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

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 


 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2017

 

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

 

Western New England Bancorp, 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  No

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer Accelerated filer Non-accelerated filer
     
Smaller reporting company Emerging growth company

  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act

 

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

 

At November 3, 2017, the registrant had 30,634,170 shares of common stock, $0.01 par value, issued and outstanding.

 

 

 

 

 

TABLE OF CONTENTS

 

    Page
     
FORWARD-LOOKING STATEMENTS i
     
PART I – FINANCIAL INFORMATION  
     
Item 1. Financial Statements of Western New England Bancorp, Inc. and Subsidiaries (Unaudited)  
     
  Consolidated Balance Sheets – September 30, 2017 and December 31, 2016 1
   
  Consolidated Statements of Net Income – Three and Nine Months Ended September 30, 2017 and 2016 2
   
  Consolidated Statements of Comprehensive Income – Three and Nine Months Ended September 30, 2017 and 2016 3
   
  Consolidated Statements of Changes in Shareholders’ Equity – Nine Months Ended September 30, 2017 and 2016 4
   
  Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2017 and 2016 5
     
  Notes to Consolidated Financial Statements 6
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 44
     
Item 4. Controls and Procedures 44
     
PART II – OTHER INFORMATION  
     
Item 1. Legal Proceedings 45
     
Item 1A. Risk Factors 45
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 45
     
Item 3. Defaults upon Senior Securities 45
     
Item 4. Mine Safety Disclosures 45
     
Item 5. Other Information 45
     
Item 6. Exhibits 46

 

 

 

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;

 

the inability to realize expected cost savings or achieve other anticipated benefits in connection with business combinations and other acquisitions;

 

changes in the securities markets which affect investment management revenues;

 

increases in Federal Deposit Insurance Corporation 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 governmental legislation and regulation, including changes in accounting regulation or standards, the nature and timing of the adoption and effectiveness of new requirements under the Dodd-Frank Act Wall Street Reform and Consumer Protection Act of 2010, Basel guidelines, capital requirements and other applicable laws and regulations;

 

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 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 (UNAUDITED)

 WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

   September 30,   December 31, 
   2017   2016 
ASSETS          
CASH AND DUE FROM BANKS  $25,108   $23,297 
FEDERAL FUNDS SOLD   885    4,388 
INTEREST-BEARING DEPOSITS AND OTHER SHORT-TERM INVESTMENTS   2,907    42,549 
CASH AND CASH EQUIVALENTS   28,900    70,234 
           
SECURITIES AVAILABLE-FOR-SALE – AT FAIR VALUE   297,919    300,115 
FEDERAL HOME LOAN BANK OF BOSTON AND OTHER RESTRICTED STOCK - AT COST   15,704    16,124 
LOANS - Net of allowance for loan losses of $10,518 and $10,068 at September 30, 2017 and December 31, 2016, respectively   1,608,255    1,556,416 
PREMISES AND EQUIPMENT, Net   23,440    20,885 
ACCRUED INTEREST RECEIVABLE   5,764    5,782 
BANK-OWNED LIFE INSURANCE   68,307    66,938 
DEFERRED TAX ASSET, Net   15,636    16,159 
GOODWILL   12,487    13,747 
CORE DEPOSIT INTANGIBLE   4,156    4,438 
OTHER REAL ESTATE OWNED   103    298 
OTHER ASSETS   5,707    4,882 
TOTAL ASSETS  $2,086,378   $2,076,018 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
LIABILITIES:          
DEPOSITS :          
Non-interest-bearing  $308,934   $303,993 
Interest-bearing   1,206,264    1,214,078 
Total deposits   1,515,198    1,518,071 
           
SHORT-TERM BORROWINGS   192,465    172,351 
LONG-TERM DEBT   106,339    124,836 
SECURITIES PENDING SETTLEMENT   137    455 
OTHER LIABILITIES   19,684    21,909 
TOTAL LIABILITIES   1,833,823    1,837,622 
           
SHAREHOLDERS’ EQUITY:          
Preferred stock - $0.01 par value, 5,000,000 shares authorized, none outstanding at September 30, 2017 and December 31, 2016        
Common stock - $0.01 par value, 75,000,000 shares authorized, 30,816,813 shares issued and outstanding at September 30, 2017; 30,380,231 shares issued and outstanding at December 31, 2016   309    304 
Additional paid-in capital   206,914    205,996 
Unearned compensation - ESOP   (5,946)   (6,418)
Unearned compensation - Equity Incentive Plan   (950)   (536)
Retained earnings   61,695    51,711 
Accumulated other comprehensive loss   (9,467)   (12,661)
Total shareholders’ equity   252,555    238,396 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY  $2,086,378   $2,076,018 

 

See accompanying notes to unaudited consolidated financial statements.

 

1

 

 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF NET INCOME

(Dollars in thousands, except per share data)

                 
   Three Months   Nine Months 
   Ended September 30,   Ended September 30, 
   2017   2016   2017   2016 
INTEREST AND DIVIDEND INCOME:                    
Residential and commercial real estate loans  $13,474   $7,367   $40,042   $20,803 
Commercial and industrial loans   2,883    1,728    8,180    5,098 
Consumer loans   88    43    260    126 
Debt securities, taxable   1,828    1,618    5,529    5,723 
Debt securities, tax-exempt   25    32    81    136 
Equity securities   35    45    105    140 
Other investments   172    130    501    398 
Federal funds sold, interest-bearing deposits and other short-term investments   11    14    103    67 
Total interest and dividend income   18,516    10,977    54,801    32,491 
                     
INTEREST EXPENSE:
                    
Deposits   2,111    1,582    6,180    4,589 
Long-term debt   534    446    1,633    1,749 
Short-term borrowings   1,075    621    2,946    1,580 
Total interest expense   3,720    2,649    10,759    7,918 
Net interest and dividend income   14,796    8,328    44,042    24,573 
PROVISION FOR LOAN LOSSES   200    375    850    400 
Net interest and dividend income after provision for loan losses   14,596    7,953    43,192    24,173 
                     
NON-INTEREST INCOME (LOSS):                    
Service charges and fees   1,714    953    4,789    2,696 
Income from bank-owned life insurance   450    369    1,369    1,133 
Loss on prepayment of borrowings               (915)
Gain on sales of securities, net   70    1    52    684 
Gain on sale of OREO   67        67     
Other income   111        227     
Total non-interest income   2,412    1,323    6,504    3,598 
                     
NON-INTEREST EXPENSE:                    
Salaries and employee benefits   6,490    4,057    18,954    11,709 
Occupancy   891    555    2,815    1,712 
Furniture and equipment   410    242    1,149    723 
Data processing   680    404    1,740    1,167 
Professional fees   642    656    1,919    1,717 
FDIC insurance assessment   163    214    466    594 
Merger related expenses       830    626    1,913 
Advertising   328    192    961    696 
Other   1,552    1,075    4,792    3,064 
Total non-interest expense   11,156    8,225    33,422    23,295 
INCOME BEFORE INCOME TAXES   5,852    1,051    16,274    4,476 
INCOME TAX PROVISION   2,037    423    3,600    1,495 
NET INCOME  $3,815   $628   $12,674   $2,981 
                     
EARNINGS PER COMMON SHARE:                    
Basic earnings per share  $0.13   $0.04   $0.42   $0.17 
Weighted average shares outstanding   30,103,095    17,377,844    29,895,621    17,340,101 
Diluted earnings per share  $0.13   $0.02   $0.42   $0.17 
Weighted average diluted shares outstanding   30,219,083    17,377,844    30,074,361    17,340,101 

  

 See accompanying notes to unaudited consolidated financial statements.

 

2

 

                   

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES

 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2017   2016   2017   2016 
                 
Net income  $3,815   $628   $12,674   $2,981 
                     
Other comprehensive income (loss):                    
Unrealized gains (losses) on securities:                    
Unrealized holding gains (losses) on available for sale securities   381    (359)   2,133    5,820 
Reclassification adjustment for gains realized in income(1)   (70)   (1)   (52)   (684)
Amortization of net unrealized loss on held-to-maturity securities(2)               26 
Net unrealized loss upon transfer of held-to-maturity to available-for-sale(3)               2,288 
Net unrealized gains (losses)   311    (360)   2,081    7,450 
Tax effect   (100)   125    (627)   (2,567)
Net-of-tax amount   211    (235)   1,454    4,883 
                     
Derivative instruments:                    
Change in fair value of derivatives used for cash flow hedges   (14)   417    (307)   (2,863)
Reclassification adjustment for loss realized in interest expense(4)   228    128    751    313 
Reclassification adjustment for termination fee realized in interest expense(5)   269    269    799    687 
Net adjustments relating to derivative instruments   483    814    1,243    (1,863)
Tax effect   (133)   (277)   32    633 
Net-of-tax amount   350    537    1,275    (1,230)
                     
Defined benefit pension plans:                    
Amortization of defined benefit plans actuarial loss(6)   51    24    153    71 
Tax effect   28    (8)   312    (24)
Net-of-tax amount   79    16    465    47 
                     
Other comprehensive income   640    318    3,194    3,700 
                     
Comprehensive income  $4,455   $946   $15,868   $6,681 

 

(1)  

Realized gains on available-for-sale securities are recognized as a component of non-interest income. The tax effects applicable to net realized gains were $29,000 and $407 for the three months ended September 30, 2017 and 2016, respectively. The tax effects applicable to net realized gains were $21,000 and $236,000 for the nine months ended September 30, 2017 and 2016, respectively.

     
(2)   Amortization of net unrealized gains on held-to-maturity securities is recognized as a component of interest income on debt securities. Income tax effects associated with the reclassification adjustments were $(9,000) for the nine months ended September 30, 2016.
     
(3)   Income tax effect associated with the reclassification adjustments upon transfer of held-to-maturity to available-for-sale was $790,000 for the nine months ended September 30, 2016.
     
(4)   Loss realized in interest expense on derivative instruments is recognized as a component of interest expense on short-term debt. Income tax effects associated with the reclassification adjustment were $93,000 and $44,000 for the three months ended September 30, 2017 and 2016, respectively. Income tax effects associated with the reclassification adjustment were $307,000 and $106,000 for the nine months ended September 30, 2017 and 2016, respectively
     
(5)   Loss realized in interest expense on derivative instruments is recognized as a component of interest expense on short-term debt. Income tax effects associated with the reclassification adjustment were $110,000 and $91,000 for the three months ended September 30, 2017 and 2016, respectively. Income tax effects associated with the reclassification adjustment were $326,000 and $234,000 for the nine months ended September 30, 2017 and 2016, respectively
     
(6)   Amounts represent the reclassification of defined benefit plans amortization and have been recognized as a component of salaries and employee benefit expense. Income tax effects associated with the reclassification adjustments were $(21,000) and $8,000 for the three months ended September 30, 2017 and 2016, respectively. Income tax effects associated with the reclassification adjustments were $(63,000) and $24,000 for the nine months ended September 30, 2017 and 2016, respectively.

  

Tax rate on reclassification adjustments was 40.85% for the 2017 period and 34.0% for the comparable 2016 period.

 

See accompanying notes to unaudited consolidated financial statements.

 

3

 

 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016

(Dollars in thousands, except share data)

 

   Common Stock           Unearned       Accumulated     
  Shares     Par Value   Additional
Paid-in
Capital
   Unearned Compensation-
ESOP
   Compensation-
Equity
Incentive Plan
   Retained
Earnings
   Other
Comprehensive
Loss
   Total 
                                 
BALANCE AT DECEMBER 31, 2015   18,267,747   $183   $108,210   $(6,952)  $(313)  $49,316   $(10,978)  $139,466 
Comprehensive income                       2,981    3,700    6,681 
Common stock held by ESOP committed to be released (74,430 shares)           62    382                444 
Share-based compensation - equity incentive plan                   186            186 
Excess tax benefit from equity incentive plan           5                    5 
Issuance of common stock in connection with equity incentive plan   62,740    1    484        (485)            
Cash dividends declared and paid ($0.09 per share)                       (1,559)       (1,559)
BALANCE AT SEPTEMBER 30, 2016   18,330,487   $184   $108,761   $(6,570)  $(612)  $50,738   $(7,278)  $145,223 
                                         
BALANCE AT DECEMBER 31, 2016   30,380,231   $304   $205,996   $(6,418)  $(536)  $51,711   $(12,661)  $238,396 
Comprehensive income                       12,674    3,194    15,868 
Common stock held by ESOP committed to be released (93,679 shares)           226    472                698 
Share-based compensation - equity incentive plan                   490            490 
Common stock repurchased   (574,309)   (5)   (5,667)                   (5,672)
Issuance of common stock in connection with stock option exercises   921,849    9    5,456                    5,465 
Issuance of common stock in connection with equity incentive plan   89,042    1    903        (904)            
Cash dividends declared and paid ($0.09 per share)                       (2,690)       (2,690)
BALANCE AT SEPTEMBER 30, 2017   30,816,813   $309   $206,914   $(5,946)  $(950)  $61,695   $(9,467)  $252,555 

 

See accompanying notes to unaudited consolidated financial statements

 

4

 

 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

   Nine Months Ended September 30, 
   2017   2016 
OPERATING ACTIVITIES:          
Net income  $12,674   $2,981 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   850    400 
Depreciation and amortization of premises and equipment   1,468    969 
Accretion of purchase accounting adjustments, net   (1,431)    
Amortization of core deposit intangible   282     
Net amortization of premiums and discounts on securities and mortgage loans   2,577    2,758 
Net amortization of premiums on modified debt       60 
Share-based compensation expense   490    186 
ESOP expense   698    444 
Excess tax benefits from equity incentive plan       (5)
Net gains on sales of securities   (52)   (684)
Gain on sale of other real estate owned   (67)    
Loss on prepayment of borrowings       915 
Deferred income tax benefit   (973)    
Income from bank-owned life insurance   (1,369)   (1,133)
Changes in assets and liabilities:          
Accrued interest receivable   18    300 
Other assets   (3,578)   (1,468)
Other liabilities   1,995    (2,184)
Net cash provided by operating activities   13,582    3,539 
           
INVESTING ACTIVITIES:
          
Securities, held to maturity:          
Proceeds from calls, maturities, and principal collections       6,835 
Securities, available for sale:          
Purchases   (67,246)   (59,595)
Proceeds from sales   22,453    136,825 
Proceeds from calls, maturities, and principal collections   46,576    46,639 
Purchase of residential mortgages   (48,205)   (107,632)
Loan originations and principal payments, net   (4,133)   (21,185)
Redemption of Federal Home Loan Bank of Boston stock   420    2,880 
Proceeds from sale of other real estate owned   365     
Purchases of premises and equipment   (1,645)   (565)
Proceeds from sale of premises and equipment       20 
Net cash (used in) provided by investing activities   (51,415)   4,222 
           
FINANCING ACTIVITIES:
          
Net (decrease) increase in deposits   (2,120)   62,195 
Net change in short-term borrowings   20,114    51,866 
Repayment of long-term debt   (19,700)   (84,333)
Proceeds from long-term debt   1,420    1,165 
Cash dividends paid   (2,690)   (1,559)
Common stock repurchased   (5,990)    
Issuance of common stock in connection with stock option exercises   5,465     
Excess tax benefits in connection with equity incentive plan       5 
Net cash (used in) provided by financing activities   (3,501)   29,339 
           
NET CHANGE IN CASH AND CASH EQUIVALENTS:   (41,334)   37,100 
Beginning of period   70,234    13,703 
End of period  $28,900   $50,803 
           
Supplemental cashflow information:          
Securities reclassified from held-to-maturity to available-for-sale  $   $(232,817)
Net change in cash due to broker for common stock repurchased   (318)    
Interest paid   10,774    8,036 
Taxes paid   3,658    2,150 

 

See the accompanying notes to unaudited consolidated financial statements.

 

5

 

 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

SEPTEMBER 30, 2017

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of OperationsWestern New England Bancorp, Inc. (“Western New England Bancorp,” “WNEB,” the “Company,” “we” or “us”) is a Massachusetts-chartered stock holding company for Westfield 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 21 banking offices in western Massachusetts and northern Connecticut, and its primary sources of revenue are earnings on loans to small and middle-market businesses and to residential property homeowners and income from securities.

 

Wholly-Owned Subsidiaries and Acquisition– Elm Street Securities Corporation, WFD Securities, Inc. and CSB Colts, Inc., are Massachusetts-chartered securities corporations, formed for the primary purpose of holding qualified securities. WB Real Estate Holdings, LLC, is a Massachusetts-chartered limited liability company that holds real property acquired as security for debts previously contracted by the Bank. On October 21, 2016, we acquired Chicopee Bancorp, Inc. (“Chicopee”), the holding company for Chicopee Savings Bank. The acquisition added eight full-service banking offices located in western Massachusetts.

 

Principles of Consolidation – The unaudited consolidated financial statements include the accounts of Western New England Bancorp, the Bank, CSB Colts, Inc., Elm Street Securities Corporation, WB Real Estate Holdings, LLC and WFD Securities, Inc. 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 realizability 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, 2017, 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, 2017 are not necessarily indicative of the results of operations for the year ending December 31, 2017. 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, 2016, included in our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 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, 2017 and 2016 have been computed based on the following:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2017   2016   2017   2016 
   (In thousands, except per share data) 
                 
Net income applicable to common stock  $3,815   $628   $12,674   $2,981 
                     
Average number of common shares issued   31,001    18,330    30,799    18,298 
Less: Average unallocated ESOP Shares   (838)   (926)   (861)   (945)
Less: Average unvested equity incentive plan shares   (60)   (26)   (42)   (13)
                     
Average number of common shares outstanding used to calculate basic earnings per common share   30,103    17,378    29,896    17,340 
                     
Effect of dilutive equity incentive plan   26        12     
Effect of dilutive stock options   90        166     
                     
Average number of common shares outstanding used to calculate diluted earnings per common share   30,219    17,378    30,074    17,340 
                     
Basic earnings per share  $0.13   $0.04   $0.42   $0.17 
Diluted earnings per share  $0.13   $0.04   $0.42   $0.17 

 

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,

2017

   December 31,
2016
 
   (In thousands) 
         
Net unrealized losses on securities available-for-sale  $(3,782)  $(5,863)
Tax effect   1,397    2,024 
Net-of-tax amount   (2,385)   (3,839)
           
Fair value of derivatives used for cash flow hedges   (2,709)   (3,152)
Termination fees on forward starting interest rate swaps   (3,933)   (4,733)
Total derivatives   (6,642)   (7,885)
Tax effect   2,713    2,681 
Net-of-tax amount   (3,929)   (5,204)
           
Unrecognized actuarial loss on defined benefit plan   (5,329)   (5,482)
Tax effect   2,176    1,864 
Net-of-tax amount   (3,153)   (3,618)
           
Accumulated other comprehensive loss  $(9,467)  $(12,661)

 

The following table presents changes in accumulated other comprehensive loss for the periods ended September 30, 2017 and 2016 by component:

 

   Securities   Derivatives   Defined
Benefit
Plans
   Accumulated
Other
Comprehensive
Loss
 
   (In thousands) 
Balance at December 31, 2015  $(3,046)  $(5,501)  $(2,431)  $(10,978)
Current-period other comprehensive income (loss)   4,883    (1,230)   47    3,700 
Balance at September 30, 2016  $1,837   $(6,731)  $(2,384)  $(7,278)
                     
Balance at December 31, 2016  $(3,839)  $(5,204)  $(3,618)  $(12,661)
Current-period other comprehensive income   1,454    1,275    465    3,194 
Balance at September 30, 2017  $(2,385)  $(3,929)  $(3,153)  $(9,467)

 

8

 

 

4.       SECURITIES

 

Securities available-for-sale are summarized as follows:

 

   September 30, 2017 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
   (In thousands) 
Available-for-sale securities:                    
Government-sponsored mortgage-backed securities  $193,037   $120   $(2,836)  $190,321 
U.S. government guaranteed mortgage-backed securities   17,408        (447)   16,961 
Corporate bonds   56,192    582    (221)   56,553 
State and municipal bonds   3,223    39    (37)   3,225 
Government-sponsored enterprise obligations   25,150        (697)   24,453 
Mutual funds   6,691        (285)   6,406 
Total available-for-sale  $301,701   $741   $(4,523)  $297,919 

 

   December 31, 2016 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
    (In thousands) 
Available-for-sale securities:                    
Government-sponsored mortgage-backed securities  $184,127   $33   $(4,024)  $180,136 
U.S. government guaranteed mortgage-backed securities   17,753        (403)   17,350 
Corporate bonds   50,255    265    (203)   50,317 
State and municipal bonds   4,117    13    (122)   4,008 
Government-sponsored enterprise obligations   43,140        (1,132)   42,008 
Mutual funds   6,586        (290)   6,296 
Total available-for-sale securities  $305,978   $311   $(6,174)  $300,115 

 

Our repurchase agreements are collateralized by government-sponsored enterprise obligations and certain mortgage-backed securities (see Note 8).

 

The amortized cost and fair value of available-for-sale debt securities at September 30, 2017, by maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers have the right to call or repay obligations. Also, because mortgage-backed securities require periodic principal paydowns, they are not included in the maturity categories in the following maturity summary.

 

   September 30, 2017
   Amortized Cost  Fair Value
   (In thousands)
Available for securities:          
Debt securities:          
     Due in one year or less  $—     $—   
     Due after one year through five years   28,079    28,497 
     Due after five years through ten years   49,735    49,149 
     Due after ten years   6,751    6,585 
Total securities  $84,565   $84,231 
Mortgage-backed securities   210,445    207,282 
Total  $295,010   $291,513 

 

  

9

 

 

Gross realized gains and losses on sales of securities available-for-sale for the three and nine months ended September 30, 2017 and 2016 are as follows:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2017   2016   2017   2016 
   (In thousands) 
                 
Gross gains realized  $71   $1   $117   $1,521 
Gross losses realized   (1)       (65)   (837)
Net gain realized  $70   $1   $52   $684 

 

Proceeds from the sale of securities available-for-sale amounted to $22.5 million and $136.8 million for the nine months ended September 30, 2017 and 2016, respectively.

 

Information pertaining to securities with gross unrealized losses at September 30, 2017 and December 31, 2016, aggregated by investment category and length of time that individual securities have been in a continuous loss position are as follows:

 

   September 30, 2017 
   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  $1,022   $105,596   $1,814   $61,415 
U.S. government guaranteed mortgage-backed securities   160    9,874    287    7,086 
Corporate bonds   210    20,915    11    2,058 
State and municipal bonds           37    1,564 
Government-sponsored enterprise obligations   129    5,021    568    19,432 
Mutual funds   57    3,508    228    2,898 
Total available-for-sale  $1,578   $144,914   $2,945   $94,453 

 

 

  

December 31, 2016 

 
   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  $3,016   $147,691   $1,008   $27,303 
U.S. government guaranteed mortgage-backed securities   192    12,536    211    4,814 
Corporate bonds   203    18,481         
State and municipal bonds   95    1,507    27    305 
Government-sponsored enterprise obligations   1,132    42,008         
Mutual funds   79    3,429    211    2,867 
Total available-for-sale  $4,717   $225,652   $1,457   $35,289 

 

10

 

 

   September 30, 2017 
   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   41   $106,618   $1,022    1.0%   27   $63,229   $1,814    2.9%
U.S. government guaranteed mortgage-backed securities   3    10,034    160    1.6    4    7,373    287    3.9 
Corporate bonds   7    21,125    210    1.0    1    2,069    11    0.5 
Government-sponsored enterprise obligations   1    5,150    129    2.5    8    20,000    568    2.8 
State and municipal bonds                   3    1,601    37    2.3 
Mutual funds   1    3,565    57    1.6    2    3,126    228    7.3 
        $146,492   $1,578             $97,398   $2,945      

 

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 basis, no declines are deemed to be other-than-temporary.

 

5.         LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans consisted of the following amounts:  September 30,   December 31, 
   2017   2016 
   (In thousands) 
Commercial real estate  $716,890   $720,741 
Residential real estate:          
Residential   555,768    522,083 
Home equity   92,359    92,083 
Commercial and industrial   244,374    222,286 
Consumer   4,467    4,424 
 Total Loans   1,613,858    1,561,617 
Unearned premiums and deferred loan fees and costs, net   4,915    4,867 
Allowance for loan losses   (10,518)   (10,068)
   $1,608,255   $1,556,416 

 

During the nine months ended September 30, 2017 and 2016, we purchased residential real estate loans aggregating $48.2 million and $107.6 million, respectively.

 

We have transferred a portion of our originated commercial real estate and commercial and industrial 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, 2017 and December 31, 2016, we serviced commercial loans for participants aggregating $32.4 million and $42.6 million, respectively.

 

11

 

 

Residential mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid balances of these loans totaled $67.8 million and $75.2 million at September 30, 2017 and December 31, 2016, respectively. Service fee income of $49,000 and $3,000 was recorded for the nine months ended September 30, 2017 and 2016, respectively, and is included in service charges and fees on the consolidated statements of net income.

 

Residential real estate mortgages are originated by the Bank both for its portfolio and for sale into the secondary market. The Bank may sell its loans to institutional investors such as the Federal Home Loan Mortgage Corporation. Under loan sale and servicing agreements with the investor, the Bank generally continues to service the residential real estate mortgages. The Bank pays the investor an agreed upon rate on the loan, which is less than the interest rate received from the borrower. The Bank retains the difference as a fee for servicing the residential real estate mortgages. The Bank capitalizes mortgage servicing rights at their fair value upon sale of the related loans, amortizes the asset over the estimated life of the serviced loan, and periodically assesses the asset for impairment. The significant assumptions used by a third party to estimate the fair value of capitalized servicing rights at September 30, 2017, include weighted average prepayment speed for the portfolio using the Public Securities Association Standard Prepayment Model (203 PSA), weighted average internal rate of return (10.05%), weighted average servicing fee (0.2501%), and average net cost to service loans ($59.32 per loan). The estimated fair value of capitalized servicing rights may vary significantly in subsequent periods primarily due to changing market interest rates, and their effect on prepayment speeds and discount rates.

 

A summary of the activity in the balances of mortgage servicing rights follows:

 

    

Three Months
Ended

September 30,

2017 

  

Nine Months
Ended

September 30,

2017

 
     (In thousands) 
           
  Balance at the beginning of period:  $408   $465 
  Capitalized mortgage servicing rights        
  Amortization   (28)   (85)
  Balance at the end of period  $380   $380 
  Fair value at the end of period  $538   $538 

 

Prior to the acquisition of Chicopee in 2016, mortgage servicing rights were not material to the consolidated financial statements, and therefore, were not recorded.

 

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.

 

12

 

 

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.

 

13

 

 

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, 2017 and 2016 is as follows:

 

   Commercial Real Estate   Residential Real Estate   Commercial and Industrial   Consumer   Unallocated   Total 
   (In thousands) 
Three Months Ended    
Balance at June 30, 2016  $3,956   $2,804   $2,797   $20   $(7)  $9,570 
Provision (credit)   62    189    83    43    (2)   375 
Charge-offs       (40)       (46)       (86)
Recoveries   59            9        68 
Balance at September 30, 2016  $4,077   $2,953   $2,880   $26   $(9)  $9,927 
                               
Balance at June 30, 2017  $4,472   $3,126   $2,754   $53   $13   $10,418 
Provision (credit)   (68)   146    (109)   83    148    200 
Charge-offs       (107)       (104)       (211)
Recoveries       80    3    28        111 
Balance at September 30, 2017  $4,404   $3,245   $2,648   $60   $161   $10,518 
                               
Nine Months Ended                              
Balance at December 31, 2015  $3,856   $2,431   $2,485   $22   $46   $8,840 
Provision (credit)   (614)   610    395    64    (55)   400 
Charge-offs   (170)   (90)       (87)       (347)
Recoveries   1,005    2        27        1,034 
Balance at September 30, 2016  $4,077   $2,953   $2,880   $26   $(9)  $9,927 
                               
Balance at December 31, 2016  $4,083   $2,862   $3,085   $38   $   $10,068 
Provision (credit)   239    427    (180)   203    161    850 
Charge-offs   (36)   (148)   (285)   (237)       (706)
Recoveries   118    104    28    56        306 
Balance at September 30, 2017  $4,404   $3,245   $2,648   $60   $161   $10,518 

 

14

 

 

Further information pertaining to the allowance for loan losses by segment at September 30, 2017 and December 31, 2016 follows:

 

   Commercial Real Estate   Residential Real Estate   Commercial and Industrial   Consumer   Unallocated   Total 
   (In thousands) 
September 30, 2017                        
                         
Amount of allowance for impaired loans  $   $   $   $   $   $ 
Amount of allowance for non-impaired loans   4,404    3,245    2,648    60    161    10,518 
Total allowance for loan losses  $4,404   $3,245   $2,648   $60   $161   $10,518 
                               
Impaired loans  $3,993   $3,854   $2,869   $127   $   $10,843 
Non-impaired loans   699,945    640,622    240,421    4,340        1,585,328 
Loans acquired with deteriorated credit quality   12,952    3,651    1,084            17,687 
Total loans  $716,890   $648,127   $244,374   $4,467   $   $1,613,858 
                               
December 31, 2016                              
                               
Amount of allowance for impaired loans  $   $   $   $   $   $ 
Amount of allowance for non-impaired loans   4,083    2,862    3,085    38        10,068 
Total allowance for loan losses   4,083    2,862    3,085    38        10,068 
                               
Impaired loans  $3,335   $452   $3,042   $   $   $6,829 
Non-impaired loans   701,766    609,107    217,972    4,424        1,533,269 
Loans acquired with deteriorated credit quality   15,640    4,607    1,272            21,519 
Total loans  $720,741   $614,166   $222,286   $4,424   $   $1,561,617 
                               

15

 

 

The following is a summary of past due and non-accrual loans by class at September 30, 2017 and December 31, 2016:

 

   30 – 59 Days
Past Due
   60 – 89 Days
Past Due
   Greater than
90 Days
Past Due
   Total Past
Due
   Past Due 90
Days or More
and Still
Accruing
   Loans on Non-
Accrual
 
   (In thousands) 
September 30, 2017                        
Commercial real estate  $196   $295   $136   $627   $   $2,181 
Residential real estate:                              
Residential   2,308    570    572    3,450        1,744 
Home equity   218    135    72    425        73 
Commercial and industrial   472    59    108    639        2,700 
Consumer   54    18    5    77        17 
Total legacy loans   3,248    1,077    893    5,218        6,715 
                               
Loans acquired from Chicopee Savings Bank   2,957    1,610    1,279    5,846        6,450 
                               
Total  $6,205   $2,687   $2,172   $11,064   $   $13,165 
                               
December 31, 2016                              
Commercial real estate  $302   $555   $137   $994   $   $2,740 
Residential real estate:                              
Residential   791    262    689    1,742        1,658 
Home equity   208    36        244        37 
Commercial and industrial   326    32        358        3,214 
Consumer   27    9    7    43        14 
Total legacy loans   1,654    894    833    3,381        7,663 
                               
Loans acquired from Chicopee Savings Bank   3,854    1,907    551    6,312        6,394 
                               
Total past due loans  $5,508   $2,801   $1,384   $9,693   $   $14,057 

 

The following is a summary of impaired loans by class at and for the periods ended September 30, 2017 and December 31, 2016:

 

   Impaired Loans(1)(2) 
           Three Months Ended   Nine Months Ended 
   At September 30, 2017 (1)   September 30, 2017   September 30, 2017 
   Recorded
Investment
   Unpaid
Principal
Balance
   Average
Recorded
Investment
   Interest
Income
Recognized
   Average
Recorded
Investment
   Interest
Income
Recognized
 
   (In thousands) 
Impaired loans without a valuation allowance (2):                              
Commercial real estate  $16,945   $19,380   $17,731   $199   $18,788   $650 
Residential real estate:                              
Residential real estate   6,939    7,410    7,016    11    6,548    34 
Home equity   566    590    407    1    260    3 
Commercial and industrial   3,953    10,242    4,442    54    4,538    183 
Consumer   127    131    122        83     
                               
Total impaired loans  $28,530   $37,753   $29,718   $265   $30,217   $870 

  

 

(1)   Includes loans acquired with deteriorated credit quality and performing troubled debt restructurings.

(2)   Includes loans acquired with deteriorated credit quality from the Chicopee Bancorp merger.

 

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   Impaired Loans (1)(2) 
           Three Months Ended   Nine Months Ended 
   At December 31, 2016 (1)   September 30, 2016   September 30, 2016 
   Recorded
Investment
   Unpaid
Principal
Balance
   Average
Recorded
Investment
   Interest
Income
Recognized
   Average
Recorded
Investment
   Interest
Income
Recognized
 
   (In thousands) 
Impaired loans without a valuation allowance (2):                              
Commercial real estate  $18,975   $21,330   $3,487   $17   $3,551   $49 
Residential real estate   5,059    5,676    515        482     
Commercial and industrial   4,314    11,049    3,356        3,434     
                               
Total impaired loans  $28,348   $38,055   $7,358   $17   $7,467   $49 

 

 

(1) Includes loans acquired with deteriorated credit quality from the Chicopee Bancorp, Inc. merger.

(2) Includes loans acquired with deteriorated credit quality from the Chicopee Bancorp merger.

 

No interest income was recognized for impaired loans on a cash-basis method during the three and nine months ended September 30, 2017 or 2016. Interest income recognized on an accrual basis during the three and nine months ended September 30, 2017 related to performing purchase impaired loans while activity in the comparable 2016 periods related to performing TDR loans.

 

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 classified as impaired.

 

When we modify loans in a TDR, we measure 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. There were no loans modified in TDRs during the three and nine months ended September 30, 2017. A substandard impaired loan relationship in the amount of $4.6 million was designated a TDR during the nine months ended September 30, 2016. The bank entered into a forbearance agreement which offered an interest only period. Due to the borrower continuing to experience declining sales, the interest only period was extended during the second quarter of 2016, resulting in the TDR classification. The loans are on non-accrual and are current. The loans are measured for impairment quarterly and appropriate reserves/charge offs have been taken.

 

   Nine Months Ended 
   September 30, 2016 
   Number of
Contracts
   Pre-Modification
Outstanding
Recorded
Investment
   Post-Modification Outstanding
Recorded
Investment
 
   (Dollars in thousands) 
Troubled Debt Restructurings               
Commercial Real Estate   1   $1,940   $1,940 
Commercial and Industrial   3    2,681    2,681 
Residential   2    161    161 
Total   6   $4,782   $4,782 

 

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A default occurs when a loan is 30 days or more past due. No TDRs defaulted within twelve months of restructuring during the three and nine months ended September 30, 2017 or 2016.

 

There were no charge-offs on TDRs during the three and nine months ended September 30, 2017 and 2016.

 

Loans Acquired with Deteriorated Credit Quality

 

The following is a summary of loans acquired from Chicopee with evidence of credit deterioration as of September 30, 2017.

 

    Contractual Required Payments Receivable   Cash Expected To Be Collected   Non-
Accretable Discount
   Accretable
Yield
   Loans
Receivable
 
    (In thousands) 
                      
Balance at December 31, 2016   $37,437   $29,040   $8,397   $7,521   $21,519 
Collections    (3,860)   (3,326)   (534)   (1,003)   (2,323)
Dispositions    (1,833)   (1,503)   (330)   6    (1,509)
Balance at September 30, 2017   $31,744   $24,211   $7,533   $6,524   $17,687 

 

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,” with an acceptable level of risk. Loans in this category remain “pass” rated and are not a criticized or classified loan, however, represent borrowers which may exhibit tight cash flows and/or leveraged balance sheets.

 

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

 

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 $67.6 million and $88.9 million at September 30, 2017 and December 31, 2016, 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. In addition, management utilizes delinquency reports, the watch list and other loan reports to monitor credit quality in other segments.

 

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The following table presents our loans by risk rating at September 30, 2017 and December 31, 2016:

 

   Commercial
Real Estate
   Residential
1-4 Family
   Home
Equity
   Commercial
and Industrial
   Consumer   Total 
   (In thousands) 
September 30, 2017                        
Loans rated 1 – 3  $647,599   $549,936   $91,854   $192,968   $4,340   $1,486,697 
Loans rated 4   45,339    95        35,585        81,019 
Loans rated 5   14,724            7,521        22,245 
Loans rated 6   9,228    5,737    505    8,300    127    23,897 
   $716,890   $555,768   $92,359   $244,374   $4,467   $1,613,858 
                               
December 31, 2016                              
Loans rated 1 – 3  $673,957   $516,339   $91,964   $180,675   $4,391   $1,467,326 
Loans rated 4   24,207            16,621    6    40,834 
Loans rated 5   14,068            6,727        20,795 
Loans rated 6   6,604    5,744    119    15,379    27    27,873 
Loans rated 7   1,905            2,884        4,789 
   $720,741   $522,083   $92,083   $222,286   $4,424   $1,561,617 

 

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6.       GOODWILL AND OTHER INTANGIBLES

 

Goodwill

Goodwill for the nine months ended September 30, 2017 is summarized as follows:

 

   

Nine Months
Ended
September 30,

2017

 
      (In thousands) 
 Balance at December 31, 2016   $13,747 
 Current period adjustments    (1,260)
 Balance at September 30, 2017   $12,487 

 

At September 30, 2017 and December 31, 2016, the Company’s goodwill related to the acquisition of Chicopee in October 2016. Annually, or more frequently if events or changes in circumstances warrant such evaluation, the Company evaluates its goodwill for impairment. No goodwill impairment was recorded for the nine months ended September 30, 2017.

 

During the three months ended March 31, 2017, management completed their evaluation of premises and equipment acquired from Chicopee, which resulted in a $2.4 million adjustment to the provisional fair values of bank premises acquired and a $1.4 million reduction in goodwill. The remaining adjustments to goodwill of $140,000 during the three months ended March 31, 2017 resulted from information obtain during the quarter about events and circumstances that existed as of the acquisition date.

 

Core Deposit Intangibles

In connection with the assumption of $545.7 million of deposit liabilities from the Chicopee acquisition in October 2016, of which $345.2 million were core deposits, the Bank recorded a core deposit intangible of $4.5 million. The resulting core deposit intangible is amortized over twelve years using the straight-line method. Core deposit intangibles are summarized as follows:

 

   

Nine Months
Ended
September 30,

2017

 
      (In thousands) 
 Balance at December 31, 2016   $4,438 
 Amortization    (282)
 Balance at September 30, 2017   $4,156 

 

Amortization expense was $282,000 for the nine months ended September 30, 2017. At September 30, 2017, future amortization of the core deposit intangible totals $375,000 for each of the next five years and $2.3 million thereafter.

 

7. SHARE-BASED COMPENSATION

 

Stock Options – Under the terms of the Chicopee merger agreement dated April 4, 2016, each option to purchase shares of Chicopee common stock issued by Chicopee and outstanding at the effective time of the merger, October 21, 2016, pursuant to the Chicopee 2007 Equity Incentive Plan fully vested and converted into an option to purchase shares of WNEB common stock on the same terms and conditions as were applicable before the merger, except (1) the number of shares of WNEB common stock subject to the new option was adjusted to be equal to the product of the number of shares of Chicopee common stock subject to the existing option and the exchange ratio (rounding fractional shares to the nearest whole share) and (2) the exercise price per share of WNEB common stock under the new option was adjusted to be equal to the exercise price per share of Chicopee common stock of the existing option divided by the exchange ratio (rounded to the nearest whole cent).

 

20

 

 

A summary of stock option activity for the nine months ended September 30, 2017 is presented below. No options were outstanding during the nine months ended September 30, 2016.

 

    Shares   Weighted
Average
Exercise
Price
  

Weighted
Average
Remaining Contractual
Term

(in years)

  

Aggregate
Intrinsic
Value 

(in thousands)

 
                  
Outstanding at December 31, 2016    1,178,899   $6.01    1.98   $3,930 
Exercised    (921,849)   5.93    0.91    3,675 
Outstanding at September 30, 2017    257,050   $6.31    4.66   $1,175 
                      
Exercisable at September 30, 2017    257,050   $6.31    4.66   $1,175 

 

Cash received for options exercised during the nine months ended September 30, 2017 was $5.5 million.

 

Restricted Stock Awards In May 2014, our shareholders approved a stock-based compensation plan under which up to 516,000 shares of our common stock were reserved for grants of stock awards, including stock options and restricted stock, which may be granted to any officer, key employee or non-employee director of WNEB. Authorized but unissued shares are issued to awardees upon vesting of such awards. Any shares not issued because vesting requirements are not met will again be available for issuance under the plans.

 

In January 2015, 48,560 shares were granted under this plan and vest ratably over five years. The fair market value of shares awarded, based on the market price at the date of grant, was recorded as unearned compensation and is being amortized over the applicable vesting period.

 

In 2016, the Compensation Committee (the “Committee”) approved the long-term incentive program (the “LTI Plan”). The LTI Plan provides a periodic award that is both performance and retention based in that it is designed to recognize the executive’s responsibilities, reward demonstrated performance and leadership and to retain such executives. The objective of the LTI Plan is to align compensation for the named executive officers and directors over a multi-year period directly with the interests of our shareholders by motivating and rewarding creation and preservation of long-term financial strength, shareholder value and relative shareholder return.

 

The LTI Plan includes eligible officers of the Company who are nominated by the Company’s Chief Executive Officer and approved by the Committee. The LTI Plan is triggered by the Company’s achievement of satisfactory safety and soundness results from its most recent regulatory examination. Employee stock grants made through the 2016 LTI plan will be a combination of 50% time-vested restricted stock and 50% performance-based restricted stock.

 

In May 2016, 62,740 shares were granted under the LTI Plan. Of this total, 36,543 shares are retention-based, with 10,352 vesting in one year and 26,191 vesting ratably over a three year period. The remaining 26,197 shares granted are performance based and are subject to the achievement of the 2016 LTI performance metric before vesting is realized after a three year period. For the performance shares, the primary performance metric for 2016 awards is return on equity. Performance shares will be earned based upon how the Company performs relative to threshold and target absolute goals (i.e. Company-specific, not relative to a peer index) over the three-year performance period. The threshold amount for the performance period will be a return on equity of 5.85% and a target amount of 6.32%. Participants will be able to earn between 50% (for threshold performance) and 100% of the target amount for the performance shares but will not earn additional shares if performance exceeds target performance.

 

In May 2017, 89,042 shares were granted under the LTI Plan. Of this total, 55,159 shares are retention-based, with 21,276 vesting in one year and 33,883 vesting ratably over a three year period. The remaining 33,883 shares granted are performance based and are subject to the achievement of the 2017 LTI performance metric before vesting is realized after a three year period. For the performance shares, the primary performance metric for 2017 awards is return on equity. Performance shares will be earned based upon how the Company performs relative to threshold, target and maximum absolute goals (i.e. Company-specific, not relative to a peer index) on an annual performance period, but will be distributed at the end of the three year period.

 

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The threshold, target and maximum for the three year period under the 2017 Plan is as follows:

 

    Return on Equity Targets 
      
Performance Period Ending   Threshold    Target    Maximum 
                
December 31, 2017   6.00%   6.60%   7.30%
December 31, 2018   6.30%   7.00%   7.60%
December 31, 2019   6.50%   7.20%   7.90%
                

Participants will be able to earn between 50% (for threshold performance), 100% (for target performance) and 150% (for the maximum performance).

 

The fair market value of shares awarded, based on the market price at the date of grant, is recorded as unearned compensation and amortized over the applicable vesting period. Shares granted under performance-based conditions are monitored on a quarterly basis in order to compare actual results to the performance metric established, with any necessary adjustments being recognized through share-based compensation expense and unearned compensation. At September 30, 2017, an additional 315,658 shares were available for future grants under this plan.

 

Our stock award plan activity for the nine months ended September 30, 2017 and 2016 is summarized below:

 

    Unvested Stock Awards
Outstanding
 
    Shares    Weighted
Average
Grant Date
Fair Value
 
           
Outstanding at December 31, 2016   91,371   $7.51 
Shares granted   89,042    10.15 
Shares vested   (21,552)   7.44 
Outstanding at September 30, 2017   158,861   $9.00 
           
Outstanding at December 31, 2015   54,160   $7.28 
Shares granted   62,740    7.73 
Shares vested   (11,200)   7.18 
Outstanding at September 30, 2016   105,700   $7.56 

 

We recorded compensation cost related to the stock awards of $490,000 and $186,000 for the nine months ended September 30, 2017 and 2016, respectively.

 

8. 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, a line of credit with the FHLBB and customer repurchase agreements, which mature daily. Short-term borrowings issued by the FHLBB were $174.0 million at September 30, 2017 and $155.0 million at December 31, 2016. We have an “Ideal Way” line of credit with the FHLBB for $9.5 million at September 30, 2017 and December 31, 2016. Interest on this line of credit is payable at a rate determined and reset by the FHLBB on a daily basis. The outstanding principal is due daily, but the portion not repaid will be automatically renewed. There were no advances outstanding on the line of credit as of September 30, 2017 or December 31, 2016. Customer repurchase agreements were $18.5 million at September 30, 2017 and $17.4 million at December 31, 2016. 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. 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, 2017 or December 31, 2016. 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.

 

22

 

 

Long-term debt consists of FHLBB advances with an original maturity of one year or more. At September 30, 2017, we had $106.3 million in long-term debt with the FHLBB. This compares to $124.8 million in long-term debt with FHLBB advances at December 31, 2016.

 

Customer repurchase agreements are collateralized by government-sponsored enterprise obligations with fair value of $6.8 million and $24.6 million, and mortgage backed securities with a fair value of $61.1 million and $57.6 million, at September 30, 2017 and December 31, 2016, respectively. The securities collateralizing repurchase agreements are subject to fluctuations in fair value. We monitor the fair value of the collateral on a periodic basis, and would pledge additional collateral if necessary based on changes in fair value of collateral or the balances of the repurchase agreements.

 

All FHLBB advances are collateralized by a blanket lien on our owner occupied residential real estate loans and certain eligible commercial real estate loans.

 

9.   PENSION BENEFITS

 

We maintain a pension plan for our eligible employees. On September 30, 2016, we effected a soft freeze on the Plan and therefore no new participants will be included in the Plan after such effective date. 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 2017. No contributions have been made to the plan for the nine months ended September 30, 2017. The pension plan assets are invested in group annuity contracts with the Principal Financial Group, who also acts as third-party administrator for our 401(k) and ESOP plans.

 

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

  

   Three Months Ended
September 30,
   Nine Months Ended,
September 30,
 
   2017   2016   2017   2016 
   (In thousands) 
Service cost  $245   $283   $778   $854 
Interest cost   254    240    761    719 
Expected return on assets   (298)   (275)   (895)   (823)
Amortization of actuarial losses   51    24    153    71 
Net periodic pension cost  $252   $272   $797   $821 

 

10. 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.

 

23

 

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, 2017 and December 31, 2016.

 

September 30, 2017   Asset Derivatives     Liability Derivatives
    Balance Sheet Location     Fair Value     Balance Sheet Location     Fair Value  
    (In thousands)  
                         
Interest rate swaps   Other Assets   $ 1     Other Liabilities   $ 2,710  

 

December 31, 2016   Asset Derivatives     Liability Derivatives
    Balance Sheet Location     Fair Value     Balance Sheet Location     Fair Value  
    (In thousands)  
                         
Interest rate swaps   Other Assets   $     Other Liabilities   $ 3,152  

 

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 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, 2017 and December 31, 2016:

 

  Notional    Weighted
Average
   Weighted Average Rate   Estimated Fair  
September 30, 2017  Amount   Maturity   Receive   Pay   Value  
   (In thousands)   (In years)           (In thousands)
Interest rate swaps on FHLBB borrowings  $75,000    2.6    1.31%   2.46%  $ (2,709 )

 

  Notional    Weighted
Average
   Weighted Average Rate   Estimated Fair  
December 31, 2016  Amount   Maturity   Receive   Pay   Value  
   (In thousands)   (In years)             (In thousands)  
Interest rate swaps on FHLBB borrowings  $75,000    3.4    0.92%   2.46%  $ (3,152 )

 

During 2016, we terminated a forward-starting interest rate swap with a notional amount of $32.5 million and incurred a termination fee of $3.4 million. During 2015, we terminated forward-starting interest rate swaps with notional amounts of $47.5 million and incurred a termination fee of $2.4 million. The termination fees are amortized as a reclassification of other comprehensive income into interest expense over the terms of the previously hedged borrowings, which were six and five years for the swaps terminated in 2016 and 2015, 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 did not recognize any hedge ineffectiveness in earnings during the nine months ended September 30, 2017 or 2016.

 

24

 

 

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

 

The table below presents the pre-tax net 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, 
   2017   2016   2017   2016 
   (In thousands) 
Interest rate swaps  $(14)  $417   $(307)  $(2,863)

 

Amounts reported in accumulated other comprehensive loss related to these derivatives are reclassified to interest expense as interest payments are made on our rate sensitive assets/liabilities. The amount reclassified from accumulated other comprehensive income into net income for the effective portion of interest rate swaps and termination fees was $497,000 and $397,000 during the three months ended September 30, 2017 and 2016, respectively and $1.6 million and $1.0 million during the nine months ended September 30, 2017 and 2016, respectively. During the next 12 months, we estimate that $1.8 million will be reclassified as an increase in interest expense. During the nine months ended September 30, 2017 and 2016, no gains or losses were reclassified from accumulated other comprehensive loss into income for ineffectiveness on cash flow hedges.

 

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, 2017, 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 $2.7 million. As of September 30, 2017, we have mortgage-backed securities with a fair value of $3.0 million and $50,000 cash posted as collateral against our obligations under these agreements. If we had breached any of these provisions at September 30, 2017, we could have been required to settle our obligations under the agreements at the termination value.

 

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11.   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 and mortgage-backed 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 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.

 

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Deposit liabilities – The fair values disclosed for demand deposits (e.g., interest and non-interest checking, 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 time deposits approximate their fair values at the reporting date. Fair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on time deposits to a schedule of aggregated expected monthly maturities on time deposits.

 

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.

 

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

 

   September 30, 2017 
   Level 1   Level 2   Level 3   Total 
Assets:  (In thousands) 
Securities available-for-sale                    
Government-sponsored mortgage-backed securities  $   $190,321   $   $190,321 
U.S. government guaranteed mortgage-backed securities       16,961        16,961 
Corporate bonds       56,553        56,553 
State and municipal bonds       3,225        3,225 
Government-sponsored enterprise obligations       24,453        24,453 
Mutual funds   6,406            6,406 
Total securities available-for-sale   6,406    291,513        297,919 
                     
Interest rate swaps       1        1 
Total assets  $6,406   $291,514   $   $297,920 
                     
Liabilities:                    
Interest rate swaps  $   $2,710   $   $2,710 

 

   December 31, 2016 
   Level 1   Level 2   Level 3   Total 
Assets:  (In thousands) 
Government-sponsored mortgage-backed securities  $   $180,136   $   $180,136 
U.S. government guaranteed mortgage-backed securities       17,350        17,350 
Corporate bonds       50,317        50,317 
State and municipal bonds       4,008        4,008 
Government-sponsored enterprise obligations       42,008        42,008 
Mutual funds   6,296            6,296 
Total assets  $6,296   $293,819   $   $300,115 
                     
Liabilities:                    
Interest rate swaps  $   $3,152   $   $3,152 

 

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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. There were no assets measured at fair value on a non-recurring basis at September 30, 2017. The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related assets at September 30, 2016. Total losses represent the change in carrying value as a result of fair value adjustments related to assets still held at September 30, 2016.

 

   At September 30, 2016   Three Months Ended September 30, 2016   Nine Months Ended September 30, 2016 
               Total   Total 
   Level 1   Level 2   Level 3   Gains (Losses)   Gains (Losses) 
   (In thousands)         
Impaired Loans  $   $   $2,059   $   $(220)

 

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, 2017 and 2016. We did not measure any liabilities at fair value on a 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, 2017 
   Carrying Value   Fair Value 
       Level 1   Level 2   Level 3   Total 
   (In thousands) 
Assets:                    
Cash and cash equivalents  $28,900   $28,900   $—     $—     $28,900 
Securities available-for-sale   297,919    6,406    291,513    —      297,919 
Federal Home Loan Bank of Boston and other restricted stock   15,704    —      —      15,704    15,704 
Loans - net   1,608,255    —      —      1,577,309    1,577,309 
Accrued interest receivable   5,764    —      —      5,764    5,764 
Mortgage servicing rights   380    —      380    —      380 
Derivative assets   1    —      1    —      1 
                          
Liabilities:                         
Deposits   1,515,198    —      —      1,514,641    1,514,641 
Short-term borrowings   192,465    —      192,482    —      192,482 
Long-term debt   106,339    —      106,517    —      106,517 
Accrued interest payable   394    —      —      394    394 
Derivative liabilities   2,710    —      2,710    —      2,710 

 

   December 31, 2016 
   Carrying Value   Fair Value 
       Level 1   Level 2   Level 3   Total 
   (In thousands) 
Assets:                    
Cash and cash equivalents  $70,234   $70,234   $—     $—     $70,234 
Securities available-for-sale   300,115    6,296    293,819    —      300,115 
Federal Home Loan Bank of Boston and other restricted stock   16,124    —      —      16,124    16,124 
Loans - net   1,556,416    —      —      1,525,274    1,525,274 
Accrued interest receivable   5,782    —      —      5,782    5,782 
Mortgage servicing rights   465    —      628    —      628 
                          
Liabilities:                         
Deposits   1,518,071    —      —      1,521,580    1,521,580 
Short-term borrowings   172,351    —      172,351    —      172,351 
Long-term debt   124,836    —      125,183    —      125,183 
Accrued interest payable   1,012    —      —      1,012    1,012 
Derivative liabilities   3,152    —      3,152    —      3,152 

 

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12. RECENT ACCOUNTING PRONOUNCEMENTS

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). The amendments in this Update create Topic 606, Revenue from Contracts with Customers, and supersede the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU is effective for annual reporting periods, including interim periods, beginning after December 15, 2017. We do not expect the application of this guidance to have a material impact on our consolidated financial statements other than expanded disclosures regarding non-interests income.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall, (Subtopic 825-10). The amendments in this Update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Targeted improvements to generally accepted accounting principles include the requirement for equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income and the elimination of the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost. The amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We do not expect the application of this guidance to have a material impact on our consolidated financial statements due to the limited amounts of marketable equity securities owned by the Company.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes the requirements in Topic 840, Leases. The objective of Topic 842 is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. The amendments in this Update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application of the amendments in this Update is permitted for all entities. Management is currently evaluating the impact to the consolidated financial statements of adopting this Update but does not expect adoption to have a material impact on our consolidated financial statements. As of September 30, 2017, the Company had $9.9 million of outstanding operating leases pertaining to banking premises, which would be recognized as assets and corresponding liabilities upon adoption.

 

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting (Topic 718). This Update was issued as part of the FASB’s simplification initiative. The areas for simplification in this Update involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The Company adopted this Update during the nine months ended September 30, 2017 which resulted in the recognition of $821,000 in income tax benefit that would have previously been recognized in additional paid in capital.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The ASU also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. This ASU is effective for fiscal years beginning after December 15, 2019, and for interim periods within that fiscal years. Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is in the process of evaluating the standard. We have put together a project team that has begun to identify appropriate loan segments along with related historical losses for each segment and potential models that would be most appropriate for each individual segment. We have not quantified the effects of any models, but do expect the standard to significantly change the approach to calculating our allowance for loan losses.

 

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In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. This Update provides guidance on eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; distributions received from equity method investees; beneficial interests in securitization transactions; separately identifiable cash flows and application of the predominance principle. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. We do not expect the application of this guidance to have a material impact on our consolidated financial statements.

 

In March 2017, the FASB issued ASU No. 2017-08—Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. This Update amends guidance on the amortization period of premiums on certain purchased callable debt securities. Specifically, the amendments shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments affect all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer at the earliest call date (that is, at a premium). The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. We do not expect the application of this guidance to have a material impact on our consolidated financial statements.

 

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities (ASU 2017-12). The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. ASU 2017-12 is effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. The Company plans to adopt ASU 2017-12 on January 1, 2018. ASU 2017-12 requires a modified retrospective transition method in which the Company will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption. While the Company continues to assess all potential impacts of the standard, 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 areas of western Massachusetts and 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.

 

You should read the following financial results for the three and nine months ended September 30, 2017 in the context of this strategy. The third quarter financial results for 2016 reflect the pre-merger operations of the Company. As a result, the Company’s 2017 third quarter may not be comparable to financial results for the third quarter of 2016.

 

Net income was $3.8 million, or $0.13 per diluted share, for the three months ended September 30, 2017, compared to $628,000, or $0.04 per diluted share, for the same period in 2016. For the nine months ended September 30, 2017, net income was $12.7 million, or $0.42 per diluted share, as compared to net income of $3.0 million, or $0.17 per diluted share, for the same period in 2016.

 

The provision for loan losses was $200,000 and $375,000 for the three months ended September 30, 2017 and 2016, respectively, and $850,000 and $400,000 for the nine months ended September 30, 2017 and 2016, respectively. The lower provision for the nine months ended September 30, 2016 was primarily the result of a $1.0 million partial recovery on a previously charged-off single commercial real estate loan during the first quarter of 2016.

 

Net interest income was $14.8 million and $8.3 million for the three months ended September 30, 2017 and 2016, respectively. The net interest margin, on a tax-equivalent basis, was 3.09% for the three months ended September 30, 2017, compared to 2.65% for the same period in 2016. Net interest income was $44.0 million and $24.6 million for the nine months ended September 30, 2017 and 2016, respectively. The net interest margin, on a tax-equivalent basis, was 3.09% and 2.62% for the nine months ended September 30, 2017 and 2016, respectively.

 

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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 nine months ended September 30, 2017. 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 2016 Annual Report.

 

COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2017 AND DECEMBER 31, 2016

 

Total assets were $2.1 billion at September 30, 2017 and December 31, 2016. A slight increase in total assets of $10.4 million, or 0.5%, was primarily due to an increase in total loans of $52.3 million, or 3.3%, offset by a decrease in cash and cash equivalents of $41.3 million, or 58.8%, and a decrease in investments of $2.6 million, or 0.8%.

 

Total loans of $1.6 billion increased $52.3 million, or 3.3%, at September 30, 2017, from $1.6 billion at December 31, 2016. The increase was due to a $33.9 million, or 5.5%, increase in residential loans, including home equity loans, an increase of $22.1 million, or 9.9%, in commercial and industrial loans, partially offset by a decrease of $3.9 million, or 0.5%, in commercial real estate loans. The decrease in the commercial real estate portfolio was largely related to the expected payoff of a $7.5 million completed commercial real estate construction project during first quarter 2017.

 

All loans where the payments are 90 days or more in arrears as of the closing date of each month are placed on nonaccrual status. Nonperforming loans were $13.2 million at September 30, 2017 and $14.1 million at December 31, 2016. If all nonaccrual loans had been performing in accordance with their terms, we would have earned additional interest income of $580,000 and $371,000 for the nine months ended September 30, 2017 and 2016, respectively. At September 30, 2017, we had $103,000 in other real estate owned (“OREO”). At September 30, 2017 and December 31, 2016, our nonperforming loans to total loans were 0.81% and 0.90%, respectively, while our nonperforming assets to total assets were 0.64% and 0.69%, respectively. A summary of our nonaccrual and past due loans by class are listed in Note 5 of the accompanying unaudited consolidated financial statements.

 

During the three months ended March 31, 2017, management completed an evaluation of premises and equipment acquired from Chicopee, which resulted in a $2.4 million adjustment to the provisional fair values of bank premises acquired and a $1.4 million reduction to goodwill. The remaining adjustments to goodwill of $140,000 during the three months ended March 31, 2017 resulted from information obtain during the quarter about events and circumstances that existed as of the acquisition date. There were no adjustments to goodwill during the three months ended September 30, 2017.

 

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At September 30, 2017, total deposits of $1.5 billion decreased $2.9 million, or 0.2%, from December 31, 2016. Savings accounts decreased $5.2 million, or 3.5%, to $144.3 million. Time deposits decreased $6.3 million, or 1.1%, from $572.9 million at December 31, 2016 to $566.7 million at September 30, 2017. The decrease in time deposits was due to non-relationship customers and brokered deposits seeking higher yields. We are focused on allowing high cost non-relationship deposits to mature and be replaced with low cost relationship-based core deposits. Core deposits, defined as all deposits except time deposits, represented 62.6% of total deposits, and increased $3.4 million, or 0.4%, from $945.1 million at December 31, 2016 to $948.5 million at September 30, 2017. Non-interest bearing deposits increased $4.9 million, or 1.6%, to $308.9 million, money market accounts increased $3.4 million, or 0.8%, to $412.7 million, and interest-bearing checking accounts increased $228,000, or 0.3%, to $82.6 million.

 

Borrowings increased $1.6 million, or 0.5%, to $298.8 million at September 30, 2017 from $297.2 million at December 31, 2016. Short-term borrowings increased $20.1 million, or 11.7%, to $192.5 million at September 30, 2017 from $172.4 million at December 31, 2016 due to an increase in short-term FHLBB funding. Long-term debt decreased $18.5 million, or 14.8%, to $106.3 million at September 30, 2017 from $124.8 million at December 31, 2016.

 

Shareholders’ equity was $252.6 million, or 12.1% of total assets at September 30, 2017 and $238.4 million, or 11.5% of total assets at December 31, 2016. The increase in shareholders’ equity during the nine months reflects net income of $12.7 million, the exercise of stock options for $5.7 million and other comprehensive income of $3.2 million. These increases were offset by the repurchase of common stock for $5.7 million and the payment of regular dividends of $2.7 million for the nine months ended September 30, 2017.

 

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2017 AND SEPTEMBER 30, 2016

 

General

 

Net income was $3.8 million, or $0.13 per diluted share for the three months ended September 30, 2017, compared to $628,000, or $0.04 per diluted share for the same period in 2016. Net interest income was $14.8 million and $8.3 million for the three months ended September 30, 2017 and 2016, 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, 2017 and 2016, 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. 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, 
   2017   2016 
   Average       Average
Yield/
   Average       Average
Yield/
 
   Balance   Interest   Cost   Balance   Interest   Cost 
   (Dollars in thousands) 
ASSETS:                        
Interest-earning assets                              
Loans(1)(2)  $1,605,376   $16,681    4.16%  $932,140   $9,168    3.93%
Securities(2)   302,030    1,901    2.52    296,406    1,709    2.31 
Other investments   17,748    172    3.88    12,728    130    4.09 
Short-term investments(3)   5,206    11    0.85    17,380    14    0.32 
Total interest-earning assets   1,930,360    18,765    3.89    1,258,654    11,021    3.50 
Total non-interest-earning assets   141,119              79,032           
Total assets  $2,071,479             $1,337,686           
                               
LIABILITIES AND EQUITY:                              
Interest-bearing liabilities                              
Interest-bearing checking accounts  $82,164    81    0.39   $31,194    24    0.31%
Savings accounts   148,433    43    0.12    75,566    20    0.11 
Money market accounts   400,400    386    0.39    278,257    293    0.42 
Time deposit accounts   568,578    1,601    1.13    383,288    1,245    1.30 
Total interest-bearing deposits   1,199,575    2,111    0.70    768,305    1,582    0.82 
Short-term borrowings and long-term debt   301,715    1,609    2.13    229,718    1,067    1.86 
Interest-bearing liabilities   1,501,290    3,720    0.99    998,023    2,649    1.06 
Non-interest-bearing deposits   300,757              177,802           
Other non-interest-bearing liabilities   16,147              16,261           
Total Non-interest-bearing liabilities   316,904              194,063           
                               
Total liabilities   1,818,194              1,192,086           
Total equity   253,285              145,601           
Total liabilities and equity  $2,071,479             $1,337,687           
Less: Tax-equivalent adjustment(2)        (249)             (44)     
Net interest and dividend income       $14,796             $8,328      
Net interest rate spread(4)             2.90%             2.44%
Net interest margin(5)             3.09%             2.65%
Ratio of average interest-earning assets to average interest-bearing liabilities             128.58%             126.11%

 

 

 

(1)Loans, including non-accrual loans, are net of deferred loan origination costs, and unadvanced funds.

(2)Securities and loan income are presented on a tax-equivalent basis using a tax rate of 35% for the 2017 period and 34% for the 2016 period. The tax-equivalent adjustment is deducted from tax-equivalent net interest and dividend income to agree to the amount reported in the unaudited consolidated statements of net income.

(3)Short-term investments include federal funds sold.

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

(5)Net interest margin represents tax-equivalent net interest and dividend income as a percentage of average interest earning assets.

 

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The following table shows how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to:

 

interest income changes attributable to changes in volume (changes in volume multiplied by prior rate);

interest income changes attributable to changes in rate (changes in rate multiplied by current volume); and the net change.

 

The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

 

   Three Months Ended September 30, 2017 compared to Three Months Ended September 30, 2016 
   Increase (Decrease) Due to     
   Volume   Rate   Net 
Interest-earning assets  (In thousands) 
Loans (1)  $6,622   $891   $7,513 
Securities (1)   32    160    192 
Other investments   51    (9)   42 
Short-term investments   (10)   7    (3)
Total interest-earning assets   6,695    1,049    7,744 
                
Interest-bearing liabilities               
Interest-bearing checking accounts   39    18    57 
Savings accounts   19    4    23 
Money market accounts   129    (36)   93 
Time deposit accounts   602    (246)   356 
Short-term borrowing and long-time debt   334    208    542 
Total interest-bearing liabilities   1,123    (52)   1,071 
Change in net interest and dividend income (1)  $5,572   $1,101   $6,673 

 

 

 

(1)Securities, loan income and change in net interest and dividend income are presented on a tax-equivalent basis using a tax rate of 35%. The tax-equivalent adjustment is deducted from tax-equivalent net interest income.

 

Net interest and dividend income increased $6.5 million, or 78.3%, to $14.8 million for the three months ended September 30, 2017, compared to $8.3 million for the three months ended September 30, 2016. The increase reflected a $7.5 million, or 68.2%, increase in interest income as average interest-earning assets increased $671.7 million, or 53.4%, primarily due to loan growth as a result of the merger. The yield on interest-earning assets increased 39 basis points from 3.50% for the three months ended September 30, 2016 to 3.89% for the three months ended September 30, 2017.

 

For the three months ended September 30, 2017, interest expense increased $1.1 million, or 42.3%, compared to the three months ended September 30, 2016. During the same period, interest-bearing liabilities increased $431.3 million, or 56.1%, while non-interest bearing liabilities, such as demand accounts, increased $123.0 million, or 69.2%. The net interest margin of 3.09% for the three months ending September 30, 2017 increased 44 basis points, compared to 2.65% for the three months ended September 30, 2016. The three months ended September 30, 2017 include amortization of purchase accounting adjustments related to the Chicopee acquisition, which increased net interest income by $448,000. Excluding these items, net interest margin for the third quarter of 2017 would have been 3.00%.

 

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Provision for Loan Losses

 

The provision for loan losses is reviewed by management based upon our evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan portfolio.

 

The amount of the provision for loan losses during the three months ended September 30, 2017 was based upon the changes that occurred in the loan portfolio during that same period. The changes in the loan portfolio primarily includes an increase in residential loans and a higher level of net charge-offs. After evaluating all factors, we recorded a provision for loan losses of $200,000 for the three months ended September 30, 2017, compared to $375,000 for the same period in 2016. The allowance was $10.5 million, or 0.65% of total loans, and $10.1 million, or 0.64% of total loans, at September 30, 2017 and December 31, 2016, respectively.

 

For the three months ended September 30, 2017, net charge-offs were $100,000. This was comprised of $211,000 in charge-offs, partially offset by recoveries of $111,000.

 

For the three months ended September 30, 2016, net charge-offs were $18,000. This was comprised of $86,000 in charge-offs, partially offset by recoveries of $68,000.

 

Although we believe that we have established and maintained the allowance for loan losses at adequate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.

 

Non-interest Income

 

For the three months ended September 30, 2017, non-interest income of $2.4 million increased $1.1 million, or 84.6%, compared to $1.3 million for the three months ended September 30, 2016. The increase was primarily due to the merger with Chicopee. The increase was primarily driven by an increase in service charges and fee income of $761,000, or 79.9%, an increase in other income of $111,000, an increase of $81,000, or 22.0%, in income from bank-owned life insurance and an increase of $48,000 in gains on sales of securities.

 

Non-interest Expense

 

For the three months ended September 30, 2017, non-interest expense of $11.2 million increased $3.0 million, or 36.6%, from $8.2 million, for the three months ended September 30, 2016. The increase was primarily due to a $2.4 million, or 58.5%, increase in salaries and benefits due to the addition of the Chicopee staff and normal merit increases that typically occur during the first quarter of each year. Occupancy expense increased $336,000, or 60.5%, due to the acquisition of the Chicopee branches, and data processing expense increased $276,000, or 68.3%, while merger related expenses decreased $830,000. The increase to non-interest expense reflects generally higher level of expenses associated with operating a larger financial institution, which include additional employees, increased costs for data processing, occupancy, and professional services. Although there are overall added expenses, the merger provided the opportunity to achieve greater economies of scale as reflected in the improvement in the efficiency ratio from 76.6%, for the three months ended September 30, 2016, to 65.4% for the three months ended September 30, 2017.

 

Income Taxes

 

For the three months ended September 30, 2017, we had a tax provision of $2.0 million as compared to $423,000 for the same period in 2016. The effective tax rate was 34.8% for the three months ended September 30, 2017 and 40.2% for the same period in 2016. The three months ended September 30, 2017 include higher levels of pre-tax income as a result of the merger, while the comparable 2016 period includes nondeductible merger expenses of $691,000.

 

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COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2017 AND SEPTEMBER 30, 2016

 

General

 

Net income was $12.7 million, or $0.42 per diluted share, for the nine months ended September 30, 2017, compared to $3.0 million, or $0.17 per diluted share, for the same period in 2016. Net interest income was $44.0 million and $24.6 million for the nine months ended September 30, 2017 and 2016, respectively.

 

Net Interest and Dividend Income

 

The following tables set forth the information relating to our average balance and net interest income for the nine months ended September 30, 2017 and 2016, 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. 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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   Nine Months Ended September 30, 
   2017   2016 
   Average
Balance
   Interest   Average Yield/
Cost
   Average
Balance
   Interest   Average Yield/
Cost
 
   (Dollars in thousands) 
ASSETS:                        
Interest-earning assets                              
Loans(1)(2)  $1,589,423   $49,202    4.13%  $875,325   $26,118    3.98%
Securities(2)   305,111    5,761    2.52    334,938    6,062    2.41 
Other investments   17,665    501    3.78    14,703    398    3.61 
Short-term investments(3)   24,023    102    0.57    33,457    67    0.27 
Total interest-earning assets   1,936,222    55,566    3.83    1,258,423    32,645    3.46 
Total Non-interest-earning assets   137,775              77,626           
Total assets  $2,073,997             $1,336,049           
                               
LIABILITIES AND EQUITY:                              
Interest-bearing liabilities                              
Interest-bearing checking accounts  $86,841    249    0.38   $31,353    64    0.27 
Savings accounts   150,975    137    0.12    76,381    63    0.11 
Money market accounts   398,400    1,150    0.38    264,354    785    0.40 
Time deposit accounts   568,728    4,643    1.09    391,793    3,677    1.25 
Total interest-bearing deposits   1,204,944    6,179    0.68    763,881    4,589    0.80 
Short-term borrowings and long-term debt   302,254    4,579    2.02    250,462    3,329    1.77 
Interest-bearing liabilities   1,507,198    10,758    0.95    1,014,343    7,918    1.04 
Non-interest-bearing deposits   304,492              165,156           
Other non-interest-bearing liabilities   13,774              15,273           
Total non-interest-bearing liabilities   318,266              180,429           
                               
Total liabilities   1,825,464              1,194,772           
Total equity   248,533              141,277           
Total liabilities and equity  $2,073,997             $1,336,049           
Less: Tax-equivalent adjustment(2)        (766)             (154)     
Net interest and dividend income       $44,042             $24,573      
Net interest rate spread(4)             2.86%             2.42%
Net interest margin(5)             3.09%             2.62%
Ratio of average interest-earning assets to average interest-bearing liabilities             128.47%             124.06%

 

 

 

(1)Loans, including non-accrual loans, are net of deferred loan origination costs, and unadvanced funds.
(2)Securities and loan income are presented on a tax-equivalent basis using a tax rate of 35% for the 2017 period and 34% for the 2016 period. The tax-equivalent adjustment is deducted from tax-equivalent net interest and dividend income to agree to the amount reported in the statements of net income.
(3)Short-term investments include federal funds sold.
(4)Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(5)Net interest margin represents tax-equivalent net interest and dividend income as a percen