10-K 1 hbnk-2014630x10k.htm 10-K HBNK-2014.6.30-10K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2014

COMMISSION FILE NUMBER: 001-33144
HAMPDEN BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware
20-5714154
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
19 HARRISON AVE.
SPRINGFIELD, MASSACHUSETTS
01102
(Zip Code)
(Address of principal executive offices)
 
 
(413) 736-1812
(Registrant’s telephone number, including area code) 
Securities registered pursuant to section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock ($0.01 par value per share)
The NASDAQ Stock Market LLC
 
Securities registered pursuant to section 12(g) of the Act:
None
Indicate by check mark whether 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 whether the registrant is not required to file reports pursuant to section 13 or Section 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.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 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 checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Sec. 229.405 of this chapter) 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
Accelerated filer x
  Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12(b)-2 of the Exchange Act).  Yes o     No x.
Based upon the closing price of the registrant’s common stock as of December 31, 2013, the aggregate market value of the voting and non-voting common stock held by non-affiliates of the Registrant (without admitting that any person whose shares are not included in such calculation is an affiliate) was $76,998,665.
The number of shares of Common Stock outstanding as of September 10, 2014 was 5,532,018.



Documents Incorporated By Reference:
 
The following documents (or parts thereof) are incorporated by reference into the following parts of this Form 10-K: Certain information required in Part III of this Annual Report on Form 10-K is incorporated from the Registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on November 4, 2014.

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HAMPDEN BANCORP, INC. AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2014
TABLE OF CONTENTS
 
 
 
 
Page No.



38


39


 








 





 

 
 



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Part I

Item 1.      Business
 
General

Hampden Bancorp, Inc. (the “Company”), a Delaware corporation that became the holding company of Hampden Bank (the “Bank”) in 2007, is registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Bank completed its conversion to the holding company structure on January 16, 2007. The information set forth in this Annual Report on Form 10-K for Hampden Bancorp, Inc. and its subsidiaries, the Bank, and Hampden LS, Inc., including the consolidated financial statements and related financial data, relates primarily to the Bank. The Bank has three wholly-owned subsidiaries: Hampden Investment Corporation and Hampden Investment Corporation II, both of which engage in buying, selling, holding and otherwise dealing in securities, and Hampden Insurance Agency, which ceased selling insurance products in November of 2000 and remains inactive.  All significant intercompany accounts and transactions have been eliminated in consolidation.
Established in 1852 and headquartered in Springfield, Massachusetts, the Bank is a full service, community bank that offers a variety of loan and deposit products from its ten office locations in Springfield, Agawam, Longmeadow, West Springfield, Wilbraham and Indian Orchard, Massachusetts, as well as insurance and investment products through its Financial Services Division, Hampden Financial. The Bank offers customers the latest in internet banking, including on-line banking and bill payment services.
Available Information

The Company makes available free of charge through its website at www.hampdenbank.com its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (the “SEC”). The Company’s reports filed with or furnished to the SEC are also available at the SEC’s website at www.sec.gov. The information contained on our website is not incorporated by reference into, and does not form any part of, this Annual Report on Form 10-K.
Market Area

 
Hampden Bank offers financial products and services designed to meet the financial needs of our customers. Our primary deposit-gathering area is concentrated in the Massachusetts cities and towns of Springfield, West Springfield, Longmeadow, Agawam and Wilbraham. We offer Remote Deposit Capture to our customers, which allows us to expand our deposit gathering outside of our normal deposit area. Our lending area is broader than our deposit-gathering area and primarily includes Hampden, Hampshire, Franklin, and Berkshire Counties of Massachusetts as well as portions of northern Connecticut.
 
The Bank is headquartered in Springfield, Massachusetts. All of the Bank's offices are located in Hampden County. Springfield is the third largest city in Massachusetts, located in south western Massachusetts, 90 miles west of Boston and 30 miles north of Hartford, Connecticut, connected by major interstate highways. A diversified mix of industry groups operate within Hampden County, including manufacturing, health care, higher education, wholesale/retail trade and service. The major employers in the area include MassMutual Financial Group, Baystate Health System, several area universities and colleges, and Big Y supermarkets. The county in which Hampden Bank currently operates includes a mixture of suburban, rural, and urban markets. According to 2010 census data, Hampden Bank's market area is projected to remain substantially unchanged in population and household growth through 2015.

Competition

The Company faces intense competition in attracting deposits and loans from financial institutions and credit unions operating in its market area and, to a lesser extent, from other financial service companies, such as brokerage firms, insurance companies, mortgage companies and mortgage brokers. The Company also faces competition for depositors’ funds from money market funds, mutual funds and other corporate and government securities. Large super-regional banks such as Bank of America, Santander, Citizens and TD Bank operate in the Company’s market area. These institutions have significantly greater resources than the Company. We expect the competition in our market area to continue.


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The Company’s competition for loans comes primarily from financial institutions in our market areas, and from other financial service providers such as mortgage companies and mortgage brokers. Competition for loans also comes from a number of non-depository financial service companies entering the mortgage market. These include insurance companies, securities companies and specialty finance companies.
 
The Company expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered the barriers to market entry, allowed banks and other lenders to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Changes in federal law permit affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in the financial services industry. Competition for deposits and the origination of loans could limit the Company’s future growth.
 
Lending Activities
 
General. The Company's gross loan portfolio amounted to $510.6 million at June 30, 2014, representing 72.8% of total assets at that date. In its lending activities, the Company originates commercial real estate loans, residential real estate loans secured by one- to four-family residences, residential and commercial construction loans, commercial and industrial loans, home equity lines of credit, fixed rate home equity loans and other personal consumer loans. While the Company makes loans throughout Massachusetts, most of its lending activities are concentrated in Hampden and Hampshire Counties. Loans originated and purchased totaled $191.9 million in the fiscal year ended June 30, 2014 (“fiscal 2014”) and $161.1 million in the fiscal year ended June 30, 2013 (“fiscal 2013”). Residential mortgage loans sold into the secondary market, on a servicing-retained basis, totaled $10.1 million during fiscal 2014 and $22.6 million in fiscal 2013, and residential mortgage loans sold into the secondary market, on a servicing-released basis, totaled $7.7 million during fiscal 2014 and $9.1 million during fiscal 2013. At June 30, 2014, the Company’s largest loan was $8.9 million, and the average balance of the Company’s ten largest loans was $5.8 million.
The following table summarizes the composition of the Company's loan portfolio as of the dates indicated:
 
 
June 30,
 
2014
 
2013
 
2012
 
2011
 
2010
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars In Thousands)
Mortgage loans on real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
200,750

 
39.31
%
 
$
167,381

 
36.95
%
 
$
152,965

 
37.43
%
 
$
151,395

 
37.79
%
 
$
138,746

 
33.35
%
Residential
107,498

 
21.05
%
 
107,617

 
23.75
%
 
112,294

 
27.48
%
 
121,462

 
30.32
%
 
130,977

 
31.49
%
Home equity
76,144

 
14.91
%
 
78,421

 
17.31
%
 
72,983

 
17.86
%
 
62,975

 
15.72
%
 
65,006

 
15.63
%
Construction
39,996

 
7.84
%
 
24,973

 
5.51
%
 
6,553

 
1.60
%
 
5,265

 
1.31
%
 
13,460

 
3.24
%
Total mortgage loans on real estate
424,388

 
83.11
%
 
378,392

 
83.52
%
 
344,795

 
84.37
%
 
341,097

 
85.15
%
 
348,189

 
83.70
%
Other loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial
54,756

 
10.72
%
 
43,566

 
9.62
%
 
35,567

 
8.70
%
 
35,739

 
8.92
%
 
42,539

 
10.23
%
Consumer and other
31,504

 
6.17
%
 
31,077

 
6.86
%
 
28,323

 
6.93
%
 
23,742

 
5.93
%
 
25,257

 
6.07
%
Total other loans
86,260

 
16.89
%
 
74,643

 
16.48
%
 
63,890

 
15.63
%
 
59,481

 
14.85
%
 
67,796

 
16.30
%
Total loans
510,648

 
100.00
%
 
453,035

 
100.00
%
 
408,685

 
100.00
%
 
400,578

 
100.00
%
 
415,985

 
100.00
%
Other items:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Net deferred loan costs
2,638

 
 

 
2,726

 
 

 
2,807

 
 

 
2,603

 
 

 
2,943

 
 

Allowance for loan losses
(5,651
)
 
 

 
(5,414
)
 
 

 
(5,148
)
 
 

 
(5,473
)
 
 

 
(6,314
)
 
 

Total loans, net
$
507,635

 
 

 
$
450,347

 
 

 
$
406,344

 
 

 
$
397,708

 
 

 
$
412,614

 
 

 
Commercial Real Estate Loans.  The Company originated $50.8 million and $30.9 million of commercial real estate loans in fiscal 2014 and fiscal 2013, respectively, and had $200.8 million of commercial real estate loans with an average yield of 5.2% in its portfolio as of June 30, 2014, representing 39.31% of the total gross loan portfolio on such date. The Company intends to further grow this segment of its loan portfolio, both in absolute terms and as a percentage of its total loan portfolio.
 


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Interest rates on commercial real estate loans adjust over periods of three, five, or ten years based primarily on Federal Home Loan Bank rates. In general, rates on commercial real estate loans are priced at a spread over Federal Home Loan Bank advance rates.  Commercial real estate loans are generally secured by commercial properties such as industrial properties, hotels, small office buildings, retail facilities, warehouses, multi-family income properties and owner-occupied properties used for business. Generally, commercial real estate loans are approved with a maximum 80% loan to appraised value ratio.
 
In its evaluation of a commercial real estate loan application, the Company considers the net operating income of the property, the borrower’s expertise, credit history, and the profitability and value of the underlying property. For loans secured by rental properties, the Company will also consider the terms of the leases and the quality of the tenant. The Company generally requires that the properties securing these loans have minimum debt service coverage sufficient to support the loan. The Company generally requires the borrowers seeking commercial real estate loans to personally guarantee those loans.
 
Commercial real estate loans generally have larger balances and involve a greater degree of risk than residential mortgage loans. Loan repayment is often dependent on the successful operation and management of the properties, as well as on the collateral value of the commercial real estate securing the loan. Economic events and changes in government regulations could have an adverse impact on the cash flows generated by properties securing the Company’s commercial real estate loans and on the value of such properties.

Residential Real Estate Loans.  The Company offers fixed-rate and adjustable-rate residential mortgage loans. These loans have original maturities of up to 30 years and generally have maximum loan amounts of up to $1.0 million. In its residential mortgage loan originations, the Company lends up to a maximum loan-to-value ratio of 100% for first-time home buyers and immediately sells all of its 100% loan-to-value ratio loans.  For fiscal year 2014, the Company originated 47 loans with a loan-to-value ratio of 95% or greater, of which 100% were sold. Hampden Bank has an Asset Liability Committee, which evaluates whether the Company should retain or sell any fixed rate loans that have maturities greater than 15 years. As of June 30, 2014, the residential real estate mortgage loan portfolio totaled $107.5 million, or 21.05% of the total gross loan portfolio on that date, and had an average yield of 4.3%. Of the residential mortgage loans outstanding on that date, $62.5 million were adjustable-rate loans with an average yield of 4.3% and $45.0 million were fixed-rate mortgage loans with an average yield of 4.4%. Residential mortgage loan originations totaled $29.8 million and $48.5 million for fiscal 2014 and fiscal 2013, respectively.

A licensed appraiser appraises all properties securing residential first mortgage purchase loans and all real estate transactions greater than $250,000. If appropriate, flood insurance is required for all properties securing real estate loans made by the Company.

During the origination of fixed rate mortgages, each loan is analyzed to determine if the loan will be sold into the secondary market or held in portfolio. The Company retains servicing for loans sold to the Federal National Mortgage Association ("Fannie Mae") and earns a fee equal to 0.25% of the loan amount outstanding for providing these services.  Loans which the Company originates that have a higher risk profile or are outside of our normal underwriting standards are sold to a third party along with the servicing rights.  The total of loans serviced for third parties as of June 30, 2014 is $71.8 million.

The adjustable-rate mortgage loans (“ARM loans”) offered by the Company make up the largest portion of the residential mortgage loans held in portfolio. At June 30, 2014, ARM loans totaled $62.5 million, or 58.1% of total residential loans outstanding at that date. The Company originates ARM loans with a maximum loan-to-value ratio of up to 95% with private mortgage insurance. Generally, any ARM Loan with a loan-to-value ratio greater than 85% requires private mortgage insurance. ARM loans are offered for terms of up to 30 years with initial interest rates that are fixed for 1, 3, 5, 7 or 10 years. After the initial fixed-rate period, the interest rates on the loans are reset based on the relevant U.S. Treasury Constant Maturity Treasury Index, or CMT Index, plus add-on margins of varying amounts, for periods of 1, 3, and 5 years. Maximum interest rate adjustments on such loans typically range from 2.0% to 3.0% during any adjustment period and 5.0% to 6.0% over the life of the loan. Periodic adjustments in the interest rate charged on ARM loans help to reduce the Company’s exposure to changes in interest rates. However, ARM loans generally possess an element of credit risk not inherent in fixed-rate mortgage loans, because borrowers are potentially exposed to increases in debt service requirements over the life of the loan in the event market interest rates rise, resulting in higher payments. These higher payments may increase the risk of default or prepayments.

In light of the national housing crisis, rising unemployment, and a weakening economy, the Company offers a short term relief program, that provides our residential mortgage customers with the ability to overcome temporary financial pressures. The modification program is available to current customers that have a mortgage loan held in portfolio. The modification plan is designed to provide short term relief of generally three to six months due to job loss, reduced income, a need to restructure debt, or other events that have caused or will cause a borrower to be unable to keep current with mortgage payments. The plan is offered on a case-by-case basis and only after a review of the borrower’s current financial condition and a determination that such a plan is likely to provide to the borrowers the ability to maintain current monthly payments going forward. Debt to income ratios demonstrating an ability to pay must be achieved for a modification plan to be in place. Under this modification program, the

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borrower’s future principal payments are accelerated in order to return to the original rate and term of the original contract, and accordingly these loans are not classified as troubled debt restructurings.
 
Home Equity Loans.  The Company offers home equity lines of credit and home equity term loans. The Company originated $14.2 million and $19.9 million of home equity lines of credit and loans during fiscal 2014 and fiscal 2013, respectively, and at June 30, 2014 had $76.1 million of home equity lines of credit and loans outstanding, representing 14.91% of the loan portfolio, with an average yield of 3.7% at that date. Approximately 47.7% of the Company’s home equity lines of credit and loans are classified as first in priority liens.
 
Home equity lines of credit and loans are secured by first or second mortgages on one- to four-family owner occupied properties, and are made in amounts such that the combined first and second mortgage balances generally do not exceed 85% of the value of the property serving as collateral at time of origination. The lines of credit are available to be drawn upon for 10 to 20 years, at the end of which time they become term loans amortized over 5 to 10 years. Interest rates on home equity lines normally adjust based on the month-end prime rate published in the Wall Street Journal. The undrawn portion of home equity lines of credit totaled $35.7 million at June 30, 2014.

Commercial Loans.  The Company originates secured and unsecured commercial loans to business customers in its market area for the purpose of financing equipment purchases, working capital, expansion and other general business purposes. The Company originated $39.6 million and $13.2 million in commercial loans during fiscal 2014 and fiscal 2013, respectively, and as of June 30, 2014 had $54.8 million in commercial loans in its portfolio, representing 10.72% of the loan portfolio, with an average yield of 4.2%.
 
The Company’s commercial loans are generally collateralized by equipment, accounts receivable and inventory, and are usually supported by personal guarantees. The Company offers both term and revolving commercial loans. The former have either fixed or adjustable-rates of interest and generally fully amortize over a term of between three and seven years. Revolving loans are written on demand with annual reviews, with floating interest rates that are indexed to the Company’s base rate of interest.

When making commercial loans, the Company considers the financial statements of the borrower, the borrower’s payment history with respect to both corporate and personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, the viability of the industry in which the borrower operates and the value of the collateral. The Company has established limits on the amount of commercial loans in any single industry.
 
Because commercial loans often depend on the successful operation or management of the business, repayment of such loans may be affected by adverse changes in the economy. Further, collateral securing such loans may depreciate in value over time, may be difficult to appraise and to liquidate, and may fluctuate in value. The Company intends to further grow this segment of its loan portfolio, both in absolute terms and as a percentage of its total loan portfolio.

Construction Loans.  The Company offers residential and commercial construction loans. The majority of commercial construction loans are written to become permanent financing. The Company originated $43.6 million and $40.1 million of construction loans during fiscal 2014 and fiscal 2013, respectively, and at June 30, 2014 had $40.0 million of construction loans outstanding, representing 7.84% of the loan portfolio.
 
We originate fixed-rate and adjustable-rate loans to individuals for their primary residence.  We also make construction loans for commercial development projects, including office buildings, senior housing facilities, apartment buildings, industrial buildings, retail complexes and medical facilities.  Our construction loans generally provide for the payment of interest only during the construction phase, which is usually a period of 6 – 24 months.  At the end of the construction phase, the loan generally converts to a permanent mortgage loan.  Before making a commitment to make a construction loan, we require an appraisal of the property on an “as-is” and “as-completed” basis by an independent appraiser.  We also require an inspection of the ongoing project before disbursement of funds during the construction process.
 
At June 30, 2014, our largest outstanding residential construction loan was $608,000, of which $595,000 was outstanding.  At June 30, 2014, our largest commercial construction loan was $6.5 million, of which $6.3 million was outstanding for the development of an apartment building.  These loans were performing in accordance with their original terms at June 30, 2014.
 





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Consumer and Other Loans.  The Company originates a variety of consumer and other loans, auto loans and loans secured by passbook savings or certificate accounts. The Company also purchases manufactured home loans and automobile loans from third parties. The Company originated $13.9 million and $8.6 million of consumer and other loans, including purchases of manufactured home and automobile loans, during fiscal 2014 and fiscal 2013, respectively, and at June 30, 2014 had $31.5 million of consumer and other loans outstanding. Of the $13.9 million of originations in 2014, $2.3 million consists of purchased automobile loans and $3.0 million consists of purchased manufactured housing loans. Consumer and other loans outstanding represented 6.17% of the loan portfolio at June 30, 2014, with an average yield of 7.95%.
 
Loan Origination.  Loan originations come from a variety of sources. The primary source of originations is our salaried and commissioned loan personnel, and to a lesser extent, local mortgage brokers, advertising and referrals from customers. The Company occasionally purchases participation interests in commercial real estate loans and commercial loans from banks located in Massachusetts and Connecticut. The Company underwrites these loans using its own underwriting criteria.
 
The Company makes commitments to loan applicants based on specific terms and conditions.  As of June 30, 2014, the Company had commitments to grant loans of $20.4 million, unadvanced funds on home equity lines of credit totaling $35.7 million, unadvanced funds on overdraft lines of credit totaling $1.8 million, unadvanced funds on commercial lines of credit totaling $37.8 million, unadvanced funds due mortgagors and on construction loans totaling $37.9 million and standby letters of credit totaling $500,000.
 
Generally, the Company charges origination fees, or points, and collects fees to cover the costs of appraisals and credit reports. For information regarding the Company’s recognition of loan fees and costs, please refer to Note 1 to the Consolidated Financial Statements of Hampden Bancorp, Inc. and its subsidiaries, beginning on page F-10.

The following table sets forth certain information concerning the Company’s portfolio loan originations:
 
 
For the Years Ended June 30,
 
2014
 
2013
 
2012
 
2011
 
2010
 
(In Thousands)
Loans at beginning of year
$
453,035

 
$
408,685

 
$
400,578

 
$
415,985

 
$
387,742

Originations:
Mortgage loans on real estate:
 

 
 

 
 

 
 

 
 

Residential
29,785

 
48,458

 
35,821

 
34,306

 
33,148

Commercial
50,757

 
30,884

 
15,832

 
18,781

 
13,973

Construction
43,594

 
40,090

 
9,524

 
8,779

 
20,444

Home equity
14,211

 
19,858

 
26,609

 
15,494

 
19,927

Total mortgage loans on real estate originations
138,347

 
139,290

 
87,786

 
77,360

 
87,492

Other loans:
 

 
 

 
 

 
 

 
 

Commercial business
39,582

 
13,161

 
15,957

 
8,629

 
23,755

Consumer and other
8,602

 
2,037

 
1,725

 
1,448

 
1,858

Total other loan originations
48,184

 
15,198

 
17,682

 
10,077

 
25,613

Total loans originated
186,531

 
154,488

 
105,468

 
87,437

 
113,105

Purchase of manufactured home loans
3,017

 
2,854

 
3,300

 
1,151

 
5,769

Purchase of automobile loans
2,304

 
3,722

 
5,090

 

 

Deduct:
 

 
 

 
 

 
 

 
 

Principal loan repayments and prepayments
116,017

 
84,322

 
76,631

 
80,283

 
72,256

Loan sales
17,835

 
31,848

 
23,171

 
20,941

 
16,603

Charge-offs
387

 
544

 
859

 
2,771

 
1,772

Total deductions
134,239

 
116,714

 
100,661

 
103,995

 
90,631

Net increase (decrease) in loans
57,613

 
44,350

 
8,107

 
(15,407
)
 
28,243

Loans at end of year
$
510,648

 
$
453,035

 
$
408,685

 
$
400,578

 
$
415,985

 

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Loan Underwriting. The Company believes that credit risk is best approved in a bottom up manner.  The officer most directly responsible for credit risk, the Account Manager, typically approves exposures within delegated authority or recommends approval to the next level of authority as necessary.  All exposures require at least one signature by an officer with the appropriate authority.  No exposure will be approved without the recommendation of the Account Manager.  All new commercial loan approval actions must be documented in the individual credit file with a Credit Approval Memorandum, prior to the Bank advancing any funds.

The Company’s loan policy has established specific loan approval limits.  Loan officers may approve loans up to their individual lending limit, or two loan officers can originate loans up to their combined limit.  The loan committee reviews all loan applications and approves relationships greater than the loan officer’s limit.  Certain loan relationships require loan committee and/or of the Board of Directors of Hampden Bank (the “Board of Investment”) approval.  The members of the Bank’s loan committee include the Bank’s President and Chief Executive Officer, Chief Lending Officer, Chief Financial Officer, Senior Vice President of Retail and Mortgage Lending, Vice President of Commercial Credit and two Vice Presidents of Commercial Lending.

Residential mortgage loans are underwritten by the Bank. Residential mortgage loans for less than the corresponding Fannie Mae limit to be held in portfolio require the approval of a residential loan underwriter. Residential mortgage loans greater than the Fannie Mae limit require the approval of a Senior Retail Loan Officer and in some instances, depending on the amount of the loan, the approval of the Board of Investment.

Consumer loans are underwritten by consumer loan underwriters, including loan officers and branch managers who have approval authorities based on experience for these loans. Unsecured personal loans are generally not written for more than $5,000.

The Company generally does not make loans aggregating more than $10.0 million to one borrower (or related entity). Exceptions to this limit require the approval of the Board of Investment prior to loan origination. The Company’s internal lending limit is lower than the Massachusetts legal lending limit, which is 20.0% of a bank’s retained earnings and equity, or $15.1 million for the Company as of June 30, 2014.
 
The Company has established a risk rating system for its commercial real estate, commercial construction and commercial loans. This system evaluates a number of factors useful in indicating the risk of default and risk of loss associated with a loan. These ratings are reviewed by commercial credit analysts who do not have responsibility for loan originations. The Company also uses a third party loan review firm to test and review these ratings, and then report their results to the Audit Committee of the Board of Directors of Hampden Bancorp, Inc (the “Audit Committee”).
 
The Company occasionally participates in loans originated by third parties to supplement our origination efforts. The Company underwrites these loans using its own underwriting criteria.
 
Loan Maturity.  The following table summarizes the final maturities of the Company’s loan portfolio at June 30, 2014. This table does not reflect scheduled principal payments, unscheduled prepayments, or the ability of certain loans to reprice prior to maturity dates. Demand loans, and loans having no stated repayment schedule, are reported as being due in one year or less:
 
 
Residential Mortgage
 
Commercial Real Estate
 
Home Equity
 
Construction
 
Amount
 
Weighted
Average
Rate
 
Amount
 
Weighted
Average
Rate
 
Amount
 
Weighted
Average
Rate
 
Amount *
 
Weighted Average
Rate
 
(Dollars In Thousands)
Due in less than one year
$
175

 
5.94
%
 
$
32,980

 
6.12
%
 
$
10

 
5.56
%
 
$
2,874

 
4.48
%
Due in one year to five years
1,093

 
4.88
%
 
57,647

 
5.37
%
 
2,975

 
4.47
%
 
8,030

 
5.55
%
Due after five years
106,230

 
4.30
%
 
110,123

 
4.80
%
 
73,159

 
3.63
%
 
29,092

 
4.45
%
Total
$
107,498

 
4.31
%
 
$
200,750

 
5.18
%
 
$
76,144

 
3.66
%
 
$
39,996

 
4.67
%

9


 
Commercial
 
Consumer and Other
 
Total
 
Amount
 
Weighted
Average
Rate
 
 
Amount

 
Weighted
Average
Rate
 
 
Amount

 
Weighted
Average
Rate
 
(Dollars In Thousands)
Due in less than one year
$
2,423

 
5.21
%
 
$
332

 
11.79
%
 
$
38,794

 
5.99
%
Due in one year to five years
18,497

 
4.45
%
 
7,078

 
4.34
%
 
95,320

 
5.10
%
Due after five years
33,836

 
3.97
%
 
24,094

 
8.96
%
 
376,534

 
4.60
%
Total
$
54,756

 
4.19
%
 
$
31,504

 
7.95
%
 
$
510,648

 
4.79
%
* The amount of construction loans that are due after five years are written to be permanent loans after the construction period is over.

The following table sets forth, at June 30, 2014, the dollar amount of total loans, net of unadvanced funds on loans, contractually due after June 30, 2015 and whether such loans have fixed interest rates or adjustable interest rates.
 
 
Due After June 30, 2015
 
Fixed
 
Adjustable
 
Total
 
(In Thousands)
Residential mortgage
$
42,840

 
$
64,483

 
$
107,323

Commercial real estate
101,926

 
65,844

 
167,770

Home equity
44,438

 
31,696

 
76,134

Construction
12,816

 
24,306

 
37,122

Commercial
17,320

 
35,013

 
52,333

Consumer and other
30,419

 
753

 
31,172

Total loans
$
249,759

 
$
222,095

 
$
471,854

 
Loan Quality
 
General.  One of the Company’s most important operating objectives is to maintain a high level of asset quality. Management uses a number of strategies in furtherance of this goal, including maintaining sound credit standards in loan originations, monitoring the loan portfolio through internal and third-party loan reviews, and employing active collection and workout processes for delinquent or problem loans.
 
Delinquent Loans.  Management performs a monthly review of all delinquent loans. The actions taken with respect to delinquencies vary depending upon the nature of the delinquent loans and the period of delinquency. A late charge is normally assessed on loans where the scheduled payment remains unpaid after a 15-day grace period for residential mortgages and a 10-day grace period for commercial loans. After mailing delinquency notices, the Company’s loan collection personnel call the borrower to ascertain the reasons for delinquency and the prospects for repayment. On loans secured by one- to four-family owner-occupied property, the Company initially attempts to work out a payment schedule with the borrower in order to avoid foreclosure. Any such loan restructurings must be approved by an officer with the level of authority required for a new loan of that amount. If these actions do not result in a satisfactory resolution, the Company refers the loan to legal counsel and counsel initiates foreclosure proceedings. For commercial real estate, commercial construction and commercial loans, collection procedures may vary depending on individual circumstances.
 
Other Real Estate Owned.  The Company classifies property acquired through foreclosure or acceptance of a deed in lieu of foreclosure as other real estate owned (“OREO”) in its consolidated financial statements. When property is placed into OREO, it is recorded at the fair value less estimated costs to sell at the date of foreclosure or acceptance of deed in lieu of foreclosure. At the time of transfer to OREO, any excess of carrying value over fair value less estimated cost to sell is charged to the allowance for loan losses. Management, or its designee, inspects all OREO property periodically. Holding costs and declines in fair value result in charges to expense after the property is acquired. At June 30, 2014, the Company had $309,000 of property classified as OREO. In July 2011, the Company began leasing out a $270,000 OREO property and collected $109,000 in rental income in fiscal 2014. This property was sold to the lessee on June 12, 2014. As of September 11, 2014, the Company signed a purchase and sale

10


agreement for a $215,000 OREO property. The Company will not incur any additional costs. The Company anticipates this property will be sold by September 30, 2014.

Classification of Assets and Loan Review.  Risk ratings of 1-9 are assigned to all credit relationships to differentiate and manage levels of risk in individual exposures and throughout the portfolio. Refer to Note 5 in the consolidated financial statements in Item 8 for detailed discussion.  Ratings are called Customer Risk Ratings ("CRRs").  CRRs are designed to reflect the risk to the Company in any Total Customer Relationship Exposure.  Risk ratings are used to profile the risk inherent in portfolio outstandings and exposures to identify developing trends and relative levels of risk and to provide guidance for the promulgation of policies, which control the amount of risk in an individual credit and in the entire portfolio, identify deteriorating credits and predict the probability of default. Timeliness of this process allows early intervention in the recovery process so as to maximize the likelihood of full recovery, and establish a basis for maintaining prudent reserves against loan losses.
 
The Account Manager has the primary responsibility for the timely and accurate maintenance of CRRs. The risk rating responsibility for the aggregate portfolio rests with the Commercial and Residential Division Executives. If a disagreement surfaces regarding a risk rating, the loan review committee makes the final determination. The members of the Bank’s loan review committee include Bank’s President and Chief Executive Officer, Chief Lending Officer, Chief Financial Officer, Senior Vice President of Retail and Mortgage Lending, Vice President of Commercial Credit and a Vice President of Commercial Lending. All others in a supervisory or review function regarding credit have a responsibility for reviewing the appropriateness of the rating and bringing to senior management’s attention any dispute so it may be resolved.  Generally, changes to risk ratings are made immediately upon receipt of material information, which suggests that the current rating is not appropriate.

The Company engages an independent third party to conduct a semi-annual review of a significant portion of its commercial real estate, commercial construction and commercial loan portfolios. These loan reviews provide a credit evaluation of individual loans to determine whether the risk ratings assigned are appropriate. Independent loan review findings are presented directly to the Audit Committee.
 
Watchlist loans, including non-accrual loans, are classified as either special mention, substandard, doubtful, or loss. At June 30, 2014, loans classified as special mention totaled $13.7 million, consisting of $12.4 million commercial real estate, $533,000 commercial loans, $523,000 residential mortgage loans, $7,000 home equity loans and $161,000 consumer loans.

Substandard loans totaled $11.2 million, consisting of $4.0 million commercial real estate, $4.3 million commercial, $2.6 million residential mortgage, $150,000 home equity and $60,000 consumer loans.

Loans classified as doubtful totaled $351,000, consisting of $146,000 residential mortgage and $205,000 of consumer loans.

Non-Performing Assets.  The table below sets forth the amounts and categories of our non-performing assets at the dates indicated:
 
 
At June 30,
 
2014
 
2013
 
2012
 
2011
 
2010
 
(Dollars In Thousands)
Non-accrual loans:
 
 
 
 
 
 
 
 
 
Residential mortgage
$
2,755

 
$
1,405

 
$
1,266

 
$
2,635

 
$
2,763

Commercial mortgage
534

 
148

 
218

 
1,719

 
1,200

Commercial
1,500

 
1,988

 
597

 
1,366

 
936

Home equity, consumer and other
390

 
438

 
201

 
495

 
793

Total non-accrual loans
5,179

 
3,979

 
2,282

 
6,215

 
5,692

Other real estate owned
309

 
1,221

 
1,826

 
1,264

 
911

Total non-performing assets
$
5,488

 
$
5,200

 
$
4,108

 
$
7,479

 
$
6,603

 
 
 
 
 
 
 
 
 
 
Troubled debt restructurings, not reported above
$
4,601

 
$
7,258

 
$
9,648

 
$
10,926

 
$
4,836

 
 
 
 
 
 
 
 
 
 
Ratios:
 

 
 

 
 

 
 

 
 

Non-performing loans to total loans
1.01
%
 
0.88
%
 
1.55
%
 
1.37
%
 
1.01
%
Non-performing assets to total assets
0.78
%
 
0.80
%
 
1.30
%
 
1.13
%
 
0.93
%
 

11





Generally, loans are placed on non-accrual status either when reasonable doubt exists as to the full timely collection of interest and principal or when a loan becomes 90 days past due unless an evaluation clearly indicates that the loan is well-secured and in the process of collection. Past due status is based on the contractual terms of the loans. Non-accrual loans, including modified loans, return to accrual status once the borrower has shown the ability and an acceptable history of repayment. The borrower must be current with their payments in accordance with the loan terms for six months for commercial and residential loans. The Company may also return a loan to accrual status if the borrower evidences sufficient cash flow to service the debt and provides additional collateral to support the collectability of the loan. For non-accrual and impaired loans that make payments, the Company recognizes cash interest payments as interest income when the Company does not have a collateral shortfall for the loan and the loan has not been partially charged off. If there is a collateral shortfall for the loan or it has been partially charged off, then the Company typically applies the entire payment to the principal balance of the loan. There are no loans greater than 90 days delinquent and still accruing at the dates presented above.

As of June 30, 2014, non-accrual loans totaled $5.2 million, of which $4.3 million were 90 days or greater past due, $486,000 that are 30-89 days past due and $405,000 that are current or less than 30 days past due. It is the Company’s policy to keep loans on non-accrual status until the borrower can demonstrate their ability to make payments according to their loan terms and an acceptable history of repayment of six months. One- to four-family residential non-accrual loans less than 90 days past due were $317,000, commercial real estate non-accrual loans less than 90 days past due were $534,000, and home equity second lien non-accrual loans less than 90 days past due were $39,000. All non-accrual loans, troubled debt restructurings, and loans with risk ratings of six or higher are assessed by the Company for impairment.
 
All loans that are modified when the Bank makes a concession in light of the borrower’s financial difficulty are considered a troubled debt restructuring (“TDR”) (loans for which a portion of interest or principal has been forgiven, or the loans have been modified to lower the interest rate or extend the original term due to a borrower’s financial difficulty and are classified as impaired loans by the Company. The Bank modifies loans in the normal course of business for credit worthy borrowers that are not TDRs. In these cases, the modified terms are consistent with loan terms available to credit worthy borrowers and within normal loan pricing. At such time they meet the criteria for impairment, these loans will be classified as such. The Company does not currently have any concession programs that it offers to its commercial or mortgage loan customers. The Company’s policy for classifying the modified loans as accrual or non-accrual (at the time of modification) is as follows: (i) for loans that have been modified and remain on accrual, the modifications are completed pursuant to our existing underwriting standards, which include a review of historical financial statements, including current interim information if available, an analysis of the causes of the borrower’s decline in performance and projections to assess repayment ability going forward, and (ii) for modified loans, return to accrual status once the borrower has shown the ability and an acceptable history of repayment of six months.
 
At June 30, 2014, the Bank had twelve TDRs totaling approximately $5.1 million, of which $534,000 were on non-accrual status. The interest income recorded from the restructured loans amounted to approximately $276,000 for the year ended June 30, 2014. At June 30, 2013, the Bank had sixteen TDRs totaling approximately $7.8 million, of which $580,000 were on non-accrual status. The interest income recorded from the restructured loans amounted to approximately $239,000 for the year ended June 30, 2013. At June 30, 2012, the Bank had fourteen TDRs totaling approximately $10.3 million, of which $698,000 were on non-accrual status. The interest income recorded from the restructured loans amounted to approximately $689,000 for the year ended June 30, 2012.
 
At June 30, 2014, the interest income that would have been recorded had non-accruing loans been current according to their original terms, amounted to $53,000.
 
Allowance for Loan Losses.  In originating loans, the Company recognizes that losses will be experienced on loans and that the risk of loss will vary with many factors, including the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan over the term of the loan. The Company maintains an allowance for loan losses that is intended to absorb losses inherent in the loan portfolio, and as such, this allowance represents management’s best estimate of the probable known and inherent credit losses in the loan portfolio as of the date of the financial statements. 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.
 



12




The allowance for loan losses is evaluated on a quarterly 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 specifically allocated and general components.  The specifically allocated component relates to loans that are classified as impaired.  For such loans that are classified as impaired, an allowance is established when the discounted cash flows, or collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Allowance for Loan Losses."

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. Impairment is measured on a loan-by-loan basis by the present value of expected future cash flows discounted at the loan’s effective interest rate. Impaired loans decreased to $9.8 million at June 30, 2014 from $15.0 million at June 30, 2013. The Company has established specific reserves aggregating $11,000 for impaired loans.  Such reserves relate to one impaired loan with a carrying value of $537,000, and is based on management’s analysis of the expected cash flows. If impairment is measured based on the present value of expected future cash flows, the change in present value is recorded within the provision for loan loss.

The $9.8 million of impaired loans includes $5.2 million of non-accrual loans and $4.6 million of accruing TDRs as of June 30, 2014. The $4.6 million, or 47%, of total impaired loans, of accruing TDRs were current with all payment terms as of June 30, 2014. As of June 30, 2013, the $15.0 million of impaired loans includes $4.0 million of non-accrual loans and $7.3 million of accruing TDRs as of June 30, 2013. The remaining $3.7 million are loans that the Company believes, 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. Of the $15.0 million of impaired loans, $11.0 million, or 73%, were current with all payment terms as of June 30, 2013.
 
While the Company believes that it has established adequate specifically allocated and general allowances for losses on loans, adjustments to the allowance may be necessary if future conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Company’s regulators periodically review the allowance for loan losses.


13


The following table sets forth activity in the Company’s allowance for loan losses for the periods indicated:
 
 
At or For the Years Ended June 30,
 
2014
 
2013
 
2012
 
2011
 
2010
 
(Dollars In Thousands)
Balance at beginning of year
$
5,414

 
$
5,148

 
$
5,473

 
$
6,314

 
$
3,742

Charge-offs:
 

 
 

 
 

 
 

 
 

Residential mortgage loans
(147
)
 
(185
)
 
(391
)
 
(147
)
 
(39
)
Commercial real estate
(22
)
 
(207
)
 
(166
)
 
(2,000
)
 
(184
)
Commercial

 

 
(213
)
 
(530
)
 
(1,511
)
Consumer and other
(218
)
 
(152
)
 
(89
)
 
(94
)
 
(38
)
Total charge-offs
(387
)
 
(544
)
 
(859
)
 
(2,771
)
 
(1,772
)
Recoveries:
 

 
 

 
 

 
 

 
 

Residential mortgage loans

 
8

 
71

 
8

 
2

Commercial real estate

 

 
16

 

 

Commercial
50

 
104

 
11

 
21

 
3

Consumer and other
24

 
23

 
11

 
1

 
2

Total recoveries
74

 
135

 
109

 
30

 
7

Net charge-offs
(313
)
 
(409
)
 
(750
)
 
(2,741
)
 
(1,765
)
Provision for loan losses
550

 
675

 
425

 
1,900

 
4,337

Balance at end of year
$
5,651

 
$
5,414

 
$
5,148

 
$
5,473

 
$
6,314

 
 
 
 
 
 
 
 
 
 
Ratios:
 

 
 

 
 

 
 

 
 

Net charge-offs to average loans outstanding
0.06
%
 
0.09
%
 
0.19
%
 
0.68
%
 
0.43
%
Allowance for loan losses to non-performing loans at end of year
109.11
%
 
136.06
%
 
225.59
%
 
88.06
%
 
110.93
%
Allowance for loan losses to total loans at end of year
1.11
%
 
1.20
%
 
1.26
%
 
1.37
%
 
1.52
%

As shown in the table above, the provision for loan losses has decreased over the past year. The Company completes its allowance for loan loss review using a calculation that includes specific reserves on impaired credits and general reserves on all non-impaired credits. During this review process, the Company has implemented a qualitative review of the non-impaired loans, using historical charge-offs as the starting point, including charge-offs recognized in the current quarter or year, and then adding additional basis points for specific qualitative factors such as the levels and trends in delinquency and impairments, trends in volume and terms as risk rating migration, effects of changes in risk selection and underwriting standards, experience of lending management and staff, and national and local economic trends and conditions. Adjustments to the provision are made on a quarterly basis, as necessary.

When calculating the general allowance component of the allowance for loan losses, the Company analyzes the trend in delinquencies. If there is an increase in the amount of delinquent loans in a particular loan category, this may cause the Company to increase the general allowance requirement for that loan category. A partial charge-off on a non-performing loan will decrease the amount of non-performing and impaired loans, as well as any specific allowance allocated to that loan. This will also decrease our allowance for loan losses, as well as our allowance for loan losses to non-performing loans ratio and our allowance for loan losses to total loans ratio.

It is the Company’s policy to classify all non-accrual loans as impaired loans. All impaired loans are measured on a loan-by-loan basis to determine if any specific allowance is required for the allowance for loan loss. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. If an impaired loan has a shortfall in the expected future cash flows, then a specific allowance will be placed on the loan in that amount. The Company may consider collateral values where it feels there is greater risk and the expected future cash flow allowance is not sufficient. Residential, commercial real estate, construction and some consumer loans are secured by real estate. As of June 30, 2014, all impaired commercial loans except for one are secured

14


by business assets and many also include primary or secondary mortgage positions on business and/or personal real estate. The other commercial loan is secured by shares of stock of a subsidiary of the borrower. In certain cases additional collateral may be obtained.

For the year ended June 30, 2014, total charge-offs were $387,000 compared to $544,000 for the year ended June 30, 2013. There was a decrease in specific reserves on impaired loans from $32,000 at June 30, 2013 to $11,000 at June 30, 2014 due to a decrease in impaired loans requiring specific reserve allocations in fiscal 2014. In addition, the general reserve allocations decreased due to improving economic factors and decreases in historical losses. These factors contributed to the decrease in the ratio of allowance for loan losses to total loans at the end of the year from 1.20% at June 30, 2013 to 1.11% at June 30, 2014. The allowance for loan losses to non-performing loans has decreased from 136.06% at June 30, 2013 to 109.11% at June 30, 2014. Our allowance for loan losses increased between June 30, 2013 and June 30, 2014 due to increase in loan volume.

The following table sets forth the Company’s allowance by loan category and the percent of the loans to total loans in each of the categories listed at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories:
 
 
At June 30,
 
2014
 
2013
 
2012
 
Allowance
for Loan
Losses
 
Loan
Balance by
Category
 
%
of Loans
in Each
Category
to Total
Loans
 
Allowance
for Loan
Losses
 
Loan
Balance by
Category
 
%
of Loans
in Each
Category
to Total
Loans
 
Allowance
for Loan
Losses
 
Loan
Balance by
Category
 
%
of Loans
in Each
Category
to Total
Loans
 
(Dollars In Thousands)
Mortgage loans on real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential
$
697

 
$
107,498

 
21.05
%
 
$
762

 
$
107,617

 
23.75
%
 
$
865

 
$
112,294

 
27.48
%
Commercial real estate
2,288

 
200,750

 
39.31
%
 
2,215

 
167,381

 
36.95
%
 
2,360

 
152,965

 
37.43
%
Home equity
472

 
76,144

 
14.91
%
 
535

 
78,421

 
17.31
%
 
486

 
72,983

 
17.86
%
Construction
502

 
39,996

 
7.83
%
 
348

 
24,973

 
5.51
%
 
58

 
6,553

 
1.60
%
Total mortgage loans on real estate
3,959

 
424,388

 
83.11
%
 
3,860

 
378,392

 
83.52
%
 
3,769

 
344,795

 
84.37
%
 
 
 
 
 


 
 
 
 
 


 
 
 
 
 
 
Commercial
1,216

 
54,756

 
10.72
%
 
1,065

 
43,566

 
9.62
%
 
969

 
35,567

 
8.70
%
Consumer and other
476

 
31,504

 
6.17
%
 
489

 
31,077

 
6.86
%
 
410

 
28,323

 
6.93
%
Total loans
$
5,651

 
$
510,648

 
100.00
%
 
$
5,414

 
$
453,035

 
100.00
%
 
$
5,148

 
$
408,685

 
100.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

15


 
At June 30,
 
2011
 
2010
 
Allowance
for Loan
Losses
 
Loan
Balance by
Category
 
%
of Loans
in Each
Category
to Total
Loans
 
Allowance
for Loan
Losses
 
Loan
Balance by
Category
 
%
of Loans
in Each
Category
to Total
Loans
 
(Dollars In Thousands)
Mortgage loans on real estate:
 
 
 
 
 
 
 
 
 
 
 
Residential
$
893

 
$
121,462

 
30.32
%
 
$
1,175

 
$
130,977

 
31.76
%
Commercial real estate
2,922

 
151,395

 
37.79
%
 
2,267

 
138,746

 
32.91
%
Home equity
517

 
62,975

 
15.72
%
 
496

 
65,006

 
15.15
%
Construction
65

 
5,265

 
1.31
%
 
60

 
13,460

 
4.45
%
Total mortgage loans on real estate
4,397

 
341,097

 
85.15
%
 
3,998

 
348,189

 
84.27
%
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
1,020

 
35,739

 
8.92
%
 
2,264

 
42,539

 
10.04
%
Consumer and other
56

 
23,742

 
5.93
%
 
52

 
25,257

 
5.69
%
Total loans
$
5,473

 
$
400,578

 
100.00
%
 
$
6,314

 
$
415,985

 
100.00
%

 Investment Activities
 
General.  The Company’s investment policy is approved and adopted by the Board of Directors. The President and Chief Executive Officer and the Chief Financial Officer, as authorized by the Board of Directors, implement this policy based on the established guidelines within the written policy.
 
The basic objectives of the investment function are (1) to enhance the profitability of the Company by keeping its investable funds fully employed at the maximum after-tax return, (2) to provide adequate regulatory and operational liquidity, (3) to minimize and/or adjust the interest rate risk position of the Company, (4) to assist in reducing the Company’s corporate tax liability, (5) to minimize the Company’s exposure to credit risk, (6) to provide collateral for pledging requirements, (7) to serve as a countercyclical balance to earnings by absorbing funds when the Company’s loan demand is low and infusing funds when loan demand is high and (8) to provide a diversity of earning assets to mortgage/loan investments.

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities purchased and held principally for the purpose of trading in the near term are classified as “trading securities”. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income/loss. Gains and losses on disposition of securities are recorded on the trade date and determined using the specific identification method. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.

Declines in fair value of securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining other-than-temporary impairment losses, impairment is required to be recognized (1) if we intend to sell the security, (2) if it is “more likely than not” that we will be required to sell the security before recovery of its amortized cost basis, or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For all impaired available-for-sale debt securities that we intend to sell, or likely will be required to sell, the full amount of the other-than-temporary impairment is recognized through earnings. For all other impaired available-for-sale debt securities, credit-related impairment is recognized through earnings, while non-credit related impairment is recognized in other comprehensive income/loss, net of applicable taxes. Marketable equity securities are evaluated for OTTI based on the severity and duration of the impairment and, if deemed to be other than temporary, the declines in fair value are reflected in earnings as realized losses. The Company did not incur a write-down for OTTI of investment securities in fiscal 2014, 2013 and 2012.
 
Corporate Obligations. At June 30, 2014, the Company’s portfolio of corporate obligations totaled $3.1 million, or 2.2% of the portfolio at that date. The Company’s policy requires that investments in corporate obligations be restricted only to those obligations that are readily marketable and rated ‘A’ or better by a nationally recognized rating agency at the time of purchase. At June 30, 2014, all investments in corporate obligations were rated ‘A’ or better.

16


 Municipal Bonds. At June 30, 2014, the Company’s portfolio of municipal bonds totaled $9.3 million, or 6.9% of the portfolio at that date. The Company’s policy requires that investments in municipal bonds be restricted only to those obligations that are readily marketable and rated ‘A’ or better by a nationally recognized rating agency at the time of purchase. At June 30, 2014, all investments in municipal bonds were rated ‘A’ or better.

Residential Mortgage-Backed Securities.  At June 30, 2014, the Company’s portfolio of residential mortgage-backed securities totaled $130.8 million, or 97.6% of the portfolio on that date, and included pass-through securities totaling $69.7 million and collateralized mortgage obligations totaling $59.4 million directly insured or guaranteed by Freddie Mac, Fannie Mae or the Government National Mortgage Association (“Ginnie Mae”). The Company also invests in securities issued by non-agency or private mortgage originators, provided those securities are rated AAA by nationally recognized rating agencies at the time of purchase. At June 30, 2014, we held 16 securities issued by private mortgage originators that had an amortized cost of $1.7 million and a fair value of $1.7 million. All of these investments are “Senior” Class tranches and have underlying credit enhancement.  These securities were originated in the period 2002-2005 and are performing in accordance with contractual terms. The majority of the decrease in the fair value of these securities is attributed to changes in market interest rates.  Management estimates the loss projections for each security by evaluating the industry rating, amount of delinquencies, amount of foreclosure, amount of other real estate owned, average credit scores, average amortized loan to value and credit enhancement.  Based on this review, management determines whether other-than-temporary impairment existed. Management has determined that no other-than-temporary impairment existed as of June 30, 2014. We will continue to evaluate these securities for other-than-temporary impairment, which could result in a future non-cash charge to earnings.
 
Marketable Equity Securities.  At June 30, 2014, the Company’s portfolio of marketable equity securities totaled $79,000, or 0.06% of the portfolio at that date, and consisted of common stock of two corporations. The Company’s investment policy requires investments of no more than 5% of Tier I capital in any one issuer and no more than 20% of Tier I capital in any one industry.  The total of all investments in common and preferred stocks may not exceed 100% of Tier I capital.  Issues must be listed on the NYSE or NASDAQ. 

Restricted Equity Securities.  At June 30, 2014, the Company held $6.6 million of FHLB stock. This stock is restricted and must be held as a condition of membership in the FHLB and as a condition for the Bank to borrow from the FHLB.
































17


The following table sets forth certain information regarding the amortized cost and fair value of the Company’s securities at the dates indicated:
 
 
At June 30,
 
2014
 
2013
 
2012
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
(In Thousands)
Securities available for sale
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$

 
$

 
$
395

 
$
395

 
$

 
$

Corporate bonds
3,026

 
3,086

 
3,036

 
3,076

 
6,134

 
6,136

Residential mortgage-backed securities:
 
 

 
 
 
 

 
 

 
 

Agency
128,938

 
129,073

 
132,498

 
132,988

 
130,157

 
133,543

Non-agency
1,688

 
1,698

 
2,209

 
2,203

 
4,196

 
4,118

Total debt securities
133,652

 
133,857

 
138,138

 
138,662

 
140,487

 
143,797

Marketable equity securities:
 

 
 

 
 

 
 

 
 

 
 

Common stock
51

 
79

 
51

 
68

 
51

 
54

Total marketable equity securities
51

 
79

 
51

 
68

 
51

 
54

 
 
 
 
 
 
 
 
 
 
 
 
Total securities available for sale
$
133,703

 
$
133,936

 
$
138,189

 
$
138,730

 
$
140,538

 
$
143,851

 
 
 
 
 
 
 
 
 
 
 
 
Securities held to maturity
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$
9,302

 
$
9,302

 
$

 
$

 
$

 
$

Total securities held to maturity
$
9,302

 
$
9,302

 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
Restricted equity securities
 

 
 

 
 

 
 

 
 

 
 

Federal Home Loan Bank of Boston stock
$
6,648

 
$
6,648

 
$
5,092

 
$
5,092

 
$
4,959

 
$
4,959

Total restricted equity securities
$
6,648

 
$
6,648

 
$
5,092

 
$
5,092

 
$
4,959

 
$
4,959

 
 
 
 
 
 
 
 
 
 
 
 
Total securities
$
149,653

 
$
149,886


$
143,281


$
143,822


$
145,497


$
148,810

 

18


The table below sets forth certain information regarding the amortized cost, and weighted average yields by contractual maturity of the Company’s debt securities portfolio at June 30, 2014. In the case of mortgage-backed securities, this table does not reflect scheduled principal payments, unscheduled prepayments, or the ability of certain of these securities to reprice prior to their contractual maturity:
 
 
One Year or Less
 
More Than One Year
Through Five Years
 
More Than Five Years
Through Ten Years
 
More Than Ten Years
 
Total Securities
 
Amortized Cost
 
Weighted Average Yield
 
Amortized Cost
 
Weighted Average Yield
 
Amortized Cost
 
Weighted Average Yield
 
Amortized Cost
 
Weighted Average Yield
 
Amortized Cost
 
Weighted Average Yield
 
(Dollars In Thousands)
Securities available for sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate bonds
$

 
%
 
$
3,026

 
1.74
%
 
$

 
%
 
$

 
%
 
$
3,026

 
1.74
%
Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency

 
%
 
10,941

 
2.03
%
 
7,338

 
2.46
%
 
110,659

 
2.01
%
 
128,938

 
2.04
%
Non-agency

 
%
 
61

 
4.44
%
 

 
%
 
1,627

 
2.61
%
 
1,688

 
2.68
%
Total
$

 
%
 
$
14,028

 
1.98
%
 
$
7,338

 
2.46
%
 
$
112,286

 
2.02
%
 
$
133,652

 
2.04
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities held to maturity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$
6,813

 
0.66
%
 
$
2,148

 
1.93
%
 
$
341

 
2.13
%
 
$

 
%
 
$
9,302

 
1.01
%
Total
$
6,813

 
0.66
%
 
$
2,148

 
1.93
%
 
$
341

 
2.13
%
 
$

 
%
 
$
9,302

 
1.01
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total debt securities
$
6,813

 
0.66
%
 
$
16,176

 
1.97
%
 
$
7,679

 
2.45
%
 
$
112,286

 
2.02
%
 
$
142,954

 
1.97
%

Sources of Funds
 
General.  Deposits are the primary source of the Company’s funds for lending and other investment purposes. In addition to deposits, the Company obtains funds from the amortization and prepayment of loans and mortgage-backed securities, the sale or maturity of investment securities, advances from the FHLB, and cash flows generated by operations. 

Deposits.  Consumer and commercial deposits are gathered primarily from the Company’s primary market area through the offering of a broad selection of deposit products including checking, regular savings, money market deposits and time deposits, including certificate of deposit accounts and individual retirement accounts. The FDIC insures deposits up to certain limits and the Massachusetts Deposit Insurance Fund fully insures amounts in excess of such limits.
 
Competition and general market conditions affect the Company’s ability to attract and retain deposits.  We offer Remote Deposit Capture to our business customers which allows us to expand our deposit gathering outside of our normal deposit area. The Company offers rates on various deposit products based on local competitive pricing and the Company’s need for new funds.  Occasionally, the Company does offer “special” rate pricing in an effort to attract new customers.  The Company does not have any brokered deposits.
















19


The following table sets forth certain information relative to the composition of the Company’s average deposit accounts and the weighted average interest rate on each category of deposits:
 
 
Years Ended June 30,
 
2014
 
2013
 
2012
 
Average
Balance
 
Percent
 
Weighted
Average
Rate
 
Average
Balance
 
Percent
 
Weighted
Average
Rate
 
Average
Balance
 
Percent
 
Weighted
Average
Rate
 
(Dollars In Thousands)
Deposit type:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand
$
78,220

 
16.08
%
 
%
 
$
66,855

 
14.74
%
 
%
 
$
57,055

 
13.49
%
 
%
Savings
107,503

 
22.11
%
 
0.13
%
 
100,372

 
22.13
%
 
0.20
%
 
91,828

 
21.70
%
 
0.28
%
Money market
89,084

 
18.32
%
 
0.36
%
 
73,767

 
16.26
%
 
0.39
%
 
54,462

 
12.87
%
 
0.40
%
NOW accounts
46,436

 
9.55
%
 
0.27
%
 
40,589

 
8.95
%
 
0.26
%
 
37,799

 
8.94
%
 
0.36
%
Total transaction accounts
321,243

 
66.06
%
 
0.18
%
 
281,583

 
62.08
%
 
0.22
%
 
241,144

 
57.00
%
 
0.25
%
Certificates of deposit
165,077

 
33.94
%
 
1.47
%
 
171,994

 
37.92
%
 
1.77
%
 
181,941

 
43.00
%
 
1.97
%
Total deposits
$
486,320

 
100.00
%
 
0.62
%
 
$
453,577

 
100.00
%
 
0.81
%
 
$
423,085

 
100.00
%
 
0.99
%

The following table sets forth time deposits of the Company classified by interest rate as of the dates indicated:
 
 
At June 30,
Interest Rate
2014
 
2013
 
2012
 
(In Thousands)
Less than 2%
$
130,068

 
$
113,112

 
$
108,574

2.00% - 2.99%
19,951

 
25,460

 
36,687

3.00% - 3.99%
12,699

 
21,976

 
24,813

4.00% - 4.99%

 
4,779

 
6,954

5% or Greater

 

 
828

Total
$
162,718

 
$
165,327

 
$
177,856

 
The following table sets forth time deposits of the Company at June 30, 2014 by maturity:
 
 
Years Ending June 30,
Interest Rate
2015
 
2016
 
2017
 
2018
 
2019
 
Total
 
(In Thousands)
Less than 2%
$
53,820

 
$
18,849

 
$
27,313

 
$
13,326

 
$
16,760

 
$
130,068

2.00% - 2.99%
3,561

 
11,488

 
4,333

 
569

 

 
19,951

3.00% - 3.99%
10,803

 
1,896

 

 

 

 
12,699

Total
$
68,184

 
$
32,233

 
$
31,646

 
$
13,895

 
$
16,760

 
$
162,718

 












20


As of June 30, 2014, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $102.7 million. The following table sets forth the maturity of those certificates as of June 30, 2014:
 
 
At June 30, 2014
 
(In Thousands)
Three months or less
$
13,848

Over three months through six months
10,165

Over six months through one year
13,756

Over one year through three years
44,235

Over three years
20,687

Total
$
102,691


Borrowings.  The Company utilizes advances from the FHLB primarily in connection with funding growth in the balance sheet and to assist in the management of its interest rate risk by match funding longer term fixed rate loans. FHLB advances are secured primarily by certain of the Company’s mortgage loans, investment securities and by its holding of FHLB stock. As of June 30, 2014, the Company had outstanding $116.4 million in FHLB advances, and had the ability to borrow an additional $61.1 million based on available collateral.
 
The following table sets forth certain information concerning balances and interest rates on the Company’s short-term and long-term FHLB advances at the dates and for the years indicated:
 
 
At or For the Years Ended June 30,
 
2014
 
2013
 
2012
 
(Dollars In Thousands)
Balance at end of year
$
116,446

 
$
86,992

 
$
79,661

Average balance during year
117,841

 
89,235

 
55,250

Maximum outstanding at any month end
127,968

 
94,746

 
79,938

Weighted average interest rate at end of year
1.61
%
 
1.64
%
 
1.95
%
Weighted average interest rate during year
1.83
%
 
2.04
%
 
2.39
%

Of the $116.4 million in advances outstanding at June 30, 2014, $6.0 million bearing a weighted-average interest rate of 3.52% are callable by the FHLB at its option and in its sole discretion only if the level of a specific index were to exceed a pre-determined maximum rate. In the event the FHLB calls these advances, the Company will evaluate its liquidity and interest rate sensitivity position at that time and determine whether to replace the called advances with new borrowings.
 
In an effort to decrease the Bank’s interest rate risk from rising interest rates, the Bank took advantage of the Federal Home Loan Bank of Boston’s program to further restructure outstanding borrowings. In September 2012, the Company restructured $8.6 million of FHLB borrowings. After the restructuring, the weighted average cost of these borrowings was reduced by 1.00% to 2.74%. There were no advances restructured during the year ended June 30, 2014.

The Company recognizes the need to assist the communities it serves with economic development initiatives. These initiatives focus on creating or retaining jobs for lower income workers, benefits for lower income families, supporting small business and funding affordable housing programs. To assist in funding these initiatives, the Company has participated in FHLB’s Community Development Advance program. The Company continues to originate loans that qualify under this program.

The Company had no overnight repurchase agreements as of June 30, 2014 and 2013.  As of June 30, 2012, the Company had $7.3 million of overnight repurchase agreements with business customers with a weighted average rate of 0.10%.  These repurchase agreements were collateralized by residential mortgage-backed securities.







21


The following table sets forth certain information concerning balances and interest rates on the Company’s repurchase agreements at the dates and for the years indicated:
 
 
At or For the Years Ended June 30,
 
2014
 
2013
 
2012
 
(Dollars In Thousands)
Balance at end of year
$

 
$

 
$
7,315

Average balance during year

 
5,017

 
7,228

Maximum outstanding at any month end

 
6,026

 
9,088

Weighted average interest rate at end of year
%
 
%
 
0.10
%
Weighted average interest rate during year
%
 
0.07
%
 
0.12
%
 
Personnel
 
As of June 30, 2014, the Company had 106 full-time and 19 part-time employees, none of whom is represented by a collective bargaining unit. We believe we have a good relationship with our employees.

Subsidiary Activities and Portfolio Management Services
 
Hampden Bancorp, Inc. conducts its principal business activities through its wholly-owned subsidiary, Hampden Bank. Hampden Bank has three operating subsidiaries, Hampden Investment Corporation ("HIC"), Hampden Investment Corporation II ("HIC II) and Hampden Insurance Agency ("HIA").
 
Hampden Investment Corporation. HIC is a Massachusetts securities corporation and a wholly owned subsidiary of Hampden Bank. HIC is an investment company that engages in buying, selling and holding securities on its own behalf. At June 30, 2014 and June 30, 2013, HIC had total assets of $108.7 million and $107.4 million, respectively, consisting primarily of mortgage backed securities, respectively. HIC’s net income for each of the years ending June 30, 2014 and June 30, 2013 was $1.3 million. As a Massachusetts securities corporation, HIC has a lower state income tax rate compared to other corporations.

Hampden Investment Corporation II. HIC II is a Massachusetts securities corporation and a wholly owned subsidiary of Hampden Bank. HIC II is an investment company that engages in buying, selling and holding securities on its own behalf. At June 30, 2014, HIC II had total assets of $6.1 million consisting primarily of mortgage backed securities. HIC II's net income for the year ending June 30, 2014 was $45,000. At June 30, 2013, HIC II had total assets of $2.0 million consisting primarily of municipal bonds and mortgage backed securities. HIC II’s net income for the year ending June 30, 2013 was $16,000. As a Massachusetts securities corporation, HIC II has a lower state income tax rate compared to other corporations.

Hampden Insurance Agency. HIA is an inactive insurance agency.  As of June 30, 2014 and 2013, HIA had no assets.
 
Hampden Bancorp, Inc.’s subsidiary, in addition to Hampden Bank, is described below.
 
Hampden LS, Inc. Hampden Bancorp, Inc. contributed funds to a subsidiary, Hampden LS, Inc. to enable it to make a 15-year loan to the Employee Stock Ownership Plan to allow it to purchase shares of the Company common stock as part of the completion of the initial public offering. On January 16, 2007, at the completion of the conversion and initial public offering, the Employee Stock Ownership Plan purchased 635,990 shares, or 8% of the 7,949,879 shares outstanding from the initial public offering.








22


SUPERVISION AND REGULATION
The following discussion addresses elements of the regulatory framework applicable to bank holding companies and their subsidiaries, in particular subsidiary banks. This regulatory framework is intended primarily to protect the safety and soundness of depository institutions, the federal deposit insurance system, and depositors, rather than the protection of stockholders of a bank holding company such as the Company.
As a bank holding company, the Company is subject to regulation, supervision and examination by the Federal Reserve under the BHC Act. The Bank is subject to extensive regulation, supervision and examination by the Massachusetts Commissioner of Banks (the “Commissioner”) and the FDIC.
The following is a summary of certain aspects of various statutes and regulations applicable to the Company and the Bank. This summary is not a comprehensive analysis of all applicable law, and is qualified by reference to the applicable statutes and regulations.
The Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted on July 21, 2010, comprehensively reformed the regulation of financial institutions, products and services. Among other things, the Dodd-Frank Act:
granted the Federal Reserve increased supervisory authority and codified the source of strength doctrine, as discussed in more detail in “-Regulation of the Company-Source of Strength” below;
provided for new capital standards applicable to the Company and the Bank, as discussed in more detail in “-Capital Adequacy and Safety and Soundness-Regulatory Capital Requirements” below;
modified the scope and costs associated with deposit insurance coverage, as discussed in “-Regulation of the Bank-Deposit Insurance Premiums” below;
permitted well capitalized and well managed banks to acquire other banks in any state, subject to certain deposit concentration limits and other conditions, as discussed in “-Regulation of the Bank-Acquisitions and Branching” below;
permitted the payment of interest on business demand deposit accounts;
established new minimum mortgage underwriting standards for residential mortgages, as discussed in “-Consumer Protection Regulation-Mortgage Reform” below;
established the Bureau of Consumer Financial Protection (the “CFPB”);
barred banking organizations, such as the Company, from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain circumstances; and
established the Financial Stability Oversight Council to designate certain activities as posing a risk to the U.S. financial system and recommend new or heightened standards and safeguards for financial institutions engaging in such activities.

Regulation of the Company
The Company is subject to regulation, supervision and examination by the Federal Reserve, which has the authority, among other things, to order bank holding companies to cease and desist from unsafe or unsound banking practices; to assess civil money penalties; and to order termination of non-banking activities or termination of ownership and control of a non-banking subsidiary by a bank holding company.
Source of Strength. Under the BHC Act as well as the Dodd-Frank Act, the Company is required to serve as a source of financial strength for the Bank. This support may be required at times when the bank holding company may not have the resources to provide support to the Bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy trustee and entitled to a priority of payment. In addition, any loans by a bank holding company to any of its bank subsidiaries are subordinate to the payment of deposits and to certain other indebtedness.
Acquisitions and Activities. The BHC Act prohibits a bank holding company from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank or bank holding company without prior approval of the Federal Reserve.


23


The BHC Act prohibits a bank holding company from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks. However, a bank holding company may engage in and may own shares of companies engaged in certain activities that the Federal Reserve determines to be so closely related to banking or managing and controlling banks so as to be a proper incident thereto.
Limitations on Acquisitions of Company Common Stock. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company unless the Federal Reserve has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve, the acquisition of 10% or more of a class of voting securities of a bank holding company, such as the 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 of a bank holding company.
In addition, any company would be required to obtain the approval of the Federal Reserve under the BHC Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more, or otherwise obtaining control or a controlling influence over a bank holding company. In 2008, the Federal Reserve released guidance on minority investments in banks that relaxed the presumption of control for investments of greater than 10% of a class of outstanding voting securities of a bank holding company in certain instances discussed in the guidance.
Limitations on Redemption of Common Stock. A bank holding company is generally required to give the Federal Reserve prior written notice of any purchase or redemption of then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve order or directive, or any condition imposed by, or written agreement with, the Federal Reserve. The Federal Reserve has adopted an exception to this approval requirement for well-capitalized bank holding companies that meet certain other conditions.
Regulation of the Bank
The Bank is subject to the supervision and regulation of the Commissioner and the FDIC. Additionally, under the Dodd-Frank Act, the Federal Reserve may directly examine the subsidiaries of the Company, including the Bank. The enforcement powers available to federal and state banking regulators include, among other things, the ability to issue cease and desist or removal orders to terminate insurance of deposits; to assess civil money penalties; to issue directives to increase capital; to place the bank into receivership; and to initiate injunctive actions against banking organizations and institution-affiliated parties.
Deposit Insurance. Substantially all of the deposits of the Bank are insured up to applicable limits by the FDIC’s Deposit Insurance Fund and are subject to deposit insurance assessments to maintain the Deposit Insurance Fund. The Federal Deposit Insurance Act (the “FDIA”), as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits-the designated reserve ratio-of 1.35%. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating (“CAMELS rating”). CAMELS ratings reflect the applicable bank regulatory agency’s evaluation of the financial institution’s capital, asset quality, management, earnings, liquidity and sensitivity to risk. Assessment rates may also vary for certain institutions based on long-term debt issuer ratings, secured or brokered deposits. Pursuant to the Dodd-Frank Act, deposit premiums are based on assets rather than insurable deposits. To determine its actual deposit insurance premiums, the Bank computes the base amount on its average consolidated assets less its average tangible equity (defined as the amount of Tier I capital) and the applicable assessment rate. The FDIC has the power to adjust deposit insurance assessment rates at any time. For 2014, the aggregate FDIC insurance expense for the Bank was $366,000.
Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended June 30, 2014, the annualized FICO assessment was equal to 0.64 basis points for each $100 in domestic deposits maintained at an institution.

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All Massachusetts-chartered savings banks, such as the Bank, are required to be members of the Massachusetts Depositors Insurance Fund, a corporation that insures savings bank deposits in excess of federal deposit insurance coverage. The Massachusetts Depositors Insurance Fund is authorized to charge Massachusetts savings banks an annual assessment of up to 1/50th of 1.0% of a savings bank’s deposit balances in excess of amounts insured by the FDIC.
Acquisitions and Branching. The Bank must seek prior regulatory approval from the Commissioner and the FDIC to acquire another bank or establish a new branch office. Well capitalized and well managed banks may acquire other banks in any state, subject to certain deposit concentration limits and other conditions, pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Dodd-Frank Act. In addition, the Dodd-Frank Act authorizes a state-chartered bank, such as the Bank, to establish new branches on an interstate basis to the same extent a bank chartered by the host state may establish branches.
Activities and Investments of Insured State-Chartered Banks. Section 24 of the FDIA generally limits the investment activities of FDIC-insured, state-chartered banks, such as the Bank, when acting as principal to those that are permissible for national banks. Further, the Gramm-Leach-Bliley Act of 1999 (the “GLBA”) permits national banks and state banks, to the extent permitted under state law, to engage through “financial subsidiaries” in certain activities which are permissible for subsidiaries of a financial holding company. In order to form a financial subsidiary, a state-chartered bank must be well capitalized, and such banks would be subject to certain capital deduction, risk management and affiliate transaction rules, among other things.
Massachusetts-chartered savings banks may broadly invest in equity securities subject to certain limitations, including on the aggregate amount of such investment as a percentage of the bank’s deposits. Although such equity investments are generally not permitted under federal law, under the FDIA, state-chartered banks may, with FDIC approval, continue to exercise state authority to invest in common or preferred stocks. The Bank received approval from the FDIC to retain and acquire such equity instruments equal to the lesser of 100% of the Banks’ Tier 1 capital or the maximum permissible amount specified by Massachusetts law. This authority may be terminated upon the FDIC’s determination that such investments pose a safety and soundness risk or upon the occurrence of certain events such as a change in the Bank’s charter.
Lending Restrictions. Federal and state law limits a bank’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. Also, the terms of such extensions of credit may not involve more than the normal risk of repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the bank’s capital. The Dodd-Frank Act explicitly provides that an extension of credit to an insider includes credit exposure arising from a derivatives transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction or securities borrowing transaction. Additionally, the Dodd-Frank Act requires that asset sale transactions with insiders must be on market terms, and if the transaction represents more than 10% of the capital and surplus of the Bank, be approved by a majority of the disinterested directors of the Bank. Under Massachusetts law, the Bank is also subject to restrictions on the amount it may lend to one borrower, which subject to certain limited exceptions, total obligations of one borrower may not exceed 20.0% of the total of the Bank’s capital
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the FDIC to evaluate the Bank’s performance in helping to meet the credit needs of the entire communities it serves, including low and moderate-income neighborhoods, consistent with its safe and sound banking operations, and to take this record into consideration when evaluating certain applications. The FDIC’s CRA regulations are generally based upon objective criteria of the performance of institutions under three key assessment tests: (i) a lending test, to evaluate the institution’s record of making loans in its service areas; (ii) an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (iii) a service test, to evaluate the institution’s delivery of services through its branches, ATMs, and other offices. The Bank currently has an “outstanding” CRA rating. Massachusetts has also enacted a similar statute that requires the Commissioner to evaluate the performance of the Bank in helping to meet the credit needs of its entire community and to take that record into account in considering certain applications.
Capital Adequacy and Safety and Soundness
Regulatory Capital Requirements. The Federal Reserve and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to U.S. banking organizations. These guidelines are intended to reflect the relationship between the banking organization’s capital and the degree of risk associated with its operations based on transactions recorded on-balance sheet as well as off-balance sheet items. The Federal Reserve and the FDIC may from time to time require that a banking organization maintain capital above the minimum levels discussed below due to the banking organization’s financial condition or actual or anticipated growth.

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Current Federal Reserve capital adequacy guidelines define a three-tier capital framework. Tier I capital for bank holding companies generally consists of the sum of common stockholders’ equity, perpetual preferred stock and trust preferred securities (both subject to certain limitations and, in the case of the latter, to specific limitations on the kind and amount of such securities that may be included as Tier I capital and certain additional restrictions described below), and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and other non-qualifying intangible assets. Tier II capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities, perpetual preferred stock and trust preferred securities (to the extent not eligible to be included as Tier I capital), term subordinated debt and intermediate-term preferred stock, and, subject to limitations, general allowances for loan losses. The sum of Tier I and Tier II capital less certain required deductions, such as investments in unconsolidated banking or finance subsidiaries, represents qualifying total capital. Risk-based capital ratios are calculated by dividing Tier I and total capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned to one of four categories of risk-weights, based primarily on relative credit risk. The minimum Tier I risk-based capital ratio is 4% and the minimum total risk-based capital ratio is 8%. As of June 30, 2014, the Company’s Tier I risk-based capital ratio was 17.2% and its total risk-based capital ratio was 18.3%. The Company is currently considered “well capitalized” under all regulatory definitions.
In addition to the risk-based capital requirements, the Federal Reserve requires top-rated bank holding companies to maintain a minimum leverage capital ratio of Tier I capital (defined by reference to the risk-based capital guidelines) to its average total consolidated assets of at least 3.0%. For most other bank holding companies (including the Company), the minimum leverage capital ratio is 4.0%. Bank holding companies with supervisory, financial, operational or managerial weaknesses, as well as bank holding companies that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. The Company’s leverage capital ratio as of June 30, 2014 was 12.2%.
The FDIC has adopted a statement of policy regarding the capital adequacy of state-chartered banks and promulgated regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. Under the FDIC regulations, a bank is “well capitalized” if it has: (i) a total risk-based capital ratio of 10.0% or greater; (ii) a Tier I risk-based capital ratio of 6.0% or greater; (iii) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. A bank is “adequately capitalized” if it has: (i) a total risk-based capital ratio of 8.0% or greater; (ii) a Tier I risk-based capital ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or greater (3.0% under certain circumstances) and does not meet the definition of a “well capitalized” bank. The FDIC must also take into consideration (1) concentrations of credit risk; (2) interest rate risk; and (3) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as part of the institution’s regular safety and soundness examination. The Bank is currently considered “well capitalized” under all regulatory definitions.
Generally, a bank, upon receiving notice that it is “undercapitalized,” becomes subject to the prompt corrective action provisions of Section 38 of the FDIA that, for example, (i) restrict payment of capital distributions and management fees, (ii) require that the FDIC monitor the condition of the institution and its efforts to restore its capital, (iii) require submission of a capital restoration plan, (iv) restrict the growth of the institution’s assets and (v) require prior regulatory approval of certain expansion proposals. A bank that is required to submit a capital restoration plan must concurrently submit a performance guarantee by each company that controls the bank. A bank that is “critically undercapitalized,” a ratio of tangible equity to total assets that is equal to or less than 2.0%, will be subject to further restrictions, and generally will be placed in conservatorship or receivership within 90 days.
The Basel Committee on Banking Supervision has also released new capital requirements, known as Basel III, setting forth higher capital requirements, enhanced risk coverage, a global leverage ratio, provisions for counter-cyclical capital, and liquidity standards. On July 2, 2013, the Federal Reserve, along with the other federal banking agencies, issued a final rule (the “Final Capital Rule”) implementing the Basel III capital standards and establishing the minimum capital requirements for banks and bank holding companies required under the Dodd-Frank Act. The majority of the provisions of the Final Capital Rule apply to bank holding companies and banks with consolidated assets of $500 million or more, such as the Company and the Bank. The Final Capital Rule establishes a new capital risk-based capital ratio, a minimum common equity Tier 1 capital ratio of 6.5% of risk-weighted assets to be a “well capitalized” institution, and increase the minimum total Tier 1 capital ratio to be a “well capitalized institution from 6.0% to 8.0%. The Final Capital Rule also requires that an institution establish a capital conservation buffer of common equity Tier 1 capital in an amount above the minimum risk-based capital requirements for “adequately capitalized” institutions equal to 2.5% of total risk weight assets, or face restrictions on capital distributions and executive bonuses. The Final Capital Rule increases the required capital for certain categories of assets, including higher-risk construction real estate loans and certain exposures related to securitizations. Under the Final Capital Rule, the Company may make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. If the Company does not make this election, unrealized gains and losses would be included in the calculation of its regulatory capital.

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The Company and the Bank must comply with the Final Capital Rule beginning on January 1, 2015.
Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, risk management, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate