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EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - Western New England Bancorp, Inc.ex32-2.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - Western New England Bancorp, Inc.ex32-1.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - Western New England Bancorp, Inc.ex31-1.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - Western New England Bancorp, Inc.ex31-2.htm
 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

______________________

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2014

 

OR

 

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

 

For the transition period from _____ to _____.

 

 Commission file number 001-16767

 

Westfield Financial, Inc.

(Exact name of registrant as specified in its charter)

 

Massachusetts 73-1627673
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

141 Elm Street, Westfield, Massachusetts 01086

(Address of principal executive offices)

(Zip Code)

 

(413) 568-1911

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes S No £

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes S 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 the 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 S
   
Non-accelerated filer £ 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 S

 

At October 31, 2014, the registrant had 18,793,583 shares of common stock, $.01 par value, issued and outstanding.

 

 
 

 

TABLE OF CONTENTS

 

 

    Page
     
FORWARD-LOOKING STATEMENTS    i
     
PART I – FINANCIAL INFORMATION
     
Item 1. Financial Statements of Westfield Financial, Inc. and Subsidiaries  
     
  Consolidated Balance Sheets (Unaudited) – September 30, 2014 and December 31, 2013 1
     
  Consolidated Statements of Net Income (Unaudited) – Three and Nine Months Ended
September 30, 2014 and 2013
  2
     
  Consolidated Statements of Comprehensive Income (Loss) (Unaudited) –
Three and Nine Months Ended September 30, 2014 and 2013  
   3
     
  Consolidated Statement of Changes in Shareholders’ Equity (Unaudited) –
Nine Months Ended September 30, 2014 and 2013
  4
     
  Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended
September 30, 2014 and 2013
  5
     
  Notes to Consolidated Financial Statements (Unaudited)   6
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 30
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 42
     
Item 4. Controls and Procedures 43
     
     
PART II – OTHER INFORMATION  
     
Item 1. Legal Proceedings 43
     
Item 1A. Risk Factors 43
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 44
     
Item 3. Defaults upon Senior Securities 44
     
Item 4. Mine Safety Disclosures 44
     
Item 5. Other Information 44
     
Item 6. Exhibits 44

 

 
 

 

FORWARD–LOOKING STATEMENTS

 

We may, from time to time, make written or oral “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements contained in our filings with the Securities and Exchange Commission (the “SEC”), our reports to shareholders and in other communications by us. This Quarterly Report on Form 10-Q contains “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “would,” “plan,” “estimate,” “potential” and other similar expressions. Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operation and business that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to:

·changes in the interest rate environment that reduce margins;
·changes in the regulatory environment;
·the highly competitive industry and market area in which we operate;
·general economic conditions, either nationally or regionally, resulting in, among other things, a deterioration in credit quality;
·changes in business conditions and inflation;
·changes in credit market conditions;
·changes in the securities markets which affect investment management revenues;
·increases in Federal Deposit Insurance Corporation (“FDIC”) deposit insurance premiums and assessments could adversely affect our financial condition;
·changes in technology used in the banking business;
·the soundness of other financial services institutions which may adversely affect our credit risk;
·certain of our intangible assets may become impaired in the future;
·our controls and procedures may fail or be circumvented;
·new line of business or new products and services, which may subject us to additional risks;
·changes in key management personnel which may adversely impact our operations;
·the effect on our operations of recent legislative and regulatory initiatives that were or may be enacted in response to the ongoing financial crisis;
·severe weather, natural disasters, acts of war or terrorism and other external events which could significantly impact our business; and
·other factors detailed from time to time in our Securities and Exchange Commission (“SEC”) filings.

Although we believe that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

i
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS - UNAUDITED

(Dollars in thousands, except per share data)

 

   September 30,  December 31,
   2014  2013
ASSETS      
CASH AND DUE FROM BANKS  $9,723   $14,112 
FEDERAL FUNDS SOLD   197    521 
INTEREST-BEARING  DEPOSITS AND OTHER SHORT-TERM INVESTMENTS   4,509    5,109 
CASH AND CASH EQUIVALENTS   14,429    19,742 
           
SECURITIES AVAILABLE FOR SALE – AT FAIR VALUE   212,460    243,204 
SECURITIES HELD TO MATURITY  (Fair value of $279,499 and $282,555 at September 30, 2014 and
December 31,2013, respectively)
   283,684    295,013 
FEDERAL HOME LOAN BANK OF BOSTON AND OTHER RESTRICTED STOCK - AT COST   14,720    15,631 
LOANS - Net of allowance for loan losses of $7,695 and $7,459 at September 30, 2014 and  December 31, 2013, respectively   711,860    629,968 
PREMISES AND EQUIPMENT, Net   11,199    10,995 
ACCRUED INTEREST RECEIVABLE   4,192    4,201 
BANK-OWNED LIFE INSURANCE   48,329    47,179 
DEFERRED TAX ASSET, Net   7,817    6,334 
OTHER ASSETS   2,491    4,574 
TOTAL ASSETS  $1,311,181   $1,276,841 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
LIABILITIES:           
DEPOSITS:           
Noninterest-bearing  $136,940   $145,040 
Interest-bearing   691,845    672,072 
Total deposits   828,785    817,112 
           
SHORT-TERM BORROWINGS   78,685    48,197 
LONG-TERM DEBT   246,804    248,377 
SECURITIES PENDING SETTLEMENT   137    299 
OTHER LIABILITIES   12,464    8,712 
TOTAL LIABILITIES   1,166,875    1,122,697 
           
SHAREHOLDERS’ EQUITY:           
Preferred stock - $0.01 par value, 5,000,000 shares authorized, none outstanding at September 30, 2014 and December 31, 2013   —      —   
Common stock - $0.01 par value, 75,000,000 shares authorized, 18,822,724 shares issued and outstanding at September 30, 2014; 20,140,669 shares issued and outstanding at December 31, 2013   188    201 
Additional paid-in capital   112,322    121,860 
Unearned compensation - ESOP   (7,603)   (8,003)
Unearned compensation - Equity Incentive Plan   (113)   (187)
Retained earnings   44,568    43,248 
Accumulated other comprehensive loss   (5,056)   (2,975)
Total shareholders’ equity   144,306    154,144 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY  $1,311,181   $1,276,841 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

 

WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF NET INCOME – UNAUDITED

(Dollars in thousands, except per share data)

 

 

    Three Months    Nine Months
    Ended September 30,    Ended September 30,
   2014  2013  2014  2013
INTEREST AND DIVIDEND INCOME:            
Residential and commercial real estate loans  $5,590   $5,037   $16,256   $15,039 
Commercial and industrial loans   1,509    1,299    4,154    3,807 
Consumer loans   36    35    103    104 
Debt securities, taxable   2,896    3,659    9,050    10,985 
Debt securities, tax-exempt   208    259    626    833 
Equity securities   43    36    132    108 
Other investments - at cost   59    20    187    60 
Federal funds sold, interest-bearing deposits and other short-term investments   2    3    11    6 
Total interest and dividend income   10,343    10,348    30,519    30,942 
INTEREST EXPENSE:                     
Deposits   1,298    1,390    3,877    4,167 
Long-term debt   1,125    1,094    3,207    3,540 
Short-term borrowings   86    36    245    101 
Total interest expense   2,509    2,520    7,329    7,808 
Net interest and dividend income   7,834    7,828    23,190    23,134 
PROVISION (CREDIT) FOR LOAN LOSSES   750    (71)   1,300    (376)
Net interest and dividend income after provision for loan losses   7,084    7,899    21,890    23,510 
                     
NONINTEREST INCOME (LOSS):                     
Service charges and fees   655    615    1,958    1,779 
Income from bank-owned life insurance   384    388    1,150    1,161 
Gain on bank-owned life insurance death benefit   —      —      —      563 
Loss on prepayment of borrowings   —      (540)   —      (3,370)
Gain on sales of securities, net   226    546    276    2,796 
Total noninterest income   1,265    1,009    3,384    2,929 
NONINTEREST EXPENSE:                     
Salaries and employees benefits   3,623    4,059    11,066    11,684 
Occupancy   743    733    2,255    2,167 
Computer operations   600    602    1,725    1,754 
Professional fees   495    499    1,489    1,536 
FDIC insurance assessment   166    169    508    493 
Other   721    789    2,370    2,520 
Total noninterest expense   6,348    6,851    19,413    20,154 
INCOME BEFORE INCOME TAXES   2,001    2,057    5,861    6,285 
INCOME TAX PROVISION   491    476    1,360    1,339 
NET INCOME  $1,510   $1,581   $4,501   $4,946 
                     
EARNINGS PER COMMON SHARE:                     
Basic earnings per share  $0.08   $0.08   $0.25   $0.24 
Weighted average shares outstanding   17,910,223    19,583,632    18,340,642    20,315,076 
Diluted earnings per share  $0.08   $0.08   $0.25   $0.24 
Weighted average diluted shares outstanding   17,910,223    19,583,632    18,340,642    20,315,094 
                     

 

See accompanying notes to unaudited consolidated financial statements.

 

 

2
 

 

 

WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) – UNAUDITED

(Dollars in thousands)

 

   Three Months Ended September 30,  Nine Months Ended September 30,
   2014  2013  2014  2013
             
Net income  $1,510   $1,581   $4,501   $4,946 
                     
Other comprehensive loss:                     
Unrealized (loss) gains on securities:                     
Unrealized holding (loss) gains on available for sale securities   (1,211)   (1,462)   1,770    (19,041)
Reclassification adjustment for gains realized in income   (226)   (546)   (276)   (2,796)
Amortization of net unrealized loss on held-to-maturity securities (1)   (20)   (108)   (19)   (231)
Net unrealized (loss) gains   (1,457)   (2,116)   1,475    (22,068)
Tax effect   500    724    (510)   7,588 
Net-of-tax amount   (957)   (1,392)   965    (14,480)
                     
Derivative instruments:                     
Change in fair value of derivatives used for cash flow hedges   255    (79)   (4,744)   (79)
Reclassification adjustment for loss realized in interest expense (2)   48    —      142    —   
Tax effect   (103)   27    1,565    27 
Net-of-tax amount   200    (52)   (3,037)   (52)
                     
Defined benefit pension plans:                     
Reclassification adjustment (3):                     
Actuarial (gain) loss   (4)   17    (4)   46 
Transition asset        (3)   (10)   (9)
Net adjustments pertaining to defined benefit plans   (4)   14    (14)   37 
Tax effect   2    (5)   5    (12)
Net-of-tax amount   (2)   9    (9)   25 
                     
Other comprehensive loss   (759)   (1,435)   (2,081)   (14,507)
                     
Comprehensive income (loss)  $751   $146   $2,420   $(9,561)

 

(1) Amortization of net unrealized loss on held-to-maturity securities is recognized as a component of interest income on debt securities, taxable.

(2) Loss realized in interest expense on derivative instruments is recognized as a component of interest expense on long-term debt.

(3) Amounts represent the reclassification of defined benefit plans amortization and have been recognized as a component of salaries and benefit expense.

 

See accompanying notes to unaudited consolidated financial statements.

 

 

3
 

 

 

WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY - UNAUDITED
NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(Dollars in thousands, except share data)

 

   Common Stock                  
   Shares    Par 
Value
  Additional
Paid-in
Capital
  Unearned
Compensation
- ESOP
  Unearned
Compensation
- Equity
Incentive Plan
  Retained
Earnings
  Accumulated
Other
Comprehensive
Income (Loss)
  Total
                         
BALANCE, DECEMBER 31, 2012   22,843,722   $228   $144,718   $(8,553)  $(265)  $42,364   $10,695   $189,187 
Comprehensive income (loss)   —      —      —      —      —      4,946    (14,507)   (9,561)
Common stock held by ESOP committed to be released (81,803 shares)   —      —      43    412    —      —      —      455 
Share-based compensation - stock options   —      —      128    —      —      —      —      128 
Share-based compensation - equity incentive plan   —      —      —      —      96    —      —      96 
Excess tax benefit from equity incentive plan   —      —      3    —      —      —      —      3 
Common stock repurchased   (2,107,576)   (21)   (15,965)   —      —      —      —      (15,986)
Issuance of common stock in connection with equity incentive plan   —      —      53    —      (53)   —      —      —   
Tender offer to purchase outstanding options   —      —      (2,717)   —      —      —      —      (2,717)
Cash dividends declared ($0.23 per share)   —      —      —      —      —      (4,706)   —      (4,706)
BALANCE AT SEPTEMBER 30, 2013   20,736,146   $207   $126,263   $(8,141)  $(222)  $42,604   $(3,812)  $156,899 
                                         
BALANCE, DECEMBER 31, 2013   20,140,669   $201   $121,860   $(8,003)  $(187)  $43,248   $(2,975)  $154,144 
Comprehensive income (loss)   —      —      —      —      —      4,501    (2,081)   2,420 
Common stock held by ESOP committed to be released (79,345 shares)   —      —      35    400    —      —      —      435 
Share-based compensation - equity incentive plan   —      —      —      —      74    —      —      74 
Excess tax benefit from equity incentive plan   —      —      1    —      —      —      —      1 
Common stock repurchased   (1,317,945)   (13)   (9,574)   —      —      —      —      (9,587)
Return of dividends issued in connection with equity incentive plan   —      —      —      —      —      121    —      121 
Cash dividends declared ($0.18 per share)   —      —      —      —      —      (3,302)   —      (3,302)
BALANCE AT SEPTEMBER 30, 2014   18,822,724   $188   $112,322   $(7,603)  $(113)  $44,568   $(5,056)  $144,306 

 

See accompanying notes to unaudited consolidated financial statements

 

 

4
 

 

WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(Dollars in thousands)

 

   Nine Months Ended September 30,
   2014  2013
OPERATING ACTIVITIES:      
Net income  $4,501   $4,946 
Adjustments to reconcile net income to net cash provided by operating activities:           
Provision (credit) for loan losses   1,300    (376)
Depreciation and amortization of premises and equipment   865    820 
Net amortization of premiums and discounts on securities and mortgage loans   3,167    3,228 
Net amortization of premiums on modified debt   471    469 
Share-based compensation expense   74    224 
ESOP expense   435    455 
Excess tax benefits from equity incentive plan   (1)   (3)
Excess tax expense in connection with tender offer completion   —      566 
Net gains on sales of securities   (276)   (2,796)
Loss on sale of other real estate owned   —      6 
Deferred income tax benefit   —      (35)
Income from bank-owned life insurance   (1,150)   (1,161)
Gain on bank-owned life insurance death benefit   —      (563)
Changes in assets and liabilities:           
Accrued interest receivable   9    438 
Other assets   (278)   135 
Other liabilities   469    1,399 
Net cash provided by operating activities   9,586    7,752 
INVESTING ACTIVITIES:           
Securities, held to maturity:           
Purchases   —      (2,636)
Proceeds from calls, maturities, and principal collections   9,485    1,898 
Securities, available for sale:           
Purchases   (50,136)   (163,580)
Proceeds from sales   63,584    168,968 
Proceeds from calls, maturities, and principal collections   17,770    52,460 
Purchase of residential mortgages   (38,354)   (34,564)
Loan (originations) principal payments, net   (44,278)   9,173 
Redemption (purchase) of Federal Home Loan Bank of Boston stock   911    (1,393)
Proceeds from redemption of other restricted stock   —      31 
Proceeds from sale of other real estate owned   —      958 
Purchases of premises and equipment   (1,109)   (960)
Proceeds from sale of premises and equipment   40    —   
Disbursement of bank-owned life insurance gain   —      (282)
Proceeds from bank-owned life insurance   —      1,437 
Net cash (used in) provided by investing activities   (42,087)   31,510 
FINANCING ACTIVITIES:           
Net increase in deposits   11,673    40,097 
Net change in short-term borrowings   30,488    (8,150)
Repayment of long-term debt   (7,150)   (63,250)
Proceeds from long-term debt   5,106    32,104 
Return of dividends issued in connection with equity incentive plan   121      
Tender offer to purchase outstanding options   —      (2,151)
Excess tax expense in connection with tender offer completion   —      (566)
Cash dividends paid   (3,302)   (4,706)
Common stock repurchased   (9,749)   (15,986)
Excess tax shortfalls benefits in connection with equity incentive plan   1    3 
Net cash provided by (used in) financing activities   27,188    (22,605)
           
NET CHANGE IN CASH AND CASH EQUIVALENTS:    (5,313)   16,657 
Beginning of period   19,742    11,761 
End of period  $14,429   $28,418 
           
Supplemental cashflow information:           
Securities reclassified from available-for-sale to held-to-maturity  $—     $299,203 
Securities reclassified to loan portfolio   606    —   
Interest paid   7,332    7,946 
Taxes paid   1,831    743 
Net cash due to broker for common stock repurchased   137    —   

  

See accompanying notes to unaudited consolidated financial statements.

 

5
 

 

WESTFIELD FINANCIAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

SEPTEMBER 30, 2014

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of OperationsWestfield Financial, Inc. (“Westfield Financial,” “we” or “us”) is a Massachusetts-chartered stock holding company and the parent company of Westfield Bank (the “Bank”), a federally chartered stock savings bank (the “Bank”).

 

The Bank’s deposits are insured to the limits specified by the Federal Deposit Insurance Corporation (“FDIC”). The Bank operates 11 branches in western Massachusetts and 1 branch in Granby, Connecticut.  The Bank’s primary source of revenue is income from securities and earnings on loans to small and middle-market businesses and to residential property homeowners.

 

Elm Street Securities Corporation and WFD Securities Corporation, Massachusetts-chartered security corporations, were formed by Westfield Financial for the primary purpose of holding qualified securities. WB Real Estate Holdings, LLC, a Massachusetts-chartered limited liability company was formed for the primary purpose of holding real property acquired as security for debts previously contracted by the Bank.

 

Principles of Consolidation – The unaudited consolidated financial statements include the accounts of Westfield Financial, the Bank, Elm Street Securities Corporation, WB Real Estate Holdings, LLC and WFD Securities Corporation. All material intercompany balances and transactions have been eliminated in consolidation.

 

Estimates – The preparation of unaudited consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of income and expenses for both at the date of the unaudited consolidated financial statements. Actual results could differ from those estimates. Estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, other-than-temporary impairment of securities, and the valuation of deferred tax assets.

 

Basis of Presentation – In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our financial condition as of September 30, 2014, and the results of operations, changes in shareholders’ equity and cash flows for the interim periods presented. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results of operations for the year ending December 31, 2014. Certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission.

 

These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements as of and for the year ended December 31, 2013, included in our Annual Report on Form 10-K for the year ended December 31, 2013 (the “2013 Annual Report”).

 

Reclassifications - Amounts in the prior period financial statements are reclassified when necessary to conform to the current year presentation.

 

 

6
 

 

2. EARNINGS PER SHARE

 

Basic earnings per share represent income available to shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential shares had been issued, as well as any adjustment to income that would result from the assumed issuance. No dilutive potential shares were outstanding during the periods presented. Share-based compensation awards that qualify as participating securities (entitled to receive non-forfeitable dividends) are included in basic earnings per share.

 

Earnings per common share for the three and nine months ended September 30, 2014 and 2013 have been computed based on the following:

 

   Three Months Ended  Nine Months Ended
   September 30,  September 30,
   2014  2013  2014  2013
   (In thousands, except per share data)
             
Net income applicable to common stock  $1,510   $1,581   $4,501   $4,946 
                     
Average number of common shares issued   18,990    20,744    19,441    21,501 
Less: Average unallocated ESOP Shares   (1,080)   (1,161)   (1,100)   (1,181)
Less: Average ungranted equity incentive plan shares   —      —      —      (5)
                     
Average number of common shares outstanding used                    
to calculate basic and diluted earnings per common share   17,910    19,583    18,341    20,315 
                     
Basic and diluted earnings per share  $0.08   $0.08   $0.25   $0.24 
                     
Antidilutive shares (1)   —      —      —      1,110 

__________

 

(1)Options outstanding but not included in the computation of earnings per share because they were anti-dilutive, meaning the exercise price of such options exceeded the market value of the Company’s common stock. At September 30, 2014, there were no stock options outstanding.

 

 

7
 

 

3. COMPREHENSIVE INCOME/LOSS

 

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

 

The components of accumulated other comprehensive loss included in shareholders’ equity are as follows:

 

   September 30,
2014
  December 31,
2013
   (In thousands)
       
Net unrealized loss on securities available for sale  $(916)  $(2,410)
Tax effect   321    837 
Net-of-tax amount   (595)   (1,573)
           
Net unrealized loss on securities transferred from available-for-sale to held-to-maturity (1)   (1,751)   (1,732)
Tax effect   605    599 
Net-of-tax amount   (1,146)   (1,133)
           
Fair value of derivatives used for cash flow hedges   (2,847)   1,755 
Tax effect   968    (597)
Net-of-tax amount   (1,879)   1,158 
           
Unrecognized transition asset pertaining to defined benefit plan   —      10 
Unrecognized loss pertaining to defined benefit plan   (2,176)   (2,172)
Net adjustments pertaining to defined benefit plans   (2,176)   (2,162)
Tax effect   740    735 
         Net-of-tax amount   (1,436)   (1,427)
           
Accumulated other comprehensive loss  $(5,056)  $(2,975)

__________

 

(1) The net unrealized loss at the date of transfer before tax was $1.5 million for all securities transferred in 2013. The gains or losses on individual securities are amortized through comprehensive income over the remaining life of the security.

 

The following table presents changes in accumulated other comprehensive income (loss) for the periods ended September 30, 2014 and 2013 by component:

 

   Securities  Derivatives  Defined Benefit  Plans  Accumulated Other Comprehensive  Income (Loss)
   (In thousands)
Balance at December 31, 2012  $13,253   $—     $(2,558)  $10,695 
Current-period other comprehensive income (loss)   (14,480)   (52)   25    (14,507)
Balance at September 30, 2013  $(1,227)  $(52)  $(2,533)  $(3,812)
                     
Balance at December 31, 2013  $(2,706)  $1,158   $(1,427)  $(2,975)
Current-period other comprehensive income (loss)   965    (3,037)   (9)   (2,081)
Balance at September 30, 2014  $(1,741)  $(1,879)  $(1,436)  $(5,056)

 

 

8
 

 

4.SECURITIES

 

Securities available for sale and held to maturity are summarized as follows:

 

   September 30, 2014
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair Value
   (In thousands)
Available for sale securities:            
Government-sponsored mortgage-backed securities  $142,503   $177   $(2,011)  $140,669 
U.S. government guaranteed mortgage-backed securities   1,712    —      (23)   1,689 
Corporate bonds   25,809    567    (39)   26,337 
State and municipal bonds   16,482    665    —      17,147 
Government-sponsored enterprise obligations   19,303    38    (193)   19,148 
Mutual funds   6,258    7    (167)   6,098 
Common and preferred stock   1,309    63    —      1,372 
                     
Total available for sale securities   213,376    1,517    (2,433)   212,460 
                     
Held to maturity securities:                     
Government-sponsored mortgage-backed securities  $167,160   $1,022   $(2,718)  $165,464 
U.S. government guaranteed mortgage-backed securities   38,850    24    (812)   38,062 
Corporate bonds   26,914    113    (372)   26,655 
State and municipal bonds   7,301    59    (114)   7,246 
Government-sponsored enterprise obligations   43,459    99    (1,486)   42,072 
                     
Total held to maturity securities   283,684    1,317    (5,502)   279,499 
                     
Total  $497,060   $2,834   $(7,935)  $491,959 

 

   December 31, 2013
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair Value
   (In thousands)
Available for sale securities:            
Government-sponsored mortgage-backed securities  $135,981   $419   $(4,028)  $132,372 
U.S. government guaranteed mortgage-backed securities   46,225    240    (137)   46,328 
Corporate bonds   26,716    766    (93)   27,389 
State and municipal bonds   18,240    659    (2)   18,897 
Government-sponsored enterprise obligations   10,992    18    (310)   10,700 
Mutual funds   6,150    8    (239)   5,919 
Common and preferred stock   1,310    289    —      1,599 
                     
Total available for sale securities   245,614    2,399    (4,809)   243,204 
                     
Held to maturity securities:                     
Government-sponsored mortgage-backed securities   176,986    —      (6,819)   170,167 
U.S. government guaranteed mortgage-backed securities   39,705    —      (1,391)   38,314 
Corporate bonds   27,566    30    (567)   27,029 
State and municipal bonds   7,351    5    (345)   7,011 
Government-sponsored enterprise obligations   43,405    —      (3,371)   40,034 
                     
Total held to maturity securities   295,013    35    (12,493)   282,555 
                     
Total  $540,627   $2,434   $(17,302)  $525,759 

 

 

9
 

 

 

U.S. government-sponsored and guaranteed mortgage-backed securities are collateralized by both residential and multifamily loans.

 

Our repurchase agreements and advances from the Federal Home Loan Bank of Boston (“FHLBB”) are collateralized by government-sponsored enterprise obligations and certain mortgage-backed securities (see Note 7).

 

The amortized cost and fair value of securities available for sale and held to maturity at September 30, 2014, by maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers have the right to call or repay obligations.

 

   September 30, 2014
   Securities  Securities
   Available for Sale  Held to Maturity
   Amortized Cost  Fair Value  Amortized Cost  Fair Value
   (In thousands)
Mortgage-backed securities:                     
     Due after one year through five years  $10,130   $10,096   $—     $—   
     Due after five years through ten years   23,270    22,528    46,434    44,844 
     Due after ten years   110,815    109,734    159,576    158,682 
Total  $144,215   $142,358   $206,010   $203,526 
                     
Debt securities:                     
     Due in one year or less  $2,743   $2,774   $—     $—   
     Due after one year through five years   38,213    38,822    22,566    22,198 
     Due after five years through ten years   20,452    20,830    40,427    39,543 
     Due after ten years   186    206    14,681    14,232 
Total  $61,594   $62,632   $77,674   $75,973 

 

Gross realized gains and losses on sales of securities available for sale for the three and nine months ended September 30, 2014 and 2013 are as follows:

 

   Three Months Ended  Nine Months Ended
   September 30,  September 30,
   2014  2013  2014  2013
   (In thousands)
             
Gross gains realized  $226   $1,086   $757   $3,407 
Gross losses realized   —      (540)   (481)   (611)
Net gain realized  $226   $546   $276   $2,796 

 

Proceeds from the sale of securities available for sale amounted to $63.6 million and $169.0 million for the nine months ended September 30, 2014 and 2013, respectively.

 

The tax provision applicable to net realized gains was $77,000 and $94,000 for the three and nine months ended September 30, 2014, respectively. The tax provision applicable to net realized gains was $185,000 and $956,000 for the three and nine months ended September 30, 2013, respectively.

 

10
 

 

Information pertaining to securities with gross unrealized losses at September 30, 2014, and December 31, 2013, aggregated by investment category and length of time that individual securities have been in a continuous loss position is as follows:

 

   September 30, 2014
   Less Than 12 Months  Over 12 Months
   Gross
Unrealized
Losses
  Fair Value  Gross
Unrealized
Losses
  Fair Value
   (In thousands)
             
Available for sale:            
Government-sponsored mortgage-backed securities  $336   $54,695   $1,675   $55,630 
U.S. government guaranteed  mortgage-backed securities   3    941    20    749 
Corporate bonds   31    6,740    8    1,492 
Government-sponsored enterprise obligations   17    8,955    176    7,323 
Mutual funds   —      —      167    5,029 
                     
Total available for sale   387    71,331    2,046    70,223 
                     
Held to maturity:                     
Government-sponsored mortgage-backed securities   282    13,537    2,436    65,116 
U.S. government guaranteed  mortgage-backed securities   —      —      812    27,423 
Corporate bonds   276    13,397    96    8,234 
State and municipal bonds   —      —      114    4,559 
Government-sponsored enterprise obligations   —      —      1,486    36,380 
                     
Total held to maturity   558    26,934    4,944    141,712 
                     
Total  $945   $98,265   $6,990   $211,935 

 

 

 

11
 

 

 

   December 31, 2013
   Less Than 12 Months  Over 12 Months
   Gross
Unrealized
Losses
  Fair Value  Gross
Unrealized
Losses
  Fair Value
   (In thousands)
             
Available for sale:            
Government-sponsored mortgage-backed securities  $3,717   $118,846   $311   $2,761 
U.S. government guaranteed  mortgage-backed securities   137    15,045    —      —   
Corporate bonds   93    4,659    —      —   
State and municipal bonds   2    256    —      —   
Government-sponsored enterprise obligations   310    7,189    —      —   
Mutual funds   84    3,205    155    1,656 
                     
Total available for sale   4,343    149,200    466    4,417 
                     
Held to maturity:                     
Government-sponsored mortgage-backed securities   5,866    145,438    953    24,729 
U.S. government guaranteed  mortgage-backed securities   1,391    38,314    —      —   
Corporate bonds   567    22,059    —      —   
State and municipal bonds   345    5,852    —      —   
Government-sponsored enterprise obligations   3,330    38,228    41    1,806 
                     
Total held to maturity   11,499    249,891    994    26,535 
                     
Total  $15,842   $399,091   $1,460   $30,952 

 

 

   September 30, 2014
   Less Than 12 Months  Over 12 Months
   Number of
Securities
  Amortized
Cost Basis
  Gross
Loss
  Depreciation
from
Amortized
Cost Basis
(%)
  Number of
Securities
  Amortized
Cost Basis
  Gross
Loss
  Depreciation
from
Amortized
Cost Basis (%)
   (Dollars in thousands)
                         
Government sponsored mortgage-backed securities   19   $68,850   $618    0.9%   33   $124,857   $4,111    3.3%
U.S. government guaranteed mortgage-backed securities   1    944    3    0.3    5    29,004    832    2.9 
Government sponsored enterprise obligations   5    8,972    17    0.2    10    45,365    1,662    3.7 
Corporate Bonds   10    20,444    307    1.5    3    9,830    104    1.1 
State and municipal bonds   0    —      —      —      8    4,673    114    2.4 
Mutual funds   0    —      —      —      2    5,196    167    3.2 

 

These unrealized losses are the result of changes in interest rates and not credit quality. Because we do not intend to sell the securities and it is more likely than not that we will not be required to sell the investments before recovery of their amortized cost bases, no declines are deemed to be other-than-temporary.

 

12
 

 

5. LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans consisted of the following amounts:  September 30,  December 31,
   2014  2013
   (In thousands)
Commercial real estate  $287,176   $264,476 
Residential real estate:           
Residential   225,240    198,686 
Home equity   39,182    35,371 
Commercial and industrial   165,389    135,555 
Consumer   1,546    2,572 
    Total Loans   718,533    636,660 
Unearned premiums and deferred loan fees and costs, net   1,022    767 
Allowance for loan losses   (7,695)   (7,459)
   $711,860   $629,968 

 

During the nine months ended September 30, 2014 and 2013, we purchased residential real estate loans aggregating $38.4 million and $34.6 million, respectively. None were deemed credit impaired at the time of acquisition.

 

We have transferred a portion of our originated commercial real estate loans to participating lenders. The amounts transferred have been accounted for as sales and are therefore not included in our accompanying unaudited consolidated balance sheets. We share ratably with our participating lenders in any gains or losses that may result from a borrower’s lack of compliance with contractual terms of the loan. We continue to service the loans on behalf of the participating lenders and, as such, collect cash payments from the borrowers, remit payments (net of servicing fees) to participating lenders and disburse required escrow funds to relevant parties. At September 30, 2014 and December 31, 2013, we serviced loans for participants aggregating $26.0 million and $14.3 million, respectively.

 

Loans are recorded at the principal amount outstanding, adjusted for charge-offs, unearned premiums and deferred loan fees and costs. Interest on loans is calculated using the effective yield method on daily balances of the principal amount outstanding and is credited to income on the accrual basis to the extent it is deemed collectable. Our general policy is to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more based on the contractual terms of the loan, or earlier if the loan is considered impaired. Any unpaid amounts previously accrued on these loans are reversed from income. Subsequent cash receipts are applied to the outstanding principal balance or to interest income if, in the judgment of management, collection of the principal balance is not in question. Loans are returned to accrual status when they become current as to both principal and interest and perform in accordance with contractual terms for a period of at least six months, reducing the concern as to the collectability of principal and interest. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income over the estimated average lives of the related loans.

 

The allowance for loan losses is established through provisions for loan losses charged to expense. Loans are charged-off against the allowance when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, allocated, and unallocated components, as further described below.

 

13
 

 

General component

 

The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate (includes one-to-four family and home equity), commercial real estate, commercial and industrial, and consumer. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: trends in delinquencies and nonperforming loans; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; and national and local economic trends and industry conditions. There were no changes in our policies or methodology pertaining to the general component of the allowance for loan losses during the periods presented for disclosure.

 

The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

 

Residential real estate – We require private mortgage insurance for all loans originated with a loan-to-value ratio greater than 80% and we do not grant subprime loans. All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment. Home equity loans are secured by first or second mortgages on one-to-four family owner occupied properties.

 

Commercial real estate – Loans in this segment are primarily income-producing investment properties and owner occupied commercial properties throughout New England. The underlying cash flows generated by the properties or operations can be adversely impacted by a downturn in the economy due to increased vacancy rates or diminished cash flows, which in turn, would have an effect on the credit quality in this segment. Management obtains financial information annually and continually monitors the cash flows of these loans.

 

Commercial and industrial loans – Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.

 

Consumer loans – Loans in this segment are secured or unsecured and repayment is dependent on the credit quality of the individual borrower.

 

Allocated component

 

The allocated component relates to loans that are classified as impaired. Impaired loans are identified by analysis of loan performance, internal credit ratings and watch list loans that management believes are subject to a higher risk of loss. Impairment is measured on a loan by loan basis for commercial real estate and commercial and industrial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement.

 

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

 

14
 

 

Unallocated component

 

An unallocated component may be maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance, if any, reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio.

 

An analysis of changes in the allowance for loan losses by segment for the periods ended September 30, 2014 and 2013 is as follows:

 

   Commercial
Real Estate
  Residential
Real Estate
  Commercial
and
Industrial
  Consumer  Unallocated  Total
   (In thousands)
Three Months Ended   
Balance at June 30, 2013  $3,244   $1,807   $2,072   $12   $338   $7,473 
Provision (credit)   162    36    45    —      (314)   (71)
Charge-offs   —      (23)   (79)   (14)   —      (116)
Recoveries   —      1    9    15    —      25 
Balance at September 30, 2013  $3,406   $1,821   $2,047   $13   $24   $7,311 
                               
Balance at June 30, 2014  $3,898   $1,848   $2,258   $14   $(1)  $8,017 
Provision (credit)   246    (25)   543    8    (22)   750 
Charge-offs   (350)   —      (713)   (13)   —      (1,076)
Recoveries   —      —      —      4    —      4 
Balance at September 30, 2014  $3,794   $1,823   $2,088   $13   $(23)  $7,695 
                               
Nine Months Ended                              
Balance at December 31, 2012  $3,406   $1,746   $2,167   $13   $462   $7,794 
Provision (credit)   (134)   154    33    9    (438)   (376)
Charge-offs   (20)   (80)   (208)   (28)   —      (336)
Recoveries   154    1    55    19    —      229 
Balance at September 30, 2013  $3,406   $1,821   $2,047   $13   $24   $7,311 
                               
Balance at December 31, 2013  $3,549   $1,707   $2,192   $13   $(2)  $7,459 
Provision (credit)   595    130    573    23    (21)   1,300 
Charge-offs   (350)   (15)   (787)   (36)   —      (1,188)
Recoveries   —      1    110    13    —      124 
Balance at September 30, 2014  $3,794   $1,823   $2,088   $13   $(23)  $7,695 

 

 

15
 

 

Further information pertaining to the allowance for loan losses by segment at September 30, 2014 and December 31, 2013 follows:

 

   Commercial
Real Estate
  Residential
Real Estate
  Commercial
and
Industrial
  Consumer  Unallocated  Total
   (In thousands)
September 30, 2014                  
                   
Amount of allowance for loans individually evaluated and deemed impaired  $—     $—     $—     $—     $—     $—   
Amount of allowance for loans collectively or individually evaluated for impairment and not deemed impaired   3,794    1,823    2,088    13    (23)   7,695 
Total allowance for loan losses  $3,794   $1,823   $2,088   $13   $(23)  $7,695 
                               
Loans individually evaluated and deemed impaired  $3,959   $206   $4,201   $—     $—     $8,366 
Loans collectively or individually evaluated and not deemed impaired   283,217    264,216    161,188    1,546    —      710,167 
Total loans  $287,176   $264,422   $165,389   $1,546   $—     $718,533 
                               
December 31, 2013                              
                               
Amount of allowance for loans individually evaluated and deemed impaired  $82   $—     $15   $—     $—     $97 
Amount of allowance for loans collectively or individually evaluated for impairment and not deemed impaired   3,467    1,707    2,177    13    (2)   7,362 
Total allowance for loan losses  $3,549   $1,707   $2,192   $13   $(2)  $7,459 
                               
Loans individually evaluated and deemed impaired  $14,962   $234   $1,352   $—     $—     $16,548 
Loans collectively or individually evaluated and not deemed impaired   249,514    233,823    134,203    2,572    —      620,112 
Total loans  $264,476   $234,057   $135,555   $2,572   $—     $636,660 

 

The following is a summary of past due and non-accrual loans by class at September 30, 2014 and December 31, 2013:

 

   30 – 59 Days
Past Due
  60 – 89 Days
Past Due
  90 Days or
More Past
Due
  Total Past
Due
  Past Due 90
Days or More
and Still
Accruing
  Loans on
Non-Accrual
   (In thousands)
September 30, 2014                  
Commercial real estate  $2,291   $460   $540   $3,291   $—     $3,152 
Residential real estate:                               
Residential   411    493    799    1,703    —      1,416 
Home equity   159    45    1    205    —      1 
Commercial and industrial   232    120    289    641    —      4,291 
Consumer   37    6    4    47    —      7 
Total  $3,130   $1,125   $1,633   $5,887   $—     $8,867 
                               
December 31, 2013                              
Commercial real estate  $430   $146   $793   $1,369   $—     $1,449 
Residential real estate:                               
Residential   1,004    325    311    1,640    —      712 
Home equity   217    —      2    219    —      38 
Commercial and industrial   516    780    140    1,436    —      386 
Consumer   25    16    1    42    —      1 
Total  $2,192   $1,267   $1,247   $4,706   $—     $2,586 

 

 

16
 

 

 

 

 

 

The following is a summary of impaired loans by class at September 30, 2014 and December 31, 2013:

 

            Three Months Ended  Nine Months Ended
   At September 30, 2014  September 30, 2014  September 30, 2014
   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
  Average
Recorded
Investment
  Interest
Income
Recognized
  Average
Recorded
Investment
  Interest
Income
Recognized
   (In thousands)
Impaired loans without a valuation allowance:                  
Commercial real estate  $3,959   $4,470   $—     $2,681   $—     $1,846    —   
Residential real estate   206    303    —      207    —      214    —   
Commercial and industrial   4,201    4,849    —      2,475    —      1,270    —   
Total   8,366    9,622    —      5,363    —      3,330    —   
                                    
Impaired loans with a valuation allowance:                               
Commercial real estate   —      —      —      6,672    142    11,176    428 
Commercial and industrial   —      —      —      477    11    800    31 
Total   —      —      —      7,149    153    11,976    459 
                                    
Total impaired loans  $8,366   $9,622   $—     $12,512   $153   $15,306   $459 

 

            Three Months Ended  Nine Months Ended
   At December 31, 2013  September 30, 2013  September 30, 2013
   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
  Average
Recorded
Investment
  Interest
Income
Recognized
  Average
Recorded
Investment
  Interest
Income
Recognized
   (In thousands)
Impaired loans without a valuation allowance:                               
Commercial real estate  $1,449   $1,756   $—     $1,489   $—     $1,515   $—   
Residential real estate   234    306    —      239    —      252    —   
Commercial and industrial   385    487    —      415    —      407    —   
Total   2,068    2,549    —      2,143    —      2,174    —   
                                    
Impaired loans with a valuation allowance:                               
Commercial real estate   13,513    13,513    82    13,637    145    13,719    438 
Commercial and industrial   967    967    15    976    10    982    31 
Total   14,480    14,480    97    14,613    155    14,701    469 
                                    
Total impaired loans  $16,548   $17,029   $97   $16,756   $155   $16,875   $469 

 

All interest income recognized for impaired loans was recognized on the accrual basis during the three and nine months ended September 30, 2014 and 2013.

 

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We may periodically agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (“TDR”). These concessions could include a reduction in the interest rate on the loan, payment extensions, postponement or forgiveness of principal, forbearance or other actions intended to maximize collection. All TDRs are initially classified as impaired.

 

When we modify loans in a TDR, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. In periods subsequent to modification, we evaluate all TDRs, including those that have payment defaults, for possible impairment and recognize impairment through the allowance.

 

Nonperforming TDRs are shown as nonperforming assets and are included in the table below. Prior to modifications, the four loans listed below had been paying interest only. Upon stabilization of the credits, the related loans were modified and placed on an amortization schedule with higher interest rates. During the three months ended September 30, 2014, one loan relationship with a balance of $14.3 million previously restructured in March 2012 was removed from TDR status upon maturity of the existing loans. The new loans were granted under market conditions and are performing according to the terms of the loan agreements.

 

   Three Months Ended  Nine Months Ended
   September 30, 2014  September 30, 2014
   Number
of
Contracts
  Pre-
Modification
Outstanding
Recorded
Investment
  Post-
Modification
Outstanding
Recorded
Investment
  Number
of
Contracts
  Pre-
Modification
Outstanding
Recorded
Investment
  Post-
Modification
Outstanding
Recorded
Investment
   (Dollars in thousands)  (Dollars in thousands)
Troubled Debt Restructurings                  
Commercial Real Estate   1   $234   $234    1   $234   $234 
Commercial and Industrial   3    206    206    3    206    206 
Total   4   $440   $440    4   $440   $440 

 

A default occurs when a loan is 30 days or more past due and is within 12 months of restructuring. No TDRs defaulted during the three and nine months ended September 30, 2014 and 2013.

 

As of September 30, 2014, we have not committed to lend any additional funds for loans that are classified as TDRs. There were no charge-offs on TDRs during the three and nine months ended September 30, 2014. There were $38,000 and $74,000 in charge-offs on TDRs during the three and nine months ended September 30, 2013.

 

Credit Quality Information

 

We utilize an eight-grade internal loan rating system for commercial real estate and commercial and industrial loans. Performing residential real estate, home equity and consumer loans are grouped with “Pass” rated loans. Nonperforming residential real estate, home equity and consumer loans are monitored individually for impairment and risk rated as “Substandard.”

 

Loans rated 1 – 3 are considered “Pass” rated loans with low to average risk.

 

Loans rated 4 are considered “Pass Watch,” which represent loans to borrowers with declining earnings, losses, or strained cash flow.

 

Loans rated 5 are considered “Special Mention.” These loans exhibit potential credit weaknesses or downward trends and are being closely monitored by us.

 

 

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Loans rated 6 are considered “Substandard.” Generally, a loan is considered substandard if the borrower exhibits a well-defined weakness that may be inadequately protected by the current net worth and cash flow capacity to pay the current debt.

 

Loans rated 7 are considered “Doubtful.” Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable and that a partial loss of principal is likely.

 

Loans rated 8 are considered uncollectible and of such little value that their continuance as loans is not warranted.

 

On an annual basis, or more often if needed, we formally review the ratings on all commercial real estate and commercial and industrial loans. Construction loans are reported within commercial real estate loans and total $27.7 million and $23.4 million at September 30, 2014 and December 31, 2013, respectively. We engage an independent third party to review a significant portion of loans within these segments on a semi-annual basis. We use the results of these reviews as part of our annual review process.

 

The following table presents our loans by risk rating at September 30, 2014 and December 31, 2013:

 

   Commercial
Real Estate
  Residential
1-4 Family
  Home
Equity
  Commercial
and Industrial
  Consumer  Total
   (In thousands)
September 30, 2014                  
Loans rated 1 – 3  $241,789   $223,824   $39,157   $145,948   $1,539   $652,257 
Loans rated 4   36,905    —      —      9,618    —      46,523 
Loans rated 5   1,543    —      24    516    —      2,083 
Loans rated 6   6,939    1,416    1    9,252    7    17,615 
Loans rated 7   —      —      —      55    —      55 
   $287,176   $225,240   $39,182   $165,389   $1,546   $718,533 
                               
December 31, 2013                              
Loans rated 1 – 3  $213,985   $197,974   $35,333   $108,671   $2,571   $558,534 
Loans rated 4   41,459    —      —      15,722    —      57,181 
Loans rated 5   1,972    —      —      3,509    —      5,481 
Loans rated 6   7,060    712    38    7,653    1    15,464 
   $264,476   $198,686   $35,371   $135,555   $2,572   $636,660 

 

6. SHARE-BASED COMPENSATION

 

Under our 2007 Recognition and Retention Plan and our 2007 Stock Option Plan, we may grant up to 624,041 stock awards and 1,560,101 stock options, respectively, to our directors, officers, and employees.

 

During the third quarter of 2013, we completed a tender offer to purchase for cancellation 1,665,415 outstanding options to purchase common stock. The recipients of each eligible option tendered received a cash payment equal to the current fair valuation of the option as measured under the binomial model. The total cash paid to purchase the options was $2.1 million, which resulted in a decrease to cash and shareholders’ equity. A deferred tax asset of $566,000 was charged to shareholders’ equity as a result of the tender offer. As of December 31, 2013, 57,232 stock options that had been available for future grants were returned to the 2007 Stock Option Plan reserve and the 2002 and 2007 Stock Option Plans were frozen.

 

Stock awards are recorded as unearned compensation based on the market price at the date of grant. Unearned compensation is amortized over the vesting period. No stock awards were granted during the three and nine months ended September 30, 2014. At September 30, 2014, no stock awards were available for future grants.

 

No stock options were granted during the three and nine months ended September 30, 2014.

 

 

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Our stock award and stock option plans activity for the nine months ended September 30, 2014 and 2013 is summarized below:

 

   Unvested Stock Awards
Outstanding
  Stock Options Outstanding
   Shares  Weighted
Average Grant
Date Fair Value
  Shares  Weighted
Average
Exercise Price
                     
Outstanding at December 31, 2013   25,720   $7.93    —      —   
No activity   —      —      —      —   
Outstanding at September 30, 2014   25,720   $7.93    —      —   
                     
Outstanding at December 31, 2012   33,800   $8.23    1,669,431   $10.02 
Shared granted   7,440    7.08    —      —   
Tender offer to purchase outstanding options   —      —      (1,665,415)   —   
Cancelled   —      —      (4,016)   —   
Outstanding at September 30, 2013   41,240   $8.02    —     $—   

 

We recorded compensation cost related to the stock options of $101,000 with a related tax benefit of $27,000 for the three months ended September 30, 2013. We recorded compensation cost related to the stock options of $128,000 with a related tax benefit of $34,000 for the nine months ended September 30, 2013.

 

We recorded compensation cost related to the stock awards of $25,000 and $41,000 for the three months ended September 30, 2014 and 2013, respectively. We recorded compensation cost related to the stock awards of $74,000 and $96,000 with related tax benefits of $1,000 and 3,000 for the nine months ended September 30, 2014 and 2013, respectively.

 

In May 2014, our shareholders approved a new stock based compensation plan under which up to 516,000 shares of our common stock have been reserved for future grants of stock awards, including stock options and restricted stock, which may be granted to any officer, key employee or non-employee director of Westfield Financial.  At September 30, 2014, no awards had been granted under this plan.

 

7. SHORT-TERM BORROWINGS AND LONG-TERM DEBT

 

We utilize short-term borrowings and long-term debt as an additional source of funds to finance our lending and investing activities and to provide liquidity for daily operations.

 

Short-term borrowings are made up of FHLBB advances with an original maturity of less than one year as well as customer repurchase agreements, which have an original maturity of one day. Short-term borrowings issued by the FHLBB were $43.0 million at September 30, 2014 and $20.0 million at December 31, 2013. We had a line of credit with the FHLBB of $312,000 at September 30, 2014 while there were no outstanding lines at December 31, 2013. Customer repurchase agreements were $35.4 million at September 30, 2014 and $28.2 million at December 31, 2013. A customer repurchase agreement is an agreement by us to sell to and repurchase from the customer an interest in specific securities issued by or guaranteed by the U.S. government. This transaction settles immediately on a same day basis in immediately available funds. Interest paid is commensurate with other products of equal interest and credit risk. All of our customer repurchase agreements at September 30, 2014 and December 31, 2013, were held by commercial customers. In addition, we have lines of credit of $4.0 million and $50.0 million with Bankers Bank Northeast (“BBN”) and PNC Bank, respectively. The interest rates on these lines are determined and reset on a daily basis by each respective bank. There were no advances outstanding under these lines of credit at September 30, 2014 or December 31, 2013.  As part of our contract with BBN, we are required to maintain a reserve balance of $300,000 with BBN for our use of this line of credit.

 

Long-term debt consists of FHLBB advances, securities sold under repurchase agreements and customer repurchase agreements with an original maturity of one year or more. At September 30, 2014, we had $231.1 million in long-term debt with the FHLBB and $10.0 million in securities sold under repurchase agreements with an approved broker-dealer. This compares to $232.7 million in long-term debt with FHLBB advances and $10.0 million in securities sold under repurchase agreements with an approved broker-dealer at December 31, 2013. The securities sold under agreement to repurchase are callable quarterly at the issuer’s option. Customer repurchase agreements were $5.7 million and $5.6 million at September 30, 2014 and December 31, 2013, respectively. All FHLBB advances are collateralized by a blanket lien on our owner occupied residential real estate loans and certain mortgage-backed securities.

 

20
 

 

 

For the nine months ended September 30, 2014, we did not prepay any repurchase agreements. Likewise, there were no prepayments of repurchase agreements as of December 31, 2013.

 

8. PENSION BENEFITS

 

The following table provides information regarding net pension benefit costs for the periods shown:

 

   Three Months Ended  Nine Months Ended,
   September 30,  September 30,
   2014  2013  2014  2013
   (In thousands)
Service cost  $250   $272   $750   $817 
Interest cost   207    178    624    533 
Expected return on assets   (239)   (232)   (719)   (696)
Transition obligation   —      (3)   (10)   (8)
Actuarial (gain) loss   (4)   17    (4)   76 
Net periodic pension cost  $214   $232   $641   $722 

 

We maintain a pension plan for our eligible employees. We plan to contribute to the pension plan the amount required to meet the minimum funding standards under Section 412 of the Internal Revenue Code of 1986, as amended. Additional contributions will be made as deemed appropriate by management in conjunction with the pension plan’s actuaries. We have not yet determined how much we expect to contribute to our pension plan in 2014. No contributions have been made to the plan for the nine months ended September 30, 2014. The pension plan assets are invested in group annuity contracts with the Principal Financial Group, who also acts as our 401(k) plan provider.

 

9. DERIVATIVES AND HEDGING ACTIVITIES

 

Risk Management Objective of Using Derivatives

 

We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of our assets and liabilities and the use of derivative financial instruments. Specifically, we entered into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments principally related to certain variable rate loan assets and variable rate borrowings.

 

 

 

21
 

 

Fair Values of Derivative Instruments on the Balance Sheet

 

The table below presents the fair value of our derivative financial instruments designated as hedging instruments as well as our classification on the balance sheet as of September 30, 2014 and December 31, 2013.

 

 September 30, 2014  Asset Derivatives  Liability Derivatives
   Balance Sheet
Location
  Fair Value  Balance Sheet
Location
  Fair Value
   (In thousands)
             
Interest rate swaps  Other Assets  $78   Other Liabilities  $2,925 
Total derivatives designated as hedging instruments     $78      $2,925 

 

 December 31, 2013  Asset Derivatives  Liability Derivatives
   Balance Sheet
Location
  Fair Value  Balance Sheet
Location
  Fair Value
   (In thousands)
             
Interest rate swaps  Other Assets  $1,755   N/A  $—  
Total derivatives designated as hedging instruments     $1,755      $—  

 

 

Cash Flow Hedges of Interest Rate Risk

 

Our objectives in using interest rate derivatives are to add stability to interest income and expense and to manage our exposure to interest rate movements. To accomplish this objective, we entered into interest rate swaps in September 2013 as part of our interest rate risk management strategy. These interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty in exchange for our making fixed payments.

 

The following table presents information about our cash flow hedges at September 30, 2014 and December 31, 2013:

 

 September 30, 2014  Notional  Weighted
Average
  Weighted Average Rate  Estimated Fair
   Amount  Maturity  Receive  Pay  Value
   (In thousands)  (In years)        (In thousands)
Interest rate swaps on FHLBB borrowings  $20,000    3.0    0.24%   1.17%  $78 
Forward starting interest rate swaps on FHLBB borrowings   135,000    6.5    —      2.93%   (2,925)
Total cash flow hedges  $155,000    6.0             $(2,847)

 

 December 31, 2013  Notional  Weighted
Average
  Weighted Average Rate  Estimated Fair
   Amount  Maturity  Receive  Pay  Value
   (In thousands)  (In years)        (In thousands)
Interest rate swaps on FHLBB borrowings  $20,000    3.8    0.24%   1.17%  $40 
Forward starting interest rate swaps on FHLBB borrowings   135,000    7.2    —      2.93%   1,715 
Total cash flow hedges  $155,000    6.8             $1,755 

 

The five forward-starting interest rate swaps will become effective in 2014, 2015, and 2016 with notional amounts of $20.0 million, $47.5 million and $67.5 million, respectively.

 

For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. We assess the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. We have not recognized any hedge ineffectiveness in earnings on any of the interest rate swaps since inception.

 

 

22
 

 

We are hedging our exposure to the variability in future cash flows for forecasted transactions over a maximum period of six years (excluding forecasted transactions related to the payment of variable interest on existing financial instruments).

 

Amounts reported in accumulated other comprehensive loss related to these derivatives will be reclassified to interest expense as interest payments are made on our rate sensitive assets/liabilities. The amount reclassified from accumulated other comprehensive loss into interest expense for the effective portion of interest rate swaps was $48,000 and $142,000 during the three and nine months ended September 30, 2014, respectively. We had no gain or loss reclassified from accumulated other comprehensive loss into income during the three and nine months ended September 30, 2014. During the next 12 months, we estimate that $728,000 will be reclassified as an increase in interest expense.

 

The table below presents the pre-tax net gains (losses) of our cash flow hedges for the periods indicated.

 

   Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion)
   Three Months Ended September 30,  Nine Months Ended September 30,
   2014  2013  2014  2013
   (In thousands)
Interest rate swaps  $255   $79   $(4,744)  $(79)

 

Credit-risk-related Contingent Features

 

By using derivative financial instruments, we expose ourselves to credit risk. Credit risk is the risk of failure by the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. When the fair value of a derivative is negative, we owe the counterparty and, therefore, it does not possess credit risk. The credit risk in derivative instruments is mitigated by entering into transactions with highly-rated counterparties that we believe to be creditworthy and by limiting the amount of exposure to each counterparty.

 

We have agreements with our derivative counterparties that contain a provision where if we default on any of our indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then we could also be declared in default on our derivative obligations. We also have agreements with certain of our derivative counterparties that contain a provision where if we fail to maintain our status as well capitalized, then the counterparty could terminate the derivative positions and we would be required to settle our obligations under the agreements. Certain of our agreements with our derivative counterparties contain provisions where if a formal administrative action by a federal or state regulatory agency occurs that materially changes our creditworthiness in an adverse manner, we may be required to fully collateralize our obligations under the derivative instrument.

 

As of September 30, 2014, the termination value of derivatives in a net liability position related to these agreements, which includes accrued interest but excludes any adjustment for nonperformance risk, was $2.9 million. As of September 30, 2014, we have minimum collateral posting thresholds with certain of our derivative counterparties and have no collateral posted against our obligations under these agreements. If we had breached any of these provisions at September 30, 2014, we could have been required to settle our obligations under the agreements at the termination value.

 

 

23
 

 

10. FAIR VALUE OF ASSETS AND LIABILITIES

 

Determination of Fair Value

 

We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for our various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

 

Fair Value Hierarchy - We group our assets and liabilities that are measured at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value.

 

Level 1 – Valuation is based on quoted prices in active markets for identical assets. Level 1 assets generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets.

 

Level 2 – Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets. Level 3 assets include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Methods and assumptions for valuing our financial instruments are set forth below. Estimated fair values are calculated based on the value without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications or estimated transaction cost.

 

Cash and cash equivalents – The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.

 

Securities – Fair value of securities are primarily measured using unadjusted information from an independent pricing service. The securities measured at fair value in Level 1 are based on quoted market prices in an active exchange market. These securities include marketable equity securities. All other securities are measured at fair value in Level 2 and are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.

 

Federal Home Loan Bank and other restricted stock - These investments are carried at cost which is their estimated redemption value.

 

Loans receivable – For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans and residential real estate loans) are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

 

Accrued interest – The carrying amounts of accrued interest approximate fair value.

 

Deposit liabilities – The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

 

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Short-term borrowings and long-term debt – The fair values of our debt instruments are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.

 

Interest rate swaps - The valuation of our interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. We have determined that the majority of the inputs used to value our interest rate derivatives fall within Level 2 of the fair value hierarchy.

 

Commitments to extend credit - Fair values for off-balance sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the term and credit risk. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Such differences are not considered significant.

 

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

 

 

   September 30, 2014
   Level 1  Level 2  Level 3  Total
Assets:  (In thousands)
    
Securities available for sale:   
Government-sponsored residential mortgage-backed securities  $—     $140,669   $—     $140,669 
U.S. government guaranteed residential mortgage-backed securities   —      1,689    —      1,689 
Corporate bonds   —      26,337    —      26,337 
State and municipal bonds   —      17,147    —      17,147 
Government-sponsored enterprise obligations   —      19,148    —      19,148 
Mutual funds   6,098    —      —      6,098 
Common and preferred stock   1,372    —      —      1,372 
Total assets  $7,470   $204,990   $—     $212,460 
                     
Liabilities:                     
Interest rate swaps, net  $—     $2,847   $—     $2,847 

 

   December 31, 2013
   Level 1  Level 2  Level 3  Total
Securities available for sale:  (In thousands)
Government-sponsored residential mortgage-backed securities  $—     $132,372   $—     $132,372 
U.S. government guaranteed residential mortgage-backed securities   —      46,328    —      46,328 
Corporate bonds   —      27,389    —      27,389 
State and municipal bonds   —      18,897    —      18,897 
Government-sponsored enterprise obligations   —      10,700    —      10,700 
Mutual funds   5,919    —      —      5,919 
Common and preferred stock   1,599    —      —      1,599 
Total securities available for sale   7,518    235,686    —      243,204 
Interest rate swaps   —      1,755    —      1,755 
Total assets  $7,518   $237,441   $—     $244,959 

 

 

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Also, we may be required, from time to time, to measure certain other assets at fair value on a non-recurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related assets at September 30, 2014 and 2013. Total gains (losses) represent the change in carrying value as a result of fair value adjustments related to assets still held at September 30, 2014 and 2013.

 

   At  Three Months Ended  Nine Months Ended
   September 30, 2014  September 30, 2014  September 30, 2014
   Level 1  Level 2  Level 3  Total Losses  Total Losses
   (In thousands)  (In thousands)  (In thousands)
Impaired loans  $—     $—     $4,783   $(950)  $(965)
Total assets  $—     $—     $4,783   $(950)  $(965)
          
   At  Three Months Ended  Nine Months Ended
   September 30, 2013  September 30, 2013  September 30, 2013
   Level 1  Level 2  Level 3  Total Losses  Total Gains
   (In thousands)  (In thousands)  (In thousands)
Impaired loans  $—     $—     $2,109   $(38)  $31 
Total assets  $—     $—     $2,109   $(38)  $31 

 

The amount of impaired loans represents the carrying value and related write-down and valuation allowance of impaired loans for which adjustments are based on the estimated fair value of the underlying collateral. The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on real estate appraisals performed by independent licensed or certified appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Management will discount appraisals as deemed necessary based on the date of the appraisal and new information deemed relevant to the valuation. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. The resulting losses were recognized in earnings through the provision for loan losses. Impaired loans with adjustments resulting from discounted cash flows or without a specific reserve are not included in this disclosure.

 

There were no transfers to or from Level 1 and 2 during the three and nine months ended September 30, 2014 and 2013. We did not measure any liabilities, other than those arising from interest rate swaps, at fair value on a recurring or non-recurring basis on the consolidated balance sheets.

 

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Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument.  Where quoted market prices are not available, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment. Changes in assumptions could significantly affect the estimates. The estimated fair values of our financial instruments are as follows:

 

   September 30, 2014
   Carrying
Value
  Fair Value
      Level 1  Level 2  Level 3  Total
   (In thousands)
Assets:               
Cash and cash equivalents  $14,429   $14,429   $—     $—     $14,429 
Securities available for sale   212,460    7,470    204,990    —      212,460 
Securities held to maturity   283,684    —      279,499    —      279,499 
Federal Home Loan Bank of Boston and other restricted stock   14,720    —      —      14,720    14,720 
Loans - net   711,860    —      —      715,235    715,235 
Accrued interest receivable   4,192    —      —      4,192    4,192 
                          
Liabilities:                          
Deposits   828,785    —      —      829,282    829,292 
Short-term borrowings   78,685    —      78,684    —      78,684 
Long-term debt   246,804    —      250,442    —      250,442 
Accrued interest payable   390    —      —      390    390 
Interest rate swaps, net   2,847    —      2,847    —      2,847 

 

   December 31, 2013
   Carrying
Value
  Fair Value
      Level 1  Level 2  Level 3  Total
   (In thousands)
Assets:               
Cash and cash equivalents  $19,742   $19,742   $—     $—     $19,742 
Securities available for sale   243,204    7,518    235,686    —      243,204 
Securities held to maturity   295,013    —      282,555    —      282,555 
Federal Home Loan Bank of Boston and other restricted stock   15,631    —      —      15,631    15,631 
Loans - net   629,968    —      —      631,417    631,417 
Accrued interest receivable   4,201    —      —      4,201    4,201 
Derivative assets   1,755    —      1,755    —      1,755 
                          
Liabilities:                          
Deposits   817,112    —      —      819,109    819,109 
Short-term borrowings   48,197    —      48,197    —      48,197 
Long-term debt   248,377    —      251,678    —      251,678 
Accrued interest payable   392    —      —      392    392 

 

 

 

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11. RECENT ACCOUNTING PRONOUNCEMENTS

 

In January 2014, FASB issued ASU 2014-04- Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure.” This ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (i) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (ii) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar agreement. In addition, the amendments require disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure in accordance with local requirements of the applicable jurisdiction. An entity can elect to adopt the amendments using either a modified retrospective method or a prospective transition method. The amendments are effective for annual and interim periods beginning after December 15, 2014. We do not expect the application of this guidance to have a material impact on our consolidated financial statements.

 

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ITEM 2:     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

Overview

 

We strive to remain a leader in meeting the financial service needs of our local community, and to provide quality service to the individuals and businesses in the market areas that we have served since 1853. Historically, we have been a community-oriented provider of traditional banking products and services to business organizations and individuals, including products such as residential and commercial loans, consumer loans and a variety of deposit products. We meet the needs of our local community through a community-based and service-oriented approach to banking.

 

We have adopted a growth-oriented strategy that has focused on increasing commercial lending. Our strategy also calls for increasing deposit relationships and broadening our product lines and services. We believe that this business strategy is best for our long-term success and viability, and complements our existing commitment to high-quality customer service. In connection with our overall growth strategy, we seek to:

 

  • grow our commercial and industrial and commercial real estate loan portfolios by targeting businesses in our primary market area and in northern Connecticut as a means to increase the yield on and diversify our loan portfolio and build transactional deposit account relationships;

 

  • focus on expanding our retail banking franchise and increase the number of households served within our market area; and

 

  • supplement the commercial focus, grow the residential loan portfolio to diversify risk and deepen customer relationships. We will maintain our arrangement with a third-party mortgage company which assists in originating and servicing residential real estate loans. By doing this, we reduce the overhead costs associated with these loans.

 

You should read the following financial results for the three and nine months ended September 30, 2014 in the context of this strategy.

 

·Net income was $1.5 million, or $0.08 per diluted share, for the three months ended September 30, 2014, compared to $1.6 million, or $0.08 per diluted share, for the same period in 2013. For the nine months ended September 30, 2014, net income was $4.5 million, or $0.25 per diluted share, compared to net income of $4.9 million, or $0.24 per diluted share, for the same period in 2013.

 

·The provision (credit) for loan losses was $750,000 and $(71,000) for the three months ended September 30, 2014 and 2013, respectively, and $1.3 million and $(376,000) for the nine months ended September 30, 2014 and 2013, respectively. The changes in the loan portfolio for both the three and nine months ended September 30, 2014 reflect overall loan growth, a decrease in impaired loan balances due to the financial improvement of a single commercial real estate relationship with a balance of $14.3 million, which returned to the general allowance pool for reserve measurement, and a partial charge off of $950,000 related to one long-standing manufacturing loan relationship deemed impaired during the third quarter of 2014. The credit for loan losses in both 2013 periods was the result of continued improvement in the overall risk profile of the commercial loan portfolio as classified loans that previously carried higher allowances showed considerable improvement, resulting in a lower allowance requirement.

 

·Net interest income was $7.8 million for the three months ended September 30, 2014 and 2013, respectively. The net interest margin, on a tax-equivalent basis, was 2.58% for the three months ended September 30, 2014, compared to 2.62% for the same period in 2013. For the nine months ended September 30, 2014 and 2013, net interest income was $23.2 million and $23.1 million, respectively. The net interest margin, on a tax-equivalent basis, was 2.61% and 2.59% for the nine months ended September 30, 2014 and 2013, respectively. The increase in net interest income for the nine months ended September 30, 2014 was due to a shift in average interest-earning assets out of securities and into loans, which tend to carry a higher average yield, as well as a decrease in the cost of average interest-bearing liabilities.

 

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CRITICAL ACCOUNTING POLICIES

 

Our consolidated financial statements are prepared in accordance with U.S. GAAP and practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Actual results could differ from those estimates.

 

Critical accounting estimates are necessary in the application of certain accounting policies and procedures, and are particularly susceptible to significant change. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. There have been no material changes to our critical accounting policies during the three and nine months ended September 30, 2014. For additional information on our critical accounting policies, please refer to the information contained in Note 1 of the accompanying unaudited consolidated financial statements and Note 1 of the consolidated financial statements included in our 2013 Annual Report.

 

COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2014 AND DECEMBER 31, 2013

 

Total assets were stable at $1.3 billion at September 30, 2014 and December 31, 2013. Securities decreased $42.9 million to $510.9 million at September 30, 2014 from $553.8 million at December 31, 2013 primarily due to sales of securities.

 

Total loans increased by $82.2 million to $719.6 million at September 30, 2014 from $637.4 million at December 31, 2013. Residential loans increased $30.3 million to $264.4 million at September 30, 2014 from $234.1 million at December 31, 2013. We purchased $24.3 million in residential loans from a New England-based bank as a means of supplementing our loan growth. In addition, through our long standing relationship with a third-party mortgage company, we purchased a total of $15.0 million in residential loans within and contiguous to our market area. While in prior quarters management has used residential loan growth to supplement the loan portfolio, the long-term strategy remains focused on commercial lending.

 

Commercial and industrial loans increased $29.8 million to $165.4 million at September 30, 2014 from $135.6 million at December 31, 2013. Commercial real estate loans increased $22.7 million to $287.2 million at September 30, 2014 from $264.5 at December 31, 2013. Non-owner occupied commercial real estate loans increased $24.8 million to $176.7 million at September 30, 2014 from $151.9 million at December 31, 2013, while owner occupied commercial real estate loans decreased $2.1 million to $110.4 million at September 30, 2014 from $112.5 million at December 31, 2013. The increase in loans was primarily due to organic growth within and contiguous to our market area.

 

All loans where the interest payment is 90 days or more in arrears as of the closing date of each month are placed on nonaccrual status. Nonperforming loans were $8.9 million at September 30, 2014 and $2.6 million at December 31, 2013. The increase in nonaccrual loans for the nine months ended September 30, 2014 was primarily due to a $6.8 million manufacturing loan relationship that went into nonaccrual and impaired status during the third quarter of 2014. If all nonaccrual loans had been performing in accordance with their terms, we would have earned additional interest income of $125,000 for both the nine months ended September 30, 2014 and 2013. At September 30, 2014 and December 31, 2013, there was no real estate in foreclosure. At September 30, 2014 and December 31, 2013, our nonperforming loans to total loans were 1.23% and 0.41%, respectively, while our nonperforming assets to total assets were 0.68% and 0.20%, respectively. A summary of our nonaccrual and past due loans by class are listed in Note 5 of the accompanying unaudited consolidated financial statements.

 

Total deposits increased $11.7 million to $828.8 million at September 30, 2014 from $817.1 million at December 31, 2013. The increase in deposits was due to a $25.9 million increase in money market accounts, which were $230.4 million and $204.5 million at September 30, 2014 and December 31, 2013, respectively. Time deposit accounts increased $3.9 million to $345.3 million at September 30, 2014 from $341.4 million at December 31, 2013. Checking accounts decreased $13.7 million to $176.3 million at September 30, 2014 from $190.0 million at December 31, 2013. Regular savings accounts decreased $4.5 million to $76.7 million at September 30, 2014. We modified the interest rate structure on consumer checking accounts, which resulted in some funds from consumer checking shifting to the relationship-based money market account.

 

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Borrowings increased $29.0 million to $325.5 million at September 30, 2014 from $296.5 million at December 31, 2013. Short-term borrowings increased $30.5 million to $78.7 million at September 30, 2014 from $48.2 million at December 31, 2013. Long-term debt decreased $1.5 million to $246.8 million at September 30, 2014 from $248.3 million at December 31, 2013. The change in our short-term debt and long-term borrowings was to take advantage of short-term, low cost FHLBB funding. Our short-term borrowings and long-term debt are discussed in Note 7 of the accompanying unaudited consolidated financial statements.

 

We have entered into several forward-starting interest rate swap contracts with a combined notional value of $155.0 million. The swap contracts have start dates ranging from the fourth quarter of 2013 to the third quarter of 2016 and have durations ranging from four to six years. This hedge strategy converts the LIBOR based rate of interest on certain FHLB advances to fixed interest rates, thereby protecting us from floating interest rate variability. On a stand-alone basis, the interest rate swaps introduce potential future volatility in tangible book value and accumulated other comprehensive income (“AOCI”); however, the valuation of the swaps is expected to change in the opposite direction of the valuations on the available-for-sale securities portfolio. This is consistent with our objective to reduce total volatility in tangible book value and AOCI.

 

Shareholders’ equity was $144.3 million and $154.1 million, which represented 11.0% and 12.1% of total assets at September 30, 2014 and December 31, 2013, respectively. The decrease in shareholders’ equity during the nine months ended September 30, 2014 reflects the repurchase of 1,317,945 shares of our common stock at a cost of $9.6 million pursuant to our stock repurchase program, the payment of regular dividends amounting to $3.3 million and a decrease in other comprehensive income of $2.1 million due to changes in the market value of our securities and swaps. This was partially offset by net income of $4.5 million for the nine months ended September 30, 2014.

 

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2014 AND SEPTEMBER 30, 2013

 

General

 

Net income was $1.5 million, or $0.08 per diluted share, for the quarter ended September 30, 2014, compared to $1.6 million, or $0.08 per diluted share, for the same period in 2013. Net interest income was $7.8 million for the three months ended September 30, 2014 and 2013, respectively.

 

Net Interest and Dividend Income

 

The following tables set forth the information relating to our average balance and net interest income for the three months ended September 30, 2014 and 2013, and reflect the average yield on interest-earning assets and average cost of interest-bearing liabilities for the periods indicated. Yields and costs are derived by dividing interest income by the average balance of interest-earning assets and interest expense by the average balance of interest-bearing liabilities for the periods shown. The interest rate spread is the difference between the total average yield on interest-earning assets and the cost of interest-bearing liabilities. Net interest margin represents tax-equivalent net interest and dividend income as a percentage of average interest-earning assets. Average balances are derived from actual daily balances over the periods indicated. Interest income includes fees earned from making changes in loan rates and terms and fees earned when the real estate loans are prepaid or refinanced. For analytical purposes, the interest earned on tax-exempt assets is adjusted to a tax-equivalent basis to recognize the income tax savings which facilitates comparison between taxable and tax-exempt assets.

 

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   Three Months Ended September 30,
   2014  2013
   Average    

Average 

  Average     Average 
   Balance  Interest  Yield/Cost  Balance  Interest  Yield/Cost
   (Dollars in thousands)
ASSETS:                  
Interest-earning assets                  
Loans(1)(2)  $703,736   $7,170    4.08%  $609,876   $6,409    4.20%
Securities(2)   492,948    3,245    2.63    573,955    4,077    2.84 
Other investments - at cost   16,129    59    1.46    17,537    20    0.46 
Short-term investments(3)   12,399    2    0.06    9,373    3    0.13 
Total interest-earning assets   1,225,212    10,476    3.42    1,210,741    10,509    3.47 
Total noninterest-earning assets   72,984              73,123           
                               
Total assets  $1,298,196             $1,283,864           
                               
LIABILITIES AND EQUITY:                               
Interest-bearing liabilities                              
Interest-bearing accounts  $38,889    22    0.23   $45,756    34    0.30 
Savings accounts   78,860    20    0.10    85,960    26    0.12 
Money market accounts   227,554    225    0.40    206,674    206    0.40 
Time certificates of deposit   342,281    1,031    1.20    330,222    1,124    1.36 
Total interest-bearing deposits   687,584    1,298         668,612    1,390      
Short-term borrowings and long-term debt   318,357    1,211    1.52    326,785    1,130    1.38 
Interest-bearing liabilities   1,005,941    2,509    1.00    995,397    2,520    1.01 
Noninterest-bearing deposits   133,817              119,462           
Other noninterest-bearing liabilities   13,139              10,676           
Total noninterest-bearing liabilities   146,956              130,138           
                               
Total liabilities   1,152,897              1,125,535           
Total equity   145,299              158,329           
Total liabilities and equity  $1,298,196             $1,283,864           
Less: Tax-equivalent adjustment(2)        (133)             (161)     
Net interest and dividend income       $7,834             $7,828      
Net interest rate spread(4)             2.42%             2.46%
Net interest margin(5)