653,000, or 34.3%, principally attributable to expenses incurred to operate our new Worcester facilities. Data processing costs increased $531,000, or 21.1%, reflecting expenses for our new Worcester accounts and a larger loan and deposit account base in our Springfield market. Marketing expenses increased $488,000, or 44.6%, in connection with advertising and promotional expenses focused on our Worcester market. Professional service costs increased $401,000, or 43.2%, as a result of increases in audit and accounting, legal and consulting costs related to the new Worcester operations and, to a lesser extent, expenses associated with loan workout activities and third party loan reviews. These items were partially offset by a decrease of $208,000, or 15.8%, in FDIC insurance premiums due to a one-time special assessment of $538,000 incurred in 2009, partially offset by a higher assessment base and premium rate in 2010.

Income Tax Expense. Income tax expense increased $684,000 to $3.9 million for nine months ended September 30, 2010 from $3.2 million for the comparable 2009 period due in large part to an increase in income before income taxes offset by a decrease in the effective rate from 41.3% to 34.7%. The higher effective tax rate in 2009 was primarily driven by non-deductible merger expenses.

Market Risk, Liquidity and Capital Resources

Market Risk

The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk (“IRR”). Our assets, the largest portion of which are mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage IRR and reduce the exposure of our net interest income (“NII”) to changes in market interest rates. Accordingly, our Board of Directors has established an Asset/Liability Management Committee which is responsible for evaluating the IRR inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors. With the assistance of an IRR management consultant, the committee monitors the level of IRR on a regular basis and meets at least on a quarterly basis to review our asset/liability policies and IRR position.

We have sought to manage our IRR in order to minimize the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset-liability management, we currently use the following strategies to manage our IRR: (i) using alternative funding sources, such as advances from the FHLBB, to “match fund” certain longer-term loans; (ii) continued emphasis on increasing core deposits; (iii) offering adjustable rate and shorter-term home equity loans, commercial real estate loans, construction loans and commercial and industrial loans; (iv) offering a variety of consumer loans, which typically have shorter-terms and (v) investing in mortgage-backed securities with variable rates or fixed rates with shorter durations. Reducing the average maturity of our interest-earning assets by increasing our investments in shorter-term loans and securities, as well as loans and securities with variable rates of interest, helps to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our NII to changes in market interest rates.

 

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Net interest income at-risk measures the risk of a decline in earnings due to potential short-term and long term changes in interest rates. The table below represents an analysis of our IRR as measured by the estimated changes in NII for the following twelve months, resulting from an instantaneous and sustained parallel shift in the yield curve of +200 and -100 basis points at September 30, 2010 and December 31, 2009.