10-K 1 v403905_10k.htm 10-K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

(Mark One)

 

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

 

For the fiscal year ended December 31, 2014

 

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

 

For the transition period from __________________ to __________________

 

Commission File Number: 0-54447

 

Naugatuck Valley Financial Corporation

(Exact name of registrant as specified in its charter)

 

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

 

333 Church Street, Naugatuck, Connecticut   06770
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (203) 720-5000

 

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

 

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

 

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

 

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

 

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

 

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

 

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

Yes x No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

x

 

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

 

  Large accelerated filer ¨ Accelerated filer ¨
         
  Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company x

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2014 was $52,976,018.

 

As of March 19, 2015, there were 7,002,208 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement for the 2015 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.

 

 
 

 

INDEX

 

    Page
     
  Part I  
     
Item 1. Business 2
Item 1A. Risk Factors 29
Item 1B. Unresolved Staff Comments 35
Item 2. Properties 35
Item 3. Legal Proceedings 35
Item 4. Mine Safety Disclosures 36
     
  Part II  
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 36
Item 6. Selected Financial Data 38
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 40
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 52
Item 8. Financial Statements and Supplementary Data 52
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 52
Item 9A. Controls and Procedures 52
Item 9B. Other Information 53
     
  Part III  
     
Item 10. Directors, Executive Officers and Corporate Governance 53
Item 11. Executive Compensation 54
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related  Stockholder Matters 54
Item 13. Certain Relationships and Related Transactions, and Director Independence 55
Item 14. Principal Accountant Fees and Services 55
     
  Part IV  
     
Item 15. Exhibits and Financial Statement Schedules 56
     
SIGNATURES   58

 

 
 

 

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

 

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include interest rate trends, the general economic climate in the market area in which Naugatuck Valley Financial operates, as well as nationwide, Naugatuck Valley Financial’s ability to control costs and expenses, competitive products and pricing, loan delinquency rates and changes in federal and state legislation and regulation. Additional factors that may affect our results are discussed in this Annual Report on Form 10-K under “Item 1A. Risk Factors.” These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Except as may be required by applicable law or regulation, Naugatuck Valley Financial assumes no obligation to update any forward-looking statements.

 

PART I

 

ITEM 1. BUSINESS.

 

General

 

Effective June 29, 2011, Naugatuck Valley Financial Corporation (“Naugatuck Valley Financial” or the “Company”) completed its public stock offering in connection with the conversion of Naugatuck Valley Mutual Holding Company (the “MHC”) from the mutual holding company to the stock holding company form of organization (the “Conversion”). As a result of the Conversion, the Company succeeded Naugatuck Valley Financial Corporation, a Federal corporation (the “Federal Corporation”), as the holding company for Naugatuck Valley Savings and Loan (“Naugatuck Valley Savings” or the “Bank”) and the MHC ceased to exist. A total of 4,173,008 shares of Company common stock were sold in a subscription and community offering at $8.00 per share, including 250,380 shares purchased by the Naugatuck Valley Savings and Loan Employee Stock Ownership Plan (the “ESOP”). Additionally, shares totaling 2,829,358 were issued to the stockholders of the Federal Corporation (other than the MHC) in exchange for their shares of Federal Corporation common stock at an exchange ratio of 0.9978 share of Company common stock for each share of Federal Corporation common stock. Shares outstanding after the stock offering and the exchange totaled 7,002,366. Share and per share data have been restated for prior periods to reflect the Conversion.

 

Naugatuck Valley Financial has no significant assets, other than all of the outstanding shares of Naugatuck Valley Savings and no significant liabilities. Accordingly, the information set forth in this report, including the consolidated financial statements and related financial data, relates primarily to Naugatuck Valley Savings.

 

Naugatuck Valley Savings is a federally chartered stock savings bank, and has served its customers in Connecticut since 1922. We operate as a community-oriented financial institution offering traditional financial services to consumers and businesses in our market area. We attract deposits from the general public and use those funds to originate one-to-four family, multi-family and commercial real estate, construction, commercial business, and consumer loans. Originations of long-term, fixed rate residential loans are primarily sold in the secondary mortgage market. We primarily hold other types of loans for investment.

 

Formal Regulatory Agreement

 

On January 17, 2012, Naugatuck Valley Savings and the Office of the Comptroller of the Currency (the “OCC”) entered into a formal written agreement (the “Agreement”). The Agreement required Naugatuck Valley Savings to take various actions, within prescribed time frames, with respect to certain operational areas of Naugatuck Valley Savings.  These operational areas include: (i) the Board of Directors and senior executive management; (ii) business planning and budgeting; (iii) capital planning; (iv) enterprise risk management; (v) internal audit; (vi) lending, including loan portfolio management, lending policy, loan review policy and systems, appraisals/evaluations of real property, commercial real estate concentration risk management, and the allowance for loan and lease losses; (vii) checking overdraft protection policy; and (viii) Bank Secrecy Act/anti-money laundering/Office of Foreign Asset Control-related risk assessment.

 

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The Agreement requires Naugatuck Valley Savings to file prior written notice with the OCC before appointing an individual to serve as a senior executive officer or as a director of Naugatuck Valley Savings. The Agreement also restricts Naugatuck Valley Savings from entering into, renewing, extending or revising any contractual arrangement relating to compensation or benefits for any senior executive officer of Naugatuck Valley Savings, unless Naugatuck Valley Savings first provides the OCC with prior written notice of the proposed contractual arrangement.

 

The Agreement restricts Naugatuck Valley Savings from declaring or paying any dividends or other capital distributions to Naugatuck Valley Financial without receiving the prior written approval of the OCC.  This provision of the Agreement relates to upstream, intercompany dividends or other capital distributions from Naugatuck Valley Savings to Naugatuck Valley Financial.

 

The Agreement and each of its provisions will remain in effect unless and until the provisions are amended in writing by mutual consent of Naugatuck Valley Savings and the OCC or accepted, waived, or terminated in writing by the OCC.

 

The OCC imposed individual minimum capital requirements (“IMCRs”) on the Bank effective June 4, 2013. The IMCRs require the Bank to maintain a Tier 1 leverage capital to adjusted total assets ratio of at least 9.00% and a total risk-based capital to risk-weighted assets ratio of at least 13.00%. Before the establishment of the IMCRs, the Bank had been operating under these capital parameters by self-imposing these capital levels as part of the capital plan the Bank was required to implement under the terms of the Agreement. The Bank exceeded the IMCRs at December 31, 2014 with a Tier 1 leverage ratio of 11.13% and a total risk-based capital ratio of 18.67%.

 

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

 

Available Information

 

Naugatuck Valley Financial’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on our website, www.nvsl.com, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. Information on our website shall not be considered a part of this Form 10-K.

 

Market Area

 

We are headquartered in Naugatuck, Connecticut, which is located in southwestern Connecticut approximately six miles south of Waterbury and 26 miles north of Bridgeport. Connecticut is one of the most attractive banking markets in the United States with a total population of approximately 3.6 million, per capita income of $37,892 and a median household income of $69,461, well above the U.S. median household income of $53,046, according to 2013 estimates from the United States Census Bureau. In addition to our main office, we operate eight branch offices in the greater Naugatuck Valley market, which we consider our market area. The greater Naugatuck Valley market encompasses the communities in the central and lower Naugatuck Valley regions in New Haven County, where our main office and seven of our branch offices are located, and Fairfield County, where one of our branch offices is located. The economy in our market area is primarily oriented to the service, retail, construction, and manufacturing industries. The median household and per capita income in New Haven County trailed the comparable figures for Connecticut as a whole, while the median household and per capita income in Fairfield County exceeded the comparable figures for Connecticut.

 

Competition

 

We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has historically come from the several financial institutions operating in our market area and, to a lesser extent, from other financial service companies, such as brokerage firms, credit unions and insurance companies. In addition, banks owned by Bank of America Corporation, Wells Fargo & Company, J.P. Morgan Chase & Co. and TD Bank Financial Group, all of which are large bank holding companies, also operate in our market area. These institutions are significantly larger than us and, therefore, have significantly greater resources. We also face competition for investors’ funds from money market funds and other corporate and government securities.

 

Our competition for loans comes from financial institutions in our market area and from other financial service providers, such as mortgage companies and mortgage brokers. Competition for loans also comes from the non-depository financial service companies in the mortgage market, such as insurance companies, securities companies and specialty finance companies.

 

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

 

Our Strategy

 

Our primary objective is to be a well-capitalized, profitable community banking organization, with an emphasis on balanced growth. This strategy is supported by a continued focus on building lending and deposit relationships with small and medium size businesses along with their owners and the general public. We consider ourselves to be an innovative team providing financial services focusing on the success of our customers. Our stated mission is: “To be Your Community Bank of choice, deliver superior service and products to our customers, build value for our shareholders and provide meaningful careers for our employees while supporting the communities we serve”. We seek to achieve our objective through the following strategies:

 

Focus on Asset Quality As a new executive management team, a strong credit culture is a high priority for us. We have developed a solid credit approval structure that will enable us to maintain a standard of asset quality that we believe is conservative while at the same time maintaining our lending objectives. We focus on loan types and markets that we know well. We focus on total banking relationships that are well diversified in both size and industry types. With respect to commercial business lending, which is a growing focus of our lending activity, we view ourselves as cash flow lenders obtaining additional support from realistic collateral values, personal guarantees and secondary sources of repayment. We have a problem loan resolution process that is focused on quick detection and resolution through feasible solutions. We seek to maintain strong internal controls and subject our loans to periodic internal loan review as well as a third party loan review process.

 

Customer Focus We have expanded the types of lending that we do while leveraging on our legacy businesses. We are building commercial and business banking relationships to enhance our reputation for superior service. We focus on owner occupied commercial real estate and the deposit balances that accompany these relationships. We launched new consumer deposit products during 2014 and are in the process of developing new business deposit products for launch in early 2015. We also focus on building part of our consumer business around these business customers as we market to the employees of our customers. We leverage our historic mortgage business into growth of consumer Home Equity lending. The growth in our business banking relationships, while cross selling what we have, and growing these new deposit products are the keys to our profitable growth.

 

Deposit Growth Our focus is to continuously grow core deposits with an emphasis on total relationship banking from our business and retail customers. We continue to increase our market share in the communities we serve by providing exceptional customer service and focusing on relationship development. As stated above, we are developing a suite of business deposit products which will allow us to compete with a bank of any size in our markets. Our retail bankers are well seasoned with long term ties to the markets that they serve.

 

Community Involvement We have, and will continue to, spend time and resources in marketing our name and increasing our involvement in the community. We received high marks in our Community Reinvestment Act exam for our work within the community and we will continue to promote our name recognition activities. We continue to call locally to grow our market share where we are.

 

Process Improvement We continue to leverage on the technology that we already have to improve efficiencies. We are in the process of creating teams throughout the Bank to examine the way that we do things and determine more efficient ways. We have critically analyzed all of our businesses and locations to determine their feasibility and profitability which resulted in us closing one of our branches, selling our mortgage servicing rights and right sizing our residential lending and servicing functions. We are becoming a mobile society and must continue to examine the way things have been done since the Bank was formed.

 

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Talent Management Our most important resource is our employees. As a service company, we have initiated programs to train and develop current employees, build a middle management team, and develop a team oriented atmosphere. Our compensation and staff development programs are aligned with our strategies to profitably grow loans and core deposits. Our incentive systems are designed to achieve high quality asset growth. We align employee performance objectives with corporate growth strategies and adding to shareholder value.

 

Lending Activities

 

General Our loan portfolio consists of one-to-four family residential mortgage loans, multi-family and commercial real estate loans, construction loans, commercial business loans and consumer loans. Substantially all of our loans are made to borrowers residing within Connecticut.

 

The following table sets forth the composition of our loan portfolio at the dates indicated.

 

   At December 31, 
(Dollars in thousands)  2014   2013   2012 
   Amount   Percent   Amount   Percent   Amount   Percent 
                         
Real estate loans:                              
One-to-four family  $180,739    48.94%  $186,985    50.47%  $209,004    48.35%
Construction   3,415    0.92%   5,609    1.51%   26,633    6.16%
Multi-family and commercial real estate   122,526    33.18%   123,134    33.23%   133,549    30.89%
Total real estate loans   306,680    83.04%   315,728    85.21%   369,186    85.40%
Commercial business loans   25,801    6.99%   25,506    6.88%   32,970    7.63%
Consumer loans:                              
Savings accounts   478    0.13%   548    0.15%   680    0.16%
Personal   683    0.18%   206    0.06%   77    0.02%
Automobile   6,983    1.89%   1,567    0.42%   540    0.12%
Home equity   28,700    7.77%   26,960    7.28%   28,829    6.67%
Total consumer loans   36,844    9.97%   29,281    7.91%   30,126    6.97%
Loans receivable, gross   369,325    100.00%   370,515    100.00%   432,282    100.00%
Less:                              
Allowance for loan losses   6,023         9,891         14,500      
Deferred loan origination fees   43         56         169      
Loans receivable, net  $363,259        $360,568        $417,613      

 

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   At December 31, 
   2011   2010 
(Dollars in thousands)  Amount   Percent   Amount   Percent 
                 
Real estate loans:                    
One-to-four family  $217,893    45.84%  $219,286    45.66%
Construction   26,245    5.52%   29,887    6.22%
Multi-family and commercial     real estate   160,858    33.84%   160,235    33.36%
Total real estate loans   404,996    85.20%   409,408    85.24%
Commercial business loans   36,645    7.71%   34,742    7.23%
Consumer loans:                    
Savings accounts   847    0.18%   956    0.20%
Personal   197    0.04%   236    0.05%
Automobile   509    0.11%   168    0.03%
Home equity   32,157    6.76%   34,807    7.25%
Total consumer loans   33,710    7.09%   36,167    7.53%
Loans receivable, gross   475,351    100.00%   480,317    100.00%
Less:                    
Allowance for loan losses   8,053         6,393      
Deferred loan origination fees   333         403      
Loans receivable, net  $466,965        $473,521      

 

The following table sets forth certain information at December 31, 2014 regarding the dollar amount of loans repricing or maturing during the periods indicated. The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated maturity are reported as due in one year or less.

 

   Within   Over   Due After     
(In thousands)  One year   1-5 years   5 years   Total 
Real estate loans:                    
One-to-four family  $20   $3,439   $177,280   $180,739 
Construction   2,137    1,025    253    3,415 
Multi-family and commercial real estate   -    1,433    121,093    122,526 
Total real estate loans   2,157    5,897    298,626    306,680 
Commercial business loans   3,740    4,627    17,434    25,801 
Consumer loans   2,054    15,023    19,767    36,844 
Total loans  $7,951   $25,547   $335,827   $369,325 

 

Management monitors the Bank’s concentration of credit on a monthly basis to ensure the Bank is operating within policy limits for each portfolio segment. The Bank’s credit policy has concentration limits for each portfolio segment as a percentage of our total regulatory capital (defined as Tier 1 capital plus the allowance for loan losses). The following table sets forth these policy limits and our compliance with them at December 31, 2014.

 

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Loan Portfolio  Policy Limit   Percentage at
December 31,
2014
 
Residential real estate (1)   500%   342.8%
Commercial real estate (2)   275%   206.2%
Commercial business   250%   42.2%
Consumer   75%   13.3%

 

(1)Includes owner-occupied residential loans and home equity lines and loans.
(2)Includes multi-family loans, land and land development loans, but excludes owner occupied properties.

 

One-to-Four Family Residential Loans. We originate mortgage loans to enable borrowers to purchase or refinance existing homes in our market area. We generally offer fixed-rate and adjustable-rate mortgage loans with terms up to 30 years. Borrower demand for adjustable-rate loans versus fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and the initial period interest rates and loan fees for adjustable-rate loans. The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment and the effect each has on our interest rate risk. The investors who may purchase our mortgage loans also determine our level of competitiveness through their pricing and competitive yields. The loan fees charged, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.

 

We offer fixed rate mortgage loans with terms of either 10, 15, 20 or 30 years. Interest rates and payments on our adjustable rate loans generally are adjusted to a rate typically in excess of 2% over the one-year constant maturity Treasury index. The maximum amount by which the interest rate may be increased or decreased is generally 2% per adjustment period and the lifetime interest rate cap is generally 6% over the initial interest rate of the loan.

 

While one-to-four family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans. As interest rates declined and remained low over the past few years, we have experienced high levels of loan repayments and refinancing.

 

We generally do not make conventional loans with loan-to-value ratios exceeding 97% and generally make loans with a loan-to-value ratio in excess of 80% only when secured by first liens on owner-occupied one-to-four family residences. Loans with loan-to-value ratios in excess of 80% require private mortgage insurance or additional collateral. We require all properties securing mortgage loans to be appraised by a Board-approved independent appraiser. We require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance, and flood insurance for loans on property located in a flood zone, before closing the loan.

 

We do not engage in “subprime lending”.

 

Loan originations come from a number of sources. The primary source of loan originations are our in house loan originators, and to a lesser extent, local mortgage brokers and referrals from customers.

 

Originations and Sales of One-to-Four Family Residential Loans. Consistent with our asset/liability management strategy, we sell a significant portion of our one-to-four family residential loans into the secondary market. Commitments to sell these mortgage loans generally are made during the period between the taking of the loan application and the closing of the mortgage loan. Most of these sale commitments are made on a “best efforts” basis whereby we are only obligated to sell the mortgage if the mortgage loan is approved and closed. As a result, management believes that market risk is minimal. In addition, some of our mortgage loan production is brokered to other lenders prior to funding.

 

The Bank originates government residential mortgage loans which are sold servicing released. The Bank also originates conventional residential mortgage loans for its portfolio and for sale, both on servicing rights retained and released basis.

 

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The Bank has not been required to repurchase any loans sold to any of its investors. Loan repurchases can be required on loans previously sold upon the occurrence of conditions established in the loan sale contract, including default by the borrower.

 

Mortgage Servicing. The Bank services loans for investors, including the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and other financial institutions. These loans are originated by the Bank and then sold without recourse to our investors.

 

As of August 29, 2014, the Company sold its mortgage servicing rights with a book value of approximately $948,000 relating to loans previously sold to and serviced for Freddie Mac of approximately $134.8 million to another financial institution. This transaction closed on September 18, 2014 with a servicing transfer date of October 16, 2014 and satisfied all of the criteria to be accounted for as a sale of financial assets. Other than acting as interim subservicer between the sale date and the servicing transfer date, the Company does not have any continuing involvement with these financial assets. The Company may have potential repurchase exposure on these underlying mortgage loans based on investor demands related to facts and circumstances which may have pre-dated this transaction. The gain on sale of mortgage servicing rights amounted to $370,000. The amounts of these loans in the Bank’s mortgage loan servicing portfolio were $0.7 million at December 31, 2014 and approximately $142.2 million at December 31, 2013.

 

The balance of mortgage servicing rights, included in other assets, and the changes therein for the years ended December 31, 2014, 2013, and 2012 were as follows:

 

(In thousands)  2014   2013   2012 
Balance at beginning of the year  $1,093   $1,039   $700 
Servicing rights capitalized   36    380    692 
Amortization of servicing rights   (195)   (370)   (323)
Periodic impairment   14    44    (30)
Servicing rights sale   (948)   -    - 
Balance at the end of the year  $-   $1,093   $1,039 

 

Multi-Family and Commercial Real Estate Loans. We offer adjustable-rate mortgage loans secured by multi-family and commercial real estate. Our multi-family and commercial real estate loans are generally secured by condominiums, apartment buildings, offices, retail and other income producing properties, as well as owner-occupied properties used for businesses.

 

We originate multi-family and commercial real estate loans for terms generally up to 20 years. Interest rates and payments on adjustable-rate loans adjust every one, three, five or ten years. Interest rates on our adjustable rate loans generally are adjusted to a rate typically equal to 2.00% to 3.00% above the one-year, three-year, five-year or ten-year Federal Home Loan Bank classic advance rate. There are no adjustment period or lifetime interest rate caps. Loan amounts generally do not exceed 75% of the appraised value for owner-occupied properties and 70% for non-owner occupied properties.

 

The largest outstanding multi-family real estate loan at December 31, 2014 had an outstanding balance of approximately $2.2 million and was performing according to its original terms at December 31, 2014.

 

The largest outstanding commercial real estate loan at December 31, 2014 had an outstanding balance of approximately $4.2 million and was performing according to its original terms at December 31, 2014.

 

Our largest commercial real estate loan relationship at December 31, 2014 involved four loans totaling approximately $5.8 million. These loans were performing according to their original terms at December 31, 2014.

 

Construction Loans. We originate loans to individuals to finance the construction of residential dwellings for personal use. Our construction loans generally provide for the payment of interest only during the construction phase, which is usually nine months. At the end of the construction phase, the loan converts to a permanent mortgage loan. Loans generally can be made with a maximum loan to value ratio of 80% of the appraised value with a maximum term of 30 years. Our largest residential construction loan at December 31, 2014 had an outstanding balance of approximately $443,000. This loan was performing according to its original terms at December 31, 2014. We also make commercial construction loans for commercial development projects, including condominiums, apartment buildings, and single family subdivisions as well as office buildings, retail and other income producing properties. These loans provide for payment of interest only during the construction phase and may, in the case of an apartment or commercial building, convert to a permanent mortgage loan or, in the case of a single family subdivision or construction or builder loan, be paid in full with the sale of the property after construction is complete. In the case of a commercial construction loan, the construction period may be from nine months to two years. Loans are generally made to a maximum of 70% to 80% of the appraised value as determined by an appraisal of the property made by an independent licensed appraiser, depending on the type of property. We also require an inspection of the property before disbursement of funds during the term of the construction loan for both residential and commercial construction loans.

 

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We originate land loans to individuals on approved residential building lots for personal use for terms of up to 20 years and to a maximum loan-to-value ratio of 75% of the lower of the appraisal value or purchase price. Our land loans adjust annually after a five-year initial fixed period. Interest rates after adjustment are equal to an additional interest spread above the one-year constant maturity Treasury index.

 

We also originate loans to local contractors and developers for the purpose of making improvements to, and on, approved subdivisions and condominium projects within two years of the date of the original loan. Such loans generally are written with a maximum loan-to-value ratio of 80% of the lower of the appraised value or purchase price of the land. These loans adjust when and as the index changes at a rate that is generally equal to the prime rate as published in The Wall Street Journal plus an additional interest spread. We require title insurance and, if applicable, a hazardous waste survey reporting that the land is free of hazardous or toxic waste.

 

Commercial Business Loans. We make commercial business loans to a variety of professionals, sole proprietorships and small businesses primarily in our market area. We offer a variety of commercial lending products. These loans are typically secured, primarily by business assets. These loans are originated with maximum loan-to-value ratios of 75% of the value of the business assets. We originate one-to-ten year term loans for the acquisition of equipment or business expansion, lines of credit for seasonal financing needs and demand loans for short term financing needs with specific repayment sources. Commercial business loans are generally written at variable rates which use the prime rate as published in The Wall Street Journal as an index and, depending on the qualifications of the borrower, an additional interest spread. These rates will change when and as the index rate changes without caps. Fixed-rate loans are written at market rates determined at the time the loan is granted and are based on the length of the term and the qualifications of the borrower. Our largest commercial business loan outstanding at December 31, 2014 was a loan in the amount of approximately $2.3 million and was performing according to its original terms at December 31, 2014.

 

When making commercial business loans, we consider the financial statements of the borrower, the borrower’s payment history of both corporate and personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, the viability of the industry in which the customer operates, and the value of the collateral.

 

Consumer Loans. We offer a variety of consumer loans, primarily second mortgage loans and home equity lines of credit, and, to a much lesser extent, loans secured by passbook or certificate accounts, automobiles, as well as unsecured personal loans and overdraft protection accounts. Unsecured loans generally have a maximum borrowing limit of $5,000 and a maximum term of three years.

 

The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loans. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount. Second mortgage loans have fixed rates of interest for terms of up to 20 years. These loans are originated with maximum combined loan-to-value ratios of 75% of the appraised value of the property. Home equity lines of credit have adjustable rates of interest that are indexed to the prime rate as published in The Wall Street Journal for terms of up to 10 years. These loans are originated with maximum loan-to-value ratios of 75% of the appraised value of the property and we require that we have a second lien position on the property.

 

Loan Underwriting Risks

 

Adjustable Rate Loans. Due to historically low interest rate levels, borrowers generally have preferred fixed rate loans in recent years. While we anticipate that our adjustable rate loans will better offset the adverse effects on our net interest income of an increase in interest rates as compared to fixed rate mortgages, the increased mortgage payments required of adjustable-rate loans in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property also may be adversely affected in a high interest rate environment. In addition, although adjustable-rate mortgage loans help make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.

 

9
 

 

The following table sets forth the dollar amount of all loans at December 31, 2014, and have either fixed interest rates or floating or adjustable rates. The amounts shown below exclude applicable loans in process, nonperforming loans and deferred loan fees, net:

 

   At December 31, 2014 
(In thousands)  Fixed-Rate   Floating or Adjustable-Rates   Total 
Real estate loans:               
One-to-four family  $153,333   $27,406   $180,739 
Construction   737    2,678    3,415 
Multi-family and commercial real estate   11,416    111,110    122,526 
Total real estate loans   165,486    141,194    306,680 
Commercial business loans   6,506    19,295    25,801 
Consumer loans   18,238    18,606    36,844 
   $190,230   $179,095   $369,325 

 

Multi-Family and Commercial Real Estate Loans. Loans secured by multi-family and commercial real estate generally have larger balances and involve a greater degree of risk than one-to-four family residential mortgage loans. Of primary concern in multi-family and commercial real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy. To monitor cash flows on income properties, we require borrowers and loan guarantors, where applicable, to provide annual financial statements on multi-family and commercial real estate loans. In reaching a decision on whether to make a multi-family or commercial real estate loan, we consider the net operating income of the property, the borrower’s expertise, credit history, profitability and the value of the underlying property. We require an environmental survey for multi-family and commercial real estate loans.

 

Construction Loans. Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a project having a value which is insufficient to assure full repayment. As a result of the foregoing, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. If we are forced to foreclose on a project before or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

 

Commercial Business Loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.

 

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

 

Loan Approval Procedures and Authority. Our lending activities follow written, nondiscriminatory, underwriting standards and loan origination procedures established by our board of directors and management.

 

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The following approval authorities have been instituted for all commercial credits:

 

Credit Exposure Amount Approval Authority
$250,000 or less Chief Credit Policy Officer or any Executive Credit Committee member
Over $250,000 to $1.5 million Executive Credit Committee
Over $ 1.5 million to $3 million Board Loan & Asset Quality Committee
Over $ 3 million Full Board

 

In order for a credit to progress to the next higher level of approval, it must first be approved and recommended by the subordinate approval authority. Likewise, unanimous votes are required at the Executive Credit Committee level for a credit to be approved or recommended to Board Loan & Asset Quality Committee.

 

For one-to-four family loans and owner occupied residential construction loans, two underwriters or one underwriter and the Group Head of Consumer and Residential Lending and Loan Servicing or a member of the Executive Credit Committee may approve loans up to $800,000. Loans from $800,000 to $1.5 million may be approved by the Executive Credit Committee. Loans from $1.5 million to $3 million require the approval of the Board Loan & Asset Quality Committee and loans in excess of $3 million will have the approval of the full Board of Directors.

 

The Board of Directors approved the following positions to serve as Consumer Loan Committee for approving consumer credit applications: President, Chief Credit Policy Officer, Residential Lending Manager and the Consumer Loan Manager. The Board of Directors set the following loan approval limits for consumer loans:

 

$5,000 or less Any of the above individually
$5,000 to $200,000 Any two of the above
Over $200,000 to $1.2 million Requires Board Loan Committee approval
Over $1.2 million Requires Full Board approval

 

Loans to One Borrower. The maximum amount that we may lend to one borrower and the borrower’s related entities is generally limited, by regulation, to 15% of our stated capital and allowance for loan losses. At December 31, 2014, our regulatory limit on loans to one borrower was $9.17 million. At that date, our largest lending relationship was approximately $5.8 million and consisted of four commercial mortgage loans, all of which were performing according to their original repayment terms. We also maintain a house limit (also known as a comfort limit) at 75% of our regulatory limit which was $6.9 million at December 31, 2014. All loans are less than the house limit as of December 31, 2014. The house limit defines a point at which the Bank may still prudently lend but which will cause discomfort due to size alone.

 

Loan Commitments. We issue commitments for fixed rate and adjustable rate mortgage loans conditioned upon the occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers and generally expire in 45 days or less.

 

Credit Risk Management

 

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

 

Credit Risk Management. Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. To address increased problem assets, we have placed our attention and resources on loan workouts. A new team of two officers with significant loan workout experience have been given responsibility for problem commercial loans. The new officers are contacting problem borrowers and following up more rigorously to improve our chances of a successful outcome in our workout efforts. Since 2013, the Bank has tightened its underwriting policies including more stringent loan to value and debt service coverage requirements. In addition, we engage an outside loan review firm to perform periodic reviews of the commercial loan portfolio. These reviews involve the analysis of our large borrowers, delinquent relationships, and loans which are classified and criticized. They also evaluate the loans for impairment to determine if a specific reserve is required on the loan.

 

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When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. We make initial contact with the borrower when the loan becomes 15 days past due. If payment is not then received by the 30th day of delinquency, additional letters and phone calls are made. At 60 days, we send a letter notifying the borrower that we will commence foreclosure proceedings against any real property that secures a mortgage loan or attempt to repossess any personal property that secures a consumer loan if not brought current within 30 days. At this point, we may consider loan workout arrangements with certain borrowers under certain circumstances. If our workout efforts are unsuccessful, we generally commence foreclosure proceedings against any real property that secures the loan or attempt to repossess any personal property that secures a consumer loan. At 90 days, our attorney issues an acceleration letter. At 120 days delinquent, foreclosure action commences. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure or taken by the Bank as other real estate owned.

 

Management informs the board of directors on a monthly basis of the amount of loans delinquent more than 30 days. Management also provides detailed reporting of loans greater than 90 days delinquent, all loans in foreclosure and all foreclosed and repossessed property that we own.

 

Analysis of Nonperforming and Classified Assets. When a loan becomes more than 90 days delinquent, the loan is placed on nonaccrual status at which time the accrual of interest ceases, the interest previously accrued to income is reversed and the loan is placed on a cash basis. Payments received on a nonaccrual loan are applied to the outstanding principal and interest as determined at the time management’s assessment of full of collection of the loan.

 

We consider repossessed assets and loans that are more than 90 days past due to be nonperforming assets. Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as foreclosed real estate until it is sold. When property is acquired, it is recorded at the lower of its cost, which is the unpaid balance of the loan, or fair market value less its cost to sell at the date of foreclosure. Holding costs and declines in fair value after acquisition of the property are charged against income.

 

Under current accounting guidelines, a loan is defined as impaired when, based on current information and events, it is probable that the creditor will be unable to collect all amounts due under the contractual terms of the loan agreement. We consider one-to-four family mortgage loans and consumer loans to be homogeneous and only evaluate them for impairment separately when they are delinquent or classified. Other loans are evaluated for impairment on an individual basis. Based on significant improvement in the Bank’s asset quality profile, the number of impaired loans decreased to 57 at December 31, 2014 from 107 at December 31, 2013.

 

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The following table provides information with respect to our nonperforming assets at the dates indicated.

 

   At December 31, 
   2014   2013   2012   2011   2010 
   (Dollars in thousands) 
Nonaccrual loans:    
One-to-four family  $1,414   $2,439   $1,506   $1,682   $2,365 
Multi-family and commerical real estate   375    1,428    7,157    5,247    1,931 
Construction and land development   726    1,295    5,249    4,041    5,136 
Commercial business loans   804    2,496    3,327    1,181    1,276 
Consumer loans   187    322    131    295    419 
Total   3,506    7,980    17,370    12,446    11,127 
                          
Troubled debt restructurings   1,600    5,403    8,278    12,235    6,761 
Total nonperforming loans   5,106    13,383    25,648    24,681    17,888 
Foreclosed real estate & other repossessed assets   335    1,846    735    873    421 
Total nonperforming assets  $5,441   $15,229   $26,383   $25,554   $18,309 
                          
Total nonperforming loans to total loans   1.38%   3.61%   5.93%   5.19%   3.73%
                          
Total nonperforming loans to total assets   1.03%   2.75%   4.87%   4.31%   3.15%
                          
Total nonperforming assets to total assets   1.10%   3.13%   5.01%   4.47%   3.22%

 

Other than disclosed in the above table and in the classified assets table below, management believes that there are no other loans at December 31, 2014 and December 31, 2013 that we have serious doubts about the ability of the borrowers to comply with the present loan repayment terms. Interest income that would have been recorded for the years ended December 31, 2014 and 2013 had non-accruing loans been current according to their original terms amounted to $80,000 and $816,000, respectively. The Company accounted for interest payments received on nonaccrual loans on the cash-basis method or the cost recovery method. For the years ended December 31, 2014, 2013 and 2012, interest income recognized on nonaccrual loans on the cash-basis method was $313,000, $831,000 and $948,000, respectively. For the years ended December 31, 2014 and 2013, the amounts of interest payments applied to principal under the cost recovery method were $36,000 and $314,000, respectively.

 

Troubled debt restructurings (“TDRs”) occur when we grant borrowers concessions that we would not otherwise grant but for economic or legal reasons pertaining to the borrower’s financial difficulties. These concessions may include, but are not limited to, modifications of the terms of the debt, the transfer of assets or the issuance of an equity interest by the borrower to satisfy all or part of the debt, or the substitution or addition of borrower(s). Generally, we will not return a troubled debt restructuring to accrual status until the borrower has demonstrated the ability to make principal and interest payments under the restructured terms for at least six consecutive months.

 

During 2014, we modified nine loans with aggregate outstanding balances of $602,000, either by a reduction of the interest rates, an extension of the terms, and/or interest only payments. As of December 31, 2014, four loans with an aggregate balance of $202,000 were performing in accordance with their modified terms with a current payment status and three modified loans with an aggregate balance of $327,000 have paid off. One modified loan with a balance of $63,000 was not performing in accordance with its modified terms at December 31, 2014. One modified loan with a balance of $10,000 was charged off during 2014.

 

Nonperforming assets totaled $5.4 million, or 1.1% of total assets, at December 31, 2014, which was a decrease of approximately $9.8 million, or 64.3%, from December 31, 2013. Nonperforming loans, comprised of nonaccrual loans and nonaccruing TDRs, accounted for 93.9% of the total nonperforming assets at December 31, 2014. Nonperforming assets totaled $15.2 million, or 3.13% of total assets, at December 31, 2013, which was a decrease of approximately $11.2 million, or 42.3%, from December 31, 2012. Nonperforming loans accounted for 87.9% of the total nonperforming assets at December 31, 2013.

 

At December 31, 2014, our allowance for loan losses represented 1.63% of total gross loans and 118.0% of nonperforming loans compared to 2.67% of total gross loans and 73.9% of nonperforming loans at December 31, 2013. The allowance for loan losses decreased $3.9 million from $9.9 million at December 31, 2013 to $6.0 million at December 31, 2014. The decrease in the allowance was largely the result of net charge-offs of $2.1 million and a $1.7 million credit provision for loan losses during the period. The credit provision was based primarily on the improvement in the level of nonperforming loans during 2014 and the significant decrease in the Bank’s loan loss experience.

 

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The following table provides information with respect to the activity within our nonperforming loans for the years ended December 31, 2014 and 2013.

 

Nonperforming Loans
(In thousands)        
         
Balance at December 31, 2012      $25,648 
           
Additions to nonperforming loans        17,187 
           
Removed from nonperforming loans:          
Loans brought current   (1,684)     
Principal paydowns   (2,007)     
Paid in full or sold   (16,362)     
Foreclosure   (3,729)     
Charged off   (5,670)     
Total removed        (29,452)
           
Balance at December 31, 2013       $13,383 
           
Additions to nonperforming loans        1,332 
           
Removed from nonperforming loans:          
Loans brought current   (2,005)     
Principal paydowns   (603)     
Paid in full or sold   (6,382)     
Foreclosure   (454)     
Charged off   (165)     
Total removed        (9,609)
Balance at December 31, 2014       $5,106 

 

Federal regulations require us to regularly review and classify our assets. In addition, our regulators have the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified “loss” is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations also provide for a “special mention” category, described as assets which do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving our close attention. If we classify an asset as loss, we must charge-off such amount.

 

The following table shows the aggregate amounts of loans classified by credit risk ratings at the dates indicated.

 

   At December 31, 
   2014   2013 
   (In thousands) 
Substandard accruing  $2,346   $2,913 
Substandard nonaccruing   5,105    13,290 
Total substandard   7,451    16,203 
Doubtful   -    93 
Total adversely classified loans   7,451    16,296 
           
Special mention loans   6,538    32,511 
Total criticized loans  $13,989   $48,807 

 

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Special mention loans at December 31, 2014 and December 31, 2013 included nonaccrual loans in the amounts of zero and $102,000, respectively. Substandard loans at December 31, 2014 and December 31, 2013 included nonaccrual loans of $5.1 million and $12.6 million, respectively. There were no doubtful loans at December 31, 2014. Doubtful loans at December 31, 2013 included nonaccrual loans of $93,000.

 

In 2014, the Company sold $11.4 million principal amount of primarily adversely classified loans (i.e. loans classified substandard or doubtful) in connection with its plan to reduce the level of classified loans in a series of transactions in which the financial assets transferred satisfied all of the criteria to be accounted for as sales of financial assets.

 

The impact of these sale transactions and the writedown of the carrying value of these loans held for sale amounted to $1.7 million in net charge-offs against the Company’s allowance for loan losses and $247,000 in expenses on the sale of loans. Furthermore, these transactions resulted in a $10.2 million reduction in adversely classified loans during 2014.

 

In June 2013 the Company sold $20.8 million in credit impaired loans which resulted in $5.1 million in net charge-offs against the Company’s allowance for loan losses.

 

Delinquencies. The following table provides information about delinquencies in our loan portfolios at the dates indicated. We did not have any accruing loans past due 90 days or more at the dates presented.

 

   Delinquencies 
As of December 31, 2014  31-60 Days
Past Due
   61-90 Days
Past Due
   Greater
Than
90 Days
   Total Past
Due
   Current   Total Loans   Carrying
Amount >
90 Days and
Accruing
 
(In thousands)                            
Real estate loans:                                   
One-to-four family  $349   $153   $1,594   $2,096   $178,643   $180,739   $- 
Construction and land development   -    -    726    726    2,689    3,415    - 
Multi-family and commercial real estate:                                 - 
Investor owned one-to-four family and multi-family   -    -    389    389    25,072    25,461    - 
Industrial and warehouse   -    -    -    -    24,875    24,875    - 
Office buildings   -    -    206    206    24,262    24,468    - 
Retail properties   -    -    -    -    17,346    17,346    - 
Special use properties   -    -    -    -    30,376    30,376    - 
Subtotal multi-family and commercial real estate   -    -    595    595    121,931    122,526    - 
Commercial business loans   972    -    703    1,675    24,126    25,801    - 
Consumer loans:                                   
Home equity loans   222    97    28    347    28,353    28,700    - 
Other consumer loans   6    -    -    6    8,138    8,144    - 
Subtotal consumer   228    97    28    353    36,491    36,844    - 
Total  $1,549   $250   $3,646   $5,445   $363,880   $369,325   $- 

 

15
 

 

   Delinquencies 
As of December 31, 2013  31-60 Days
Past Due
   61-90 Days
Past Due
   Greater
Than 90
Days
   Total Past
Due
   Current   Total Loans   Carrying
Amount >
90 Daysand
Accruing
 
(In thousands)                            
Real estate loans:                                   
One-to-four family  $1,217   $397   $2,564   $4,178   $182,807   $186,985   $- 
Construction and land development   970    538    1,799    3,307    2,302    5,609    - 
Multi-family and commercial real estate:                                 - 
Investor owned one-to-four family and multi-family   861    -    621    1,482    14,890    16,372    - 
Industrial and warehouse   -    -    32    32    29,964    29,996    - 
Office buildings   -    108    206    314    21,098    21,412    - 
Retail properties   423    -    -    423    23,096    23,519    - 
Special use properties   346    -    169    515    31,320    31,835    - 
Subtotal multi-family and commercial real estate   1,630    108    1,028    2,766    120,368    123,134    - 
Commercial business loans   487    153    1,598    2,238    23,268    25,506    - 
Consumer loans:                                   
Home equity loans   155    28    142    325    26,635    26,960    - 
Other consumer loans   2    3    -    5    2,316    2,321    - 
Subtotal consumer   157    31    142    330    28,951    29,281    - 
Total  $4,461   $1,227   $7,131   $12,819   $357,696   $370,515   $- 

 

The significant decrease in delinquencies is attributed to management’s loan workout efforts, including the 2013 and 2014 sales of credit impaired loans.

 

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

 

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

 

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

 

Our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. The examination may require us to make additional provision for loan losses based on judgments different from ours. The Bank also periodically engages an independent consultant to review the methodology, analysis and adequacy of the allowance for loan and lease losses. However, the consultant does not recommend a dollar level of the allowance. In addition, the consultant reviews our commercial loan portfolio and evaluates the Bank’s loan classifications based on their review as to the specific credits in the portfolio.

 

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

 

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

 

   Year Ended December 31, 
   2014   2013   2012   2011   2010 
   (In thousands) 
Allowance at beginning of period  $9,891   $14,500   $8,053   $6,393   $3,996 
Provision for loan losses   (1,747)   4,150    17,725    4,293    3,360 
Charge offs:                         
Real estate loans   2,291    8,065    9,590    1,850    197 
Commercial business loans   194    1,817    1,594    516    754 
Consumer loans   25    182    150    271    27 
Total charge-offs   2,513    10,064    11,334    2,637    978 
Recoveries:                         
Real estate loans   92    723    40    -    - 
Commercial business loans   168    577    15    3    15 
Consumer loans   132    5    1    1    - 
Total recoveries   392    1,305    56    4    15 
Net charge-offs (recoveries)   2,121    8,759    11,278    2,633    963 
Allowance at end of period  $6,023   $9,891   $14,500   $8,053   $6,393 
Allowance to nonperforming loans   117.96%   73.91%   56.53%   32.63%   35.74%
Allowance to total loans outstanding at the end of the period   1.63%   2.67%   3.35%   1.70%   1.33%
Net charge-offs to average loans outstanding during the period   0.57%   2.14%   2.48%   0.55%   0.20%

 

As previously stated, the Company sold $11.4 million principal amount of primarily adversely classified loans in June 2014 in two separate transactions which resulted in $1.7 million in net charge-offs. In June 2013, the Company sold $20.8 million in credit impaired loans which resulted in $5.1 million in net charge-offs against the Company’s allowance for loan losses.

 

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

 

   At December 31, 
   2014   2013 
(Dollars in thousands)  Amount   % of
Allowance
to Total
Allowance
   % of Loans
in Category
to Total
Loans
   Amount   % of
Allowance
to Total
Allowance
   % of Loans
in Category
to Total
Loans
 
One-to-four family  $1,633    27.11%   48.94%  $1,849    18.69%   50.47%
Multi-family and commercial real estate   3,097    51.42%   33.18%   5,097    51.53%   33.23%
Construction and land development   414    6.87%   0.92%   1,118    11.30%   1.51%
Commercial business loans   592    9.83%   6.99%   1,443    14.59%   6.88%
Consumer loans   287    4.77%   9.97%   384    3.88%   7.91%
Total allowance for loan losses  $6,023    100.00%   100.00%  $9,891    100.00%   100.00%

 

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   At December 31, 
   2012   2011 
(Dollars in thousands)  Amount   % of
Allowance
to Total
Allowance
   % of Loans
in Category
to Total
Loans
   Amount   % of
Allowance
to Total
Allowance
   % of Loans
in Category
to Total
Loans
 
One-to-four family  $1,988    13.71%   46.50%  $1,745    21.67%   45.41%
Multi-family and commercial real estate   4,892    33.74%   33.73%   3,745    46.50%   33.53%
Construction and land development   4,468    30.81%   5.39%   1,327    16.47%   6.35%
Commercial business loans   2,725    18.79%   7.60%   754    9.36%   7.68%
Consumer loans   427    2.94%   6.78%   482    6.00%   7.03%
Total allowance for loan losses  $14,500    100.00%   100.00%  $8,053    100.00%   100.00%

 

   At December 31, 
   2010 
(Dollars in thousands)  Amount   % of
Allowance
to Total
Allowance
   % of Loans
in Category
to Total
Loans
 
One-to-four family  $1,585    24.79%   45.56%
Multi-family and commercial real estate   2,714    42.45%   6.42%
Construction and land development   600    9.39%   33.29%
Commercial business loans   884    13.83%   7.22%
Consumer loans   610    9.54%   7.51%
Total allowance for loan losses  $6,393    100.00%   100.00%

 

Investment Activities

 

Our securities portfolio consists primarily of mortgage-backed securities, collateralized mortgage obligations, state and local municipal obligations, as well as U.S. Government and agency obligations. Securities increased by $23.6 million in the year ended December 31, 2014 due to the purchase of additional mortgage-backed securities and U.S. Government agency obligations during this period, partially offset by principal repayments on mortgage-backed securities. Securities increased by $18.9 million in the year ended December 31, 2013 due to the purchase of additional mortgage-backed securities and U.S. Government agency obligations during this period, partially offset by the sale of its auction rate trust preferred securities as well as principal repayments on mortgage-backed securities.

 

All of our mortgage-backed securities and substantially all of our collateralized mortgage obligations were issued either by Ginnie Mae, Fannie Mae or Freddie Mac. During the year ended December 31, 2014, the Company did not recognize any other than temporary impairment on its securities. During the year ended December 31, 2013, the Company recognized $1.8 million in other than temporary impairment, primarily on its auction rate preferred securities.

 

Our investment objectives are to provide and maintain liquidity, to maintain a balance of high quality, diversified investments to minimize risk, to provide collateral for pledging requirements, to establish an acceptable level of interest rate risk, to provide an alternate source of low-risk investments when demand for loans is weak, and to generate a favorable return.  During 2014, we continued to actively manage our portfolio. The size of the portfolio increased to provide liquidity and assist in the balancing of our interest sensitivity position. We reduced our position in longer duration callable securities and diversified into municipal obligations. Our board of directors has the overall responsibility for our investment portfolio, including approval of our investment policy and appointment of our Asset/Liability and Investment Committees.  The Investment Committee meets regularly and is responsible for approval of investment strategies and monitoring of investment performance.  Senior management has the overall responsibility for the daily investment activities and has authorized the CFO to make investment decisions consistent with our investment policy.

 

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The following table sets forth the amortized costs and fair values of our securities portfolio at the dates indicated.

 

   At December 31, 
   2014   2013   2012 
   Amortized   Fair   Amortized   Fair   Amortized   Fair 
(In thousands)  Cost Basis   Value   Cost Basis   Value   Cost Basis   Value 
Available-for-sale securities:                              
U.S. Government and agency obligations  $5,000   $5,042   $16,601   $16,506   $1,006   $1,029 
U.S. Government agency mortgage-backed securities   51,904    53,087    22,874    22,869    13,270    13,960 
U.S. Government agency collateralized mortgage obligations   12,802    13,179    3,736    3,738    974    985 
Private label collateralized mortgage obligations   -    -    258    266    314    294 
Auction-rate trust preferred securities   -    -    5,893    5,893    7,700    7,216 
Obligations of state and municipal subdivisions   5,920    6,230    -    -    -    - 
Total available-for-sale securities  $75,626   $77,538   $49,362   $49,272   $23,264   $23,484 
Held-to-maturity securities:                              
U.S. Government agency mortgage-backed securities  $13,441   $13,633   $18,149   $18,243   $25,519   $26,107 
Total securities  $89,067   $91,171   $67,511   $67,515   $48,783   $49,591 

 

At December 31, 2014, we did not own any securities, other than U.S. Government and agency securities, to which the obligation of any one issuer was in excess of 10% of our total stockholders’ equity at that date.

 

In November 2013, the Company securitized approximately $13.6 million in 30-year, fixed rate residential mortgage loans into U.S. agency mortgage backed securities. The purpose of this securitization was to transform residential mortgage loans into more liquid mortgage-backed securities which have a lower risk-based capital requirement and could be pledged for borrowings. This transfer of financial assets met the criteria established under FASB ASC Topic 860 and has been accounted for as a true sale of the residential mortgage loans, resulting in no gain or loss on the sale.

 

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

 

   Available-for-Sale   Held-to-Maturity 
At December 31, 2014  Amortized
Cost
   Fair Value   Amortized
Cost
   Fair Value 
   (In thousands) 
U.S. Government agency mortgage-backed securities  $51,904   $53,087   $13,441   $13,633 
U.S. Government agency collateralized mortgage obligations   12,802    13,179    -    - 
Subtotal   64,706    66,266    13,441    13,633 
Securities with fixed maturities:                    
Due in one year or less   -    -    -    - 
Due afer one year through five years   -    -    -    - 
Due afer five years through ten years   1,898    2,009    -    - 
Due after ten years   9,022    9,263    -    - 
    10,920    11,272    -    - 
Total  $75,626   $77,538   $13,441   $13,633 

 

At December 31, 2014 and 2013, securities with amortized costs of $17.6 million and $19.5 million and fair values of $17.8 million and $19.7 million respectively, were pledged as collateral to secure municipal deposits and repurchase agreements.

 

Bank Owned Life Insurance. We have purchased life insurance policies on certain key executives to help offset the costs of certain benefits provided to Naugatuck Valley Savings’ employees. Bank owned life insurance totaled $10.4 million at December 31, 2014. Bank owned life insurance is recorded as an asset at the lower of its cash surrender value or the amount that can be realized. Income earned on bank owned life insurance policies is exempt from income taxes. This program is monitored on an annual basis to ensure that Naugatuck Valley Savings remains within the established guidelines outlined in the bank regulatory policies. The risks that are reviewed on an ongoing basis are: liquidity risk; transaction/operational risk; tax and insurable interest implications; reputation risk; credit and interest rate risk; price risk; and compliance/legal risk.

 

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Deposit Activities

 

The vast majority of our depositors are residents of the State of Connecticut. Deposits are attracted from within our primary market area through the offering of a broad selection of deposit instruments, including NOW accounts, checking accounts, money market accounts, regular savings accounts, health savings accounts, certificates of deposit and various retirement accounts. Generally, we do not utilize brokered funds. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, our profitability, asset/liability management strategies and customer preferences. We generally review our deposit mix and pricing weekly. Our current strategy is to offer competitive rates, but not be the market leader in every type and maturity.

 

The following table sets forth the balances of our deposit products at the dates indicated.

 

   At December 31, 
(In thousands)  2014   2013   2012 
Noninterest bearing demand deposits  $68,957   $69,147   $70,300 
Interest bearing deposits:               
Now accounts and money market accounts   50,738    49,514    38,965 
Savings accounts   108,488    117,004    117,259 
Time certificates   145,276    155,182    176,378 
Total interest bearing deposits   304,502    321,700    332,602 
Total deposits  $373,459   $390,847   $402,902 

 

The following table indicates the amount of jumbo certificate accounts by time remaining until maturity at December 31, 2014. Jumbo certificate accounts require minimum deposits of $250,000.

 

   Certificate 
Maturity Period  Accounts 
   (In thousands) 
Three months or less  $- 
Over three through six months   1,219 
Over six through twelve months   592 
Over twelve months   11,427 
Total  $13,238 

 

Borrowings. We borrow from the Federal Home Loan Bank of Boston to supplement our supply of lendable funds and to meet deposit withdrawal requirements. The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a member, we are required to own capital stock in the Federal Home Loan Bank of Boston and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness. Under its current credit policies, the Federal Home Loan Bank generally limits advances to 25% of a member’s assets, and short-term borrowings of less than one year may not exceed 10% of the institution’s assets. The Federal Home Loan Bank determines specific lines of credit for each member institution.

 

The following table presents certain information regarding our Federal Home Loan Bank advances during the periods and at the dates indicated.

 

   At or for the year to date period ended 
(Dollars in thousands)  2014   2013   2012 
Maximium amount of advances outstanding at any month-end during the period  $65,866   $41,475   $64,004 
Average advances outstanding during the period   47,257    33,817    54,771 
Weighted average interest rate during the period   1.43%   2.50%   2.80%
Balance outstanding at the end of the period  $53,762   $25,293   $41,475 
Weighted average interest rate at end of period   1.43%   2.15%   2.72%

 

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We also use securities sold under agreements to repurchase periodically as a source of borrowings. As of December 31, 2014, we had no securities sold under agreements to repurchase outstanding.

 

Stockholders’ Equity. Total stockholders’ equity increased by $2.7 million, or 4.5%, to $60.9 million at December 31, 2014 from $58.2 million at December 31, 2013. Total stockholders’ equity decreased by $8.7 million, or 13.0%, to $58.2 million at December 31, 2013 from $66.9 million at December 31, 2012. The increase in stockholders’ equity for the year ended December 31, 2014 was primarily due to net income of $1.0 million and an increase of $1.4 million in accumulated other comprehensive income due to an increase in unrealized gains on securities available-for-sale.

 

Subsidiaries

 

Naugatuck Valley Financial’s sole subsidiary is Naugatuck Valley Savings.

 

At December 31, 2013, Naugatuck Valley Savings had two wholly-owned subsidiaries, Naugatuck Valley Mortgage Servicing Corporation (“NVMSC”) and Church Street OREO One, LLC. Established in 1999 under Connecticut law, NVMSC, a passive investment corporation was organized in order to take advantage of certain state tax benefits. Its primary business has been to service mortgage loans which the Bank originated and subsequently transferred to NVMSC. During 2014, the Bank sold its mortgage servicing rights and downsized its loan servicing staff. This downsizing resulted in the Bank not having the minimum staffing number to qualify for state tax benefits from its passive investment corporation. Based on this ineligibility and the uncertainty related to the future realizability of all of the current and future state tax benefits from the continued operation of this entity, NVMSC was dissolved on December 23, 2014. Church Street OREO One, LLC was established in February 2013 to hold properties acquired through foreclosure as well as non judicial proceedings.

 

Personnel

 

At December 31, 2014, we had 113 full-time employees and 15 part-time employees, none of whom are represented by a collective bargaining unit. We believe our relationship with our employees is good.

 

Regulation and Supervision

 

General

 

Naugatuck Valley Savings is subject to extensive regulation, examination and supervision by the Office of the Comptroller of the Currency, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as its deposits insurer. Naugatuck Valley Savings is a member of the Federal Home Loan Bank System and its deposit accounts are insured up to applicable limits by the Deposit Insurance Fund managed by the Federal Deposit Insurance Corporation. Naugatuck Valley Savings must file reports with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the Office of the Comptroller of the Currency and, under certain circumstances, the Federal Deposit Insurance Corporation to evaluate Naugatuck Valley Savings’ safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation or Congress, could have a material adverse impact on Naugatuck Valley Financial and Naugatuck Valley Savings and their operations. Naugatuck Valley Financial, as a savings and loan holding company, is required to file certain reports with, is subject to examination by, and otherwise must comply with the rules and regulations of the Federal Reserve Board. Naugatuck Valley Financial is subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.

 

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The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted in 2010, made extensive changes in the regulation and supervision of federal savings institutions like Naugatuck Valley Savings. Under the Dodd-Frank Act, the Office of Thrift Supervision was eliminated, and responsibility for the supervision and regulation of federal savings banks was transferred to the Office of the Comptroller of the Currency, the agency that regulates national banks. The Office of the Comptroller of the Currency assumed primary responsibility for examining Naugatuck Valley Savings and implementing and enforcing many of the laws and regulations applicable to federal savings institutions. At the same time, the responsibility for supervising and regulating savings and loan holding companies, such as Naugatuck Valley Financial, was transferred to the Federal Reserve Board. In addition, the Dodd-Frank Act created a new agency, the Consumer Financial Protection Bureau, as an independent bureau of the Federal Reserve Board, to take over the implementation of federal consumer financial protection and fair lending laws from the depository institution regulators. However, institutions of $10 billion or fewer in assets will continue to be examined for compliance with such laws and regulations by, and subject to the enforcement authority of, their primary federal regulator rather than the Consumer Financial Protection Bureau.

 

Certain of the regulatory requirements that are applicable to Naugatuck Valley Savings and Naugatuck Valley Financial are described below. This description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations and their effects on Naugatuck Valley Savings and Naugatuck Valley Financial and is qualified in its entirety by reference to the actual statutes and regulations.

 

Regulation of Federal Savings Institutions

 

Business Activities. Federal law and regulations govern the activities of federal savings banks, such as Naugatuck Valley Savings. These laws and regulations delineate the nature and extent of the activities in which federal savings banks may engage. In particular, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.

 

The Dodd-Frank Act authorized the payment of interest on commercial checking accounts, effective July 21, 2011.

 

Capital Requirements.  Prior to the January 1, 2015 Basel III implementation date for community banks, the applicable capital regulations require savings associations to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio, a 4% Tier 1 capital to total assets leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.

 

The risk-based capital standard for savings associations requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet activities, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the capital regulation based on the risks believed inherent in the type of asset. Tier 1 (core) capital is generally defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital (Tier 2 capital) include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible debt securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

 

The Office of the Comptroller of the Currency also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular risks or circumstances. At December 31, 2014, Naugatuck Valley Savings met each of its capital requirements.

 

The Office of the Comptroller of the Currency imposed individual minimum capital requirements (“IMCRs”) on the Bank effective June 4, 2013. The IMCRs require the Bank to maintain a Tier 1 leverage capital to adjusted total assets ratio of at least 9.00% and a total risk-based capital to risk-weighted assets ratio of at least 13.00%. Before the establishment of the IMCRs, the Bank had been operating under these capital parameters by self-imposing these capital levels as part of the capital plan the Bank was required to implement under the terms of the previously disclosed January 2012 Formal Agreement between the Bank and the OCC.

 

22
 

 

Basel III

 

On July 9, 2013, the federal bank regulatory agencies issued a final rule that revises their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision (“Basel III”) and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies.

 

The rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property.

 

The rule also includes changes in what constitutes regulatory capital, some of which are subject to a two-year transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be required to be deducted from capital, subject to a two-year transition period. Finally, Tier 1 capital will include accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), unless the depository institution elects to exclude such items by opting out in their March 31, 2015 Call Report.

 

The new capital requirements also include changes in the risk-weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and non-residential mortgage loans that are 90 days past due or otherwise on nonaccrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital; and increased risk-weights (from 0% to up to 600%) for equity exposures.

 

Finally, the rule limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.

 

The final rule became effective on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.5% on January 1, 2019.

 

Prompt Corrective Regulatory Action. The Office of the Comptroller of the Currency is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization.  In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion.  The Office of the Comptroller of the Currency could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.  Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.

 

Loans to One Borrower. Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. Subject to certain exceptions, a savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral.

 

Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness in various areas such as internal controls and information systems, internal audit, loan documentation and credit underwriting, interest rate exposure, asset growth and quality, earnings and compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the Office of the Comptroller of the Currency determines that a savings institution fails to meet any standard prescribed by the guidelines, the Office of the Comptroller of the Currency may require the institution to submit an acceptable plan to achieve compliance with the standard.

 

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Community Reinvestment Act. All federal savings associations have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low and moderate-income neighborhoods. An institution’s failure to comply with the provisions of the Community Reinvestment Act could result in restrictions on its activities. Naugatuck Valley Savings and Loan received a “satisfactory” Community Reinvestment Act rating in its most recently completed examination.

 

Limitation on Capital Distributions. Federal Reserve Board and Office of the Comptroller of the Currency regulations impose limitations upon all capital distributions by a savings association, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, a notice must be filed with the Federal Reserve Board 30 days prior to declaring a dividend, with a notice to the Office of the Comptroller of the Currency. The Federal Reserve Board may disapprove a dividend notice if the proposed dividend raises safety and soundness concerns, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the Office of the Comptroller of the Currency. In the event Naugatuck Valley Savings’ capital fell below its regulatory requirements or the Office of the Comptroller of the Currency notified it that it was in need of increased supervision, Naugatuck Valley Savings’ ability to make capital distributions could be restricted. In addition, the Federal Reserve Board could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Federal Reserve Board determines that such distribution would constitute an unsafe or unsound practice.

 

Qualified Thrift Lender Test. Federal law requires savings institutions to meet a qualified thrift lender test. Under the test, a savings institution is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least nine months out of each twelve-month period. Legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered “qualified thrift investments.”

 

A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions, including dividend limitations. The Dodd-Frank Act made noncompliance with the qualified thrift lender test subject to agency enforcement action as a violation of law. As of December 31, 2014, Naugatuck Valley Savings maintained 76.7% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.

 

Transactions with Related Parties. Federal law limits Naugatuck Valley Savings’ authority to make loans to, and engage in certain other transactions with (collectively, “covered transactions”), “affiliates” (i.e., generally, any company that controls or is under common control with an institution), including Naugatuck Valley Financial. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution’s capital and surplus. Loans and other specified transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.

 

The Sarbanes-Oxley Act generally prohibits loans by Naugatuck Valley Financial to its executive officers and directors. However, the Sarbanes-Oxley Act contains a specific exemption from such prohibition for loans by Naugatuck Valley Savings to its executive officers and directors in compliance with federal banking regulations. Federal regulations impose certain quantitative limits and require, among other things, that all loans or extensions of credit to executive officers and directors of insured institutions must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and must not involve more than the normal risk of repayment or present other unfavorable features. Naugatuck Valley Savings is therefore generally prohibited from making any new loans or extensions of credit to executive officers and directors at different rates or terms than those offered to the general public. Notwithstanding this rule, federal regulations permit Naugatuck Valley Savings to make loans to executive officers and directors at reduced interest rates if the loan is made under a benefit program generally available to all other employees and does not give preference to any executive officer or director over any other employee.

 

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In addition, loans made to a director or executive officer in an amount that, when aggregated with the amount of all other loans to the person and his or her related interests, are in excess of the greater of $25,000 or 5% of Naugatuck Valley Savings’ capital and surplus, or, in any event, greater than $500,000, must be approved in advance by a majority of the disinterested members of the board of directors.

 

Loans to executive officers are subject to additional restrictions based on the category of loan involved.

 

Enforcement. The Office of the Comptroller of the Currency has primary enforcement responsibility over federal savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The Federal Deposit Insurance Corporation has authority to recommend to the Director of the Office of the Comptroller of the Currency that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

 

Assessments. Federal savings banks are required to pay assessments to their primary federal regulator to fund its operations. The general assessments, paid on a semi-annual basis, are based upon the savings institution’s total assets, including consolidated subsidiaries, financial condition and complexity of its portfolio. Naugatuck Valley Savings had $225,000 in assessments for the year ended December 31, 2014.

 

Insurance of Deposit Accounts. Naugatuck Valley Savings’ deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. Under the FDIC’s existing risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned. Assessment rates range from 2.5 to 45 basis points on the institution’s assessment base, which is calculated as total assets minus tangible equity.

 

Deposit insurance per account owner is currently $250,000. The FDIC adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, non-interest bearing transaction accounts would receive unlimited insurance coverage until December 31, 2010, which was later extended to December 31, 2012. Naugatuck Valley Savings opted to participate in the unlimited coverage for noninterest bearing transaction accounts.

 

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of Naugatuck Valley Savings. Management cannot predict what insurance assessment rates will be in the future.

 

Federal Home Loan Bank System. Naugatuck Valley Savings is a member of the Federal Home Loan Bank System, which consists of twelve regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. Naugatuck Valley Savings, as a member of the Federal Home Loan Bank of Boston, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. Naugatuck Valley Savings was in compliance with this requirement with an investment in Federal Home Loan Bank stock at December 31, 2014 of $4.5 million. Federal Home Loan Bank advances must be secured by specified types of collateral.

 

The Federal Home Loan Banks are required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements, as well as general financial results, could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, our net interest income would likely also be reduced.

 

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Federal Reserve System

 

The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily negotiable orders of withdrawal (NOW) and regular checking accounts). For 2014, the regulations provided that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio was assessed on net transaction accounts up to and including $89.0 million; a 10% reserve ratio was applied above $89.0 million. The first $13.3 million of otherwise reservable balances were exempted from the reserve requirements. These amounts are adjusted annually and, for 2015, require a 3% ratio for up to $103.6 million and an exemption of $14.5 million. Naugatuck Valley Savings complies with the foregoing requirements.

 

Other Regulations

 

Naugatuck Valley Savings’ operations are also subject to federal laws applicable to credit transactions, including the:

 

·Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

·Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

·Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

·Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies; and

 

·Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

 

The operations of Naugatuck Valley Savings also are subject to laws such as the:

 

·Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

·Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and

 

·Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check.

 

Holding Company Regulation

 

General. As a savings and loan holding company, Naugatuck Valley Financial is required by federal law to report to, and otherwise comply with the rules and regulations of, the Federal Reserve Board.

 

Activities Restrictions. Naugatuck Valley Financial is a unitary savings and loan holding company within the meaning of federal law. No company may acquire control of a savings association unless that company engages only in the financial activities permitted for financial holding companies under the law (which includes those permitted for bank holding companies) or for multiple savings and loan holding companies as described below. Upon any non-supervisory acquisition by Naugatuck Valley Financial of another savings association or savings bank that meets the qualified thrift lender test and is deemed to be a savings association by the Office of the Comptroller of the Currency, Naugatuck Valley Financial would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies, subject to the prior approval of the Federal Reserve Board, and certain activities authorized by Federal Reserve Board regulation. In addition, Naugatuck Valley Financial may also engage in activities permitted for financial holding companies under certain conditions, including the filing of an election to be treated as a financial holding company with the Federal Reserve Board.

 

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A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings association or savings and loan holding company, without prior written approval of the Federal Reserve Board and from acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. 

 

The Federal Reserve Board may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings associations in more than one state, subject to two exceptions:  (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings association in another state if the laws of the state of the target savings association specifically permit such acquisitions.  The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

 

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

 

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

 

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

 

Federal Reserve Board policy also provides that a holding company should inform the Federal Reserve Board supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred.

 

Dividends and Stock Repurchases. The Federal Reserve Board has the power to prohibit dividends by savings and loan holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which also applies to savings and loan holding companies and which expresses the Federal Reserve Board’s view that a holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a holding company experiencing serious financial problems to borrow funds to pay dividends. Under the prompt corrective action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

 

Acquisition of Naugatuck Valley Financial.  Under the Federal Change in Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company or savings association), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company or savings association.  Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of Naugatuck Valley Financial’s outstanding voting stock, unless the Federal Reserve Board has found that the acquisition will not result in control of Naugatuck Valley Financial.  A change in control definitively occurs upon the acquisition of 25% or more of Naugatuck Valley Financial’s outstanding voting stock.  Under the Change in Control Act, the Federal Reserve Board generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition.  Any company that acquires control would then be subject to regulation as a savings and loan holding company.

 

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Future Legislation. Various legislation affecting financial institutions and the financial industry is from time to time introduced in Congress. Such legislation may change banking statutes and the operating environment of the Company and its subsidiaries in substantial and unpredictable ways, and could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance depending upon whether any of this potential legislation will be enacted, and if enacted, the effect that it or any implementing regulations, would have on the financial condition or results of operations of the Company or any of its subsidiaries. With the recent enactments of the Dodd-Frank Act, the nature and extent of future legislative and regulatory changes affecting financial institutions is very unpredictable at this time.Executive Officers of the Registrant

 

The executive officers of Naugatuck Valley Financial and Naugatuck Valley Savings are elected annually by the Board of Directors and serve at the Board’s discretion. The executive officers of Naugatuck Valley Financial and Naugatuck Valley Savings at December 31, 2014 are as follows:

 

Name   Position
William C. Calderara  

President and Chief Executive Officer of Naugatuck Valley Financial and

Naugatuck Valley Savings and Loan

     
James Hastings  

Executive Vice President and Chief Financial Officer of Naugatuck Valley

Financial and Naugatuck Valley Savings and Loan

     
James E. Cotter  

Executive Vice President and Chief Operating Officer of Naugatuck Valley

Financial and Naugatuck Valley Savings and Loan

     
Mark C. Foley  

Executive Vice President and Chief Credit Policy Officer of Naugatuck

Valley Financial and Naugatuck Valley Savings and Loan

 

Ages presented are as of December 31, 2014.

 

William C. Calderara has served as President and Chief Executive Officer of Naugatuck Valley Financial and Naugatuck Valley Savings since September 2012. From February 2008 until September 2012, Mr. Calderara served as Senior Vice President/Chief Loan Officer of Newtown Savings Bank in Newtown, Connecticut. From July 1998 to February 2008, he served as Executive Vice President/Corporate Secretary of Fairfield County Bank in Ridgefield, Connecticut. Age 54. Director of Naugatuck Valley Savings and of Naugatuck Valley Financial since 2012.

 

James Hastings has served as Executive Vice President and Chief Financial Officer of Naugatuck Valley Financial and Naugatuck Valley Savings since April 2013. From January 2008 until August 2012, Mr. Hastings served as Executive Vice President and Chief Financial Officer of Southern Community Financial Corporation and its subsidiary bank, Southern Community Bank and Trust (a $1.6 billion commercial bank headquartered in Winston-Salem, North Carolina). From August 2012 until February 2013, Mr. Hastings served initially as the interim Chief Executive Officer of Southern Community Financial Corporation and its subsidiary bank until this organization was acquired by Capital Bank, N.A. in September 2012 and then became a Senior Financial Executive of Capital Bank N.A. Age 62.

 

James E. Cotter has served as Executive Vice President and Chief Operating Officer of Naugatuck Valley Financial and Naugatuck Valley Savings since May 2013. From February 2006 until April 2013, Mr. Cotter served as Senior Vice President – Retail Banking of Newtown Savings Bank in Newtown, Connecticut. From January 2000 to February 2006, he served as Senior Vice President of Fairfield County Bank in Ridgefield, Connecticut. Mr. Cotter is a registered Certified Public Accountant with the State of Connecticut. Age 54.

 

Mark C. Foley has served as Executive Vice President and Chief Credit Policy Officer of Naugatuck Valley Financial and Naugatuck Valley Savings since May 2013. From November 2011 until May 2013, Mr. Foley served as Executive Vice President and Chief Credit Officer of Patriot National Bank in Stamford, Connecticut. From May 2010 to November 2011, he served as Chief Credit Officer and Chief Risk Officer of Herald National Bank in New York, New York. From November 2004 to April 2010, Mr. Foley served as Managing Director of Forensic Investigative Associates in New York, New York. Age 63.

 

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ITEM 1A. RISK FACTORS.

 

Risks Related to our Business

 

Commercial real estate loans and commercial business loans have a higher risk of loss than residential mortgage loans and consumer loans.

 

At December 31, 2014, $148.3 million, or 40.2%, of our loan portfolio consisted of commercial real estate and commercial business loans, a decrease of $313,000, or 0.2%, from $148.6 million, or 40.1%, at December 31, 2013. Commercial real estate and commercial business loans have a higher risk of default and loss than owner-occupied single-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the borrower. Such loans also typically involve larger loan balances to single borrowers or groups of related borrowers than single-family residential loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential mortgage loan.

 

Our nonperforming assets expose us to increased risk of loss, which may negatively affect our earnings.

 

Despite the decrease in our nonperforming assets of $9.8 million, or 64.3%, during the year ended December 31, 2014, we still had nonperforming assets of $5.4 million, or 1.1% of total assets at December 31, 2014. Our nonperforming assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans or on real estate owned. We must reserve for probable losses, which are established through a current period charge to income in the provision for loan losses, and from time to time, write down the value of properties in our other real estate owned portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to our other real estate owned. Further, the resolution of nonperforming assets requires the active involvement of management, which can distract us from the overall supervision of operations and other income-producing activities of Naugatuck Valley Savings and Loan. Finally, if our estimate of the allowance for loan losses is inadequate, we will have to increase the allowance accordingly. At December 31, 2014, our allowance for loan losses amounted to $6.0 million, or 1.6% of total loans outstanding and 118.0% of nonperforming loans.

 

The current economic conditions pose significant challenges that could adversely affect our financial condition and results of operations.

 

Our success depends to a large degree on the general economic conditions in the Greater Naugatuck Valley region of Connecticut. Our market may experience a significant downturn in which we would see falling home prices, rising foreclosures and an increased level of commercial and consumer delinquencies. Although economic conditions have slightly improved, if economic conditions in our market area do not continue to improve or we experience another downturn, we could experience reduced demand for our products and services, increased problem assets and foreclosures and increased loan losses, each of which could further adversely affect our business.

 

We could experience further adverse consequences in the event of another economic downturn in our market due to our exposure to commercial loans across various lines of business. Another economic downturn could adversely affect collateral values or cash flows of the borrowing businesses, and as a result our primary source of repayment could be insufficient to service the debt. Another adverse consequence in the event of another economic downturn in our market could be the loss of collateral value on commercial and real estate loans that are secured by real estate located in our market area. If real estate values in our market remain below their pre-recession levels or decline again the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished.

 

Future economic conditions in our market will depend on factors outside of our control such as political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government, military and fiscal policies and inflation.

 

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Our strategy of controlling commercial loan growth may have a negative effect on our earnings.

 

At December 31, 2014, our construction loan portfolio, commercial real estate portfolio and commercial business loan portfolio amounted to 5.6%, 200.6% and 42.2% respectively, of our total regulatory capital (Tier 1 capital plus ALLL) at that date. These percentages are within the limits of the loan concentration policy that we have established for these types of higher risk loans. See “Item 1. Business – Lending Activities – General” for further information regarding the policy limits. We intend to maintain our construction loan portfolio. However, we intend to grow our commercial real estate loan and commercial business loan portfolios, as a percentage of total regulatory capital. Our regulators may instruct or advise us to reduce these concentration levels if they deem it warranted. Commercial loans generally have higher yields than residential mortgage loans because they are considered to have a higher risk of loss. Our controlled growth strategy, or any change in strategy that makes it more stringent, may have a negative effect on our earnings.

 

The nature of our commercial and construction loan portfolio may expose us to increased lending risks.

 

Our recently originated commercial real estate and commercial business loans are unseasoned. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. As a result, it may be difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our expectations, which could negatively affect our future performance. Further, these types of loans generally have larger balances and involve a greater risk than one-to-four family residential mortgage loans. Accordingly, if we make any errors in judgment in the collectability of our commercial or construction loans, any resulting charge-offs may be larger on a per loan basis than those incurred historically with our residential mortgage loan or consumer loan portfolios.

 

Higher loan losses could require us to increase our allowance for loan losses, which may negatively impact our earnings.

 

When we loan money we incur the risk that our borrowers will not repay their loans. We reserve for loan losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of loan losses inherent in our loan portfolio. The process for determining the amount of the allowance is critical to our financial results and condition. It requires subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans. We might underestimate the loan losses inherent in our loan portfolio and have loan losses in excess of the amount reserved. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. In addition, when real estate values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios. The recent decline in the national economy and the local economies of the areas in which our loans are concentrated could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss provisions in future periods. In addition, our determination as to the amount of our allowance for loan losses is subject to review by our primary regulator, the Office of the Comptroller of the Currency, as part of its examination process, which may result in the establishment of an additional allowance based upon the judgment of the Office of the Comptroller of the Currency after a review of the information available at the time of its examination. Our allowance for loan losses amounted to 1.6% of total loans outstanding and 118.0% of nonperforming loans at December 31, 2014. Our allowance for loan losses at December 31, 2014, may not be sufficient to cover future loan losses. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.

 

Our emphasis on residential mortgage and commercial real estate loans exposes us to a risk of loss due to a decline in property values.

 

At December 31, 2014, $180.7 million, or 48.9%, of our loan portfolio consisted of one-to-four family residential mortgage loans, $28.7 million, or 7.8%, of our loan portfolio consisted of home equity loans and $122.5 million, or 33.2% of our loan portfolio consisted of commercial real estate loans. We originate home equity lines of credit with maximum combined loan-to-value ratios of up to 75%. Declines in the housing market and the increase in vacancy rates in the commercial real estate market during the past five years resulted in declines in real estate values in our market area. Despite the recent stabilization of these values, future declines in real estate values could cause some of our mortgage, home equity and commercial real estate loans to be inadequately collateralized which would expose us to a greater risk of loss in the event that we seek to recover on defaulted loans by selling the real estate collateral.

 

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Concentration of loans in our primary market area may increase risk.

 

Our success depends primarily on the general economic conditions in the State of Connecticut, as nearly all of our loans are to customers in this market, particularly our local greater Naugatuck Valley market area. Accordingly, any weakness in the economy in Connecticut could have a significant impact on the ability of our borrowers to repay loans. As such, a decline in real estate valuations in this market would lower the value of the collateral securing those loans. In addition, a significant weakening in general economic conditions such as inflation, recession, unemployment, or other factors beyond our control could negatively affect our financial results.

 

Income from secondary mortgage market operations is volatile, and we may incur losses or charges with respect to our secondary mortgage market operations which would negatively affect our earnings.

 

We generally sell in the secondary market the fixed-rate residential mortgage loans that we originate, earning non-interest income in the form of gains on sale. When interest rates rise, the demand for mortgage loans tends to fall and may reduce the number of loans available for sale. When interest rates fall, the demand for fixed-rate mortgage loans also tends to fall and may reduce the number of loans available for sale. In addition to interest rate levels, weak or deteriorating economic conditions also tend to reduce loan demand. Although we sell loans in the secondary market without recourse, we are required to give customary representations and warranties to the buyers. If we breach those representations and warranties, the buyers can require us to repurchase the loans and we may incur a loss on the repurchase.

 

Naugatuck Valley Savings is required to comply with the terms of the formal written agreement entered into with the Office of the Comptroller of the Currency and lack of compliance could result in monetary penalties and/or additional regulatory actions.

 

Naugatuck Valley Savings entered into a formal written agreement with the Office of the Comptroller of the Currency on January 17, 2012. See “Business – General – Formal Regulatory Agreement” for further information. The formal written agreement and each of its provisions will remain in effect unless and until the provisions are amended in writing by mutual consent of Naugatuck Valley Savings and the Office of the Comptroller of the Currency or accepted, waived, or terminated in writing by the Office of the Comptroller of the Currency.

 

The Office of the Comptroller of the Currency, also imposed IMCRs on the Bank effective June 4, 2013. The IMCRs require the Bank to maintain a Tier 1 leverage capital to adjusted total assets ratio of at least 9.00% and a total risk-based capital to risk-weighted assets ratio of at least 13.00%. Before the establishment of the IMCRs, the Bank had been operating under these capital parameters by self-imposing these capital levels as part of the capital plan the Bank was required to implement under the terms of the previously disclosed January 2012 Formal Agreement between the Bank and the OCC.

 

If we fail to comply with the formal written agreement or meet the IMCRs, the Office of the Comptroller of the Currency may pursue the assessment of civil money penalties against Naugatuck Valley Savings and its officers and directors and may seek to enforce the terms of the formal written agreement through court proceedings.

 

New capital rules generally require insured depository institutions and their holding companies to hold more capital. The impact of the new rules on our financial condition and operations is uncertain but could be materially adverse.

 

In July 2013, the Federal Reserve and the OCC adopted a final rule for the Basel III capital framework. These rules substantially amend the regulatory risk-based capital rules applicable to us. The rules phase in over time beginning in 2015 and will become fully effective in 2019. Beginning in 2015, our minimum capital requirements will be: (i) a common Tier 1 equity ratio of 4.5%; (ii) a Tier 1 capital (common Tier 1 capital plus Additional Tier 1 capital) of 6% (up from 4%); and (iii) a total capital ratio of 8% (the current requirement). Our leverage ratio requirement will remain at the 4% level now required. Beginning in 2016, a capital conservation buffer will phase in over three years, ultimately resulting in a requirement of 2.5% on top of the common Tier 1, Tier 1 and total capital requirements, resulting in a required common Tier 1 equity ratio of 7%, a Tier 1 ratio of 8.5%, and a total capital ratio of 10.5%. Failure to satisfy any of these three capital requirements will result in limits on paying dividends, engaging in share repurchases and paying discretionary bonuses. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions. Savings and loan holding companies that have total consolidated assets of less than $500 million and meet certain other requirements, such as Naugatuck Valley Financial, are exempt from the Federal Reserve’s regulatory capital requirements. The Federal Reserve has proposed increasing the asset threshold for this exemption to $1 billion.

 

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The Dodd – Frank Act, among other things, created a new regulatory agency, tightened capital standards and will continue to result in new laws and regulations that are expected to increase our costs of operations.

 

The Dodd-Frank Act, enacted in 2010, has significantly changed the Bank regulatory structure and has affected the lending, deposit, investment and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years. However, it is expected that the legislation and implementing regulations may materially increase our operating and compliance costs. Under the Dodd-Frank Act, the Office of Thrift Supervision, which previously regulated Naugatuck Valley Savings, was merged into the Office of the Comptroller of the Currency, which until then only regulated national banks. As a result of the Dodd-Frank Act, savings and loan holding companies, including Naugatuck Valley Financial, are now regulated by the Board of Governors of the Federal Reserve System. The Dodd-Frank Act also created a new federal agency, Consumer Financial Protection Bureau (“CFPB”) to administer consumer protection and fair lending laws, a function that was formerly performed by the depository institution regulators. The federal preemption of state laws previously accorded federally chartered depository institutions has been reduced, and State Attorneys General now have greater authority to bring a suit against a federally chartered institution, such as Naugatuck Valley Savings, for violations of certain state and federal consumer protection laws. The Dodd-Frank Act also will impose consolidated capital requirements on savings and loan holding companies by July 2015, which will limit our ability to borrow at the holding company level and invest the proceeds from such borrowings as capital in Naugatuck Valley Savings that could be leveraged to support additional growth. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs.

 

In addition to the enactment of the Dodd-Frank Act, the federal regulatory agencies have taken stronger supervisory actions against financial institutions that have experienced increased loan losses and other weaknesses as a result of the recent economic crisis. The actions include the entering into of written agreements and cease and desist orders that place certain limitations on their operations. Federal bank regulators recently have also been using with more frequency their ability to impose individual minimal capital requirements on banks, which requirements may be higher than those imposed under the Dodd-Frank Act or which would otherwise qualify the Bank as being “well capitalized” under the FDIC’s prompt corrective action regulations. Given the Bank’s formal agreement with the OCC and our higher individual capital requirements, such action has, and will continue to have, a negative impact on the Company’s ability to execute its business plans, as well as the ability to grow, pay dividends or engage in mergers and acquisitions and may result in restrictions in the Company’s future operations.

 

Changes in interest rates could reduce our net interest income and earnings.

 

Our net interest income is the interest we earn on loans and investments less the interest we pay on our deposits and borrowings. Our net interest spread is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in interest rates—up or down—could adversely affect our net interest spread and, as a result, our net interest income and net interest margin. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract. This contraction could be more severe following a prolonged period of lower interest rates, as a larger proportion of our fixed rate residential loan portfolio will have been originated at those lower rates and borrowers may be more reluctant or unable to sell their homes in a higher interest rate environment. Changes in the slope of the “yield curve” —or the spread between short-term and long-term interest rates—could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.

 

32
 

 

If we conclude that the decline in value of any of our investment securities is other-than-temporary, we are required to write down the value of that security.

 

Companies are required to record other-than-temporary impairment if they have the intent to sell, or will more likely than not be required to sell, an impaired debt security before recovery of its amortized cost basis. In addition, companies are required to record other-than-temporary impairment for the amount of credit losses, regardless of the intent or requirement to sell. We evaluate investments that have a fair value less than book value for other-than-temporary impairment on a quarterly basis. Changes in the expected cash flows, credit enhancement levels or credit ratings of investment securities and/or prolonged price declines may result in our concluding in future periods that the impairment of these securities is other-than-temporary, which would require a charge to earnings to write down the value of these securities. Any charges for other-than-temporary impairment would not impact cash flow, tangible capital or liquidity.

 

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

 

We face intense competition both in making loans and attracting deposits. This competition has made it more difficult for us to make new loans and at times has forced us to offer higher deposit rates. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which would reduce net interest income. Competition also makes it more difficult to grow loans and deposits. As of June 30, 2014, which is the most recent date for which information is available, we held less than 2% of the deposits in each of the counties in which our offices are located. Several of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area.

 

Our size makes it more difficult for us to compete.

Our asset size makes it more difficult to compete with other financial institutions which are generally larger and can more easily afford to invest in the marketing and technologies needed to attract and retain customers. Because our principal source of income is the net interest income we earn on our loans and investments after deducting interest paid on deposits and other sources of funds, our ability to generate the revenues needed to cover our expenses and finance such investments is limited by the size of our loan and investment portfolios. Accordingly, we are not always able to offer new products and services as quickly as our competitors. Our lower earnings also make it more difficult to offer competitive salaries and benefits. Finally, as a smaller institution, we are disproportionately affected by the continually increasing costs of compliance with new banking and other regulations.

 

We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.

 

We are subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency, our primary federal regulator, and by the Federal Deposit Insurance Corporation, as insurer of our deposits. Such regulation and supervision governs the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of Naugatuck Valley Savings rather than for holders of our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

 

We are dependent on our information technology and telecommunications systems and third-party servicers, and systems failures, interruptions or breaches of security could have a material adverse effect on us.

 

The Bank’s business is highly dependent on the ability to process, record and monitor, on a continuous basis, a large number of transactions. Integral to the Bank’s performance is the continued efficiency of internal processes, systems, relationships with third parties, and employees in day-to-day operations. With regard to the physical infrastructure and systems that support operations, the Bank has taken measures to implement backup systems and other safeguards. The ability to conduct business may be adversely affected by any significant and widespread disruption to the infrastructure or systems. Financial, accounting, data processing, backup or other operating systems may fail to operate properly as a result of events that are wholly or partially beyond the Bank’s control and adversely affect the ability to process transactions or provide services. The Bank continuously updates these systems to support operations. This updating entails significant costs and creates risks associated with implementing new systems and integrating them with existing ones.

 

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Information security risks for financial institutions have significantly increased in recent years because of proliferation of new technologies, use of the Internet and telecommunications technologies to conduct financial transactions, and increased sophistication of organized crime, hackers, terrorists and other external parties. The Bank’s operations rely on secure processing, transmission and storage of confidential, proprietary and other information in computer systems and networks. The banking business relies on digital technologies, computer and email systems, software, and networks to conduct operations. In addition, to access products and services, customers may use personal smartphones, PCs and other computing devices, tablet PCs and other mobile devices that are beyond the Bank’s control systems. Technologies, systems, networks and customers’ devices could be subject to the target of cyber attacks, computer viruses, malicious code, phishing attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of the Bank’s or customers’ confidential, proprietary and other information, or otherwise disrupt the Bank’s customers’ or other third parties’ business operations.

 

The Bank has not experienced any material losses relating to cyber attacks or other information security breaches, however there can be no assurance that such losses will not occur in the future. As a result, cybersecurity and the continued development and enhancement of controls, processes and practices designed to protect systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority. As cyber threats continue to evolve, the Bank may be required to expend additional resources to continue to modify or enhance protective measures or to investigate and remediate any information security vulnerabilities.

 

In addition, the Bank also faces risk of operational failure, termination or capacity constraints for any third party that provides business or facilitates business activities. Any such failure, termination or constraint could adversely affect the Bank’s ability to effect transactions, service clients, manage exposure to risk or expand business, and could have an adverse impact on liquidity, financial condition and results of operations.

 

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

 

The Federal Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "PATRIOT Act") and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions that we may acquire in the future are deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

 

We are subject to a variety of operational risks, environmental, legal and compliance risks, and the risk of fraud or theft by employees or outsiders, which may adversely affect our business and results of operations.

 

We are exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, and unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to attract and keep customers and can expose us to litigation and regulatory action. Actual or alleged conduct by the Bank can also result in negative public opinion about our other businesses.

 

34
 

 

If personal, non-public, confidential or proprietary information of customers in our possession were to be misappropriated, mishandled or misused, we could suffer significant regulatory consequences, reputational damage and financial loss. Such mishandling or misuse could include, for example, erroneously providing such information to parties who are not permitted to have the information, either by fault of our systems, employees, or counterparties, or the interception or inappropriate acquisition of such information by third parties.

 

Because the nature of the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. Our necessary dependence upon automated systems to record and process transactions and our large transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. We also may be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control (for example, computer viruses or electrical or telecommunications outages, or natural disasters, disease pandemics or other damage to property or physical assets) which may give rise to disruption of service to customers and to financial loss or liability. We are further exposed to the risk that our external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as we are) and to the risk that our (or our vendors’) business continuity and data security systems prove to be inadequate. The occurrence of any of these risks could result in our diminished ability to operate our business (for example, by requiring us to expend significant resources to correct the defect), as well as potential liability to clients, reputational damage and regulatory intervention, which could adversely affect our business, financial condition or results of operations, perhaps materially.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

 

None.

 

ITEM 2.PROPERTIES.

 

We conduct our business through our main office and branch offices. We own our main office and four of our branches. We lease four of our branch facilities under leases that expire in 2016 through 2020, each of which have options to renew.

 

All of our properties, including land, buildings and improvements, furniture, equipment and vehicles had a net book value at December 31, 2014 of $9.1 million. See further information presented in Note 7 to the Consolidated Financial Statements, which are presented in Item 8 in this Form 10-K.

 

ITEM 3. LEGAL PROCEEDINGS.

 

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

 

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

 

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On February 20, 2014, the court entered a scheduling order providing a period for completion of discovery and the filing of dispositive motions. However, on May 23, 2014 those deadlines were stayed by the court pending regulatory consideration of a settlement. The settlement agreement proposed by the parties is currently under review by the regulatory agencies. A status conference has been set by the court for May 13, 2015.

 

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

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

PART II

 

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

 

Naugatuck Valley Financial’s common stock is listed on the Nasdaq Global Market under the trading symbol “NVSL.” The following table sets forth the high and low sales prices of the common stock, as reported on the Nasdaq Global Market, and the dividend declared, if any, by Naugatuck Valley Financial during each quarter of 2014 and 2013.

 

   High   Low   Dividends 
Year Ending December 31, 2014:               
Fourth Quarter  $8.58   $7.52   $0.00 
Third Quarter   8.63    7.60    0.00 
Second Quarter   8.89    7.52    0.00 
First Quarter   7.85    7.07    0.00 
Year Ended December 31, 2013:               
Fourth Quarter  $7.55   $7.00   $0.00 
Third Quarter   7.94    7.01    0.00 
Second Quarter   7.50    6.96    0.00 
First Quarter   7.28    6.61    0.00 

 

At March 19, 2015, there were 732 holders of record of Naugatuck Valley Financial’s common stock.

 

For a discussion of restrictions on the payment of cash dividends by Naugatuck Valley Financial, see “Business—Regulation and Supervision—Regulation of Federal Savings Institutions—Limitation on Capital Distributions” in this Annual Report on Form 10-K and note 2 to the Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

Naugatuck Valley Financial did not repurchase any stock during the year ended December 31, 2014.

 

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Stock Performance Graph

 

The chart shown below depicts total return to stockholders during the period beginning December 31, 2009 and ending December 31, 2014. Total return includes appreciation or depreciation in market value of the Company’s common stock as well as any cash dividends paid to common stockholders. Indicies shown below, for comparison purposes only, are the Total Return Index for the NASDAQ Stock Market (U.S. Companies), which is a nationally recognized index of stock performance for publicly traded companies and the NASDAQ Bank Index, which is an index that contains securities of NASDAQ- listed companies according to the Industry Classification Benchmark as banks. The chart assumes that the value of the investment in Naugatuck Valley Financial’s common stock and each of the three indicies was $100 on December 31, 2009, and that all dividends were reinvested in Naugatuck Valley Financial’s common stock.

 

 

Index  2009   2010   2011   2012   2013   2014 
Naugatuck Valley Financial Corporation  $100.00   $117.60   $118.29   $115.85   $126.13   $149.13 
NASDAQ Composite  $100.00   $116.91   $114.81   $133.07   $184.06   $208.71 
NASDAQ Bank Index  $100.00   $111.89   $97.98   $113.45   $157.59   $162.07 

 

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ITEM 6.SELECTED FINANCIAL DATA.

 

The following table sets forth certain information concerning our consolidated financial position and results of operations at and for the dates indicated and have been derived from our audited Consolidated Financial Statements. The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and “Item 8. Financial Statements and Supplementary Data.”

 

   At December 31, 
(In thousands)  2014   2013   2012   2011   2010 
Selected financial condition data:                         
Total assets  $495,090   $486,781   $526,800   $572,899   $568,743 
Securities held-to-maturity   13,441    18,149    25,519    25,292    15,334 
Securities available-for-sale   77,538    49,272    23,484    25,051    31,683 
Loans receivable, net   363,259    360,568    417,581    466,953    473,521 
Cash and cash equivalents   10,940    26,374    23,123    15,436    11,186 
Deposits   373,459    390,847    402,902    410,887    405,875 
Borrowed funds   53,762    29,466    47,870    70,817    102,842 
Total stockholders' equity   60,871    58,234    66,908    82,314    52,260 

 

   For the Year Ended December 31, 
(Dollars in thousands, except for per share data)  2014   2013   2012   2011   2010 
Selected operating data:                         
Interest and dividend income  $19,771   $20,612   $24,611   $27,523   $28,812 
Interest expense   3,109    3,678    5,385    8,252    10,279 
Net interest income   16,662    16,934    19,226    19,271    18,533 
(Credit) provision for loan losses   (1,747)   4,150    17,725    4,293    3,360 
Net interest income after provision for loan losses   18,409    12,784    1,501    14,978    15,173 
Noninterest income   4,267    1,172    4,625    4,664    3,014 
Noninterest expense   21,688    22,425    21,226    17,150    15,907 
Income (loss) before tax provision (benefit)   988    (8,469)   (15,100)   2,492    2,280 
(Benefit)/provision for income taxes   (13)   370    148    850    829 
Net income (loss)  $1,001   $(8,839)  $(15,248)  $1,642   $1,451 
Net income (loss) per share  $0.15   $(1.33)  $(2.31)  $0.24   $0.21 
Dividends per share  $-   $-   $0.09   $0.12   $0.12 

 

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   At or For the Year Ended December 31,     
   2014   2013   2012   2011   2010   2009 
Performance ratios:                              
Return (loss) on average assets   0.20%   (1.73)%   (2.74)%   0.28%   0.25%   0.37%
Return (loss) on average equity   1.70%   (13.92)%   (19.40)%   2.40%   2.79%   4.10%
Interest rate spread (1)   3.43%   3.39%   3.49%   3.36%   3.32%   3.00%
Net interest margin (2)   3.49%   3.47%   3.61%   3.50%   3.42%   3.09%
Noninterest expense to average assets   4.34%   4.40%   3.81%   2.97%   2.79%   2.68%
Efficiency ratio (3)   103.64%   123.87%   88.85%   70.46%   72.74%   78.43%
Dividend payout ratio (4)   N/M    N/M    N/M    50.00%   23.48%   24.25%
Book value per common share  $8.69   $8.32   $9.56   $11.75   $7.45   $12.03 
Equity to assets ratio   12.29%   11.97%   12.70%   14.37%   9.19%     
                               
Capital ratios - bank:                              
Total capital to risk-weighted assets   18.67%   18.01%   16.21%   17.08%   11.84%   11.10%
Tier I capital to risk-weighted assets   17.41%   16.74%   14.92%   15.82%   10.59%   10.16%
Tier I capital to adjusted total assets   11.13%   11.04%   9.98%   11.79%   8.03%   7.76%
                               
Asset quality ratios:                              
Allowance for loan losses as a percent of total loans   1.63%   2.67%   3.35%   1.70%   1.33%   0.84%
Allowance for loan losses as a  percent of nonperforming loans   117.96%   73.91%   56.53%   32.63%   35.74%   66.60%
Net charge-offs (recoveries) to average loans outstanding during the period   0.57%   2.14%   2.48%   0.55%   0.20%   n/a 
Nonperforming loans as a percent of total loans   1.38%   3.61%   5.93%   5.19%   3.73%   1.26%
Nonperforming assets as a percent of total assets   1.10%   3.13%   5.01%   4.47%   3.22%   1.10%
                               
Other data:                              
Number of:                              
Full service customer service facilities   9    10    10    10    10    10 

 

(1)Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.
(2)Represents net interest income as a percent of average interest-earning assets.
(3)Represents noninterest expense (less intangible amortization) divided by the sum of net interest income and noninterest income.
(4)Represents dividends declared divided by net income. There were no dividends declared for the year ended December 31, 2014. The ratio is not meaningful for the 2013 and 2012 periods due to the net loss for those years.

 

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

 

Critical Accounting Policies

 

The Company’s Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Companies may apply certain critical accounting policies requiring management to make subjective or complex judgments, often as a result of the need to estimate the effect of matters that are inherently uncertain.

 

The Company considers its most critical accounting policies, requiring the use of estimates, to be the allowance for loan losses and other than temporary impairments in the market value of investments, deferred income taxes and, fair value of financial instruments, and transfers of financial assets.

 

Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged against earnings. The balance of the allowance for loan losses is maintained at the amount management believes will be appropriate to absorb known and inherent losses in the loan portfolio at the balance sheet date. The allowance for loan losses is determined by applying estimated loss factors to the credit exposure from outstanding loans.

 

We assess the estimated credit losses inherent in our loan portfolio by considering a number of elements for each loan segment including:

·Historical loss experience in that loan segment;
·Levels of and trends in delinquencies, non-accrual and adversely classified loans;
·Levels and trends in charge-offs and recoveries;
·Effects of changes in risk grades, underwriting standards, and other changes in lending policies, procedures and practices;
·Experience, ability and depth of lending management and other relevant staff;
·National and local economic trends and conditions;
·External factors such as competition, legal, and regulatory; and
·Effect of changes in credit concentrations.

 

As of June 30, 2013, we added factors to more granularly assess loan quality trends, specifically, the changes and the trend in charge-offs and recoveries, changes in the volume of Watch and Special Mention loans and the changes in the quality of the Bank’s loan review system. This analysis establishes factors that are applied to each of the segregated groups of loans to determine an appropriate level of loan loss allowance.

 

We calculate an allowance for the collectively evaluated portion of our loan portfolio based on an appropriate percentage loss factor that is calculated based on the above-noted elements and trends. We may record specific provisions for each impaired loan after an individual evaluation and analysis of that loan’s credit and collateral. Our analysis of an allowance combines the assessments made on the collectively evaluated portion of our loan portfolio with the specific impairment estimates for each impaired loan.

 

As of June 30, 2013, the Company adopted significant changes to its ALLL methodology, which are summarized as follows:

 

·Further disaggregated the commercial real estate loan segment to increase the granularity of the risks inherent in the loans in the expanded segments;
·A different basis on which historical loss experience is calculated to determine inherent losses on the collectively evaluated portion of the loan portfolio; and
·Changes in the utilization of qualitative risk adjustment factors (“Q Factors”) including an increased number of these Q Factors and a change in the calibration and application of the Q Factors.

 

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Previously, the Company’s historical loss experience was derived from the net loan charge-offs incurred in the prior four quarters and apportioned against the related loan portfolio segment to determine an average loss history factor for each segment. Beginning with the June 30, 2013 calculation, the Company adopted a two year weighted average as the basis for the calculation of its historical loss experience in which the current year is weighted 56% versus 44% for the prior year experience. While the Company is mindful of its loss history, loss experience from the past four quarters may not accurately reflect losses embedded in the older vintages of loans originated in prior years. It is therefore considered by the Company to be more appropriate to look back at least two years in establishing loss history, albeit more heavily weighted to the current year. As discussed above, the Company believes it has significantly improved its risk grades through its increased workout efforts and as evidenced by the sales of approximately $32 million principal amount of primarily adversely classified loans in 2013 and 2014. The general loan loss component derived from the loss history utilizing a longer time period which contains more heightened, recent losses will be more consistent with, and reflective of, the inherent loss experience in the loan portfolio.

 

With respect to the Q Factors, the new methodology increased the number of Q factors, in particular, factors to measure the changes in the level and trends in net charge-offs. Despite the addition to the number of Q Factors, the overall impact of the Q Factors is greatly diminished due to the improvement in the Bank’s asset quality cited above. The related charge-offs and their impact on the recent and more heavily weighted loss experience, limits, to a large extent, the need for additions to reserves resulting from Q Factors, and increases the confidence level in historical loss experience as an indicator of losses inherent in the loan portfolio.

 

The impact of the changes in the Company’s ALLL methodology implemented as of June 30, 2013 related to the Q Factors and the recalculation of the historical loan loss factors resulted in a reduction in the ALLL balance of a combined $3.8 million when implemented as of June 30, 2013.

 

While we believe we use the best information available to determine the allowance for loan losses, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. A further decline in local and national economic conditions, or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review by bank regulators, as part of their routine examination process, which may result in the establishment of additional allowance for loan losses based upon their judgment of information available to them at the time of their examination.

 

For additional information regarding the allowance for loan losses, its relation to the provision for loan losses, risk related to asset quality and lending activity, see “Results of Operations for the Years Ended December 31, 2014, and 2013 - Provision for Loan Losses” below, Part I of “Item 1. Business - Analysis of Allowance for Loan Losses” as well as Note 4 of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data”.

 

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

 

Deferred income taxes. The Bank recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets and liabilities are reduced by a valuation allowance when, in the opinion of management, it is more-likely-than-not that all or some portion of the deferred tax assets will not be realized. As of December 31, 2014 and December 31, 2013, valuation allowances of $16.0 million and $8.7 million, respectively, were established because management believes it is more-likely-than-not that the net balance of the deferred tax asset will not be realized.

 

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When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more-likely-than-not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company determined that it had no liabilities for uncertain tax positions at December 31, 2014 and 2013. See Note 14 of the Notes to the Consolidated Financial Statements in this Annual Report on Form 10-K.

 

Fair Value of Financial Instruments. We use fair value measurements to record certain assets at fair value on a recurring basis, primarily related to the carrying amounts for available-for-sale investment securities. Additionally, we may be required to record at fair value other assets, such as foreclosed real estate, on a nonrecurring basis. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or market value accounting or write-down of individual assets. Valuation techniques based on unobservable inputs are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows and the selection of discount rates that may appropriately reflect market and credit risks. Changes in these judgments often have a material impact on the fair value estimates. In addition, since these estimates are as of a specific point in time, they are susceptible to material near-term changes. The fair values disclosed do not reflect any premium or discount that could result from the sale of a large volume of a particular financial instrument, nor do they reflect the possible tax ramifications or estimated transaction costs. See Notes 3, 5 and 17 of the Notes to the Consolidated Financial Statements in this Annual Report on Form 10-K.

 

Transfers of Financial Assets. Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Company, put presumably beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership; (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and no condition both constrains the transferee from taking advantage of that right and provides more than a trivial benefit for the transferor; and (3) the transferor does not maintain effective control over the transferred assets through either (a) an agreement that both entitles and obligates the transferor to repurchase or redeem the assets before maturity or (b) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call.

 

Financial Condition at December 31, 2014 and 2013

 

During the year ended December 31, 2014, our total assets increased to $495.1 million from $486.8 million at the prior year end. This increase was primarily attributable to the increase in our investment securities of $23.6 million. Compared to the December 31, 2013 level, gross loans decreased year-over-year by only $1.2 million, or 0.3%. Business development and loan origination efforts began to show results in the second half of 2014 and largely offset sales of impaired loans in June 2014, weak loan demand and management’s focus on problem loan remediation. The Company’s liquidity improved during the year as investment securities and cash and cash equivalents increased $8.1 million, or 8.7%. Total deposits were $373.5 million at December 31, 2014, a decrease of $17.4 million, or 4.4%, from the year ago period. Time deposits decreased $9.9 million while demand deposits and NOW accounts increased $1.0 million. With the decline in deposit offering rates throughout the banking industry, management decided to influence its deposit mix by less aggressively pricing its time deposits, especially for terms of one year or less. As a result, rate sensitive depositors moved their funds to other investment opportunities. Asset quality metrics showed improvement through more robust problem asset identification and resolution efforts, including the impaired loan sales in June 2014 and June 2013. Nonperforming loans declined 61.8% to $5.1 million, or 1.4% of total loans, at December 31, 2014 from $13.4 million, or 3.6% of total loans, at December 31, 2013. Nonperforming assets decreased 64.3% to $5.4 million, or 1.1% of total assets, at December 31, 2014 from $15.2 million, or 3.1% of total assets, at December 31, 2013.

 

The $1.2 million decrease in the loan portfolio during 2014 was attributable to a decrease of $9.0 million in real estate loans ($6.2 million in residential mortgage loans, $2.2 million in construction and land development loans and $0.6 million in commercial real estate loans). These decreases were partially offset by increases of $5.8 million in other consumer loans, $1.7 million in home equity loans and $0.3 million in commercial business loans. Impaired loan sales in mid-2014 was the largest factor contributing to the decrease in real estate loans. In addition, the $2.2 million decline in construction and land development loans resulted from the Bank’s self-imposed moratorium on new originations as well as workout efforts in this segment. The $5.8 million increase in other consumer loans was due to the Bank’s acquisition of indirect auto loans during the first nine months of 2014. The $1.7 million increase in home equity loans was the result of product promotions and increased marketing efforts related to this product.

 

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Results of Operations for the Years Ended December 31, 2014 and 2013

 

Earnings Summary. Net income of $1.0 million, or $0.15 per diluted common share, was recorded for the year ended December 31, 2014 compared to a net loss of $8.8 million, or ($1.33) per diluted common share for the year ended December 31, 2013. The improvement in earnings was primarily the result of a $5.9 million favorable change in the provision for loan losses as well as a $3.1 million increase in non-interest income and a $0.7 million decrease in non-interest expenses.

 

Average Balances and Yields. The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities and the resulting average yields and costs. Average loans include nonaccrual loans, the effect of which is to lower the average yield.

 

   Year Ended December 31, 
   2014   2013   2012 
       Interest   Annualized       Interest   Annualized       Interest   Annualized 
   Average   Earned/   Average   Average   Earned/   Average   Average   Earned/   Average 
   Balance   Paid   Yield/Rate   Balance   Paid   Yield/Rate   Balance   Paid   Yield/Rate 
    (Dollars in thousands)
Interest-earning assets                                             
Loans  $371,296   $16,851    4.54%  $409,784   $19,323    4.72%  $455,053   $23,054    5.07%
Investment securities and Fed Funds sold   94,624    2,823    2.98    49,956    1,209    2.42    55,374    1,487    2.69 
Overnight funds   6,741    19    0.28    22,568    59    0.26    16,129    40    0.25 
Federal Home Loan Bank stock   5,008    78    1.56    5,557    21    0.38    5,989    30    0.50 
Total interest-earning assets   477,669    19,771    4.14%   487,865    20,612    4.22%   532,545    24,611    4.62%
Non interest-earning assets   22,595              21,786              24,812           
Total assets  $500,264             $509,651             $557,357           
Interest-bearing liabilities                                             
Certificate accounts  $150,550    2,020    1.34%  $162,956    2,346    1.44%  $190,365    3,301    1.73%
Regular savings accounts & escrow   116,128    193    0.17    120,572    284    0.24    115,964    366    0.32 
Checking and NOW accounts (1)   94,563    131    0.14    86,122    112    0.13    74,737    63    0.08 
Money market savings accounts   24,894    42    0.17    27,195    63    0.23    27,487    78    0.28 
Total interest-bearing deposits   386,135    2,386    0.62    396,845    2,805    0.71    408,553    3,808    0.93 
FHLB advances   48,040    723    1.50    33,817    847    2.50    54,771    1,532    2.80 
Other borrowings   3,383    -    0.00    10,866    26    0.24    11,126    45    0.40 
Total interest-bearing liabilities   437,558    3,109    0.71%   441,528    3,678    0.83%   474,450    5,385    1.13%
Non interest-bearing liabilities   3,755              4,607              4,329           
Total liabilities   441,313              446,135              478,779           
Total stockholders' equity   58,951              63,516              78,578           
Total liabilities and stockholders' equity  $500,264             $509,651             $557,357           
Net interest income       $16,662             $16,934             $19,226      
Net interest spread             3.43%             3.39%             3.49%
Net interest margin             3.49%             3.47%             3.61%
Average interest earning assets to average interest bearing liabilities             109.17%             110.49%             112.24%

(1) Includes mortgagor's escrow accounts

 

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Rate / Volume Analysis. The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to the changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). For purposes of this table, changes attributable to changes in both rate and volume have been allocated proportionately.

 

   Year Ended December 31, 
   2014 Compared to 2013   2013 Compared to 2012 
   Increase ( Decrease) Due To   Increase ( Decrease) Due To 
   Volume   Rate   Total   Volume   Rate   Net 
   (In thousands) 
Interest income:                              
Loans  $(1,758)  $(714)  $(2,472)  $(2,202)  $(1,529)  $(3,731)
Investment securities / Federal Funds sold   880    734    1,614    (137)   (141)   (278)
Overnight funds   (41)   1    (40)   16    2    18 
Federal Home Loan Bank stock   (3)   60    57    (2)   (7)   (9)
Total interest income   (922)   81    (841)   (2,325)   (1,675)   (4,000)
Interest expense:                              
Certificate accounts   (171)   (155)   (326)   (441)   (514)   (955)
Regular savings accounts   (11)   (80)   (91)   15    (97)   (82)
Checking and NOW accounts   11    8    19    8    41    49 
Money market savings accounts   (5)   (16)   (21)   (1)   (14)   (15)
Total deposit expense   (176)   (243)   (419)   (419)   (584)   (1,003)
FHLBB advances   327    (451)   (124)   (535)   (150)   (685)
Other borrowings   (11)   (15)   (26)   (1)   (18)   (19)
Total interest expense   140    (709)   (569)   (955)   (752)   (1,707)
Increase (decrease) in net interest income  $(1,062)  $790   $(272)  $(1,370)  $(923)  $(2,293)

 

Net Interest Income. Net interest income for the year ended December 31, 2014 was $16.7 million compared to $16.9 million for 2013, a decrease of $272,000 or 1.6%. The $841,000, or 4.1%, decrease in total interest income on earning assets was attributable to both volume and rate, mostly related to loans. Average interest earning assets for 2014 decreased by $10.2 million, or 2.1%, which resulted in an unfavorable volume variance of $922,000. The impact of the reduction in asset yields from 4.22% for 2013 to 4.14% for 2014 for an overall 0.08% yield reduction was responsible for the remaining $81,000 unfavorable variance. Average loan balances decreased $38.5 million. As mentioned previously, the decrease in average loans was attributable to the mid-year 2014 sales of credit impaired loans, problem loan remediation results, including payoffs and charge-offs, loan runoff and payoffs exceeding the slow loan demand year over year. The $44.7 million year-over-year increase in the average balance of investment securities partially mitigated the impact of the unfavorable loan volume variance as management purchased a significant amount of securities in early 2014 as earning asset placeholders for loans to be originated in latter 2014. The decrease in overall asset yields was the result of average loan yields declining 0.18% from the continued decline in market rates and a change in asset mix from loans to lower yielding investments.

 

Interest expense for 2014 decreased $569,000 compared to the prior year, of which $419,000 was related to deposits. This $419,000 decrease in interest expense on deposits was attributable to both favorable variances in volume for $176,000 and rate for $243,000. Average deposit balances decreased by $10.7 million for 2014 compared to 2013 primarily due to the $12.4 million decline in the average balances of time deposits. This movement in time deposits was partially diminished by an increase in lower costing transaction accounts. This deposit mix shift and the decline in the level of market interest rates, particularly our offering rates on time deposits, were the predominant factors for the year over year reduction in the cost of deposits from 0.71% for 2013 to 0.62% for 2014. Interest expense on borrowed funds decreased by $150,000 from 2013 to 2014 primarily as a result of a decrease in the average cost of FHLB advances from 2.50% for 2013 to 1.50% for 2014. This decrease in the average cost of FHLB advances was due to the restructuring of $15.4 million shorter term, higher costing FHLB advances into longer term, lower costing FHLB advances in August 2013 as well as a decline in the market interest rates on new FHLB advances borrowed during 2014. Partially mitigating the impact of the favorable rate variance on the cost of borrowed funds, the average balance of FHLB advances increased by $14.2 million.

 

Net interest rate spread, which is the combination of the weighted average of interest earning assets less interest bearing liabilities, as of December 31, 2014 was 3.43%. This represents an increase of 4 basis points from 3.39% as of December 31, 2013.

 

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Net interest income for the year ended December 31, 2013, totaled $16.9 million compared to $19.2 million for the year ended December 31, 2012, a decrease of $2.3 million or 11.9%. The decrease in net interest income was primarily due to a decrease of $4.0 million in interest income partially offset by a $1.7 million decrease in interest expense. The $4.0 million, or 16.2%, decrease in interest income was attributable to unfavorable variances in volume and rate. Average interest earning assets decreased by $44.7 million primarily due to the $45.3 million decrease in the average loan balances which resulted from the June 2013 credit impaired loan sales, problem loan remediation results and loan runoff exceeding the slow loan demand year-over-year. The impact of the reduction in asset yields of 0.40%, of which 0.35% was related to loans, was responsible for the remaining $1.7 million in unfavorable rate variance for interest earning assets. The 2013 year-over-year decrease in the interest expense was attributable to favorable variances of volume and rate. The average balances of total interest bearing liabilities declined by $32.9 million year-over-year, of which borrowed funds accounted for a decrease of $21.2 million, along with an $11.7 million decrease in average deposit balances. The average balance of FHLB advances decreased by $21.0 million year-over-year, resulting from the Bank repaying its maturing advances as the average loan balances declined. The $11.7 million decline in average deposit balances was primarily due to the $27.4 million decrease in time deposits and the shift of depositor funds into lower yielding savings and transaction accounts. The Bank’s cost of funds decreased by 30 basis points year-over-year mostly as a result of the decline in market interest rates during 2012 and 2013 as well as the shift in deposit mix and the payoff of higher costing FHLB advances.

 

Net interest rate spread, which is the combination of the weighted average of interest earning assets less interest bearing liabilities, as of December 31, 2013 was 3.39%. This represents a decrease of 10 basis points from 3.49% as of December 31, 2012.

 

Provision for Loan Losses. During the year ended December 31, 2014, a credit provision of $1.7 million was made to the allowance for loan losses which was $5.9 million more favorable than the $4.2 million provision made for 2013. The Company experienced net charge-offs of $2.1 million during 2014 compared to $8.8 million during 2013. The decrease in the provision expense was substantially due to the improvement in the Company’s asset quality trends during this twelve month period. The balance for the allowance for loan losses decreased from $9.9 million at December 31, 2013 to $6.0 million at December 31, 2014, a decrease of $3.9 million, or 39.1%. This ALLL decrease was directionally consistent with the improvement in the Company’s asset quality trends during 2014. During the year, nonperforming loans decreased $8.2 million, or 61.6%, and its adversely classified loans decreased by $8.8 million, or 54.0%. Furthermore, the improvement in the risk profile of the loan portfolio can also be demonstrated by the significant reduction in loans classified as special mention of $25.9 million, or 79.8%. These improvements in the Company’s asset quality were attributed to the aggressive workout efforts in the past year, including the credit impaired loan sale transactions in mid-year 2014.

 

During the year ended December 31, 2013, a provision of $4.2 million was recorded to the allowance for loan losses which was $13.58 million less than the provision recorded for 2012. The Company experienced net charge-offs of $8.76 million during 2013 compared to $11.3 million during 2012. The decrease in the provision expense was primarily due to the improvement in the Company’s asset quality trends during this twelve month period. The balance for the allowance for loan losses decreased from $14.5 million at December 31, 2012 to $9.9 million at December 31, 2013, a decrease of $4.6 million, or 31.8%. This ALLL decrease was also directionally consistent with the improvement in the Company’s asset quality trends during 2013. During the year, nonperforming loans decreased $12.3 million, or 47.8%, and its adversely classified loans decreased by $23.2 million, or 58.6%. Furthermore, the improvement in the risk profile of the loan portfolio is reflected by the significant reduction in construction and land development loans of $21.0 million, or 78.9%, and, to a lesser extent, reductions in multi-family and commercial real estate loans of $10.4 million, or 7.8%, and in commercial business loans of $7.5 million, or 22.6%. These improvements in the Company’s asset quality were attributed to the more aggressive workout efforts than in 2012, including the credit impaired loan sale transactions in June 2013.

 

While we believe we have established the allowance for loan losses in accordance with generally accepted accounting principles, there can be no assurance that regulators, in reviewing the Bank’s loan portfolio, will not require management to increase significantly the allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the allowance for loan losses at December 31, 2014 is appropriate or that increased provisions will not be necessary should the quality of the loans deteriorate. Any material increase in the allowance for loan losses would adversely affect the Company’s financial condition and results of operations. For additional information, see “Item 1. Business-Analysis of Allowance for Loan Losses.

 

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Noninterest Income. The following table shows the components of noninterest income for 2014, 2013, and 2012.

 

(In thousands)  2014   2013   2012 
Mortgage banking income  $1,085   $1,317   $2,797 
Service charge income   711    756    815 
Fees for other services   299    302    370 
Income from bank owned life insurance   261    278    299 
Income from investment advisory services, net   348    234    242 
Net gain (loss) on sale of investments   1,428    (4)   - 
Other than temporary impairment on investments   -    (1,812)   - 
Other income   135    101    102 
Total  $4,267   $1,172   $4,625 

 

Noninterest income for 2014 was $4.3 million compared to $1.2 million for 2013, an increase of $3.1 million, or 264.1%. The increase was primarily due to the gain on sale of investments of $1.4 million and no other-than-temporary impairment charge in 2014. The $232,000, or 17.6%, decrease in mortgage banking income was primarily attributable to a $376,000 decrease in gains on sales of mortgage loans which resulted from lower origination and sales volume in 2014. This was partially offset by a $144,000 increase in income related to mortgage servicing, including the $370,000 gain on the sale of mortgage servicing rights in 2014. Service charges on deposits decreased by $45,000, or 6.0%, due to a lower volume of overdraft transactions as a result of increased monitoring of this activity. The $114,000, or 48.7%, increase in income from investment advisory services was due to an increase in year-over-year sales volume, particularly in annuity products which have higher than average commission rates. Other income increased by $34,000, or 33.7%, year-over-year as a result of increased rental income of $40,000 during 2014.

 

Noninterest income for 2013 was $1.2 million compared to $4.6 million for 2012, a decrease of $3.5 million, or 74.7%. In addition to the $1.8 million in other-than-temporary impairment charge taken in 2013, the decrease was primarily related to the $1.5 million, or 52.9%, decrease in mortgage banking income. The decrease in mortgage banking income, associated with sales of one-to-four family fixed rate mortgages in the secondary market, was due to a $1.4 million decrease in gains on sales of one-to-four family fixed rate mortgage loans in the secondary market resulting from lower origination and sales volume in 2013. The other component of mortgage banking income, mortgage servicing income, decreased by $81,000, or 19.1%, due to the decrease of $82,000, or 19.1% in reverse mortgage income. Service charges on deposits decreased $59,000, or 7.2%, due to a lower volume of overdraft transactions as a result of the Bank more aggressively monitoring and controlling such activity. Fees for other services decreased by $68,000, or 18.4%, due primarily to the decreases in loan related fees of $57,000, or 78.3%.

 

Noninterest Expense. The following table shows the components of noninterest expense for 2014, 2013 and 2012.

 

(In thousands)  2014   2013   2012 
Compensation, taxes and benefits  $11,717   $10,840   $11,042 
Office occupancy   2,220    1,935    1,879 
FDIC insurance premiums   781    939    674 
Professional fees   1,564    1,979    1,867 
Computer processing   1,443    1,297    1,163 
Directors' compensation   328    351    592 
Insurance and surety bond   613    576    233 
Advertising   433    465    514 
Property taxes on loan sales   250    776    - 
Expenses on foreclosed real estate, net   436    874    447 
Writedowns on foreclosed real estate   173    263    77 
Office supplies   264    228    240 
Other expenses (1)   1,466    1,902    2,498 
Total  $21,688   $22,425   $21,226 

 

(1)Other expenses for all periods include, among other items, postage and expenses related to checking.

 

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Noninterest expense for 2014 was $21.7 million compared to $22.4 million, a decrease of $737,000, or 3.3%. The year-over-year decrease was primarily due to decreases in property taxes on loan sales of $526,000, expenses on foreclosed real estate of $438,000 and related writedowns of $90,000 for an aggregate decrease of $528,000, professional fees of $415,000, FDIC insurance premiums of $158,000, and other expenses of $436,000. These decreases were partially offset by increases in compensation, taxes and benefits of $877,000, occupancy expense of $285,000 and computer processing of $146,000. The $528,000, or 46.4%, decrease in expenses on foreclosed real estate was attributable to a lower balance of foreclosed properties in 2014 with less attendant costs of acquiring, maintaining and selling foreclosed real estate, including fewer write downs and lower net losses on sales of foreclosed properties in 2014. The $526,000, or 67.8%, reduction in property taxes on loan sales was primarily attributable to the lower volume of credit impaired loans sold in 2014 and their property tax status compared to those sold in 2013. The $415,000, or 21.0%, decrease in professional fees was attributable to a significantly decreased use of consultants during 2014, in particular compared to the use of transitional accounting and finance staffing in the first four months of 2013 and reductions in outsourced internal audit work. The $436,000, or, 22.9%, decrease in other expenses was due to: (1) a $95,000 decrease in supervisory assessments attributable to lower regulatory surcharges in 2014; (2) a $182,000 in securitization expenses in 2013 related to the Bank securitizing $13.6 million of residential mortgage loans into mortgage-backed securities; (3) $184,000 in primarily appraisals on problem workout loans during 2013; and (4) $105,000 for recruiter fees related to three senior management executives hired in 2013. The $158,000, or 16.8%, decrease in FDIC insurance premiums resulted from a lower premium assessment beginning in the second quarter of 2014. The $877,000, or 8.1%, increase in compensation, taxes and benefits was attributable to the following: (1) the full year impact of the new executive management team and other staff additions which were partially offset by mid-year 2014 staffing reductions in force in the residential lending and servicing areas; (2) $487,000 reduction in post retirement benefit expense as the Bank discontinued, in November 2013, a program to provide certain healthcare benefits to retired employees; and (3) increases in benefits expense ranging from medical insurance to employee stock ownership plan (“ESOP”) expense due to an increase in NVSL stock price and stock compensation expense for stock options granted in 2014. Occupancy expenses increased by $285,000, or 14.7%, primarily due to: $55,000 increase in utilities; $63,000 increase in property taxes; $59,000 increase in rental expense; and $90,000 increase in amortization of capitalized software and depreciation on facilities. In December 2013, the Bank placed into service a network computer server room at its headquarters at an approximate cost of $250,000 which accounted for $35,000 of the increased expense in 2014. In early 2014, the Bank replaced the automated teller machines (“ATM”) at three locations and purchased licenses for new commercial lending documentation software as well as general ledger system upgrades and increased user licenses for the Bank’s core processing system. Computer processing increased by $146,000, or 11.3%, primarily due to the full year impact of new systems applications, which were used beginning in mid-2013 and were related to regulatory reporting, the calculation of the Bank’s allowance for loan losses and management analysis, including peer bank data comparisons.

 

Noninterest expense for 2013 was $22.4 million compared to $21.2 million in 2012, an increase of $1.2 million, or 5.6%. The year-over-year increase was primarily the result of $776,000 of delinquent property taxes incurred on credit impaired loans sold in the loan sale transactions in June 2013 as well as increases in expenses on foreclosed real estate of $427,000 and related writedowns of $186,000 for an aggregate increase of $613,000, insurance and surety bond expense of $343,000, FDIC insurance premiums of $265,000, computer processing of $134,000, professional fees of $112,000 and occupancy expense of $56,000. These increases were partially offset by decreases in other expenses of $596,000, directors’ compensation of $241,000, compensation, taxes and benefits of $202,000 and advertising of $49,000. The $613,000, or 117%, increase in expenses in foreclosed real estate was attributable to increased foreclosure activity in 2013 with the attendant costs of acquiring, maintaining and selling foreclosed real estate, including fewer write downs and net losses on sales of $68,000 during 2013. The increase in insurance and surety bond expense was due to premium increases in directors’ and officers’ liability and blanket bond insurance, resulting from regulatory issues. The increase in FDIC insurance premiums was also due to regulatory issues, more specifically the regulatory agreement. The increase in computer processing was primarily due to an $86,000 increase in software service maintenance contracts as well as increases in the cost of outsourced data processing and network security. Professional fees were higher in 2013 due to $242,000 increase in external audit fees mostly related to a change in independent registered public accountant during 2013, $137,000 increase in internal audit and risk management consulting services, $102,000 increase in supervisory assessments related to the regulatory agreement, partially offset by a $267,000 decrease in legal services. The higher legal services in 2012 were related to the January 2012 regulatory agreement with the OCC. Occupancy expenses increased by $56,000 primarily due to $76,000 increase in repairs and maintenance and $18,000 in utilities partially offset by reductions in depreciation and other occupancy expenses. Other expenses decreased $596,000 primarily due to $712,000 of expenses in the first quarter of 2012 related to the underpayment of interest on certain time deposits which did not recur in 2013. The decrease in compensation, taxes and benefits was primarily due to the following factors: (1) The cost of hiring new management team and other new staff additions; (2) discontinuation of certain post retirement benefits; and (3) other changes in employee benefits. The year-over-year increase in compensation expense for the new management team and staff additions of $202,000 was partially reduced by a reduction in temporary staffing of $78,000 for a net increase of $124,000. In 2013, the Company discontinued certain post retirement benefits which had the impact of reducing the accrued liability of $487,000 in comparison to the $86,000 in expenses for these benefits during 2012. The other $124,000 decrease in benefits was attributed to a $174,000 decrease in pension expense for the Company’s frozen defined benefit plan partially offset by the cost of employee benefits for the increase in personnel during 2013. The $241,000 decrease in director’s compensation was a result of fewer meetings and fewer average number of non-employee directors during 2013.

 

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Provision for Income Taxes. The Company recorded an income tax benefit of $13,000 for the year ended December 31, 2014 compared to income tax expense of $370,000 for 2013 and $148,000 for 2012. At December 31, 2014 and 2013, there was a 100% valuation allowance on the deferred tax asset in the amount of $16.0 million and $8.7 million, respectively. At December 31, 2014, the Company has recaptured all available prior year taxes paid and has a net operating loss carryforward of $13.2 million. See Note 14 Income Taxes in the Consolidated Financial Statements in this Annual Report on Form 10-K for further disclosure on this matter.

 

Asset / Liability Management

 

Our most significant form of market risk is interest rate risk. We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts may react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. To reduce the potential volatility of our earnings, we have sought to improve the match between assets and liability maturities (or rate adjustment periods), while maintaining an acceptable interest rate spread, by originating adjustable-rate mortgage loans for retention in our loan portfolio, variable-rate home equity lines and variable-rate commercial loans and by purchasing variable-rate investments and investments with expected maturities of less than 10 years. We currently do not participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative financial instruments.

 

Our Asset/Liability Committee communicates, coordinates and controls all aspects of asset/liability management. The Committee establishes and monitors the volume and mix of assets and funding sources.

 

We also use a third party consultant to perform interest rate sensitivity and net interest income simulation analysis. The net interest income simulation measures the volatility of net interest income as a consequence of different interest rate conditions at a particular point in time. Using a range of assumptions, the simulations provide an estimate of the impact of changes in market interest rates on net interest income. The various assumptions used in the model are reviewed on a quarterly basis by the Asset/Liability Committee. Changes to these assumptions can significantly affect the results of the simulation.

 

The following table, which is based on information that we provided to our third party consultant as of December 31, 2014, presents an approximation of our exposure as a percentage of estimated net interest income for the next 12-month period using net interest income simulation. The simulation uses projected repricing of assets and liabilities on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. In addition, assumptions are made on the speed with which changes in market interest rates will be reflected in our deposit pricing and the speed at which our customers will react to changes in market interest rates by either moving their deposits or paying their loans prior to their scheduled maturity. Our third party consultant also performs dynamic modeling. This type of modeling employs a further set of assumptions attempting to simulate scenarios that are more likely to occur than an immediate and sustained shock of 100 to 400 basis points and includes the business planning strategies such as budgeted balance sheet growth. The change in market interest rates in these simulations are assumed to occur immediately with no mitigating activity by management.

 

Changes in Market Rates   At December 31, 2014
Percentage Change in
Estimated Net Interest
Income Over 12 Months
 
 +400 bps    2.7%
 +300 bps    2.6%
 +200 bps    2.4%
 +100 bps    1.4%
 0 bps     
 -100 bps    (3.7)%

 

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Economic Value of Equity Analysis. We also use an interest rate sensitivity analysis to measure interest rate risk by computing changes in the value of the Company as measured by changes in our Economic Value of Equity. The Economic Value of Equity represents the market value of balance sheet equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items which is calculated using the estimated cash flows resulting from the assumed liquidation of assets, liabilities and off-balance sheet items given a range of assumed changes in market interest rates. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 400 basis point increase or a 100 basis point decrease in market interest rates with no effect given to any steps that we might take to counter the effect of that interest rate movement. The following table presents the change in the net value of Naugatuck Valley Financial at December 31, 2014 that would occur in the event of an immediate change in interest rates.

 

    Economic Value of Equity 
Changes in Market
Interest Rates
   $ Amount   $ Change   % Change   EVE Ratio   Change 
    (Dollars in thousands)         
 +400 bps   $51,254   $(23,974)   (31.87)%   11.48%   (3.41)%
 +300 bps   $58,678   $(16,550)   (22.00)%   12.71%   (2.18)%
 +200 bps   $65,626   $(9,602)   (12.76)%   13.75%   (1.14)%
 +100 bps   $71,103   $(4,125)   (5.48)%   14.47%   (0.42)%
 0 bps   $75,228    -    -    14.89%   - 
 -100 bps   $81,298   $6,070    8.07%   15.73%   0.84%

 

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

 

Liquidity Management

 

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

 

Each quarter we project liquidity availability and demands on this liquidity for the next 90 days. We regularly adjust our investments in liquid assets based upon our assessment of: (1) expected loan demand; (2) expected deposit flows; (3) yields available on interest-earning deposits and securities; and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in federal funds and short- and intermediate-term U.S. Government agency obligations.

 

Our most liquid assets are cash and cash equivalents and interest-bearing deposits. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At December 31, 2014, cash and cash equivalents totaled approximately $10.9 million. The Bank was required to hold compensating balances of $717,000 for normal branch operations and perfunding of offical bank checks at December 31, 2014. Securities classified as available for sale, which provide additional sources of liquidity, totaled $77.5 million. At December 31, 2014, we had the ability to borrow a total of $76.3 million from the Federal Home Loan Bank of Boston, of which $53.8 million was outstanding.

 

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At December 31, 2014, we had $19.1 million in unused line availability on home equity lines of credit, $12.6 million in un-advanced commercial lines, $30.3 million in commercial mortgage loan commitments, $600,000 in letters of credit and $7.3 million in other commitments. Certificates of deposit due within one year of December 31, 2014 totaled $56.9 million, or 15.2% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and lines of credit. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before December 31, 2014. We believe, however, based on past experience, a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

 

Naugatuck Valley Financial is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, Naugatuck Valley Financial, on a stand-alone basis, is responsible for paying any dividends declared to its shareholders. Naugatuck Valley Financial’s primary source of income is dividends received from the Bank. Under the written Formal Agreement with its primary regulator, the Bank is restricted from declaring or paying any dividends or other capital distributions to the Company without prior written regulatory approval. This provision relates to the up streaming intercompany dividends or other capital distributions from the Bank to the Company. On a stand-alone basis, Naugatuck Valley Financial had liquid assets of $3.3 million at December 31, 2014 which could be down streamed as a capital contribution to the Bank.

 

Historically, we have remained highly liquid. We expect that all of our liquidity needs, including the contractual commitments set forth in the table below and increases in loan demand can be met by our currently available liquid assets and cash flows. If loan demand were to increase at a pace greater than expected, or any unforeseen demand or commitment were to occur, we would access our borrowing capacity with the Federal Home Loan Bank of Boston. We expect that our currently available liquid assets and our ability to borrow from the Federal Home Loan Bank of Boston would be sufficient to satisfy our liquidity needs without any material adverse effect on our liquidity. We are not aware of any trends and/or demands, commitments, events or uncertainties that could result in a material decrease in liquidity.

 

The following table presents certain of our contractual obligations as of December 31, 2014.

 

   Payments Due by Period 
Contractual Obligations  Total   Less Than
One Year
   One to
Three Years
   Three to
Five Years
   More than
Five Years
 
   (In thousands) 
Operating lease obligations (1)  $7,779   $352   $705   $718   $6,004 
FHLB advances and other borrowings (2)   53,762    6,792    42,832    3,420    718 
Total  $61,541   $7,144   $43,537   $4,138   $6,722 

 

(1)Represents lease obligations for four of Naugatuck Valley Savings’ branch offices and three other properties, one of which is subleased to other tenants.
(2)Represents principal amounts due.

 

Our primary investing activities are the origination of loans and the purchase and sale of securities. Our primary financing activities consist of activity in deposit accounts and borrowed funds. Deposit flows are affected by the overall levels of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive and to increase core deposit relationships. Occasionally, we offer promotional rates on certain deposit products to attract deposits.

 

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The following table presents cash flows provided by (used in) our primary investing and financing activities during the periods indicated.

 

   Year Ended December 31, 
(In thousands)  2014   2013 
Investing activities:          
Loan originations, net of principal payments  $(9,892)  $21,619 
Security purchases   (83,532)   (21,183)
Security sales   43,367    751 
Security maturities, call and principal repayments   19,981    12,502 
Financing activities:          
Decreases in deposits   (17,388)   (12,055)
Net increase (decrease) in FHLB advances   28,469    (16,183)
Decrease in other borrowings   (4,173)   (2,221)

 

Capital Management. The Bank is subject to various regulatory capital requirements administered by the Office of the Comptroller of the Currency. Effective June 4, 2013, the OCC imposed individual minimum capital requirements (“IMCRs”) on the Bank. The IMCRs require the Bank to maintain a Tier 1 leverage capital to adjusted total assets ratio of at least 9.00% and a total risk-based capital to risk-weighted assets ratio of at least 13.00%. Before the establishment of the IMCRs, the Bank had been operating under these capital parameters by self-imposing these capital levels as part of the capital plan the Bank was required to implement under the terms of the previously disclosed January 2012 Formal Agreement between the Bank and the OCC. The Bank exceeded the IMCRs at December 31, 2014 with a Tier 1 leverage ratio of 11.13% and a total risk-based capital ratio of 18.67%.

 

As a source of strength to its subsidiary bank, the Company had liquid assets of approximately $3.3 million at December 31, 2014 which the Company could contribute to the Bank, if needed, to enhance the Bank’s capital levels. If the Company had contributed those assets to the Bank as of December 31, 2014, the Bank would have had a Tier 1 leverage ratio of approximately 11.81%.

 

The Bank is considered “adequately capitalized” under regulatory guidelines. See “Regulation and Supervision—Regulation of Federal Savings Associations—Capital Requirements,” and “—Regulatory Capital Compliance” and the notes to the consolidated financial statements included in this Annual Report on Form 10-K.

 

Off-Balance Sheet Arrangements

 

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, unused lines of credit, amounts due mortgagors on construction loans, amounts due on commercial loans, commercial letters of credit and commitments to sell loans. See Note 16 of the notes to the financial statements in this Annual Report on Form 10-K.

 

For the years ended December 31, 2014 and 2013, we engaged in no off-balance-sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

 

Impact of Recent Accounting Pronouncements

 

The information required by this item is included in Note 1 to the consolidated financial statements for Naugatuck Valley Financial included in this Annual Report on Form 10-K.

 

Effect of Inflation and Changing Prices

 

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

 

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ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

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

 

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.

 

The information regarding this item is included herein beginning on page F-1.

 

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

 

On April 8, 2013, the Audit Committee of Naugatuck Valley Financial, on behalf of the Company and its subsidiary bank, notified Whittlesley & Hadley, P.C. that they will be dismissed as the Company’s independent public accountants upon completion of the audit for the fiscal year ended December 31, 2012. The decision to change independent public accountants was approved by the Audit Committee.

 

During the two years ended December 31, 2012, and the subsequent interim period through April 1, 2013, there have been no disagreements with Whittlesley & Hadley, P.C. on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to the satisfaction of Whittlesley & Hadley, P.C., would have caused them to make reference to such disagreements in their report on the financial statements for such years. During the two fiscal years ended December 31, 2012 and the subsequent period through April 1, 2013, there have been no reportable events (as defined in Regulation S-K Item 304 (a) (1)(V)). The audit reports of Whittlesley & Hadley, P.C. on the Company’s Consolidated Financial Statements as of and for the years ended December 31, 2012 and 2011 does not contain an adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles.

 

On April 8, 2013, the Audit Committee engaged the firm of McGladrey LLP as independent public accountants of the Company and its subsidiaries for the fiscal year ending December 31, 2013. During the years ended December 31, 2014 and December 31, 2013, there were no disagreements with McGladrey LLP, and the audit reports of McGladrey LLP on the Company’s Consolidated Financial Statements for the two years ended December 31, 2014 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.

 

ITEM 9A.CONTROLS AND PROCEDURES.

 

Disclosure Controls and Procedures

 

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer (collectively, the "Certifying Officers"), our management has evaluated the effectiveness of internal control over financial reporting, including controls over the preparation of financial statements, as of December 31, 2014. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, the Company’s disclosure controls and procedures are effective in ensuring that information relating to the Company required to be disclosed in reports that it files under the Securities Exchange Act of 1934 is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2)accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Management’s Report On Internal Control Over Financial Reporting

 

The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-l5(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with US generally accepted accounting principles. Because of their inherent limitations, systems of internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to financial statement preparation and presentation.

 

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The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting, including controls over the preparation of financial statements, based on the framework in Internal Control – Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that, as of December 31, 2014, the Company’s internal control over financial reporting is effective based on these criteria.

 

Management is also responsible for compliance with laws and regulations relating to safety and soundness which are designated by the Bank’s primary federal banking regulatory agency, the OCC. As previously disclosed in this document, the Bank, by and through its Board of Directors, executed effective January 17, 2012 a Formal Agreement with the OCC. Management has assessed its compliance with these designated laws and regulations relating to safety and soundness and believes that the Bank has complied, in all significant respects, with such laws and regulations during the year ended December 31, 2014.

 

Attestation Report of the Registered Public Accountant

 

Because the Company’s market capitalization was less than the $75 million threshold, the Company is exempt from the Sarbanes-Oxley Section 404(b) auditor attestation on management’s assessment of its internal controls.

 

Changes to Internal Control Over Financial Reporting

 

There were no changes in the Company’s internal control over financial reporting during the year ended December 31, 2014 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

 

ITEM 9B.OTHER INFORMATION

 

Not applicable.

PART III

 

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

 

Directors

 

For information concerning Naugatuck Valley Financial’s directors, the information contained under the section captioned “Item 1—Election of Directors” in Naugatuck Valley Financial’s Proxy Statement for the 2015 Annual Meeting of Stockholders (the “Proxy Statement”) is incorporated herein by reference.

 

Executive Officers

 

For information relating to officers of Naugatuck Valley Financial, the section captioned “Item 1—Election of Directors” in the Proxy Statement, and Part I, Item 1, “Business—Executive Officers of the Registrant” in this Annual Report on Form 10-K, are incorporated by reference.

 

Compliance with Section 16(a) of the Exchange Act

 

For information regarding compliance with Section 16(a) of the Exchange Act, the information contained under the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement is incorporated herein by reference.

 

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Disclosure of Code of Ethics

 

Naugatuck Valley Financial has adopted a Code of Ethics and Business Conduct, a copy of which has been filed as an exhibit to this Form 10-K.

 

Corporate Governance

 

For information regarding the audit committee and its composition and the audit committee financial expert, the section captioned “Corporate Governance and Board Matters” in the Proxy Statement is incorporated herein by reference.

 

ITEM 11.EXECUTIVE COMPENSATION

 

The information regarding executive compensation is set forth under the section captioned “Executive Compensation” in the Proxy Statement and is incorporated herein by reference.

 

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS

 

(a)Security Ownership of Certain Beneficial Owners

 

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

 

(b)Security Ownership of Management

 

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

 

(c)Changes in Control

 

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

 

(d)Equity Compensation Plan Information

 

The following table sets forth information as of December 31, 2014 about Company common stock that may be issued under the Naugatuck Valley Financial Corporation 2005 Equity Incentive Plan. The plan was approved by the Company’s stockholders.

 

Plan Category  Number of securities
to be issued upon 
the exercise of 
outstanding options,
warrants and rights
   Weighted-average
exercise price of
outstanding options,
warrants and rights
   Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in the first
column)
 
             
Equity compensation plans approved by security holders   99,110   $9.36    60,613 
                
Equity compensation plans not approved by security holders   n/a    n/a    n/a 
                
Total   99,110   $9.36    60,613 

 

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ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

The information relating to certain relationships and related transactions and director independence is set forth under the sections captioned “Transactions with Related Persons” and “Corporate Governance and Board Matters – Director Independence” in the Proxy Statement and is incorporated herein by reference.

 

ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information relating to the principal accountant fees and services is set forth under the section captioned “Ratification of the Independent Registered Public Accounting Firm” in the Proxy Statement and is incorporated herein by reference.

 

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PART IV

 

ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

 

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

 

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

 

(3)Exhibits

 

Exhibit No.   Description
3.1   Articles of Incorporation of Naugatuck Valley Financial Corporation (1)
3.2   Bylaws of Naugatuck Valley Financial Corporation (2)
4.1   Specimen Stock Certificate of Naugatuck Valley Financial Corporation (3)
10.1   Naugatuck Valley Financial Corporation and Naugatuck Valley Savings Deferred Compensation Plan for Directors (4)*
10.2   Form of Naugatuck Valley Savings Employee Severance Compensation Plan (5)*
10.3   Naugatuck Valley Financial Corporation 2005 Equity Incentive Plan (6)*
10.4   Employment Agreement by and between Naugatuck Valley Savings and Loan and William C. Calderara dated July 7, 2014(7)*
10.5   Employment Agreement by and between Naugatuck Valley Savings and Loan and James E. Cotter dated July 24, 2014 (8)*
10.6   Agreement by and between Naugatuck Valley Savings and Loan and the Comptroller of the Currency, dated January 17, 2012 (9)
14.0   Code of Ethics and Business Conduct (10)
21.0   List of Subsidiaries
23.1   Consent of Whittlesey & Hadley, P.C.
23.2   Consent of McGladrey, LLP
31.1   Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2   Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.0   Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
101.0   The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Changes In Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements.

 

*Management contract or compensation plan arrangement

(1)Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, as amended, initially filed on June 11, 2011.
(2)Incorporated herein by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1, as amended, initially filed on June 11, 2011.
(3)Incorporated herein by reference to Exhibit 4.0 to the Company’s Registration Statement on Form S-1, as amended, initially filed on June 11, 2011.
(4)Incorporated herein by reference to Exhibit 10.1 to the Naugatuck Valley Financial Corporation (File No. 000-50876) Quarterly Report on Form 10-Q for the three months ended March 31, 2007, filed on May 15, 2007.
(5)Incorporated herein by reference to Exhibit 10.8 to the Naugatuck Valley Financial Corporation (File No. 333-116627) Registration Statement on Form S-1, as amended, initially filed on June 18, 2004.
(6)Incorporated herein by reference to Appendix C to the Naugatuck Valley Financial Corporation (File No. 000-50876) Proxy Statement filed on April 1, 2005.
(7)Incorporated herein by reference to Exhibit 10.1 to the Naugatuck Valley Financial Corporation (File No. 00-54447) Current Report on Form 8-K, Filed on July 8, 2014
(8)Incorporated herein by reference to Exhibit 10.1 to the Naugatuck Valley Financial Corporation (File No. 00-54447) Current Report on Form 8-K, Filed on July 8, 2014

 

56
 

  

(9)Incorporated herein by reference to Exhibit 10.1 to the Naugatuck Valley Financial Corporation (File No. 000-54447) Current Report on Form 8-K, filed on January 20, 2012.
(10)Incorporated by reference to Exhibit 14 to Naugatuck Valley Financial Corporation (File No. 000-50876) Form 10-K for the fiscal year ended December 31, 2004 filed on March 31, 2005.

 

57
 

 

SIGNATURES

 

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

 

  NAUGATUCK VALLEY FINANCIAL CORPORATION
     
Date: March 19, 2015 By:  /s/ William C. Calderara
    William C. Calderara
    President and Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicted.

 

SIGNATURE   TITLE   DATE
         
/s/ William C. Calderara Chief Executive Officer, President and Director March 19, 2015
William C. Calderara   (principal executive officer)    
         
/s/ James Hastings Executive Vice President and Chief Financial Officer March 19, 2015
James Hastings   (principal financial and accounting officer)    
         
/s/ Orville G. Aarons   Director   March 19, 2015
Orville G. Aarons        
         
/s/ Carlos S. Batista Director March 19, 2015
Carlos S. Batista        
         
/s/ Robert M. Bolton   Director   March 19, 2015
Robert M. Bolton        
   
/s/ Frederick A. Dlugokecki   Director   March 19, 2015
Frederick A. Dlugokecki        
     
/s/ Richard M. Famiglietti   Director   March 19, 2015
Richard M. Famiglietti        
     
/s/ Kevin A. Kennedy   Director   March 19, 2015
Kevin A. Kennedy        
         
/s/ James A. Mengacci   Director   March 19, 2015
James A. Mengacci        
         
/s/ Lawrence B. Seidman     Director   March 19, 2015

Lawrence B. Seidman

       

 

58
 

 

NAUGATUCK VALLEY FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2014, 2013 and 2012

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

  Page
Report of Independent Registered Public Accounting Firm – As of and for the Years Ended December 31, 2014 and 2013 F-2
   
Report of Independent Registered Public Accounting Firm- For the Year ended December 31, 2012 F-3
   
Consolidated Statements of Financial Condition – December 31, 2014 and December 31, 2013 F-4
   
Consolidated Statements of  Income – Years Ended December 31, 2014, 2013 and 2012 F-5
   
Consolidated Statements of Comprehensive Income (Loss)  – Years Ended December 31, 2014, 2013 and 2012 F-6
   
Consolidated Statements of Stockholders’ Equity – Years Ended December 31, 2014, 2013 and 2012 F-7
   
Consolidated Statements of Cash Flows – Years Ended December 31, 2014, 2013 and 2012 F-8
   
Notes to Consolidated Financial Statements F-10

 

F-1
 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders

Naugatuck Valley Financial Corporation

 

We have audited the accompanying consolidated statements of financial condition of Naugatuck Valley Financial Corporation and subsidiary (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Naugatuck Valley Financial Corporation and subsidiary as of December 31, 2014 and 2013, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

/s/ McGladrey, LLP

New Haven, Connecticut

March 19, 2015

 

F-2
 

 

 

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders 

Naugatuck Valley Financial Corporation: 

 

We have audited the accompanying consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows of Naugatuck Valley Financial Corporation and subsidiary (the “Company”) for the year ended December 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Naugatuck Valley Financial Corporation and subsidiary for the year ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.

  

/s/ Whittlesey & Hadley, P.C. 

Hartford, Connecticut 

April 1, 2013

 

Offices in Hartford, Connecticut & Holyoke, Massachusetts 

F-3
 

 

 

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 

(In thousands)  2014   2013 
     
ASSETS          
Cash and due from depository institutions  $10,940   $26,330 
Federal funds sold   -    44 
Cash and cash equivalents   10,940    26,374 
Investment securities available-for-sale, at fair value   77,538    49,272 
Investment securities held-to-maturity (fair value of $13,633 and $18,243)   13,441    18,149 
Loans held for sale   1,062    1,079 
Loans receivable, net   363,259    360,568 
Accrued income receivable   1,599    1,494 
Foreclosed real estate   335    1,846 
Premises and equipment, net   9,125    9,364 
Bank owned life insurance   10,393    10,132 
Federal Home Loan Bank ('FHLB') of Boston stock, at cost   4,548    5,444 
Other assets   2,850    3,059 
Total assets  $495,090   $486,781 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Liabilities:          
Deposits  $373,459   $390,847 
Federal Home Loan Bank advances   53,762    25,293 
Other borrowed funds   -    4,173 
Mortgagors' escrow accounts   4,341    4,392 
Deferred tax liabilities   651    - 
Other liabilities   2,006    3,842 
Total liabilities   434,219    428,547 
Commitments and contingencies          
Stockholders' equity          
Preferred stock, $.01 par value; 1,000,000 shares authorized; no shares issued or outstanding   -    - 
Common stock, $.01 par value; 25,000,000 shares authorized; 7,002,366 shares issued; 7,002,208 shares outstanding at  December 31, 2014 and December 31, 2013, respectively   70    70 
Paid-in capital   58,698    58,757 
Retained earnings   3,323    2,322 
Unearned employee stock ownership plan ("ESOP") shares (294,387 shares at December 31, 2014 and 326,751 shares at December 31, 2013)   (2,480)   (2,824)
Treasury Stock, at cost (158 shares at December 31, 2014 and December 31, 2013)   (1)   (1)
Accumulated other comprehensive income (loss)   1,261    (90)
Total stockholders' equity   60,871    58,234 
Total liabilities and stockholders' equity  $495,090   $486,781 

 

See accompanying notes to the consolidated financial statements

 

F-4
 

 

 

CONSOLIDATED STATEMENTS OF INCOME

 

   For the Years Ended December 31, 
(In thousands except for per share data)  2014   2013   2012 
             
Interest and dividend income               
Interest and fees on loans  $16,851   $19,323   $23,054 
Interest and dividends on investments and deposits   2,920    1,289    1,557 
Total interest income   19,771    20,612    24,611 
Interest expense               
Interest on deposits   2,386    2,805    3,808 
Interest on borrowed funds   723    873    1,577 
Total interest expense   3,109    3,678    5,385 
Net interest income   16,662    16,934    19,226 
(Credit) provision for loan losses   (1,747)   4,150    17,725 
Net interest income after provision/credit for loan losses   18,409    12,784    1,501 
Noninterest income               
Service charge income   711    756    815 
Fees for other services   299    302    370 
Mortgage banking income   1,085    1,317    2,797 
Income from bank owned life insurance   261    278    299 
Net gain (loss) on sale of investments   1,428    (4)   - 
Income from investment advisory services, net   348    234    242 
Other income   135    101    102 
Impairment loss on investment securities   -    (1,812)   - 
Total noninterest income   4,267    1,172    4,625 
Noninterest expense               
Compensation, taxes and benefits   11,717    10,840    11,042 
Office occupancy   2,220    1,935    1,879 
FDIC insurance premiums   781    939    674 
Professional fees   1,564    1,979    1,867 
Computer processing   1,443    1,297    1,163 
Directors' compensation   328    351    592 
Insurance and surety bond   613    576    233 
Advertising   433    465    514 
Property taxes on loan sales   250    776    - 
Expenses on foreclosed real estate, net   436    874    447 
Writedowns on foreclosed real estate   173    263    77 
Office supplies   264    228    240 
Other expenses   1,466    1,902    2,498 
Total noninterest expense   21,688    22,425    21,226 
Income (loss) before tax provision (benefit)   988    (8,469)   (15,100)
Income tax provision (benefit)   (13)   370    148 
Net income (loss)  $1,001   $(8,839)  $(15,248)
                
Earnings (loss) per share - basic and diluted  $0.15   $(1.33)  $(2.31)

 

See accompanying notes to the consolidated financial statements

 

F-5
 

  

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

(In thousands)  2014   2013   2012 
Net income (loss)  $1,001   $(8,839)  $(15,248)
                
Other comprehensive income (loss):               
Unrealized gain (loss) on securities available-for-sale   3,430    (73)   163 
Reclassification adjustment for gains               
realized in net income (loss) (1)   (1,428)   4    - 
                
Other comprehensive income (loss) before tax effect   2,002    (69)   163 
                
Income tax (expense) benefit related to items of other               
comprehensive income (loss)   (651)   -    37 
                
Other comprehensive income (loss) net of tax effect   1,351    (69)   200 
                
Total comprehensive income (loss)  $2,352   $(8,908)  $(15,048)

 

(1)    Net gain (loss) on sale of investments is the affected line item in the Consolidated Statements of Operations.

 

 

See accompanying notes to the consolidated financial statements

 

F-6
 

 

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

   Common   Paid-in   Retained   Unearned 
ESOP
   Unearned 
Stock
   Treasury   Accumulated
Other
Comprehensive
     
(In thousands)  Stock   Capital   Earnings   Shares   Awards   Stock   Income (Loss)   Total 
                                 
Balance at December 31, 2011  $70   $58,908   $27,014   $(3,442)  $(14)  $(1)  $(221)  $82,314 
                                         
Net loss   -    -    (15,248)   -    -    -    -    (15,248)
ESOP shares released - 32,364 shares   -    (66)   -    299    -    -    -    233 
Dividends paid ($0.09 per common share)   -    -    (599)   -    -    -    -    (599)
Stock based compensation awards - options   -    -    -    -    8    -    -    8 
Stock based compensation - 200 shares vested   -    -    (3)   -    3    -    -    - 
Other comprehensive income   -    -    -    -    -    -    200    200 
Balance at December 31, 2012  $70   $58,842   $11,164   $(3,143)  $(3)  $(1)  $(21)  $66,908 
                                         
Net loss   -    -    (8,839)   -    -    -    -    (8,839)
ESOP shares released - 32,364 shares   -    (85)   -    319    -    -    -    234 
Stock based compensation - 200 shares vested   -    -    (3)   -    3    -    -    - 
Other comprehensive loss   -    -    -    -    -    -    (69)   (69)
Balance at December 31, 2013   70    58,757    2,322    (2,824)   -    (1)   (90)   58,234 
                                         
Net income  $-   $-   $1,001   $-   $-   $-   $-   $1,001 
ESOP shares released - 32,364 shares   -    (92)   -    344    -    -    -    252 
Stock based compensation - options   -    33    -    -    -    -    -    33 
Other comprehensive income   -    -    -    -    -    -    1,351    1,351 
Balance at December 31, 2014  $70   $58,698   $3,323   $(2,480)  $0  $(1)  $1,261   $60,871 

 

See accompanying notes to the consolidated financial statements

 

F-7
 

  

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   For the Years Ended December 31, 
(In thousands)  2014   2013   2012 
Cash flows from operating activities            
Net income (loss)  $1,001   $(8,839)  $(15,248)
Adjustments to reconcile net income (loss) to cash provided by operating activities:               
(Credit) provision for loan losses   (1,747)   4,150    17,725 
Depreciation and amortization expense   768    684    718 
Net loss (gains) on sales of foreclosed assets   35    66    (117)
Writedowns on foreclosed real estate   173    263    77 
Gain on sale of mortgage loans   (598)   (946)   (2,373)
Gain on sale of mortgage servicing rights   (370)   -    - 
Loans originated for sale   (31,482)   (33,516)   (81,399)
Proceeds from sale of mortgage servicing rights   1,217    -    - 
Proceeds from sale of loans held for sale   36,055    36,144    83,648 
Proceeds from the sale of credit impaired loans   4,550   15,778    - 
Net amortization from investments   56    381    268 
Amortization of intangible assets   -    -    20 
Provision for deferred taxes   -    242    2,475 
Net (gain) loss on investment securities   (1,428)   4    - 
Other than temporary impairment on investments   -    1,812    - 
Stock-based compensation   285    234    239 
Net change in:               
 Accrued income receivable   (105)   267    171 
 Deferred loan fees   (13)   (113)   (165)
 Cash surrender value of bank owned life insurance   (261)   (278)   (298)
 Other assets   (640)   3,657    709 
 Other liabilities   (1,836)   (431)   (2,606)
 Net cash provided by (used in) operating activities   5,660   19,559    3,844 
Cash flows from investing activities               
Proceeds from maturities and repayments of available-for-sale securities   15,449    5,512    9,694 
Proceeds from sale of available-for-sale securities   43,367    751    300 
Proceeds from maturities of held-to-maturity securities   4,532    6,990    3,172 
Redemption of Federal Home Loan Bank stock   896    473    - 
Purchase of available-for-sale securities   (83,532)