10-K 1 sse-10k_123112.htm ANNUAL REPORT sse-10k_123112.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________
 
FORM 10 – K
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 31, 2012.
 
o
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 1-32219
 
SOUTHERN CONNECTICUT BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
Connecticut
 
06-1609692
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
     
215 Church Street
New Haven, Connecticut
 
 
06510
(Address of Principal Executive Offices)
 
(Zip Code)
     
Registrant's telephone number, including area code
 
(203) 782-1100
 
Securities registered pursuant to Section 12(b) of the Act:
 
Common Stock, par value $.01 per share
  NYSE MKT 
(Title of each class)
  (Name of each exchange on which registered)
 
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  o   No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes  o   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  x   No  o
 
 
1

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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  o

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

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

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates (assumes all directors, executive officers and 10% or greater holders are affiliates) of the registrant, computed by reference to the price at which the common equity was last sold as of June 30, 2012, the last business day of the registrant’s most recently completed second fiscal quarter: $3,394,000.

The number of shares outstanding of each of the registrant’s classes of common equity: Common Stock, par value $.01 per share, outstanding as of March 28, 2013: 2,810,273

 
2

 
 
Table of Contents
 
 
Page
     
4
     
17
     
17
     
17
     
18
     
18
     
   
     
19
 
 
 
20
 
 
20
     
39
     
39
     
39
     
39
     
40
     
   
     
40
     
43
     
50
     
55
     
56
     
   
     
57
     
 
60

 
3

 
 


Background
 
Southern Connecticut Bancorp, Inc. (the “Company”) is a bank holding company headquartered in New Haven, Connecticut that was incorporated on November 8, 2000. The Company’s strategic objective is to serve as a bank holding company for a community-based commercial bank serving primarily New Haven County (the “Greater New Haven Market”). The Company owns 100% of the capital stock of The Bank of Southern Connecticut (the “Bank”), a Connecticut-chartered bank with its headquarters in New Haven, Connecticut, and 100% of the capital stock of SCB Capital, Inc. The Company and its subsidiaries focus on meeting the financial service needs of consumers and small to medium-sized businesses, professionals and professional corporations, and their owners and employees in the Greater New Haven Market.

The Bank operates branches at four locations, including downtown New Haven, the Amity/Westville section of New Haven, Branford and North Haven. The Bank’s branches have a consistent, attractive appearance. Each location has an open lobby, comfortable waiting area, offices for the branch manager and a loan officer, and a conference room. The design of the branches complements the business development strategy of the Bank, affording an appropriate space to deliver personalized banking services in professional, confidential surroundings.

The Bank focuses on serving the banking needs of small to medium-sized businesses, professionals and professional corporations, and their owners and employees in the Greater New Haven Market. The Bank’s target commercial customer has between $1.0 and $30.0 million in revenues, 15 to 150 employees, and borrowing needs of up to $3.0 million. The primary focus on this commercial market makes the Bank uniquely qualified to move deftly in responding to the needs of its clients. The Bank has been successful in winning business by offering a combination of competitive pricing for its services, quick decision making processes and a high level of personalized, “high touch” customer service.

On January 16, 2013, the Company and the Bank entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Liberty Bank, a Connecticut-chartered mutual savings bank with its main office in Middletown, Connecticut (“Liberty”), pursuant to which a to-be-formed wholly-owned subsidiary of Liberty will be merged with and into the Company with the Company being the surviving entity, immediately followed by the merger of the Company with and into Liberty with Liberty being the surviving entity (collectively, the “Merger”), and immediately followed by the merger of the Bank with and into Liberty with Liberty being the surviving bank. See Note 18 to the Consolidated Financial Statements for additional information relating to the Merger.

The Greater New Haven Market

The Company serves the Greater New Haven Market, which is comprised of the communities located in and around New Haven County in Southern Central Connecticut. The Greater New Haven Market is located in the center of, and is a critical component of, the commercial activity of the northeast corridor in New England. The market focus resides in the busy transportation and commercial area between New York City to the south, Hartford to the north, Providence to the east, and Boston to the northeast. The diversified economic base of this market region includes educational, pharmaceutical, advanced manufacturing, healthcare, defense, technology, service and energy companies. The region is also one of New England’s most popular tourist destinations, featuring popular shoreline and heritage sites. In addition, the Company’s headquarters is located in downtown New Haven, in the area of Yale University’s campus.
 
 
4

 
 
Bank Growth and Operating Strategy
 
The Bank seeks to differentiate itself by offering prompt, personal “high touch” service and quality banking products. The Bank’s target customers are small to medium-sized businesses, professionals and professional corporations, and their owners and employees. The Bank emphasizes personal relationships with customers, community involvement by employees and the board of directors, and responsive lending decisions by an accessible and experienced local management team.
 
The key elements of the Bank’s business strategy include:

·    
Provision of individualized attention with local underwriting and credit decision-making authority. As a commercial bank based in and wholly focused on the greater New Haven area, the Bank is better able to provide the individualized customer service, combined with prompt local underwriting and credit decision-making authority that management believes small to medium-sized businesses desire.

·    
Employing qualified and experienced banking professionals. The Company and the Bank seek to continue to hire and retain highly experienced and qualified local commercial lenders and other banking professionals with successful track records and established relationships with small to medium-sized businesses in targeted market areas. The experience and expertise of these individuals serves to enhance the Bank’s image within the communities it serves, thereby increasing the Bank’s business.

·    
Leveraging personal relationships and community involvement. The directors, officers and senior employees of the Company and the Bank have extensive personal contacts, business relationships and involvement in communities in which they live and work and which the Bank serves. By building on and leveraging these relationships and community involvement, management believes that the Bank has generated and will continue to generate enthusiasm and interest from small to medium-sized businesses and professionals in the targeted market areas.

·    
Offering a suite of products attractive to our core customer base. The Bank seeks to offer competitive basic, popular products to its commercial and consumer customer base. The Bank offers internet-banking services to its customers through a partnership with Digital Insight, a subsidiary of Intel. The Bank offers remote deposit capture, a system that allows our customers to deposit checks from their places of business, rather than having to make a trip to the Bank. The Bank offers a full complement of banking services utilized by small business customers.

·    
Maintaining high credit quality. The success of the Bank’s business plan depends to a significant extent on the quality of the Bank’s assets, particularly loans. The Bank has built a strong internal emphasis on credit quality and has established stringent underwriting standards and loan approval processes. The Bank actively manages past due and non-performing loans in an effort to minimize credit loss and related expenses and to ensure that the allowance for loan losses is adequate.

·    
Taking market share from large, non-local competitors. The Greater New Haven Market is dominated by large, non-locally owned financial institutions with headquarters typically located outside of Connecticut. Management believes that the Bank has attracted and can continue to attract small to medium-sized businesses and professionals that prefer local decision-making authority and interaction with banking professionals who can provide prompt personalized and knowledgeable service.

·    
Optimizing net interest margin. The Bank’s focus on commercial customers helps to support its net interest margin. The high percentage of assets concentrated in loans to commercial entities that typically provide higher yield than consumer loans, particularly residential mortgages and home equity related loans. The Bank maintains a high percentage of commercial transaction accounts and money market deposit accounts to fund its operations. These deposits typically have a lower interest rate expense than certificates of deposits. The combination of the higher yielding assets and lower expense deposits produces a favorable margin for the Company.
 
 
5

 
 
Lending, Depository and Other Products
 
Lending Products. The Bank offers a broad range of loans to businesses and individuals in its service area, including commercial and business loans, industrial loans, personal loans, commercial and home mortgage loans, home equity loans and automobile loans. The Bank has received lending approval status from the Small Business Administration (“SBA”) to enable it to make SBA loans in communities located throughout the State of Connecticut. The Bank holds certified lending status (“CLP”) from the SBA.
 
Loans are made on a variable or fixed rate basis, with fixed rate loans typically limited to three to five year terms. All loans are approved pursuant to lending policies and procedures authorized by the Bank’s board of directors. The Bank, at times, participates in multi-bank loans to companies in its market area. Commercial loans and commercial real estate loans may be written for maturities of up to twenty years. Loans to purchase or refinance commercial real estate are typically supported by personal guarantees of the principal owners and related parties, and are collateralized by the subject real estate, which may in certain cases be supplemented by additional collateral in the form of liquid assets. Loans to local businesses are generally supported by the personal guarantees of the principal owners and are carefully underwritten to determine appropriate collateral and covenant requirements.
 
Depository Products. The Bank has attracted a base of core deposits, including interest bearing and non-interest bearing checking accounts, money market accounts, savings accounts, sweep accounts, NOW accounts, repurchase agreements, and a variety of certificates of deposits and IRA accounts. To continue to attract deposits, the Bank employs an aggressive marketing plan in its service area and features a broad product line and rates and services competitive with those offered in the Greater New Haven Market. The primary sources of deposits have been and are expected to continue to be small to medium-sized businesses, professionals (lawyers, doctors, accountants, etc.) and professional corporations, and their owners and employees. The Bank obtains these deposits through personal solicitation by its officers and directors, outside programs and advertisements published and/or broadcasted in the local media. The Bank offers internet-banking services to its customers, including commercial cash management services and personal banking services. The Bank offers remote deposit capture, which offers check deposit capabilities for customers from their place of business. The Bank also offers drive-in teller services, automated teller services, wire transfer, lock box and safe deposit services.
 
Other Services. The Bank provides a broad range of other services and products, including cashier’s checks, money orders, travelers’ checks, bank-by-mail, direct deposit and U.S. Savings Bonds. The Bank is associated with a shared network of automated teller machines that its customers are able to use throughout Connecticut and other regions. The Bank does not expect to offer trust services directly in the near future, but may offer trust services in the future independently or possibly through a joint venture with a third party. To directly offer trust services, the Bank would need the approval of the Connecticut Banking Commissioner and the FDIC.

 
6

 
 
Investment Services

The Company does not engage in investment services.

 Investment Securities
 
Investment securities are held by the Company and the Bank with the objective of maximizing the long-term rate of return for shareholders. Investments are overseen by the Board of Directors and a committee of officers who take into account returns, liquidity needs, and the overall asset/liability management of the Company and the Bank. Permissible investments include debt securities such as U.S. Government securities, government-sponsored agency securities, municipal bonds, domestic certificates of deposit that are insured by the FDIC, mortgage-backed securities and collateralized mortgage obligations. The Bank’s current investment portfolio is limited to U.S. Treasury bills, which have been classified as available for sale. Accordingly, the principal risk associated with the Bank’s current investing activities is market risk (variations in value resulting from general changes in interest rates) rather than credit risk. The Bank does not take credit risk for the purposes of increasing interest income. Management continually reviews its portfolio and prevailing market conditions, and under certain market conditions, the Company’s strategy may be reviewed and revised by management and the board of directors.
 
Asset and Liability Management
 
Interest rate risk measures the impact that changing interest rates have on current and future earnings. The Company’s goal is to optimize long-term profitability while minimizing exposure to interest rate fluctuations. Interest rate risk exposure, including, among other things, the Company’s exposure to changes in interest income and equity value based on fluctuations in interest rates, is monitored by senior management and reported to the Bank’s Asset Liability Committee (ALCO) and the board of directors on a quarterly basis. The Bank employs the services of a national service provider for monitoring, analyzing and managing interest rate risk.

Regulatory Compliance
 
The Company operates in a heavily regulated industry and is subject to increasing regulatory review and scrutiny from the Federal Reserve Board, the Connecticut Banking Commissioner, and the FDIC. The Company and the Bank have invested and continue to invest significant time and resources to ensure compliance and conformity with applicable regulations (see “REGULATION AND SUPERVISION” below). The Bank is committed to meeting its obligations under the Bank Secrecy Act, the Gramm-Leach-Bliley Act and the USA PATRIOT Act, as well as various other regulations. Management meets and reports to the board of directors on a regular basis regarding new developments in compliance and the Bank’s efforts to comply therewith.

Competition
 
There are numerous banks and other financial institutions serving the Greater New Haven Market posing significant competition to attract deposits and loans. The Bank competes for loans and deposits with other commercial banks, savings and loan associations, finance companies, money market funds, insurance companies, credit unions and other financial institutions, a number of which are much larger and have substantially greater resources. To increase its business, the Bank will have to win existing customers away from existing banks and financial institutions as well as successfully compete for new customers from growth in the target markets.
 
 
7

 

New Haven county is currently served by approximately 271 offices of 26 commercial and savings banks. The majority of these banks are substantially larger than the Bank expects to be in the near future, and are able to offer products and services which may be impractical for the Bank to provide at this time. There are numerous banks and other financial institutions serving the communities surrounding New Haven, which also draw customers from New Haven, posing significant competition for the Bank to attract deposits and loans. The Bank also experiences competition from out-of-state financial institutions with little or no traditional bank branches in New Haven. Many of these banks and financial institutions are well established and better capitalized than the Bank, allowing them to provide a greater range of services.
 
Intense market demands, economic pressures, and significant legislative and regulatory actions have eroded traditional banking industry classifications and have increased competition among banks and other financial institutions. Market dynamics as well as legislative and regulatory changes have resulted in a number of new competitors offering services historically offered only by commercial banks. Increased customer awareness of product and service differences among competitors has also increased competition among banks.

Employees

As of December 31, 2012, the Bank had 33 full-time employees. Relationships with all employees are believed to be excellent.

REGULATION AND SUPERVISION
 
Banks and bank holding companies are extensively regulated under both federal and state law. The Company and the Bank have set forth below brief summaries of various aspects of supervision and regulation to which they are subject. These summaries do not purport to be complete and are qualified in their entirety by reference to applicable laws, rules and regulations.
 
Laws and Regulations to which The Company is Subject
 
General. As a bank holding company registered in accordance with the Bank Holding Company Act of 1956 (the “BHC Act”), the Company is regulated by and subject to the supervision of the Federal Reserve Board and is required to file with the Federal Reserve Board an annual report and such other information as may be required. The Federal Reserve Board has the authority to conduct examinations of the Company as well. The Federal Reserve Board has the authority to issue orders to bank holding companies to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the Federal Reserve Board. The Federal Reserve Board is also empowered to assess civil money penalties against companies or individuals who violate the BHC Act or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies, and to order termination of ownership and control of a non-banking subsidiary by a bank holding company.
 
The BHC Act—Acquisitions and Permissible Activities. The BHC Act requires the prior approval of the Federal Reserve Board for a bank holding company to acquire substantially all the assets of a bank or acquire direct or indirect ownership or control of more than 5% of any class of the voting shares of any bank, bank holding company or savings association, or increase any such non-majority ownership or control of any bank, bank holding company or savings association, or merge or consolidate with any bank holding company. Federal law generally authorizes bank holding companies to acquire banks located in any state, subject to certain state-imposed age and deposit concentration limits, and also generally authorizes interstate bank holding company and bank mergers and to a lesser extent, interstate branching.
 
 
8

 
 
Unless a bank holding company becomes a financial holding company under the Gramm-Leach-Bliley Act of 1999 (“GLBA”) (as discussed below), the BHC Act prohibits a bank holding company from acquiring a direct or indirect interest in or control of more than 5% of any class of the voting shares of a company that is not a bank or a bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
 
The GLBA permits a qualifying bank holding company to become a “financial holding company” and thereby engage in a broader range of activities than is permissible for a traditional bank holding company. In order to qualify for this election, all of the depository institution subsidiaries of the bank holding company must be well capitalized and well managed, as defined under Federal Reserve Board regulations, and all such subsidiaries must have achieved a rating of “satisfactory” or better with respect to meeting community credit needs. Pursuant to the GLBA, financial holding companies are permitted to engage in activities that are “financial in nature” or incidental or complementary thereto, as determined by the Federal Reserve Board. The GLBA identifies several activities as “financial in nature,” including, among others, insurance underwriting and agency activities, investment advisory services, merchant banking and underwriting, and dealing in or making a market in securities. At this time, the Company has not elected to become a financial holding company and has no immediate plans to do so.
 
Capital Requirements. The Company is required to comply with minimum capital adequacy standards established by the Federal Reserve Board. There are two basic measures of capital adequacy for bank holding companies and the depository institutions that they own: a risk based measure and a leverage measure. All applicable capital standards must be satisfied for a bank holding company to be considered in compliance.
 
The risk-based capital guidelines for bank holding companies such as the Company currently require a minimum ratio of total capital to risk-weighted assets (including off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital is required to be Tier 1 capital, consisting principally of common shareholders’ equity, non-cumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interest in the equity accounts of consolidated subsidiaries, less goodwill. The remainder of the total capital (Tier 2 capital) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the general loan loss allowance.

In addition to the risk-based capital guidelines, the federal banking regulators established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of at least 4%. Banking organizations with supervisory, financial, operational, or managerial weaknesses, as well as organizations that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. Moreover, higher capital ratios may be required for any bank holding company if warranted by its particular circumstances or risk profile. In all cases, bank holding companies should hold capital commensurate with the level and nature of the risks, including the volume and severity of problem loans, to which they are exposed.
 
 
9

 

Capital adequacy is one of the most important factors used to determine the safety and soundness of individual banks and the banking system. To be considered “well capitalized,” an institution must generally have a Tier 1 leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10%. Based on the above ratios, the Bank is considered to be “well capitalized” under applicable regulations. As of December 31, 2012, the Bank’s Tier I leverage ratio, Tier I risk-based capital ratio and total risk-based capital ratios were above such minimums. However, in July 2012, the Bank entered into a Consent Order with the Federal Deposit Insurance Corporation and the State of Connecticut Department of Banking which, among other things, require it to maintain a minimum Tier 1 leverage ratio of at least 8.0%, a Tier 1 risk-based capital ratio of at least 9% and a total risk-based capital ratio of at least 10%. At December 31, 2012, the Bank’s capital ratios exceeded such minimums set forth in the Consent Order. In September 2012, the Bank also submitted a revised capital plan outlining its strategy for increasing its capital amounts and ratios to the Federal Deposit Insurance Corporation and the State of Connecticut Department of Banking for their approval. In October 2012, the Bank received regulatory approval for its revised capital plan. In the event the Company and Bank’s pending merger with Liberty Bank is not consummated, the Company and the Bank will seek to implement the plan to increase capital as soon as practicable. Further regulatory action is possible if the Bank does not maintain the minimum capital ratios set forth in the Consent Order.

Limitations on Acquisitions of Common Stock. The federal Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a depository institution or a depository institution holding company unless the appropriate federal banking agency has been given at least 60 days to review the proposal and public notice has been provided. “Control” is generally defined under this act as ownership of 25% or more of any class of voting stock. In addition, under a rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a depository institution or a depository institution holding company with a class of securities registered under Section 12 of the Exchange Act would, under the circumstances set forth in the presumption, constitute the acquisition of control. Furthermore, any company, as that term is broadly defined in the BHC Act, would be required to obtain the approval of the Federal Reserve Board under BHC Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of voting securities of a depository institution or a depository institution holding company, or such lesser percentage as the Federal Reserve Board deems to constitute a “controlling influence.”
 
Bank Holding Company Dividends. The Federal Reserve Board has authority to prohibit bank holding companies from paying cash dividends if such payment is deemed to be an unsafe or unsound practice. The Federal Reserve Board has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the bank holding company’s net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization’s capital needs, asset quality, and overall financial condition. The Company’s ability to pay dividends is also subject to laws and regulations of the Connecticut Department of Banking.
 
Bank Holding Company Support of Subsidiary Banks. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to their support. This support may be required at times when the bank holding company may not have the resources to provide it. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act (“FDIA”), the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (1) the “default” of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution “in danger of default.”

Dodd-Frank Wall Street Reform And Consumer Protection Act Of 2010. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). The Dodd-Frank Act has a broad impact on the financial services industry, including significant regulatory and compliance changes including, among other things, (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased capital and liquidity requirements; (iii) increased regulatory examination fees; (iv) changes to assessments to be paid to the FDIC for federal deposit insurance; and (v) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector. Additionally, the Dodd-Frank Act established a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC.
 
 
10

 

Effective as of July 21, 2011, the Dodd-Frank Act provided for the elimination of the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. To date, this change to existing law has not had an adverse impact on our net interest margin. However, depending on competitive responses, it may result in an increase in our interest expense in the future, which could impact our net interest margin.

The Dodd-Frank Act changed the base for FDIC deposit insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution, rather than on deposits. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per account, retroactive to January 1, 2008, and non-interest bearing transaction accounts had unlimited deposit insurance through December 31, 2012. The legislation also increased the required minimum reserve ratio for the Deposit Insurance Fund, from 1.15% to 1.35% of insured deposits, and directed the FDIC to offset the effects of increased assessments on depository institutions with less than $10 billion in assets.

The Dodd-Frank Act requires publicly traded companies, like the Company, to give their stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizes the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. It also provides that the listing standards of the national securities exchanges shall require listed companies to implement and disclose “clawback” policies mandating the recovery of incentive compensation paid to executive officers in connection with accounting restatements. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not. Since the Company qualifies as a “smaller reporting company” under the rules of the Securities and Exchange Commission, the non-binding vote on executive compensation, including “golden parachute” payments, is not required until the Company’s first annual meeting of stockholders after January 21, 2013.

The Dodd-Frank Act also created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws. The Dodd-Frank Act requires minimum leverage (Tier 1) and risk based capital requirements for bank and savings and loan holding companies that are no less than those applicable to banks.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years. It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.
 
 
11

 

The Sarbanes-Oxley Act. The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) implements a broad range of corporate governance and accounting measures for public companies (including publicly-held bank holding companies such as the Company) designed to promote honesty and transparency in corporate America. Sarbanes-Oxley’s principal provisions, many of which have been interpreted through regulations of the Securities and Exchange Commission, provide for and include, among other things: (i) the creation of an independent accounting oversight board; (ii) auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients; (iii) additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer of a public company certify financial statements; (iv) internal control reporting requirements by management pursuant to Section 404 of Sarbanes-Oxley; (v) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; (vi) an increase in the oversight of, and enhancement of certain requirements relating to, audit committees of public companies and how they interact with the company’s independent auditors; (vii) requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer; (viii) requirements that companies disclose whether at least one member of the audit committee is a “financial expert” (as such term is defined by the SEC); (ix) expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods; (x) a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions on non-preferential terms and in compliance with other bank regulatory requirements; (xi) disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; and (xii) a range of enhanced penalties for fraud and other violations. As a result of a provision of the Dodd-Frank Act, which, among other things, permanently exempted non-accelerated filers, such as the Company, from complying with the requirements of Section 404(b) of Sarbanes-Oxley, which requires an issuer to include an attestation report from an issuer’s independent registered public accounting firm on the issuer’s internal control over financial reporting, this Annual Report on Form 10-K does not include an attestation report of the company’s registered public accounting firm regarding the company’s internal control over financial reporting.

USA PATRIOT ACT. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”), designed to deny terrorists and others the ability to obtain access to the United States financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The Patriot Act, as implemented by various federal regulatory agencies, requires financial institutions, including the Company and the Bank, to implement new policies and procedures or amend existing policies and procedures with respect to, among other matters, anti-money laundering, compliance, suspicious activity and currency transaction reporting, and due diligence on customers. The Patriot Act and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the Federal Reserve Board (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under the BHC Act or the Bank Merger Act.

Significant Laws and Regulations to which the Bank is Subject
 
General. The Bank is organized under the Banking Law of the State of Connecticut. Its operations are subject to federal and state laws applicable to commercial banks and to extensive regulation, supervision and examination by the Connecticut Banking Commissioner, as well as by the FDIC, as its primary federal regulator and insurer of deposits. While the Bank is not a member of the Federal Reserve System, it is subject to certain regulations of the Federal Reserve Board. In addition to banking laws, regulations and regulatory agencies, the Bank is subject to various other laws, regulations and regulatory agencies, all of which directly or indirectly affect the Bank’s operations. The Connecticut Banking Commissioner and the FDIC examine the affairs of the Bank for the purpose of determining its financial condition and compliance with laws and regulations. The Connecticut Banking Commissioner and the FDIC have the authority to limit the Bank’s payment of cash dividends based on such factors as the maintenance of adequate capital, which could reduce the amount of dividends otherwise payable.
 
 
12

 
 
The Connecticut Banking Commissioner and the FDIC have significant 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 FDIC, Congress, the Connecticut Banking Commissioner, or the Connecticut General Assembly, could have a material adverse impact on the Bank.
 
Activities and Investments of Insured State-Chartered Banks. Section 24 of the FDIA generally limits the activities of principal and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. The Company does not expect such provisions to have a material adverse effect on the Company or the Bank.
 
Capital Requirements. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) required each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of non-traditional activities. In addition, pursuant to FDICIA, each federal banking agency has promulgated regulations, specifying the levels at which a bank would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” and to take certain mandatory and discretionary supervisory actions based on the capital level of the institution.
 
The regulations implementing these provisions of FDICIA provide that a bank will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a Tier 1 leverage ratio of at least 5.0 percent, and (iv) meets certain other requirements. A bank will be classified as “adequately capitalized” if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 4.0 percent, (iii) has a Tier 1 leverage ratio of (a) at least 4.0 percent, or (b) at least 3.0 percent if the bank was rated 1 in its most recent examination and is not experiencing or anticipating significant growth, and (iv) does not meet the definition of “well capitalized.” A bank will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, or (iii) has a Tier 1 leverage ratio of (a) less than 4.0 percent, or (b) less than 3.0 percent if the bank was rated 1 in its most recent examination and is not experiencing or anticipating significant growth. A bank will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 3.0 percent, or (iii) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if the FDIC has determined (i) that the insured depository institution is in unsafe or unsound condition or (ii) that, in the most recent examination of the insured depository institution, the insured depository institution received and has not corrected a less-than-satisfactory rating for any of the categories of asset quality, management, earnings, or liquidity.

The Company and the Bank’s capital ratios are as follows:
 
   
Company
   
Bank
 
               
Capital
               
Capital
 
               
Adequacy
               
Adequacy
 
   
2012
 
2011
   
Target Ratio
   
2012
   
2011
   
Target Ratio
 
Total Capital to Risk Weighted Assets
    12.33%       10.88%       8.00%       11.60%       10.28%       8.00%  
Tier 1Capital to Risk Weighted Assets
    11.07%       9.62%       4.00%       10.34%       9.03%       4.00%  
Tier 1(Leverage) Capital Ratio to Average Assets
    9.31%       7.41%       4.00%       8.70%       6.95%       4.00%  
 
 
13

 
 
To be considered “well capitalized,” an institution must generally have a Tier 1 leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10%. Based on the above ratios, the Bank is considered to be “well capitalized” under applicable regulations. As of December 31, 2012, the Bank’s Tier I leverage ratio, Tier I risk-based capital ratio and total risk-based capital ratios were above such minimums. However, in July 2012, the Bank entered into a Consent Order with the Federal Deposit Insurance Corporation and the State of Connecticut Department of Banking which, among other things, require it to maintain a minimum Tier 1 leverage ratio of at least 8.0%, a Tier 1 risk-based capital ratio of at least 9% and a total risk-based capital ratio of at least 10%. At December 31, 2012, the Bank’s capital ratios exceeded such minimums set forth in the Consent Order. In September 2012, the Bank also submitted a revised capital plan outlining its strategy for increasing its capital amounts and ratios to the Federal Deposit Insurance Corporation and the State of Connecticut Department of Banking for their approval. In October 2012, the Bank received regulatory approval for its revised capital plan. In the event the Company and Bank’s pending merger with Liberty bank is not consummated, the Company and the Bank will seek to implement the plan to increase capital as soon as practicable. Further regulatory action is possible if the Bank does not maintain the minimum capital ratios set forth in the Consent Order.

The current risk-based capital guidelines are based upon the 1988 capital accord of the International Basel Committee on Banking Supervision, a committee of central banks and bank supervisors and regulators from the major industrialized countries that develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies they apply. A new international accord, referred to as Basel II, became mandatory for large or “core” international banks outside the U.S. in 2008 (total assets of $250 billion or more or consolidated foreign exposures of $10 billion or more) and emphasizes internal assessment of credit, market and operational risk, as well as supervisory assessment and market discipline in determining minimum capital requirements. It is optional for other banks. In December 2010, the Group of Governors and Heads of Supervisors of the Basel Committee on Banking Supervision, the oversight body of the Basel Committee, published its “calibrated” capital standards for major banking institutions, referred to as Basel III. Under these standards, when fully phased-in on January 1, 2019, banking institutions will be required to maintain heightened Tier 1 common equity, Tier 1 capital, and total capital ratios, as well as maintaining a “capital conservation buffer.” The Tier 1 common equity and Tier 1 capital ratio requirements will be phased-in incrementally between January 1, 2013 and January 1, 2015; the deductions from common equity made in calculating Tier 1 common equity will be phased-in incrementally over a four-year period commencing on January 1, 2014; and the capital conservation buffer will be phased-in incrementally between January 1, 2016 and January 1, 2019. The Basel Committee also announced that a countercyclical buffer of 0% to 2.5% of common equity or other fully loss-absorbing capital will be implemented according to national circumstances as an extension of the conservation buffer.

In June 2012, the federal bank regulatory agencies issued a series of proposed rules that would revise their risk-based and leverage capital requirements and their method for calculating risk-weighted assets to make them consistent with Basel III and certain provisions of the Dodd-Frank Act. The proposed rules would apply 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 (“banking organizations”). Among other things, the proposed rules establish a new minimum common equity Tier 1 capital ratio of 4.5% of risk-weighted assets and a higher minimum Tier 1 risk-based capital ratio of 6.0% (up from the present 4.0%). Additionally, the U.S. implementation of Basel III contemplates that, for banking organizations with less than $15 billion in assets, the ability to treat trust preferred securities as Tier 1 capital would be phased out over a ten-year period. The proposed rules also required unrealized gains and losses on certain securities holdings to be included for purposes of calculating regulatory capital requirements. In addition, the proposed rules limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of a specified amount of common equity Tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. The proposed rules indicated that the final rule would become effective on January 1, 2013, and the changes set forth in the final rules will be phased in from January 1, 2013 through January 1, 2019. However, the federal bank regulatory agencies indicated in November 2012 that they did not expect that any of the proposed rules would become effective on January 1, 2013. The federal bank regulatory agencies did not specify a new deadline.

Prompt Corrective Action and Other Enforcement Mechanisms. Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. An institution that, based upon its capital levels, is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat an institution as “critically undercapitalized” unless its capital ratio actually warrants such treatment.
 
In addition to restrictions and sanctions imposed under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.
 
 
14

 

Premiums for Deposit Insurance. The FDIC has implemented a risk-based assessment system, under which an institution’s deposit insurance premium assessment is based on the probability that the deposit insurance fund will incur a loss with respect to the institution, the likely amount of any such loss, and the revenue needs of the deposit insurance fund.
 
In February 2011, the FDIC adopted final rules to implement changes required by the Dodd-Frank Act with respect to the FDIC assessment rules. In particular, the definition of an institution’s deposit insurance assessment base is being changed from total deposits to total assets less tangible equity. In addition, the FDIC is revising the deposit insurance assessment rates down. The changes became effective April 1, 2011. The new initial base assessment rates range from 5 to 9 basis points for Risk Category I banks to 35 basis points for Risk Category IV banks. Risk Category II and III banks will have an initial base assessment rate of 14 or 23 basis points, respectively. Accordingly, if the risk category of the Bank changes adversely, its FDIC insurance premiums could increase.

Recent insured depository institution failures, as well as deterioration in banking and economic conditions, have significantly increased the loss provisions of the FDIC, resulting in a decline in the designated reserve ratio of the Deposit Insurance Fund to historical lows. The FDIC recently increased the designated reserve ratio from 1.25 to 2.00. In addition, the deposit insurance limit on FDIC deposit insurance coverage generally has increased to $250,000, which may result in even larger losses to the Deposit Insurance Fund.

The FDIC may further increase or decrease the assessment rate schedule in order to manage the Deposit Insurance Fund to prescribed statutory target levels. An increase in the risk category for the Bank or in the assessment rates could have an adverse effect on the Bank’s earnings. FDIC insurance of deposits may be terminated by the FDIC, after notice and hearing, upon finding by the FDIC that the insured institution has engaged in unsafe or unsound practices, or is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule or order of, or conditions imposed by, the FDIC.
 
 Safety and Soundness Standards. Federal law requires each federal banking agency to prescribe for depository institutions under its jurisdiction standards relating to, among other things: internal controls; information systems and audit systems; loan documentation; credit underwriting; interest rate risk; asset growth; compensation; fees and benefits; and such other operational and managerial standards as the agency deems appropriate. The federal banking agencies have promulgated regulations and Interagency Guidelines Establishing Standards for Safety and Soundness (the “Guidelines”) to implement these safety and soundness standards. 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. The Guidelines address internal controls and information systems; internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset quality; earnings and compensation; and fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standards prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard set by the FDIC.
 
The federal banking agencies also have adopted regulations for real estate lending prescribing uniform guidelines for real estate lending. The regulations require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan-to-value limits that do not exceed the supervisory limits prescribed by the regulations.
 
 
15

 
 
Community Reinvestment Act. Under the Community Reinvestment Act (“CRA”), as implemented by FDIC regulations, the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not prescribe specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC, in connection with its examination of a depository institution, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The FDIC is required to provide a written evaluation and make public disclosure of an institution’s CRA performance utilizing a four-tiered descriptive rating system. Institutions are evaluated and rated by the FDIC as “Outstanding,” “Satisfactory,” “Needs to Improve,” or “Substantial Non Compliance.” Failure to receive at least a “Satisfactory” rating may inhibit an institution from undertaking certain activities, including acquisitions of other financial institutions, which require regulatory approval based, in part, on CRA compliance considerations. In its most recent CRA evaluation, dated December 31, 2010, the Bank was rated as “Satisfactory.”

Transactions with Affiliates. Sections 23A and 23B of the Federal Reserve Act restrict transactions between a bank and an affiliated company, including a parent bank holding company. The Bank is subject to certain restrictions on loans to affiliated companies, on investments in the stock or securities thereof, on the taking of such stock or securities as collateral for loans to any borrower, and on the issuance of a guarantee or letter of credit on their behalf. Among other things, these restrictions limit the amount of such transactions, require collateral in prescribed amounts for extensions of credit, prohibit the purchase of low quality assets and require that the terms of such transactions be substantially equivalent to terms of similar transactions with nonaffiliates. Generally, the Bank is limited in its extensions of credit to any affiliate to 10% of the Bank’s capital and in its extensions of credit to all affiliates to 20% of the Bank’s capital.

 Customer Information Security. The FDIC and other bank regulatory agencies have adopted guidelines (the “Security Guidelines”) for safeguarding confidential, personal customer information. The Security Guidelines require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information, and protect against unauthorized access to or use of such information, and ensure the proper disposal of information that could result in substantial harm or inconvenience to any customer.
 
Recent Legislative and Regulatory Initiatives to Address Difficult Market and Economic Conditions. Among the numerous initiatives the United States government has taken in response to the financial crises affecting the banking system and financial markets, was the enactment of the Emergency Economic Stabilization Act of 2008 (“EESA”) on October 3, 2008. The EESA included a provision for an increase in the amount of deposits insured by the FDIC to $250,000 until December 2009 (which was subsequently extended to December 31, 2013 by the Helping Families Save Their Homes Act of 2009) as a way to instill confidence in the banking system. The increase in the amount of deposits insured by the FDIC to $250,000 has been made permanent by the Dodd-Frank Act. On October 14, 2008, the FDIC announced a new program, the Temporary Liquidity Guarantee Program (“TLGP”) that provided unlimited FDIC deposit insurance on funds in noninterest-bearing transaction deposit accounts that were not otherwise covered by the existing FDIC deposit insurance limit of $250,000. The TLGP also provided that the FDIC will guarantee qualifying senior unsecured debt issued before June 2009 by participating banks and certain qualifying holding companies. Participating institutions were assessed a surcharge of 10 basis points on the additional insured deposits and an assessment of 50 to 100 basis points on qualifying senior unsecured debt issued under the debt guarantee segment of the program. The Bank elected to participate in both aspects of the TLGP and incurred the surcharge as a cost of such participation. The unlimited FDIC deposit insurance on funds in noninterest-bearing transaction deposit accounts expired on December 31, 2012 and reverted to the standard FDIC deposit insurance limit of $250,000.
 
 
16

 

Privacy. Financial institutions are required to implement policies and procedures regarding their information collection practices and the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the financial institution’s policies and procedures.

 
Not required.


None.


The table below sets forth information about properties the Bank uses for its branch offices. The Company also owns property located in Clinton, Connecticut.
 
Office
 
Location
 
Square Feet
 
Status
Main Office
 
215 Church Street, New Haven, Connecticut
 
11,306
 
Leased
Branford Office
 
445 West Main Street, Branford, Connecticut
 
3,714
 
Leased
Amity Office
 
1475 Whalley Avenue, New Haven, Connecticut
 
2,822
 
Owned
North Haven Office
 
24 Washington Avenue, North Haven, Connecticut
 
2,430
 
Leased
 
Property at 215 Church Street, New Haven, Connecticut. The Bank leases a free-standing building located at 215 Church Street, New Haven, Connecticut, in the central business and financial district of New Haven. The headquarters of the Bank and the Company are located within this building. The building has a drive-up teller, an automated teller machine, two vaults and a night deposit drop.

The initial lease term ended in 2006, but was extended for five years when the Bank exercised the first of its three options to extend the lease. In 2011, the Bank exercised its second option to extend the lease for an additional five years such that the lease now ends in 2016.  The Bank has a right of first refusal to purchase the building. The Bank’s annual rent, which is fixed in the terms of the lease, including during the option periods, is currently $172,110. The Bank is responsible for all costs to maintain the interior of the building, other than structural repairs, and for all real estate taxes.

When practical, the Bank seeks to sublease space within this building that is not needed for operations. The Bank of Southern Connecticut had no tenants in this building during 2012.
 
 
17

 

Property at 445 West Main Street, Branford, Connecticut. The Bank of Southern Connecticut leases space at 445 West Main Street, Branford, Connecticut, the site of the Branford branch, which opened for business on October 7, 2002.

The current term of the Branford branch lease expires on September 30, 2017. The Bank of Southern Connecticut has an option to extend the lease for an additional five year term. The annual base rent payable for the current term is $47,094 until September 30, 2017. The base rent for the option periods increases and is fixed in the lease. The Bank is responsible for all costs to maintain the building, other than structural repairs, and for all real estate taxes.

Property at 1475 Whalley Avenue, New Haven, Connecticut.  The Bank owns a one-acre site with a single story, stucco facility of approximately 2,822 square feet that is located at 1475 Whalley Avenue, New Haven, Connecticut. The Bank operates its Amity branch from this location.

Property at 24 Washington Avenue, North Haven, Connecticut. On February 16, 2006, the Company entered into a lease agreement to lease the facility at 24 Washington Avenue, North Haven, Connecticut, the site of The Bank of North Haven, a division of The Bank of Southern Connecticut. The facility was improved to accommodate the new branch, and $295,000 was expended for improvements, furnishings and equipment. The Bank of North Haven, a division of The Bank of Southern Connecticut, opened for operations on July 10, 2006. The lease is for an initial term of five years, with three successive five-year option periods. In 2011, the Bank exercised its first five-year option covering the period through April 30, 2016. Base rent is $43,133 annually until April 30, 2016. The base rent for the option period increases and is fixed in the lease. The Bank is responsible for its pro rata share of operating expenses.

Property in Clinton, Connecticut. In June 2005, the Company purchased a one-acre improved site with two buildings in Clinton, Connecticut for the primary purpose of establishing a branch office of the Bank. The net purchase price of the property was $495,000. During 2007, the Bank determined that it would not establish a branch at this location and subsequently retained a commercial real estate broker to represent the Company in the sale of the property, and the property is classified as held for sale at December 31, 2012.

In December 2011, the Company entered into an agreement to lease one of the two buildings located in Clinton, Connecticut. The lease is for an initial term of five years, with two successive five-year option periods. Base rent is $26,400 annually until December 15, 2016. The base rent for the option periods increases and is fixed in the lease. The tenant has a right of first refusal for the purchase of the property. The tenant is responsible for all costs to maintain the building, other than structural repairs and real estate taxes. Prior to December 2011, the Company had a lease agreement in place under similar terms and conditions with a different tenant. The Company and the former tenant mutually agreed to terminate this lease agreement in August 2011. The Company received $31,800 and $13,600 in rent for this Clinton, Connecticut property in 2012 and 2011, respectively.

 
Periodically, there have been various claims and lawsuits against the Company, such as claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the making and servicing of real property loans and other issues incident to our business. However, neither the Company nor any subsidiary is a party to any pending legal proceedings that management believes would have a material adverse effect on the Company’s financial condition, results of operations or cash flows.


Not applicable.
 
 
18

 



The Company’s Common Stock is quoted on the NYSE MKT under the symbol "SSE."

The following table sets forth the high and low sales price per share of the Company’s Common Stock for the last two years:

Quarter Ended
 
High
   
Low
 
March 31, 2012
  $ 2.29     $ 1.48  
June 30, 2012
  $ 1.86     $ 1.19  
September 30, 2012
  $ 1.54     $ 0.92  
December 31, 2012
  $ 2.32     $ 1.00  
                 
March 31, 2011
  $ 4.74     $ 4.15  
June 30, 2011
  $ 4.53     $ 3.10  
September 30, 2011
  $ 3.25     $ 1.65  
December 31, 2011
  $ 2.54     $ 1.51  
 
Holders

There were approximately 100 registered shareholders of record of the Company’s Common Stock as of March 28, 2013.

Dividends

No cash dividends have been declared to date by the Company. Management expects that earnings, if any, will be retained and that no cash dividends will be paid in the near future. No stock dividends were declared in 2012 and 2011 by the Company. The Company and Bank are required to obtain written approval from its regulators prior to declaring or paying any dividends. In addition, the Company has agreed in the merger agreement with Liberty Bank to not declare or pay any dividends on the Company’s Common Stock.

The Company’s only significant operating subsidiary during 2012 is the Bank. The Company is dependent upon the ability of the Bank to declare and pay dividends to the Company. The Bank’s ability to declare cash dividends is dependent upon the Bank’s ability to earn profits and to maintain acceptable capital ratios, as well as to meet regulatory requirements and remain compliant with banking law.

The policy of the Connecticut Banking Commissioner is to prohibit payment of any cash dividends prior to recapture of organization and pre-operating expenses from operating profits. In addition, the Bank is prohibited by Connecticut law from declaring a cash dividend on its Common Stock without prior approval of the Connecticut Banking Commissioner except from its net profits for that year and any retained net profits of the preceding two years. “Net profits” is defined as the remainder of all earnings from current operations. In some instances, the FDIC may impose further restrictions on dividends. At December 31, 2012 and 2011, no cash dividends may be declared by the Bank without regulatory approval.

The payment of cash dividends by the Bank may also be affected by other factors, such as the requirement to maintain capital in accordance with regulatory guidelines. If, in the opinion of the Connecticut Banking Commissioner, the Bank were engaged in or was about to engage in an unsafe or unsound practice, the Commissioner could require, after notice and a hearing, the Bank to cease and desist from the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvements Act of 1991, a depository institution may not pay any cash dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal banking agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
 
 
19

 

Recent Sales of Unregistered Securities

The Company has not sold unregistered securities during the period covered by this report on Form 10-K.

Repurchases of Securities by the Company

The Company did not repurchase any of its securities during the period covered by this report on Form 10-K.


Not required.


The following discussion is intended to assist you in understanding the financial condition and results of operations of the Company and the Bank, and should be read in conjunction with the consolidated financial statements and related notes beginning on page F-3.
 
Overview
 
Southern Connecticut Bancorp, Inc. is a bank holding company headquartered in New Haven, Connecticut that was incorporated on November 8, 2000. The Company’s strategic objective is to serve as a bank holding company for The Bank of Southern Connecticut, a commercial bank serving New Haven, Connecticut and the surrounding communities.  The Bank of Southern Connecticut commenced operations on October 1, 2001. The Company owns 100% of the capital stock of The Bank of Southern Connecticut (the “Bank”), a Connecticut-chartered bank with its headquarters in New Haven, Connecticut, and 100% of the capital stock of SCB Capital, Inc.

The Company’s net loss for fiscal year 2012 was $173,000 (or basic and diluted loss per share of $.06), compared to a net loss of $2,738,000 (or basic and diluted loss per share of $1.01) in fiscal year 2011.

The Company’s net losses for the years ended December 31, 2012 and 2011 were largely attributable to provisions for loan losses of $473,000 and $3,036,000, respectively. The decrease in the provision for loan losses was primarily due to a significant decrease in loan charge-offs in 2012 compared to 2011. The decline in loan charge-offs in 2012 was largely attributable to an initiative undertaken by the Company in 2011 to aggressively identify potential problem loans and reduce the Company's exposure to these loans through loan modifications and partial or complete charge-offs in 2011.
 
 
20

 

In addition to the impact of the decrease in the provision for loan losses, the Company’s operating results for the year ended December 31, 2012, when compared to the year ended December 31, 2011, were influenced by the following factors:

·    
Net interest income decreased by $243,000 due to the combined effects of decreases in loan volume and lower yields on interest earning assets (primarily attributable to a decline in yields in the loan portfolio), which were partially offset by decreases in liability volumes and lower rates paid on interest bearing liabilities;
·    
Noninterest income increased by $60,000 because of loan prepayment fees and net insurance proceeds received during 2012 with no similar income recognized in 2011, as well as an increase in other noninterest income, which were partially offset by a decrease in the recognition of gain on a derivative financial instrument and declines in service charges and fees resulting from changes in the business practices of customers of the Bank; and
·    
Noninterest expenses decreased by $185,000 during 2012 compared to 2011 primarily due to declines in a number of categories of operating expenses, which were partially offset by increases in salaries and benefits expense and insurance expense. The decreases in operating expenses for 2012 when compared to 2011 primarily consisted of declines in foreclosed and repossessed asset expenses and write-downs, loan related collection expenses, including legal and appraisal fees, and decreases in directors’ fees and data processing fees. The decreases in foreclosed and repossessed asset expenses and write-downs and loan related collection expenses were due to a decline in loan collection efforts resulting from a significant decrease in newly identified impaired loans in 2012 compared to 2011.The decrease in directors’ fees was attributable to reductions in director fees that were approved by the Company’s compensation committee effective January 1, 2012. The decrease in data processing fees resulted from benefits the Company continued to realize during 2012 related to the renewal of certain data processing service contracts on more favorable terms during the fourth quarter of 2011. The increase in salaries and benefits expense during 2012 when compared to 2011 was primarily attributable to restricted stock compensation expense recorded by the Company based upon the vesting schedule for restricted stock granted to the Chief Executive Officer under his employment agreement and restricted stock agreement executed on February 28, 2012 and to a full year of salary and benefits paid to the Chief Executive Officer, who was hired on October 24, 2011 to fill an open position at the Bank that existed during 2011. Insurance expense increased due to increased costs in 2012 associated with insurance policies that the Company had entered into during a more favorable environment in July 2008. In addition, the Company realized a loss on the sale of other real estate owned during 2011 with no similar loss realized in 2012.

The Company offers a wide range of services to businesses, professionals, and individuals. The Company focuses on serving the banking needs of small to medium-sized businesses in its geographic areas. The Company makes commercial loans, industrial loans, real estate loans, construction loans and consumer loans, accepts demand, savings, and time deposits and provides a broad range of other services to its customers, either directly or through third parties. The Company derives revenues principally from interest earned on loans and fees from other banking-related services. The operations of the Company are influenced significantly by general economic conditions and by policies of financial institution regulatory agencies, primarily the Connecticut Banking Commissioner and the FDIC. The Company’s cost of funds is influenced by interest rates on competing investments and general market interest rates. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rates at which such financings may be offered.

On January 16, 2013, the Company and the Bank entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Liberty Bank, a Connecticut-chartered mutual savings bank with its main office in Middletown, Connecticut (“Liberty”), pursuant to which a to-be-formed wholly-owned subsidiary of Liberty will be merged with and into the Company with the Company being the surviving entity, immediately followed by the merger of the Company with and into Liberty with Liberty being the surviving entity (collectively, the “Merger”), and immediately followed by the merger of the Bank with and into Liberty with Liberty being the surviving bank. See Note 18 to the Consolidated Financial Statements for additional information relating to the Merger.
 
 
21

 

Selected Operating and Balance Sheet Data –
Years Ended December 31, 2012 and December 31, 2011
 
Operating Data
 
2012
   
2011
 
Interest income
  $ 6,016,433     $ 7,137,608  
Interest expense
    1,072,651       1,950,318  
Net interest income
    4,943,782       5,187,290  
Provision for loan losses
    472,848       3,036,340  
Noninterest income
    639,569       579,358  
Noninterest expenses
    5,282,996       5,468,225  
Net loss
    (172,493 )     (2,737,917 )
Basic and diluted loss per share
    (0.06 )     (1.01 )

Balance sheet data
           
Cash and due from banks
  $ 6,913,610     $ 18,167,794  
Short term investments
    4,674,556       6,764,409  
Interest bearing certificates of deposit
    655,278       99,426  
Investment securities
    1,249,925       3,849,847  
Loans, net
    103,279,437       111,644,142  
Total assets
    121,446,561       145,969,905  
Total deposits
    108,251,238       132,630,681  
Repurchase agreements
   
      68  
Total shareholders' equity
    11,547,692       11,545,933  
Book value per share
    4.16       4.28  
 
Segment Reporting

The Company has three reporting segments for purposes of reporting business line results, Community Banking, Mortgage Brokerage and the Holding Company. The Community Banking segment is defined as all operating results of the Bank. The Mortgage Brokerage segment is defined as the results of SCB Capital, Inc., and the Holding Company segment is defined as the results of Southern Connecticut Bancorp, Inc. on an unconsolidated or standalone basis. The Company uses an internal reporting system to generate information by operating segment. Estimates and allocations are used for noninterest expenses.

Assets

The Company’s total assets were $121.5 million as of December 31, 2012, a decrease of $24.5 million from total assets of $146.0 million at December 31, 2011. The $24.5 million decrease in total assets was primarily attributable to decreases of $11.3 million in cash and cash equivalents, $8.3 million in net loans receivable and $2.6 million in available for sale securities, which were partially offset by a $560,000 increase in interest-bearing certificates of deposit. Earning assets comprised $112.1 million of the total assets at December 31, 2012 and consisted of short-term investments, interest-bearing certificates of deposit, available for sale securities and loans receivable, which collectively decreased $12.6 million from the prior fiscal year end. 

Cash and cash equivalents, including short term investments, decreased to $11.6 million as of December 31, 2012 from $24.9 million as of December 31, 2011 and the Bank’s net loans receivable decreased to $103.3 million at December 31, 2012 from $111.6 million at December 31, 2011. Total deposits decreased to $108.3 million as of December 31, 2012 from $132.6 million as of December 31, 2011. The decreases in net loans receivable and cash and cash equivalents corresponded with the decrease in deposit liabilities during the year ended December 31, 2012.

The Company maintained liquidity by maintaining balances in short-term investments, primarily money market mutual funds and overnight investments at the Federal Reserve Bank, to provide funding for higher yielding loans as such loans were approved by the Bank. As of December 31, 2012 and 2011, short-term investment balances were $4.7 million and $6.8 million, respectively. Investment securities classified as available for sale were $1.2 million and $3.8 million as of December 31, 2012 and 2011, respectively. The gross loan portfolio decreased $8.4 million to $105.5 million as of December 31, 2012 from $113.9 million as of December 31, 2011. The allowance for loan losses of $2.2 million at December 31, 2012 decreased $70,000 when compared to the allowance for loan losses at December 31, 2011.
 
 
22

 

Investments

The amortized cost of the Company’s investments decreased $2.6 million during 2012, representing the difference between purchases of new securities ($18.8 million) and securities that matured ($21.4 million).

The following table presents the maturity distribution of the amortized cost of investment securities at December 31, 2012, and the weighted average yield of such securities. The weighted average yields were calculated based on the amortized cost and effective yields to maturity of each security.
 
         
 
   
 
                         
         
Over One Year
      Over Five Years   
 
               
Weighted
 
   
One Year
   
Through
   
Through
   
Over
   
No
         
Average
 
Available for sale
 
or Less
   
Five Years
   
Ten Years
   
Ten Years
   
Maturity
   
Total
   
Yield
 
U.S. Treasury Bill
  $ 1,250,000     $
    $
    $
    $
    $ 1,250,000       0.02 %
                                                         
Weighted Average Yield
    0.02 %     0.00 %     0.00 %     0.00 %     0.00 %     0.02 %        
 
The following table presents a summary of investments for any issuer that exceeds 10% of shareholders’ equity at December 31, 2012:
 
 
 
Amortized
   
Fair
 
December 31, 2012
 
Cost
   
Value
 
U.S. Treasury Bills
  $ 1,250,000     $ 1,249,925  
 
Please see also, “Notes to Consolidated Financial Statements.”

Loans

The Bank’s net loan portfolio was $103.3 million at December 31, 2012 versus $111.6 million at December 31, 2011, a decrease of $8.3 million. The Company attributes the decline in the net loan portfolio in 2012 to the combined effects of a decline in loan demand and the impact of charge-offs of loan balances during 2012. The Bank’s loans have been made to small to medium-sized businesses, primarily in the New Haven market area. There are no other significant loan concentrations in the loan portfolio.

The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions. See Note 4 – Loans Receivable and Allowance for Loan Losses in the accompanying notes to consolidated financial statements included elsewhere in this report for further details of the Company’s policies and procedures related to loan origination and risk management.
 
 
23

 

The following table presents the maturities of loans in the Company’s portfolio at December 31, 2012 by type of loan, and the sensitivities of loans to changes in interest rates:
 
         
Due after
                   
   
Due in
   
one year
                   
   
one year
   
through
   
Due after
             
   
or less
   
five years
   
five years
   
Total
   
% of Total
 
                               
Commercial loans secured by real estate
  $ 16,128,511     $ 24,735,336     $ 23,813,698     $ 64,677,545       61.24 %
Commercial
    16,498,542       7,145,145       2,268,210       25,911,897       24.53 %
Residential mortgages
    2,583,839       5,051,041       5,547,961       13,182,841       12.48 %
Construction and land
    1,343,296       98,444      
      1,441,740       1.37 %
Consumer
    123,702       279,879      
      403,581       0.38 %
Total
  $ 36,677,890     $ 37,309,845     $ 31,629,869     $ 105,617,604       100.00 %
                                         
Fixed rate loans
  $ 15,835,612     $ 8,850,356     $ 28,444,867     $ 53,130,835          
Variable rate loans
    20,842,278       28,459,489       3,185,002       52,486,769          
Total
  $ 36,677,890     $ 37,309,845     $ 31,629,869     $ 105,617,604          
 
Please see “Notes to Consolidated Financial Statements.”

Critical Accounting Policy

In the ordinary course of business, the Company has made a number of estimates and assumptions relating to reporting the results of operations and financial condition in preparing its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company believes the following discussion addresses the Company’s only critical accounting policy, which is the policy that is most important to the portrayal of the Company’s financial condition and results, and requires management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has reviewed this critical accounting policy and estimates with its audit committee. Refer to the discussion below under “Allowance for Loan Losses” and Note 1 to the consolidated financial statements for a detailed description of our estimation process and methodology related to the allowance for loan losses.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components. The allocated component relates to loans that are considered impaired. For such impaired loans, an allowance is established when the discounted cash flows (or observable market price or collateral value if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans, segregated generally by loan type (and further segregated by risk rating), and is based on historical loss experience with adjustments for qualitative factors which are made after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data.
 
 
24

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and real estate loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

Impaired loans also include loans modified in troubled debt restructurings where concessions have been granted to borrowers either experiencing financial difficulties or absent such concessions, it is probable the borrowers would experience financial difficulty complying with the original terms of the loan. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

A modified loan is considered a troubled debt restructuring (“TDR”) when two conditions are met: (1) the borrower is experiencing documented financial difficulty and (2) concessions are made by the Company that would not otherwise be considered for a borrower with similar credit characteristics. The most common types of modifications include interest rate reductions and/or maturity extensions. Modified terms are dependent upon the financial position and needs of the individual borrower, as the Bank does not employ modification programs for temporary or trial periods. All modifications are permanent. The modified loan does not revert back to its original terms, even if the modified loan agreement is violated. The Company’s workout committee continues to monitor the modified loan and if a re-default occurs, the loan is classified as a re-defaulted TDR and collection is pursued through liquidation of collateral, from guarantors, if any, or through other legal action.

Most TDRs are placed on nonaccrual status at the time of restructuring, and continue on nonaccrual status until they have performed under the revised terms of the modified loan agreement for a minimum of six months. In certain instances, for TDRs that are on accrual status at the time the loans are restructured, the Bank may continue to classify the loans as accruing loans based upon the terms and conditions of the restructuring. At December 31, 2012, the Bank had two commercial and industrial loans and one commercial loan secured by real estate classified as TDRs on nonaccrual status and two commercial loans secured by real estate and one commercial loan classified as TDRs on accrual status. TDRs are classified as impaired loans and remain as TDRs for the remaining life of the loan. At December 31, 2012, all TDRs have been performing in accordance with the restructured terms.

Impairment analysis is performed on a loan by loan basis for all modified commercial loans, residential mortgages and consumer loans that are deemed to be TDRs, and related charge-offs are recorded or specific reserves are established as appropriate. Commercial loans include loans categorized as commercial loans secured by real estate, commercial loans, and construction and land loans. Impairment is measured by the present value of expected future cash flows discounted at the loan’s effective interest rate. The original contractual interest rate for the loan is used as the discount rate for fixed rate loan modifications. The current rate is used as the discount rate when the loan’s interest rate floats with a specified index. A change in terms or payments would be included in the impairment calculation.
 
 
25

 

The allowances established for losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the borrower’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed by the credit department, in consultation with the loan officers, for all commercial loans. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

General valuation allowances are calculated based on the historical loss experience of specific types of loans. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include analogous risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

Due to the relatively small asset size and loans outstanding of the Company, the Company uses readily available data from the FDIC regarding the loss experience of national banks with assets between $100 million and $300 million and combines this data with the Company’s actual loss experience to develop average loss factors by weighting the national banks’ loss experience and the Company’s loss experience. In reviewing the performance and trends of the Company’s loan portfolio during the year ended December 31, 2012 compared to the year ended December 31, 2011, management determined to update the methodology relating to the calculation of the general reserve by reducing the historical loss period to three years from the four year loss period utilized during the year ended December 31, 2011, which is considered more representative of average annual losses inherent in the Bank’s loan portfolio. The Company returned to the use of the three year loss period at December 31, 2012 after considering trends in loan loss activity, current loan portfolio quality and present economic, political and regulatory conditions. For the year ended December 31, 2012, the provision for loan losses was $262,000 higher as a result of the effect of this change. Since there was no significant change in both the Company’s asset size and outstanding loan balance during 2012, the Company determined to continue to weight the loss experience of national banks and the Company’s loss experience equally. As the size of the Company’s loan portfolio becomes more significant, the Company intends to weight the Company’s loss experience more heavily in determining the allowance for loan loss provision.

General valuation allowances are based on general economic conditions and other qualitative risk factors, both internal and external, to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Bank’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; and (vi) the impact of national and local economic trends and conditions. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then entered into a general allocation matrix to determine an appropriate general valuation allowance.
 
 
26

 

Based upon this evaluation, management believes the allowance for loan losses of $2,229,334 or 2.11% of gross loans outstanding at December 31, 2012 is adequate, under prevailing economic conditions, to absorb losses on existing loans.

At December 31, 2011, the allowance for loan losses was $2,299,625 or 2.02% of gross loans outstanding. The decrease in the allowance at December 31, 2012 compared to December 2011 was attributable to a $66,000 decrease in the general component of the allowance and a $4,000 decrease in the specific component of the allowance.

The Company’s provision for loan losses decreased by $2.6 million for the year ended December 31, 2012 primarily due to a significant decrease in loan charge-offs in 2012 compared to 2011. The decline in charge-offs in 2012 was largely attributable to an initiative undertaken by the Company in 2011 to aggressively identify potential problem loans and reduce the Company’s exposure to these loans through loan modifications and partial or complete charge-offs in 2011.

The decrease in the general component of the reserve from December 31, 2011 to December 31, 2012 amounted to $66,000, of which $328,000 was due to a decline in loan volume, which was partially offset by an increase of $262,000 resulting from changes in the reserve factors. The $262,000 increase resulted from changes in general reserve factors and consisted of $94,000 attributable to changes to the qualitative factors and $168,000 attributable to changes to the quantitative factors that resulted from the Company reducing the historical period of the average loss experience to the prior three years instead of the prior four years that were used in the Company’s calculations for the year ended December 31, 2011. The decrease in specific reserves totaling $4,000 related to an impaired loan that became a troubled debt restructuring during the year ended December 31, 2011 for which no specific reserve was required at December 31, 2012.

 The Company had $661,000 in loan charge-offs in 2012, of which $558,000 was for loans that were identified as impaired during 2012 and $103,000 was related to collateral dependent loans previously identified as impaired at December 31, 2011 that the Company determined to have experienced a decline in the collateral value of the properties securing such loans. Of the $661,000 in loan charge-offs in 2012, approximately $456,000 was for commercial and industrial loans and $178,000 was for residential loans, each of which were severely impacted by current economic conditions. During 2012, the Company had $118,000 in recoveries of loans that were charged off in prior years.

The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the loan is well-secured and in process of collection. Consumer installment loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis method until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
 
27

 

Management considers all non-accrual loans and troubled-debt restructured loans to be impaired. In most cases, loan payments that are past due less than 90 days and the related loans are not considered to be impaired.

Allowance for Loan Losses and Non-Accrual, Past Due and Restructured Loans

The table below details the changes in the allowance for loan losses for the years ended December 31, 2012 and 2011:
 
   
2012
   
2011
 
Balance at beginning of year
  $ 2,299,625     $ 2,786,641  
   Provision for loan losses
    472,848       3,036,340  
   Recoveries of loans previously charged-off:
               
      Commercial
    88,562          
      Commercial loans secured by real estate
    29,113       10,253  
      Consumer
   
      2,301  
         Total recoveries
    117,675       12,554  
   Loans charged-off:
               
      Commercial
    (455,696 )     (1,590,419 )
      Residential mortgages
    (177,916 )     (192,704 )
      Commercial loans secured by real estate
    (24,243 )     (1,743,112 )
      Consumer
    (2,959 )     (9,675 )
         Total charge-offs
    (660,814 )     (3,535,910 )
Balance at end of period
  $ 2,229,334     $ 2,299,625  
                 
Net charge-offs to average loans
    (0.28 )%     (2.90 %)

 
28

 
 
The table below provides an allocation of the year-end allowance for loan losses by loan type; however, allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories:
 
   
2012
   
2011
 
         
Percent of
         
Percent of
 
   
Allowance
   
Loans in Each
   
Allowance
   
Loans in Each
 
   
for
   
Category to
   
for
   
Category to
 
   
Loan Losses
   
Total Loans
   
Loan Losses
   
Total Loans
 
Commercial loans secured by real estate
  $ 1,150,619       61.24 %   $ 1,122,699       58.95 %
Commercial
    844,347       24.53 %     965,979       27.81 %
Residential mortgages
    225,601       12.48 %     187,224       11.01 %
Construction and land
    2,062       1.37 %     20,431       2.02 %
Consumer
    6,705       0.38 %     3,292       0.21 %
    $ 2,229,334       100.00 %   $ 2,299,625       100.00 %
 
Non-Performing Assets and Potential Problem Loans

The following represents nonperforming assets and potential problem loans at December 31, 2012 and 2011:
 
Nonaccrual loans:
 
2012
   
2011
 
Commercial
  $ 1,687,827     $ 1,707,720  
Construction and land
    1,343,295       1,420,156  
Residential mortgages
    860,522       554,678  
Commercial loans secured by real estate
    796,775       787,311  
Consumer
   
      1,460  
Total non-accrual loans
    4,688,419       4,471,325  
                 
Troubled debt restructured (TDR) loans:
               
Nonaccrual TDR loans not included in Total nonaccrual loans above:                
Commercial
    247,344       1,899,342  
Commercial loans secured by real estate
    243,678       1,314,030  
Accruing TDR impaired loans:
               
Commercial loans secured by real estate
    3,457,170      
 
Commercial
    1,628,761      
 
Foreclosed assets:
               
Commercial
    582,911       374,211  
Total non-performing assets
  $ 10,848,283     $ 8,058,908  
                 
Ratio of non-performing assets to:
               
Total loans and foreclosed assets
    10.23 %     7.05 %
Total assets
    8.93 %     5.52 %
Accruing past due loans:
               
30 to 89 days past due
  $ 998,169     $ 1,392,936  
90 or more days past due
   
     
 
Total accruing past due loans
  $ 998,169     $ 1,392,936  
                 
Ratio of accruing past due loans to total loans net of unearned income:                
30 to 89 days past due
    0.95 %     1.22 %
90 or more days past due
    0.00 %     0.00 %
Total accruing past due loans
    0.95 %     1.22 %

 
29

 

Deposits

Total deposits were $108.2 million at December 31, 2012, a decrease of $24.4 million (18.4%) in comparison to total deposits of $132.6 million at December 31, 2011. Non-interest bearing deposits were $29.9 million at December 31, 2012, a decrease of $1.1 million (3.5%) from $31.0 million at December 31, 2011. Total interest bearing checking, money market and savings deposits decreased $11.1 million or 19.9% to $44.6 million at December 31, 2012 from $55.7 million at December 31, 2011. Time deposits decreased to $33.7 million at December 31, 2012 from $45.9 million at December 31, 2011, a $12.2 million or 26.6% decrease. Included in time deposits at December 31, 2012 and December 31, 2011 were $4.5 million and $9.1 million, respectively, in brokered deposits. This included the Company’s placement of $279,000 and $2.2 million at December 31, 2012 and 2011, respectively, in customer deposits and the purchase of $4.0 million and $4.2 million, respectively, at December 31, 2012 and 2011 in brokered certificates of deposit through the CDARS program. The CDARS program offers the Bank reciprocal swap programs which allow customers to enjoy additional FDIC insurance for deposits that might not otherwise be eligible for FDIC insurance.

The Bank maintains relationships with several deposit brokers and could utilize the services of one or more of these brokers if management determines that issuing brokered certificates of deposit would be in the best interest of the Bank and the Company.

As a result of the Consent Order, described in Note 14, the Bank does not intend to renew or accept brokered deposits without obtaining prior regulatory approval while the Consent Order is in place.

The Greater New Haven Market is highly competitive. The Bank faces competition from a large number of banks (ranging from small community banks to large international banks), credit unions, and other providers of financial services. The level of rates offered by the Bank reflects the high level of competition in its market.

 December 31, 2012, the Bank’s maturities of time deposits were:

    $100,000    
Less than
       
(Thousands of dollars)
 
or greater
    $100,000    
Totals
 
Due within:
                     
Three months or less
  $ 2,715     $ 1,246     $ 3,961  
Over three months to six months
    5,077       1,322       6,399  
Over six months to one year
    6,744       4,039       10,783  
Over one year to two years
    2,813       1,921       4,734  
Over two years to three years
    3,100       1,300       4,400  
Over three years
    2,385       1,046       3,431  
    $ 22,834     $ 10,874     $ 33,708  
 
Other

The $851,000 decrease in other assets was attributable mainly to proceeds received by the Bank in 2012 for net settlement proceeds on the sale of foreclosed real estate collateral securing the Bank’s participation in a commercial loan and a reduction in FDIC deposit insurance the Bank was required to prepay in December 2009.
 
 
30

 

Results of Operations

The Company’s net loss for fiscal year 2012 was $173,000 (or basic and diluted loss per share of $.06), compared to a net loss of $2,738,000 (or basic and diluted loss per share of $1.01) in fiscal year 2011.

The Company’s net losses for the years ended December 31, 2012 and 2011 were largely attributable to provisions for loan losses of $473,000 and $3,036,000, respectively. The decrease in the provision for loan losses was primarily due to a significant decrease in loan charge-offs in 2012 compared to 2011. The decline in loan charge-offs in 2012 was largely attributable to an initiative undertaken by the Company in 2011 to aggressively identify potential problem loans and reduce the Company's exposure to these loans through loan modifications and partial or complete charge-offs in 2011.

In addition to the impact of the decrease in the provision for loan losses, the Company’s operating results for the year ended December 31, 2012, when compared to the year ended December 31, 2011, were influenced by the following factors:

·     
Net interest income decreased by $243,000 due to the combined effects of decreases in loan volume and lower yields on interest earning assets (primarily attributable to a decline in yields in the loan portfolio), which were partially offset by decreases in liability volumes and lower rates paid on interest bearing liabilities;
·     
Noninterest income increased by $60,000 because of loan prepayment fees and net insurance proceeds received during 2012 with no similar income recognized in 2011, as well as an increase in other noninterest income, which were partially offset by a decrease in the recognition of gain on a derivative financial instrument and declines in service charges and fees resulting from changes in the business practices of customers of the Bank; and
·     
Noninterest expenses decreased by $185,000 during 2012 compared to 2011 primarily due to declines in a number of categories of operating expenses, which were partially offset by increases in salaries and benefits expense and insurance expense. The decreases in operating expenses for 2012 when compared to 2011 primarily consisted of declines in foreclosed and repossessed asset expenses and write-downs, loan related collection expenses, including legal and appraisal fees, and decreases in directors’ fees and data processing fees. The decreases in foreclosed and repossessed asset expenses and write-downs and loan related collection expenses were due to a decline in loan collection efforts resulting from a significant decrease in newly identified impaired loans in 2012 compared to 2011.The decrease in directors’ fees was attributable to reductions in director fees that were approved by the Company’s compensation committee effective January 1, 2012. The decrease in data processing fees resulted from benefits the Company continued to realize during 2012 related to the renewal of certain data processing service contracts on more favorable terms during the fourth quarter of 2011. The increase in salaries and benefits expense during 2012 when compared to 2011 was primarily attributable to restricted stock compensation expense recorded by the Company based upon the vesting schedule for restricted stock granted to the Chief Executive Officer under his employment agreement and restricted stock agreement executed on February 28, 2012 and to a full year of salary and benefits paid to the Chief Executive Officer, who was hired on October 24, 2011 to fill an open position at the Bank that existed during 2011. Insurance expense increased due to increased costs in 2012 associated with insurance policies that the Company had entered into during a more favorable environment in July 2008. In addition, the Company realized a loss on the sale of other real estate owned during 2011 with no similar loss realized in 2012.
 
Net Interest Income

The principal source of revenue for the Bank is net interest income. The Bank’s net interest income is dependent primarily upon the difference or spread between the average yield earned on loans receivable and securities and the average rate paid on deposits and borrowings, as well as the relative amounts of such assets and liabilities. The Bank, like other banking institutions, is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different times, or on a different basis, than its interest-earning assets.

For the year ended December 31, 2012, net interest income was $4,944,000 versus $5,187,000 for the same period in 2011. The $243,000 or 4.7% decrease was the result of a $1,121,000 decrease in interest income which was partially offset by an $878,000 decrease in interest expense. This net decrease was primarily the result of decreased asset volumes and lower yields on interest earning assets, which were partially offset by decreases in average balances on interest bearing liabilities and lower rates paid on interest bearing liabilities.
 
 
31

 
 
The Company’s average total interest earning assets were $116.7 million for the period ended December 31, 2012, compared to $133.3 million for the same period in 2011, a decrease of $16.6 million or 12.4%. The decrease in average interest earning assets of $16.6 million during the year ended December 31, 2012 was comprised of decreases in average balances of loans of $13.6 million, as well as decreases in average balances of short-term and other investments of $2.9 million and investments of $83,000.

The yield on average interest earning assets for the period ended December 31, 2012 was 5.16% compared to 5.35% for the same period in 2011, a decrease of 19 basis points. The decrease in the yield on average interest earning assets was primarily attributable to lower yields on the Bank’s loan portfolio because of the low interest rate environment.

The combined effects of the $16.6 million decrease in average balances of interest earning assets and the 19 basis point decrease in yield on average interest earning assets resulted in the $1,121,000 decrease in interest income for the year ended December 31, 2012 when compared to the year ended December 31, 2011.

The average balance of the Company’s interest bearing liabilities was $87.0 million for the period ended December 31, 2012 compared to $114.6 million for the period ended December 31, 2011, a decrease of $27.5 million or 24.0%. The cost of average interest bearing liabilities decreased 47 basis points to 1.23% for the period ended December 31, 2012 compared to 1.70% for the same period in 2011, which was primarily due to maturities of higher priced time deposits as well as a general decrease in market interest rates.

The combined effect of the $27.5 million decrease in average balances of interest bearing liabilities and the 47 basis point decrease in the cost of average interest bearing liabilities resulted in the $878,000 decrease in interest expense for the year ended December 31, 2012 when compared to the year ended December 31, 2011.

 
32

 
 
Average Balances, Yields, and Rates

The following table presents average balance sheets (daily averages), interest income, interest expense, and the corresponding annualized rates on earning assets and rates paid on interest bearing liabilities for the years ended December 31, 2012 and 2011.

Distribution of Assets, Liabilities and Shareholders' Equity;
 
Interest Rates and Interest Differential
 
   
2012
   
2011
             
                                        Change    
 
 
          Interest                 Interest           in Interest    
Change in
 
   
Average
   
Income/
   
Average
   
Average
    Income/    
Average
   
Income/
   
Average
 
(Dollars in thousands)
 
Balance
   
Expense
   
Rate
   
Balance
    Expense     Rate    
Expense
   
Balance
 
Interest earning assets
                                               
    Loans (1)(2)
  $ 107,864     $ 5,974       5.54 %   $ 121,506     $ 7,046       5.80 %   $ (1,072 )   $ (13,642 )
    Short-term  and other investments
    5,957       41       0.69 %     8,808       91       1.03 %     (50 )     (2,851 )
    Investments
    2,876       1       0.03 %     2,959      
      0.00 %     1       (83 )
Total interest earning assets
    116,697       6,016       5.16 %     133,273       7,137       5.35 %     (1,121 )     (16,576 )
Cash and due from banks
    10,313                       22,798                               (12,485 )
Premises and equipment, net
    1,954                       2,104                               (150 )
Allowance for loan losses
    (2,349 )                     (2,520 )                             171  
Other
    2,981                       3,127                               (146 )
Total assets
  $ 129,596                     $ 158,782                             $ (29,186 )
Interest bearing liabilities
                                                               
    Time certificates
  $ 35,908       588       1.64 %   $ 61,806       1,293       2.09 %     (705 )   $ (25,898 )
    Money market / checking deposits
    46,770       314       0.67 %     47,951       471       0.98 %     (157 )     (1,181 )
    Savings deposits
    2,956       5       0.17 %     2,611       14       0.54 %     (9 )     345  
    Capital lease obligations
    1,158       165       14.25 %     1,166       171       14.67 %     (6 )     (8 )
    Repurchase agreements
    252      
      0.00 %     1,011       1       0.10 %     (1 )     (759 )
Total interest bearing liabilities
    87,044       1,072       1.23 %     114,545       1,950       1.70 %     (878 )     (27,501 )
                                                                 
Non-interest bearing deposits
    30,284                       29,546                               738  
Accrued expenses and other liabilities
    432                       745                               (313 )
Shareholder's equity
    11,836                       13,946                               (2,110 )
Total liabilities and equity
  $ 129,596                     $ 158,782                             $ (29,186 )
Net interest income
          $ 4,944                     $ 5,187             $ (243 )        
                                                                 
Interest spread
                    3.93 %                     3.65 %                
Interest margin
                    4.24 %                     3.89 %                
 
(1)   Average balance includes nonaccruing loans.
(2)   Interest income includes loan fees, which are not material.

 
33

 
 
Rate Volume Variance Analysis

The following table summarizes the variance in interest income and expense for 2012 and 2011 resulting from changes in assets and liabilities and fluctuations in interest rates earned and paid. The changes in interest income and expense attributable to both rate and volume have been allocated to both rate and volume on a pro rata basis.
 
   
2012 vs 2011
 
   
Due to Change in Average
   
(Decrease)
 
(Dollars in thousands)
 
Volume
   
Rate
   
Increase
 
Interest earning assets
                 
    Loans
  $ (766 )   $ (306 )   $ (1,072 )
    Short-term and other investments
    (24 )     (26 )     (50 )
    Investments
   
      1       1  
Total interest earning assets
    (790 )     (331 )     (1,121 )
                         
Interest bearing liabilities
                       
    Time certificates
    (465 )     (240 )     (705 )
    Money market / checking deposits
    (12 )     (145 )     (157 )
    Savings deposits
    2       (11 )     (9 )
    Capital lease obligations
    (1 )     (5 )     (6 )
    Repurchase agreements
    (1 )    
      (1 )
Total interest bearing liabilities
    (477 )     (401 )     (878 )
Net interest income
  $ (313 )   $ 70     $ (243 )
 
The decrease in net interest income during 2012 reflected a $16.6 million decrease in total average interest earning asset balances to $116.7 million for the year ended December 31, 2012 when compared to the same period of 2011 and a decrease in the yields on interest earning assets to 5.16% for the year ended December 31, 2012 from 5.35% for the same period of 2011. The combined effects of these changes were partially offset by a $27.5 million decrease in average interest bearing liabilities to $87.0 million for the year ended December 31, 2012 from $114.5 million for the same period of 2011 as well as a decrease in rates on interest bearing liabilities to 1.23% for the year ended December 31, 2012 from 1.70% for the same period in 2011. Overall, the decrease in net interest income attributed to volume changes was $313,000 which was partially offset by a $70,000 increase in net interest income due to interest rate changes. Interest income from interest earning assets decreased by $1,121,000 in 2012 compared to 2011 because of a $790,000 decrease due to volume considerations and a $331,000 decrease due to a decline in interest rates. Variances in the cost of interest bearing liabilities during the year ended December 31, 2012 in comparison to the same period in 2011 were due to decreased rate considerations of $401,000 and decreased volume considerations of $477,000.

The Company intends for the Bank to continue to emphasize lending to small to medium-sized businesses in its market area as it maintains its strategy to increase assets under management and to improve earnings. The Bank will seek opportunities through marketing to increase its deposit base, with a primary objective of attracting core non-interest checking and related money market deposit accounts, in order to support its earning assets and through the consideration of additional branch locations and new product and service offerings.

 
34

 
 
The following are measurements of the Company’s results of operations in relation to assets and equity and average equity to average assets for the years ended December 31, 2012 and 2011:
 
    2012   2011  
Loss on average assets     (0.13%)     (1.72 %)
Loss on average equity     (1.46%)     (19.63 %)
Average equity to average assets     9.13%     8.78 %
 
Provision for Loan Losses

The Bank’s provision for loan losses was $473,000 for the year ended December 31, 2012 compared to $3,036,000 for the year ended December 31, 2011. The decrease in the provision for loan losses was primarily due to a significant decrease in loan charge-offs in 2012 compared to 2011. The decline in loan charge-offs in 2012 was largely attributable to an initiative undertaken by the Company in 2011 to aggressively identify potential problem loans and reduce the Company's exposure to these loans through loan modifications and partial or complete charge-offs in 2011.

Noninterest Income

Total noninterest income increased $60,000 to $639,000 for the year ended December 31, 2012 from $579,000 for the same period in 2011. This increase in noninterest income for the year ended December 31, 2012 was primarily due to loan prepayment fees of $92,000 and $36,000 in net insurance proceeds received in 2012 with no similar income in 2011, as well as a $41,000 increase in other noninterest income.  The combined effect of these favorable changes were partially offset by a $77,000 decrease in gains on a derivative financial instrument to $9,000 in 2012 compared to $86,000 in 2011 and a $32,000 decrease in service charges and fees due to changes in business practices of customers of the Bank for the year ended December 31, 2012 as compared to the same period in 2011.

Noninterest Expenses

Total noninterest expense was $5,283,000 for the year ended December 31, 2012 compared to $5,468,000 for the same period in 2011, a decrease of $185,000 or 3.4%.

Salaries and benefits expense increased $272,000 to $2,926,000 for the year ended December 31, 2012 from $2,654,000 for the same period in 2011. The increase in salaries and benefits expense during 2012 when compared to 2011 was primarily attributable to restricted stock compensation expense recorded by the Company based upon the vesting schedule for restricted stock granted to the Chief Executive Officer under his employment agreement and restricted stock agreement executed on February 28, 2012 and to a full year of salary and benefits paid to the Chief Executive Officer, who was hired on October 24, 2011 to fill an open position at the Bank that existed during 2011.

Occupancy and equipment expense decreased by $59,000 to $602,000 for the year ended December 31, 2012 from $661,000 for the same period in 2011 primarily due to declines in asset depreciation expense and lower repairs and maintenance expenditures.

Professional services expense increased by $11,000 to $437,000 for the year ended December 31, 2012 30, 2012 from $426,000 for the same period in 2011 due to increased expenditures for loan review and internal auditing and consulting services performed for the year ended December 31, 2012 compared to the same period in 2011.

Fees for data processing and other outside services declined $121,000 to $269,000 for the year ended December 31, 2012 from $390,000 for the same period in 2011. The decrease was primarily due to benefits the Company realized on the renewal of certain related service contracts.
 
 
35

 

FDIC insurance expense increased by $8,000 to $223,000 for the year ended December 31, 2012 from $215,000 for the same period in 2011. The increase was attributable to an increase in FDIC assessment rates paid by the Bank, partially offset by a decline in deposit balances subject to the FDIC deposit insurance assessment.

Directors’ fees decreased by $129,000 to $169,000 for the year ended December 31, 2012 from $298,000 for the same period in 2011. The decrease was attributable to a reduction in fees paid to directors effective January 1, 2012 that was approved by the Company’s compensation committee.

Loan collection expenses decreased by $60,000 to $100,000 for the year ended December 31, 2012 from $160,000 for the year ended December 31, 2011. This $60,000 decrease in loan collection expenses was due to reduced loan collection efforts resulting from a significant decrease in newly identified impaired loans in 2012 compared to 2011.

Insurance expense increased by $38,000 to $123,000 for the year ended December 31, 2012 from $85,000 in 2011 primarily due to increased costs in 2012 associated with insurance policies the Company had entered into during a more favorable environment in July 2008.

Other real estate owned expenses (OREO) of less than $1,000 were incurred during 2012 compared to $93,000 for the year ended December 31, 2011. The expenses incurred during 2011 were related to foreclosed and repossessed asset expenses and write-downs recorded on three OREO properties that resulted from a decline in the appraised value of the properties during 2011.

The Bank incurred a loss on the sale of an OREO property of $51,000 during 2011. In 2012, the Bank sold three OREO properties and realized a net gain of $1,000, which was included in other noninterest income.

Other operating expenses increased by $5,000 to $352,000 for the year ended December 31, 2012 compared to the same period in 2011 primarily due to an increase in other miscellaneous expenses totaling $62,000 that were partially offset by a favorable variance of $57,000 relating to a write-down of other assets held for sale in 2011 due to a decline in the appraised value of a property, with no such write-down in 2012.

Off-Balance-Sheet Arrangements

See Note 13 to the accompanying Consolidated Financial Statements for required disclosure regarding off-balance-sheet arrangements.

Liquidity

The Company’s liquidity position as of December 31, 2012 and 2011 consisted of liquid assets totaling $13.5 million and $28.9 million, respectively. This represents 11.1% and 19.8% of total assets at December 31, 2012 and 2011, respectively. The liquidity ratio is defined as the percentage of liquid assets to total assets. The following categories of assets as described in the accompanying balance sheet are considered liquid assets: Cash and due from banks, short-term investments, interest-bearing certificates of deposit and securities available for sale. Liquidity is a measure of the Company’s ability to generate adequate cash to meet financial obligations. The principal cash requirements of a financial institution are to cover downward fluctuations in deposits and increases in its loan portfolio.
 
Management believes the Company’s short-term assets provide sufficient liquidity to cover potential fluctuations in deposit accounts and loan demand and to meet other anticipated operating cash and investment requirements.
 
 
36

 

Capital

The following table illustrates the Company’s and Bank’s regulatory capital ratios at December 31, 2012 and 2011:

   
Company
   
Bank
 
               
Capital
               
Capital
 
               
Adequacy
               
Adequacy
 
   
2012
   
2011
   
Target Ratio
   
2012
   
2011
   
Target Ratio
 
Total Capital to Risk Weighted Assets
    12.33 %     10.88 %     8.00 %     11.60 %     10.28 %     8.00 %
Tier 1 Capital to Risk Weighted Assets
    11.07 %     9.62 %     4.00 %     10.34 %     9.03 %     4.00 %
Tier 1 (Leverage) Capital Ratio to Average Assets
    9.31 %     7.41 %     4.00 %     8.70 %     6.95 %     4.00 %

Capital adequacy is one of the most important factors used to determine the safety and soundness of individual banks and the banking system. To be considered “well capitalized,” an institution must generally have a Tier 1 leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10%. Based on the above ratios, the Bank is considered to be “well capitalized” under applicable regulations. As of December 31, 2012, the Bank’s Tier I leverage ratio, Tier I risk-based capital ratio and total risk-based capital ratios were above such minimums. However, in July 2012, the Bank entered into a Consent Order with the Federal Deposit Insurance Corporation and the State of Connecticut Department of Banking which, among other things, require it to maintain a minimum Tier 1 leverage ratio of at least 8.0%, a Tier 1 risk-based capital ratio of at least 9% and a total risk-based capital ratio of at least 10%. At December 31, 2012, the Bank’s capital ratios exceeded such minimums set forth in the Consent Order. In September 2012, the Bank also submitted a revised capital plan outlining its strategy for increasing its capital amounts and ratios to the Federal Deposit Insurance Corporation and the State of Connecticut Department of Banking for their approval. In October 2012, the Bank received regulatory approval for its revised capital plan. In the event the Company and Bank’s pending merger with Liberty Bank is not consummated, the Company and the Bank will seek to implement the plan to increase capital as soon as practicable. Further regulatory action is possible if the Bank does not maintain the minimum capital ratios set forth in the Consent Order.

Market Risk

Market risk is defined as the sensitivity of income to fluctuations in interest rates, foreign exchange rates, equity prices, commodity prices and other market-driven rates or prices. Based upon the nature of the Company’s business, market risk is primarily limited to interest rate risk, which is defined as the impact of changing interest rates on current and future earnings.

The Company’s goal is to maximize long-term profitability, while minimizing its exposure to interest rate fluctuations. The first priority is to structure and price the Company’s assets and liabilities to maintain an acceptable interest rate spread, while reducing the net effect of changes in interest rates. In order to reach an acceptable interest rate spread, the Company must generate loans and seek acceptable long-term investments to replace the lower yielding balances in Federal Funds sold and short-term investments. The focus also must be on maintaining a proper balance between the timing and volume of assets and liabilities re-pricing within the balance sheet. One method of achieving this balance is to originate variable loans for the portfolio to offset the short-term re-pricing of the liabilities. In fact, a number of the interest bearing deposit products have no contractual maturity. Customers may withdraw funds from their accounts at any time and deposits balances may therefore run off unexpectedly due to changing market conditions.
 
The exposure to interest rate risk is monitored by senior management of the Bank and reported quarterly to the Asset and Liability Management Committee and the Board of Directors. Management reviews the interrelationships within the balance sheet to maximize net interest income within acceptable levels of risk.
 
 
37

 

Impact of Inflation and Changing Prices

The Company’s consolidated financial statements have been prepared in terms of historical dollars, without considering changes in relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Notwithstanding this fact, inflation can directly affect the value of loan collateral, in particular, real estate. Inflation, or disinflation, could significantly affect the Company’s earnings in future periods.

Factors Affecting Future Results

Some of the statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and elsewhere in this Annual Report on Form 10-K may include forward-looking statements which reflect our current views with respect to future events and financial performance. Statements which include the words “expect,” “intend,” “plan,” “believe,” “project,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise. All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in these statements or that could adversely affect the holders of our common stock. These factors include, but are not limited to, (1) changes in prevailing interest rates which would affect the interest earned on the Company’s interest earning assets and the interest paid on its interest bearing liabilities, (2) the timing of re-pricing of the Company’s interest earning assets and interest bearing liabilities, (3) the effect of changes in governmental monetary policy, (4) the impact of recently enacted federal legislation and the effect of changes in regulations applicable to the Company and the conduct of its business, (5) changes in competition among financial service companies, including possible further encroachment of non-banks on services traditionally provided by banks, (6) the ability of competitors which are larger than the Company to provide products and services which are impractical for the Company to provide, (7) the volatility of quarterly earnings, due in part to the variation in the number, dollar volume and profit realized from SBA guaranteed loan participation sales in different quarters, (8) the effect of a loss of any executive officer, key personnel, or directors, (9) the effect of the Company’s opening of branches and the receipt of regulatory approval to complete such actions, (10) the concentration of the Company’s business in southern and southeastern Connecticut, (11) the concentration of the Company’s loan portfolio in commercial loans to small-to-medium sized businesses, which may be impacted more severely than larger businesses during periods of economic weakness, (12) lack of seasoning in the Company’s loan portfolio, which may increase the risk of future credit defaults, and (13) the effect of any decision by the Company to engage in any business not historically permitted to it. Other such factors may be described in other filings made by the Company with the SEC.

Although the Company believes that it has the resources needed for success, future revenues and interest spreads and yields cannot be reliably predicted. These trends may cause the Company to adjust its operations in the future. Because of the foregoing and other factors, recent trends should not be considered reliable indicators of future financial results or stock prices.

Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
 
 
38

 


Not required.


The consolidated balance sheets of the Company as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive loss, shareholders’ equity and cash flows for the years then ended, together with the report thereon of McGladrey LLP dated March 28, 2013 are included as part of this Form 10-K following page 59 hereof.
 

Not applicable.

 
                      (a)
Evaluation of Disclosure Controls and Procedures

Based upon an evaluation of the effectiveness of the Company’s disclosure controls and procedures performed by the Company’s management, with participation of the Company’s Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer as of the end of the period covered by this report, the Company’s Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer concluded that the Company’s disclosure controls and procedures have been effective in ensuring that material information relating to the Company, including its consolidated subsidiary, is made known to the certifying officers by others within the Company and the Bank during the period covered by this report.

As used herein, “disclosure controls and procedures” means controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

                      (b)  
Management’s Annual Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) under the Securities Exchange Act of 1934. Under the supervision and with the participation of the Chief Executive Officer, the Chief Financial Officer and the Chief Accounting Officer, we conducted an evaluation of the effectiveness of our control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the framework, management has concluded that our internal control over financial reporting was effective as of December 31, 2012.
 
 
39

 
 
                      (c)
Attestation Report of the Registered Public Accounting Firm

As of result of a provision of the Dodd-Frank Act, which, among other things, permanently exempted non-accelerated filers, such as the Company, from complying with the requirements of Section 404(b) of Sarbanes-Oxley, which requires an issuer to include an attestation report from an issuer’s independent registered public accounting firm on the issuer’s internal control over financial reporting, this Annual Report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding the Company’s internal control over financial reporting.

                      (d)
Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal controls over financial reporting during the Company’s last fiscal quarter ended December 31, 2012 that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.


None.
 


The Board is divided into three classes designated as Class I, Class II and Class III, with each class containing approximately the same percentage of the total of non employee directors. The Company has one employee director, the Company’s Chief Executive Officer, who is a Class II director elected by shareholders to serve until the 2015 Annual Meeting. The term of office of one class of directors expires at each annual meeting of the Company’s shareholders. Directors serve for a term of three years and until his or her successor is elected and qualified, or until his or her earlier resignation, removal from office, death or disability. The term of office of Class I directors will expire at the annual meeting of shareholders in 2014; Class II directors will expire at the annual meeting of shareholders in 2015; and Class III directors will expire at the annual meeting of shareholders in 2013. A plurality of votes is required for the election of directors.

The following table sets forth each of the Company’s current directors and executive officers and includes such person’s name, age, the year he or she first became a director of the Company and the biographies of such directors and executive officers.
 
 
40

 
 
Name
 
Age
 
Position And Offices With the Company or the Bank
and Principal Occupation and Employment During the Past Five Years
 
Director of the Company Since
       
DIRECTORS
   
Class I
           
Alphonse F. Spadaro, Jr.
 
71
 
Chairman of the Company, the Bank, and SCB; managing principal of Levitsky & Berney, P.C. (public accounting firm). Mr. Spadaro’s knowledge of accounting issues makes him a valuable member of the Boards of the the Company, the Bank and SCB.
 
2001. To serve until 2014.
             
Joshua H. Sandman, Ph.D.
 
70
 
Director of the Company and the Bank; Vice President, Deitsch Plastics (plastics fabricating) and Professor, University of New Haven; former Director of The Bank of New Haven. Dr. Sandman’s experience as a former director of a community bank and senior executive of a local business, which is the type of customer targeted by the Bank, makes him a valuable member of the Boards of the Company and the Bank.
 
2000. To serve until 2014
             
Class II
           
James S. Brownstein, Esq.
 
64
 
Director of the Company, the Bank and SCB; managing partner, Law Offices of James S. Brownstein, LLC (law firm). Mr. Brownstein’s years of practicing law provide insight on legal issues for the Boards of the Company, the Bank and SCB.
 
2008. To serve until 2015
             
Joseph J. Greco
 
62
 
Director and CEO of the Company, the Bank and SCB; Prior to joining the the Company and the Bank, Mr. Greco served from April 2010 to October 2011 as Executive Vice President, Corporate Development, of Union Savings Bank, headquartered in Danbury, Connecticut. From June 2002 to April 2010, Mr. Greco was President and Chief Executive Officer of First Litchfield Financial Corp. and its primary subsidiary, The First National Bank of Litchfield (collectively, “First Litchfield”),headquartered in Litchfield, Connecticut prior to its acquisition by Union. Mr. Greco's years of experience as a Bank Director and CEO make him well suited to serve as a Director of the Company, the Bank and SCB.
 
2011. To serve until 2015
             
Class III
           
Alfred J. Ranieri, Jr., M.D.
 
70
 
Vice Chairman of the Company and the Bank; Private practice physician, New Haven, CT. Dr. Ranieri brings valuable managerial experience and local knowledge of the Bank’s primary market area to the Boards of the Company and the Bank.
 
2007. To serve until 2013.
             
Janette J. Parker
 
82
 
Director of the Company and the Bank; Currently a member of the Mayor of New Haven’s Task Force for Universal Access to Pre-School, as well as Director of the Dixwell Community House, Inc and the Historic Wooster Square Association. Ms. Parker’s many years as a small business owner and her knowledge of the Bank’s primary market area make her a valuable member of the Boards of the Company and the Bank.
 
2012. To serve until 2013.
             
       
NON-DIRECTORS EXECUTIVE OFFICERS
   
             
Sunil Pallan
 
50
 
President of the Company and the Bank since April 2011. Senior Vice President of the Bank from March 2008 to September 2012. Senior Loan Officer of the Bank since September 2012. Chief Credit Officer of the Bank from March 2008 to September 2012; Vice President of Loan Administration and Chief Credit Officer from January 2008 to March 2008;
   
             
Stephen V. Ciancarelli
 
57
 
Senior Vice President and Chief Financial Officer of the Company, the Bank and SCB since May 2008. Prior to May 2008, Mr. Ciancarelli spent 5 years as Senior Vice President and Chief Financial Officer with Essex Corporation, a subsidiary of John Hancock Life Insurance the Company. Mr. Ciancarelli is a graduate of L.I.U.-C.W. Post in New York and holds an M.B.A. from L.I.U.-C.W. Post in New York.
   
 
 
41

 
  
Audit Committee of the Board

Audit Committee. The Company’s Audit Committee oversees all internal and external audit and compliance functions. Both the internal auditor and the external auditor report directly to the Audit Committee. In performing its functions, the Audit Committee acts as a joint Audit Committee of the Company, the Bank and SCB. All of the members of the Audit Committee are independent as that term is defined in Section 803A of the NYSE MKT Company Guide. The Board of Directors has determined that Alphonse F. Spadaro, Jr. is an audit committee financial expert under the rules of the Securities and Exchange Commission. The Audit Committee acts under a written charter adopted by the Board of Directors, a copy of which is available on the Company’s website at www.scbancorponline.com. The current members of the Company’s Audit Committee are Alphonse F. Spadaro, Jr. (Chair), Alfred J. Ranieri, Jr., M.D. and Joshua H. Sandman, Ph.D. In 2012, Carl R. Borelli served as a member of the Audit Committee from January 1, 2012 until he passed away on December 13, 2012. To replace Mr. Borelli, Alfred J. Ranieri, Jr., M.D. was appointed to the Audit Committee effective December 18, 2012. In 2012, Elmer F. Laydon served as a member of the Audit Committee from January 1, 2012 until his retirement on March 20, 2012. To replace Mr. Laydon, Joshua H. Sandman, Ph.D. was appointed to the Audit Committee effective March 20, 2012. The Audit Committee met 7 times during 2012.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s officers and directors, and persons who own more than ten percent (10%) of the Company’s Common Stock, to file reports of ownership and changes in ownership of the Company’s Common Stock with the Securities and Exchange Commission (“SEC”). Officers, directors and greater than ten percent (10%) beneficial owners are required by applicable regulations to furnish the Company with copies of all forms they file pursuant to Section 16(a). Based upon a review of the copies of forms furnished to the Company, the Company believes all forms required by Section 16(a) of the Exchange Act were filed on a timely basis during the year ended December 31, 2012.
 
Code of Ethics

The Company has adopted a Code of Ethics and Conduct that is designed to promote the highest standards of ethical conduct by the Company’s and the Bank’s directors, executive officers and employees. The Code of Ethics and Conduct applies to the Company’s CEO, President and Chief Financial Officer and is considered to be the Company’s Code of Ethics in accordance with Regulations of the Securities and Exchange Commission. The Code of Ethics and Conduct requires that the Company’s, the Bank’s and SCB’s directors, executive officers and employees avoid conflicts of interest, comply with all laws and other legal requirements, conduct business in an honest and ethical manner and otherwise act with integrity and in the Company’s, the Bank’s and SCB’s best interest. Under the terms of the Code of Ethics and Conduct, directors, executive officers, officers and employees are required to report any conduct that they believe in good faith to be an actual or apparent violation of the Code. The Code of Ethics and Conduct is available on the Company’s website at www.scbancorponline.com. Amendments to or waivers from the Code of Ethics and Conduct will be discussed in Form 8-Ks filed by the Company and accessible on the Company’s website.
 
 
42

 
 

The following is a summary compensation table for the Company’s Chief Executive Officer and the next two highest paid executive officers of the Company (collectively, the “named executive officers”).

The Summary Compensation Table summarizes the total compensation paid for the fiscal year ended December 31, 2012 and 2011 to our named executive officers.

Name and Principal Position
 
Year
Ended
 
Salary
   
Bonus 
($)
   
Stock
Awards 
($)
   
Option
Awards
($)
   
All Other Compensation
($)
   
Total ($)
 
Joseph J. Greco (1)
 
2012
  $ 245,000     $
    $ 106,752     $
    $ 17,093 (2 ) $ 368,845  
Director and Chief Executive Officer of the Company, the Bank and SCB
 
2011
  $ 37,692     $ 100     $
    $
    $ 2,081 (2 ) $ 39,873  
                                                     
Sunil Pallan (3)
 
2012
  $ 175,000     $ 2,750     $
    $
    $ 690 (4 ) $ 178,440  
President of the Company and the Bank and Senior Loan Officer of the Bank
 
2011
  $ 164,365     $ 500     $
    $
    $ 667 (4 ) $ 165,532  
                                                     
Stephen V. Ciancarelli
 
2012
  $ 165,000     $ 5,750     $
    $
    $ 1,290 (4 ) $ 172,040  
Senior Vice President and CFO
 
2011
  $ 165,000     $ 500     $ 4,150 (5)   $
    $ 1,290 (4 ) $ 170,940  
of the Company, the Bank and SCB
                                                   
                                                     
John H. Howland (6)
 
2011
  $ 67,692     $
    $
    $
    $ 188 (4 ) $ 67,880  
Former President & Chief Operating Officer of the Company and the Bank
                                                   
 
(1)   Mr. Greco was hired as CEO of the Company, the Bank and SCB on October 24, 2011. Mr. Greco, who has served as a Class II Director of the Company, the Bank and SCB since November 15, 2011, does not receive any additional compensation for his services as a director of the Company, the Bank and SCB.

(2)   Represents the dollar value of the use of an automobile provided by the Bank and the dollar value of group term life insurance premiums paid by the Bank.

(3)   Mr. Pallan was promoted to President of the Company and the Bank effective April 2011 and Senior Loan Officer of the Bank effective September 2012. Prior to his promotion to Senior Loan Officer of the Bank, Mr. Pallan had served as Chief Credit Officer of the Bank.

(4)   Represents the dollar value of group term life insurance premiums paid by the Bank.

(5)   Includes the dollar value of 1,000 shares of common stock held by Stephen V. Ciancarelli which vested on May 5, 2011. The market price of the common stock on May 5, 2011 was $4.15.

(6)   Mr. Howland resigned as President and COO of the Company and the Bank effective April 2011.
 
 
43

 
 
Employment Agreements

From October 24, 2011 to February 28, 2012, Joseph J. Greco served as Chief Executive Officer without an employment agreement at an annual base salary of $245,000. He was also entitled to the use of a vehicle owned by the Bank and other customary benefits associated with the hiring of employees by the Bank. Following regulatory approval of his proposed employment agreement, the Company and the Bank entered into an employment agreement with Joseph J. Greco effective as of February 28, 2012. The Company and Mr. Greco also entered into a restricted stock agreement dated as of February 28, 2012.

Under the employment agreement, Mr. Greco will serve as Chief Executive Officer of the Company and the Bank from the date of the employment agreement through December 31, 2014, unless the Company and the Bank terminate the employment agreement earlier under the terms of the employment agreement. Mr. Greco will also serve as a director of the Company and the Bank.

Mr. Greco will earn an annual base salary of $245,000 over the term of the employment agreement and be entitled to receipt of incentive compensation at the end of each calendar year during the term in an amount up to 10% of his base salary for achieving individual or corporate goals established by the Board of Directors of the Company or the Bank. In addition, Mr. Greco has been granted 112,371 shares of restricted common stock of the Company pursuant to the restricted stock agreement. Under the restricted stock agreement, the 112,371 shares of restricted common stock vests as follows: 37,457 shares as of the date of the restricted stock agreement, 37,457 shares as of July 2, 2012 and 37,457 shares as of January 2, 2013.

During the term, Mr. Greco will be entitled to benefits including, but not limited to, comprehensive health insurance and major medical and dental coverage, participation in any long-term disability insurance plan and pension plan maintained by the Company or the Bank, supplemental disability insurance such that the monthly disability benefit payable to Mr. Greco is equal to 70% of his monthly base salary, use of a Bank-owned vehicle with a purchase price of up to $40,000, and term life insurance in an amount not less than $300,000.

If Mr. Greco is terminated for “Cause” or voluntarily terminates his employment other than for “Good Reason,” he will only be entitled to base salary accrued through the date of his termination. If Mr. Greco’s employment is terminated by reason of “Disability,” he will receive disability benefits under any long-term disability plan maintained by the Company or the Bank. In the event of Mr. Greco’s death, his beneficiary(ies) or estate will be paid Mr. Greco’s base salary for a period of six months following his death. If Mr. Greco is terminated for any reason other than for “Cause” or “Disability” or if Mr. Greco voluntarily terminates his employment for “Good Reason,” then he will be entitled to receive (i) twelve months of base salary and (ii) his individual and/or family health benefits coverage for a period of twelve months following his termination (or such other period prescribed by the then applicable COBRA law), with Mr. Greco paying the same portion of the cost of such coverage as existed at the time of termination; provided, however, that no payments will be made to Mr. Greco if such payments would constitute a “golden parachute payment” and is made after the occurrence of certain events specified under regulations promulgated by the Federal Deposit Insurance Corporation (the “FDIC”), including the determination by the FDIC that the Bank is in “troubled condition.” Any lump sum payment made to Mr. Greco is also subject to claw back by the Company and the Bank if it is later determined he committed or is substantially responsible for certain acts or omissions prohibited under regulations promulgated by the FDIC.

Effective as of January 1, 2011, the Company and the Bank entered into an employment agreement with Mr. Pallan to serve as Senior Vice President and Chief Credit Officer of the Bank through December 31, 2012, unless the Bank terminates the employment agreement earlier under the terms of the employment agreement. Mr. Pallan was subsequently promoted to President of the Company and the Bank in April 2011, while maintaining his position as Chief Credit Officer. The annual base salary payable under the employment agreement was increased from $140,000 to $175,000 when Mr. Pallan was promoted to President of the Company and the Bank. All other terms and conditions of Mr. Pallan’s employment agreement remained unchanged. In addition to base salary, Mr. Pallan will be eligible for salary increases and other merit bonuses at the discretion of the Company’s Board of Directors.
 
 
44

 

Mr. Pallan will be provided with health and life insurance comparable to coverage provided to other officers of the Bank, will be reimbursed for certain business expenses, and will be eligible to participate in the profit sharing or 401(k) plan of the Company (or its subsidiaries).

If Mr. Pallan's employment is terminated as a result of a "Business Combination" (as such term is defined in the employment agreement), Mr. Pallan will, subject to certain conditions, be entitled to receive a lump sum payment in an amount equal to two times the total of his then current base annual salary plus the amount of any bonus for the prior calendar year in the event that (i) Mr. Pallan is not offered a position with the remaining entity at his then current base annual salary (subject to the remaining entity having a reasonable opportunity to remedy the situation), (ii) Mr. Pallan determines in his sole discretion that the position offered by the remaining entity is inconsistent with his current position (subject to the remaining entity having a reasonable opportunity to remedy the situation), (iii) Mr. Pallan's office is relocated more than 25 miles from its location as of the date of the employment agreement or (iv) Mr. Pallan is terminated (other than for certain specified events that constitute cause or as the result of his death or disability) or his office is relocated, within two years following a "Business Combination." In any such event, Mr. Pallan will also be entitled to (a) an acceleration of vesting of all stock options and restricted stock previously granted to him and (b) a continuation of benefits under the employment agreement for the balance of the unexpired term of his employment, which will be paid at his option as a lump sum payment or ratably over the balance of the unexpired term.

On January 29, 2013, the Company and the Bank entered into an employment agreement with Mr. Pallan effective January 1, 2013.
 
Under the employment agreement, Mr. Pallan will serve as President of the Company and the Bank and Senior Loan Officer of the Bank for the period from January 1, 2013 to December 31, 2013, unless the employment agreement is terminated earlier in accordance with its terms. Mr. Pallan will be paid a base salary at the annual rate of $175,000 and be eligible for salary increases and bonuses reflecting job performance achievements at the discretion of the Board of Directors of the Company and the Bank. In addition, he will be provided with group life insurance and comprehensive health insurance, including major medical coverage, comparable to the coverage provided to officers generally. Mr. Pallan will also be eligible to participate in any profit sharing plan or 401(k) plan in accordance with their terms.
 
The employment agreement may be terminated prior to December 31, 2013 as a result of Mr. Pallan engaging in certain specified acts that constitute cause or the death or disability of Mr. Pallan. In addition, in the event (i) the Company and the Bank enter into a “Business Combination” as defined in the employment agreement and (ii) Mr. Pallan (a) is not offered the same position at his current base salary with the surviving entity, (b) determines in his sole discretion that the position offered by the surviving entity is inconsistent with his current position, including diminution in title, authority, duties or responsibilities, (c) has his office relocated more than 25 miles from its current location or (d) is terminated within 2 years following the “Business Combination,” Mr. Pallan will be entitled to receipt of a lump sum payment equal to his then current base salary; provided, however, that no payment will be made to Mr. Pallan if such payment would constitute a “golden parachute payment” and is made after the occurrence of certain events specified under regulations promulgated by the FDIC, including the determination by the FDIC that the Bank is in “troubled condition.” Any lump sum payment made to Mr. Pallan is also subject to claw back by the Company and the Bank if it is later determined that he committed or is substantially responsible for certain acts or omissions prohibited under regulations promulgated by the FDIC.

On December 17, 2010, the Company and its subsidiary, the Bank, entered into an employment agreement with Stephen V. Ciancarelli effective January 1, 2011. Under the employment agreement, Mr. Ciancarelli will serve as the Senior Vice President and Chief Financial Officer of the Company through December 31, 2012, unless the Company terminates the employment agreement pursuant to the terms thereof. Mr. Ciancarelli will receive an annual base salary of $165,000 from January 1, 2011 to December 31, 2012. Mr. Ciancarelli will be eligible for salary increases and other merit bonuses at the discretion of the Company’s Board of Directors.

Mr. Ciancarelli will be provided with health and life insurance, will be reimbursed for certain business expenses, and will be eligible to participate in the profit sharing or 401(k) plan of the Company (or its subsidiaries).
 
 
45

 

If Mr. Ciancarelli's employment is terminated as a result of a "Business Combination" (as such term is defined in the employment agreement), Mr. Ciancarelli will, subject to certain conditions, be entitled to receive a lump sum payment in an amount equal to two times the total of his then current base annual salary plus the amount of any bonus for the prior calendar year in the event that (i) Mr. Ciancarelli is not offered a position with the remaining entity at his then current base annual salary (subject to the remaining entity having a reasonable opportunity to remedy the situation), (ii) Mr. Ciancarelli determines in his sole discretion that the position offered by the remaining entity is inconsistent with his current position (subject to the remaining entity having a reasonable opportunity to remedy the situation), (iii) Mr. Ciancarelli's office is relocated more than 25 miles from its location as of the date of the employment agreement or (iv) Mr. Ciancarelli is terminated (other than for certain specified events that constitute cause or as the result of his death or disability) or his office is relocated, within two years following a "Business Combination". In either such event, Mr. Ciancarelli will also be entitled to (a) an acceleration of vesting of all stock options and restricted stock previously granted to him and (b) a continuation of benefits under the employment agreement for the balance of the unexpired term of his employment, which will be paid at his option as a lump sum payment or ratably over the balance of the unexpired term.

On January 29, 2013, the Company and the Bank entered into an employment agreement with Mr. Ciancarelli effective January 1, 2013.

Under the employment agreement, Mr. Ciancarelli will serve as Senior Vice President and Chief Financial Officer of the Company and the Bank for the period from January 1, 2013 to December 31, 2013, unless the employment agreement is terminated earlier in accordance with its terms. Mr. Ciancarelli will be paid a base salary at the annual rate of $165,000 and be eligible for salary increases and bonuses reflecting job performance achievements at the discretion of the Board of Directors of the Company and the Bank. In addition, Mr. Ciancarelli will be provided with group life insurance and comprehensive health insurance, including major medical coverage, comparable to the coverage provided to officers generally. He will also be eligible to participate in any profit sharing plan or 401(k) plan in accordance with their terms.
 
The employment agreement may be terminated prior to December 31, 2013 as a result of Mr. Ciancarelli engaging in certain specified acts that constitute cause or the death or disability of Mr. Ciancarelli. In addition, in the event (i) the Company and the Bank enter into a “Business Combination” as defined in the employment agreement and (ii) Mr. Ciancarelli (a) is not offered the same position at his current base salary with the surviving entity, (b) determines in his sole discretion that the position offered by the surviving entity is inconsistent with his current position, including diminution in title, authority, duties or responsibilities, (c) has his office relocated more than 25 miles from its current location or (d) is terminated within 2 years following the “Business Combination,” Mr. Ciancarelli will be entitled to receipt of a lump sum payment equal to his then current base salary; provided, however, that no payment will be made to him if such payment would constitute a “golden parachute payment” and is made after the occurrence of certain events specified under regulations promulgated by the FDIC, including the determination by the FDIC that the Bank is in “troubled condition.” Any lump sum payment made to Mr. Ciancarelli is also subject to claw back by the Company and the Bank if it is later determined that he committed or is substantially responsible for certain acts or omissions prohibited under regulations promulgated by the FDIC.

On December 17, 2010, the Company and the Bank entered into an employment agreement with John H. Howland effective January 1, 2011. Under the employment agreement, Mr. Howland served as the President and Chief Operating Officer of the Company through the date of his resignation from the Company and the Bank in April 2011. Mr. Howland was to receive an annual base salary of $200,000 from January 1, 2011 to December 31, 2012. Mr. Howland was eligible for salary increases and other merit bonuses at the discretion of the Company’s Board of Directors. In addition, he was provided with health and life insurance, was reimbursed for certain business expenses, and was eligible to participate in the profit sharing or 401(k) plan of the Company (or its subsidiaries).
 
 
46

 
 
DIRECTOR COMPENSATION
 
The following is the directors’ compensation table for the year ended December 31, 2012.
 
Name
 
Fees Earned
or Paid in
Cash ($)
   
Stock
Awards ($)
   
Option
Awards ($)
   
All
Other
Compensation ($)
   
Total ($)
 
Carl R. Borrelli (1)
  $ 30,100     $
    $
    $
    $ 30,100  
James S. Brownstein, Esq.
    23,100      
     
     
      23,100  
Elmer F. Laydon (2)
    16,200      
     
     
      16,200  
Alfred J. Ranieri, Jr., M.D.
    22,650      
     
     
      22,650  
Joshua H. Sandman, Ph.D.
    20,700      
     
     
      20,700  
Alphonse F. Spadaro, Jr.
    38,600      
     
     
      38,600  
Janette J. Parker
    17,400      
     
     
      17,400  
 
(1)  
Carl R. Borelli served as Vice Chairman of the Board and a director of the Company, the Bank and SCB until his death on December 13, 2012.
(2)  
Elmer F. Laydon retired as Chairman of the Board and as a director of the Company, the Bank and SCB on March 20, 2012.

During 2012, directors of the Company and the Bank, who are not employees of the Company or the Bank, receive compensation in cash as follows: the Chairman and Vice Chairman of the Board receive $600 and $400 per month, respectively; each director receive $300 for each board meeting attended, $400 for each board committee meeting chaired, $300 for each board committee meeting attended and $300 for each executive committee meeting attended. Directors who sit on the Company and Bank boards are compensated for only one meeting where a meeting of both boards or more than one committee is held jointly. Directors of SCB, who are not employees of the Company, SCB or the Bank, receive no compensation for the SCB board or SCB board committee meetings attended. Each Bank director received an annual stipend of $7,500 for 2012.

Effective January 1, 2013, each Bank director received an annual stipend of $12,500 in 2013.
 
 
47

 

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE

The following table sets forth information concerning outstanding restricted stock and stock options as of December 31, 2012 held by the named executive officers.

   
Option Awards
   
Stock Awards
 
Name
 
Number of Securities Underlying Unexercised Options (#) Exercisable
   
Option Exercise
Price ($)
   
Option
Expiration Date
   
Number of Shares or Units of Stock that have not Vested (#)
   
Market Value of Shares or Units of Stock that have not Vested ($)
 
Joseph J. Greco
   
    $
     
      37,457     $ 58,058  
Sunil Pallan
    500     $ 7.08    
12/31/2015
     
    $
 
 
As of December 31, 2012, non-employee directors have the following outstanding stock option awards:

Name
 
Option
Awards (#)
 
Alfred J. Ranieri, Jr., M.D.
    18,538  
Joshua H. Sandman, Ph.D.
    14,938  
Alphonse F. Spadaro, Jr.
    14,203  
Janette J. Parker
    7,054  
 
Elmer F. Laydon retired as Chairman of the Board and as a director of the Company, the Bank and SCB on March 20, 2012. Mr. Laydon has 47,345 outstanding stock options that vested while he served as the Chairman of the Board and as director of the Company and the Bank.

Carl R. Borelli served as Vice Chairman of the Board and a director of the Company, the Bank and SCB until his death on December 13, 2012. Mr. Borelli’s estate is entitled to 21,276 outstanding stock options that vested while Mr. Borelli served as the Vice Chairman of the Board and as director of the Company and the Bank.

The Company maintains directors’ and officers’ liability insurance and the Company’s by-laws provide for mandatory indemnification of directors and officers to the fullest extent permitted by Connecticut law. In addition, the Company’s certificate of incorporation limits the liability of directors to the Company or its shareholders for breaches of directors’ fiduciary duties to the fullest extent permitted by Connecticut law.
 
 
48

 

The 2005 Stock Option and Award Plan

The Company adopted the Southern Connecticut Bancorp, Inc. 2005 Stock Option and Award Plan (the “2005 Stock Plan”). The purpose of the 2005 Stock Plan is to provide equity-based incentives to employees, officers and directors of the Company in order to attract them to, give them a proprietary interest in, and encourage them to remain in the employ or service of the Company. An aggregate of 150,000 shares of the Company’s Common Stock is reserved for issuance upon the exercise of both incentive stock options and nonqualified stock options granted by the Company under the 2005 Stock Plan. All eligible employees and directors of the Company or any subsidiary of the Company, including the Bank, are eligible to receive options under the 2005 Stock Plan. The exercise price for each share for an incentive stock option may not be less than the fair market value of a share of the Company’s Common Stock on the date of grant. Although the Plan does not prescribe a minimum option price for non-qualified stock options, it is the current intention of the Compensation Committee to grant non-qualified stock options at or above fair market value of a share of the Company’s Common Stock on the date of grant. Options under the 2005 Stock Plan have a term of 10 years unless otherwise determined at the time of grant. As of December 31, 2012 there were 4,820 outstanding options under the 2005 Stock Plan.

The Compensation Committee has broad authority under the 2005 Stock Plan with respect to awards granted under the 2005 Stock Plan, including, without limitation, the authority to:

·  
authorize the granting of shares of common stock or options under the 2005 Stock Plan;

·  
determine and designate the employees and directors of the Company to receive awards under the 2005 Stock Plan;
 
·  
determine the type, number, price, vesting requirements and other features and conditions of individual stock awards and options under the 2005 Stock Plan; and

·  
interpret the 2005 Stock Plan and the various written agreements made in connection with grants of shares of common stock or options thereunder.

The 2002 Stock Option Plan

The Company adopted the Southern Connecticut Bancorp, Inc. 2002 Stock Option Plan (the “2002 Plan”). The purpose of the 2002 Plan is to attract and retain the continued services of employees and directors of the Company and the Bank, encourage employees and directors to obtain or increase their stock ownership in the Company, and provide incentive compensation programs competitive with those of other similarly situated companies. An aggregate of 383,250 shares of the Company’s Common Stock were reserved for issuance upon the exercise of both incentive stock options and nonqualified stock options granted by the Company under the 2002 Plan, which number has been adjusted to reflect a 10% stock dividend declared in January 2004 and a 5% stock dividend declared in April 2005. All eligible employees and directors of the Company or any subsidiary of the Company, including the Bank, are eligible to receive options under the 2002 Plan. The exercise price for each share covered by an option may not be less than the fair market value of a share of the Company’s Common Stock on the date of grant. Options under the 2002 Plan have a term of 10 years unless otherwise determined at the time of grant. On December 22, 2005, the Compensation Committee of the Board of Directors approved the acceleration of all unvested options outstanding as of December 31, 2005 that were granted under the 2002 Plan. Pursuant to this acceleration of all unvested options, options to purchase 197,571 shares of the Company’s Common Stock became immediately exercisable as of December 31, 2005. As of December 31, 2012, there were 145,072 outstanding options under the 2002 Plan. The 2002 Plan expired on May 14, 2012.

The 2001 Stock Option Plan

The Company adopted the Southern Connecticut Bancorp, Inc. 2001 Stock Option Plan (the “2001 Option Plan”) in 2001 and it was approved by the sole shareholder of the Company in 2001. Under the 2001 Option Plan, an aggregate of 90,000 shares of the Company’s Common Stock was reserved for issuance upon the exercise of options granted under the 2001 Option Plan. The Compensation Committee of the Board administers the 2001 Option Plan. The Board voted to terminate the 2001 Option Plan, except for outstanding options previously granted under the 2001 Option Plan, effective as of May 15, 2002. As of December 31, 2012, there were no outstanding options under the 2001 Option Plan.
 
 
49

 
 
Warrant Plan

The Company adopted a 2001 Warrant Plan and 2001 Supplemental Warrant Plan (collectively, the “Warrant Plans”) on April 11, 2001 and October 16, 2001. Under the Warrant Plans, each non-employee director of the Company and each director of the Bank who was not a director of the Company, as of the initial public offering of the Company in July 2001, received a warrant to purchase one share of the Company’s Common Stock for each four shares purchased in the offering by such director or members of such director’s immediate family. Under the 2001 Supplemental Warrant Plan, certain organizers of the Company who are not directors, officers or employees of the Company or the Bank but who made contributions to the Company or the Bank received a warrant to purchase one share of the Company’s Common Stock for each five shares purchased in the offering by such person or member of such person’s immediate family. The warrants have a term of ten years. The exercise price of the warrants is $10.39, the price at which the Company’s Common Stock was sold in the initial public offering, as adjusted for the January 2004 10% stock dividend and the April 2005 5% stock dividend. They became exercisable as to 40%, 30% and 30% of the shares covered thereby on the first, second and third anniversary of the closing of the initial public offering of the Company, respectively. All warrants issued under the Warrant Plans expired in November 2011.


Equity Compensation Plan Information. The following schedule provides information with respect to the compensation plans (including individual compensation arrangements) under which equity securities of the Company are authorized for issuance as of December 31, 2012:
 
               
Number of securities
 
               
remaining
 
   
Number of securities
to be issued
   
Weighted-average
   
 available forfuture
issuance under
 
   
upon exercise of
   
exercise price of
   
equity compensation
 
   
outstanding options,
   
outstanding options,
   
plans (excluding
 
   
warrants and rights
   
warrants and rights
   
securities reflected in
 
Plan Category
 
(a)
   
(b)
   
column (a))
 
Equity Compensation Plans approved by security holders
    145,072     $ 7.62       48,209  
Equity Compensation Plan not approved by security holders (1)    
     
     
 
Total
    145,072     $ 7.62       48,209  
 
(1) The Company adopted a 2001 Warrant Plan and 2001 Supplemental Warrant Plan (collectively, the “Warrant Plans”) on April 11, 2001 and October 16, 2001, respectively. The Warrant Plans were not approved by security holders. Under the Warrant Plans, each director of the Company, other than Mr. Joseph V. Ciaburri (who served as the Chairman of the board of directors of the Company at the time), and each director of the Bank who is not a director of the Company, as of the initial public offering of the Company in July 2001, received a warrant to purchase one share of the Company common stock for each four shares purchased in the offering by such director or members of such director’s immediate family. Under the 2001 Supplemental Warrant Plan, certain organizers of the Company who are not directors, officers or employees of the Company or the Bank but who made contributions to the Company’s enterprise received a warrant to purchase one share of the Company common stock for each five shares purchased in the offering by such person or member of such person’s immediate family. The warrants have a term of ten years. The exercise price of the warrants is $10.39, the price at which the Company’s common stock was sold in the initial public offering, as adjusted for subsequent stock dividends. All warrants issued under the Warrant Plans expired in November 2011.
 
 
50

 

Security Ownership of Certain Beneficial Owners and Management
 
The following table sets forth certain information concerning the ownership of the Company’s Common Stock as of March 15, 2013 by the Company’s directors and named executive officers. Except as otherwise indicated, all shares are owned directly, and the named person possesses sole voting and sole investment power with respect to all such shares. No shares are pledged as collateral. Shares not outstanding but deemed beneficially owned because a person or member of a group has a right to acquire them within 60 days after March 15, 2013 are treated as outstanding only when determining the amount and percent owned by such person or group.
 
Name and Address of Beneficial Owner
the Company Incumbent Directors
 
Amount and
Nature of
Beneficial Ownership
   
Percent of
Class (1)