10-Q 1 v416727_10q.htm 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2015

 

OR

 

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

 

For the transition period from ______________ to _____________

 

Commission file number: 0-54447

 

  NAUGATUCK VALLEY FINANCIAL CORPORATION  
  (Exact name of registrant as specified in its charter)  

 

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

 

333 CHURCH STREET, NAUGATUCK, CONNECTICUT   06770
(Address of principal executive offices)   (Zip Code)

 

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

 

  N/A  
  (Former name, former address and former fiscal year, if changed since last report)  

 

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 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 ¨

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x   No ¨

 

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

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨   No x

 

As of August 10, 2015, there were 7,002,208 shares of the registrant’s common stock outstanding.

 

 
 

  

NAUGATUCK VALLEY FINANCIAL CORPORATION

 

Table of Contents

 

Page No.
Part I.  Financial Information  
     
Item 1. Consolidated Financial Statements (unaudited)  
     
  Consolidated Statements of Financial Condition at June 30, 2015 and December 31, 2014 3
     
  Consolidated Statements of Operations for the three and six months ended June 30, 2015 and 2014 4
     
  Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2015 and 2014 5
     
  Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2015 and 2014 6
     
  Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014 7
     
  Notes to Unaudited Consolidated Financial Statements 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 35
     
  Liquidity and Capital Resources 47
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 50
     
Item 4. Controls and Procedures 50
     
Part II.  Other Information  
     
Item 1. Legal Proceedings 51
     
Item 1A. Risk Factors 51
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 52
     
Item 3. Defaults Upon Senior Securities 52
     
Item 4. Mine Safety Disclosures 52
     
Item 5. Other Information 52
     
Item 6. Exhibits 52
     
Signatures   53
     
Exhibits    

 

2
 

  

Part I - FINANCIAL INFORMATION

 

 

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (unaudited)

 

(In thousands)  June 30,
2015
   December 31,
2014
 
         
ASSETS          
Cash and due from depository institutions  $17,391   $10,940 
Federal funds sold   32    - 
Cash and cash equivalents   17,423    10,940 
Investment securities available-for-sale, at fair value   67,346    77,538 
Investment securities held-to-maturity, at amortized cost   11,434    13,441 
Loans held for sale   2,204    1,062 
Loans receivable, net   374,418    363,259 
Accrued income receivable   1,566    1,599 
Foreclosed real estate   39    335 
Premises and equipment, net   9,101    9,125 
Bank owned life insurance   10,525    10,393 
Federal Home Loan Bank ("FHLB") of Boston stock, at cost   4,548    4,548 
Other assets   2,170    2,850 
Total assets  $500,774   $495,090 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Liabilities          
Deposits  $373,167   $373,459 
FHLB advances   59,811    53,762 
Mortgagors' escrow accounts   4,385    4,341 
Deferred tax liabilities   94    651 
Other liabilities   2,135    2,006 
Total liabilities   439,592    434,219 
Stockholders' equity          
Preferred stock, $.01 par value; 1,000,000 shares authorized; no shares issued or outstanding   -    - 
Common stock, $.01 par value; 25,000,000 shares authorized; 7,002,366 shares issued; 7,002,208 shares outstanding at  June 30, 2015 and December 31, 2014, respectively   70    70 
Paid-in capital   58,761    58,698 
Retained earnings   4,684    3,323 
Unearned employee stock ownership plan ("ESOP") shares (294,387 shares at June 30, 2015 and December 31, 2014)   (2,480)   (2,480)
Treasury Stock, at cost (158 shares at June 30, 2015 and December 31, 2014)   (1)   (1)
Accumulated other comprehensive income, net of tax   148    1,261 
Total stockholders' equity   61,182    60,871 
Total liabilities and stockholders' equity  $500,774   $495,090 

 

See accompanying notes to unaudited consolidated financial statements.

 

3
 

 

 

CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands, except share data)  2015   2014   2015   2014 
                 
Interest income                    
Interest and fees on loans  $4,207   $4,236   $8,287   $8,483 
Interest and dividends on investments and deposits   594    856    1,212    1,518 
Total interest income   4,801    5,092    9,499    10,001 
Interest expense                    
Interest on deposits   593    598    1,164    1,203 
Interest on borrowed funds   223    189    418    342 
Total interest expense   816    787    1,582    1,545 
                     
Net interest income   3,985    4,305    7,917    8,456 
                     
Provision for loan losses   (1,420)   (739)   (1,420)   (739)
                     
Net interest income after provision for loan losses   5,405    5,044    9,337    9,195 
                     
Noninterest income                    
Service charge income   175    176    327    350 
Fees for other services   67    84    130    157 
Mortgage banking income   232    177    450    325 
Income from bank owned life insurance   66    63    132    129 
Net gain on sale of investments   413    34    829    193 
Income from investment advisory services, net   113    74    156    168 
Other income   31    33    62    63 
Total noninterest income   1,097    641    2,086    1,385 
                     
Noninterest expense                    
Compensation, taxes and benefits   2,583    2,973    5,064    5,989 
Occupancy   562    582    1,102    1,124 
Professional fees   392    323    802    842 
FDIC insurance premiums   125    270    288    531 
Insurance   143    117    318    262 
Computer processing   339    327    686    697 
Expenses on foreclosed real estate, net   78    168    97    378 
Writedowns on foreclosed real estate   -    11    -    38 
Directors' compensation   78    70    172    172 
Advertising   104    118    220    213 
Supplies   46    60    112    129 
Merger related expenses   612    -    612    - 
Expenses related to sale of loans   -    196    -    196 
Other expenses   343    376    589    724 
Total noninterest expense   5,405    5,591    10,062    11,295 
                     
Income (loss) before provision (benefit) for income taxes   1,097    94    1,361    (715)
                     
Provision (benefit) for income taxes   -    -    -    - 
                     
Net income (loss)  $1,097   $94   $1,361   $(715)
                     
Earnings (loss) per common share - basic and diluted  $0.16   $0.01   $0.20   $(0.11)

 

See accompanying notes to unaudited consolidated financial statements.

 

4
 

  

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands)    2015   2014   2015   2014 
                 
Net income (loss)  $1,097   $94   $1,361   $(715)
Other comprehensive income (loss):                    
Increase (decrease) in unrealized gain on available-for-sale investment securities   (1,462)   1,262    (841)   1,859 
Reclassification adjustment for net gains recognized in net income (1)   (413)   (34)   (829)   (193)
Other comprehensive income (loss) before tax effect   (1,875)   1,228    (1,670)   1,666 
Income tax benefit (expense) related to items in other  comprehensive income (loss)   730    (418)   (557)   (537)
Reclassification adjustment net of tax amount   (1,145)   810    (1,113)   1,129 
Total comprehensive income (loss)  $(48)  $904   $248   $414 

 

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

 

See accompanying notes to unaudited consolidated financial statements.

 

5
 

  

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Six months ended June 30, 2015 and 2014 (unaudited)

 

   Common   Paid-in   Retained   Unearned
ESOP
   Treasury   Accumulated
Other
Comprehensive
     
(In thousands)  Stock   Capital   Earnings   Shares   Stock   Income (Loss)   Total 
                             
Balance at December 31, 2014  $70   $58,698   $3,323   $(2,480)  $(1)  $1,261   $60,871 
Net income   -    -    1,361    -    -    -    1,361 
Stock based compensation - options   -    63    -    -    -    -    63 
Other comprehensive loss   -    -    -    -    -    (1,113)   (1,113)
                                    
Balance at June 30, 2015  $70   $58,761   $4,684   $(2,480)  $(1)  $148   $61,182 

 

   Common   Paid-in   Retained   Unearned
ESOP
   Treasury   Accumulated
Other
Comprehensive
     
(In thousands)  Stock   Capital   Earnings   Shares   Stock   Income (Loss)   Total 
                             
Balance at December 31, 2013  $70   $58,757   $2,322   $(2,824)  $(1)  $(90)  $58,234 
Net loss   -    -    (715)   -    -    -    (715)
Stock based compensation - options   -    2    -    -    -    -    2 
Other comprehensive income   -    -    -    -    -    1,129    1,129 
                                    
Balance at June 30, 2014  $70   $58,759   $1,607   $(2,824)  $(1)  $1,039   $58,650 

 

See accompanying notes to unaudited consolidated financial statements.

 

6
 

  

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

 

   Six Months Ended 
   June 30, 
(In thousands)  2015   2014 
Cash flows from operating activities          
Net income (loss)  $1,361   $(715)
Adjustments to reconcile net loss to cash provided by operating activities:          
(Credit) Provision for loan losses   (1,420)   (739)
Depreciation and amortization expense   405    369 
Net (gain) loss on sales of foreclosed assets   8    59 
Writedowns on foreclosed real estate   -    38 
Mortgage banking activity:          
Gain on sales of mortgage loans   (449)   (296)
Mortgage loans originated for sale   (8,145)   (10,682)
Proceeds from sale of mortgage loans   7,452    10,962 
Net amortization of investment premiums and discounts   205    3 
Net gain on sale of investments   (829)   (193)
Stock-based compensation   63    2 
Net change in:          
 Accrued income receivable   33    (218)
 Deferred loan fees   9    (7)
 Cash surrender value of life insurance   (132)   (129)
 Other assets   680    (466)
 Other liabilities   129    294 
Net cash (used in)/provided by operating activities   (630)   (1,718)
Cash flows from investing activities          
Proceeds from maturities, calls and repayments of available-for-sale securities   14,849    17,285 
Proceeds from sale of available-for-sale securities   12,248    7,224 
Proceeds from maturities of held-to-maturity securities   829    2,569 
Redemption of Federal Home Loan Bank Stock   -    234 
Purchase of available-for-sale securities   (16,773)   (59,168)
Loan originations net of principal payments   (9,749)   (5,938)
Purchase of premises and equipment   (381)   (395)
Loan proceeds held in escrow   -    (3,970)
Proceeds from the sale of commercial loans   -    580 
Proceeds from the sale of foreclosed assets   288    1,604 
Net cash (used in)/provided by investing activities   1,311    (39,975)
Cash flows from financing activities          
Net change in time deposits   (7,219)   (2,851)
Net change in other deposit accounts   6,927    (2,016)
Proceeds from FHLB advances   15,097    38,000 
Repayment of FHLB advances   (9,048)   (9,129)
Net change in mortgagors' escrow accounts   45    238 
Change in other borrowings   -    (206)
Net cash provided by/(used in) financing activities   5,802    24,036 
Net change in cash and cash equivalents   6,483    (17,657)
Cash and cash equivalents at beginning of period   10,940    26,374 
Cash and cash equivalents at end of period  $17,423   $8,717 
Supplementary disclosures of cash flow information:          
Non-cash investing activities:          
Transfer of loans to foreclosed assets  $-   $391 
Transfer of commercial loans to loans held for sale  $-   $3,957 
Cash paid during the period for:          
Interest paid  $1,572   $1,529 
Unrealized (losses) gains on available for sale securities arising during the period  $(1,670)  $1,666 

 

See accompanying notes to unaudited consolidated financial statements.

 

7
 

 

Notes to Unaudited Consolidated Financial Statements

 

NOTE 1 – DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

 

Nature of Operations

 

Naugatuck Valley Financial Corporation (“Naugatuck Valley Financial” or the “Company”) is a stock savings and loan holding company incorporated in the State of Maryland. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary bank, Naugatuck Valley Savings and Loan (“Naugatuck Valley Savings” or the “Bank”). The Company became the holding company for the Bank effective June 29, 2011.

 

Naugatuck Valley Savings is a federally chartered stock savings association and has served its customers in Connecticut since 1922. The Bank operates as a community-oriented financial institution dedicated to serving the financial services needs of consumers and businesses with a variety of deposit and lending products from its full service banking offices in the Greater Naugatuck Valley region of southwestern Connecticut. The Bank attracts deposits from the general public and uses those funds to originate one-to-four family, multi-family and commercial real estate, construction, commercial real estate, construction, commercial business and consumer loans.

 

At June 30, 2015, Naugatuck Valley Savings had one wholly-owned subsidiary, Church Street OREO One, LLC. Church Street OREO One, LLC was established in February 2013 to hold properties acquired through foreclosure as well as from non-judicial proceedings.

 

Proposed Merger

 

On June 3, 2015, the Company and Liberty Bank, a Connecticut-chartered mutual savings bank (“Liberty”), entered into an Agreement and Plan of Merger (“the Merger Agreement”) under which Liberty will acquire the Company and the Bank. Consummation of the transaction remains subject to customary closing conditions, including receipt of requisite shareholder approval and all required regulatory approvals, and is expected to occur in the first quarter of 2016. Under the terms of the Merger Agreement, Liberty will acquire all of the Company’s outstanding common stock at a price of $11.00 per share in cash. If the Merger Agreement is terminated under certain circumstances, the Company will be required to pay Liberty a termination fee of $3.1 million.

 

In connection with the proposed merger, the Company has incurred merger related expenses of $612,000, principally legal and professional services, for the three months and six months ended June 30, 2015.

 

Basis of Presentation

 

The accompanying consolidated interim financial statements are unaudited and include the accounts of the Company, the Bank, and the Bank’s wholly owned subsidiaries, Naugatuck Valley Mortgage Servicing Corporation (through December 31, 2014) and Church Street OREO One, LLC. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements. These consolidated financial statements should be read in conjunction with the December 31, 2014 audited Consolidated Financial Statements and the accompanying Notes included in our Annual Report on Form 10-K. All significant intercompany accounts and transactions have been eliminated in consolidation. These consolidated financial statements reflect, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position and the results of its operations and its cash flows at the dates and for the periods presented.

 

In preparing the consolidated financial statements, management makes estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of condition, and the reported amounts of income and expenses for the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, the valuation of real estate acquired in connection with foreclosure or in satisfaction of loans, deferred income taxes and the valuation of and the evaluation for other than temporary impairment (“OTTI”) on investment securities. While management uses available information to recognize losses and properly value these assets, future adjustments may be necessary based on changes in economic conditions both in Connecticut and nationally.

 

8
 

  

The Company’s only business segment is Community Banking. This segment represented all the revenues, income and assets of the consolidated Company and therefore, is the only reported segment as defined by FASB ASC 820, Segment Reporting.

 

Management has evaluated subsequent events for potential recognition or disclosure in the consolidated financial statements as of the date of this filing. No subsequent events were identified that would have required a change to the consolidated financial statements or disclosure in the notes to the consolidated financial statements.

 

Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

 

Certain reclassifications have been made to the prior period amounts to conform with the June 30, 2015 consolidated financial statement presentation. These reclassifications only changed the reporting categories and did not affect the Company’s results of operations or financial position.

 

Summary of Significant Accounting Policies

 

The significant accounting policies used in preparation of our consolidated financial statements are disclosed in our 2014 Annual Report on Form 10-K. There have not been any material changes in our significant accounting policies compared with those contained in our Form 10-K disclosure for the year ended December 31, 2014.

 

Recently Adopted Accounting Guidance

 

Income Taxes — Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists: (a consensus of the FASB Emerging Issues Task Force). In July 2013, the FASB issued ASU 2013-11. Per this ASU, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The ASU became effective during the three months ended June 30, 2014. The adoption of this guidance has not had a material impact on the Company’s consolidated financial statements.

 

Receivables – Troubled Debt Restructurings by Creditors: In January 2014, the FASB issued ASU 2014-04. This update clarifies that when an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of the residential real estate property collateralizing a consumer mortgage loan, upon either: (i) the creditor obtaining legal title to the property upon completion of the foreclosure; or (ii) the borrower conveying all interest in the property to the creditor to satisfy the loan through completion of a deed-in-lieu of foreclosure or through a similar legal agreement. The ASU became effective in January 2014 and its adoption has not had a material impact on the Company’s consolidated financial statements.

 

Transfer and Servicing (Topic 860) — Repurchase to Maturity Transactions, Repurchase Refinancings and Disclosures: In June 2014, the FASB issued ASU 2014-11. The standard introduces two new disclosure requirements. The first requires an entity to disclose information about certain transactions that are economically similar to a repurchase agreement. The second disclosure increases the transparency about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. This standard became effective in December 2014 and its adoption has not had a material impact on the Company’s consolidated financial statements.

 

Receivables – Troubled Debt Restructurings by Creditors (Topic 310-40) — Classification of Certain Government- Guaranteed Mortgage Loans Upon Foreclosure: In August 2014, the FASB issued ASU 2014-14. This guidance requires that, upon foreclosure, a government-guaranteed mortgage loan be transferred from loans to other receivables when all of the following conditions are met: (i) the loan has a government guarantee that is not separable from the loan before foreclosure; (ii) at the time of foreclosure, the creditor has the intent to convey the real property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (iii) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of real estate is fixed, which is an attribute specific to VA loans. The amount of the separate other receivable shall be measured based on the amount of the loan balance, including interest, expected to be recovered from the guarantor. The standard became effective in December 2014 and its adoption has not had a material impact on the Company’s consolidated financial statements.

 

9
 

  

Recently Issued Accounting Guidance

 

Revenue from Contracts with Customers (Topic 606). In May 2014, the FASB issued ASU 2014-09. This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Transfer of control is not the same as transfer of risks and rewards, as it is considered in current guidance. The Company will also need to apply new guidance to determine whether revenue should be recognized over time or at a point in time. This standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016, with no early adoption permitted, using either of two methods: (a) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (b) retrospective with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined in ASU 2014-09. The Company has not yet selected a transition method and is currently evaluating the impact of the pending adoption of ASU 2014-09 on the consolidated financial statements.

 

Presentation of Financial Statements – Going Concern (Subtopic 205-40) Disclosures of Uncertainties About an Entity’s Ability to Continue as a Going Concern: In August 2014, the FASB issued ASU 2014-15 which defines management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related disclosures in the notes to the financial statements. This standard will be effective for the first annual reporting period beginning after December 15, 2016 and interim periods thereafter.

 

Interest - Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs: In April 2015, the FASB issued ASU No. 2015-03. The update simplifies the presentation of debt issuance costs by requiring that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. For public companies, this update will be effective for interim and annual periods beginning after December 15, 2015, and is to be applied retrospectively. Early adoption is permitted. The Company is currently assessing the impact that this guidance will have on its consolidated financial statements, but does not expect the guidance to have a material impact on the Company's consolidated financial statements.

 

NOTE 2 – INVESTMENT SECURITIES

 

At June 30, 2015, the composition of the investment portfolio was:

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Available-for-sale securities:                    
U.S. Government and agency obligations  $-   $-   $-   $- 
U.S. Government agency mortgage-backed securities   43,471    545    (279)   43,737 
U.S. Government agency collateralized mortgage obligations   6,994    75    (8)   7,061 
Obligations of state and municipal subdivisions   16,639    216    (307)   16,548 
                     
Total available-for-sale securities  $67,104   $836   $(594)  $67,346 

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Held-to-maturity securities:                    
U.S. Government agency mortgage-backed securities  $11,434   $167   $(30)  $11,571 
                     
Total held-to-maturity securities  $11,434   $167   $(30)  $11,571 

 

10
 

  

At December 31, 2014, the composition of the investment portfolio was:

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Available-for-sale securities:                    
U.S. Government and agency obligations  $5,000   $42   $-   $5,042 
U.S. Government agency mortgage-backed securities   51,904    1,332    (149)   53,087 
U.S. Government agency collateralized mortgage obligations   12,802    378    (1)   13,179 
Obligations of state and municipal subdivisions   5,920    310    -    6,230 
                     
Total available-for-sale securities  $75,626   $2,062   $(150)  $77,538 

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Held-to-maturity securities:                    
U.S. Government agency mortgage-backed securities  $13,441   $212   $(20)  $13,633 
                     
Total held-to-maturity securities  $13,441   $212   $(20)  $13,633 

 

For the three and six months ended June 30, 2015 and June 30, 2014, the Company realized gross gains on sales of investment securities of $413,000, $34,000, $829,000 and $193,000, respectively.

 

The following is a summary of the fair values and related unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2015, and December 31, 2014:

 

At June 30, 2015 (In thousands)  Less than 12 Months   12 Months or Greater   Total 
   Fair Value   Unrealized Loss   Fair Value   Unrealized Loss   Fair Value   Unrealized Loss 
U.S. Government agency collateralized mortgage obligations  $2,000   $(8)  $-   $-   $2,000   $(8)
U.S. Government agency mortgage-backed securities  21,800   (244)  1,430   (35)  23,230   (279)
Obligations of state and municipal subdivisions   10,989    (307)   -    -    10,989    (307)
Total securities in unrealized loss position  $34,789   $(559)  $1,430   $(35)  $36,219   $(594)

 

At December 31, 2014 (In thousands)  Less than 12 Months   12 Months or Greater   Total 
   Fair Value   Unrealized Loss   Fair Value   Unrealized Loss   Fair Value   Unrealized Loss 
U.S. Government agency collateralized mortgage obligations  $10,804   $(55)  $6,300   $(94)  $17,104   $(149)
U.S. Government agency mortgage-backed securities   1,351    (1)   -    -    1,351    (1)
Total securities in unrealized loss position  $12,155   $(56)  $6,300   $(94)  $18,455   $(150)

 

 

11
 

  

The amortized cost and fair value of securities at June 30, 2015 and December 31, 2014, by expected maturity, are set forth below. Actual maturities of mortgage-backed securities and collateralized mortgage obligations may differ from contractual maturities because the mortgages underlying the securities may be prepaid or called with or without call or prepayment penalties. Because these securities are not due at a single maturity date, the maturity information is not presented.

 

   Available-for-Sale   Held-to-Maturity 
At June 30, 2015  Amortized
Cost
   Fair Value   Amortized
Cost
   Fair Value 
   (In thousands) 
U.S. Government agency mortgage-backed securities  $43,471   $43,737   $11,434   $11,571 
U.S. Government agency collateralized mortgage obligations   6,994    7,061    -    - 
Subtotal   50,465    50,798    11,434    11,571 
Securities with fixed maturities:                    
Due in one year or less   -    -    -    - 
Due after one year through five years   -    -    -    - 
Due after five years through ten years   1,904    2,014    -    - 
Due after ten years   14,735    14,534    -    - 
Subtotal   16,639    16,548    -    - 
Total  $67,104   $67,346   $11,434   $11,571 

 

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

 

Pledged Securities

 

The following table summarizes the amortized cost and fair value of available for sale and held to maturity securities that are pledged as collateral for the following obligations:

 

   June 30, 2015   December 31, 2014 
   Amortized
Cost
   Fair Value   Amortized
Cost
   Fair Value 
       (In thousands)     
State of Connecticut to secure public deposits  $2,014   $2,024   $18,446   $18,881 
Federal Home Loan Bank of Boston to secure borrowing                    
arrangements   15,010    15,116    -    - 
Total  $17,024   $17,140   $18,446   $18,881 

 

Effective May 4, 2015 upon the termination of the Bank’s Formal Agreement with the OCC, the collateral requirement for public deposits with the State of Connecticut was reduced from 110% to 10% of the uninsured balance of public deposits.

 

12
 

  

NOTE 3 – LOANS RECEIVABLE

 

A summary of loans receivable at June 30, 2015 and December 31, 2014 is as follows:

 

   June 30,   December 31, 
(In thousands)  2015   2014 
         
Real estate loans:          
One-to-four family  $176,892   $180,739 
Multi-family and commercial real estate   137,857    122,526 
Construction and land development   3,748    3,415 
Total real estate loans   318,497    306,680 
           
Commercial business loans   21,711    25,801 
Consumer loans:          
Home equity   31,704    28,700 
Other consumer   7,143    8,144 
Total consumer loans   38,847    36,844 
Total loans   379,055    369,325 
           
Less:          
Allowance for loan losses   4,583    6,023 
Deferred loan origination fees, net   54    43 
 Loans receivable, net  $374,418   $363,259 

 

The Bank’s lending activities are conducted principally in the Naugatuck Valley area of Connecticut. The Bank’s investment in loans includes both adjustable and fixed rate loans.

 

Credit quality of financing receivables

 

Management segregates the loan portfolio into portfolio segments which are defined as the level at which the Company develops and documents a systematic method for determining its allowance for loan losses. The portfolio segments are segregated based on loan types and the underlying risk factors present in each loan type. Such risk factors are periodically reviewed by management and revised as deemed appropriate.

 

The Company’s loan portfolio is segregated as follows:

 

One-to-four Family Owner Occupied Loans. This portfolio segment consists of the origination of first mortgage loans secured by one-to-four family owner occupied residential properties and residential construction loans to individuals to finance the construction of residential dwellings for personal use located in our market area. The Company has experienced a significant decrease in foreclosures on its owner occupied loan portfolio over the past year. Foreclosures are at relatively low levels. Management believes this is due mainly to its conservative underwriting and lending strategies which do not allow for high risk loans such as “Option ARM,” “sub-prime” or “Alt-A” loans.

 

Multi-family and Commercial Real Estate Loans. As described above, this portfolio grouping has been further disaggregated into loans secured by:

 

·Investor owned one-to-four family and multi-family properties;

 

·Industrial and warehouse properties;

 

·Office buildings;

 

·Retail properties; and

 

·Special use properties.

 

13
 

  

Loans secured by these types of commercial real estate collateral generally have larger loan balances and more credit risk than owner occupied one-to-four family mortgage loans. The increased risk is the result of several factors, including the concentration of principal in a limited number of loans and borrowers, the impact of local and general economic conditions on the borrower’s ability to repay the loan, and the increased difficulty of evaluating and monitoring these types of loans.

 

Construction and Land Development Loans. This portfolio segment includes commercial construction loans for commercial development projects, including condominiums, apartment buildings, and single family subdivisions as well as office buildings, retail and other income producing properties and land loans, which are loans made with land as security. Construction and land development financing generally involves greater credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost proves to be inaccurate, the Company may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property. Moreover, if the estimated value of the completed project proves to be inaccurate, the borrower may hold a property with a value that is insufficient to assure full repayment. Construction loans also expose the Company to the risks that improvements will not be completed on time in accordance with specifications and projected costs and that repayment will depend on the successful operation or sale of the properties, which may cause some borrowers to be unable to continue with debt service which exposes the Company to greater risk of non-payment and loss. Additionally, economic factors such as the decline of property values may have an adverse affect on the ability of the borrower to sell the property.

 

Commercial Business Loans. This portfolio segment includes commercial business loans secured by real estate, assignments of corporate assets, and personal guarantees of the business owners. Commercial business loans generally have higher interest rates and shorter terms than other loans, but they also may involve higher average balances, increased difficulty of loan monitoring and a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business.

 

Real Estate Secured Consumer Loans. This portfolio segment includes home equity loans and home equity lines of credit secured by owner occupied one-to-four family residential properties. Loans of this type are written at a maximum of 75% of the appraised value of the property and we require that we have no lower than a second lien position on the property. These loans are written at a higher interest rate and a shorter term than mortgage loans. The Company has experienced a low level of foreclosure in this type of loan during recent periods. These loans can be affected by economic conditions and the values of the underlying properties.

 

Other Consumer Loans. This portfolio segment includes loans secured by passbook or certificate accounts, or automobiles, as well as unsecured personal loans and overdraft lines of credit. This type of loan may entail greater risk than do residential mortgage loans, particularly in the case of loans that are unsecured or secured by assets that depreciate rapidly.

 

Credit Quality Indicators

 

The Company’s policies provide for the classification of loans into the following categories: pass (1 - 5); special mention (6); substandard-accruing (7); substandard-nonaccruing (8); doubtful (9); and loss (10). In June 2013, the Company added substandard-accruing as an additional risk grade to further delineate the Bank’s risk profile in the previous substandard category. Consistent with regulatory guidelines, loans that are considered to be of lesser quality are considered adversely classified as substandard, doubtful or loss. A loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans include those loans characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans (or portions of loans) classified as loss are those considered uncollectible. The Company generally charges off loans or portions of loans as soon as they are considered to be uncollectible and of little value. Loans that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve close attention, are required to be designated as special mention. When loans are classified as special mention, substandard or doubtful, management focuses increased monitoring and attention on these loans in assessing the credit risk and specific allowance requirements for these loans.

 

14
 

 

The following tables are a summary of the loan portfolio credit quality indicators, by loan class, as of June 30, 2015 and December 31, 2014:

 

   Credit Risk Profile by Internally Assigned Grade: 
June 30, 2015  One-to-Four
Family
   Multi-Family and
Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business Loans
   Consumer Loans   Total 
(In thousands)                        
Risk Rating:                              
Pass  $173,470   $132,254   $2,355   $19,569   $38,094   $365,742 
Special Mention   721    3,298    797    1,002    205    6,023 
Substandard:                              
- Accruing   123    1,457    -    423    74    2,077 
- Nonaccruing   2,578    848    596    717    474    5,213 
Subtotal - substandard   2,701    2,305    596    1,140    548    7,290 
Doubtful   -    -    -    -    -    - 
Total  $176,892   $137,857   $3,748   $21,711   $38,847   $379,055 

 

   Multi-Family and Commercial Real Estate 
   Credit Risk Profile by Internally Assigned Grade: 
June 30, 2015  Investor Owned
One-to-Four
family and multi-
family
   Industrial and
Warehouse
Properties
   Office Buildings   Retail Properties   Special Use
Properties
   Total Multi-Family
and Commercial
Real Estate
 
(In thousands)                        
Risk Rating:                              
Pass  $33,433   $24,005   $23,201   $16,979   $34,636   $132,254 
Special Mention   454    1,125    29    382    1,308    3,298 
Substandard:                              
- Accruing   245    -    97    146    969    1,457 
- Nonaccruing   389    19    433    -    7    848 
Subtotal - substandard   634    19    530    146    976    2,305 
Doubtful   -    -    -    -    -    - 
Total  $34,521   $25,149   $23,760   $17,507   $36,920   $137,857 

 

   Credit Risk Profile by Internally Assigned Grade: 
December 31, 2014  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business Loans
   Consumer
Loans
   Total 
(In thousands)                              
Risk Rating:                              
Pass  $177,598   $116,020   $1,835   $23,535   $36,348   $355,336 
Special Mention   731    4,040    853    707    207    6,538 
Substandard:                              
- Accruing   19    1,498    -    755    74    2,346 
- Nonaccruing   2,391    968    727    804    215    5,105 
Subtotal - substandard   2,410    2,466    727    1,559    289    7,451 
Doubtful   -    -    -    -    -    - 
Total  $180,739   $122,526   $3,415   $25,801   $36,844   $369,325 

 

15
 

 

   Multi-Family and Commercial Real Estate 
   Credit Risk Profile by Internally Assigned Grade: 
December 31, 2014  Investor
Owned One-to-
Four family
and multi-
family
   Industrial and
Warehouse
Properties
   Office
Buildings
   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial Real
Estate
 
(In thousands)                              
Risk Rating:                              
Pass  $23,793   $23,707   $23,503   $17,092   $27,925   $116,020 
Special Mention   1,027    1,145    319    104    1,445    4,040 
Substandard:                              
- Accruing   252    -    100    150    996    1,498 
- Nonaccruing   389    23    546    -    10    968 
Subtotal - substandard   641    23    646    150    1,006    2,466 
Doubtful   -    -    -    -    -    - 
Total  $25,461   $24,875   $24,468   $17,346   $30,376   $122,526 

 

Delinquencies

 

When a loan is 15 days past due, the Company sends the borrower a late notice. The Company also contacts the borrower by phone if the delinquency is not corrected promptly after the notice has been sent. When the loan is 30 days past due, the Company mails the borrower a letter reminding the borrower of the delinquency and attempts to contact the borrower personally to determine the reason for the delinquency in order to ensure that the borrower understands the terms of the loan and the importance of making payments on or before the due date. If necessary, subsequent delinquency notices are issued and the account will be monitored on a regular basis thereafter. By the 90th day of delinquency, the Company will send the borrower a final demand for payment and may recommend foreclosure. A summary report of all loans 30 days or more past due is provided to the Board of Directors of the Company each month.

 

Loans, including troubled debt restructurings (“TDRs”), are automatically placed on nonaccrual status when payment of principal or interest is more than 90 days delinquent. Loans may also be placed on nonaccrual status if collection of principal or interest in full, or in part, is in doubt or if the loan has been restructured. When loans are placed on nonaccrual status, unpaid accrued interest is fully reversed, and further income is recognized only to the extent received. The loan may be returned to accrual status if unpaid principal and interest are repaid so that the loan’s payment status is current for a reasonable period of time (usually six consecutive months) to establish a reliable assessment of collectability.

 

The following tables set forth certain information with respect to our loan portfolio delinquencies, by loan class, as of June 30, 2015 and December 31, 2014:

 

   Delinquencies 
As of June 30, 2015  31-60 Days
Past Due
   61-90 Days
Past Due
   Greater
Than
90 Days
   Total Past
Due
   Current   Total Loans   Carrying
Amount > 90
Days and
Accruing
 
(In thousands)                            
Real estate loans                                   
One-to-four family  $667   $728   $1,287   $2,682   $174,210   $176,892   $- 
Construction and land development   -    919    596    1,515    2,233    3,748    - 
Multi-family and commercial real estate:                                   
Investor owned one-to-four family and multi-family   1,663    -    389    2,052    32,469    34,521    - 
Industrial and Warehouse   -    -    -    -    25,149    25,149    - 
Office buildings   -    -    433    433    23,327    23,760    - 
Retail properties   -    -    -    -    17,507    17,507    - 
Special use properties   -    -    -    -    36,920    36,920    - 
Subtotal Multi-family and commercial real estate   1,663    -    822    2,485    135,372    137,857    - 
Commercial business loans   -    -    666    666    21,045    21,711    - 
Consumer loans:                                   
Home equity loans   92    199    234    525    31,179    31,704    - 
Other consumer loans   2    -    -    2    7,141    7,143    - 
Subtotal Consumer   94    199    234    527    38,320    38,847    - 
Total  $2,424   $1,846   $3,605   $7,875   $371,180   $379,055   $- 

 

16
 

  

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

 

Impaired loans and nonperforming assets

 

The following table sets forth certain information with respect to our nonperforming assets as of June 30, 2015 and December 31, 2014:

 

   June 30,   December 31, 
   2015   2014 
Nonperforming Assets  (Dollars in thousands) 
Nonaccrual loans:          
 One-to-four family  $1,503   $1,414 
 Multi-family and commercial real estate   367    375 
 Construction and land development   596    726 
 Commercial business loans   665    804 
 Consumer loans   474    187 
 Total   3,605    3,506 
Troubled debt restructurings - non-accrual   1,608    1,600 
 Subtotal nonperforming loans   5,213    5,106 
Foreclosed real estate   39    335 
Total nonperforming assets  $5,252   $5,441 
           
Total nonperforming loans to total loans   1.38%   1.38%
           
Total nonperforming loans to total assets   1.04%   1.03%
          
Total nonperforming assets to total assets   1.05%   1.10%

 

 

Nonperforming loans (defined as nonaccrual loans and nonperforming TDRs) totaled $5.2 million at June 30, 2015 compared to $5.1 million at December 31, 2014, an increase of $107,000, or 2.1%. The amount of income that was contractually due but not recognized on nonperforming loans totaled $67,000 and $61,000 for the six months ended June 30, 2015 and June 30, 2014, respectively.

 

At June 30, 2015, the Company had 35 loans on nonaccrual status of which 14 were less than 90 days past due; however, these loans were placed on nonaccrual status due to the uncertainty of their collectability.

 

At December 31, 2014, the Company had 34 loans on nonaccrual status of which 17 were less than 90 days past due; however, these loans were placed on nonaccrual status due to the uncertainty of their collectability.

 

The Company accounts for impaired loans in accordance with GAAP. An impaired loan generally is one for which it is probable, based on current information, that the Company will not collect all the amounts due under the contractual terms of the loan. All impaired loans are individually evaluated for impairment at least quarterly. As a result of this impairment evaluation, the Company provides a specific reserve for, or charges off, that portion of the asset that is deemed uncollectible.

 

17
 

  

The following tables summarize impaired loans by portfolio segment as of June 30, 2015 and December 31, 2014:

 

As of June 30, 2015  Recorded
Investment with
No Specific
Valuation
Allowance
   Recorded
Investment with
Specific
Valuation
Allowance
   Total
Recorded
Investment
   Unpaid
Contractual
Principal
Balance
   Related Specific
Valuation
Allowance
 
   (In thousands) 
Real estate loans                         
One-to-four family  $2,863   $1,272   $4,135   $4,481   $62 
Construction and land development   596    -    596    887    - 
Multi-family and commercial real estate:                         
Investor owned one-to-four family and  multi-family properties   389    -    389    395    - 
Industrial and warehouse properties   19    -    19    25    - 
Office buildings   433    -    433    638    - 
Retail properties   -    -    -    -    - 
Special use properties   7    -    7    22    - 
Subtotal   848    -    848    1,080    - 
Commercial business loans   788    80    868    929    - 
Consumer loans   501    174    675    705    32 
Total impaired loans  $5,596   $1,526   $7,122   $8,082   $94 

 

As of December 31, 2014  Recorded
Investment with
No Specific
Valuation
Allowance
   Recorded
Investment with
Specific
Valuation
Allowance
   Total
Recorded
Investment
   Unpaid
Contractual
Principal
Balance
   Related
Specific
Valuation
Allowance
 
   (In thousands) 
Real estate loans                         
One-to-four family  $2,793   $1,536   $4,329   $4,555   $59 
Construction and land development   685    -    685    1,022    - 
Multi-family and commercial real estate:                         
Investor owned one-to-four family and                         
    multi-family properties   389    -    389    395    - 
Industrial and warehouse properties   22    -    22    28    - 
Office buildings   546    -    546    750    - 
Retail properties   -    -    -    -    - 
Special use properties   10    -    10    24    - 
Subtotal   967    -    967    1,197    - 
Commercial business loans   759    192    951    1,042    4 
Consumer loans   385    133    518    521    9 
Total impaired loans  $5,589   $1,861   $7,450   $8,337   $72 

 

In the above table, the unpaid contractual principal balance represents the aggregate amounts legally owed to the Bank under the terms of the borrowers’ loan agreements. The recorded investment amounts shown above represent the unpaid contractual principal balance owed to the Bank less any amounts paid by borrowers on nonaccrual loans which were recognized as principal curtailments. On those nonaccrual loans accounted for under the cost recovery method, the Bank applies any borrower payments first against the principal balance of the loan and once the entire principal balance has been recovered, any subsequent payments are recognized as interest income.

 

18
 

 

 

The following table relates to interest income recognized by segment of impaired loans for the six months ended June 30, 2015 and 2014:

 

   Six Months Ended June 30, 
   2015   2014 
   Average
Recorded
Investments
   Interest Income
Recognized
   Average
Recorded
Investments
   Interest Income
Recognized
 
   (In thousands) 
Real estate loans                    
One-to four-family  $4,265   $79   $5,951   $175 
Construction   655    1    1,567    7 
Multi-family and commercial real estate   928    -    2,594    90 
Commercial business loans   923    7    1,661    40 
Consumer loans   542    10    492    8 
Total  $7,313   $97   $12,265   $320 

 

Interest payments received on nonaccrual loans are accounted for on the cash-basis method or the cost recovery method until qualifying for return to accrual status. Under the cost recovery method, the interest payment is applied to the principal balance of the loan. The table above shows the interest income recognized on nonaccrual loans and on performing TDR loans using the cash-basis method. For the six month periods ended June 30, 2015 and 2014, the amount of interest payments applied to principal under the cost recovery method was $18,000 and $30,000, respectively.

 

Troubled Debt Restructured Loans

 

A TDR is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider. TDRs are considered impaired and are separately measured for impairment, whether on accrual or nonaccrual status.

 

Loan modifications are generally granted at the request of the individual borrower and may include concessions such as reduction in interest rates, changes in payments, maturity date extensions, or debt forgiveness/forbearance. TDRs are loans for which the original contractual terms of the loans have been modified and both of the following conditions exist: (i) the restructuring constitutes a concession (including reduction of interest rates or extension of maturity dates); and (ii) the borrower is either experiencing financial difficulties or absent such concessions, it is probable the borrower would experience financial difficulty complying with the original terms of the loan. Loans are not classified as TDRs when the modification is short-term or results in only an insignificant delay or shortfall in the payments to be received. The Company’s loan modifications are determined on a case-by-case basis in connection with ongoing loan collection processes.

 

The recorded investment balance of performing and nonperforming TDRs as of June 30, 2015 and December 31, 2014 are as follows:

 

(In thousands)  As of June 30, 2015   As of December 31,
2014
 
Aggregate recorded investment of impaired loans performing under terms modified through a troubled debt restructuring:          
Performing (1)  $2,254   $2,549 
Nonperforming (2)   1,255    1,256 
Total  $3,509   $3,805 

 

(1)Of the $2,254,000 in TDRs which were performing under the modified terms of their agreements at June 30, 2015, there were $392,000 in TDRs that remain on nonaccrual status because these TDRs have not yet demonstrated the requisite period of sustained performance. The combination of the $392,000 performing TDRs and the $1,216,000 nonperforming TDRs on nonaccrual status at June 30, 2015 equal the $1,608,000 in TDRs that were on nonaccrual status at June 30, 2015.

 

Of the $2,549,000 in TDRs which were performing under the modified terms of their agreements at December 31, 2014, there were $2,164,000 in TDRs that remain on nonaccrual status because these TDRs have not yet demonstrated the requisite period of sustained performance. The combination of the $385,000 performing TDRs and the $1,215,000 nonperforming TDRs on nonaccrual status at December 31, 2014 equal the $1,600,000 in TDRs that were on nonaccrual status at December 31, 2014.

 

19
 

 

(2)Of the $1,255,000 in TDRs that were not performing under the modified terms of their agreements at June 30, 2015, all of these loans, except for one loan in the amount of $39,000, was on nonaccrual status.

 

All of the $1,256,000 in TDRs which were not performing under the modified terms of their agreements at December 31, 2014, except for one loan in the amount of $40,000, were on nonaccrual status.

 

As illustrated in the table below, during the six months ended June 30, 2015, the following concession was made on one loan totaling $53,000 (measured as a percentage of loan balances on TDRs):

 

·Extension of payment terms for 100.0%

 

The following tables present a breakdown of the type of concessions made by loan class during the six months ended June 30, 2015 and June 30, 2014:

 

   For the Six Months Ended June 30, 2015 
(Dollars in thousands)  Number of
Loans
   Pre-
Modification
Recorded
Investment
   Post-
Modification
Recorded
Investment
   % 
                 
Extended payment terms:                    
Commercial business loans   1   $53   $53    100.0%
Subtotal   1    53    53    100.0%
                     
                     
Grand Totals   1   $53   $53    100.0%

 

   For the Six Months Ended June 30, 2014 
(Dollars in thousands)  Number
of Loans
   Pre-
Modification
Recorded
Investment
   Post-
Modification
Recorded
Investment
   % 
Below market interest rate:                    
Real estate loans:                    
One-to-four family   1   $35   $35    6.8%
Commercial real estate loans   1    10    10    2.0%
Commercial business loans   2    20    20    3.9%
Subtotal   4    65    65    12.7%
                     
Extended payment terms:                    
Commercial business loans   1    98    98    19.2%
Subtotal   1    98    98    19.2%
                     
Principal payments deferred:                    
Real estate loans:                    
One-to-four family   2    348    348    68.1%
Subtotal   2    348    348    68.1%
                     
Grand Totals   7   $511   $511    100.0%

 

In cases where there was more than one concession granted, the modification was classified by the more dominant concession.

 

20
 

 

The majority of the Bank’s TDRs are a result of principal payment deferrals to troubled credits which have already been adversely classified. The Bank grants such consessions to reassess the borrower’s financial status and to develop a plan for repayment. These modifications did not have a material effect on the Company or the Bank.

 

The financial effects of each modification will vary based on the specific restructure. For some of the Bank’s TDRs, the loans were interest-only with a balloon payment at maturity. If the interest rate is not adjusted and the terms are consistent with the market, the Bank might not experience any loss associated with the restructure. If, however, the restructure involves forbearance agreements or interest rate modifications, the Bank might not collect all the principal and interest based on the original contractual terms. The Bank applies its procedures for placing TDRs on accrual or nonaccrual status using the same general guidance as for loans. The Bank estimates the necessary allowance for loan losses on TDRs using the same guidance as for other impaired loans.

 

There were no TDRs that had been modified during the previous twelve months ended June 30, 2015 that subsequently defaulted or were charged off during the six months ended June 30, 2015.

 

Allowance for Loan Losses

 

The allowance for loan losses (“ALLL”) is maintained at a level deemed appropriate by management to adequately provide for known and inherent risks in the loan portfolio.

 

The allowance for loan losses is established through a provision for loan losses charged to operations. Management periodically reviews the allowance for loan losses in order to identify those known and inherent losses and to assess the overall collection probability for the loan portfolio. The evaluation process begins with an individual evaluation of loans that are considered impaired. For these loans, an allowance is established based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or for loans that are considered collateral dependent, the fair value of the collateral.

 

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

 

The determination of the allowance for loan losses is significantly affected by management’s judgment and uncertainties, and there is likelihood that different amounts would be reported under different conditions or assumptions. The OCC, as an integral part of its examination process, periodically reviews the allowance for loan losses and may require the Company to make additional provisions for estimated loan losses based upon judgments different from those of management.

 

The allowance generally consists of specific (or allocated) and general components. The specific component relates to loans that are recognized as impaired. For such impaired loans, an allowance is established when the discounted cash flows (or observable market price or collateral value, if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.

 

The ALLL balance decreased from $6.02 million at December 31, 2014 to $4.58 million at June 30, 2015, a decrease of $1.44 million or 23.9%. The decrease was the result of a credit provision of $1.4 million and net charge-offs of $20,000 in the six months ended June 30, 2015. The decrease in the ALLL was consistent with the lower historical loss experience, especially during the most recent four quarters, of the rolling eight quarter historical loss period, and the stability shown in the Bank’s asset quality trends during the six month period ended June 30, 2015. For the most recent quarter ended June 30, 2015, the Company incurred net charge-offs of $20,000. This recent quarterly data replaced the net charge-offs of $7.6 million for the quarter ended June 30, 2013 in the Company’s rolling eight quarters of historical loss experience methodology. The Bank’s nonperforming loans decreased $107,000, or 2.1%, for the six months ended June 30, 2015. The Bank’s adversely classified loans decreased $161,000, or 2.2%, during the six months ended June 30, 2015.

 

21
 

 

The Company continues to monitor and modify its allowance for loan losses as conditions dictate. No assurances can be given that the level of allowance for loan losses will cover all of the inherent losses on the loans or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.

 

The following tables set forth the balance of and transactions in the allowance for loan losses at June 30, 2015, December 31, 2014 and June 30, 2014, by portfolio segment, disaggregated by impairment methodology, which is then further segregated by loans evaluated for impairment individually and collectively.

 

As of and for the Six Months
Ended June 30, 2015
  One-to-Four Family   Multi-Family and Commercial Real Estate   Construction and Land Development   Commercial Business Loans   Consumer Loans   Total 
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $1,633   $3,097   $414   $592   $287   $6,023 
Provision for loan losses   202    (1,172)   (139)   (502)   191    (1,420)
Charge-offs   (27)   -    -    (21)   (101)   (149)
Recoveries   -    -    50    52    27    129 
Balance at June 30, 2015  $1,808   $1,925   $325   $121   $404   $4,583 
Allowance related to loans:                              
Individually evaluated for impairment  $62   $-   $-   $-   $32   $94 
Collectively evaluated for impairment   1,746    1,925    325    121    372    4,489 
Total allowance  $1,808   $1,925   $325   $121   $404   $4,583 
                               
Ending loan balance individually evaluated for impairment  $4,135   $848   $596   $868   $675   $7,122 
Ending loan balance collectively evaluated for impairment   172,757    137,009    3,152    20,843    38,172    371,933 
Total loans  $176,892   $137,857   $3,748   $21,711   $38,847   $379,055 

  

   Multi-Family and Commercial Real Estate 
As of and for the Six Months
Ended June 30, 2015
  Investor One-to-Four Family and Multi-Family   Industrial and Warehouse Properties   Office Buildings   Retail Properties   Special Use Properties   Total Multi-Family and Commercial Real Estate 
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $509   $597   $352   $548   $1,091   $3,097 
Provision for loan losses   (88)   (268)   (120)   (188)   (508)   (1,172)
Charge-offs   -    -    -    -    -    - 
Recoveries   -    -    -    -    -    - 
Balance at June 30, 2015  $421  $329   $232   $360   $583   $1,925 
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $-   $-   $- 
Collectively evaluated for impairment   421    329    232    360    583    1,925 
Total allowance  $421   $329   $232   $360   $583   $1,925 
                               
Ending loan balance individually evaluated for impairment  $389   $19   $433   $-   $7   $848 
Ending loan balance collectively evaluated for impairment   34,132    25,130    23,327    17,507    36,913    137,009 
Total loans  $34,521   $25,149   $23,760   $17,507   $36,920   $137,857 

 

22
 

 

As of and for the Six Months
Ended June 30, 2014
  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction and
Land Development
   Commercial
Business Loans
   Consumer
Loans
   Total 
(In thousands)                              
Allowance for loan losses:                              
Beginning balance  $1,849   $5,097   $1,118   $1,443   $384   $9,891 
Provision for loan losses   306    51    (117)   (845)   (134)   (739)
Charge-offs   (541)   (1,306)   (148)   (74)   (13)   (2,082)
Recoveries   10    19    16    96    86    227 
Balance at June 30, 2014  $1,624   $3,861   $869   $620   $323   $7,297 
Allowance related to loans:                              
Individually evaluated for impairment  $56   $-   $21   $88   $10   $175 
Collectively evaluated for impairment   1,568    3,861    848    532    313    7,122 
Total allowance  $1,624   $3,861   $869   $620   $323   $7,297 
                               
Ending loan balance individually evaluated for impairment  $4,061   $825   $1,272   $1,120   $397   $7,675 
Ending loan balance collectively evaluated for impairment   177,970    120,686    3,482    23,791    36,066    361,995 
Total loans  $182,031   $121,511   $4,754   $24,911   $36,463   $369,670 
                               
   Multi-Family and Commercial Real Estate 
As of and for the Six Months
Ended June 30, 2014
  Investor One-
to-Four
Family and
Multi-Family
   Industrial and
Warehouse
Properties
   Office Buildings   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial
Real Estate
 
(In thousands)                              
Allowance for loan losses:                              
Beginning balance  $515   $1,034   $563   $856   $2,129   $5,097 
Provision for loan losses   96    (64)   (92)   243    (132)   51 
Charge-offs   (166)   (234)   -    (491)   (415)   (1,306)
Recoveries   -    -    -    -    19    19 
Segment ending balance as of June 30, 2014  $445   $736   $471   $608   $1,601   $3,861 
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $-   $-   $- 
Collectively evaluated for impairment   445    736    471    608    1,601    3,861 
Total allowance  $445   $736   $471   $608   $1,601   $3,861 
                               
Ending loan balance individually evaluated for impairment  $554   $27   $205   $-   $39   $825 
Ending loan balance collectively evaluated for impairment   18,614    27,245    26,932    18,931    28,964    120,686 
Total loans  $19,168   $27,272   $27,137   $18,931   $29,003   $121,511 

 

23
 

 

As of and for the Year
Ended December 31, 2014
  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction and
Land Development
   Commercial
Business Loans
   Consumer
Loans
   Total 
(In thousands)                              
Allowance related to loans:                              
Individually evaluated for impairment  $59   $-   $-   $4   $9   $72 
Collectively evaluated for impairment   1,574    3,097    414    588    278    5,951 
Total allowance  $1,633   $3,097   $414   $592   $287   $6,023 
                               
Ending loan balance individually evaluated for impairment  $4,223   $969   $726   $978   $492   $7,388 
Ending loan balance collectively evaluated for impairment   176,516    121,557    2,689    24,823    36,352    361,937 
Total loans  $180,739   $122,526   $3,415   $25,801   $36,844   $369,325 
                               
   Multi-Family and Commercial Real Estate 
As of and for the Year
Ended December 31, 2014
  Investor One-
to-Four
Family and
Multi-Family
   Industrial and
Warehouse
Properties
   Office Buildings   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial
Real Estate
 
(In thousands)                              
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $-   $-   $- 
Collectively evaluated for impairment   509    597    352    548    1,091    3,097 
Total allowance  $509   $597   $352   $548   $1,091   $3,097 
                               
Ending loan balance individually evaluated for impairment  $389   $23   $546   $-   $11   $969 
Ending loan balance collectively evaluated for impairment   25,072    24,852    23,922    17,346    30,365    121,557 
Total loans  $25,461   $24,875   $24,468   $17,346   $30,376   $122,526 

 

The allowance for loan losses allocated to each portfolio segment is not necessarily indicative of future losses in any particular portfolio segment and does not restrict the use of the allowance to absorb losses in other portfolio segments.

 

Our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. The examination may require us to make additional provisions for loan losses based on judgments different from ours. The Company also periodically engages an independent consultant to review our credit risk grading process and the risk grades on selected portfolio segments as well as the methodology, analysis and adequacy of the allowance for loan and lease losses.

 

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

 

NOTE 4 - MORTGAGE BANKING ACTIVITY

 

Mortgage banking includes three components: (1) the origination of residential mortgage loans for sale in the secondary market, (2) the servicing of mortgage loans sold to investors, and (3) the sale of mortgage servicing rights.

24
 

 

The following represents the Company’s noninterest income derived from these activities:

 

   For the Three Months
Ended June 30,
   For the Six Months
Ended June 30,
 
(In thousands)  2015   2014   2015   2014 
Gain on sales of mortgage loans  $231   $179   $449   $296 
Mortgage servicing income   1    (2)   1    3 
Gain on sale of mortgage servicing rights   -    -    -    26 
Total  $232   $177   $450   $325 

 

The Bank originates government sponsored residential mortgage loans which are sold servicing released. The Bank also originates conventional residential mortgage loans for its portfolio and for sale, both on a servicing rights retained and released basis. The decrease in the Bank’s mortgage servicing income for the six month period ended June 30, 2015 compared to the same period in 2014 is due to the sale of mortgage servicing rights detailed below and was the result of the Bank selling most of their loans on the secondary market on a servicing released basis.

 

As of August 29, 2014, the Company sold its mortgage servicing rights with a book value of approximately $948,000 relating to loans previously sold to and serviced for Federal Home Loan Mortgage Company (“Freddie Mac”) of approximately $134.8 million to another financial institution. This transaction closed on September 18, 2014 with a servicing transfer date of October 16, 2014 and satisfied all of the criteria to be accounted for as a sale of financial assets. The Company may have potential repurchase exposure on these underlying mortgage loans based on investor demands related to facts and circumstances which may have pre-dated this transaction. The investor has not exercised any repurchase obligations from the sale date through June 30, 2015.

 

NOTE 5 – FORECLOSED REAL ESTATE

 

Changes in foreclosed real estate during the three and six months ended June 30, 2015 and June 30, 2014 are as follows:

 

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
(In thousands)  2015   2014   2015   2014 
Beginning balance  $100   $1,114   $335   $1,846 
Additions   -    53    -    391 
Proceeds from dispositions   (52)   (625)   (288)   (1,604)
Gain (loss) on sales   (9)   5    (8)   (59)
Writedowns   -    (11)   -    (38)
Balance at end of period  $39   $536   $39   $536 

 

At June 30, 2015, the Bank held two properties consisting of one single family residence and one unimproved parcel zoned as residential. At June 30, 2015 and at December 31, 2014, the Bank had $2.8 million and $3.2 million in loans in process of foreclosure, respectively.

 

The Company records the gain (loss) on sale of foreclosed real estate in the expenses on foreclosed properties, net category along with expenses for acquiring and maintaining foreclosed real estate properties.

 

NOTE 6 – DEPOSITS

 

A summary of deposits at June 30, 2015 and December 31, 2014 consisted of the following:

 

   June 30, 2015   December 31, 2014 
(Dollars in thousands)  Amount   Percent   Amount   Percent 
Noninterest bearing demand deposits  $74,529    20.0%  $68,957    18.5%
Interest bearing deposits                    
Now accounts and money market accounts   51,118    13.7%   50,738    13.6%
Savings accounts   109,463    29.3%   108,488    29.0%
Certificates of deposit   138,057    37.0%   145,276    38.9%
Total interest bearing deposits   298,638    80.0%   304,502    81.5%
Total deposits  $373,167    100.0%  $373,459    100.0%

 

25
 

 

Scheduled maturities of certificates of deposit are as follows:

 

(In thousands)  At June 30,
2015
   At December 31,
2014
 
Through twelve months  $51,387   $56,895 
Twelve months through three years   52,499    55,962 
Over three years   34,171    32,419 
   $138,057   $145,276 

 

The aggregate amount of individual certificate of deposit accounts of $100,000 or more at June 30, 2015 and December 31, 2014 was $56.4 million and $60.7 million, respectively. Deposits up to $250,000 are federally insured through the Federal Deposit Insurance Corporation (“FDIC”). The aggregate amount of individual certificate of deposit accounts of $250,000 or more at June 30, 2015 and December 31, 2014 was $11.6 million and $13.2 million, respectively.

 

NOTE 7 – FHLB ADVANCES

 

The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). At June 30, 2015, the Bank had the ability to borrow up to $98.5 million from the FHLB. This borrowing capacity is based on a certain percentage of the value of the Bank’s qualified collateral, as defined in the FHLB Statement of Products Policy, at the time of the borrowing. In accordance with an agreement with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances.

 

The following table presents certain information regarding our FHLB advances during the periods or at the dates indicated.

 

   At June 30, 2015   At December 31, 2014 
       Weighted       Weighted 
   Amount   Average   Amount   Average 
(Dollars in thousands)  Due   Cost   Due   Cost 
Year of maturity: (1)                    
2015  $5,228    0.74%  $6,792    0.73%
2016   16,150    0.85%   16,068    0.85%
2017   22,570    1.56%   21,021    1.59%
2018   7,748    2.53%   5,743    2.90%
2019   5,752    2.08%   3,420    2.59%
2020 - 2024   2,028    1.33%   383    0.18%
2025 - 2028   335    -    335    - 
Total FHLB advances  $59,811    1.46%  $53,762    1.43%

 

(1) Amount due includes scheduled principal payments on amortizing advances.

 

The Bank is required to maintain an investment in capital stock of the FHLB in an amount that is based on a percentage of its outstanding residential first mortgage loans. The stock is bought from and sold to the Federal Home Loan Bank based upon its $100 par value. The stock does not have a readily determinable fair value and as such is classified as restricted stock, carried at cost and evaluated for impairment. The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation persists; (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to its operating performance; (c) the impact of legislative and regulatory changes on the customer base of the FHLB; and (d) the liquidity position of the FHLB. Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein.

 

NOTE 8 – OTHER BORROWED FUNDS

 

The Bank utilized securities sold under agreements to repurchase to accommodate its customers’ needs to invest funds short term and as a source of borrowings. During 2014, the Bank changed product types in order to make it more advantageous for these customers to be in a deposit product. At December 31, 2014, there were no customers utilizing securities sold under agreement to repurchase as an investment.

 

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The Bank maintains a credit facility with the Federal Reserve Bank of Boston for which certain assets are pledged to secure such borrowings. As of June 30, 2015 and December 31, 2014, there were no borrowings outstanding under this facility. In addition, the Federal Reserve Bank of Boston, as one of the Bank’s correspondent banks, requires the Bank to pledge at least $1 million in loans and/or investment securities for potential daylight overdraft exposure. At June 30, 2015 and December 31, 2014, the Bank had $7.2 million and $7.4 million, respectively, in commercial real estate loans pledged with the Federal Reserve Bank of Boston.

 

At June 30, 2015, the Bank had reserve requirements with the Federal Reserve Bank of Boston amounting to $2.7 million. The Bank’s balances in cash on hand and on deposit with the Federal Reserve Bank of Boston were sufficient to meet these reserve requirements.

 

NOTE 9 – STOCK BASED COMPENSATION

 

Both stock options and restricted stock awards vest at 20% per year beginning on the first anniversary of the date of grant. The Company records stock-based compensation expense related to outstanding stock options and restricted stock awards based upon the fair value at the date of grant over the vesting period of such awards on a straight-line basis. Stock options expire ten years after the date of the grant.

 

(a)Stock Option Awards

 

Stock option awards have been granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Stock options and restricted stock awards are considered common stock equivalents for the purpose of computing earnings per share on a diluted basis.

 

A summary of the status of outstanding stock options at June 30, 2015 and changes therein was as follows:

 

   2015 
   Number of
Shares
   Weighted Average
Exercise Price
 
Options outstanding at the beginning of year   209,808   $9.36 
Granted   162,566    8.60 
Forfeited   (2,947)   9.41 
Exercised   -    - 
Expired   -    - 
Options outstanding at June 30, 2015   369,427   $9.03 
           
Options exercisable at June 30, 2015   98,861   $11.17 
           
Weighted-average fair value of options granted during the year       $2.61 

 

The exercise price and weighted average remaining contractual life in years for all options outstanding at June 30, 2015 are detailed below.

 

   Outstanding as of
June 30, 2015
   Exercise Price   Weighted Average
Remaining
Contractual Life
 (in years)
Exercise price for outstanding options   95,469   $11.12   0.08
    3,392   $12.51   1.5
    110,000   $7.74   8.9
    160,566   $8.60   9.6
    369,427         

  

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The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model which includes several assumptions such as volatility, expected dividends, expected term and risk-free rate for each stock option award.

 

In determining the expected volatility of the options, the Company utilized the historical volatility of other similar companies during a period of time equal to the expected life of the options because the Company’s common shares have been publicly traded for a period less than the expected life of the options.

 

The Company assumed no dividend payments would be made during the expected contractual term of the option period.

 

The Company determined the expected contractual term of the options to be 6.5 years using the simplified method under SEC’s Staff Accounting Bulletin No. 110 due to the Company not having sufficient historical data to provide a reasonable basis for estimation.

 

The risk-free rate utilized for this calculation was based upon the U.S. Treasury yield curve in effect at the date of the options grant.

 

Assumptions used to determine the weighted average fair value of the stock options granted were as follows:

 

   Grant Date 
   May 27, 2014   January 31, 2015 
Dividend yield   0.00%   0.00%
Expected volatility   28.42%   26.76%
Risk-free rate   1.95%   1.49%
Expected life in years   6.5    6.5 
           
Weighted-average fair value of options at grant date  $2.55   $2.61 

 

Restricted Stock Awards

 

The following table summarizes the restricted stock awards outstanding for the year ended December 31, 2014 and the six months ended June 30, 2015:

 

   Number of
Shares
   Weighted
Average Fair
Value on Grant
Date
 
Nonvested at January 1, 2014   -   $- 
Granted   4,114    8.01 
Vested   -    - 
Forefeited   -    - 
Nonvested at December 31, 2014   4,114    8.01 
Granted   -    - 
Vested   -    - 
Forefeited   -    - 
Nonvested at June 30, 2015   4,114   $8.01 
           
Weighted average remaining contractual life in years        9.4 

 

The fair value of restricted stock awards is measured based on the number of shares granted and the closing market price of the Company’s common stock on the date of grant. The share-based compensation expense is reduced for an estimate of the restricted stock unit awards that are expected to be forfeited. The forfeiture estimate is zero based on historical data and other factors.

 

The Company recorded stock-based compensation expense of $39,000 and $66,000 for the three and six months ended June 30, 2015, respectively, in connection with the stock options and restricted stock awards. At June 30, 2015 the Company has unrecognized option expense of $587,264 to be recognized over the remaining vesting period of the options. The Company has unrecognized compensation expense related to non-vested restricted stock awards of $28,600 to be recognized over the remaining vesting period of the restricted stock awards.

 

28
 

 

NOTE 10 – STOCKHOLDERS’ EQUITY

 

Income (Loss) Per Share

 

Basic net income (loss) per common share is calculated by dividing the net income (loss) available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed in a manner similar to basic net income (loss) per common share except that the weighted-average number of common shares outstanding is increased to include the incremental common shares (as computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents were issued during the period. The Company’s common stock equivalents relate solely to stock option and restricted stock awards. Anti-dilutive shares are common stock equivalents with weighted-average exercise prices in excess of the weighted-average market value for the periods presented. For the six months ended June 30, 2015, anti-dilutive options excluded from the calculations totaled 95,469 options (with an exercise price of $11.12 per share), and 3,392 options (with an exercise price of $12.51 per share). For the six months ended June 30, 2014, anti-dilutive options excluded from the calculations totaled 105,787 options (with an exercise price of $11.12 per share) and 4,290 options (with an exercise price of $12.51 per share), respectively. Unreleased common shares held by the ESOP are not included in the weighted-average number of common shares outstanding for purposes of calculating either basic or diluted net income per common share.

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
(in thousands except for per share data)                     
Net income (loss)  $1,097   $94   $1,361   $(715)
                     
Weighted-average common shares outstanding:                    
Basic   6,679,360    6,675,457    6,679,360    6,675,457 
Diluted   6,725,110    6,676,391    6,714,182    6,675,457 
                     
Earnings (loss) per common share:                    
Basic  $0.16   $0.01   $0.20   $(0.11)
Diluted  $0.16   $0.01   $0.20   $(0.11)

 

Dividends

 

The ability of the Company to pay dividends depends, in part, on the ability of the Bank to pay dividends to the Company.

 

NOTE 11 – REGULATORY CAPITAL REQUIREMENTS

 

On May 4, 2015, the Office of the Comptroller of the Currency (“OCC”) notified the Bank that the Formal Agreement between the Bank and the OCC dated January 17, 2012 was terminated. In addition to the termination of the Formal Agreement, the OCC notified the Bank that it no longer requires the Bank to maintain the individual minimum capital requirements imposed on June 4, 2013. On June 11, 2015, the Federal Reserve Bank of Boston notified the Company that the Memorandum of Understanding between the Company and the Federal Reserve Bank of Boston dated May 21, 2013 was terminated.

 

As a savings and loan holding company with consolidated assets of less than $1.0 billion, the Company is not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. There is a five- year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements apply to savings and loan holding companies.

 

As a source of strength to its subsidiary bank, the Company had liquid assets of approximately $3.2 million at June 30, 2015, which the Company could contribute to the Bank if needed, to enhance the Bank’s capital levels. If the Company had contributed those assets to the Bank as of June 30, 2015, the Bank would have had a Tier 1 leverage ratio of approximately 11.71%.

 

Effective January 1, 2015, Basel III implementation date for community banks, the applicable capital regulations have been revised to:

 

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·Establish a new common equity Tier 1 minimum capital requirement (at 4.5% of risk-weighted assets);

 

·Increase the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets);

 

·Change what constitutes regulatory capital including the phasing out of certain components over a transition period;

 

·Amends the risk-weights of certain assets to better reflect credit risk and other risk exposures; and

 

·Phase in a “capital conservation buffer” requirement beginning January 1, 2016 at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.5% on January 1, 2019. If a depository institution does not maintain the applicable “capital conservation buffer” in addition to its minimum risk-based capital requirements, the Basel III capital regulation may limit capital distributions and certain discretionary bonus payments.

 

For the Bank, the new common equity Tier 1 capital ratio is the same as its Tier 1 risk-based capital ratio because the Bank’s Tier 1 capital consists only of common equity. Furthermore, as of March 31, 2015, the Bank elected to exclude its accumulated other comprehensive income (which, for the Bank, primarily consists of unrealized gains and losses on available for sale investment securities) from its Tier 1 capital. This is consistent with its previous treatment of this item.

 

The following tables are summaries of the Company’s consolidated capital amounts and ratios and the Bank’s actual capital amounts and ratios as computed under the standards established by the Federal Deposit Insurance Act at June 30, 2015 and December 31, 2014.

 

At June 30, 2015  Well Capitalized
Requirements
   Minimum Requirements (3)   Actual 
(Dollars in thousands)  $   %   $   %   $   % 
The Company Consolidated                              
Tier 1  Leverage Capital (1)   N/A    N/A    N/A    N/A   $61,034    11.96%
Tier 1 Risk-Based Capital (2)   N/A    N/A    N/A    N/A    61,034    18.03%
Total Risk-Based Capital (2)   N/A    N/A    N/A    N/A    65,271    19.28%
                               
The Bank                              
Tier 1  Leverage Capital (1)  $25,541    5.00%  $22,987    4.50%  $56,597    11.08%
Common Equity Tier 1 (CET1) (2) (4)   22,004    6.50%   15,234    4.50%   56,597    16.72%
Tier 1 Risk-Based Capital (2)   27,082    8.00%   20,312    6.00%   56,597    16.72%
Total Risk-Based Capital (2)   33,853    10.00%   27,082    8.00%   60,833    17.97%

(1) Tier 1 capital to total assets.

(2) Tier 1 or total risk-based capital to risk-weighted assets.

(3) Formal Agreement and related ICMRs terminated on May 4, 2015.

(4) New capital requirement under Basel III effective January 1, 2015.

 

At December 31, 2014  Adequately Capitalized
Requirements
   Individual Minimum
Capital Requirements (3)
   Actual 
(Dollars in thousands)  $   %   $   %   $   % 
The Company Consolidated                              
Tier 1  Leverage Capital (1)    N/A      N/A      N/A      N/A    $59,611    12.09%
Tier 1 Risk-Based Capital (2)    N/A      N/A      N/A      N/A     59,611    18.94%
Total Risk-Based Capital (2)    N/A     N/A     N/A     N/A    63,571    20.20%
                               
The Bank                              
Tier 1  Leverage Capital (1)  $19,796    4.00%  $44,541    9.00%  $55,090    11.13%
Tier 1 Risk-Based Capital (2)   12,658    4.00%           N/A      N/A     55,090    17.41%
Total Risk-Based Capital (2)   25,317    8.00%   41,139    13.00%   59,071    18.67%

(1) Tier 1 capital to total assets.

(2) Tier 1 or total risk-based capital to risk-weighted assets.

(3) Imposed on June 4, 2013 and teminated on May 4, 2015.

 

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As of June 30, 2015, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.

 

NOTE 12 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

 

In the normal course of business, the Company is a party to financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the financial statements. The contractual amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

 

The contractual amounts of commitments to extend credit represents the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults, and the value of any existing collateral becomes worthless. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments and evaluates each customer’s creditworthiness on a case-by-case basis.

 

The Company controls the credit risk of these financial instruments through credit approvals, credit limits, monitoring procedures and the receipt of collateral that it deems necessary.

 

Financial instruments whose contractual amounts represent credit risk at June 30, 2015 and December 31, 2014 were as follows:

 

   June 30,   December 31, 
(In thousands)  2015   2014 
Commitments to extend credit:          
Commercial real estate loan committments  $20,827   $30,254 
Unused home equity lines of credit   19,990    19,084 
Commercial and industrial loan commitments   13,617    12,587 
Amounts due on other commitments   4,732    7,257 
Commercial letters of credit   523    588 

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counter-party. Collateral held varies, but may include residential and commercial property, deposits and securities.

 

NOTE 13 – FAIR VALUE

 

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below:

 

Cash and cash equivalents—The carrying amounts for cash and due from banks and federal funds sold approximate fair value because of the short maturities of those investments. The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 1 within the fair value hierarchy.

 

Available for sale and held to maturity securitiesWhere quoted prices are available in an active market, the securities are classified within Level 1 of the valuation hierarchy. Examples of such instruments include mutual funds. If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) or quoted prices of securities with similar characteristics and the securities are classified within Level 2 of the valuation hierarchy. Examples of such instruments include U.S. government agency bonds, U.S. government agency mortgage-backed securities and private label collateralized mortgage obligations. Available for sale securities are recorded at fair value on a recurring basis and held to maturity securities are only disclosed at fair value.

 

Loans held for sale—The carrying amounts of these assets approximate fair value because these loans, are generally sold through forward sales (either already contracted or soon to be executed at the recording date). The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 2 within the fair value hierarchy.

 

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Loans receivableFor variable rate loans that reprice frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values, adjusted for credit losses inherent in the loan portfolio. The fair value of fixed rate loans is estimated by discounting the future cash flows using estimated period end market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for credit losses inherent in the loan portfolio. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for credit losses is established. The specific reserves for collateral dependent impaired loans are based on the fair value of collateral less estimated costs to sell. The fair value of collateral is determined based on appraisals. In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments are based on unobservable inputs, the resulting fair value measurement is categorized as a Level 3 measurement.

 

Accrued interest receivable—The carrying amount approximates fair value. The Company does not record these assets at fair value on a recurring basis. These assets are classified as Level 1 within the fair value hierarchy.

 

Federal Home Loan Bank stock The Bank is a member of the FHLB and is required to maintain an investment in capital stock of the FHLB. The carrying amount is a reasonable estimate of fair value. The Company does not record this asset at fair value on a recurring basis. Based on redemption provisions, the stock of the FHLB has no quoted market value and is carried at cost. FHLB stock is classified as Level 3 within the fair value hierarchy.

 

Foreclosed real estate— Foreclosed real estate represents real estate acquired through or in lieu of foreclosure and which are recorded at fair value on a nonrecurring basis. Fair value is based upon appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company classifies the fair value measurement as Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the fair value measurement as Level 3. The Company classified these assets as Level 3 within the fair value hierarchy.

 

Deposit liabilitiesThe fair value of demand deposits, savings and money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered by market participants for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities of such deposits. The Company does not record deposits at fair value on a recurring basis. Demand deposits, savings and money market deposits are classified as Level 1 within the fair value hierarchy. Certificates of deposit are classified as Level 2 within the fair value hierarchy.

 

Borrowed funds—The fair value of FHLB advances and other borrowed funds (repurchase agreements) are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The Company does not record this liability at fair value on a recurring basis. FHLB advances and other borrowings are classified as Level 2 within the fair value hierarchy.

 

Accrued interest payable—The carrying amounts approximates fair value. The Company does not record the liability at fair value on a recurring basis. This liability is classified as Level 1 within the fair value hierarchy.

 

Mortgagors’ escrow accounts—The carrying amount approximates fair value. The Company does not record this liability at fair value on a recurring basis. This liability is classified as Level 2 within the fair value hierarchy.

 

32
 

 

The following is a summary of the carrying values and estimated fair values of the Company’s significant financial instruments as of June 30, 2015 and December 31, 2014:

 

      June 30, 2015   December 31, 2014 
   Fair Value  Carrying   Fair   Carrying   Fair 
(In thousands)  Hierarchy Level  Value   Value   Value   Value 
                    
Financial Assets                       
Cash and cash equivalents  Level 1  $17,423   $17,423   $10,940   $10,940 
Investment securities, available-for-sale  Level 2   67,346    67,346    77,538    77,538 
Investment securities, held-to-maturity  Level 2   11,434    11,571    13,441    13,633 
Loans held for sale  Level 2   2,204    2,204    1,062    1,062 
Loans receivable, net:                       
Performing  Level 2   367,390    371,604    355,943    359,687 
Impaired  Level 3   7,028    7,028    7,316    7,316 
Accrued interest receivable  Level 1   1,566    1,566    1,599    1,599 
FHLB Stock  Level 3   4,548    4,548    4,548    4,548 
Financial Liabilities                       
Demand deposits, savings, Now and money market deposits  Level 1   235,110    235,110    228,183    228,183 
Time deposits  Level 2   138,057    139,886    145,276    147,385 
FHLB advances  Level 2   59,811    60,269    53,762    54,148 
Mortgagors' escrow accounts  Level 2   4,385    4,385    4,341    4,341 
Accrued interest payable  Level 1   73    73    67    67 

 

The Company discloses fair value information about financial instruments, whether or not recognized in the statement of financial condition, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

 

The estimated fair value amounts as of June 30, 2015 and December 31, 2014 have been measured as of their respective period-ends and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than amounts reported at such dates.

 

The information presented should not be interpreted as an estimate of the fair value of the Company as a whole since a fair value calculation is only required for a limited portion of the Company’s assets and liabilities. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.

 

The Company uses fair value measurements to record available-for sale investment securities and residential loans held for sale at fair value on a recurring basis. Additionally, the Company uses fair value measurements to measure the reported amounts of impaired loans, foreclosed real estate and mortgage-servicing rights at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or market value accounting or write-downs of individual assets.

 

Unrecognized financial instrumentsLoan commitments on which the committed interest rate is less than the current market rate were insignificant at June 30, 2015 and December 31, 2014.

 

The following table represents a further breakdown of investment securities and other financial instruments measured at fair value on a recurring basis:

 

33
 

 

   Fair Value At June 30, 2015 
(In thousands)  Level 1   Level 2   Level 3   Total 
Assets measured at fair value on a recurring basis:                    
Available-for-sale investment securities:                    
U.S. Government agency mortgage-backed obligations  $-   $43,737   $-   $43,737 
U.S. Government agency collateralized mortgage obligations   -    7,061    -    7,061 
Obligations of state and municipal subdivisions   -    16,548    -    16,548 

 

                 
   Fair Value At December 31, 2014 
(In thousands)  Level 1   Level 2   Level 3   Total 
Assets measured at fair value on a recurring basis:                    
Available-for-sale investment securities:                    
U.S. Government and agency obligations  $-   $5,042   $-   $5,042 
U.S. Government agency mortgage-backed obligations   -    53,087    -    53,087 
U.S. Government agency collateralized mortgage obligations   -    13,179    -    13,179 
Obligations of state and municipal subdivisions   -    6,230    -    6,230 

 

The following table represents assets measured at fair value on a non-recurring basis:

 

   Fair Value At June 30, 2015 
(In thousands)  Level 1   Level 2   Level 3   Total 
Assets measured at fair value on a non-recurring basis:                    
Impaired loans  $-   $-   $7,028   $7,028 
Foreclosed real estate   -    -    39    39 

 

   Fair Value At December 31, 2014 
(In thousands)  Level 1   Level 2   Level 3   Total 
Assets measured at fair value on a non-recurring basis:                    
Impaired loans  $-   $-   $7,316   $7,316 
Foreclosed real estate   -    -    335    335 

 

During the six months ended June 30, 2015, the following fair values of those reflected in the above table were remeasured:

 

·$2.8 million in collateral dependent impaired loans; and
·$39,000 in foreclosed real estate.

 

Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

 

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent management believes necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment.

 

Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion and analysis is intended to assist you in understanding the financial condition and results of operations of the Company. This discussion should be read in conjunction with the accompanying unaudited financial statements as of and for the three and six months ended June 30, 2015 and 2014 together with the audited financial statements as of and for the year ended December 31, 2014, included in the Company’s Form 10-K initially filed with the Securities and Exchange Commission on March 19, 2015.

 

Forward-Looking Statements

 

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project” or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the size, quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area, changes in real estate market values in the Company’s market area, changes in relevant accounting principles and guidelines and the receipt of requisite shareholder or regulatory approval of the proposed merger with Liberty may not be received or other conditions to the completion of the merger might not be satisfied or waived. In addition, operations will continue to be impacted until the merger transaction is either consummated or terminated. Additional factors are discussed under “Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

 

Overview: As of June 30, 2015, the Company had $500.8 million of total assets, $379.1 million of gross loans receivable, and $373.2 million of total deposits. Total stockholders’ equity at June 30, 2015 was $61.2 million.

 

The Company had net income for the quarter ended June 30, 2015 of $1.1 million (or basic and diluted income per share of $0.16 as compared to net income of $94,000 (or basic and diluted loss per share of $0.01) for the second quarter of 2014. The improvement in the Company’s operating results was largely attributable to a credit provision for loan losses of $1.4 million for the three months ended June 30, 2015 compared to the credit provision for loan losses of $739,000 for the same period in 2014 for a net change of $681,000; and a gain on the sale of investments of $413,000 for the three months ended June 30, 2015 compared to $34,000 for the same period in 2014. These improvements in the Company’s operating results were partially offset by the $612,000 in merger related expenses incurred during the 2015 quarter.

 

The Company had net income for the six months ended June 30, 2015 of $1.4 million (or basic and diluted income per share of $0.20) as compared to a net loss of $715,000 (or basic and diluted loss per share of $0.11) for the six months ended June 30, 2014. The improvement in the Company’s earnings was largely attributable to a credit provision for loan losses of $1.4 million for the three months ended June 30, 2015 compared to the credit provision for loan losses of $739,000 for the same period in 2014 for a net change of $681,000; and a gain on sale of investment securities of $829,000 for the 2015 period compared to $193,000 for the same period in 2014. These improvements in the Company’s operating results were partially offset by the $612,000 in merger related expenses incurred during the 2015 period.

 

Critical Accounting Policies. We consider accounting policies involving significant judgment and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the following to be critical accounting policies: allowance for loan losses, other than temporary impairments in the market value of investments, deferred income taxes and fair value of financial instruments.

 

Allowance for Loan Losses. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a quarterly basis, at a minimum, and establishes the provision for loan losses based on the composition of the loan portfolio, delinquency levels, loss experience, economic conditions, and other factors related to the collectability of the loan portfolio.

 

Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. We engage an independent firm to review our commercial loan portfolio at least quarterly and adjust our loan ratings based in part upon this review. In addition, our banking regulator, as an integral part of its examination process, periodically reviews our allowance for loan losses. Such agency may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination.

 

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

 

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed periodically as regulatory and business factors change.

 

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

 

This discussion should be read in conjunction with the Company’s Consolidated Financial Statements for the year ended December 31, 2014 included in the Company’s Annual Report on Form 10-K.

 

Results of Operations for the Three and Six Months Ended June 30, 2015 and 2014

 

Earnings Summary. For the three months ended June 30, 2015, the Company recorded net income of $1.1 million compared to net income of $94,000 for the same period in 2014. This $1.0 million improvement in the Company’s operating results was attributable to a $681,000 increase in credit provision for loan losses, $456,000 increase in noninterest income and a $186,000 decrease in noninterest expense which was partially offset by a $320,000 decrease in net interest income for the three months ended June 30, 2015 compared to the same period in 2014.

 

For the six months ended June 30, 2015, the Company earned net income of $1.4 million compared to a net loss of $715,000 in the same period in 2014. This $2.1 million improvement in the Company’s operating results was due to a $681,000 increase in credit provision for loan losses, $701,000 increase in noninterest income and a $1.2 million decrease in noninterest expense which was partially offset by a $539,000 decrease in net interest income for the six months ended June 30, 2015 compared to the same period in 2014.

 

Average Balance and Yields. The following table summarizes average balances and average yields and costs for the three months ended June 30, 2015 and 2014. For the purpose of this table, average balances have been calculated using the average daily balances and nonaccrual loans are included in average balances.

 

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   For the Quarter Ended June 30, 
   2015   2014 
       Interest   Annualized       Interest   Annualized 
   Average   Earned/   Average   Average   Earned/   Average 
   Balance   Paid   Yield/Rate   Balance   Paid   Yield/Rate 
   (Dollars in thousands) 
Interest-earning assets                              
Loans  $378,813   $4,207    4.45%  $376,421   $4,236    4.51%
Investment securities and Fed Funds sold   89,531    564    2.53    103,973    832    3.21 
Overnight Funds   14,855    10    0.27    4,910    4    0.33 
Federal Home Loan Bank stock   4,548    20    1.76    5,289    20    1.52 
Total interest-earning assets   487,747    4,801    3.95%   490,593    5,092    4.16%
Non interest-earning assets   22,972              21,766           
Total Assets  $510,719             $512,359           
Interest-bearing liabilities                              
Certificate accounts  $147,108    505    1.38%  $151,800   $505    1.33%
Regular savings accounts and escrow   113,417    46    0.16    118,129    49    0.17 
Checking and NOW  accounts   99,056    33    0.13    94,373    33    0.14 
Money market accounts   23,941    9    0.15    24,743    11    0.18 
Total interest-bearing deposits   383,522    593    0.62    389,045    598    0.62 
FHLB advances   62,950    223    1.42    55,920    189    1.36 
Other borrowings   -    -    -    5,536    -    0.00 
Total interest-bearing liabilities   446,472    816    0.73%   450,501    787    0.70%
Non interest-bearing liabilities   2,401              3,958           
Total Liabilities   448,873              454,459           
Total Stockholders' Equity   61,846              57,900           
Total Liabilities and Stockholders' Equity  $510,719             $512,359           
Net interest income       $3,985             $4,305      
Net interest spread             3.22%             3.46%
Net interest margin             3.28%             3.52%
Average interest earning assets to average interest bearing liabilities             109.24%             108.90%

 

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The following table summarizes average balances and average yields and costs for the six months ended June 30, 2015 and 2014. For the purpose of this table, average balances have been calculated using average daily balances and nonaccrual loans are included in average balances.

 

   For the Six Months Ended June 30, 
   2015   2014 
       Interest   Annualized       Interest   Annualized 
   Average   Earned/   Average   Average   Earned/   Average 
   Balance   Paid   Yield/Rate   Balance   Paid   Yield/Rate 
   (Dollars in thousands) 
Interest-earning assets                              
Loans  $374,318   $8,287    4.46%   373,816   $8,483    4.58%
Investment securities and Fed Funds sold   90,934    1,159    2.57    94,892    1,469    3.12 
Overnight Funds   10,490    13    0.25    6,206    9    0.29 
Federal Home Loan Bank stock   4,548    40    1.77    5,366    40    1.50 
Total interest-earning assets   480,290    9,499    3.99%   480,280    10,001    4.20%
Non interest-earning assets   23,311              21,957           
Total Assets  $503,601              502,237           
Interest-bearing liabilities                              
Certificate accounts  $146,326    991    1.37%   153,203   $1,014    1.33%
Regular savings accounts & escrow   111,809    91    0.16    118,111    98    0.17 
Checking and NOW acounts   98,067    63    0.13    92,771    69    0.15 
Money Market accounts   24,314    19    0.16    25,212    22    0.18 
Total interest-bearing deposits   380,516    1,164    0.62    389,297    1,203    0.62 
FHLB advances   58,518    418    1.44    44,921    342    1.54 
Other borrowings   -    -    -    6,031    -    - 
Total interest-bearing liabilities   439,034    1,582    0.73%   440,249   1,545    0.71%
Non interest-bearing liabilities   2,798              3,887           
Total Liabilities   441,832              444,136           
Total Stockholders' Equity   61,769              58,101           
Total Liabilities and Stockholders' Equity  $503,601              502,237           
Net interest income       $7,917             $8,456      
Net interest spread             3.26%             3.49%
                               
Net interest margin             3.32%             3.55%
                               
Average interest earning assets to average interest bearing liabilities             109.40%             109.09%

 

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Rate / Volume Analysis. The following table summarizes the changes in the components of net interest income attributable to both rate and volume for the three and six months ended June 30, 2015 and 2014:

 

   For the Quarter Ended   Six Months Ended 
   June 30, 2015 compared to   June 30, 2015 compared to 
   June 30, 2014   June 30, 2014 
   Increase (Decrease) Due to   Increase (Decrease) Due to 
(In thousands)  Volume   Rate   Net   Volume   Rate   Net 
Interest income:                              
Loans  $27   $(56)  $(29)  $10   $(206)  $(196)
Investment securities / Federal funds Sold   (106)   (162)   (268)   (59)   (251)   (310)
Overnight funds   8    (2)   6    5    (1)   4 
Federal Home Loan Bank stock   (3)   3    -    (6)   6    - 
Total interest income   (74)   (217)   (291)   (50)   (452)   (502)
Interest expense:                              
Certificate accounts   (16)   16    -    (40)   17    (23)
Regular savings accounts   (1)   (2)   (3)   (5)   -   (7)
Checking and NOW accounts   2    (2)   -    3    (11)   (6)
Money market accounts   -    (2)   (2)   (1)   (2)   (3)
Total deposit expense   (15)   10    (5)   (43)   4    (39)
FHLBB advances   26    8    34    99    (23)   76 
Other borrowings   -    -    -    -    -    - 
Total interest expense   11    18    29    56    (19)   37 
Increase (decrease) in net interest income  $(85)  $(235)  $(320)  $(106)  $(433)  $(539)

 

Net Interest Income. Net interest income for the quarter ended June 30, 2015 was $4.0 million, a decrease of $320,000, or 7.4%, compared to $4.3 million for the quarter ended June 30, 2014. Interest income on earning assets for the quarter ended June 30, 2015 decreased by $291,000, or 5.7%, compared to the comparable prior year period. This decrease in interest income was primarily the result of a $262,000, or 30.6%, decrease in interest income on investment securities and a $29,000, or 0.7%, decrease in interest income on loans. These decreases were principally due to a 21 basis point decline in the weighted average yield for interest earning assets to 3.95% for the 2015 quarter compared to 4.16% for the 2014 quarter. The six basis point decrease in average loan yields in the 2015 quarter compared to the 2014 quarter was generally due to a decrease in market interest rates and the impact of increased lending competition on loan pricing. The 68 basis point decrease in average quarterly investment yields year-over-year resulted from the sale and reinvestment into securities and overnight funds at lower yields due to a decline in market interest rates over these periods. The average balance of investment securities for the 2015 quarter decreased $14.4 million and the average balance of overnight funds increased $9.9 million compared to the 2014 quarter. The Company purchased $16.8 million in investment securities in the first six months of 2015 to grow its interest income and to partially reinvest the $27.9 million in cashflows from sales, paydowns, and calls of investment securities during 2015. Management took advantage of market opportunities to sell some higher yielding, longer duration investment securities during the first half of 2015.

 

Interest expense for the quarter ended June 30, 2015 increased by $29,000, or 3.7%, compared to the same period in 2014. This variance was principally attributable to a funding mix shift from deposits to FHLB borrowings whose cost impact from the increased average cost of FHLB borrowings (of six basis points) was partially offset by a decrease in the average balance of deposits. Quarter over quarter, the $5.5 million decrease in the average balance of deposits resulted from a $4.7 million decrease in time deposits and a $4.7 million decrease in savings accounts partially offset by a $4.7 million increase in transaction accounts as depositors sought either alternative higher yielding investments and/or more liquid deposit accounts during this persistent low rate environment. The cost impact of these changes allowed the Bank to maintain its average cost of deposits at 0.62% for the 2015 quarter and for the 2014 quarter, respectively.

 

Net interest income for the 2015 quarter was $320,000 lower than the 2014 quarter, resulting in a decrease of the Company’s net interest spread and net interest margin by 24 basis points (from 3.46% to 3.22%) and by 24 basis points (from 3.52% to 3.28%), respectively.

 

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Interest income for the six months ended June 30, 2015 decreased $502,000, or 5.0%, due primarily to a decrease in rate. This decrease in interest income was primarily the result of a $306,000, or 20.2%, decrease in interest income on investment securities and a $196,000, or 2.3%, decrease in interest income on loans. These decreases were principally due to a 21 basis point decline in the weighted average yield for interest earning assets to 3.99% for the 2015 period compared to 4.20% for the 2014 period. The 12 basis point decrease in average loan yields in the 2015 period compared to the 2014 period was generally due to a decrease in market interest rates and the impact of increased lending competition on loan pricing. The 55 basis point decrease in average investment yields year-over-year resulted from the sale and reinvestment into securities and overnight funds at lower yields due to a decline in market interest rates over these periods. The average balance of investment securities for the 2015 period decreased $4.0 million and the average balance of overnight funds increased $4.3 million compared to the 2014 period. As stated above, management took advantage of market opportunities to sell some higher yielding, longer duration investment securities during the first half of 2015.

 

Interest expense for the six months ended June 30, 2015 decreased $37,000, or 2.4%, compared to the 2014 comparable period. The factors influencing this category year-over-year in terms of rate/volume variances for the three month periods discussed above had a similar impact for the six month period comparisons; however, the magnitude of impact of these factors was due to their relative timing. During the six months ended June 30, 2015, average interest bearing liabilities decreased $1.2 million, or 0.3%, compared to the same period in 2014, reflecting customer movement out of time deposits and into low costing transaction accounts and other market alternatives during this period of declining market interest rates. Management took advantage of this rate scenario to increase the Bank’s FHLB advances through a mix of intermediate term borrowings at long run favorable pricing. With the average cost of interest-bearing deposits at 0.62% for both six-month periods, these changes in FHLB advances (along with the impact of maturing FHLB advances at higher rates) caused the weighted cost of FHLB advances to decrease by 10 basis points to 1.44% for the six months ended June 30, 2015 as compared to 1.54% for the same period in 2014, thus only increasing the Company’s cost of funds by two basis points (from 0.71% for the 2014 six month period to 0.73% for the 2015 comparable period.

 

Net interest income for the for the first six months of 2015 was $539,000 lower than the 2014 comparable period, resulting in a decrease of the Company’s net interest spread and net interest margin by 23 basis points (from 3.49% to 3.26%) and by 23 basis points (from 3.55% to 3.32%), respectively.

 

Provision for Loan Losses. For the three months ended June 30, 2015, the Company recorded a $1.4 million credit provision for loan losses compared to a credit provision for loan losses of $739,000 for the same period in 2014. Net charge-offs were $20,000 during the six month period ended June 30, 2015, compared to $1.8 million during the same period in 2014. The credit provision for the 2015 period was attributable to (i) management’s judgment that the inherent credit risk exposure in the loan portfolio had been significantly reduced and the significant improvement in the Company’s asset quality metrics due to increased loan workout efforts and prior period sales of adversely classified assets; and (ii) a $1.8 million decrease in net chargeoffs in the six month period ended June 30, 2015, compared to the same period in 2014. The allowance for loan losses as a percentage of total loans decreased to 1.21% at June 30, 2015 from 1.63% at December 31, 2014 as the Company’s rolling two year historical loss experience utilized in the periodic measurement of the ALLL continued to decrease with the stability of improved asset quality.

 

Noninterest Income. The following table summarizes the components of noninterest income for the three and six months ended June 30, 2015 and 2014:

 

   Three Months   Six months 
   Ended June 30,   Ended June 30, 
(In thousands)  2015   2014   2015   2014