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EX-32 - EXHIBIT 32 - Naugatuck Valley Financial Corpv385062_ex32.htm

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, DC 20549

 

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended June 30, 2014

 

OR

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

 

For the transition period from ______________ to _____________

 

Commission file number: 0-54447

 

                  NAUGATUCK VALLEY FINANCIAL CORPORATION                  

(Exact name of registrant as specified in its charter)

 

MARYLAND   01-0969655
(State or other jurisdiction of incorporation or   (I.R.S. Employer Identification No.)
organization)    

 

333 CHURCH STREET, NAUGATUCK, CONNECTICUT   06770
(Address of principal executive offices)   (Zip Code)

 

                                 (203) 720-5000                                

(Registrant’s telephone number, including area code)

 

N/A

 

(Former name, former address and former fiscal year, if changed since last report)

 

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 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x     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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large Accelerated Filer  ¨ Accelerated Filer  ¨
Non-accelerated Filer  ¨ Smaller Reporting Company  x
(Do not check if a 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

 

As of August 12, 2014, there were 7,002,208 shares of the registrant’s common stock outstanding.

 

 
 

 

NAUGATUCK VALLEY FINANCIAL CORPORATION

 

Table of Contents

 

  Page No.
       
Part I.  Financial Information  
   
  Item 1. Consolidated Financial Statements (Unaudited)  
       
    Consolidated Statements of Financial Condition at June 30, 2014 and December 31, 2013  3
       
    Consolidated Statements of Operations for the three and six months ended June 30, 2014 and 2013  4
       
    Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2014 and 2013  5
       
    Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2014 and 2013  6
       
    Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013  7
       
    Notes to Unaudited Consolidated Financial Statements  8
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 35
       
    Liquidity and Capital Resources 48
       
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 50
       
  Item 4. Controls and Procedures 51
       
Part II.  Other Information  
       
  Item 1. Legal Proceedings 51
       
  Item 1A. Risk Factors 52
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 52
       
  Item 3. Defaults Upon Senior Securities 52
       
  Item 4. Mine Safety Disclosures 52
       
  Item 5. Other Information 52
       
  Item 6. Exhibits 53
       
Signatures 54
   
Exhibits  

 

2
 

 

Part I - FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements (Unaudited)

 

 

Consolidated Statements of Financial Condition (unaudited)

 

(Dollars in thousands)  June 30, 
2014
   December
31, 2013
 
     
ASSETS          
Cash and due from depository institutions  $8,699   $26,330 
Federal funds sold   18    44 
Cash and cash equivalents   8,717    26,374 
Investment securities available-for-sale, at fair value   86,386    49,771 
Investment securities held-to-maturity, at amortized cost   15,480    18,149 
Loans held for sale   5,052    1,079 
Loans receivable, net   362,324    360,568 
Accrued income receivable   1,712    1,494 
Foreclosed real estate   536    1,846 
Premises and equipment, net   9,390    9,364 
Bank owned life insurance   10,261    10,132 
Federal Home Loan Bank (“FHLB”) of Boston stock, at cost   5,210    5,444 
Other assets   6,996    2,560 
Total assets  $512,064   $486,781 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Liabilities          
Deposits  $385,980   $390,847 
FHLB advances   54,164    25,293 
Other borrowed funds   3,967    4,173 
Mortgagors' escrow accounts   4,630    4,392 
Other liabilities   4,673    3,842 
Total liabilities   453,414    428,547 
Commitments and contingencies          
Stockholders' equity          
Preferred stock, $.01 par value; 1,000,000 shares authorized; no shares issued or outstanding   -    - 
Common stock, $.01 par value; 25,000,000 shares authorized; 7,002,366 shares issued; 7,002,208 shares outstanding at June 30, 2014 and December 31, 2013, respectively   70    70 
Paid-in capital   58,759    58,757 
Retained earnings   1,607    2,322 
Unearned employee stock ownership plan ("ESOP") shares (326,751 shares at June 30, 2014 and December 31, 2013)   (2,824)   (2,824)
Treasury Stock, at cost (158 shares at June 30, 2014 and December 31, 2013)   (1)   (1)
Accumulated other comprehensive income (loss)   1,039    (90)
Total stockholders' equity   58,650    58,234 
Total liabilities and stockholders' equity  $512,064   $486,781 

 

See accompanying notes to unaudited consolidated financial statements.

 

3
 

 

 

Consolidated Statements of Operations (unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands, except share data)  2014   2013   2014   2013 
                 
Interest income                    
Interest and fees on loans  $4,200   $5,021   $8,412   $10,072 
Interest and dividends on investments and deposits   856    292    1,518    612 
Total interest income   5,056    5,313    9,930    10,684 
Interest expense                    
Interest on deposits   598    752    1,203    1,538 
Interest on borrowed funds   189    249    342    543 
Total interest expense   787    1,001    1,545    2,081 
                     
Net interest income   4,269    4,312    8,385    8,603 
                     
(Credit) Provision for loan losses   (739)   3,550    (739)   3,850 
                     
Net interest income after provision for loan losses   5,008    762    9,124    4,753 
                     
Noninterest income                    
Service charge income   176    182    350    360 
Fees for other services   138    180    232    290 
Mortgage banking income   140    393    276    895 
Income from bank owned life insurance   63    70    129    140 
Net gain (loss) on sale of investments   34    (4)   193    (4)
Income from investment advisory services, net   74    87    168    139 
Other income   33    28    63    53 
Total noninterest income   658    936    1,411    1,873 
                     
Noninterest expense                    
Compensation, taxes and benefits   2,973    2,896    5,989    5,573 
Occupancy   582    456    1,124    946 
Professional fees   323    637    842    1,296 
FDIC insurance premiums   270    249    531    454 
Insurance   117    124    262    282 
Computer processing   327    315    697    631 
Expenses on foreclosed real estate, net   168    202    378    559 
Writedowns on foreclosed real estate   11    49    38    60 
Directors’ compensation   70    77    172    211 
Advertising   118    108    213    195 
Supplies   60    48    129    109 
Expenses related to sale of loans   196    765    196    765 
Other expenses   357    571    679    935 
Total noninterest expense   5,572    6,497    11,250    12,016 
                     
Income (loss) before provision (benefit) for income taxes   94    (4,799)   (715)   (5,390)
                     
Provision (benefit) for income taxes   -    -    -    - 
                     
Net income (loss)  $94   $(4,799)  $(715)  $(5,390)
Earnings (loss) per common share - basic and diluted  $0.01   $(0.72)  $(0.11)  $(0.81)

  

See accompanying notes to unaudited consolidated financial statements.

 

4
 

 

 

Consolidated Statements of Comprehensive Income (Loss) (unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands)  2014   2013   2014   2013 
     
Net income (loss)  $94   $(4,799)  $(715)  $(5,390)
Other comprehensive income (loss):                    
Unrealized gain (loss) on available-for-sale investment securities   1,262    (688)   1,859    (739)
Reclassification adjustment for gains realized in net income (loss)   (34)   4   (193)   4
Other comprehensive income (loss) before tax effect   1,228    (684)   1,666    (735)
Income tax expense benefit related to items in other                    
comprehensive income (loss)   (418)   241    (537)   241 
Other comprehensive income (loss) net of tax effect   810    (443)   1,129    (494)
Total comprehensive income (loss)  $904   $(5,242)  $414   $(5,884)

 

See accompanying notes to unaudited consolidated financial statements.

 

5
 

 

 

Consolidated Statements of Changes in Stockholders’ Equity

 

Six months ended June 30, 2014 and 2013 (Unaudited)

 

   Common   Paid-in   Retained   Unearned
ESOP
   Unearned
Stock
   Treasury   Accumulated
Other
Comprehensive
     
(In thousands)  Stock   Capital   Earnings   Shares   Awards   Stock   Income (Loss)   Total 
                                         
Balance at December 31, 2013  $70   $58,757   $2,322   $(2,824)  $-   $(1)  $(90)  $58,234 
Net income (loss)   -    -    (715)   -    -    -         (715)
Stock based compensation        2                             2 
Other comprehensive income (loss)   -    -    -    -    -    -    1,129    1,129 
                                         
Balance at June 30, 2014  $70   $58,759   $1,607   $(2,824)  $-   $(1)  $1,039   $58,650 

 

   Common   Paid-in   Retained   Unearned
ESOP
   Unearned
Stock
   Treasury   Accumulated
Other
Comprehensive
     
(In thousands)  Stock   Capital   Earnings   Shares   Awards   Stock   Income (Loss)   Total 
                                         
Balance at December 31, 2012  $70   $58,842   $11,164   $(3,143)  $(3)  $(1)  $(21)  $66,908 
Net income (loss)   -    -    (5,390)   -    -    -    -    (5,390)
Other comprehensive income (loss)   -    -    -    -    -    -    (494)   (494)
                                         
Balance at June 30, 2013  $70   $58,842   $5,774   $(3,143)  $(3)  $(1)  $(515)  $61,024 

 

See accompanying notes to unaudited consolidated financial statements.

 

6
 

 

 

Consolidated Statements of Cash Flows (Unaudited)

 

   Six Months Ended 
   June 30, 
(In thousands)  2014   2013 
Cash flows from operating activities          
Net income (loss)  $(715)  $(5,390)
Adjustments to reconcile net loss to cash provided by operating activities:          
(Credit) Provision for loan losses   (739)   3,850 
Depreciation and amortization expense   369    354 
Net loss on sales of foreclosed assets   59    65 
Writedowns on foreclosed real estate   38    60 
Mortgage banking activity:          
Gain on sale   (271)   (728)
Loans originated for sale   (10,682)   (17,575)
Proceeds from sale of loans   10,937    18,189 
Net amortization of investment premiums and discounts   3    212 
Net gain on sale of investments   (193)   - 
Stock-based compensation   2    - 
Net change in:          
Accrued income receivable   (218)   187 
Deferred loan fees   (7)   (49)
Cash surrender value of life insurance   (129)   (141)
Other assets   (466)   (1,276)
Other liabilities   294    3,647 
Net cash (used in)/provided by operating activities   (1,718)   1,405 
Cash flows from investing activities          
Proceeds from maturities and repayments of available-for-sale securities   17,285    2,487 
Proceeds from sale of available-for-sale securities   7,224    762 
Proceeds from maturities of held-to-maturity securities   2,569    3,910 
Redemption of Federal Home Loan Bank stock   234    473 
Purchase of available-for-sale securities   (59,168)   (772)
Loan originations net of principal payments   (5,938)   26,857 
Purchase of premises and equipment   (395)   (103)
Loan sales proceeds held in escrow   (3,970)   (11,753)
Proceeds from the sale of commercial loans   580    - 
Proceeds from the sale of foreclosed assets   1,604    627 
Net cash (used in)/provided by investing activities   (39,975)   22,488 
Cash flows from financing activities          
Net change in time deposits   (2,851)   (12,881)
Net change in other deposit accounts   (2,016)   9,388 
Proceeds from FHLB advances   38,000    - 
Repayment of FHLB advances   (9,129)   (8,966)
Net change in mortgagors' escrow accounts   238    60 
Change in other borrowings   (206)   (944)
Net cash provided/(used) in by financing activities   24,036    (13,343)
Net change in cash and cash equivalents   (17,657)   10,550 
Cash and cash equivalents at beginning of period   26,374    23,229 
Cash and cash equivalents at end of period  $8,717   $33,779 
Supplementary disclosures of cash flow information:          
Non-cash investing activities:          
Transfer of loans to foreclosed assets  $391   $251 
Transfer of loans to loans held for sale  $3,957   $- 
Cash paid during the period for:          
Interest  $1,529   $2,112 
Unrealized gains (losses) on available for sale securities arising during the period  $1,666   $(735)

 

See accompanying notes to unaudited consolidated financial statements.

 

7
 

 

Notes to Unaudited Consolidated Financial Statements

 

NOTE 1 – DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

 

Description of Business

 

Naugatuck Valley Financial Corporation (“Naugatuck Valley Financial” or the “Company”) is a stock savings and loan holding company incorporated in the State of Maryland. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary bank, Naugatuck Valley Savings and Loan (“Naugatuck Valley Savings” or the “Bank”). The Company became the holding company for the Bank effective June 29, 2011.

 

Naugatuck Valley Savings is a federally chartered stock savings association and has served its customers in Connecticut since 1922. The Bank operates as a community-oriented financial institution dedicated to serving the financial services needs of consumers and businesses with a variety of deposit and lending products from its full service banking offices in the Greater Naugatuck Valley region of southwestern Connecticut. The Bank attracts deposits from the general public and uses those funds to originate one-to-four family, multi-family and commercial real estate, construction, commercial business and consumer loans.

 

Naugatuck Valley Savings has two wholly owned subsidiaries, Naugatuck Valley Mortgage Servicing Corporation and Church Street OREO One, LLC. Naugatuck Valley Mortgage Servicing Corporation qualifies and operates as a passive investment company pursuant to Connecticut regulation. Church Street OREO One, LLC was established in February 2013 to hold properties acquired through foreclosure as well as from nonjudicial proceedings.

 

Basis of Presentation

 

The accompanying consolidated interim financial statements are unaudited and include the accounts of the Company, the Bank, and the Bank’s wholly owned subsidiaries, Naugatuck Valley Mortgage Servicing Corporation and Church Street OREO One, LLC. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements. These consolidated financial statements should be read in conjunction with the December 31, 2013 audited Consolidated Financial Statements and the accompanying Notes included in our Annual Report on Form 10-K. All significant intercompany accounts and transactions have been eliminated in consolidation. These consolidated financial statements reflect, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position and the results of its operations and its cash flows at the dates and for the periods presented.

 

In preparing the consolidated financial statements, management makes estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of condition, and the reported amounts of income and expenses for the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, the valuation of real estate acquired in connection with foreclosure or in satisfaction of loans, deferred income taxes and the valuation of and the evaluation for other than temporary impairment (“OTTI”) on investment securities. While management uses available information to recognize losses and properly value these assets, future adjustments may be necessary based on changes in economic conditions both in Connecticut and nationally.

 

The Company’s only business segment is Community Banking. This segment represented all the revenues, income and assets of the consolidated Company and therefore, is the only reported segment as defined by FASB ASC 820, Segment Reporting.

 

Management has evaluated subsequent events for potential recognition or disclosure in the consolidated financial statements as of the date of this filing. No subsequent events were identified that would have required a change to the consolidated financial statements or disclosure in the notes to the consolidated financial statements.

 

8
 

 

Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

 

Certain reclassifications have been made to the prior period amounts to conform with the June 30, 2014 consolidated financial statement presentation. These reclassifications only changed the reporting categories and did not affect the Company’s results of operations or financial position.

 

Significant Accounting Policies

 

The significant accounting policies used in preparation of our consolidated financial statements are disclosed in our 2013 Annual Report on Form 10-K. There have not been any material changes in our significant accounting policies compared with those contained in our Form 10-K disclosure for the year ended December 31, 2013.

 

Recently Issued Accounting Pronouncements

 

Income Taxes- Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists: (a consensus of the FASB Emerging Issues Task Force). In July 2013, the FASB issued ASU 2013-11. Per this ASU, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The ASU became effective during the three months ended June 30, 2014. The adoption of this guidance has not had a material impact on the Company’s consolidated financial statements.

 

Receivables – Troubled Debt Restructurings by Creditors: In January 2014, the FASB issued ASU 2014-04. This update clarifies that when an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of the residential real estate property collateralizing a consumer mortgage loan, upon either: (i) the creditor obtaining legal title to the property upon completion of the foreclosure; or (ii) the borrower conveying all interest in the property to the creditor to satisfy the loan through completion of a deed-in-lieu of foreclosure or through a similar legal agreement. The ASU became effective in January 2014 and its adoption has not had a material impact on the Company’s consolidated financial statements.

 

Revenue from Contracts with Customers (Topic 606). In May 2014, the FASB issued ASU 2014-09. This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Transfer of control is not the same as transfer of risks and rewards, as it is considered in current guidance. The Company will evaluate this new guidance to determine whether revenue should be recognized over time or at a point in time. This standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016, with no early adoption permitted, using either of two methods: (a) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (b) retrospective with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined in ASU 2014-09. The Company has not yet selected a transition method and is currently evaluating the impact of the pending adoption of ASU 2014-09 on the consolidated financial statements.

 

NOTE 2 – REGULATORY MATTERS

 

Effective January 17, 2012, the Bank entered into a written Formal Agreement (the “Agreement”) with the Office of the Comptroller of the Currency (the “OCC”). The Agreement requires the Bank to take various actions, within prescribed time frames, with respect to certain operational areas of the Bank, including the following:

·Restricts the Bank from declaring or paying any dividends or other capital distributions to the Company without prior written regulatory approval. This provision relates to upstreaming intercompany dividends or other capital distributions from the Bank to the Company.
·Provide prior written notice to the OCC before appointing an individual to serve as a senior executive officer or as a director of the Bank.
·Restricts the Bank from entering into, renewing, extending or revising any contractual arrangement relating to the compensation or benefits for any senior executive officer of the Bank, unless the Bank provides the OCC with prior written notice of the proposed transaction.
·Subjects the Bank to six month financial and operational examination review. The most recent examination occurred in January 2014. The next scheduled review is expected in the third quarter 2014.

 

In April and May 2013, additional senior management team members were retained to assist the new CEO (who was hired in September 2012) to address the provisions of the Agreement.

 

The Agreement and each of its provisions will remain in effect until these provisions are amended in writing by mutual consent or waived in writing by the OCC or terminated in writing by the OCC.

 

9
 

 

The OCC regulations require savings institutions to maintain minimum levels of regulatory capital. Effective June 4, 2013, the OCC imposed individual minimum capital requirements (“IMCRs”) on the Bank. The IMCRs require the Bank to maintain a Tier 1 leverage capital to adjusted total assets ratio of at least 9.00% and a total risk-based capital to risk-weighted assets ratio of at least 13.00%. Before the establishment of the IMCRs, the Bank had been operating under these capital parameters by self-imposing these capital levels as part of the capital plan the Bank was required to implement under the terms of the Agreement. The Bank exceeded the IMCRs at June 30, 2014, with a Tier 1 leverage ratio of 10.39% and a total risk-based capital ratio of 17.45%.

 

As a source of strength to its subsidiary bank, the Company had liquid assets of approximately $2.9 million at June 30, 2014, which the Company could contribute to the Bank if needed, to enhance the Bank’s capital levels. If the Company had contributed those assets to the Bank as of June 30, 2014, the Bank would have had a Tier 1 leverage ratio of approximately 10.95%.

 

On May 21, 2013, the Company entered into a Memorandum of Understanding (“MOU”) with the Federal Reserve Bank of Boston. Among other things, the MOU prohibits the Company from paying dividends, repurchasing its stock or making other capital distributions without prior written approval of the Federal Reserve Bank of Boston.

 

As a savings and loan holding company regulated by the Federal Reserve Board, the Company is not currently subject to specific regulatory capital requirements. The Dodd- Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. There is a five- year transition period (from the July 21, 2010 effective date of the Dodd- Frank Act) before the capital requirements will apply to savings and loan holding companies.

 

The following tables are summaries of the Company’s consolidated capital amounts and ratios and the Bank’s actual capital amounts and ratios as computed under the standards established by the Federal Deposit Insurance Act at June 30, 2014 and December 31, 2013.

 

At June 30, 2014  Adequately Capitalized
Requirements
   Individual Minimum
Capital Requirements (3)
   Actual 
(Dollars in thousands)  $   %   $   %   $   % 
The Company Consolidated                              
Tier 1  Leverage Capital (1)   N/A    N/A    N/A    N/A   $57,610    11.29%
Tier 1 Risk-Based Capital (2)   N/A    N/A    N/A    N/A    57,610    17.63%
Total Risk-Based Capital (2)   N/A    N/A    N/A    N/A    61,734    18.90%
                               
The Bank                              
Tier 1  Leverage Capital (1)  $20,509    4.00%  $46,146    9.00%  $53,290    10.39%
Tier 1 Risk-Based Capital (2)   13,136    4.00%   N/A    N/A    53,290    16.19%
Total Risk-Based Capital (2)   26,273    8.00%   42,693    13.00%   57,445    17.45%

 

(1) Tier 1 capital to total assets.

(2) Tier 1 or total risk-based capital to risk-weighted assets.

(3) Effective June 4, 2013.

 

10
 

  

At December 31, 2013  Adequately Capitalized
Requirements
   Individual Minimum
Capital Requirements
   Actual 
(Dollars in thousands)  $   %   $   %   $   % 
The Company Consolidated                              
Tier 1  Leverage Capital (1)    N/A    N/A    N/A    N/A   $58,323    11.98%
Tier 1 Risk-Based Capital (2)    N/A    N/A    N/A    N/A    58,323    18.21%
Total Risk-Based Capital (2)   N/A   N/A    N/A    N/A    62,399    19.49%
                               
The Bank                              
Tier 1  Leverage Capital (1)  $19,545    4.00%  $43,977    9.00%  $53,946    11.04%
Tier 1 Risk-Based Capital (2)   12,891    4.00%   N/A    N/A    53,946    16.74%
Total Risk-Based Capital (2)   25,783    8.00%   41,897    13.00%   58,047    18.01%

  

(1) Tier 1 capital to total assets.

(2) Tier 1 or total risk-based capital to risk-weighted assets.

 

As of June 30, 2014, the most recent regulatory notifications categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action.

 

NOTE 3 – INVESTMENT SECURITIES

 

At June 30, 2014, the composition of the investment portfolio was:

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Available-for-sale securities:                    
U.S. Government and agency obligations  $40,192   $798   $(56)  $40,934 
U.S. Government agency mortgage-backed securities   28,269    820    (284)   28,805 
U.S. Government agency collateralized mortgage obligations   8,487    170    -    8,657 
Small Business Administration securitized pool of loans   2,014    56    -    2,070 
Obligations of state and municipal subdivisions   5,349    63    -    5,412 
Subtotal   84,311    1,907    (340)   85,878 
Mutual fund - fixed income securities   500    8    -    508 
                     
Total available-for-sale securities  $84,811   $1,915   $(340)  $86,386 

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Held-to-maturity securities:           
U.S. Government agency mortgage-backed securities  $15,480   $225   $(10)  $15,695 
                     
Total held-to-maturity securities  $15,480   $225   $(10)  $15,695 

 

11
 

 

At December 31, 2013, the composition of the investment portfolio was:

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Available-for-sale securities:                    
U.S. Government and agency obligations  $16,601   $35   $(130)  $16,506 
U.S. Government agency mortgage-backed securities   22,874    527    (532)   22,869 
U.S. Government agency collateralized mortgage obligations   3,736    11    (9)   3,738 
Private label collateralized mortgage obligations   258    8    -    266 
Subtotal   43,469    581    (671)   43,379 
Auction-rate trust preferred securities   5,893    -    -    5,893 
Mutual fund - Fixed Income securities   500    -    (1)   499 
                     
Total available-for-sale securities  $49,862   $581   $(672)  $49,771 

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Held-to-maturity securities:                    
U.S. Government agency mortgage-backed securities  $18,149   $134   $(40)  $18,243 
                     
Total held-to-maturity securities  $18,149   $134   $(40)  $18,243 

 

12
 

 

The following is a summary of the fair values and related unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2014, and December 31, 2013:

 

At June 30, 2014  Less than 12 Months   12 Months or Greater   Total 
(Dollars in thousands)  Fair
Value
   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
U.S. Government agency obligations  $4,857   $56   $-   $-   $4,857   $56 
U.S. Government agency mortgage-backed securities   8,588    274    1,882    10    10,470    284 
U.S. Government agency collateralized mortgage obligations   -    -    -    -    -    - 
Small Business Administration securitized pool of loans   -    -    -    -    -    - 
Mutual fund - fixed income securities   -    -    -    -    -    - 
Total securities in unrealized loss position  $13,445   $330   $1,882   $10   $15,327   $340 

 

At December 31, 2013  Less than 12 Months   12 Months or Greater   Total 
(Dollars in thousands)  Fair
Value
   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
U.S. Government agency obligations  $9,865   $130   $-   $-   $9,865   $130 
U.S. Government agency mortgage-backed securities   8,075    531    65    1    8,140    532 
U.S. Government agency collateralized mortgage obligations   3,228    9    -    -    3,228    9 
Mutual fund - fixed income securities   499    1    -    -    499    1 
Total securities in unrealized loss position  $21,667   $671   $65   $1   $21,732   $672 

 

The amortized cost and fair value of securities at June 30, 2014 and December 31, 2013, by expected maturity, are set forth below. Actual maturities of mortgage-backed securities and collateralized mortgage obligations may differ from contractual maturities because the mortgages underlying the securities may be prepaid or called with or without call or prepayment penalties. Because these securities are not due at a single maturity date, the maturity information is not presented.

 

   Available-for-Sale   Held-to-Maturity 
At June 30, 2014  Amortized
Cost
   Fair Value   Amortized
Cost
   Fair Value 
   (Dollars in thousands) 
U.S. Government agency mortgage-backed securities  $26,255   $26,735   $15,480   $15,695 
U.S. Government agency collateralized mortgage obligations   8,487    8,657    -    - 
Small Business Administration securitized pool of loans   2,014    2,070    -    - 
Mutual fund - fixed income securities   500    508    -    - 
Subtotal   37,256    37,970    15,480    15,695 
Securities with Fixed Maturities:                    
Due in one year or less   -    -    -    - 
Due after one year through five years   2,954    2,983    -    - 
Due after five years through ten years   1,892    1,900    -    - 
Due after ten years   42,709    43,533    -    - 
Subtotal   47,555    48,416    -    - 
Total  $84,811   $86,386   $15,480   $15,695 

 

   Available-for-Sale   Held-to-Maturity 
At December 31, 2013  Amortized
Cost
   Fair Value   Amortized Cost   Fair Value 
   (Dollars in thousands) 
U.S. Government agency mortgage-backed securities  $22,874   $22,869   $18,149   $18,243 
U.S. Government agency collateralized mortgage obligations   3,736    3,738    -    - 
Private label collateralized mortgage obligations   258    266    -    - 
Mutual fund - fixed income securities   500    499    -    - 
Subtotal   27,368    27,372    18,149    18,243 
Securities with Fixed Maturities:                    
Due in one year or less             -    - 
Due after one year through five years   6,606    6,641    -    - 
Due after five years through ten years   9,995    9,865    -    - 
Due after ten years   5,893    5,893    -    - 
Subtotal   22,494    22,399    -    - 
Total  $49,862   $49,771   $18,149   $18,243 

 

13
 

 

As of June 30, 2014 and December 31, 2013, securities with an amortized cost of $19.31 million and $19.53 million respectively, and a fair value of $21.60 million and $19.67 million, respectively, were pledged as collateral to secure municipal deposits and repurchase agreements.

 

NOTE 4 – LOANS RECEIVABLE

 

A summary of loans receivable at June 30, 2014 and December 31, 2013 is as follows:

 

   June 30,   December 31, 
(Dollars in thousands)  2014   2013 
         
Real estate loans:          
One-to-four family  $182,031   $186,985 
Multi-family and commercial real estate   121,511    123,134 
Construction and land development   4,754    5,609 
Total real estate loans   308,296    315,728 
           
Commercial business loans   24,911    25,506 
Consumer loans:          
Home equity   28,080    26,960 
Other consumer   8,383    2,321 
Total consumer loans   36,463    29,281 
Total loans   369,670    370,515 
           
Less:          
Allowance for loan losses   7,297    9,891 
Deferred loan origination fees, net   49    56 
Loans receivable, net  $362,324   $360,568 

 

In June 2014, the Company offered for sale $11.4 million principal amount of primarily adversely classified loans (i.e. loans classified substandard or doubtful) in connection with its plan to reduce the level of classified loans. $4.9 million of commercial loans were sold in June 2014 in two separate transactions in which the financial assets transferred satisfied all of the criteria to be accounted for as sales of financial assets. The remaining loans (comprised of $2.9 million in residential mortgage loans and $3.1 million in commercial loans) were transferred to loans held for sale at June 30, 2014 because the loan sale process for these loans was in the process of completion pending final buyer due diligence in July 2014. The closing for the sale of these loans occurred in July 2014. The carrying value of these loans held for sale was based on the final bid prices which, in the aggregate, amounted to approximately $4.0 million.

 

The impact of these two sale transactions and the writedown of the carrying value of these loans held for sale amounted to $1.8 million in net charge-offs against the Company’s allowance for loan losses and $196,000 in expenses related to the sale of loans.

 

Furthermore, these transactions resulted in a $10.2 million reduction in adversely classified loans.

 

Credit quality of financing receivables

 

Management segregates the loan portfolio into portfolio segments which are defined as the level at which the Company develops and documents a systematic method for determining its allowance for loan losses. The portfolio segments are segregated based on loan types and the underlying risk factors present in each loan type. Such risk factors are periodically reviewed by management and revised as deemed appropriate.

 

During the second quarter of 2013, management analyzed the risk concentration within the loan portfolio. As a result of this analysis, the loan portfolio was further disaggregated by expanding the number of loan segments from six segments to ten segments as of June 30, 2013. The commercial real estate loan segment, the second largest grouping of loans after one-to-four family owner occupied loans, was expanded into five segments to increase the granularity of analysis of the risks inherent in the loans in these segments. The expanded commercial loan segments are: investor owned one-to-four family and multi-family properties, industrial and warehouse properties, office buildings, retail properties and special use properties.

 

14
 

 

The Company’s loan portfolio is segregated as follows:

 

One-to-four Family Owner Occupied Loans. This portfolio segment consists of the origination of first mortgage loans secured by one-to-four family owner occupied residential properties and residential construction loans to individuals to finance the construction of residential dwellings for personal use located in our market area. Although the Company has experienced an increase in foreclosures on its owner occupied loan portfolio over the past year, foreclosures are still at relatively low levels. Management believes this is due mainly to its prudent underwriting and lending strategies which do not allow for high risk loans such as “Option ARM,” “sub-prime” or “Alt-A” loans.

 

Multi-family and Commercial Real Estate Loans. As described above, this portfolio grouping has been further disaggregated into loans secured by:

 

·Investor owned one-to-four family and multi-family properties;
   
·Industrial and warehouse properties;
   
·Office buildings;
   
·Retail properties; and
   
·Special use properties.

 

Loans secured by these types of commercial real estate collateral generally have larger loan balances and more credit risk than owner occupied one-to-four family mortgage loans. The increased risk is the result of several factors, including the concentration of principal in a limited number of loans and borrowers, the impact of local and general economic conditions on the borrower’s ability to repay the loan, and the increased difficulty of evaluating and monitoring these types of loans.

 

Construction and Land Development Loans. This portfolio segment includes commercial construction loans for commercial development projects, including condominiums, apartment buildings, and single family subdivisions as well as office buildings, retail and other income producing properties and land loans, which are loans made with land as security. Construction and land development financing generally involves greater credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost proves to be inaccurate, the Company may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property. Moreover, if the estimated value of the completed project proves to be inaccurate, the borrower may hold a property with a value that is insufficient to assure full repayment. Construction loans also expose the Company to the risks that improvements will not be completed on time in accordance with specifications and projected costs and that repayment will depend on the successful operation or sale of the properties, which may cause some borrowers to be unable to continue with debt service which exposes the Company to greater risk of non-payment and loss. Additionally, economic factors such as the decline of property values may have an adverse affect on the ability of the borrower to sell the property.

 

Commercial Business Loans. This portfolio segment includes commercial business loans secured by real estate, assignments of corporate assets, and personal guarantees of the business owners. Commercial business loans generally have higher interest rates and shorter terms than other loans, but they also may involve higher average balances, increased difficulty of loan monitoring and a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business.

 

Real Estate Secured Consumer Loans. This portfolio segment includes home equity loans and home equity lines of credit secured by owner occupied one-to-four family residential properties. Loans of this type are written at a maximum of 75% of the appraised value of the property and we require that we have no lower than a second lien position on the property. These loans are written at a higher interest rate and a shorter term than mortgage loans. The Company has experienced a low level of foreclosure in this type of loan during recent periods. These loans can be affected by economic conditions and the values of the underlying properties.

 

15
 

 

Other Consumer Loans. This portfolio segment includes loans secured by passbook or certificate accounts, or automobiles, as well as unsecured personal loans and overdraft lines of credit. This type of loan may entail greater risk than do residential mortgage loans, particularly in the case of loans that are unsecured or secured by assets that depreciate rapidly.

 

Credit Quality Indicators

 

The Company’s policies provide for the classification of loans into the following categories: pass (1 - 5), special mention (6), substandard-accruing (7), substandard-nonaccruing (8), doubtful (9), and loss (10). In June 2013, the Company added substandard-accruing as an additional risk grade to further delineate the Bank’s risk profile in the previous substandard category. Consistent with regulatory guidelines, loans that are considered to be of lesser quality are considered adversely classified as substandard, doubtful or loss. A loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans include those loans characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans (or portions of loans) classified as loss are those considered uncollectible. The Company generally charges off loans or portions of loans as soon as they are considered to be uncollectible and of little value. Loans that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve close attention, are required to be designated as special mention. When loans are classified as special mention, substandard or doubtful, management focuses increased monitoring and attention on these loans in assessing the credit risk and specific allowance requirements for these loans.

 

The following tables are a summary of the loan portfolio credit quality indicators, by loan class, as of June 30, 2014 and December 31, 2013:

 

   Credit Risk Profile by Internally Assigned Grade: 
June 30, 2014  One-to-Four
Family
   Multi-Family
and Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business Loans
   Consumer Loans   Total 
Risk Rating:                              
Pass  $178,713   $108,039   $3,169   $20,869   $35,971   $346,761 
Special Mention   784   11,155    314    2,441    265    14,959 
Substandard:                              
- Accruing   20   1,491    -    849    42    2,402 
- Nonaccruing   2,514   826    1,271    664    185    5,460 
Subtotal - substandard   2,534    2,317    1,271    1,513    227    7,862 
Doubtful   -    -    -    88    -    88 
Total  $182,031   $121,511   $4,754   $24,911   $36,463   $369,670 
     
   Multi-Family and Commercial Real Estate 
   Credit Risk Profile by Internally Assigned Grade: 
June 30, 2014  Investor Owned
One-to-Four
family and multi-
family
   Industrial and
Warehouse
Properties
   Office Buildings   Retail Properties   Special Use
Properties
   Total Multi-Family
and Commercial
Real Estate
 
Risk Rating:                              
Pass  $16,216   $22,989   $24,058   $18,307   $26,469   $108,039 
Special Mention   2,398    3,732    2,408    471    2,146    11,155 
Substandard:                              
- Accruing   -    524    465    153    349    1,491 
- Nonaccruing   554    27    206    -    39    826 
Subtotal - substandard   554    551    671    153    388    2,317 
Doubtful   -    -    -    -    -    - 
Total  $19,168   $27,272   $27,137   $18,931   $29,003   $121,511 

 

16
 

 

   Credit Risk Profile by Internally Assigned Grade: 
December 31, 2013  One-to-Four
Family
   Multi-Family
and Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business Loans
   Consumer
Loans
   Total 
Risk Rating:                              
Pass  $180,704   $90,462   $3,102   $18,939   $28,603   $321,810 
Special Mention   500    26,832    946    3,869    262    32,409 
Substandard:                              
- Accruing   349    2,470    -    -    94    2,913 
- Nonaccruing (1)   5,432    3,370    1,561    2,605    322    13,290 
Subtotal - substandard   5,781    5,840    1,561    2,605    416    16,203 
Doubtful   -    -    -    93    -    93 
Total  $186,985   $123,134   $5,609   $25,506   $29,281   $370,515 
                               
   Multi-Family and Commercial Real Estate 
   Credit Risk Profile by Internally Assigned Grade: 
December 31, 2013  Investor Owned
One-to-Four
family and multi-
family
   Industrial and
Warehouse
Properties
   Office Buildings   Retail Properties   Special Use
Properties
   Total Multi-Family
and Commercial
Real Estate
 
Risk Rating:                              
Pass  $10,682   $21,500   $16,821   $16,250   $25,209   $90,462 
Special Mention   4,523    7,310    4,015    6,130    4,854    26,832 
Substandard:                              
- Accruing   -    1,155    370    457    488    2,470 
- Nonaccruing   1,167    31    206    683    1,283    3,370 
Subtotal - substandard   1,167    1,186    576    1,139    1,772    5,840 
Doubtful   -    -    -    -     -    - 
Total  $16,372   $29,996   $21,412   $23,520   $31,834   $123,134 

(1) Non-accrual loans included substandard nonaccruing loans and non-performing consumer loans.

 

Delinquencies

 

When a loan is 15 days past due, the Company sends the borrower a late notice. The Company also contacts the borrower by phone if the delinquency is not corrected promptly after the notice has been sent. When the loan is 30 days past due, the Company mails the borrower a letter reminding the borrower of the delinquency and attempts to contact the borrower personally to determine the reason for the delinquency in order to ensure that the borrower understands the terms of the loan and the importance of making payments on or before the due date. If necessary, subsequent delinquency notices are issued and the account will be monitored on a regular basis thereafter. By the 90th day of delinquency, the Company will send the borrower a final demand for payment and may recommend foreclosure. A summary report of all loans 30 days or more past due is provided to the Board of Directors of the Company each month.

 

Loans, including troubled debt restructurings (“TDRs”) are automatically placed on nonaccrual status when payment of principal or interest is more than 90 days delinquent. Loans may also be placed on nonaccrual status if collection of principal or interest in full, or in part, is in doubt or if the loan has been restructured. When loans are placed on nonaccrual status, unpaid accrued interest is fully reversed, and further income is recognized only to the extent received. The loan may be returned to accrual status if unpaid principal and interest are repaid so that the loan is less than 90 days delinquent for a reasonable period of time (usually six consecutive months) to establish a reliable assessment of collectability.

 

17
 

 

The following tables set forth certain information with respect to our loan portfolio delinquencies, by loan class, as of June 30, 2014 and December 31, 2013:

 

   Delinquencies 
As of June 30, 2014  31-60 Days
Past Due
   61-90
Days Past
Due
   Greater
Than 90
Days
   Total Past
Due
   Current   Total Loans   Carrying
Amount >
90 Days and
Accruing
 
(In thousands)                                   
Real estate loans                                   
One-to-four family  $443   $140   $1,969   $2,552   $179,479   $182,031   $- 
Construction and land development   -    -    1,101    1,101    3,653    4,754    - 
Multi-family and commercial real estate:                                 - 
Investor owned one-to-four family and multi-family   -    -    389    389    18,779    19,168    - 
Industrial and warehouse   27    -    -    27    27,245    27,272    - 
Office buildings   362    -    206    568    26,569    27,137    - 
Retail properties   -    -    -    -    18,931    18,931    - 
Special use properties   236    -    -    236    28,767    29,003    - 
Subtotal Multi-family and commercial real estate   625    -    595    1,220    120,291    121,511    - 
Commercial business loans   38    -    714    752    24,159    24,911      
Consumer loans:                                   
Home equity loans   74    107    96    277    27,803    28,080    - 
Other consumer loans   3    -    -    3    8,380    8,383    - 
Subtotal Consumer   77    107    96    280    36,183    36,463    - 
Total  $1,183   $247   $4,475   $5,905   $363,765   $369,670   $- 
     
   Delinquencies 
As of December 31, 2013  31-60 Days
Past Due
   61-90 Days
Past Due
   Greater
Than
90 Days
   Total Past
Due
   Current   Total Loans   Carrying
Amount >
90 Days and
Accruing
 
(In thousands)                            
Real estate loans                                   
One-to-four family  $1,217   $397   $2,564   $4,178   $182,807   $186,985   $- 
Construction and land development   970    538    1,799    3,307    2,302    5,609    - 
Multi-family and commercial real estate:                                 - 
Investor owned one-to-four family and multi-family   861    -    621    1,482    14,890    16,372    - 
Industrial and warehouse   -    -    32    32    29,964    29,996    - 
Office buildings   -    108    206    314    21,098    21,412    - 
Retail properties   423    -    -    424    23,096    23,520    - 
Special use properties   346    -    169    514    31,320    31,834    - 
Subtotal Multi-family and commercial real estate   1,630    108    1,028    2,766    120,368    123,134    - 
Commercial business loans   487    153    1,598    2,238    23,268    25,506    - 
Consumer loans:                                   
Home equity loans   155    28    142    325    26,635    26,960    - 
Other consumer loans   2    3    -    5    2,316    2,321    - 
Subtotal Consumer   157    31    142    330    28,951    29,281    - 
Total  $4,461   $1,227   $7,131   $12,819   $357,696   $370,515   $- 

 

Impaired loans and nonperforming assets

 

The following table sets forth certain information with respect to our nonperforming assets as of June 30, 2014 and December 31, 2013:

 

   June 30,   December 31, 
   2014   2013 
Nonperforming Assets  (Dollars in thousands) 
Nonaccrual loans  $3,528   $7,953 
TDRs nonaccruing   2,020    5,430 
Subtotal nonperforming loans   5,548    13,383 
Foreclosed real estate   536    1,846 
Total nonperforming assets  $6,084   $15,229 
           
Total nonperforming loans to total loans   1.50%   3.61%
Total nonperforming assets to total assets   1.19%   3.13%

 

18
 

 

Nonperforming loans (defined as nonaccrual loans and nonperforming TDRs) totaled $5.5 million at June 30, 2014 compared to $13.4 million at December 31, 2013, a decrease of $7.9 million. Of the loans sold in June 2014 and the loans transferred to loans held for sale at June 30, 2014 as a part of a loan sale process, there were $4.7 million in nonaccruing loans. The amount of income that was contractually due but not recognized on nonperforming loans totaled $30,000 and $149,000 for the six months ended June 30, 2014 and June 30, 2013, respectively.

 

At June 30, 2014, the Company had 36 loans on nonaccrual status of which 12 were less than 90 days past due; however, these loans were placed on nonaccrual status due to the uncertainty of their collectability. 

 

At December 31, 2013, the Company had 90 loans on nonaccrual status of which 44 were less than 90 days past due; however, these loans were placed on nonaccrual status due to the uncertainty of their collectability.

 

An impaired loan generally is one for which it is probable, based on current information, that the Company will not collect all the amounts due under the contractual terms of the loan. All impaired loans are individually evaluated for impairment at least quarterly. As a result of this impairment evaluation, the Company provides a specific reserve for, or charges off, that portion of the asset that is deemed uncollectible.

 

The following tables summarize impaired loans by portfolio segment as of June 30, 2014 and December 31, 2013:

 

As of June 30, 2014  Recorded
Investment with
No Specific
Valuation
Allowance
   Recorded
Investment with
Specific
Valuation
Allowance
   Total
Recorded
Investment
   Unpaid
Contractual
Principal
Balance
   Related Specific
Valuation
Allowance
 
   (In thousands) 
Real estate loans                         
One-to four-family  $2,566   $1,495   $4,061   $4,422   $56 
Construction and land development   978    294    1,272    1,580    21 
Multi-family and commercial real estate:                         
Investor owned one-to-four family and multi-family properties   554    -    554    572    - 
Industrial and warehouse properties   27    -    27    30    - 
Office buildings   205    -    205    405    - 
Retail properties   -    -    -    -    - 
Special use properties   39    -    39    52   - 
Subtotal   825    -    825    1,059    - 
Commercial business loans   833    287    1,120    1,181    88 
Consumer loans   234    163    397    426    10 
Total impaired loans  $5,436   $2,239   $7,675   $8,668   $175 

 

19
 

 

As of December 31, 2013  Recorded
Investment with
No Specific
Valuation
Allowance
   Recorded
Investment with
Specific
Valuation
Allowance
   Total
Recorded
Investment
   Unpaid
Contractual
Principal Balance
   Related Specific
Valuation
Allowance
 
   (In thousands) 
Real estate loans                         
One-to four-family  $4,570   $2,431   $7,001   $7,734   $70 
Construction and land development   1,405    449    1,854    2,424    75 
Multi-family and commercial real estate:                         
Investor owned one-to-four family and multi-family properties   1,167    -    1,167    1,274    - 
Industrial and warehouse properties   565    -    565    567    - 
Office buildings   206    -    206    405    - 
Retail properties   158    389    547    621    23 
Special use properties   1,600    -    1,600    2,086    - 
Subtotal   3,696    389    4,085    4,953    23 
Commercial business loans   1,996    584    2,580    2,693    105 
Consumer loans   412    167    579    805    10 
Total impaired loans  $12,079   $4,020   $16,099   $18,609   $283 

 

In the above table, the unpaid contractual principal balance represents the aggregate amounts legally owed to the Bank under the terms of the borrowers’ loan agreements. The recorded investment amounts shown above represent the unpaid contractual principal balance owed to the Bank less any amounts charged off based on collectability assessments by the Bank and less any amounts paid by borrowers on nonaccrual loans which were recognized as principal curtailments.

 

The following table relates to interest income recognized by segment of impaired loans for the six months ended June 30, 2014 and 2013:

   Six Months Ended June 30, 
   2014   2013 
   Average
Recorded
Investments
   Interest Income
Recognized
   Average
Recorded
Investments
   Interest Income
Recognized
 
Real estate loans  (In thousands) 
One-to four-family  $5,951   $175   $6,143   $63 
Construction   1,567    7    6,124    20 
Multi-family and commercial real estate   2,594    90    2,913    15 
Commercial business loans   1,661    40    2,826    42 
Consumer loans   492    8    555    9 
Total  $12,265   $320   $18,561   $149 

 

Interest payments received on nonaccrual loans are accounted for on the cash-basis method or the cost recovery method until qualifying for return to accrual status. The table above shows the interest income recognized on nonaccrual loans on the cash-basis method. Under the cost recovery method, the interest payment is applied to the principal balance of the loan. For the six month periods ended June 30, 2014 and 2013, the amount of interest payments applied to principal under the cost recovery method was $30,000 and $210,000, respectively.

 

Troubled Debt Restructured Loans

 

A TDR is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider. TDRs are considered impaired and are separately measured for impairment, whether on accrual or nonaccrual status.

 

20
 

 

Loan modifications are generally granted at the request of the individual borrower and may include concessions such as reduction in interest rates, changes in payments, maturity date extensions, or debt forgiveness/forbearance. TDRs are loans for which the original contractual terms of the loans have been modified and both of the following conditions exist: (i) the restructuring constitutes a concession (including reduction of interest rates or extension of maturity dates); and (ii) the borrower is either experiencing financial difficulties or absent such concessions, it is probable the borrower would experience financial difficulty complying with the original terms of the loan. Loans are not classified as TDRs when the modification is short-term or results in only an insignificant delay or shortfall in the payments to be received. The Company’s loan modifications are determined on a case-by-case basis in connection with ongoing loan collection processes.

 

The recorded investment balance of performing and nonperforming TDRs as of June 30, 2014 and December 31, 2013 are as follows:

 

(In thousands)  As of 
June 30, 2014
   As of 
December 31, 2013
 
Aggregate recorded investment of impaired loans performing under terms modified through a troubled debt restructuring:          
Performing (1)  $2,576   $4,195 
Nonperforming (2)   1,467    3,051 
Total  $4,043   $7,246 

 

(1)Of the $2,576,000 in TDRs which were performing under the modified terms of their agreements at June 30, 2014, there were $594,000 in TDRs that remain on nonaccrual status because these TDRs have not yet demonstrated the requisite period of sustained performance. The combination of the $594,000 performing TDRs and the $1,426,000 nonperforming TDRs on nonaccrual status at June 30, 2014 equal the $2,020,000 in TDRs that were on nonaccrual status at June 30, 2014.

 

Of the $4,195,000 in TDRs which were performing under the modified terms of their agreements at December 31, 2013, there were $2,379,000 in TDRs that remain on nonaccrual status because these TDRs have not yet demonstrated the requisite period of sustained performance. The combination of the $2,379,000 in performing TDRs and the $3,051,000 nonperforming TDRs at December 31, 2013 equal the $5,430,000 in TDRs that were on nonaccrual status at December 31, 2013.

 

(2)Of the $1,467,000 in TDRs that were not performing under the modified terms of their agreements at June 30, 2014, all of these loans, except for one loan in the amount of $41,000, were on a nonaccrual status.

 

Of the $3,051,000 in TDRs that were not performing under the modified terms of their agreements at December 31, 2013, all of these loans were on nonaccrual status.

 

As illustrated in the table below, during the six months ended June 30, 2014, the following concessions were made on seven loans totaling $511,000 (measured as a percentage of loan balances on TDRs):

 

·Deferral of principal payments for 68.1% (2 loans for $348,000);
·Reduced interest rate for 12.7% (4 loans for $65,000); and
·Extension of payment terms for 19.2% (1 loan for $98,000).

 

21
 

 

The following tables present a breakdown of the type of concessions made by loan class during the six months ended June 30, 2014 and June 30, 2013:

 

   For the Six Months Ended June 30, 2014 
(Dollars in thousands)  Number
of Loans
   Pre-
Modification
Recorded
Investment
   Post-
Modification
Recorded
Investment
   % 
Below market interest rate:                    
Real estate loans:                    
One-to-four family   1   $35   $35    6.8%
                     
Commercial real estate loans   1    10    10    2.0%
                     
Commercial business loans   2    20    20    3.9%
                     
Subtotal   4    65    65    12.7%
                     
Extended payment terms:                    
Commercial business loans   1    98    98    19.2%
                     
Principal payments deferred                    
Real estate loans:                    
One-to-four family   2    348    348    68.1%
                     
Grand totals   7   $511   $511    100.0%

 

   For the Six Months Ended June 30, 2013 
(Dollars in thousands)  Number
of Loans
   Pre-
Modification
Recorded
Investment
   Post-
Modification
Recorded
Investment
   % 
Below market interest rate:                    
Real estate loans:                    
One-to-four family   1   $51   $51    3.9%
                     
Extended payment terms:                    
Real estate loans:                    
One-to-four family   1    19    25    1.9%
                     
Commercial real estate loans   3    546    594    45.4%
                     
Commercial business loans   5   $394   $406    31.0%
                     
Subtotal   9    959    1,025    78.4%
                     
Principal payments deferred                    
Commercial business loans   2    232    232    17.7%
                     
Grand totals   12   $1,242   $1,308    100.0%

 

22
 

 

The majority of the Bank’s TDRs are a result of principal payment deferrals to troubled credits which have already been adversely classified. The Bank grants such concessions to reassess the borrower’s financial status and to develop a plan for repayment. These modifications did not have a material effect on the Company.

 

The financial effects of each modification will vary based on the specific restructure. For some of the Bank’s TDRs, the loans were interest-only with a balloon payment at maturity. If the interest rate is not adjusted and the terms are consistent with the market, the Bank might not experience any loss associated with the restructure. If, however, the restructure involves forbearance agreements or interest rate modifications, the Bank might not collect all the principal and interest based on the original contractual terms. The Bank applies its procedures for placing TDRs on accrual or nonaccrual status using the same general guidance as for loans. The Bank estimates the necessary allowance for loan losses on TDRs using the same guidance as for other impaired loans.

 

There were no TDRs that had been modified during the previous twelve months ended June 30, 2014 that subsequently defaulted or were charged off during the three months ended June 30, 2014.

 

Allowance for Loan Losses

 

The allowance for loan losses (“ALLL”) is maintained at a level deemed appropriate by management to adequately provide for known and inherent risks in the loan portfolio.

 

The allowance for loan losses is established through a provision for loan losses charged to operations. Management periodically reviews the allowance for loan losses in order to identify those known and inherent losses and to assess the overall collection probability for the loan portfolio. The evaluation process begins with an individual evaluation of loans that are considered impaired. For these loans, an allowance is established based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or for loans that are considered collateral dependent, the fair value of the collateral.

 

All other loans are segregated into segments based on similar risk factors. Each of these groups is then evaluated based on several factors to estimate credit losses. Management will determine for each category of loans with similar risk characteristics the historical loss rate. Historical loss rates provide a reasonable starting point for the Bank’s analysis; however, this analysis and loss trends do not form a sufficient basis, by themselves, to determine the appropriate level of the loan loss allowance. Management also considers qualitative and environmental factors for each loan segment that are likely to impact, directly or indirectly, the inherent loss exposure of the loan portfolio. These factors include but are not limited to: changes in the amount and severity of delinquencies, non-accrual and adversely classified loans, changes in local, regional, and national economic conditions that will affect the collectability of the portfolio, changes in the nature and volume of loans in the portfolio, changes in concentrations of credit, lending area, industry concentrations, or types of borrowers, changes in lending policies, procedures, competition, management, portfolio mix, competition, pricing, loan to value trends, extension and modification requests, and loan quality trends. As of June 30, 2013, management added factors to more granularly assess loan quality trends, specifically, the changes and the trend in charge-offs and recoveries, changes in volume of Watch and Special Mention loans and the changes in the quality of the Bank’s loan review system. This analysis establishes factors that are applied to each of the segregated groups of loans to determine an appropriate level of loan loss allowance.

 

The establishment of the allowance for loan losses is significantly affected by management’s judgment and uncertainties, and there is likelihood that different amounts would be reported under different conditions or assumptions. The OCC, as an integral part of its examination process, periodically reviews the allowance for loan losses and may require the Company to make additional provisions for estimated loan losses based upon judgments different from those of management.

 

The allowance generally consists of specific (or allocated) and general components. The specific component relates to loans that are recognized as impaired. For such impaired loans, an allowance is established when the discounted cash flows (or observable market price or collateral value, if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.

 

The ALLL balance decreased from $9.89 million at December 31, 2013 to $7.30 million at June 30, 2014, a decrease of $2.59 million, or 26.2%. The decrease was primarily the result of net chargeoffs of $1.8 million and a $739,000 credit provision for loan losses in the second quarter of 2014. The decrease in the ALLL was consistent with the improvement in the Bank’s asset quality trends during this six month period. The Bank’s nonperforming loans decreased $5.0 million, or 48%, and $7.8 million, or 58%, for the three and six months ended June 30, 2014, respectively. The Bank’s adversely classified loans decreased $11.0 million, or 58% and $8.3 million, or 51%, for the three and six months ended June 30, 2014, respectively, primarily attributable to the more aggressive workout efforts in the three month period ended June 30, 2014. This improvement in adversely classified loans was a continuation of a trend initiated in mid-year 2013 as well as the sale of $10.2 million in adversely classified loans in June 2014.

 

23
 

 

As previously discussed in the Company’s Form 10-K for the year ended December 31, 2013, the Company adopted significant changes to its ALLL methodology as of June 30, 2013, including:

 

·Adoption of a two year weighted average as a basis for the calculation of its historical loss experience;
   
·Further disaggregated the commercial real estate loan segment to increase the granularity of the risks inherent in the loans in the expanded segments; and
   
·Changes in the utilization of qualitative risk adjustment factors (“Q factors”) including an increased number of these Q factors and a change in the calibration and application of the Q factors.

 

The Company also believes it has significantly improved its risk grades (and its risk grading process) over the past year during which the new executive management team has been in place at the Bank. The improvement in the Company’s asset quality metrics has been the result of increased workout efforts and the sales of adversely classified loans in June 2013 and in June 2014.

 

The Company continues to monitor and modify its allowance for loan losses as conditions dictate. No assurances can be given that the level of allowance for loan losses will cover all of the inherent losses on the loans or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.

 

The following tables set forth the balance of and transactions in the allowance for loan losses at June 30, 2014, December 31, 2013 and June 30, 2013, by portfolio segment, disaggregated by impairment methodology, which is then further segregated by loans evaluated for impairment individually and collectively.

 

   One-to-Four Family   Multi-Family and Commercial Real Estate   Construction and Land Development   Commercial Business Loans   Consumer Loans   Total 
As of and for the Six Months                        
Ended June 30, 2014                        
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $1,849   $5,097   $1,118   $1,443   $384   $9,891 
Provision for loan losses   306    51    (117)   (845)   (134)  (739)
Charge-offs   (541)   (1,306)   (148)   (74)   (13)  (2,082)
Recoveries   10    19    16    96    86    227 
Balance at June 30, 2014  $1,624   $3,861   $869   $620   $323   $7,297 
Allowance related to loans:                              
Individually evaluated for impairment  $56   $-   $21   $88   $10   $175 
Collectively evaluated for impairment   1,568    3,861    848    532    313    7,122 
   $1,624   $3,861   $869   $620   $323   $7,297 
                               
Ending loan balance individually evaluated for impairment  $4,061   $825   $1,272   $1,120   $397   $7,675 
Ending loan balance collectively evaluated for impairment   177,970    120,686    3,482    23,791    36,066    361,995 
Total Loans  $182,031   $121,511   $4,754   $24,911   $36,463   $369,670 

 

24
 

 

 

   Multi-Family and Commercial Real Estate 
As of and for the Six Months  Investor one-to-four family and multi-family   Industrial and Warehouse Properties   Office Buildings   Retail Properties   Special Use Properties   Total Multi-Family and Commercial Real Estate 
Ended June 30, 2014                        
(In thousands)                              
Allowance for loan losses:                              
Beginning balance  $515   $1,034   $563   $856   $2,129   $5,097 
Provision for loan losses   96    (64)   (92)   243    (132)   51 
Charge-offs   (166)   (234)   -    (491)   (415)   (1,306)
Recoveries   -    -    -    -    19    19 
Balance at June 30, 2014  $445   $736   $471   $608   $1,601   $3,861 
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $-   $-   $- 
Collectively evaluated for impairment  $445   $736   $471   $608   $1,601   $3,861 
                               
Ending loan balance individually evaluated for impairment $554   $27   $205   $-   $39   $825 
Ending loan balance collectively evaluated for impairment  18,614    27,245    26,932    18,931    28,964    120,686 
Total loans  $19,168   $27,272   $27,137   $18,931   $29,003   $121,511 

                        
As of and for the Six Months  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business
Loans
   Consumer
Loans
   Total 
Ended June 30, 2013                        
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $1,988   $4,892   $4,468   $2,725   $427   $14,500 
Provision for loan losses   (423)   3,689    (277)   883    (22)   3,850 
Charge-offs   (496)   (4,351)   (1,984)   (1,796)   (44)   (8,671)
Recoveries   -    590    102    374    1    1,067 
Ending balance  $1,069   $4,820   $2,309   $2,186   $362   $10,746 
Allowance related to loans:                              
Individually evaluated for impairment  $75   $138   $629   $681   $32   $1,555 
Collectively evaluated for impairment  $994   $4,682   $1,680   $1,505   $330   $9,191 
                               
Ending loan balance individually evaluated for impairment  $6,092   $2,884   $5,622   $2,803   $550   $17,951 
Ending loan balance collectively evaluated for impairment   199,593    126,905    5,678    25,204    26,795    384,175 
Total loans  $205,685   $129,789   $11,300   $28,007   $27,345   $402,126 
     
   Multi-Family and Commercial Real Estate 
As of and for the Six Months  Investor one-
to-four 
family and
multi-family
   Industrial and
Warehouse
Properties
   Office
Buildings
   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial
Real Estate
 
Ended June 30, 2013                        
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $-   $-   $-   $-   $-   $4,892 
Provision for loan losses   -    -    -    -    -    3,689 
Charge-offs   -    -    -    -    -    (4,351)
Recoveries   -    -    -    -    -    590 
Ending Balance                            4,820 
Redistributed through segment expansion   526    818    421    519    2,536    4,820 
Segment Ending Balance  $526   $818   $421   $519   $2,536   $4,820 
Allowance related to loans:                              
Individually evaluated for impairment  $18   $-   $82   $-   $38   $138 
Collectively evaluated for impairment  $508   $818   $339   $519   $2,498   $4,682 
                               
Ending loan balance individually evaluated for impairment  $1,198   $156   $356   $-   $1,174   $2,884 
Ending loan balance collectively evaluated for impairment   16,109    33,449    23,039    21,792    32,516    126,905 
Total loans  $17,307   $33,605   $23,395   $21,792   $33,690   $129,789 

 

25
 

 

As of December 31, 2013  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business
Loans
   Consumer
Loans
   Total 
(In thousands)                              
Allowance related to loans:                              
Individually evaluated for impairment  $70   $23   $75   $105   $10   $283 
Collectively evaluated for impairment   1,779    5,074    1,043    1,338    374    9,608 
Total allowance  $1,849   $5,097   $1,118   $1,443   $384   $9,891 
                               
Ending loan balance individually evaluated for impairment  $7,001   $4,085   $1,854   $2,580   $579   $16,099 
Ending loan balance collectively evaluated for impairment   179,984    119,049    3,755    22,926    28,702    354,416 
Total loans  $186,985   $123,134   $5,609   $25,506   $29,281   $370,515 

 

   Multi-Family and Commercial Real Estate 
As of December 31, 2013  Investor one-
to-four
family and
multi-family
   Industrial and
Warehouse
Properties
   Office
Buildings
   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial
Real Estate
 
(In thousands)                              
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $23   $-   $23 
Collectively evaluated for impairment   515    1,034    563    833    2,129    5,074 
Total allowance  $515   $1,034   $563   $856   $2,129   $5,097 
                               
Ending loan balance individually evaluated for impairment  $1,167   $565   $206   $547   $1,600   $4,085 
Ending loan balance collectively evaluated for impairment   15,205    29,431    21,206    22,973    30,234    119,049 
Total loans  $16,372   $29,996   $21,412   $23,520   $31,834   $123,134 

 

The allowance for loan losses allocated to each portfolio segment is not necessarily indicative of future losses in any particular portfolio segment and does not restrict the use of the allowance to absorb losses in other portfolio segments. Our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. The examination may require us to make additional provisions for loan losses based on judgments different from ours. The Company also periodically engages an independent consultant to review our credit risk grading process and the risk grades on selected portfolio segments as well as the methodology, analysis and adequacy of the allowance for loan and lease losses.

 

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

 

26
 

 

NOTE 5 - MORTGAGE BANKING ACTIVITY

 

Mortgage banking includes two components: (1) the origination of residential mortgage loans for sale in the secondary market and (2) the servicing of mortgage loans sold to investors. The following represents the Company’s noninterest income derived from these activities:

 

   For the Three Months 
Ended June 30,
   For the Six Months 
Ended June 30,
 
(In Thousands)  2014   2013   2014   2013 
Gain on sales of loans  $142   $308   $271   $728 
Mortgage servicing income   (2)   85    5    167 
Total   $140   $393   $276   $895 

 

The Bank originates government sponsored residential mortgage loans which are sold servicing released. The Bank also originates conventional residential mortgage loans for its portfolio and for sale, both on a servicing rights retained and released basis. The significant decline in the Bank’s mortgage servicing income for the three and six month periods in 2014 compared with the same periods in 2013 was the result of the Bank selling most of its loans on the secondary market on a servicing released basis such that the amortization of the existing mortgage servicing rights significantly exceeded the value of the newly capitalized mortgage servicing rights.

 

NOTE 6 – FORECLOSED REAL ESTATE

 

Changes in foreclosed real estate during the three and six months ended June 30, 2014 and June 30, 2013 are as follows:

  

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
(In thousands)  2014   2013   2014   2013 
Beginning balance  $1,114   $498   $1,846   $735 
Additions   53    251    391    251 
Proceeds from dispositions   (625)   (441)   (1,604)   (627)
Gain (loss) on sales   5    (25)   (59)   (65)
Writedowns   (11)   (49)   (38)   (60)
Balance at end of period  $536   $234   $536   $234 

  

At June 30, 2014, the Bank held five properties consisting of four single family residences and one unimproved parcel zoned as residential.

 

The Company records the gain (loss) on sale of foreclosed real estate in the expenses on foreclosed properties, net category along with expenses for acquiring and maintaining foreclosed real estate properties.

  

27
 

 

NOTE 7 – DEPOSITS

 

A summary of deposits at June 30, 2014 and December 31, 2013 consisted of the following:

 

   June 30, 2014   December 31, 2013 
(In thousands)  Amount   Percent   Amount   Percent 
Noninterest bearing demand deposits  $66,441    17.3%  $69,147    17.7%
Interest bearing deposits                    
Now accounts and money market accounts   53,951    14.0%   49,514    12.7%
Savings accounts   113,257    29.3%   117,004    29.9%
Certificates of deposit   152,331    39.4%   155,182    39.7%
Total interest bearing deposits   319,539    82.7%   321,700    82.3%
Total deposits  $385,980    100.0%  $390,847    100.0%

 

Scheduled maturities of certificates of deposit are as follows:

 

(In thousands)  At June 30, 2014   At December 31, 2013 
Through twelve months  $71,110   $74,268 
Twelve months through three years   54,982    50,858 
Over three years   26,239    30,056 
   $152,331   $155,182 

 

The aggregate amount of individual certificate of deposit accounts of $100,000 or more at June 30, 2014 and December 31, 2013 was $62.4 million and $62.5 million, respectively. Deposits up to $250,000 are federally insured through the Federal Deposit Insurance Corporation (“FDIC”). The aggregate amount of individual certificate of deposit accounts of $250,000 or more at June 30, 2014 and December 31, 2013 was $13.1 million and $11.5 million, respectively.

 

NOTE 8 – FHLB ADVANCES

 

The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). At June 30, 2014, the Bank had the ability to borrow from the FHLB based on a certain percentage of the value of the Bank’s qualified collateral, as defined in the FHLB Statement of Products Policy, at the time of the borrowing. In accordance with an agreement with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances.

 

The following table presents certain information regarding our FHLB advances during the periods or at the dates indicated.

 

   At June 30, 2014   At December 31, 2013 
(In thousands)  Amount
Due
   Weighted
Average
Cost
   Amount
Due
   Weighted
Average
Cost
 
Year of maturity: (1)                
2014  $10,385    0.59%  $1,377    2.64%
2015   5,528    0.67%   1,500    0.80%
2016   13,717    0.85%   2,800    0.90%
2017 - 2021   23,330    2.23%   18,368    2.56%
2022 - 2026   606    0.27%   638    0.27%
2027 - 2029   598    -    610    - 
                     
Total FHLB advances  $54,164    1.36%  $25,293    2.16%

 

(1) Amount due includes scheduled principal payments on amortizing advances.

 

28
 

 

The Bank is required to maintain an investment in capital stock of the FHLB in an amount that is based on a percentage of its outstanding residential first mortgage loans. The stock is bought from and sold to the Federal Home Loan Bank based upon its $100 par value. The stock does not have a readily determinable fair value and as such is classified as restricted stock, carried at cost and evaluated for impairment. The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation persists; (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to its operating performance; (c) the impact of legislative and regulatory changes on the customer base of the FHLB; and (d) the liquidity position of the FHLB. Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein.

 

NOTE 9 – OTHER BORROWED FUNDS

 

The Bank utilizes securities sold under agreements to repurchase to accommodate its customers’ needs to invest funds short term and as a source of borrowings.

 

The following table presents certain information regarding our repurchase agreements during the year to date periods or at the dates indicated.

 

   At or for the year to date period ended 
(Dollars in thousands)  June 30, 2014   December 31, 2013 
         
Maximum amount of advances outstanding during the period  $8,355   $21,256 
           
Average advances outstanding during the period  $6,031   $10,866 
           
Weighted average interest rate during the period   0.01%   0.24%
           
Balance outstanding at end of period  $3,967   $4,173 
           
Weighted average interest rate at end of period   0.01%   0.01%

 

The Bank maintains a credit facility with the Federal Reserve Bank of Boston for which certain assets are pledged to secure such borrowings. As of June 30, 2014 and December 31, 2013, there were no borrowings outstanding under this facility. In addition, the Federal Reserve Bank of Boston, as one of the Bank’s correspondent banks, requires the Bank to pledge at least $1 million in loans and/or investment securities for potential daylight overdraft exposure. At June 30, 2014 and December 31, 2013, the Bank had $7.6 million and $3.4 million, respectively, in commercial real estate loans pledged with the Federal Reserve Bank of Boston.

 

At June 30, 2014, the Bank had reserve requirements with the Federal Reserve Bank of Boston amounting to $3.2 million. In addition to the Bank’s $2.2 million in vault cash, the use of $0.6 million in balances held at the Federal Reserve Bank of Boston was restricted to meet these reserve requirements.

 

NOTE 10 – STOCKHOLDERS’ EQUITY

 

Income (Loss) Per Share

 

Basic net income (loss) per common share is calculated by dividing the net income (loss) available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed in a manner similar to basic net income (loss) per common share except that the weighted-average number of common shares outstanding is increased to include the incremental common shares (as computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents were issued during the period. The Company’s common stock equivalents relate solely to stock option and restricted stock awards. Anti-dilutive shares are common stock equivalents with weighted-average exercise prices in excess of the weighted-average market value for the periods presented. For the three and six months ended June 30, 2014, anti-dilutive options excluded from the calculations totaled 105,787 options (with an exercise price of $11.12 per share), and 4,290 options (with an exercise price of $12.51 per share). For the three and six months ended June 30, 2013, anti-dilutive options excluded from the calculations totaled 229,723 options (with an exercise price of $11.12 per share) and 4,290 options (with an exercise price of $12.51 per share), respectively. Unreleased common shares held by the ESOP are not included in the weighted-average number of common shares outstanding for purposes of calculating either basic or diluted net income per common share.

 

29
 

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands except for per share data)  2014   2013   2014   2013 
            
Net income (loss)   $94   $(4,799)  $(715)  $(5,390)
                     
Weighted-average common shares outstanding:                    
Basic   6,675,457    6,643,093    6,675,457    6,643,093 
Diluted   6,676,391    6,643,093    6,675,457    6,643,093 
                     
Earnings (loss) per common share:                    
Basic  $0.01   $(0.72)  $(0.11)  $(0.81)
Diluted  $0.01   $(0.72)  $(0.11)  $(0.81)

 

Dividends

 

The ability of the Company to pay dividends depends, in part, on the ability of the Bank to pay dividends to the Company. Due to current regulatory restrictions, the Company is not allowed to pay dividends to the Company’s shareholders and the Bank is not allowed to pay dividends to the Company.

 

NOTE 11 – STOCK BASED COMPENSATION

 

Stock options generally vest over five years and expire ten years after the date of the grant. The vesting schedule for stock options is 20% annually for years one through five. Restricted stock vests ratably over five years.

 

Stock option awards have been granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Stock options and restricted stock awards are considered common stock equivalents for the purpose of computing earnings per share on a diluted basis.

 

A summary of the status of outstanding stock options at June 30, 2014 and changes therein was as follows:

 

   2014 
   Number of Shares   Weighted Average
Exercise Price
 
Options outstanding at the beginning of year   119,786   $11.18 
Granted   110,000    7.74 
Forfeited   (13,299)   11.12 
Exercised   -    - 
Expired   -   - 
Options outstanding at June 30, 2014   216,487   $9.43 
           
Options exercisable at June 30, 2014   106,487   $11.18 
           
Weighted-average fair value of options granted during the year       $2.55 

  

The Company records stock-based compensation expense related to outstanding stock options and restricted stock awards based upon the fair value at the date of grant over the vesting period of such awards on a straight-line basis. Both stock options and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of grant.

 

The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model which includes several assumptions such as volatility, expected dividends, expected term and risk-free rate for each stock option award.

 

           Weighted Average 
           Remaining 
   Outstanding as of       Contractual Life 
  June 30, 2014   Exercise Price   (in years) 
Exercise prices for outstanding options   102,197   $11.12    1.1 
    4,890   $12.51    1.8 
    110,000   $7.74    9.9 
Total   216,487           

 

In determining the expected volatility of the options, the Company utilized the historical volatility of other similar companies during a period of time equal to the expected life of the options because the Company’s common shares have been publicly traded for a period less than the expected life of the options.

 

The Company assumed no dividend payments would be made during the expected contractual term of the option period.

 

The Company determined the expected contractual term of the options to be 6.5 years using the simplified method under SEC’s Staff Accounting Bulletin No. 110 due to the Company not having sufficient historical data to provide a reasonable basis for estimation.

 

The risk-free rate utilized for this calculation was based upon the U.S. Treasury yield curve in effect at the date of the options grant.

 

Assumptions used to determine the weighted average fair value of the stock options granted were as follows:

 

   Grant Date 
   May 27, 2014 
Dividend yield   0.00%
Expected volatility   28.42%
Risk-free rate   1.95%
Expected life in years   6.5 
Weighted-average fair value of options at grant date  $2.55 

 

The Company recorded stock-based compensation expense of $1,984 for the three and six months ended June 30, 2014. At June 30, 2014 the Company has unrecognized option expense of $279,000 to be recognized over the remaining vesting period of the options.

 

30
 

 

NOTE 12 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

 

In the normal course of business, the Company is a party to financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the financial statements. The contractual amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

 

The contractual amounts of commitments to extend credit represents the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults, and the value of any existing collateral becomes worthless. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments and evaluates each customer’s creditworthiness on a case-by-case basis.

 

The Company controls the credit risk of these financial instruments through credit approvals, credit limits, monitoring procedures and the receipt of collateral that it deems necessary.

 

Financial instruments whose contractual amounts represent credit risk at June 30, 2014 and December 31, 2013 were as follows:

 

   June 30,   December 31, 
(In thousands)  2014   2013 
Commitments to extend credit:          
Commercial real estate loan commitments  $19,256   $12,572 
Unused home equity lines of credit   18,909    19,169 
Commercial and industrial loan commitments   9,329    10,153 
Amounts due on other commitments   10,416    6,618 
Commercial letters of credit   1,132    1,371 

  

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counter-party. Collateral held varies, but may include residential and commercial property, deposits and securities.

 

NOTE 13 – FAIR VALUE

 

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below:

 

Cash and cash equivalents—The carrying amounts for cash and due from banks and federal funds sold approximate fair value because of the short maturities of those investments. The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 1 within the fair value hierarchy.

 

Available for sale and held to maturity securitiesWhere quoted prices are available in an active market, the securities are classified within Level 1 of the valuation hierarchy. Examples of such instruments include mutual funds. If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) or quoted prices of securities with similar characteristics and the securities are classified within Level 2 of the valuation hierarchy. Examples of such instruments include U.S. government agency bonds, U.S. government agency mortgage-backed securities and private label collateralized mortgage obligations. The auction rate trust preferred securities (“ARPs”) that were held as of December 31, 2013 were identified as “impermissible” investments under Volcker rule interpretations by the OCC and as such, the Company liquidated these securities in February 2014. Based on management’s assessment as of December 31, 2013 that the ARPs market is not an active one and to liquidate these securities would require a “forced redemption” from the trust to request delivery of the underlying preferred stock collateral for sale, the Company calculated the fair value (and the determination of the OTTI) on these securities at December 31, 2013 utilizing the current market prices of the underlying preferred stock and classified these investments as a Level 2 in the fair value hierarchy. Securities classified within Level 3 of the valuation hierarchy are securities for which significant unobservable inputs are utilized. Available for sale securities are recorded at fair value on a recurring basis and held to maturity securities are only disclosed at fair value.

 

31
 

 

Loans held for sale—The carrying amounts of these assets approximate fair value because these loans, are generally sold through forward sales (either already contracted or soon to be executed at the recording date). The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 2 within the fair value hierarchy.

 

In June 2014, the Company offered for sale $11.4 million principal amount of primarily adversely classified loans (i.e. loans classified substandard or doubtful) in connection with its plan to reduce the level of classified loans. $4.9 million in commercial loans were sold in June 2014 in two separate transactions in which the financial assets transferred satisfied all of the criteria to be accounted for as sales of financial assets. The remaining loans (comprised of $2.9 million in residential mortgage loans and $3.1 million in commercial loans) were transferred to loans held for sale at June 30, 2014 because the loan sale process for these loans was in the process of completion pending final buyer due diligence in July 2014. The carrying value of these loans held for sale was based on the final bid prices which, in the aggregate, amounted to approximately $4.0 million.

 

Loans receivableFor variable rate loans that reprice frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values, adjusted for credit losses inherent in the loan portfolio. The fair value of fixed rate loans is estimated by discounting the future cash flows using estimated period end market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for credit losses inherent in the loan portfolio. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for credit losses is established. The specific reserves for collateral dependent impaired loans are based on the fair value of collateral less estimated costs to sell. The fair value of collateral is determined based on appraisals. In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments are based on unobservable inputs, the resulting fair value measurement is categorized as a Level 3 measurement.

 

Accrued interest receivable—The carrying amount approximates fair value. The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 1 within the fair value hierarchy.

 

Mortgage servicing assetsThe fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The Company does not record these assets at fair value on a recurring basis. Servicing assets are classified as Level 2 within the fair value hierarchy.

 

Federal Home Loan Bank stock The Bank is a member of the FHLB and is required to maintain an investment in capital stock of the FHLB. The carrying amount is a reasonable estimate of fair value. The Company does not record this asset at fair value on a recurring basis. Based on redemption provisions, the stock of the FHLB has no quoted market value and is carried at cost. FHLB stock is classified as Level 3 within the fair value hierarchy.

 

Foreclosed real estate— Foreclosed real estate represents real estate acquired through or in lieu of foreclosure and which are recorded at fair value on a nonrecurring basis. Fair value is based upon appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company classifies the fair value measurement as Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the fair value measurement as Level 3. The Company classified these assets as Level 3 within the fair value hierarchy.

 

Deposit liabilitiesThe fair value of demand deposits, savings and money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered by market participants for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities of such deposits. The Company does not record deposits at fair value on a recurring basis. Demand deposits, savings and money market deposits are classified as Level 1 within the fair value hierarchy. Certificates of deposit are classified as Level 2 within the fair value hierarchy.

 

Borrowed funds—The fair value of FHLB advances and other borrowed funds (repurchase agreements) are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The Company does not record this liability at fair value on a recurring basis. FHLB advances and other borrowings are classified as Level 2 within the fair value hierarchy.

  

Accrued interest payable—The carrying amounts approximates fair value. The Company does not record the liability at fair value on a recurring basis. This liability is classified as Level 1 within the fair value hierarchy.

 

Mortgagors’ escrow accounts—The carrying amount approximates fair value. The Company does not record this liability at fair value on a recurring basis. This liability is classified as Level 2 within the fair value hierarchy.

 

32
 

  

The following is a summary of the carrying values and estimated fair values of the Company’s significant financial instruments as of June 30, 2014 and December 31, 2013:

 

      June 30, 2014   December 31, 2013 
(In thousands)  Fair Value
Hierarchy Level
  Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
 
                    
Financial Assets                       
Cash and cash equivalents  Level 1  $8,717   $8,717   $26,374   $26,374 
Investment securities, available-for-sale:                       
Mutual fund -fixed income securities  Level 1   508    508    499    499 
Other  Level 2   85,878    85,878    49,272    49,272 
Investment securities, held-to-maturity  Level 2   15,480    15,695    18,149    18,243 
Loans held for sale  Level 2   5,052    5,052    1,079    1,079 
Loans receivable, net:                       
Performing  Level 2   354,649    357,999    344,468    347,496 
Impaired  Level 3   7,675    7,500    16,100    15,816 
Accrued interest receivable  Level 1   1,712    1,712    1,494    1,494 
Mortgage servicing assets  Level 3   948    1,628    1,093    1,598 
FHLB Stock  Level 3   5,210    5,210    5,444    5,444 
Financial Liabilities                       
Demand deposits, savings, Now and                       
money market deposits  Level 1   233,649    233,649    235,665    235,665 
Time deposits  Level 2   152,331    154,929    155,182    157,591 
FHLB advances  Level 2   54,164    54,713    25,293    25,942 
Borrowed funds  Level 2   3,967    3,967    4,173    4,173 
Mortgagors' escrow accounts  Level 2   4,630    4,630    4,392    4,392 
Accrued interest payable  Level 1   67    67    51    51 

 

The Company discloses fair value information about financial instruments, whether or not recognized in the statement of financial condition, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

 

The estimated fair value amounts as of June 30, 2014 and December 31, 2013 have been measured as of their respective period-ends and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than amounts reported at such dates.

 

The information presented should not be interpreted as an estimate of the fair value of the Company as a whole since a fair value calculation is only required for a limited portion of the Company’s assets and liabilities. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.

 

The Company uses fair value measurements to record available-for sale investment securities and residential loans held for sale at fair value on a recurring basis. Additionally, the Company uses fair value measurements to measure the reported amounts of impaired loans, foreclosed real estate and mortgage-servicing rights at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or market value accounting or writedowns of individual assets.

 

Unrecognized financial instrumentsLoan commitments on which the committed interest rate is less than the current market rate were insignificant at June 30, 2014 and December 31, 2013.

 

33
 

  

The following table represents a further breakdown of investment securities and other financial instruments measured at fair value on a recurring basis:

 

   Fair Value At June 30, 2014 
(In thousands)  Level 1   Level 2   Level 3   Total 
Assets measured at fair value on a recurring basis:                    
Available-for-sale investment securities:                    
U.S. Government and agency obligations  $-   $40,934   $-   $40,934 
U.S. Government agency mortgage-backed obligations   -    28,805    -    28,805 
U.S. Government agency collateralized mortgage obligations   -    8,657    -    8,657 
Small Business Administration securitized pool of loans   -    2,070    -    2,070 
State and municipal subdivisions   -    5,412    -    5,412 
Mutual fund - mortgage-backed securities   508    -    -    508 

 

   Fair Value At December 31, 2013 
(In thousands)  Level 1   Level 2   Level 3   Total 
Assets measured at fair value on a recurring basis:                    
Available-for-sale investment securities:                    
U.S. Government and agency obligations  $-   $16,506   $-   $16,506 
U.S. Government agency mortgage-backed obligations   -    22,869    -    22,869 
U.S. Government agency collateralized mortgage obligations   -    3,738    -    3,738 
Private label collateralized mortgage obligations   -    266    -    266 
Auction-rate trust preferred securities   -    5,893    -    5,893 
Mutual fund - mortgage-backed securities   499    -    -    499 

 

The following table represents assets measured at fair value on a non-recurring basis:

 

   Fair Value At June 30, 2014 
(In thousands)  Level 1   Level 2   Level 3   Total 
Assets measured at fair value on a non-recurring basis:                    
Impaired loans  $-   $-   $7,500   $7,500 
Foreclosed real estate   -    -    536    536 
Mortgage servicing rights   -    -    1,628    1,628 

 

   Fair Value At December 31, 2013 
(In thousands)  Level 1   Level 2   Level 3   Total 
Assets measured at fair value on a non-recurring basis:                    
Impaired loans  $-   $-   $15,816   $15,816 
Foreclosed real estate   -    -    1,846    1,846 
Mortgage servicing rights   -    -    1,598    1,598 

 

During the six months ended June 30, 2014, the following fair values of those reflected in the above table were remeasured:

 

·$1.7 million in collateral dependent impaired loans,
·$380,000 in foreclosed real estate; and
·$1.6 million in mortgage servicing rights.

 

Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

 

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The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent management believes necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment.

 

Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

 

NOTE 14 – SUBSEQUENT EVENT

 

On July 7, 2014, the Company signed an agreement to sell its Federal Home Loan Mortgage Corporation (“Freddie Mac”) mortgage servicing portfolio of approximately $138 million at June 30, 2014 to another financial institution. This transaction is scheduled to close on August 29, 2014 with an expected servicing transfer date of October 16, 2014. Mortgage servicing rights were recorded on the Company’s statement of financial condition at $948,000 at June 30, 2014 and are included in Other Assets in the accompanying unaudited financial statements. Management expects to recognize a gain from this transaction of approximately $320,000 during the third quarter of 2014.

 

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

 

The following discussion and analysis is intended to assist you in understanding the financial condition and results of operations of the Company. This discussion should be read in conjunction with the accompanying unaudited financial statements as of and for the three and six months ended June 30, 2014 and 2013 together with the audited financial statements as of and for the year ended December 31, 2013, included in the Company’s Form 10-K initially filed with the Securities and Exchange Commission on March 31, 2014.

 

Forward-Looking Statements

 

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project” or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the size, quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area, changes in real estate market values in the Company’s market area, and changes in relevant accounting principles and guidelines. Additional factors are discussed under “Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

 

Overview

 

As of June 30, 2014, the Company had $512.1 million of total assets, $369.7 million of gross loans receivable, and $386.0 million of total deposits. Total stockholders’ equity at June 30, 2014 was $58.7 million.

 

The Company had net income for the quarter ended June 30, 2014 of $94,000 (or basic and diluted income per share of $0.01) as compared to a net loss of $4.8 million (or basic and diluted loss per share of $0.72) for the second quarter of 2013. The improvement in the Company’s operating results was largely attributable to a credit provision for loan losses of $739,000 for the three months ended June 30, 2014 compared to the $3.6 million provision for loan losses for the same period in 2013, a net change of $4.3 million.

 

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The Company’s operating results for the second quarter of 2014, when compared to the same period of 2013, were influenced by the following factors:

 

·Net interest income decreased by $43,000 due to the combined effects of decreases in loan volume and a decline in yields in the loan portfolio, which were partially offset by increases in investment securities volume and yields, as well as decreases in liability volumes and lower rates paid on interest bearing liabilities;
·Provision for loan losses decreased by $4.3 million primarily due to improvements in asset quality metrics during the second quarter of 2014;
·Noninterest income decreased by $278,000 primarily because of a $253,000 decrease in mortgage banking income, consisting of a $166,000 decrease in gains on sales of mortgage loans and a $87,000 decrease in mortgage servicing income during the three months ended June 30, 2014;
· Noninterest expenses decreased by $925,000, or 14.2%, during the second quarter of 2014 compared to the same period in 2013 primarily due to a $569,000 decrease in expenses related to loan sales and by decreases in professional fees of $314,000, expenses in foreclosed properties of $72,000, and other expenses of $214,000. There were increases in compensation of $77,000, FDIC insurance premiums of $21,000 and occupancy expenses of $126,000.

 

The Company had a net loss for the six months ended June 30, 2014 of $715,000 (or basic and diluted loss per share of $0.11) as compared to a net loss of $5.4 million (or basic and diluted loss per share of $0.81) for the six months ended June 30, 2013. The decrease in the Company’s net loss was largely attributable to a $4.6 million decrease in the provision for loan losses from $3.9 million to ($739,000).

 

Critical Accounting Policies

We consider accounting policies involving significant judgment and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the following to be critical accounting policies: allowance for loan losses, deferred income taxes and fair value of financial instruments.

 

Allowance for Loan Losses. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a quarterly basis, at a minimum, and establishes the provision for loan losses based on the composition of the loan portfolio, delinquency levels, loss experience, economic conditions, and other factors related to the collectability of the loan portfolio.

 

Although we believe that we use the best information available to establish the allowance for loan losses, future additions 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. We engage an independent firm to review our commercial loan portfolio at least quarterly and adjust our loan ratings based in part upon this review. In addition, our banking regulator, as an integral part of its examination process, periodically reviews our allowance for loan losses. Such agency may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination.

 

Other-Than-Temporary Impairments in the Market Value of Investments. Investment securities are reviewed at each reporting period for other-than-temporary impairment. For debt securities, an unrealized loss is generally deemed to be other-than-temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis. The credit loss component of an other-than-temporary impairment writedown is recorded in earnings, while the remaining portion of the impairment loss is recognized in other comprehensive income (loss), provided the Company does not intend to sell the underlying debt security and it is more likely than not that the Company will not be required to sell the debt security prior to recovery. In determining whether a credit loss exists and the period over which the fair value of the debt security is expected to recover, management considers the following factors: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, any external credit ratings, the level of excess cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities, the level of credit enhancement provided by the structure and the Company's ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. If an equity security is deemed other-than-temporarily impaired, the full impairment is considered credit related and a charge to earnings is recorded.

 

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Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed periodically as regulatory and business factors change.

 

Fair Value of Financial Instruments. We use fair value measurements to record certain assets at fair value on a recurring basis, primarily related to the carrying amounts for available-for-sale investment securities. Additionally, we may be required to record at fair value other assets, such as foreclosed real estate, on a nonrecurring basis. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or market value accounting or writedown of individual assets. Valuation techniques based on unobservable inputs are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows and the selection of discount rates that may appropriately reflect market and credit risks. Changes in these judgments often have a material impact on the fair value estimates. In addition, since these estimates are as of a specific point in time, they are susceptible to material near-term changes. The fair values disclosed do not reflect any premium or discount that could result from the sale of a large volume of a particular financial instrument, nor do they reflect the possible tax ramifications or estimated transaction costs.

 

This discussion should be read in conjunction with the Company’s Consolidated Financial Statements for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K.

 

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Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013

 

Earnings Summary. For the three months ended June 30, 2014, the Company recorded net income of $94,000 compared to a net loss of $4.8 million for the same period in 2013. The quarter-over-quarter improvement in the Company’s operating results was the result of a decrease in the provision for loan losses from $3.6 million for the three months ended June 30, 2013 to a credit of $739,000 for the June 2014 period, partially offset by a decrease in net interest income of $43,000, a decrease in noninterest income of $278,000 and a decrease in noninterest expenses of $925,000.

 

Average Balance and Yields. The following table summarizes average balances and average yields and costs for the three months ended June 30, 2014 and 2013. For the purpose of this table, average balances have been calculated using the average daily balances and nonaccrual loans are included in average balances.

 

   For the Quarter Ended June 30, 
   2014   2013 
       Interest   Annualized       Interest   Annualized 
   Average   Earned/   Average   Average   Earned/   Average 
   Balance   Paid   Yield/Rate   Balance   Paid   Yield/Rate 
   (Dollars in thousands) 
Interest-earning assets                              
Loans  $376,421   $4,200    4.48%  $426,876   $5,021    4.72%
Investment securities and Federal funds sold   104,466    832    3.19    45,538    271    2.39 
Overnight funds   4,909    4    0.33    22,224    15    0.27 
Federal Home Loan Bank stock   5,289    20    1.52    5,444    6    0.44 
Total interest-earning assets   491,085    5,056    4.13%   500,082    5,313    4.26%
Non interest-earning assets   21,267              21,026           
Total Assets  $512,352             $521,108           
Interest-bearing liabilities                              
Certificate accounts  $151,800    505    1.33%  $167,212   $634    1.52%
Regular savings accounts and escrow   118,129    48    0.16    121,621    72    0.24 
Checking and NOW  accounts   94,373    34    0.14    85,918    28    0.13 
Money market accounts   24,743    11    0.18    27,135    18    0.27 
Total interest-bearing deposits   389,045    598    0.62    401,886    752    0.75 
FHLB advances   55,920    189    1.36    37,152    241    2.60 
Other borrowings   5,536    -    0.00    11,020    8    0.29 
Total interest-bearing liabilities   450,501    787    0.70%   450,058    1,001    0.89%
Non interest-bearing liabilities   3,958              4,600           
Total Liabilities   454,459              454,658           
Total Stockholders' Equity   57,893              66,450           
Total Liabilities and Stockholders' Equity  $512,352             $521,108           
Net interest income       $4,269             $4,312      
Net interest spread             3.43%             3.37%
Net interest margin             3.49%             3.46%
Average interest earning assets to average interest bearing liabilities             109.01%             111.12%

 

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The following table summarizes average balances and average yields and costs for the six months ended June 30, 2014 and 2013. For the purpose of this table, average balances have been calculated using the average daily balances and nonaccrual loans are included in average balances.

 

   For the Six Months Ended June 30, 
   2014   2013 
       Interest   Annualized       Interest   Annualized 
   Average   Earned/   Average   Average   Earned/   Average 
   Balance   Paid   Yield/Rate   Balance   Paid   Yield/Rate 
   (Dollars in thousands) 
Interest-earning assets                              
Loans  $373,816   $8,412    4.54%   429,651   $10,072    4.73%
Investment securities and Federal funds sold   95,389    1,469    3.11    47,286    575    2.45 
Overnight funds   6,206    9    0.29    21,097    26    0.25 
Federal Home Loan Bank stock   5,366    40    1.50    5,671    11    0.39 
Total interest-earning assets   480,777    9,930    4.17%   503,705    10,684    4.28%
Non interest-earning assets   21,467              20,476           
Total Assets  $502,244              524,181           
Interest-bearing liabilities                              
Certificate accounts  $153,203    1,014    1.33%   169,629   $1,295    1.54%
Regular savings accounts & escrow   118,111    96    0.16    120,614    158    0.26 
Checking and NOW acounts   92,771    71    0.15    83,927    50    0.12 
Money Market accounts   25,212    22    0.18    26,640    35    0.26 
Total interest-bearing deposits   389,297    1,203    0.62    400,810    1,538    0.77 
FHLB advances   44,921    342    1.54    39,091    518    2.67 
Other borrowings   6,031    -    0.00    13,054    25    0.39 
Total interest-bearing liabilities   440,249    1,545    0.71%   452,955    2,081    0.93%
Non interest-bearing liabilities   3,886              4,491           
Total Liabilities   444,135              457,446           
Total Stockholders' Equity   58,109              66,735           
Total Liabilities and Stockholders' Equity  $502,244              524,181           
Net interest income       $8,385             $8,603      
Net interest spread             3.46%             3.35%
Net interest margin             3.52%             3.44%
Average interest earning assets to average interest bearing liabilities             109.21%             111.20%

 

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Rate / Volume Analysis. The following table summarizes the changes in the components of net interest income attributable to both rate and volume for the three and six months ended June 30, 2014 and 2013:

 

   For the Quarter Ended   Six Months Ended 
   June 30, 2014 compared to   June 30, 2014 compared to 
   June 30, 2013   June 30, 2013 
   Increase (Decrease)
Due to
       Increase (Decrease)
Due to
     
   Volume   Rate   Net   Volume   Rate   Net 
Interest income:                              
  Loans  $(574)  $(247)  $(821)  $(1,268)  $(392)  $(1,660)
  Investment securities / Federal funds Sold   446    115    561    706    188    894 
  Overnight funds   (12)   1    (11)   (18)   1    (17)
  Federal Home Loan Bank stock   -    14    14    (1)   30    29 
         Total interest income   (140)   (117)   (257)   (581)   (173)   (754)
Interest expense:                              
   Certificate accounts   (55)   (74)   (129)   (116)   (165)   (281)
   Regular savings accounts   (2)   (23)   (25)   (3)   (59)   (62)
   Checking and NOW accounts   3    4    7    4    17    21 
   Money market accounts   (2)   (5)   (7)   (2)   (11)   (13)
         Total deposit expense   (56)   (98)   (154)   (117)   (218)   (335)
   FHLB advances   107   (159)   (52)   73    (250)   (177)
   Other borrowings   (3)   (5)   (8)   (8)   (16)   (24)
         Total interest expense   48   (262)   (214)   (52)   (484)   (536)
Increase (decrease) in net interest income  $(188)  $145   $(43)  $(529)  $311   $(218)

 

Net Interest Income. Net interest income for the quarter ended June 30, 2014 totaled $4.3 million which remained relatively unchanged compared to the quarter ended June 30, 2013. Interest income on earning assets for the quarter ended June 30, 2014 decreased by $257,000, or 4.8%, compared to the comparable prior year period. This decrease in interest income was the net result of an $821,000, or 16.4%, decrease in interest income on loans which was partially offset by a $564,000, or 193.0% increase in interest income on investment securities, Federal funds sold, overnight funds and FHLB stock. The $821,000, or 16.4%, decrease in interest on loans is due to a decrease in both volume and rate. For the quarter ended June 30, 2014, average interest earning assets decreased $9.0 million, or 1.8%, to $491.1 million from $500.1 million for the quarter ended June 30, 2013. Of this $9.0 million decrease, the $58.9 million increase in the average balance of investments securities and Federal funds sold year-over-year was primarily attributable to the purchase of approximately $75 million in investment securities from July 2013 through June 2014, partially offset by the sale of the auction rate preferred securities of $5.9 million in the first six months of 2014 as well as ongoing scheduled paydowns and prepayments of mortgage-backed securities and calls of U. S. Government agency securities. The continued decline in market interest rates and the change in asset mix primarily from loans and overnight funds into investment securities caused the weighted average yield for interest earning assets to decrease by 13 basis points to 4.13% for the quarter ended June 30, 2014 as compared to 4.26% for the same period in 2013.

 

Interest expense for the quarter ended June 30, 2014 decreased by $214,000 compared to the same period in 2013. This variance was principally attributable to a 19 basis point decline in the average cost of interest bearing liabilities to a 0.70% for the 2014 quarter as compared to 0.89% for the same period in 2013. While there was a small increase in average interest bearing liability balances, there was an approximate $13.0 million shift in the funding mix from deposits to borrowings from the 2013 quarter to the 2014 quarter. During the quarter ended June 30, 2014, average interest bearing liabilities increased $443,000, or 0.1%, to $450.5 million for the first quarter of 2014 from $450.1 million for the same period in 2013. This shift in average interest bearing liability balances reflects an increase in average FHLB advances of $18.8 million offset by decreases in other borrowings of $5.5 million. The decrease in average balance of interest bearing deposits was caused by a greater movement out of time deposits offset by an increase in lower cost transaction and savings accounts.

 

While net interest income for the 2014 quarter was $43,000 less than the 2013 quarter, the Company’s net interest spread and net interest margin increased year-over-year by 6 basis points (from 3.37% to 3.43%) and by 3 basis points (from 3.46% to 3.49%), respectively. While the overall decrease in net interest income was primarily earning asset volume related, the rate related changes, primarily the reduction in the Company’s cost of funds aided by the impact of asset mix changes, softened the overall decrease in the net interest income.

 

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Net interest income for the six months ended June 30, 2014 totaled $8.4 million compared to $8.6 million for the six months ended June 30, 2013, a decrease of $218,000, or 2.5%. The $754,000, or 7.1%, decrease in interest on earning assets was due to a decrease in both volume and rate. For the six months ended June 30, 2014 and 2013, average interest earning assets decreased $22.9 million, or 4.6%, to $480.8 million from $503.7 million for the same period in 2013. Of this $22.9 million decrease, the increase in the average balance of investment securities and Federal funds sold year-over-year was primarily attributable to the above mentioned investment securities activity. The continued decline in market interest rates and the change in asset mix primarily from loans and overnight funds into investment securities and Federal funds sold caused the weighted average yield for interest earning assets to decrease by 11 basis points to 4.17% for the six months ended June 30, 2014 as compared to 4.28% for the same period in 2013.

 

Interest expense for the six months ended June 30, 2014 decreased $536,000, or 25.8%, compared to the 2013 comparable period. The factors influencing the Company’s interest expense year-over-year comparison in terms of rate/volume variances for the three month periods discussed above had a similar impact for the six month period comparisons; however, the magnitude of impact of these factors was due to their relative timing. During the six months ended June 30, 2014, average interest bearing liabilities decreased $12.7 million, or 2.8%, compared to the same period in 2013. This shift in average interest bearing liability balances reflects decreases in interest bearing deposits and other borrowings of $11.5 million and $7.0 million, respectively, offset by an increase in average FHLB advances of $5.8 million. The decrease in average balance of interest bearing deposits was caused by a greater movement out of time deposits offset by an increase in lower cost transaction and savings accounts. These changes caused the weighted cost of interest bearing liabilities to decrease by 22 basis points to 0.71% for the six months ended June 30, 2014 as compared to 0.93% for the same period in 2013.

 

While net interest income for the six months of 2014 was $218,000 less than the six months of 2013, the Company’s net interest spread and net interest margin increased year-over-year by 11 basis points (from 3.35% to 3.46%) and by 8 basis points (from 3.44% to 3.52%), respectively. While the overall decrease in net interest income was primarily earning asset volume related, the rate related changes, the reduction in the Company’s cost of funds aided by the impact of asset mix changes, softened the overall decrease in the net interest income.

 

Provision for Loan Losses. For the three months ended June 30, 2014, the Company recorded a credit provision for loan losses of $739,000, compared to a $3.6 million provision for loan losses for the same period in 2013. Net charge-offs were $1.8 million during the three months ended June 30, 2014, compared to $7.1 million during the three months ended June 30, 2013. The credit provision for the 2014 period was attributable to (i) management’s judgment that the inherent credit risk exposure in the loan portfolio has been significantly reduced due to increased loan workout efforts, including the sale of $10.2 million in adversely classified loans in June and July 2014, which resulted in significant improvement in the Company’s asset quality metrics; and (ii) a $5.3 million decrease in net charge-offs in the three month period ended June 30, 2014, compared to the same period in 2013.

 

Noninterest Income. The following table summarizes the components of noninterest income for the three and six months ended June 30, 2014 and 2013:

 

   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
(Dollars in thousands)  2014   2013   2014   2013 
                 
Service charge income  $176   $182   $350   $360 
Fees for other services   138    180    232    290 
Mortgage banking income   140    393    276    895 
Income from bank owned life insurance   63    70    129    140 
Net gain (loss) on sale of investments   34    (4)   193    (4)
Income from investment advisory services, net   74    87    168    139 
Other income   33    28    63    53 
Total noninterest income  $658   $936   $1,411   $1,873 

 

Noninterest income was $658,000 for the quarter ended June 30, 2014 and $936,000 for the same period in 2013, a decrease of $278,000, or 29.7%. The largest quarter-over-quarter change was in mortgage banking income which decreased by $253,000, or 64.4%. Noninterest income was $1.4 million for the six months ended June 30, 2014 and $1.9 million for the same period in 2013, a decrease of $462,000, or 24.7%. The largest year-over-year change was in mortgage banking income which decreased by $619,000, or 69.2%.

 

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The components of mortgage banking income, gains on sales of loans and mortgage servicing income, both decreased significantly year-over-year, as the Company originated and sold a lower volume of mortgage loans during the 2014 periods due to a national trend of reduction in residential mortgage refinancing beginning in the second quarter of 2013, primarily attributable to an increase in market interest rates on residential mortgage loans, and a somewhat tepid level of purchase related mortgage financings during the past year. Furthermore, the volume of mortgage loans sold on a servicing retained basis versus on a servicing released basis during the 2014 periods was also less than the 2013 activity in the comparable periods, thus accounting for the reduction in servicing rights capitalized in total, and in relation to the amortization of mortgage servicing rights in the 2014 periods and its impact on that period’s mortgage servicing income.

 

The impact of the decrease in mortgage banking income was partially reduced by net gains on the sale of investment securities of $34,000 and $193,000 for the three month and six month periods, respectively. The gain on sale of investment securities was primarily the result of the sale of the auction rate preferred securities in February 2014. The Company sold these securities after being identified as “impermissible” under Volcker rule interpretations.

 

The decreases in fees for other services of $42,000 and $58,000 for the three month and six month periods in 2014, respectively, compared to the 2013 periods were due to $50,000 fewer loan prepayment penalties received in 2014 compared to 2013.

 

The variances in investment advisory services income were primarily related to transaction volume and transaction mix as commissions on insurance products are significantly higher than brokerage commissions on other products such as mutual funds.

 

The decreases in service charge income were primarily transaction volume related, such as a lower volume of overdraft transactions due to the Bank more aggressively monitoring and controlling such activity.

 

The decrease in income from bank owned life insurance was attributable to a lower crediting rate on certain policies during the past year as the insurance carriers have reacted to the continuation of low market interest rates and their effect on investment portfolio yields.

 

The increases in other income for the three month and six month periods ended June 30, 2014 compared to 2013 were attributable to increases in rental income of $9,000 and 18,000, respectively.

 

Noninterest Expense. The following table summarizes the components of noninterest expense for the three months ended June 30, 2014 and 2013:

 

   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
(Dollars in thousands)  2014   2013   2014   2013 
Compensation, taxes and benefits  $2,973   $2,896   $5,989   $5,573 
Occupancy   582    456    1,124    946 
Professional fees   323    637    842    1,296 
FDIC insurance premiums   270    249    531    454 
Insurance   117    124    262    282 
Computer processing   327    315    697    631 
Expenses on foreclosed real estate, net   168    202    378    559 
Writedowns on foreclosed real estate   11    49    38    60 
Directors compensation   70    77    172    211 
Advertising   118    108    213    195 
Supplies   60    48    129    109 
Expenses related to sale of loans   196    765    196    765 
Other expenses   357    571    679    935 
Total  $5,572   $6,497   $11,250   $12,016 

 

Noninterest expense was $5.6 million for the quarter ended June 30, 2014 compared to $6.5 million for the quarter ended June 30, 2013, a decrease of $925,000, or 14.2%. Noninterest expense was $11.2 million for the six months ended June 30, 2014 compared to $12.0 million for the same period in 2013, a decrease of $766,000 or 6.4%.

 

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The year-over-year quarterly decrease of $925,000 was primarily the result of decreases in: expenses related to loan sales of $569,000, or 74%, professional fees of $314,000, or 49.3%, and expenses and writedowns on foreclosed real estate of $72,000, or 28.7%, over the same period in 2013. These decreases were partially offset by increases in: occupancy expenses of $126,000, or 27.6%, and compensation, taxes and benefits of $77,000, or 2.7%.

 

For the comparable six month periods, noninterest expense decreased $766,000, or 6.4%, primarily due to the $569,000, or 74.4% decrease in expenses related to loan sales, decreased in professional fees of $454,000, or 35.0%, and decreases in expenses and writedowns on foreclosed real estate of $203,000, or 32.8%. These decreases were partially offset by increases in compensation, taxes and benefits of $416,000, or 7.5%, and in occupancy expenses of $178,000, or 18.8%

 

The $569,000 decrease in expenses related to loan sales was primarily attributable to higher transaction costs, such as delinquent property taxes, in the June 2013 loan sales. Professional fees were lower in 2014 due to a decline in expenses paid to loan review firms, outside attorneys and advisors and due to the decreased use of consultants utilized to staff previously vacant positions. Expenses and writedowns on foreclosed real estate decreased due to an increase in the sales of properties, resulting in lower property taxes and decreases in other costs of acquiring and maintaining foreclosed real estate. The increase in occupancy expenses were due to utilities and repairs and maintenance related to the harsh winter and an increase in property taxes. The increases in compensation were attributable to (i) the increased cost of replacing existing management, outsourced finance positions and other key staff with more experienced and skilled personnel; and (ii) increases in employee benefits and payroll taxes. Some of the increases in compensation were partially offset by a lower level of mortgage commissions during 2014 compared to 2013.

 

Income Tax Expense (Benefit). The Company has reported no tax provision for its pre-tax operating income for the quarter ended June 30, 2014 nor has the Company reported a tax benefit for the operating loss for the six month period. At June 30, 2014, there was a 100% valuation allowance on the deferred tax asset. The Company records a valuation allowance against deferred tax assets if, based on the weight of available evidence, it is more-likely-than not that some or all of the deferred tax assets will not be realized.

 

The valuation allowance was established during the year ended December 31, 2012, at which time the Company had $5.3 million in net deferred tax assets related to the provision for loan losses and current year operating losses. Management concluded that it was more likely-than-not that the Company would not be able to realize its deferred tax assets and accordingly has established a 100% valuation allowance equal to the net deferred tax asset balance at June 30, 2014. If, in the future, the Company generates taxable income on a sustained basis sufficient to support the deferred tax assets, management’s conclusion regarding the need for a deferred tax valuation allowance could change, resulting in the reversal of all or a portion of the deferred tax asset valuation at that time.

 

Management regularly analyzes the Company’s tax positions and at June 30, 2014, does not believe that the Company has taken any tax positions where future deductibility is not certain. As of June 30, 2014, the Company is subject to unexpired statutes of limitation for examination of its tax returns for U.S. federal and Connecticut income taxes for the years 2010-2012.

 

Naugatuck Valley Mortgage Servicing Corporation, a wholly-owned subsidiary of the Bank, qualifies and operates as a Connecticut passive investment company pursuant to legislation. Because the subsidiary earns income from passive investments which are exempt from Connecticut Corporation Business Tax and its dividends to the Bank are exempt from state tax, the Bank no longer expects to incur state income tax expense.

 

Comparison of Financial Condition at June 30, 2014 and December 31, 2013

 

Overview

 

Total assets were $512.1 million as of June 30, 2014, an increase of $25.3 million or 5.2%, from $486.8 million as of December 31, 2013. Loans receivable, gross, of $369.7 million decreased by $845,000, or 0.2%, and investment securities increased by $34.0 million, or 50.0%, partially offset by a decrease in cash and cash equivalents of $17.7 million, or 67.0%. The loan portfolio decreased during the period by type as follows: real estate loans decreased by $7.4 million, or 2.4%; commercial business loans decreased by $595,000, or 2.3%. These decreases were offset by an increase in consumer loans (mostly purchased indirect auto loans) of $7.2 million, or 24.5%. The net decrease in the loan portfolio was primarily due to the $10.4 million reduction from the loan sales in June 2014 and loans transferred to held for sale at June 30, 2014, which were sold in July 2014, contractual amortization, repayments, and charge offs, partially offset by new loan production.

 

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Total liabilities were $453.4 million at June 30, 2014 compared to $428.5 million at December 31, 2013. Deposits decreased $4.9 million, or 1.2%, to $386.0 million at June 30, 2014 from $390.8 million at December 31, 2013. Between December 31, 2013 and June 30, 2014, core deposits (defined as all deposits other than certificates of deposit) of $233.6 million decreased $2.1 million in concert with a decrease of $2.9 million in certificates of deposit. Management attributes the slight decrease in deposits primarily to the seasonal needs of depositors. Advances from the FHLB increased by $28.9 million, from $25.3 million at December 31, 2013 to $54.2 million at June 30, 2014, primarily to fund the purchases of investment securities. Other borrowed funds decreased $206,000 to $4.0 million from $4.2 million over the same period.

 

Total stockholders’ equity was $58.7 million at June 30, 2014 compared to $58.2 million at December 31, 2013. The decrease in stockholders’ equity was due to the net loss of $715,000 for the six month period ended June 30, 2014 and an increase in unrealized gain in available for sale investment securities of $1.1 million.

 

Lending Activities

 

As indicated in the table below, total gross loans receivable decreased $845,000, or 0.2%, to $369.7 million at June 30, 2014 from $370.5 million at December 31, 2013.

 

   June 30,   December 31, 
(Dollars in thousands)  2014   2013 
         
Real estate loans:          
One-to-four family  $182,031   $186,985 
Multi-family and commercial real estate   121,511    123,134 
Construction and land development   4,754    5,609 
Total real estate loans   308,296    315,728 
           
Commercial business loans   24,911    25,506 
Consumer loans:          
Home equity   28,080    26,960 
Other consumer   8,383    2,321 
Total consumer loans   36,463    29,281 
Total loans   369,670    370,515 
           
Less:          
Allowance for loan losses   7,297    9,891 
Deferred loan origination fees, net   49    56 
          Loans receivable, net  $362,324   $360,568 

 

In June 2014, the Company offered for sale $11.4 million principal amount of primarily adversely classified loans (i.e. loans classified substandard or doubtful) in connection with its plan to reduce the level of classified loans. $4.9 million in commercial loans were sold in June 2014 in two separate transactions in which the financial assets transferred satisfied all of the criteria to be accounted for as sales of financial assets. The remaining loans (comprised of $2.9 million in mortgage loans and $3.1 million in commercial loans) were transferred to loans held for sale at June 30, 2014 because the loan sale process for these loans was in the process of completion pending final buyer due diligence in July 2014. The closing for the sale of these remaining loans occurred in July 2014. The carrying value of these loans held for sale was based on the final bid prices which, in the aggregate, amounted to approximately $4.0 million.

 

The impact of these two sale transactions and the writedown of the carrying value of these loans held for sale amounted to $1.8 million in net charge-offs against the Company’s allowance for loan losses and $196,000 in expenses related to the sale of loans.

 

These transactions resulted in a $10.2 million reduction in adversely classified loans.

 

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Nonperforming Assets

 

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

 

   June 30,   December 31, 
   2014   2013 
Nonperforming Assets  (Dollars in thousands) 
 Nonaccrual loans  $3,528   $7,953 
 TDRs nonaccruing   2,020    5,430 
       Subtotal nonperforming loans   5,548    13,383 
 Foreclosed real estate   536    1,846 
          Total nonperforming assets  $6,084   $15,229 
           
 Total nonperforming loans to total loans   1.50%   3.61%
           
 Total nonperforming assets to total assets   1.19%   3.13%

 

The following table shows the aggregate amounts of the Company’s adversely classified loans and criticized loans at the dates indicated:

 

   At June 30,   At December 31, 
   2014   2013 
Loans by risk grade:  (In thousands) 
 Special mention  $14,959   $32,409 
           
 Substandard   7,862    16,203 
 Doubtful   88    93 
     Subtotal - adversely classified loans   7,950    16,296 
 Total criticized loans  $22,909   $48,705 

 

The balances of nonperforming loans decreased $7.9 million, or $59%, between December 31, 2013 and June 30, 2014. During this same period, the Bank’s adversely classified loans decreased by $8.3 million, or 51%. This significant improvement in the Company’s asset quality metrics was primarily attributable to the impact of the June 2014 loan sales comprised of $10.2 million in adversely classified loans of which $4.7 million were nonaccrual loans. In addition to the improvement in nonperforming loans, and adversely classified loans, the Company has also experienced a reduction of $17.5 million, or 54%, in its Special Mention loans during the first six months of 2014. The levels and trends of adversely classified loans, and to a certain extent, the trend in Special Mention loans, warrant and receive management oversight and focus in management’s estimates related to the allowance for loan losses. In certain cases, where appropriate, specific allowances have been established to account for the increased credit risk of these assets.

 

Allowance for Loan Losses and Asset Quality. The allowance for loan losses is a valuation allowance for the probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When an increase to the allowance is needed, a provision for loan losses is charged against earnings. The recommendations for increases or decreases to the allowance are presented by management to the board of directors on a quarterly basis.

 

On a quarterly basis, or more often if warranted, management analyzes the loan portfolio. For individually evaluated loans that are considered impaired, an allowance is established as required, based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or for loans that are considered collateral dependent, the fair value of the collateral. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due under the contractual term of the loan agreement.

 

All other loans, excluding loans that are individually evaluated, including those not considered impaired, are segregated into groups based on similar risk factors. Each of these groups is then evaluated based on several factors to estimate credit losses. Management will determine for each category of loans with similar risk characteristics the historical loss rate. Historical loss rates provide a reasonable starting point for the Bank’s analysis; however, this analysis and loss trends do not form a sufficient basis, by themselves, to determine the appropriate level of the loan loss allowance. Management also considers qualitative and environmental factors for each loan segment that are likely to impact, directly or indirectly, the inherent loss exposure of the loan portfolio. These factors include but are not limited to: changes in the amount and severity of delinquencies, non-accrual and adversely classified loans, changes in local, regional, and national economic conditions that will affect the collectability of the portfolio, changes in the nature and volume of loans in the portfolio, changes in concentrations of credit, lending area, industry concentrations, or types of borrowers, changes in lending policies, procedures, competition, management, portfolio mix, competition, pricing, loan to value trends, extension and modification requests, and loan quality trends. As of June 30, 2013, management added factors to assess with greater granularity loan quality trends, in particular, the changes and the trend in charge-offs and recoveries, change in volume of loans classified as Watch or Special Mention, and the changes in the quality of the Bank’s loan review system. This analysis establishes factors that are applied to each of the segregated groups of loans to determine an appropriate level of loan loss allowance.

 

45
 

  

Our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. The examination may require us to make additional provisions for loan losses based on judgments different from ours. The Company also periodically engages an independent consultant to review our credit risk grading process and the risk grades on selected portfolio segments as well as the methodology, analysis and adequacy of the allowance for loan and lease losses.

 

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

 

The following table summarizes the activity in the allowance for loan losses and provision for loan losses for the six months ended June 30, 2014 and 2013:

 

   One-to-Four Family   Multi-Family and Commercial Real Estate   Construction and Land Development   Commercial Business Loans   Consumer Loans   Total 
As of and for the Six Months                        
Ended June 30, 2014                        
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $1,849   $5,097   $1,118   $1,443   $384   $9,891 
Provision for loan losses   306    51    (117)   (845)   (134)  (739)
Charge-offs   (541)   (1,306)   (148)   (74)   (13)  (2,082)
Recoveries   10    19    16    96    86    227 
Balance at June 30, 2014  $1,624   $3,861   $869   $620   $323   $7,297 
Allowance related to loans:                              
Individually evaluated for impairment  $56   $-   $21   $88   $10   $175 
Collectively evaluated for impairment   1,568    3,861    848    532    313    7,122 
   $1,624   $3,861   $869   $620   $323   $7,297 
                               
Ending loan balance individually evaluated for impairment  $4,061   $825   $1,272   $1,120   $397   $7,675 
Ending loan balance collectively evaluated for impairment   177,970    120,686    3,482    23,791    36,066    361,995 
Total loans  $182,031   $121,511   $4,754   $24,911   $36,463   $369,670 

 

46
 

 

   Multi-Family and Commercial Real Estate 
As of and for the Six Months  Investor one-to-four family and multi-family   Industrial and Warehouse Properties   Office Buildings   Retail Properties   Special Use Properties   Total Multi-Family and Commercial Real Estate 
Ended June 30, 2014                        
(In thousands)                              
Allowance for loan losses:                              
Beginning balance  $515   $1,034   $562   $856   $2,129   $5,097 
Provision for loan losses   96    (64)   (93)   243    (132)   51 
Charge-offs   (166)   (234)   -    (491)   (415)   (1,306)
Recoveries   -    -    -    -    19    19 
Balance at June 30, 2014  $445   $736   $471   $608   $1,601   $3,861 
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $-   $-   $- 
Collectively evaluated for impairment  $445   $736   $471   $608   $1,601   $3,861 
                               
Ending loan balance individually evaluated for impairment $554   $27   $205   $-   $39   $825 
Ending loan balance collectively evaluated for impairment  18,614    27,245    26,932    18,931    28,964    120,686 
Total loans  $19,168   $27,272   $27,137   $18,931   $29,003   $121,511 

  

As of and for the Six Months
  Ended June 30, 2013
  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business
Loans
   Consumer
Loans
   Total 
(In thousands)                              
Allowance for loan losses:                              
Beginning balance  $1,988   $4,892   $4,468   $2,725   $427   $14,500 
Provision for loan losses   (423)   3,689    (277)   883    (22)   3,850 
Charge-offs   (496)   (4,351)   (1,984)   (1,796)   (44)   (8,671)
Recoveries   -    590    102    374    1    1,067 
Ending balance  $1,069   $4,820   $2,309   $2,186   $362   $10,746 
Allowance related to loans:                              
Individually evaluated for impairment  $75   $138   $629   $681   $32   $1,555 
Collectively evaluated for impairment  $994   $4,682   $1,680   $1,505   $330   $9,191 
                               
Ending loan balance individually evaluated for impairment  $6,092   $2,884   $5,622   $2,803   $550   $17,951 
Ending loan balance collectively evaluated for impairment   199,593    126,905    5,678    25,204    26,795    384,175 
Total loans  $205,685   $129,789   $11,300   $28,007   $27,345   $402,126 

 

   Multi-Family and Commercial Real Estate 
As of and for the Six Months
  Ended June 30, 2013
  Investor one-
to-four
family and
multi-family
   Industrial and
Warehouse
Properties
   Office
Buildings
   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial
Real Estate
 
(In thousands)                              
Allowance for loan losses:                              
Beginning balance  $-   $-   $-   $-   $-   $4,892 
Provision for loan losses   -    -    -    -    -    3,689 
Charge-offs   -    -    -    -    -    (4,351)
Recoveries   -    -    -    -    -    590 
Ending Balance                            4,820 
Redistributed through segment expansion   526    818    421    519    2,536    4,820 
Segment Ending Balance  $526   $818   $421   $519   $2,536   $4,820 
Allowance related to loans:                              
Individually evaluated for impairment  $18   $-   $82   $-   $38   $138 
Collectively evaluated for impairment  $508   $818   $339   $519   $2,498   $4,682 
                               
Ending loan balance individually evaluated for impairment  $1,198   $156   $356   $-   $1,174   $2,884 
Ending loan balance collectively evaluated for impairment   16,109    33,449    23,039    21,792    32,516    126,905 
Total loans  $17,307   $33,605   $23,395   $21,792   $33,690   $129,789 

 

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As of December 31, 2013  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business
Loans
   Consumer
Loans
   Total 
(In thousands)                              
Allowance related to loans:                              
Individually evaluated for impairment  $70   $23   $75   $105   $10   $283 
Collectively evaluated for impairment   1,779    5,074    1,043    1,338    374    9,608 
Total allowance  $1,849   $5,097   $1,118   $1,443   $384   $9,891 
                               
Ending loan balance individually evaluated for impairment  $7,001   $4,085   $1,854   $2,580   $579   $16,099 
Ending loan balance collectively evaluated for impairment   179,984    119,049    3,755    22,926    28,702    354,416 
Total loans  $186,985   $123,134   $5,609   $25,506   $29,281   $370,515 
                               
   Multi-Family and Commercial Real Estate 
As of December 31, 2013  Investor one-
to-four
family and
multi-family
   Industrial and
Warehouse
Properties
   Office
Buildings
   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial
Real Estate
 
(In thousands)                              
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $23   $-   $23 
Collectively evaluated for impairment   515    1,034    563    833    2,129    5,074 
Total allowance  $515   $1,034   $563   $856   $2,129   $5,097 
                               
Ending loan balance individually evaluated for impairment  $1,167   $565   $206   $547   $1,600   $4,085 
Ending loan balance collectively evaluated for impairment   15,205    29,431    21,206    22,973    30,234    119,049 
Total loans  $16,372   $29,996   $21,412   $23,520   $31,834   $123,134 

 

Liquidity and Capital Resources

 

Liquidity is the ability to meet current and future short-term financial obligations. The Bank’s primary sources of funds consist of retail deposit inflows, loan repayments, maturities and sales of investment securities and advances from the Federal Home Loan Bank of Boston. The deposit base is comprised of certificate accounts, regular savings accounts, checking and NOW accounts, money market savings accounts and health savings accounts. The Bank borrows funds from the Federal Home Loan Bank of Boston during periods of low liquidity to match fund increases in our fixed-rate mortgage portfolio and to provide long-term fixed-rate funding with the goal of decreasing our exposure to an increase in interest rates. We also use securities sold under agreements to repurchase as a source of borrowings.

 

Each quarter the Bank projects liquidity availability and demands on this liquidity for the next ninety days. The Bank regularly adjusts its investments in liquid assets based upon its assessment of (1) expected loan demand, (2) expected retail deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in federal funds and short- and intermediate-term U.S. Government agency obligations. While maturities and scheduled amortization of loans and securities are predictable sources of funds, retail deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

 

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The Bank’s most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At June 30, 2014, cash and cash equivalents totaled $8.7 million, including federal funds sold of $18,000. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $86.4 million at June 30, 2014. At June 30, 2014, the Bank had the ability to borrow a total of $80.6 million from the FHLB based on the collateral pledged, of which $54.2 million in borrowings was outstanding. The Bank also had other borrowed funds of $4.0 million in repurchase agreements with customers. In addition, the Bank had the ability to borrow $3.6 million from the Federal Reserve Bank Discount Window which was not utilized at June 30, 2014.

 

The following table summarizes the commitments and contingent liabilities as of the dates indicated:

 

   June 30,   December 31, 
(In thousands)  2014   2013 
Commitments to extend credit:          
Commercial real estate loan commitments  $19,256   $12,572 
Unused home equity lines of credit   18,909    19,169 
Commercial and industrial loan commitments   9,329    10,153 
Amounts due on other commitments   10,416    6,618 
Commercial letters of credit   1,132    1,371 

 

Certificates of deposit due within one year of June 30, 2014 totaled $71.1 million, or 18.4% of total deposits. If these deposits do not remain with the Bank, the Bank will need to seek other sources of funds, including other certificates of deposit, FHLB advances or other borrowings, and its available lines of credit. Depending on market conditions, the Bank may be required to pay higher rates on such deposits or other borrowings than are currently paid on these maturing certificates of deposit. Based on past experience, however, the Bank believes that a significant portion of our certificates of deposit will remain with us. The Bank has the ability to attract and retain deposits by adjusting the interest rates offered.

 

Historically, the Bank has remained highly liquid. The Bank is not aware of any trends and/or demands, commitments, events or uncertainties that could result in a material decrease in liquidity. The Bank expects that all of our liquidity needs, including the contractual commitments stated above and increases in loan demand, can be met by our currently available liquid assets and cash flows. In the event loan demand was to increase at a pace greater than expected, or any unforeseen demand or commitment were to occur, we could access our borrowing capacity with the Federal Home Loan Bank of Boston or the Federal Reserve Bank Discount Window. The Bank expects that our currently available liquid assets and our ability to borrow from both the Federal Home Loan Bank of Boston and the Federal Reserve Bank would be sufficient to satisfy our liquidity needs without any material adverse effect on our liquidity.

 

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company, on a stand-alone basis, is responsible for paying any dividends declared to its shareholders. The Company’s primary source of income is dividends received from the Bank. Under the Agreement with the OCC, the Bank is restricted from declaring or paying any dividends or other capital distributions to the Company without prior written approval from the OCC. This provision relates to up streaming intercompany dividends or other capital distributions from the Bank to the Company. On a stand-alone basis, the Company had liquid assets of $2.9 million at June 30, 2014.

 

Effective June 4, 2013, the OCC imposed IMCRs on the Bank. The IMCRs require the Bank to maintain a Tier 1 leverage capital to adjusted total assets ratio of at least 9.00% and a total risk-based capital to risk-weighted assets ratio of at least 13.00%. Before the establishment of the IMCRs, the Bank had been operating under these capital parameters by self-imposing these capital levels as part of the capital plan the Bank was required to implement under the terms of the Agreement. The Bank exceeded the IMCRs at June 30, 2014, with a Tier 1 leverage ratio of 10.39% and a total risk-based capital ratio of 17.45%.

 

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As a source of strength to its subsidiary bank, the Company has liquid assets which the Company could contribute to the Bank if needed to enhance the Bank’s capital levels. The Company’s liquid assets totaled approximately $2.9 million at June 30, 2014. If the Company had contributed those assets to the Bank as of June 30, 2014, the Bank would have had a Tier 1 leverage ratio of approximately 10.95%.

 

On May 21, 2013, the Company entered into a MOU with the Federal Reserve Bank of Boston. Among other things, the MOU prohibits the Company from paying dividends, repurchasing its stock or making other capital distributions without prior written approval of the Federal Reserve Bank of Boston.

 

The following tables are summaries of the Company’s consolidated and the Bank’s actual capital amounts and ratios at June 30, 2014 and December 31, 2013 as computed under the regulatory guidelines.

 

At June 30, 2014  Adequately Capitalized
Requirements
   Individual Minimum
Capital Requirements (3)
   Actual 
(Dollars in thousands)  $   %   $   %   $   % 
The Company Consolidated                              
Tier 1  Leverage Capital (1)    N/A     N/A     N/A     N/A   $57,610    11.29%
Tier 1 Risk-Based Capital (2)    N/A     N/A     N/A     N/A    57,610    17.63%
Total Risk-Based Capital (2)   N/A    N/A    N/A    N/A    61,734    18.90%
                               
The Bank                              
Tier 1  Leverage Capital (1)  $20,509    4.00%  $46,146    9.00%  $53,290    10.39%
Tier 1 Risk-Based Capital (2)   13,136    4.00%           N/A     N/A    53,290    16.19%
Total Risk-Based Capital (2)   26,273    8.00%   42,693    13.00%   57,445    17.45%

 

(1) Tier 1 capital to total assets.

(2) Tier 1 or total risk-based capital to risk-weighted assets.

(3) Effective June 4, 2013.

 

At December 31, 2013  Adequately  Capitalized
Requirements
   Individual Minimum
Capital Requirements
   Actual 
(Dollars in thousands)  $   %   $   %   $   % 
The Company Consolidated                              
Tier 1 Leverage Capital (1)    N/A     N/A     N/A     N/A   $58,323    11.98%
Tier 1 Risk-Based Capital (2)    N/A     N/A     N/A     N/A    58,323    18.21%
Total Risk-Based Capital (2)    N/A    N/A    N/A    N/A    62,399    19.49%
                               
The Bank                              
Tier 1 Leverage Capital (1)  $19,545    4.00%  $43,977    9.00%  $53,946    11.04%
Tier 1 Risk-Based Capital (2)   12,891    4.00%    N/A     N/A    53,946    16.74%
Total Risk-Based Capital (2)    25,783    8.00%   41,897    13.00%   58,047    18.01%

 

(1) Tier 1 capital to total assets.

(2) Tier 1 or total risk-based capital to risk-weighted assets.

  

Off-Balance Sheet Arrangements

 

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risks. Such transactions are used primarily to manage customers’ requests for funding, and take the form of loan commitments, unused lines of credit, amounts due on construction loans and on commercial loans, commercial letters of credit and commitments to sell loans.

 

For the three months ended June 30, 2014, the Company did not engage in any off-balance-sheet transactions reasonably likely to have a material effect on its financial condition, results of operations or cash flows.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Our results of operations are highly dependent upon our ability to manage interest rate risk. We consider interest rate risk to be a significant market risk that could have a material effect on our financial condition and results of operations. Interest rate risk is measured and assessed on a quarterly basis. In our opinion, there has not been a material change in our interest rate risk exposure since the information disclosed in our annual report on Form 10-K for the year ended December 31, 2013.

 

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We do not maintain a trading account for any class of financial instrument nor do we engage in hedging activities or purchase high-risk derivative instruments. Moreover, we have no material foreign currency exchange rate risk or commodity price risk.

 

Item 4. Controls and Procedures.

 

(a)Disclosure Controls and Procedures

 

The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13(a)-15(e) of the Securities Exchange Act of 1934). Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of June 30, 2014 were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) as appropriate to allow timely decisions regarding required disclosures, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

(b)Changes in Internal Control Over Financial Reporting

 

There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13(a)-15(f) of the Act) that occurred during the three months ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 Part II - OTHER INFORMATION

 

Item 1. - Legal Proceedings.

 

On November 8, 2012, John Roman, then a director of Naugatuck Valley Financial and Naugatuck Valley Savings and the former President and Chief Executive Officer of Naugatuck Valley Financial and Naugatuck Valley Savings, filed a complaint and an application for an injunction in Connecticut state court. Mr. Roman named Naugatuck Valley Financial, Naugatuck Valley Savings, and all of the other then existing directors of each entity as defendants. The complaint requested that the court enter temporary and permanent injunctions to prevent his removal as a director of Naugatuck Valley Savings. The complaint alleged that cause did not exist to remove Mr. Roman as required under the Bylaws, and that the removal vote was in retribution for his threatened legal action against Naugatuck Valley Savings based on his resignation as President and Chief Executive Officer. Subsequent to his removal as a director of Naugatuck Valley Savings on November 30, 2012, Mr. Roman modified his requested injunction, asking that the court reinstate him as a director of Naugatuck Valley Savings. A hearing on Mr. Roman’s request for a temporary injunction was held on February 26-27, 2013. By court order dated March 20, 2013, the court denied Mr. Roman’s request for a temporary injunction, finding that Mr. Roman was not “likely to prevail on the merits” and that there was not a “substantial probability” that any harm would result if his requested injunction was not granted. Effective May 16, 2013, Mr. Roman resigned as a director of Naugatuck Valley Financial. On May 28, 2013, the Board of Directors accepted Mr. Roman’s resignation.

 

On June 17, 2013, Mr. Roman filed a request to amend his complaint, which was granted on July 16, 2013. The amended complaint dropped certain claims, including his request for injunctive relief, and added claims arising from his resignation as President and Chief Executive Officer of Naugatuck Valley Financial and Naugatuck Valley Savings, including claims for breach of his employment agreement, breach of the duty of good faith and fair dealing underlying that employment agreement, negligent infliction of emotional distress, and for indemnification for enforcement of his employment agreement. Mr. Roman requested unspecified damages as well as recovery of attorneys’ fees.

 

On February 20, 2014, the court entered a scheduling order providing a period for completion of discovery and the filing of dispositive motions. A trial date has been set for March 3, 2015. However, on May 23, 2014, those deadlines were stayed by the court pending regulatory consideration of a settlement.

 

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Naugatuck Valley Financial and Naugatuck Valley Savings are also subject to claims and litigation that arise primarily in the ordinary course of business. Based on information presently available and advice received from legal counsel representing Naugatuck Valley Financial and Naugatuck Valley Savings in connection with such claims and litigation, it is the opinion of management that the disposition or ultimate determination of such claims and litigation will not have a material adverse effect on the consolidated financial position, results of operations or liquidity of Naugatuck Valley Financial.

 

Item 1A. – Risk Factors.

 

In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, which could materially affect the Company’s business, financial condition or future results. The risks described in the Company’s Annual Report on Form 10-K are not the only risks that the Company faces. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

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

 

(a)        Not applicable.

 

(b)        Not applicable.

 

(c)        The Company did not repurchase any shares of its common stock during the quarter ended June 30, 2014.

 

Item 3. – Defaults Upon Senior Securities. Not applicable

 

Item 4. – Mine Safety Disclosures. Not applicable

 

Item 5. – Other Information. Not applicable

 

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Item 6. – Exhibits.

 

Exhibits

 

3.1Articles of Incorporation of Naugatuck Valley Financial Corporation (1)

 

3.2Bylaws of Naugatuck Valley Financial Corporation, as amended (2)

 

4.1Specimen Stock Certificate of Naugatuck Valley Financial Corporation (3)

 

31.1Rule 13a-14(a)/15d-14(a) Certification.

 

31.2Rule 13a-14(a)/15d-14(a) Certification.

 

32Section 1350 Certifications.

 

101The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in XBRL (Extensible Business reporting Language): (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Income and Comprehensive Income, (iii) the Consolidated Statements of Changes in Stockholder’s Equity, (iv) the Consolidated Statements of Cash Flows, and (v) the Notes to Unaudited Consolidated Financial Statements.

 

 

(1) Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, as amended, initially filed on September 11, 2010.

 

(2) Incorporated herein by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1, as amended, initially filed on September 11, 2010.

 

(3) Incorporated herein by reference to Exhibit 4.0 to the Company’s Registration Statement on Form S-1, as amended, initially filed on September 11, 2010.

 

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Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

Naugatuck Valley Financial Corporation

   
Date: August 14, 2014 by: /s/ William C. Calderara  
  William C. Calderara
  President and Chief Executive Officer
  (principal executive officer)
   
   
Date: August 14, 2014 by: /s/ James Hastings  
  James Hastings
  Executive Vice President and Chief Financial Officer
  (principal accounting and financial officer)