10-K 1 t1600130_10k.htm FORM 10-K

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

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

For the Fiscal Year Ended December 31, 2015

 

OR

 

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

 

For the transition period from________ to ________                     

 

Commission File No. 333-171913

 

 

First Connecticut Bancorp, Inc.

(Exact name of Registrant as Specified in its Charter)

 

Maryland   45-1496206

(State or Other Jurisdiction of

Incorporation or Organization)

 

(IRS Employer

Identification Number)

     
One Farm Glen Boulevard, Farmington, CT   06032
(Address of Principal Executive Office)   (Zip Code)

 

(860) 676-4600

(Registrant’s Telephone Number including Area Code)

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of Class   Name of Each Exchange On Which Registered
Common Stock, par value $0.01 per share   The NASDAQ Global Select Market

 

Securities Registered Pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act    YES  ¨    NO  x

 

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days  YES  x     NO  ¨

 

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

 

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

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer — See definition of “accelerated and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).

 

Large Accelerated Filer     ¨   Accelerated Filer   x
Non-Accelerated Filer     ¨   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

 

The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the closing price of the common stock as of June 30, 2015 was approximately $242.5 million.

 

As of February 29, 2016, there were outstanding 15,737,863 shares of the Registrant’s common stock.

 

 

DOCUMENT INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement for the Annual Meeting of Stockholders (Part III) expected to be filed within 120 days after the end of the Registrant’s fiscal year ended December 31, 2015, are incorporated herein by reference.

 

 

 

 

 

 

 

First Connecticut Bancorp, Inc.

 

Form 10-K Table of Contents

 

December 31, 2015

 

PART I     Page
ITEM 1.   Business 1
ITEM 1A.   Risk Factors 35
ITEM 1B.   Unresolved Staff Comments 38
ITEM 2.   Properties 39
ITEM 3.   Legal Proceedings 40
ITEM 4.   Mine Safety Disclosures 40
       
PART II      
ITEM 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 40
ITEM 6.   Selected Financial Data 42
ITEM 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations 44
ITEM 7A.   Quantitative and Qualitative Disclosures about Market Risk 61
ITEM 8.   Financial Statements and Supplementary Data 61
ITEM 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 130
ITEM 9A.   Controls and Procedures 130
ITEM 9B.   Other Information 130
       
PART III     131
ITEM 10.   Directors, Executive Officers, and Corporate Governance 131
ITEM 11.   Executive Compensation 131
ITEM 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 131
ITEM 13.   Certain Relationships and Related Transactions, and Director Independence 131
ITEM 14.   Principal Accountant Fees and Services 131
       
PART IV      
ITEM 15.   Exhibits and Financial Statement Schedules 131
       
SIGNATURES     134

 

 

 

 

Part I

Item 1. Business

 

Forward-Looking Statements

 

From time to time the Company has made and may continue to make written or oral forward-looking statements regarding our outlook or expectations for earnings, revenues, expenses, capital levels, asset quality or other future financial or business performance, strategies or expectations, or the impact of legal, regulatory or supervisory matters on our business operations or performance. This Annual Report on Form 10-K also includes forward-looking statements. With respect to all such forward-looking statements, you should review our Risk Factors discussion in Item 1A. and our Cautionary Statement Regarding Forward-Looking Information included in Item 7.

 

First Connecticut Bancorp, Inc.

 

First Connecticut Bancorp, Inc. (“First Connecticut Bancorp”, “FCB” or the “Company”) is a Maryland-chartered stock holding company that wholly owns its only subsidiary, Farmington Bank (“Bank”). At December 31, 2015, the Company had, on a consolidated basis, $2.7 billion in assets, of which $2.3 billion were in loans, $2.0 billion in deposits and stockholders’ equity of $245.7 million.

 

On July 2, 2012, the Company received regulatory approval to repurchase up to 1,788,020 shares, or 10% of its current outstanding common stock. On May 30, 2013, the Company completed its repurchase of 1,788,020 shares at a cost of $24.9 million, of which 486,947 shares were reissued as part of the 2012 Stock Incentive Plan. On June 21, 2013, the Company received regulatory approval to repurchase up to an additional 1,676,452 shares, or 10% of its current outstanding common stock. As of December 31, 2015, the Company has repurchased 918,707 of these shares at a cost of $13.7 million. Repurchased shares are held as treasury stock and are available for general corporate purposes.

 

On September 5, 2012, the Company registered 2,503,228 shares to be reserved for issuance to the First Connecticut Bancorp, Inc. 2012 Stock Incentive Plan.

 

Farmington Bank

 

Farmington Bank is a full-service, community bank with 23 branch locations throughout central Connecticut and western Massachusetts, offering commercial and residential lending as well as wealth management services. Established in 1851, Farmington Bank is a diversified consumer and commercial bank with an ongoing commitment to contribute to the betterment of the communities in our region. Farmington Bank is regulated by the Connecticut Department of Banking and the Federal Deposit Insurance Corporation (“FDIC”). Farmington Bank’s deposits are insured to the maximum allowable under the Deposit Insurance Fund, which is administered by the FDIC. Farmington Bank is a member of the Federal Home Loan Bank of Boston (“FHLBB”). Farmington Bank is the wholly-owned subsidiary of First Connecticut Bancorp.

 

The executive office of the Company is located at One Farm Glen Boulevard, Farmington, Connecticut, 06032.

 

Farmington Bank’s website (www.farmingtonbankct.com) contains a direct link to the Company’s filings with the Securities and Exchange Commission, including copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these filings, as well as ownership reports on Forms 3, 4 and 5 filed by the Company’s directors and executive officers. Copies may also be obtained, without charge, by written request to First Connecticut Bancorp, Inc. Investor Relations, One Farm Glen Boulevard, Farmington, Connecticut, 06032, Attention: Jennifer Daukas or send an email to: investor-relations@firstconnecticutbancorp.com. Information on our website is not part of this Annual Report on Form 10-K.

 

Market Area

 

We operate in a primarily suburban market area that has a stable population and household base. All but two of our current branch offices are in Hartford County, Connecticut; two of our branch offices are located in Hampden County, Massachusetts. Our primary market area is central Connecticut and western Massachusetts. Our main office is in Farmington, Connecticut and is approximately ten miles from the City of Hartford, Connecticut. The counties we serve have a mix of industry groups and employment sectors including insurance, health services, finance, manufacturing, not-for-profit, education, government and technology. Our primary market area for deposits includes the communities in which we maintain our banking office locations. Our lending area is broader than our deposit market area and primarily includes Connecticut and western Massachusetts, however, we will selectively lend to borrowers in other northeastern states. During 2015, we opened branch offices in East Longmeadow, MA and West Springfield, MA and a loan production office in Branford, CT.

 

 1 

 

 

Based on the most recent data available from the Federal Deposit Insurance Corporation (“FDIC”) as of June 30, 2015, we possess a 5.32% deposit market share in Hartford County. Our market share rank is 5th out of 27 financial institutions.

 

Lending Activities

 

Historically, our principal lending activities have been residential, consumer and commercial lending. As part of our growth strategy, we have been increasing our commercial portfolio and attracting larger, more comprehensive long-term borrowing relationships in the areas of commercial real estate lending (both owner and non-owner-occupied) and commercial lending, and supplementing these areas with more extensive cash management and depository services in an effort to increase interest income, diversify our loan portfolio and better serve the community.

 

The resulting overall loan portfolio performance has been strong with total loan growth of 10.4% in 2015, 17.5% in 2014, 18.4% in 2013, and 17.1% in 2012. Our total loans at December 31, 2015 increased by $222.8 million or 10.4% from December 31, 2014 primarily due to increases in our commercial loan portfolio which grew $195.7 million or 17.3% from December 31, 2014 to December 31, 2015.

 

Our senior management team has carefully built the infrastructure necessary to support this growth and provide critical on-going portfolio management and risk assessment. A risk management program is in place to enable us to evaluate the risk in our portfolio and to implement changes in our underwriting standards so as to minimize overall portfolio risk. As part of this program, our loan portfolio is subject to concentration limits, market analyses, stress testing, ongoing monitoring, and reporting and review of underwriting standards.

 

The following table sets forth the composition of our loan portfolio by type of loans at the dates indicated:

 

   At December 31,
   2015  2014  2013  2012  2011
   Amount  Percent  Amount  Percent  Amount  Percent  Amount  Percent  Amount  Percent
Real estate:              (Dollars in Thousands)            
Residential  $849,722    36.1%  $827,005    38.7%  $693,046    38.2%  $620,991    40.5%  $503,361    38.4%
Commercial   887,431    37.6%   765,066    35.8%   633,764    34.9%   473,788    30.9%   408,169    31.2%
Construction(1)   30,895    1.3%   57,371    2.7%   78,191    4.3%   64,362    4.2%   46,381    3.5%
Installment   2,970    0.1%   3,356    0.2%   4,516    0.2%   6,719    0.4%   10,333    0.8%
Commercial   409,550    17.4%   309,708    14.5%   252,032    13.9%   192,210    12.6%   154,300    11.8%
Collateral   1,668    0.1%   1,733    0.1%   1,600    0.1%   2,086    0.1%   2,348    0.2%
Home equity line of credit   174,701    7.4%   169,768    8.0%   151,606    8.3%   142,543    9.3%   109,771    8.4%
Demand   -    *   -    *   85    *   25    *   41    *
Revolving Credit   91    *   99    *   94    *   65    *   90    *
Resort   784    *   929    *   1,374    0.1%   31,232    2.0%   75,363    5.7%
Total loans   2,357,812    100.0%   2,135,035    100.0%   1,816,308    100.0%   1,534,021    100.0%   1,310,157    100.0%
Net deferred loan costs   3,984         3,842         2,993         3,378         2,553      
Loans   2,361,796         2,138,877         1,819,301         1,537,399         1,312,710      
Allowance for loan losses   (20,198)        (18,960)        (18,314)        (17,229)        (17,533)     
Loans, net  $2,341,598        $2,119,917        $1,800,987        $1,520,170        $1,295,177      

 

 * Less than 0.1%

(1)Construction loans include commercial and residential construction loans and are reported net of undisbursed construction loans of $44.5 million as of December 31, 2015.

 

Major loan customers: Our five largest lending relationships are with commercial borrowers with loans totaling $118.6 million or 5.0% of our total loan portfolio outstanding as of December 31, 2015. Loan commitments to these borrowers totaled $118.6 million for the same period. These relationships and commitments consist of the following:

 

1.$26.3 million relationship consisting of commercial mortgages on five distinct properties located in Connecticut, extended to a well-known local developer for refinancing of a medical office building; construction of a single tenant office building now in its permanent phase which houses the corporate headquarters of a regional medical insurance company; financing for the purchase of a 78 unit apartment complex; construction of a medical office building which is now in its permanent phase; and funding to refinance a single family investment property.

 

2.$25.0 million direct purchase bond financing to a private college located in Pennsylvania for the construction of new dorms and a student commons building.

 

3.$24.6 million relationship consisting of commercial mortgages on two distinct properties extended to a well-known New England developer for the refinancing of construction debt associated with the redevelopment of an 82-unit apartment complex located in New Hampshire and refinancing of construction debt associated with the redevelopment of a 157-unit apartment complex located in Rhode Island.

 

 2 

 

 

4.$22.5 million direct purchase bond financing to a private college located in Connecticut for the refinancing of existing bond obligations.

 

5.$20.2 million relationship consisting of commercial mortgages on two distinct Connecticut properties, extended to a well-known local developer for the refinancing of 168 and 220 unit apartment buildings.

 

All of the credit facilities extended to the five largest borrowers as of December 31, 2015 are current and performing in accordance with their respective terms.

 

Real Estate Loans:

 

Residential Real Estate Loans: One of our primary lending activities consists of the origination of one-to-four family residential real estate loans that are primarily secured by properties located in Hartford County and surrounding counties in Connecticut. Of the $849.7 million and $827.0 million of residential loans outstanding at December 31, 2015 and 2014, respectively, $407.3 million and $466.2 million are fixed-rate loans. Generally, residential real estate loans are originated in amounts up to 95.0% of the lesser of the appraised value or purchase price of the property, with private mortgage insurance required on loans with a loan-to-value ratio in excess of 80.0%. We usually do not make loans secured by single-family homes with loan-to-value ratios in excess of 95.0% (with the exception of Federal Housing Administration loans which allow for a 96.5% loan-to-value ratio). Fixed-rate mortgage loans generally are originated for terms of 7, 10, 15, 20, 25 and 30 years. All fixed-rate residential mortgage loans are underwritten pursuant to secondary market underwriting guidelines which include minimum FICO standards.

 

Based on the market environment for our residential mortgage originations we may sell our conforming 10, 15, 20 and 30 year fixed-rate residential mortgage loan production in the secondary market, while retaining the servicing rights. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. We originated $132.9 million of fixed-rate one-to-four family residential loans for the year ended December 31, 2015, $97.7 million of which were sold in the secondary market and we originated $93.7 million of fixed-rate one-to-four family residential loans for the year ended December 31, 2014, $34.1 million of which were sold in the secondary market. The loans sold meet secondary market guidelines and are subject to warranty exposure. Such exposure is mitigated by our quality control procedures and the fact that we are selling newly originated loans instead of seasoned loans in the secondary market. As of December 31, 2015, we have not been requested or required to repurchase any sold loans due to inadequate underwriting or documentation deficiencies. We have not and do not intend to originate subprime or alternative A paper (alt A) loans.

 

We also offer adjustable-rate mortgage loans for one-to-four family properties, with an interest rate that adjusts annually based on the one-year Constant Maturity Treasury Bill Index, after a one, three, five, seven or ten - year initial fixed-rate period. Our adjustable rate mortgage loans generally provide for maximum rate adjustments of 200 basis points per adjustment, with a lifetime maximum adjustment up to 6.0%, regardless of the initial rate. Our adjustable rate mortgage loans amortize over terms of up to 30 years. We originated $25.3 million and $53.2 million adjustable rate one-to-four family residential loans for the years ended December 31, 2015 and 2014, respectively. For the years ended December 31, 2015 and 2014, we purchased $111.9 million and $134.2 in million adjustable rate mortgages, respectively.

 

Adjustable rate mortgage loans decrease the risks associated with changes in market interest rates by periodically repricing, but involve other risks because as interest rates increase, the underlying payments by the borrower increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan documents and, therefore, the effectiveness of adjustable rate mortgage loans may be limited during periods of rapidly rising interest rates. Of our one-to-four family residential real estate loans, $442.4 million and $360.8 million had adjustable rates of interest at December 31, 2015 and 2014, respectively. Declines in real estate values and or a slowdown in the housing market may make it more difficult for borrowers experiencing financial difficulty to sell their homes or refinance their debt due to their declining collateral values.

 

All residential mortgage loans that we originate include “due-on-sale” clauses, which give us the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property. We also require homeowner’s insurance and, where circumstances warrant, flood insurance on properties securing real estate loans. Our largest residential mortgage loan had a principal balance of $4.1 million at December 31, 2015, which is performing in accordance with terms.

 

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Commercial Real Estate Loans: We originate commercial investment real estate loans and loans on owner-occupied properties used for a variety of business purposes, including office buildings, multi-family dwellings, industrial and warehouse facilities and retail facilities. Commercial mortgage loans totaled $887.4 million and $765.1 million, or 37.7% and 35.8% of total loans, at December 31, 2015 and 2014, respectively. At December 31, 2015, our owner-occupied commercial mortgage loans constituted 22.3% of our commercial real estate portfolio and our investor-owned commercial mortgage real estate loans were 77.7% of the commercial real estate portfolio. The investor-owned portfolio is diversified among a number of property types as shown in the following table. Owner-occupied commercial real estate loans totaled $197.8 million and $172.9 million, or 22.3% and 22.6%, at December 31, 2015 and 2014, respectively. Our owner-occupied commercial real estate underwriting policies provide that typically such real estate loans may be made in amounts of up to 80.0% of the appraised value of the property. Our commercial real estate loans are generally made with terms of up to 20 years, amortization schedules generally up to 25 years and interest rates that are fixed for a period of time, generally set at a margin above the FHLBB Advance rates. Variable rate options are also available, generally tied to the prime rate as published in the Wall Street Journal, or for qualifying borrowers, tied to LIBOR plus a margin. Interest rate swaps are offered to qualified borrowers to effect a fixed-rate equivalent for the borrower and allows us to effectively hedge against interest rate risk on large, long-term loans. In reaching a credit decision on whether to make a commercial real estate loan, we consider gross revenues and the net operating income of the property, the borrower’s cash flow and credit history, and the appraised value of the underlying property. In addition, with respect to commercial real estate rental properties, we also consider the terms and conditions of the leases, the credit quality of the tenants and the borrower’s global cash flow. We typically require that the properties securing our commercial real estate loans have debt service coverage ratios (the ratio of earnings before interest, taxes, depreciation and amortization divided by interest expense and current maturities of long-term debt) of at least 1.20x. Environmental reports and current appraisals are required for commercial real estate loans as governed by our written environmental and appraisal policies. Generally, a commercial real estate loan made to a corporation, partnership or other business entity requires personal guarantees by the principals and owners of 20.0% or more of the entity, though, we do offer non-recourse financing to commercial real estate borrowers who exhibit strong credit metrics including, but not limited to, strong debt service coverage and low loan-to-value ratios.

 

A commercial real estate borrower’s financial information and various credit quality indicators are monitored on an ongoing basis by requiring the submission of periodic financial statement updates and annual tax returns and the periodic review of payment history. In addition, we typically conduct periodic face-to-face meetings with the borrower, as well as property site visits. These requirements also apply to guarantors of commercial real estate loans. Borrowers with loans secured by rental investment property are required to provide an annual report of income and expenses for such property, including a tenant rent roll and copies of leases, as applicable. The largest commercial real estate loan, excluding commercial construction, was $16.1 million at December 31, 2015 and is performing in accordance with terms.

 

Loans secured by commercial real estate generally involve larger principal amounts and a greater degree of risk than one-to-four family residential mortgage loans. Because payments on loans secured by commercial real estate are often dependent on the successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market, the economy or the tenant(s). Given our level of commercial real estate exposure, our commercial real estate portfolio risk management program enables us to evaluate the risk in our portfolio and to implement changes in our lending practices to minimize overall portfolio risk. As part of this program, the commercial real estate portfolio is subject to concentration limits, market analyses, stress testing, ongoing monitoring, and review and reporting of underwriting standards.

 

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The following table presents the amounts and percentages of commercial real estate loans held by type as of December 31, 2015 and 2014.

 

   2015  2014
   Amount  Percent  Amount  Percent
Type of Commercial Real Estate Loans:  (Dollars in thousands)
Owner occupied  $197,801    22.3%  $172,942    22.6%
Retail   237,729    26.8%   214,618    28.1%
Multi-family   177,628    20.0%   127,044    16.6%
Office   143,180    16.1%   126,685    16.6%
Other   83,641    9.4%   77,551    10.1%
Industrial   24,653    2.8%   24,394    3.2%
Hotel   21,878    2.5%   19,378    2.5%
Land   921    0.1%   2,454    0.3%
Total  $887,431    100.0%  $765,066    100.0%

 

Construction Loans: We offer construction loans, including commercial construction loans and real estate subdivision development loans, to developers, licensed contractors and builders for the construction and development of commercial real estate projects and residential properties. Construction loans outstanding, including commercial and residential, totaled $30.9 million and $57.4 million, or 1.3% and 2.7% of total loans outstanding at December 31, 2015 and 2014, respectively. At December 31, 2015, the unadvanced portion of these construction loans totaled $44.5 million, as compared to $41.6 million at December 31, 2014. Our underwriting policies provide that construction loans typically be made in amounts of up to 75.0% of the appraised value of the property. We extend loans to residential subdivision developers for the purpose of land acquisition, the development of infrastructure and the construction of homes. Advances are determined as a percentage of the cost or appraised value of the improvements, whichever is less, and each project is physically inspected prior to each advance either by a loan officer or an engineer approved by us. We typically limit the number of speculative units financed by a customer, with the majority of construction advances supported by purchase contracts.

 

We also originate construction loans to individuals and contractors for the construction and acquisition of personal residences. Residential construction loans outstanding totaled $4.9 million and $10.0 million at December 31, 2015 and 2014, respectively. The unadvanced portion of these construction loans totaled $4.6 million and $4.8 million at December 31, 2015 and 2014, respectively. Our residential construction mortgage loans generally provide for the payment of interest only during the construction phase, which is typically up to nine months, although our policy is to consider construction periods as long as 12 months. At the end of the construction phase, the construction loan converts to a long-term owner-occupied residential mortgage loan. Construction loans can be made with a maximum loan-to-value ratio of 80.0%. Before making a commitment to fund a residential construction loan, we require an appraisal of the property by an independent licensed appraiser. We also review and inspect each property before disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection based on the percentage of completion method. Construction loans to individuals are generally made on the same terms as our one-to-four family mortgage loans.

 

Construction financing is generally considered to involve a higher degree of credit risk than longer-term financing on improved 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 actual cost (including interest) of construction and other assumptions. If the estimate of construction cost is too low, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value is too high, we may be confronted with a project, when completed, with a value that is insufficient to assure full payment. Construction lending contains a unique risk characteristic as loans are originated under market and economic conditions that may change between the time of origination and the completion and subsequent purchaser financing of the property. In addition, construction subdivision loans and commercial and residential construction loans to contractors and developers entail additional risks as compared to single-family residential mortgage lending to owner-occupants. These loans typically involve large loan balances concentrated in single borrowers or groups of related borrowers. A continued economic downturn could have an additional adverse impact on the value of the properties securing construction loans and on our borrowers’ ability to sell their units for the amounts necessary to complete their projects and repay their loans.

 

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The following table presents the amounts and percentages of construction loans held by type as of December 31, 2015 and 2014.

 

   2015  2014
   Amount  Percent  Amount  Percent
Type of Construction Loans:  (Dollars in thousands)
Multi-family  $10,484    33.9%  $10,166    17.7%
Retail   5,436    17.6%   11,420    19.9%
Residential   4,893    15.8%   9,966    17.4%
Commercial owner-occupied   4,086    13.3%   5,537    9.7%
Subdivision   3,567    11.5%   4,714    8.2%
Subdivision speculative   1,475    4.8%   2,143    3.7%
Other   954    3.1%   296    0.5%
Office   -    0.0%   13,129    22.9%
Total  $30,895    100.0%  $57,371    100.0%

 

The establishment of interest reserves for construction and development loans is an established banking practice, but the handling of such interest reserves varies widely within the industry. Many of our construction and development loans provide for the use of interest reserves, and based upon our knowledge of general industry practices, we believe that our practices related to such interest reserves are appropriate and adequate. When we underwrite construction and development loans, we consider the expected total project costs, including hard costs such as land, site work and construction costs and soft costs such as architectural and engineering fees, closing costs, leasing commissions and construction period interest. Based on the total project costs and other factors, we determine the required borrower cash equity contribution and the maximum amount we are willing to loan. In the vast majority of cases, we require that all of the borrower’s cash equity contribution be contributed prior to any material loan advances. This ensures that the borrower’s cash equity required to complete the project will in fact be available for such purposes. As a result of this practice, the borrower’s cash equity typically goes toward the purchase of the land and early stage hard costs and soft costs. This results in our funding the loan later as the project progresses, and accordingly we typically fund the majority of the construction period interest through loan advances. As of December 31, 2015, we are committed to advance construction period interest totaling approximately $602,000 on construction and development loans. The maximum committed balance of all construction and development loans which provide for the use of interest reserves at December 31, 2015 was approximately $45.8 million, of which $20.6 million was outstanding at December 31, 2015 and $25.2 million remained to be advanced.

 

The largest commercial construction loan was $13.4 million of which $6.1 million was outstanding at December 31, 2015, and is performing in accordance with terms.

 

Commercial Loans:

 

Our approach to commercial lending is centered in relationship banking. While our primary focus is to extend financing to meet the needs of creditworthy borrowers, we also endeavor to provide a comprehensive solution for all of a business’ banking needs including depository, cash management and investment needs. The commercial business loan portfolio is comprised of both middle market companies and small businesses located primarily in Connecticut and western Massachusetts. Market segments represented include manufacturers, distributors, service businesses, financial services, healthcare providers, not-for-profits, higher and secondary education institutions and professional service companies. Typically, our middle market lending group seeks relationships with companies that have borrowing needs in excess of $750,000, while our small business lending group supports companies with borrowing needs of $750,000 or less.

 

We had $409.6 million and $309.7 million in commercial loans at December 31, 2015 and 2014, respectively. Of the loans in our commercial loan portfolio, $18.7 million and $18.4 million were guaranteed by either the Small Business Administration, the Connecticut Development Authority or the United States Department of Agriculture at December 31, 2015 and 2014, respectively. Total commercial business loans amounted to 17.4% and 14.5% of total loans at December 31, 2015 and 2014, respectively.

 

Commercial business lending products generally include term loans, revolving lines of credit for working capital needs, equipment lines of credit to facilitate the purchase of equipment, and letters of credit. Commercial business loans are made with either adjustable or fixed-rates of interest. Variable rates are tied to either the prime rate, as published in The Wall Street Journal, or LIBOR, plus a margin. The interest rates of fixed-rate commercial business loans are typically set at a margin above the FHLBB Advance rates. Interest rate swaps are offered to qualified borrowers to effect a fixed-rate equivalent for the borrower and allows us to effectively hedge against interest rate risk on large, long-term loans.

 

 6 

 

 

When making commercial business loans, we consider the character and capabilities of the borrower’s management, our lending history with the borrower, the debt service capabilities of the borrower, the historical and projected cash flows of the business, the relative strength of the borrower’s balance sheet, the value and composition of the collateral, and the financial strength and commitment of the guarantors, if any. Commercial loans are generally secured by a variety of collateral, including accounts receivable, inventory and equipment, and supported by personal guarantees. Depending on the collateral used to secure the loans, commercial business loans are typically advanced at a discount to the value of the loan’s collateral. As of December 31, 2015 and 2014, unsecured commercial loans totaled $57.7 million and $8.2 million, respectively, or less than 3.0% of total loans outstanding. Generally, a commercial loan made to a corporation, partnership or other business entity requires personal guarantees by the principals and owners of 20.0% or more of the entity, though, we do offer non-recourse financing to commercial borrowers who exhibit strong credit metrics including but not limited to, strong debt service coverage and low loan-to-value ratios.

 

Commercial loans generally have greater credit risk than residential real estate loans. Unlike residential mortgage loans, which largely are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans generally are made on the basis of the borrower’s ability to repay the loan from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of a commercial business loan depends substantially on the success of the business itself. Further, any collateral securing the loan may depreciate over time, be difficult to appraise and or fluctuate in value. We seek to minimize these risks through our underwriting standards.

 

In an effort to both attract more sophisticated borrowers, as well as to hedge our interest rate risk associated with long-term commercial loans, we offer interest rate swaps via our correspondent banking partners. Interest rate swaps are primarily used to exchange a floating rate payment stream into a fixed-rate payment stream. The variable rates on swaps will change as market interest rates change. We will enter into swap transactions solely to limit our interest rate risk and effectively “fix” the rate for appropriate customer borrowings. We do not engage in any speculative swap transactions. Generally, swap options are offered to “pass” rated borrowers requesting long-term commercial loans or commercial mortgages in amounts of at least $1.0 million. We have established a derivative policy which sets forth the parameters for such transactions (including underwriting guidelines, rate setting process, maximum maturity, approval and documentation requirements), as well as identifying internal controls for the management of risks related to these hedging activities (such as approval of counterparties, limits on counterparty credit risk, maximum loan amounts, and limits to single dealer counterparties). Our interest rate swap derivatives are primarily collateralized by cash. As of December 31, 2015, we have 66 mirrored swap transactions with a total current notional amount of $281.1 million. The fair value of the interest rate swap derivative asset and liability is $10.6 million and $10.7 million, respectively, at December 31, 2015.

 

Our small business customers typically generate annual revenues from their businesses of up to $2.5 million and have borrowing needs of up to $750,000. We deliver and promote the delivery of small business loan products to our existing and prospective customer base by leveraging our retail branch network, including our branch managers, supplemented by a team of dedicated business development officers. Our branch managers and business development officers are fully trained to assist small business owners through the entire loan process from application to closing. We offer a streamlined process for our customers by utilizing a credit scoring system as a key part of our underwriting process, along with a standardized loan documentation package. This results in our ability to deliver quick decision-making along with cost effective loan closings to our small business customers. As a designated Small Business Administration (“SBA”) preferred lender, we are also able to offer flexible financing terms to those borrowers who otherwise would not qualify under our traditional underwriting standards. The Small Business Administration program is a cornerstone of our small business loan program. Based on the SBA 2015 fiscal year, we were ranked 1st out of 76 small business lenders in CT as measured by number of loans, originating 66 loans totaling $5.5 million. Based on the SBA 2014, 2013 and 2012 fiscal years, we were ranked 2nd, 3rd and 1st, respectively, out of over 50 small business lenders in CT as measured by number of loans. We also were awarded the “Top Lender to Women Entrepreneurs” award for fiscal year 2015. As of December 31, 2015, our entire small business loan portfolio totaled $79.8 million or 3.4% of total loans, with an additional $18.9 million in unfunded loan commitments and an average loan size of approximately $92,000.

 

As of December 31, 2015, our largest commercial business loan relationship was fully advanced at $25.0 million, which was performing according to its terms. In addition to the commercial business loans discussed above, we had $3.6 million in letter of credit commitments as of December 31, 2015.

 

 7 

 

 

Home equity line of credit:

 

We also offer home equity loans and home equity lines of credit, both of which are secured by owner-occupied one-to-four family residences. Home equity loans and home equity lines of credit totaled $174.7 million and $169.8 million, or 7.4% and 8.0% of total loans at December 31, 2015 and 2014, respectively. At December 31, 2015, the unadvanced amount of home equity lines of credit totaled $205.0 million, as compared to $173.5 million at December 31, 2014.

 

The underwriting standards utilized for home equity loans and home equity lines of credit include a determination of the borrower’s credit history, an assessment of the borrower’s ability to meet existing obligations and future payments on the proposed loan and the value of the collateral securing the loan. Home equity loans are offered with fixed-rates of interest and with terms of up to 15 years. The loan-to-value ratio for our home equity loans and our lines of credit, including any first mortgage, is generally limited to no more than 80.0%. Our home equity lines of credit have a ten-year draw period which amortizes over a 20-year period and adjustable rates of interest which are indexed to the prime rate, as reported in The Wall Street Journal.

 

Interest rates on home equity lines of credit are generally limited to a maximum rate of 18.0% per annum.

 

Installment, Demand, Collateral, Revolving Credit and Resort Loans: We offer various types of consumer loans, including installment, demand, revolving credit and collateral loans, principally to customers residing in our primary market area with acceptable credit ratings. Our installment and collateral consumer loans generally consist of loans on new and used automobiles, loans collateralized by deposit accounts and unsecured personal loans. The resort portfolio consists of a direct receivable loan outside the Northeast which is amortizing to its contractual obligations. The Bank has exited the resort financing market with a residual portfolio remaining. Installment, demand, collateral, revolving credit and resort loans totaled $5.5 million and $6.1 million, or 0.2% and 0.3% of our total loan portfolio at December 31, 2015 and 2014, respectively. While the asset quality of these portfolios is currently good, there is increased risk associated with consumer loans during economic downturns as increased unemployment and inflationary costs may make it more difficult for some borrowers to repay their loans.

 

Origination, Purchasing and Servicing of Loans:

 

In order to reduce our exposure to rising interest rates, we sell fixed-rate conforming loans into the secondary market while retaining the servicing for the majority of these loans. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans.

 

We are an approved seller and servicer of the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Federal Home Loan Bank. All adjustable rate mortgages are currently being held in our residential portfolio. We also originate Federal Housing Administration loans through our “Direct Endorsed” designation with the U.S. Department of Housing and Urban Development.

 

We were servicing residential real estate loans sold in the amount of $457.5 million and $335.2 million at December 31, 2015 and 2014, respectively. We anticipate our servicing assets will continue to grow as we expect to sell a portion of our fixed-rate conforming loan production into the secondary market.

 

We also purchase one-to-four family residential mortgage loans throughout the New England and New York/New Jersey markets, from approved Correspondents licensed with the respective State Departments of Banking. The approved Correspondents are not employed by us and sell their loans based on competitive pricing. The loans are underwritten by us to the same credit specifications as our internally originated loans. We do not, however, participate in the purchase of credit impaired loans. We expect to continue to purchase one-to-four family residential mortgage loans from approved Correspondents so long as pricing and purchase opportunities remain favorable.

 

From time to time we enter into participations with other regional lenders in commercial real estate and commercial business loan transactions. We participate in transactions (purchase a share of the loan commitment), as well as sell portions of transactions that we originate. As of December 31, 2015 and 2014, our loan portfolio included $151.0 million and $121.4 million, respectively, in loans in which we purchased a participation share, and $152.1 million and $126.6 million, respectively, in loans participated to other institutions.

 

 8 

 

 

Loan Portfolio Maturities and Yields:

 

The following table summarizes the scheduled maturities of our loan portfolio at December 31, 2015. Demand loans, loans having no stated repayment schedule or maturity are reported as being due in one year or less. Weighted average rates are computed based on the rate of the loan at December 31, 2015.

 

   Loans Maturing During the Years Ending December 31,      
   2016  2017 to 2020  2021 and beyond  Total
   Amount  Weighted
Average
Rate
  Amount  Weighted
Average
Rate
  Amount  Weighted
Average
Rate
  Amount  Weighted
Average
Rate
Real estate:  (Dollars in Thousands)
Residential  $131    6.87%  $17,810    3.22%  $831,781    3.54%  $849,722    3.53%
Commercial   30,836    3.31%   102,573    3.03%   754,022    3.68%   887,431    3.59%
Construction   8,475    3.55%   1,099    4.28%   21,321    3.76%   30,895    3.72%
Installment   71    7.04%   695    6.62%   2,204    5.26%   2,970    5.62%
Commercial   72,271    3.50%   116,823    3.49%   220,456    3.13%   409,550    3.30%
Collateral   745    2.55%   -    -    923    2.49%   1,668    2.52%
Home equity line of credit   2,996    3.14%   30,749    3.10%   140,956    2.64%   174,701    2.73%
Revolving Credit   91    17.58%   -    -    -    -    91    17.58%
Resort   -    -    784    3.44%   -    -    784    3.44%
Total  $115,616    3.46%  $270,533    3.26%  $1,971,663    3.49%  $2,357,812    3.46%

 

The following table sets forth the fixed-rate and adjustable rate loans at December 31, 2015 that are contractually due after December 31, 2016:

 

   Fixed  Adjustable  Total
Real estate:  (Dollars in Thousands)
Residential  $407,170   $442,421   $849,591 
Commercial   301,537    555,058    856,595 
Construction   7,480    14,940    22,420 
Installment   2,899    -    2,899 
Commercial   222,461    114,818    337,279 
Collateral   13    910    923 
Home equity line of credit   423    171,282    171,705 
Revolving Credit   -    -    - 
Resort   -    784    784 
Total  $941,983   $1,300,213   $2,242,196 

 

Loan Approval Procedures and Authority:

 

Our lending activities follow written, non-discriminatory and regulatory compliant underwriting standards and loan origination procedures established by our board of directors and documented in our loan policy. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy of the value of the collateral that will secure the loan, if applicable. To assess a business borrower’s ability to repay, we review and analyze, among other factors: the borrower’s historical, current, and projected financial performance; the borrower’s balance sheet and balance sheet trends; its capitalization; its ability to repay the proposed loan(s); the value and complexion of the assets offered as collateral; the ability of management to lead the borrower through the current and future economic cycles; and the financial strength and commitment of the personal or corporate guarantors, if any. To assess an individual borrower’s ability to repay, we review their employment and credit history and information on their historical and projected income and expenses, as well as the adequacy of the collateral.

 

Our policies and loan approval limits are established by our board of directors. Our board has delegated its authority to grant loans in varying amounts to the board of directors’ loan committee, which is currently comprised of all board members. The board loan committee is charged with general oversight of our credit extension functions and has designated the responsibility for the approval of loans, depending on risk rating and size (generally $5.0 million and under) to our management loan committee. In general, loan requests above $5.0 million are required to be approved by the board’s loan committee. Our management loan committee, in turn, has the right to delegate approval authority with respect to such loans to individual lenders as deemed appropriate.

 

 9 

 

 

Review of Credit Quality:

 

At the time of loan origination, a risk rating based on a nine point grading system is assigned to each commercial-related loan based on the loan officer’s and management’s assessment of the risk associated with each particular loan. This risk assessment is based on an in depth analysis of a variety of factors. More complex loans and larger commitments require that our internal Credit Risk Management Department further evaluate the risk rating of the individual loan or relationship, with our Credit Risk Management Department having final determination of the appropriate risk rating. These more complex loans and relationships receive ongoing periodic review to assess the appropriate risk rating on a post-closing basis with changes made to the risk rating as the borrower’s and economic conditions warrant. Our risk rating system is designed to be a dynamic system and we grade loans on a “real time” basis. Considerable emphasis is placed on risk rating accuracy, risk rating justification, and risk rating triggers. Our risk rating process is enhanced with the utilization of industry-based risk rating “cards.” The cards are utilized to promote risk rating accuracy and consistency on an institution-wide basis. Most loans are reviewed annually as part of a comprehensive portfolio review conducted by management and/or by our independent loan review firm. More frequent reviews of loans rated special mention, substandard and doubtful are conducted by our Credit Risk Management Department. We utilize an independent loan review consulting firm to affirm our rating accuracy and opine on the overall credit quality of our loan portfolio. The consulting firm conducts two loan reviews per year aiming at a 65.0% or higher commercial portfolio penetration. Summary findings of all loan reviews performed by the outside consulting firm are reported to our board of directors and senior management upon completion.

 

Our board of directors and senior management receive reporting throughout the year on credit trends in the commercial, residential and consumer portfolios (delinquencies, non-performing loans, risk rating migration, charge-off requests, etc.), as well as an update on any significant or developing troubled assets. We use risk management “dashboards” to assist in our ongoing portfolio monitoring and credit risk management reporting. The dashboards provide detailed analysis of portfolio and industry concentrations, as well as a variety of asset quality trends within industry and loan product types, and are presented to the board of directors on a monthly basis. This reporting system also performs various credit administration tracking functions, credit grade migration analysis and allows for an enhanced level of stress testing of the portfolios utilizing multiple variables.

 

In addition to the dashboards, on a periodic basis our board of directors and senior management receive reports on various “highly monitored” industries and portfolios, such as investment commercial real estate, “for-sale” real estate (i.e. subdivision and condominium lending) and home equity loans.

 

This comprehensive portfolio monitoring process is supplemented with several risk assessment tools including monitoring of delinquency levels, analysis of historical loss experience by loan portfolio segment, identification of portfolio concentrations by borrower and industry, and a review of economic conditions that might impact loan quality.

 

Non-performing and Problem Assets:

 

Our senior management places considerable emphasis on the early identification of problem assets, problem resolution and minimizing loss exposure. A loan is considered delinquent when the customer does not make their payments according to their contractual terms. Delinquencies are monitored daily and delinquency notices are mailed monthly to borrowers who have exceeded their payment grace period. In general, if a borrower fails to bring a loan current within 120 days from the original due date the matter may be referred to legal counsel and foreclosure or other collection proceedings may be initiated. We may consider a loan modification, forbearance or other loan restructuring in certain circumstances where a temporary loss of income is the primary cause of the delinquency, and if a reasonable plan is presented by the borrower. Commercial delinquencies are handled on a case by case basis, typically by our Special Assets Department. Appropriate problem resolution and working strategies are formulated based on the specific facts and circumstances.

 

Loans are placed on non-accrual status when they become 90 days or more delinquent. In certain cases, if a loan is less than 90 days delinquent but the borrower is experiencing financial difficulties, such loan may be placed on non-accrual status if we determine that collection of the loan in full is not probable. When loans are placed on non-accrual status, unpaid accrued interest is reversed and cash payments received are applied as a reduction to the loan principal. 

 

Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within a reasonable period and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with contractual terms involving payment of cash or cash equivalents. The interest on these loans is not recognized, until qualifying for return to accrual status. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. If a residential real estate, commercial real estate, construction, installment, commercial, collateral, home equity line of credit, demand or revolving credit loan is on non-accrual status or is considered to be impaired, cash payments are applied first as a reduction of principal.

 

 10 

 

 

Classified Assets: Under our internal risk rating system, we currently classify loans and other assets considered to be of lesser quality as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by either the current net worth or the paying capacity of the obligor or by the collateral pledged, if any. “Substandard” assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Assets classified as “loss” are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. In addition to the classifications discussed above, consistent with ASC 310-10-35, assets are classified as impaired when it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement.

 

The loan portfolio is reviewed on a regular basis to determine whether any loans require risk classification or reclassification. Not all classified assets constitute non-performing assets. For example, at December 31, 2015, 93% of commercial real estate, construction real estate, commercial business and resort loans rated substandard were on accrual status and current as to payments. Our classified assets include loans identified as “substandard”, “doubtful” or “loss”. Substandard assets consisted of $33.0 million and $38.3 million of our total loan portfolio at December 31, 2015 and 2014, respectively. We had assets classified as “doubtful” or “loss” totaling $166,000 and $212,000 at December 31, 2015 and 2014, respectively.

 

On a quarterly basis, our loan policy requires that we evaluate for impairment all commercial real estate, construction and commercial loans that are classified as non-accrual, secured by real property in foreclosure or are otherwise likely to be impaired, residential and consumer non-accruing loans greater than $100,000 and all troubled debt restructurings. We have determined that $41.0 million and $43.5 million of impaired loans existed at December 31, 2015 and 2014, respectively. Based upon our analysis, $5.9 million and $14.3 million of impaired loans required an allowance of $534,000 and $752,000 to be established as of December 31, 2015 and 2014, respectively. At December 31, 2015 and 2014, $28.3 million and $37.2 million, respectively, were included on the classified loan list and were not considered impaired.

 

 11 

 

 

Loan Delinquencies: The following is a summary of loan delinquencies at recorded investment values at the dates indicated.

 

   Loans Delinquent For      
   30-59 Days  60-89 Days  90 Days and Over  Total
   Number  Amount  Number  Amount  Number  Amount  Number  Amount
At December 31, 2015  (Dollars in thousands)
Real estate:                                        
Residential   18   $3,379    5   $863    15   $6,304    38   $10,546 
Commercial   2    318    -    -    1    994    3    1,312 
Construction   -    -    -    -    1    187    1    187 
Installment   3    38    -    -    -    -    3    38 
Commercial   4    153    -    -    2    1,752    6    1,905 
Collateral   7    68    -    -    1    10    8    78 
Home equity line of credit   3    280    2    360    2    210    7    850 
Demand   1    29    -    -    -    -    1    29 
Revolving Credit   -    -    -    -    -    -    -    - 
Resort   -    -    -    -    -    -    -    - 
Total   38   $4,265    7   $1,223    22   $9,457    67   $14,945 
At December 31, 2014                                        
Real estate:                                        
Residential   16   $3,599    6   $1,263    16   $6,819    38   $11,681 
Commercial   2    348    -    -    3    1,979    5    2,327 
Construction   -    -    -    -    1    187    1    187 
Installment   3    69    2    82    2    33    7    184 
Commercial   1    40    1    4    7    550    9    594 
Collateral   9    99    -    -    -    -    9    99 
Home equity line of credit   3    202    1    349    5    389    9    940 
Demand   1    67    -    -    -    -    1    67 
Revolving Credit   -    -    -    -    -    -    -    - 
Resort   -    -    -    -    -    -    -    - 
Total   35   $4,424    10   $1,698    34   $9,957    79   $16,079 
At December 31, 2013                                        
Real estate:                                        
Residential   9   $2,586    8   $1,600    20   $8,518    37   $12,704 
Commercial   1    231    -    -    1    827    2    1,058 
Construction   -    -    -    -    1    187    1    187 
Installment   -    -    -    -    2    47    2    47 
Commercial   1    5    -    -    6    584    7    589 
Collateral   2    9    -    -    -    -    2    9 
Home equity line of credit   1    283    1    183    5    441    7    907 
Demand   1    10    -    -    -    -    1    10 
Revolving Credit   -    -    -    -    -    -    -    - 
Resort   -    -    -    -    -    -    -    - 
Total   15   $3,124    9   $1,783    35   $10,604    59   $15,511 

 

 12 

 

 

Non-performing Assets: The table below sets forth the amounts and categories of our non-performing assets at the dates indicated. Once a loan is 90 days delinquent or either the borrower or the loan collateral experiences an event that makes full collectability of the loan improbable, the loan is placed on “non-accrual” status. Our policy requires at least six months of continuous payments in order for the loan to be removed from non-accrual status.

 

   At December 31,
   2015  2014  2013  2012  2011
Non-performing loans:  (Dollars in thousands)
Real estate:                         
Residential  $9,773   $9,706   $10,599   $9,194   $9,224 
Commercial   1,106    2,112    827    925    2,934 
Construction   187    187    187    419    484 
Installment   32    155    162    157    209 
Commercial   3,232    2,268    2,285    2,351    956 
Collateral   10    -    -    -    - 
Home equity line of credit   573    1,040    740    711    1,669 
Demand   -    -    -    25    25 
Revolving Credit   -    -    -    -    - 
Resort   -    -    -    -    - 
Total non-performing loans   14,913    15,468    14,800    13,782    15,501 
Loans 90 days past due and still accruing   -    -    -    -    - 
Other real estate owned   279    400    393    549    302 
Total nonperforming assets  $15,192   $15,868   $15,193   $14,331   $15,803 
                          
Total non-performing loans to total loans   0.63%   0.72%   0.81%   0.90%   1.18%
Total non-performing loans to total assets   0.55%   0.62%   0.70%   0.76%   0.96%

 

The amount of income that was contractually due but not recognized on non-accrual loans totaled $610,000 for the year ended December 31, 2015.

 

Troubled debt restructurings: The following table presents information on loans whose terms had been modified in a troubled debt restructuring:

 

   At December 31,
   2015  2014  2013  2012  2011
   (Dollars in thousands)
                
Restructured loans on accrual status  $16,952   $18,664   $15,790   $22,124   $23,515 
Restructured loans on non-accrual status   7,258    7,581    7,578    7,550    7,809 
Total restructured loans  $24,210   $26,245   $23,368   $29,674   $31,324 

 

A loan is considered a troubled debt restructuring (“TDR”) when we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession to the borrower in modifying or renewing the loan that we would not otherwise consider. In connection with troubled debt restructurings, terms may be modified to fit the ability of the borrower to repay in line with their current financial status, which may include a reduction in the interest rate to market rate or below, a change in the term or amortization, or other modifications to the structure of the loan. A loan is placed on non-accrual status upon being restructured, even if it was not previously, unless the modified loan was current for the six months prior to its modification and we believe the loan is fully collectable in accordance with its new terms. Our policy to restore a restructured loan to performing status is dependent on the receipt of regular payments, generally for a period of six months and one calendar year-end. All troubled debt restructurings are classified as impaired loans and are reviewed for impairment by management on a quarterly basis and at calendar year-end reporting period per our policy.

 

At December 31, 2015, 100% of the accruing TDRs were performing in accordance with the restructured terms. At December 31, 2015 and 2014, the allowance for loan losses included specific reserves of $340,000 and $592,000 related to TDRs, respectively. For the years ended December 31, 2015 and 2014, the Bank had charge-offs totaling $296,000 and $1.3 million, respectively, related to portions of TDRs deemed to be uncollectible. The amount of additional funds committed to borrowers in TDR status was $272,000 and $206,000 at December 31, 2015 and 2014, respectively.

 

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Potential Problem Loans: We perform a comprehensive internal analysis of our loan portfolio in order to identify and quantify loans with higher than normal risk. Loans having a higher risk profile are assigned a risk rating corresponding to the level of weakness identified in the loan. All special mention, substandard and doubtful loans are included on our “Watched Asset” report which is updated and reviewed quarterly by our Credit Risk Management Department. In addition, on a quarterly basis, loans rated special mention, substandard or doubtful are formally presented to and reviewed by management to assess the level of risk, ensure the risk ratings are appropriate, and ensure appropriate actions are being taken to minimize potential loss exposure. The review cycle is determined based on the risk rating and level of overall credit exposure. This quarterly review is performed by the Chief Risk Officer, Chief Lending Officer and members of the Credit Risk Management and Special Assets Departments. Loans identified as being “loss” are normally fully charged off. Loans risk rated substandard or more severe are generally transferred to the Special Assets Department, although it is not uncommon for commercial lenders to manage stable or improving substandard loans with significant oversight from the Special Assets Department. We do not use interest reserves to keep problem loans current. Interest reserves are only used for construction loans during the construction phase of the loan.

 

Allowance for Loan Losses

 

The allowance for loan losses is maintained at a level believed adequate by management to absorb potential losses inherent in the loan portfolio as of the statement of condition date. The allowance for loan losses consists of a formula allowance following FASB ASC 450 – “Contingencies” and FASB ASC 310 – “Receivables”. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a quarterly basis by management. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, allocated and unallocated components, as further described below. All reserves are available to cover any losses regardless of how they are allocated.

 

General component:

 

The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, construction, installment, commercial, collateral, home equity line of credit, demand, revolving credit and resort. Construction loans include classes for commercial investment real estate construction, commercial owner occupied construction, residential development, residential subdivision construction and residential owner occupied construction loans. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies and nonaccrual loans; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no material changes in the Company’s policies or methodology pertaining to the general component of the allowance for loan losses during the year ended December 31, 2015.

 

The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

 

Residential real estate – Residential real estate loans are generally originated in amounts up to 95.0% of the lesser of the appraised value or purchase price of the property, with private mortgage insurance required on loans with a loan-to-value ratio in excess of 80.0%. The Company does not grant subprime loans. All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. Typically, all fixed-rate residential mortgage loans are underwritten pursuant to secondary market underwriting guidelines which include minimum FICO standards. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.

 

Commercial real estate – Loans in this segment are primarily income-producing properties throughout New England. The underlying cash flows generated by the properties may be adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, may have an effect on the credit quality in this segment. Management generally obtains rent rolls and other financial information, as appropriate on an annual basis and continually monitors the cash flows of these loans.

 

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Construction loans – Loans in this segment include commercial construction loans, real estate subdivision development loans to developers, licensed contractors and builders for the construction and development of commercial real estate projects and residential properties. Construction lending contains a unique risk characteristic as loans are originated under market and economic conditions that may change between the time of origination and the completion and subsequent purchaser financing of the property. In addition, construction subdivision loans and commercial and residential construction loans to contractors and developers entail additional risks as compared to single-family residential mortgage lending to owner-occupants. These loans typically involve large loan balances concentrated in single borrowers or groups of related borrowers. Real estate subdivision development loans to developers, licensed contractors and builders are generally speculative real estate development loans for which payment is derived from sale of the property. Credit risk may be affected by cost overruns, time to sell at an adequate price, and market conditions. Construction financing is generally considered to involve a higher degree of credit risk than longer-term financing on improved, owner-occupied real estate. Residential construction credit quality may be impacted by the overall health of the economy, including unemployment rates and housing prices.

 

Commercial – Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.

 

Home equity line of credit – Loans in this segment include home equity loans and lines of credit underwritten with a loan-to-value ratio generally limited to no more than 80%, including any first mortgage. Our home equity lines of credit have ten-year terms and adjustable rates of interest which are indexed to the prime rate. The overall health of the economy, including unemployment rates and housing prices, may have an effect on the credit quality in this segment.

 

Installment, Collateral, Demand, Revolving Credit and Resort – Loans in these segments include loans principally to customers residing in our primary market area with acceptable credit ratings. Our installment and collateral consumer loans generally consist of loans on new and used automobiles, loans collateralized by deposit accounts and unsecured personal loans. The overall health of the economy, including unemployment rates and housing prices, may have an effect on the credit quality in this segment. Excluding collateral loans which are fully collateralized by a deposit account, repayment for loans in these segments is dependent on the credit quality of the individual borrower. The resort portfolio consists of a direct receivable loan outside the Northeast which is amortizing to its contractual obligations. The Company has exited the resort financing market with a residual portfolio remaining.

 

Allocated component:

 

The allocated component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis for commercial real estate, construction, commercial and resort loans by the present value of expected cash flows discounted at the effective interest rate; the fair value of the collateral, if applicable; or the observable market price for the loan. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan. The Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement or they are nonaccrual loans with outstanding balances greater than $100,000.

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. Management updates the analysis quarterly. The assumptions used in appraisals are reviewed for appropriateness. Updated appraisals or valuations are obtained as needed or adjusted to reflect the estimated decline in the fair value based upon current market conditions for comparable properties.

 

The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring ("TDR"). All TDRs are classified as impaired.

 

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Unallocated component:

 

An unallocated component is maintained, when needed, to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio. The Company’s Loan Policy allows management to utilize a high and low range of 0.0% to 5.0% of our total allowance for loan losses when establishing an unallocated allowance, when considered necessary. The unallocated allowance is used to provide for an unidentified loss that may exist in emerging problem loans that cannot be fully quantified or may be affected by conditions not fully understood as of the balance sheet date. There was no unallocated allowance at December 31, 2015 and 2014.

 

Based on the quantitative and qualitative assessment of the loan portfolio segments and in thorough consideration of the characteristics, risk and credit quality indicators, a detailed review of classified, non-performing and impaired loans, management believes that the allowance for loan losses properly estimated the inherent probable credit loss that exists in the loan portfolio as of the balance sheet date. This analysis process is both quantitative and qualitative as it requires management to make estimates that are susceptible to revisions as more information becomes available. Although we believe that we have established the allowance at levels to absorb probable losses, future additions may be necessary if economic or other conditions in the future differ from the current environment.

 

Schedule of Allowance for Loan Losses: The following table sets forth activity in the allowance for loan losses for the years indicated.

 

   For the Years Ended December 31,
   2015  2014  2013  2012  2011
   (Dollars in thousands)
                
Balance at beginning of year  $18,960   $18,314   $17,229   $17,533   $20,734 
Provision for loan losses   2,440    2,588    1,530    1,380    4,090 
Charge-offs:                         
Real estate:                         
Residential   (295)   (701)   (430)   (337)   (411)
Commercial   (213)   (93)   -    (454)   (1,314)
Construction   -    -    -    -    - 
Installment   (39)   (4)   -    (9)   (28)
Commercial   (318)   (1,066)   (31)   (33)   (517)
Collateral   -    -    -    -    - 
Home equity line of credit   (238)   (106)   -    (1,019)   (114)
Demand   -    -    -    -    - 
Revolving credit   (246)   (133)   (62)   (61)   (59)
Resort   -    -    -    -    (4,880)
Total charge-offs   (1,349)   (2,103)   (523)   (1,913)   (7,323)
                          
Recoveries:                         
Real estate:                         
Residential   112    58    6    9    - 
Commercial   -    1    -    4    - 
Construction   -    -    -    -    - 
Installment   -    -    -    7    2 
Commercial   6    84    52    194    12 
Collateral   -    -    -    -    - 
Home equity line of credit   -    -    -    -    - 
Demand   -    -    -    -    18 
Revolving credit   29    18    20    15    - 
Resort   -    -    -    -    - 
Total recoveries   147    161    78    229    32 
                          
Net charge-offs   (1,202)   (1,942)   (445)   (1,684)   (7,291)
Allowance at end of year  $20,198   $18,960   $18,314   $17,229   $17,533 
                          
Ratios:                         
Allowance for loan losses to non-performing                         
loans at end of year   135.44%   122.58%   123.74%   125.01%   113.11%
Allowance for loan losses to total loans                         
outstanding at end of year   0.86%   0.89%   1.01%   1.12%   1.34%
Net charge-offs to average loans outstanding   0.05%   0.10%   0.03%   0.12%   0.61%

 

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It is our general policy to charge-off or partially charge-off any loan when it becomes evident that its collectability is highly unlikely, or our internal loan rating dictates a charge-off, either full or partial.  We take a charge-off when it is determined that there is a confirmed loss. Our charge-off policy has remained consistent and has not undergone any material revisions.

 

In making a determination on whether collection of a loan is unlikely, a number of criteria are considered including, but not limited to: the borrower’s financial condition; the borrower’s historical, current, and pro-forma debt service ability; an updated collateral valuation and / or impairment test; and the borrower’s and /or guarantor’s willingness and demonstrated ability to continue to support the credit (inclusive of a global cash flow analysis, if warranted).

 

With respect to reserves, all impaired loans are reviewed to determine if a valuation should be established based on one of three measurement tests: (1) the present value of expected cash flows discounted at the effective interest rate; (2) the fair value of the collateral, if applicable; or (3) the observable market price for the loan.  If we determine that an impairment amount exists, we will establish a valuation allowance (i.e. specific reserve) for the loan.  A charge-off is promptly recorded when a current appraisal for a collateral dependent loan indicates a fair value in excess of its recorded investment and the excess is identified as uncollectable. Updated appraisals are obtained at least annually per guidelines stated in the Loan Policy and, if appropriate, adjusted to reflect the estimated decline in the fair value based upon current market conditions for comparable properties. All other loans, including individually evaluated loans determined not to be impaired, are included in a group of loans that is collectively evaluated for impairment.  We categorize our loan portfolio into separate loan portfolio segment with similar risk characteristics.  In estimating credit losses, we consider historical loss experience on each loan portfolio segment, adjusted for changes in trends, conditions, and other relevant factors that may affect repayment of the loans as of the evaluation date.  Any partial charge-offs on our non-performing or impaired loans cause a reduction in our coverage ratio for our allowance for loan losses and other credit loss statistics.

 

As of December 31, 2015, we had impaired loans of $35.1 million with no valuation or partial charge-offs recorded.  As described above, if a loan is determined to be impaired, we will evaluate the amount of reserves for such loans based on the present value of expected cash flows discounted at the effective interest rate, the fair value of the collateral, if applicable, or the observable market price for the loan.  If we determine that an impairment amount exists, we will establish a valuation allowance for the loan.  If no impairment amount exists based on these tests, then no allowance for loan loss is required on that loan.  If an impairment is shown to exist, we establish an allowance for loan loss for the amount that the recorded investment or book value, in the loan exceeds the measure of the impaired loan.  In general, any portion of the recorded investment in a collateral dependent loan in excess of the fair value can be identified as uncollectible and is, therefore, deemed a confirmed loss which is charged-off against our allowance for loan losses.

 

Allocation of Allowance for Loan Losses: The following table sets forth the allowance for loan losses allocated by loan portfolio segment, the percentage of allowance in each category to total allowance, and the percentage of loans in each portfolio segment to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

 

   At December 31,
   2015  2014
   Allowance for
Loan Losses
  % of Allowance
for Loan
Losses
  % of Loans
in Category
to Total
Loans
  Allowance for
Loan Losses
  % of Allowance
for Loan
Losses
  % of Loans
in Category
to Total
Loans
   (Dollars in thousands)
Real estate:                              
Residential  $4,084    20.2%   36.1%  $4,382    23.1%   38.7%
Commercial   10,255    50.8%   37.6%   8,949    47.3%   35.8%
Construction   231    1.1%   1.3%   478    2.5%   2.7%
Installment   39    0.2%   0.1%   41    0.2%   0.2%
Commercial   4,119    20.4%   17.4%   3,250    17.1%   14.5%
Collateral   -    -    0.1%   -    -    0.1%
Home equity line of credit   1,470    7.3%   7.4%   1,859    9.8%   8.0%
Demand   -    -    -    -    -    - 
Revolving credit   -    -    -    -    -    - 
Resort   -    -    -    1    *   *
Unallocated allowance   -    -    n/a    -    -    n/a 
Total  $20,198    100.0%   100.0%  $18,960    100.0%   100.0%

 

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   At December 31,
   2013  2012  2011
   Allowance
for Loan
Losses
  % of Allowance
for Loan
Losses
  % of Loans
in Category
to Total
Loans
  Allowance for
Loan Losses
  % of Allowance
for Loan
Losses
  % of Loans
in Category
to Total
Loans
  Allowance
for Loan
Losses
  % of
Allowance for
Loan Losses
  % of Loans in
Category to
Total Loans
            (Dollars in thousands)         
Real estate:                                             
Residential  $3,647    19.9%   38.2%  $3,778    21.9%   40.5%  $2,874    16.4%   38.4%
Commercial   8,253    45.0%   34.9%   8,105    47.1%   30.9%   8,755    49.9%   31.2%
Construction   1,152    6.3%   4.3%   760    4.4%   4.2%   590    3.4%   3.5%
Installment   48    0.3%   0.2%   77    0.4%   0.4%   92    0.5%   0.8%
Commercial   3,746    20.5%   13.9%   2,654    15.4%   12.6%   2,140    12.2%   11.8%
Collateral   -    0.0%   0.1%   -    -    0.1%   -    -    0.2%
Home equity line of credit   1,465    8.0%   8.3%   1,377    8.0%   9.3%   1,295    7.4%   8.4%
Demand   -    -    -    -    -    -    -    -    - 
Revolving credit   -    -    -    -    -    -    -    -    - 
Resort   3    *   0.1%   456    2.7%   2.0%   1,787    10.2%   5.7%
Unallocated allowance   -    -    n/a    22    0.1%   n/a    -    -    n/a 
Total  $18,314    100.0%   100.0%  $17,229    100.0%   100.0%  $17,533    100.0%   100.0%

 

 * Less than 0.1%

 

Investment Activities

 

Our Chief Financial Officer is responsible for implementing our investment policy. The investment policy is reviewed at least annually by management and our board of directors and any changes to the policy are subject to the approval of the board of directors. Authority to make investments under the approved investment policy guidelines is delegated by the board of directors to our Chairman, President and Chief Executive Officer, our Chief Financial Officer and limited purchasing by our Finance Officer. While general investment strategies are developed and authorized by our Chief Financial Officer, the execution of specific actions rests with both our Chairman, President and Chief Executive Officer and the Chief Financial Officer, who may act jointly or severally. The Chief Financial Officer is responsible for ensuring that the guidelines and requirements included in the investment policy are followed and that all securities are considered prudent for investment.

 

Our investment policy requires that all securities transactions be conducted in a safe and sound manner. Investment decisions must be based upon a thorough analysis of each security instrument to determine its credit quality and fit within our overall asset/liability management objectives, its effect on our risk-based capital and the overall prospects for yield and/or appreciation.

 

Our investment portfolio, excluding FHLBB stock, totaled $164.7 million and $204.2 million at December 31, 2015 and 2014, respectively, and consisted primarily of United States government securities, securities issued and guaranteed by Government Sponsored Enterprises (GSE’s) including debt and mortgage-backed securities, municipal and other bonds, mutual funds and equity securities, including preferred equity securities.

 

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Our investment objectives are to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. Our board of directors has the overall responsibility for the investment portfolio, including approval of our investment policy, which is reviewed and approved at least annually. Our board of directors reviews the status of our investment portfolio on a semi-annual basis.

 

Investment Securities Portfolio: The following table sets forth the carrying values of our available-for-sale and held-to-maturity securities portfolio at the dates indicated.

 

   At December 31,
   2015  2014  2013
(Dollars in thousands)  Amortized
Cost
  Fair Value  Amortized
Cost
  Fair Value  Amortized
Cost
  Fair Value
Available-for-sale                              
Debt securities:                              
U.S. Treasury obligations  $38,782   $38,859   $123,739   $123,816   $126,000   $126,000 
U.S. Government agency obligations   82,002    81,805    49,013    49,109    7,006    6,922 
Government sponsored residential mortgage-backed securities   4,958    5,153    6,624    6,907    9,199    9,616 
Corporate debt securities   1,000    1,048    1,000    1,085    2,982    3,104 
Trust preferred debt securities   -    -    -    1,557    -    - 
Preferred equity securities   2,000    1,632    2,100    1,676    2,100    1,569 
Marketable equity securities   108    160    108    170    108    148 
Mutual funds   3,957    3,767    3,838    3,721    3,710    3,527 
Total securities available-for-sale  $132,807   $132,424   $186,422   $188,041   $151,105   $150,886 
                               
Held-to-maturity                              
U.S. Government agency obligations  $24,000   $24,008   $7,000   $6,992   $5,000   $4,930 
Government sponsored residential mortgage-backed securities   8,246    8,349    9,224    9,424    4,983    4,956 
Trust preferred debt security   -    -    -    -    3,000    3,000 
Total held-to-maturity Total securities held-to-maturity  $32,246   $32,357   $16,224   $16,416   $12,983   $12,886 

 

During the years ended December 31, 2015, 2014 and 2013, we recorded no other-than-temporary impairment charges.

 

Consistent with our overall business and asset/liability management strategy, which focuses on sustaining adequate levels of core earnings, most securities purchased were classified available-for-sale at December 31, 2015 and 2014.

 

U.S. Treasury and U.S. Government Agency Obligations: At December 31, 2015 and 2014, our U.S. Treasury and U.S. Government agency obligations portfolio totaled $144.7 million and $179.9 million, respectively, of which $120.7 million and $172.9 million, respectively, were classified as available-for-sale. There were no structured notes or derivatives in the portfolio.

 

Government Sponsored Residential Mortgage-Backed Securities: We purchase mortgage-backed securities insured or guaranteed by U.S. Government agencies and government-sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae. We do not own any “private label” mortgage backed securities. We invest in mortgage-backed securities to achieve a positive interest rate spread with minimal administrative expense and to lower our credit risk as a result of the guarantees provided by Fannie Mae, Freddie Mac and Ginnie Mae.

 

Government sponsored mortgage-backed securities are created by the pooling of mortgages and the issuance of a security with an interest rate which is less than the interest rate on the underlying mortgages. These mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although we focus our investments on mortgage-backed securities backed by one-to-four family mortgages. The issuers of such securities pool and resell the participation interests in the form of securities to investors such as us and guarantee the payment of principal and interest to investors. Government sponsored residential mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of payment guarantees, mortgage servicing and credit enhancements. However, these mortgage-backed securities are usually more liquid than individual mortgage loans and may be used to collateralize our borrowing obligations.

 

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At December 31, 2015, the carrying value of Government sponsored residential mortgage-backed securities totaled $13.4 million or 0.5% of assets, and 0.5% of interest earning assets, $5.2 million of which were classified as available-for-sale and $8.2 million of which were classified as held-to-maturity, compared to the carrying value of mortgage-backed securities at December 31, 2014 which totaled $16.1 million or 0.6% of assets, and 0.7% of interest earning assets, $6.9 million of which were classified as available-for-sale and $9.2 million of which were classified as held-to-maturity. The available-for-sale mortgage-backed securities portfolio had a book yield of 3.23% at December 31, 2015, compared to a book yield of 3.28% at December 31, 2014 and the held-to-maturity mortgage-backed securities portfolio had a book yield of 2.50% at December 31, 2015 and 2014. The estimated fair value of our mortgage-backed securities at December 31, 2015 was $13.5 million, which is $298,000 more than the amortized cost and at December 31, 2014 $16.3 million, which was $483,000 more than the amortized cost. Investments in mortgage-backed securities involve a risk that actual prepayments may differ from estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities. In addition, the market value of such securities may be adversely affected by changes in interest rates.

 

Our investment portfolio contained no Government sponsored residential mortgage-backed securities collateralized by “subprime” loans for the years ended December 31, 2015 and 2014. Although we do not have a direct exposure to subprime related assets, the value and related income of our mortgage-backed securities are sensitive to changes in economic conditions, including delinquencies and/or defaults on the underlying mortgages. Continuing shifts in the market’s perception of credit quality on securities backed by residential mortgage loans may result in increased volatility of market price and periods of illiquidity that can have a negative impact upon the valuation of certain securities held by us.

 

Corporate Debt Securities: At December 31, 2015 and 2014, the fair value of our corporate bond portfolio totaled $1.0 million and $1.1 million, respectively, all of which was classified as available-for-sale. The corporate bond portfolio was fixed rate earning a book yield of 5.39% and 5.38% at December 31, 2015 and 2014, respectively. Although corporate bonds may offer higher yields than U.S. Treasury or agency securities of comparable duration, corporate bonds also have a higher risk of default due to possible adverse changes in the credit-worthiness of the issuer. In order to mitigate this risk, our investment policy requires that corporate debt obligation purchases be rated “A” or better by a nationally recognized rating agency. A security that is subsequently downgraded below investment grade will require additional analysis of credit worthiness and a determination will be made to hold or dispose of the investment.

 

Marketable Equity Securities and Mutual Funds: We currently maintain a diversified equity securities and mutual funds portfolio. At December 31, 2015 and 2014, the fair value of our marketable equity securities portfolio totaled $160,000 and $170,000, respectively. Our marketable equity securities represented less than one percent of total assets at December 31, 2015 and 2014 and were classified as available-for-sale. At December 31, 2015 and 2014, the mutual funds portfolio totaled $3.8 million and $3.7 million, respectively. The industries represented by our common stock investments are diverse and include banking, insurance and financial services, integrated utilities and various industrial sectors. Our investment policy provides that the total equity portfolio cannot exceed 50% of the Tier I capital of Farmington Bank. Investments in equity securities and mutual funds involve risk as they are not insured or guaranteed investments and are affected by stock market fluctuations. Such investments are carried at their market value and can directly affect our net capital position.

 

Preferred Equity Securities: Our investments in preferred equity securities consist of 80,000 shares of Goldman Sachs preferred stock at December 31, 2015. The carrying value of our preferred equity securities totaled $1.6 million and $1.7 million at December 31, 2015 and 2014, respectively.

 

Trust Preferred Debt Securities: During 2015, we sold our trust preferred debt securities for a gain of $1.5 million. At December 31, 2014, the carrying value of our trust preferred debt securities totaled $1.6 million, which were classified as available-for-sale.

 

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Portfolio Maturities and Yields: The composition and maturities of the investment securities portfolio at December 31, 2015 and 2014 are summarized in the following tables. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. State agency and municipal obligations as well as common and preferred stock yields have not been adjusted to a tax-equivalent basis. Certain mortgage-backed securities have interest rates that are adjustable and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the table below.

 

   December 31, 2015
   One Year or Less  More than One Year
through Five Years
  More than Five Years
through Ten Years
  More than Ten Years  Total Securities
   Fair Value  Weighted-
Average
Yield
  Fair Value  Weighted-
Average
Yield
  Fair Value  Weighted-
Average
Yield
  Fair Value  Weighted-
Average
Yield
  Fair Value  Weighted-
Average
Yield
               (Dollars in thousands)            
Available-for-Sale:                                                  
U.S. Treasury obligations  $21,996    0.09%  $16,863    0.93%  $-    -   $-    -   $38,859    0.46%
U.S. Government agency obligations   31,998    0.32%   49,807    1.26%   -    -    -    -    81,805    0.89%
Government-sponsored residential mortgage-backed securities   2    5.50%   268    4.57%   -    -    4,883    3.15%   5,153    3.23%
Corporate debt securities   517    5.36%   531    5.41%   -    -    -    -    1,048    5.39%
Total debt securities available-for-sale  $54,513    0.28%  $67,469    1.22%  $-    -   $4,883    3.15%  $126,865    0.89%
                                                   
Held-to-Maturity:                                                  
U.S. Government agency obligations  $-    -   $24,008    1.74%  $-    -   $-    -   $24,008    1.74%
Government-sponsored residential mortgage-backed securities   -    -    -    -    -    -    8,349    2.50%   8,349    2.50%
Total debt securities held-to-maturity  $-    -   $24,008    1.74%  $-    -   $8,349    2.50%  $32,357    1.94%

 

   December 31, 2014
   One Year or Less  More than One Year
through Five Years
  More than Five Years
through Ten Years
  More than Ten Years  Total Securities
   Fair Value  Weighted-
Average
Yield
  Fair Value  Weighted-
Average
Yield
  Fair Value  Weighted-
Average
Yield
  Fair Value  Weighted-
Average
Yield
  Fair Value  Weighted-
Average
Yield
               (Dollars in thousands)            
Available-for-Sale:                                                  
U.S. Treasury obligations  $107,008    0.08%  $16,808    0.93%  $-    -   $-    -   $123,816    0.20%
U.S. Government agency obligations   -    -    49,109    1.00%   -    -    -    -    49,109    1.00%
Government-sponsored residential mortgage-backed securities   51    4.00%   527    4.63%   -    -    6,329    3.16%   6,907    3.28%
Corporate debt securities   -    -    1,085    5.38%   -    -    -    -    1,085    5.38%
Trust preferred debt securities   -    -    -    -    -    -    1,557    2.99%   1,557    2.99%
Total debt securities available-for-sale  $107,059    0.09%  $67,529    1.08%  $-    -   $7,886    3.13%  $182,474    0.59%
                                                   
Held-to-Maturity:                                                  
U.S. Government agency obligations  $-    -   $6,992    1.50%  $-    -   $-    -   $6,992    1.50%
Government-sponsored residential mortgage-backed securities   -    -    -    -    -    -    9,424    2.50%   9,424    2.50%
Total debt securities held-to-maturity  $-    -   $6,992    1.50%  $-    -   $9,424    2.50%  $16,416    2.07%

 

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Sources of Funds

 

General: Deposits have traditionally been our primary source of funds for use in lending and investment activities. In addition to deposits, funds are derived from scheduled loan payments, loan prepayments, investment maturities, retained earnings and income on earning assets.

 

Deposits: A majority of our depositors are persons who work or reside in Hartford County, Connecticut and Hampden County, Massachusetts. We offer a selection of deposit instruments, including checking, savings, money market savings accounts, negotiable order of withdrawal (“NOW”) accounts and fixed-rate time deposits. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate. The Company has established a relationship to participate in a reciprocal deposit program with other financial institutions as a service to our customers. This program provides enhanced FDIC insurance to participating customers. The Company also has established a relationship for brokered deposits. There were brokered deposits totaling $44.3 million and $-0- at December 31, 2015 and 2014, respectively.

 

Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies, market rates, liquidity requirements, rates paid by competitors and growth goals. To attract and retain deposits, we rely upon brand marketing, personalized customer service, long-standing relationships and competitive interest rates.

 

The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts that we offer allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on historical experience, management believes our deposits are relatively stable. Expansion of the branch network, the commercial and government banking divisions, as well as deposit promotions and disintermediation from investment firms due to increasing uncertainty in the financial markets, has provided us with opportunities to attract new deposit relationships.

 

It is unclear whether the recent growth in deposits will reflect our historical, stable experience with deposit customers. The ability to attract and maintain money market accounts and time deposits, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. At December 31, 2015, $440.8 million or 22.1% of our deposits were time deposits, of which $267.7 million will be maturing within one year or less. At December 31, 2014, $365.2 million or 21.1% of our deposits were time deposits, of which $239.6 million matured within one year or less.

 

Our government banking group provides deposit services to municipalities throughout Connecticut. Through the efforts of our government banking group, we attracted significant municipal deposits through existing and newly formed relationships. Municipal deposits as of December 31, 2015 and 2014 were $368.0 million or 18.5% and $300.3 million or 17.3% of our total deposits outstanding, respectively. These deposits can be more volatile than other deposits but provide significant liquidity generally at a lower or similar cost to wholesale funds. We limit the related contingent funding risk by limiting the amount of municipal deposits that can be accepted.

 

The following table displays a summary of our deposits by account type as of the dates indicated:

 

   At December 31,
   2015  2014  2013
   Balance  Percent  Balance  Percent  Balance  Percent
(Dollars in thousands)                              
Demand deposits  $401,388    20.2%  $330,524    19.1%  $308,459    20.4%
NOW accounts   468,054    23.5%   355,412    20.5%   285,392    18.9%
Money markets   460,737    23.1%   470,991    27.2%   387,225    25.6%
Savings accounts   220,389    11.1%   210,892    12.1%   193,937    12.7%
Total non-time deposit accounts   1,550,568    77.9%   1,367,819    78.9%   1,175,013    77.6%
Time deposits   440,790    22.1%   365,222    21.1%   338,488    22.4%
Total deposits  $1,991,358    100.0%  $1,733,041    100.0%  $1,513,501    100.0%

 

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The following table displays the distribution of average deposit accounts by account type with the average rates paid at the dates indicated:

 

   At December 31,
   2015  2014  2013
   Average
Balance
  Interest  Weighted
Average
Rate
  Average
Balance
  Interest  Weighted
Average
Rate
  Average
Balance
  Interest  Weighted
Average
Rate
(Dollars in thousands)                                             
Noninterest-bearing deposit  $357,156   $-    -   $315,177   $-    -   $266,217   $-    - 
NOW accounts   472,644    1,351    0.29%   380,936    976    0.26%   277,698    638    0.23%
Money markets   453,017    3,592    0.79%   420,456    3,112    0.74%   362,914    2,878    0.79%
Savings accounts   213,383    226    0.11%   200,948    205    0.10%   182,952    206    0.11%
Time deposits   407,071    4,203    1.03%   338,590    3,076    0.91%   353,677    3,460    0.98%
Total interest-bearing deposit   1,546,115   $9,372    0.61%   1,340,930   $7,369    0.55%   1,177,241   $7,182    0.61%
Total deposits  $1,903,271             $1,656,107             $1,443,458           

 

The following table displays information concerning time deposits by interest rate ranges at the dates indicated:

 

   At December 31, 2015      
   Period to Maturity  Total at December 31,
   Less Than
One Year
  One to
Two Years
  Two to
Three
Years
  More than
Three
Years
  Total  Percent of
Total
  2014  2013
(Dollars in thousands)                                        
Interest Rate Range:                                        
1.00% and below  $169,885   $39,061   $4,212   $8,493   $221,651    50.3%  $229,426   $220,040 
1.01% - 2.00%   67,134    62,169    23,889    4,811    158,003    35.8%   70,134    58,612 
2.01% - 3.00%   30,729    4,772    144    25,491    61,136    13.9%   65,504    59,680 
3.01% - 4.00%   -    -    -    -    -    -    158    156 
Total  $267,748   $106,002   $28,245   $38,795   $440,790    100.0%  $365,222   $338,488 

 

The following table sets forth time deposits by time remaining until maturity as of December 31, 2015.

 

   Maturity
   Three months
or less
  Over three to
six months
  Over six to
twelve months
  Over one year
to three years
  Over three
Years
  Total
(Dollars in thousands)                              
Time deposits less than $100,000  $41,074   $39,223   $37,646   $82,533   $14,582   $215,058 
Time deposits of $100,000 or more   50,575    38,480    60,750    51,714    24,213    225,732 
   $91,649   $77,703   $98,396   $134,247   $38,795   $440,790 

 

As of December 31, 2014, the aggregate amount of outstanding time deposits in amounts greater than or equal to $100,000 was $175.1 million.

 

The following table sets forth the interest-bearing deposit activities for the periods indicated:

 

   Years Ended December 31,
   2015  2014  2013
(Dollars in thousands)               
Balance beginning of year  $1,402,517   $1,205,042   $1,082,869 
Net increase in deposits before interest credited   178,081    190,106    114,991 
Interest credited   9,372    7,369    7,182 
Net increase in deposits   187,453    197,475    122,173 
Balance end of year  $1,589,970   $1,402,517   $1,205,042 

 

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Borrowed Funds

 

At December 31, 2015 and 2014, we had an available line of credit with the FHLBB in the amount of $8.8 million and access to additional Federal Home Loan Bank advances of up to $407.8 million subject to collateral requirements of the FHLBB at December 31, 2015. The Company also had letters of credit of $63.0 million and 22.0 million at December 31, 2015 and 2014, respectively, subject to collateral requirements of the FHLBB. Internal policies limit borrowings to 25.0% of total assets, or $677.1 million and $621.3 million at December 31, 2015 and 2014, respectively.

 

We have a Master Repurchase Agreement borrowing facility with a broker. Borrowings under the Master Repurchase Agreement are secured by our investments in certain securities with a fair value totaling $11.3 million at December 31, 2015. Outstanding repurchase agreement borrowings totaled $10.5 million and $21.0 million at December 31, 2015 and 2014.

 

The Company has access to pre-approved unsecured lines of credit with financial institutions totaling $45.0 million and $20.0 million at December 31, 2015 and 2014, which were undrawn at December 31, 2015 and 2014. The Company has access to $3.5 million unsecured line of credit agreement with a well-capitalized bank which expires on August 31, 2016. The line was undrawn at December 31, 2015 and 2014. The Company maintains a cash balance of $512,500 with certain financial institutions to avoid fees associated with the lines.

 

Competition

 

We face competition within our market area both in making loans and attracting deposits. Our primary market area is central Connecticut and western Massachusetts which has a high concentration of financial institutions including large commercial banks, community banks, credit unions and mortgage companies. We recently opened two de novo branches in western Massachusetts and a loan production office in Branford, CT during the fourth quarter in 2015. We opened a loan production office in Fairfield, CT in February 2016 and anticipate opening two de novo branches in Connecticut in 2016. Some of our competitors offer products and services that we currently do not offer, such as trust services and private banking.

 

Based on the most recent data available from the Federal Deposit Insurance Corporation (“FDIC”) as of June 30, 2015, we possess a 5.32% deposit market share in Hartford County. Our market share rank is 5th out of 27 financial institutions.

 

Our competition for loans and deposits comes principally from commercial banks, savings institutions, mortgage banking firms and credit unions. We face additional competition for deposits from money market funds, brokerage firms, mutual funds and insurance companies. Our primary focus is to build and develop profitable customer relationships across all lines of business while continuing to support the communities within our service area.

 

Subsidiary Activities

 

Farmington Bank is currently the only subsidiary of FCB and is incorporated in Connecticut. Farmington Bank currently has the following subsidiaries all of which are incorporated in Connecticut: Farmington Savings Loan Servicing, Inc., Village Investments, Inc., Village Corp., Limited, 28 Main Street Corp., Village Management Corp. and Village Square Holdings, Inc.

 

Farmington Savings Loan Servicing, Inc.: Established in 1999, Farmington Savings Loan Servicing, Inc. operates as Farmington Bank’s “passive investment company” (“PIC”) which exempts it from Connecticut income tax under current law.

 

Village Investments, Inc.: Established in 1994, Village Investments, Inc. established to offer brokerage and investment advisory services through a contract with a registered broker-dealer. Village Investments Inc. is currently inactive.

 

Village Corp., Limited: Established in 1986, Village Corp., Limited was established to hold certain commercial real estate acquired through foreclosures, deeds in lieu of foreclosure, or other similar means. Village Corp. limited is currently inactive.

 

28 Main Street Corp.: Established in 1992, 28 Main Street Corp. was established to hold residential other real estate owned. 28 Main Street Corp. is currently inactive.

 

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Village Management Corp: Established in 1992, Village Management Corp. was established to hold commercial other real estate owned. Village Management Corp. is currently inactive.

 

Village Square Holdings, Inc.: Established in 1992, held certain commercial real estate of Farmington Bank previously used as Farmington Bank’s operations center prior to our relocation to One Farm Glen Boulevard, Farmington, Connecticut. Village Square Holdings Inc. is currently inactive.

 

The activities of these subsidiaries have had an insignificant effect on our consolidated financial conditions and results of operations to date.

 

Employees

 

At December 31, 2015, we had 343 full-time equivalent employees, none of whom are represented by a collective bargaining unit. We believe our relationship with our employees is good.

 

Charitable Foundation

 

In connection with the Conversion and Reorganization in 2011, the Company established Farmington Bank Community Foundation, Inc., a non-profit charitable organization dedicated to helping the communities the Bank serves. The Foundation was funded with a contribution of 687,700 shares of the Company’s common stock, representing 4% of the outstanding shares sold in the offering.

 

Farmington Bank Community Foundation’s mission is to improve the economic viability and well-being of residents and the communities in which Farmington Bank operates. The Farmington Bank Community Foundation supports programs and organizations that impact the quality of life of the residents of the towns we serve. The Foundation’s areas of focus are Economic Empowerment, Community Investment and Health and Wellness. The Foundation’s emphasis is on programs and services that assist households most in need and make a lasting difference for the people and communities they serve.

 

SUPERVISION AND REGULATION

 

General

 

Farmington Bank, a Connecticut-chartered stock savings bank, is subject to extensive regulation by the Connecticut Department of Banking, as its chartering agency, and by the FDIC as its deposit insurer. Farmington Bank’s deposits are insured up to applicable limits by the FDIC through the Deposit Insurance Fund. Farmington Bank is required to file reports with, and is periodically examined by, the FDIC and the Connecticut Department of Banking concerning its activities and financial condition and must obtain regulatory approvals prior to entering into certain transactions, such as mergers with, or acquisitions of, other financial institutions and opening or closing branch offices. FCB, as a bank holding company is subject to regulation by and required to file reports with the Connecticut Department of Banking, the Federal Reserve Board and the Securities and Exchange Commission.

 

The following discussion of other laws and regulations material to our operations contains a summary of the current material provisions of such laws and regulations applicable to our operations. Any change in such regulations, whether by the Connecticut Department of Banking, the FDIC, the Federal Reserve Board or the Securities and Exchange Commission, could have a material adverse impact on us.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act

 

On July 21, 2010, the President of the United States signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). This law significantly changed the bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies were given significant discretion in drafting the rules and regulations, and consequently, many of the details and much of the impacts of the Dodd-Frank Act may not be known for many months or years.

 

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The Dodd-Frank Act created a new Consumer Financial Protection Bureau (“CFPB”) with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks with more than $10 billion in assets. Farmington Bank, as a bank with $10 billion or less in assets, will continue to be examined for compliance with the consumer laws by our primary bank regulators. The Dodd-Frank Act also weakened the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorney generals the ability to enforce federal consumer protection laws.

 

The Dodd-Frank Act establishes numerous restrictions and requirements that mortgage lenders must follow or satisfy before making a residential mortgage loan, including the verification of a mortgage loan applicant’s ability to repay a mortgage loan. The Dodd-Frank Act’s mortgage reform provisions also allow borrowers to assert violations of certain provisions of the Truth-in-Lending Act as a defense to foreclosure proceedings.

 

The Dodd-Frank Act requires minimum leverage (Tier 1) and risk based capital levels for bank and savings and loan holding companies that are no less than those applicable to banks, which will exclude certain instruments that previously have been eligible for inclusion by bank holding companies as Tier 1 capital, such as trust preferred securities.

 

A provision of the Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest-bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense. The Dodd-Frank Act also broadened the base for FDIC deposit insurance assessments. Assessments are based on the average consolidated total assets less tangible equity capital of a financial institution, rather than deposits. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor. The legislation also increased the required minimum reserve ratio for the Deposit Insurance Fund, from 1.15% to 1.35% of insured deposits, and directed the FDIC to offset the effects of increased assessments on depository institutions with less than $10 billion in assets. The FDIC has issued regulations to implement these provisions of the Dodd-Frank Act. It has, in addition, established a higher reserve ratio of 2% as a long-term goal beyond what is required by statute. There is no implementation deadline for the 2% ratio.

 

Under the Dodd-Frank Act we are required to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments. The Dodd-Frank Act also authorized the Securities and Exchange Commission to promulgate rules that would allow certain stockholders to nominate candidates for election to the FCB board of directors using our proxy materials. The legislation also directed the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank and bank holding company executives, regardless of whether the company is publicly traded or not.

 

The full scope and impact of the Dodd-Frank Act's provisions will continue to be determined over time as additional regulations are issued and examination practices are aligned with the new rules. We cannot predict the ultimate impact of the Dodd-Frank Act on First Connecticut Bancorp or Farmington Bank at this time, although it has increased our compliance and operating costs and may otherwise adversely affect our business, financial condition and/or results of operations. Nor can we predict the impact or substance of other future legislation or regulation.

 

Connecticut and FDIC Banking Laws and Supervision

 

Connecticut Banking Commissioner: The Connecticut Banking Commissioner regulates internal organization as well as the deposit, lending and investment activities of state chartered banks, including Farmington Bank. The approval of the Connecticut Banking Commissioner is required for, among other things, the establishment of branch offices and business combination transactions. The Commissioner conducts periodic examinations of Connecticut-chartered banks, as does the FDIC. The FDIC also regulates many of the areas regulated by the Connecticut Banking Commissioner, and federal law may limit some of the authority provided to Connecticut-chartered banks by Connecticut law.

 

Lending Activities: Connecticut banking laws grant banks broad lending authority. With certain limited exceptions, secured and unsecured loans of any one obligor under this statutory authority may not exceed 10.0% and 15.0%, respectively, of a bank’s equity capital and allowance for loan losses.

 

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Dividends: Farmington Bank may pay cash dividends out of its net profits. Further, the total amount of all dividends declared by a bank in any year may not exceed the sum of a bank’s net profits for the year in question combined with its retained net profits from the preceding two years. Federal law also prevents an institution from paying dividends or making other capital distributions that, if by doing so, would cause it to become “undercapitalized.” The FDIC may limit a bank’s ability to pay dividends. No dividends may be paid to Farmington Bank’s sole stockholder, First Connecticut Bancorp, if such dividends would reduce stockholders’ equity below the amount of the liquidation account required by Connecticut regulations.

 

Powers: Connecticut law permits Connecticut banks to sell insurance and fixed and variable rate annuities if licensed to do so by the Connecticut Insurance Commissioner. With the prior approval of the Connecticut Banking Commissioner, Connecticut banks are also authorized to engage in a broad range of activities related to the business of banking, or that are financial in nature or that are permitted under the Bank Holding Company Act or the Home Owners’ Loan Act, both federal statutes, or the regulations promulgated as a result of these statutes. Connecticut banks are also authorized to engage in any activity permitted for a national bank or a federal savings association upon filing notice with the Connecticut Banking Commissioner unless the Banking Commissioner disapproves the activity.

 

Assessments: Connecticut banks are required to pay annual assessments to the Connecticut Banking Department to fund the Department’s operations. The general assessments are paid pro-rata based upon a bank’s asset size.

 

Enforcement: Under Connecticut law, the Connecticut Banking Commissioner has extensive enforcement authority over Connecticut banks and, under certain circumstances, affiliated parties, insiders, and agents. The Connecticut Banking Commissioner’s enforcement authority includes cease and desist orders, fines, receivership, conservatorship, removal of officers and directors, emergency closures, dissolution and liquidation.

 

Holding Company Regulation

 

General: As a bank holding company, FCB is subject to comprehensive regulation and regular examinations by the Federal Reserve Board. The Federal Reserve Board also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.

 

Federal Reserve Board policy historically has required a bank holding company to serve as a source of strength for its subsidiary bank. The Dodd-Frank Act codified this policy as a statutory requirement. Pursuant to this requirement, the Federal Reserve Board may require, and has required in the past, a holding company to contribute additional capital to an undercapitalized subsidiary bank. As a bank holding company, FCB is required to obtain Federal Reserve Board approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5.0% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. Under Connecticut banking law, no person may acquire beneficial ownership of more than 10.0% of any class of voting securities of a Connecticut-chartered bank, or any bank holding company of such a bank, without prior notification of, and lack of disapproval by, the Connecticut Banking Commissioner.

 

The Bank Holding Company Act also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5.0% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve Board regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the Federal Reserve Board includes, among other things: (i) operating a savings institution, mortgage company, finance company, credit card company or factoring company; (ii) performing certain data processing operations; (iii) providing certain investment and financial advice; (iv) underwriting and acting as an insurance agent for certain types of credit-related insurance; (v) leasing property on a full-payout, non-operating basis; (vi) selling money orders, travelers’ checks and United States savings bonds; (vii) real estate and personal property appraising; (viii) providing tax planning and preparation services; (ix) financing and investing in certain community development activities; and (x) subject to certain limitations, providing securities brokerage services for customers.

 

As a public company with securities registered under the Securities Exchange Act of 1934, First Connecticut Bancorp also is subject to that statute and to the Sarbanes-Oxley Act.

 

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

 

Pursuant to Connecticut banking regulations, no dividend may be paid to stockholders if such dividends would reduce our stockholders’ equity below the amount of the liquidation account established in connection with the conversion of the company from mutual to stock form. Farmington Bank may pay cash dividends only out of its net profits. For purposes of this restriction, “net profits” represents the remainder of all earnings from current operations. Further, the total amount of all dividends declared by Farmington Bank to FCB in any year may not, without express permission of the Connecticut Banking Commissioner, exceed the sum of Farmington Bank’s retained net profits for the past two fiscal years and its net profits of the year in which the dividend is paid. In addition, FCB is subject to Maryland law limitations. Maryland law generally limits dividends to an amount equal to the excess of our capital surplus over payments that would be owed upon dissolution to stockholders whose preferential rights upon dissolution are superior to those receiving the dividend, and to an amount that would not make us insolvent.

 

Redemption: Bank holding companies are required to give the Federal Reserve Board prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10.0% or more of the consolidated net worth of the bank holding company. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve Board order or any condition imposed by, or written agreement with, the Federal Reserve Board. This notification requirement does not apply to any company that meets the well capitalized standard for commercial banks, is “well managed” within the meaning of the Federal Reserve Board regulations and is not subject to any unresolved supervisory issues. However, in February 2009, the Federal Reserve Board issued SR 09-4 which, among other things, requires all bank holding companies to consult with the Federal Reserve board prior to redeeming stock without regard to the bank holding company’s capital status or regulations otherwise permitting redemptions without prior approval of the Federal Reserve Board.

 

Federal Regulations

 

Capital Requirements: Under FDIC regulations, federally insured state-chartered banks that are not members of the Federal Reserve System (“state non-member banks”), such as Farmington Bank, are required to comply with minimum leverage capital requirements. For an institution determined by the FDIC to not be anticipating or experiencing significant growth and to be, in general, a strong banking organization, rated composite 1 under the Uniform Financial Institutions Ranking System established by the Federal Financial Institutions Examination Council, the minimum capital leverage requirement is a ratio of Tier I capital to total assets of 3.0%. For all other institutions, the minimum leverage capital ratio is 4.0%. Tier I capital is the sum of common stockholders’ equity, non-cumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing assets and purchased credit card relationships) and certain other specified items.

 

The FDIC regulations require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of regulatory capital to regulatory risk-weighted assets is referred to as a bank’s “risk-based capital ratio.” Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items (including recourse obligations, direct credit substitutes and residual interests) to four risk-weighted categories ranging from 0.0% to 100.0%, with higher levels of capital being required for the categories perceived as representing greater risk. For example, under the FDIC’s risk-weighting system, cash and securities backed by the full faith and credit of the U.S. government are given a 0.0% risk weight, loans secured by one-to-four family residential properties generally have a 50.0% risk weight, and commercial loans have a risk weighting of 100.0%.

 

State non-member banks such as Farmington Bank must maintain a minimum ratio of total capital to risk-weighted assets of 8.0%, of which at least half must be Tier I capital. Total capital consists of Tier I capital plus Tier 2 or supplementary capital items, which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and certain other capital instruments, and a portion of the net unrealized gain on equity securities. The includable amount of Tier 2 capital cannot exceed the amount of the institution’s Tier I capital. Banks that engage in specified levels of trading activities are subject to adjustments in their risk based capital calculation to ensure the maintenance of sufficient capital to support market risk.

 

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The Federal Deposit Insurance Corporation Improvement Act required each federal banking agency to revise its risk-based capital standards for insured institutions to ensure that those standards take adequate account of interest-rate risk, concentration of credit risk, and the risk of nontraditional activities, as well as to reflect the actual performance and expected risk of loss on multi-family residential loans. The FDIC, along with the other federal banking agencies, has adopted a regulation providing that the agencies will take into account the exposure of a bank’s capital and economic value to changes in interest rate risk in assessing a bank’s capital adequacy. The FDIC also has authority to establish individual minimum capital requirements in appropriate cases upon determination that an institution’s capital level is, or is likely to become, inadequate in light of the particular circumstances.

 

In July 2013, the Federal Reserve Board promulgated a final rule and the FDIC promulgated an interim final rule implementing Basel III, providing for a strengthened set of capital requirements. These new requirements became effective on January 1, 2015 for us. In general, the new rules revise regulatory capital definitions and minimum ratios, redefine Tier I capital, create a new capital ratio (common equity Tier I risk-based capital ratio), require a capital conservation buffer, revise prompt corrective action thresholds to add a new ratio to these thresholds (discussed in more detail below) and revise risk weighting for certain asset categories and off-balance sheet exposures. Under the new regulations, (1) a new requirement to maintain a ratio of common equity Tier I capital to total risk-based assets of not less than 4.5% will be implemented, (2) the minimum Leverage Capital Ratio for all financial institutions will be at least 4%, (3) the minimum Tier I Risk-Based Capital Ratio increases from 4% to 6% and (4) the Total Risk-Based Capital Ratio maintains at 8%. In addition, the new regulations impose certain limitations on dividends, share buybacks, discretionary payments on Tier I instruments and discretionary bonuses to executive officers if the organization fails to maintain a capital conservation buffer of common equity Tier I capital in an amount greater than 2.5% of its total risk-weighted assets. The end result of the capital conservation buffer will be to increase the minimum common equity Tier I capital ratio to 7%, the minimum Tier I Risk-Based Capital Ratio to 8.5% and the minimum Total Risk-Based Capital Ratio to 10.5% for financial institutions seeking to avoid limitations on capital distributions and discretionary bonus payments to executive officers. The new regulations will be phased in over a period of time. The capital conservation buffer will be phased-in over a five year period with the full 2.5% requirement starting as of January 1, 2019.

 

Additionally, under the new regulations, the method for calculating the ratios has been revised to generally enhance risk sensitivity as well as provide alternatives to credit ratings for calculating risk-weighted assets. As of December 31, 2015, we currently comply with the BASEL III requirements on a fully phased-in basis.

 

As a bank holding company, FCB is subject to capital adequacy guidelines for bank holding companies similar to those of the FDIC for state-chartered banks.

 

Prompt Corrective Regulatory Action: Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.

 

The FDIC has adopted regulations to implement the prompt corrective action legislation. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier I risk-based capital ratio of 6.0% or greater and a leverage ratio of 5.0% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier I risk-based capital ratio of 4.0% or greater, and generally a leverage ratio of 4.0% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier I risk-based capital ratio of less than 4.0%, or generally a leverage ratio of less than 4.0%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier I risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%. As of December 31, 2015, Farmington Bank was a well-capitalized institution.

 

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“Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. A bank’s compliance with such a plan is required to be guaranteed by any company that controls the undercapitalized institution in an amount equal to the lesser of 5.0% of the institution’s total assets when deemed undercapitalized or the amount necessary to achieve the status of adequately capitalized. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. “Critically undercapitalized” institutions are subject to additional measures including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.

 

Safety and Soundness Standards: The Federal Deposit Insurance Act (“FDIA”) requires the federal bank regulatory agencies to establish standards, by regulations or guidelines, designed to ensure the safety and soundness of insured financial institutions. The FDIA requires financial institutions to establish, among other things, internal controls, information systems and internal audit systems, risk management policies and procedures, credit underwriting standards, and other operational and managerial standards designed to meet the FDIA’s requirements. The federal banking agencies may, but are not required, to order an institution that is not meeting applicable safety and soundness standards to submit a plan to bring the institution into compliance with such standards. If an institution fails to submit an acceptable compliance plan or fails to implement its compliance plan, the agency must issue an order directing action to correct the deficiency.

 

Transactions with Affiliates: Under current federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act (the “FRA”). In a holding company context, at a minimum, the parent holding company of a savings bank and any companies which are controlled by such parent holding company are affiliates of the savings bank. Generally, Section 23A limits the extent to which the savings bank or its subsidiaries may engage in “covered transactions” with any one affiliate to 10.0% of such savings bank’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to 20.0% of capital stock and surplus. The term “covered transaction” includes, among other things, the making of loans or other extensions of credit to an affiliate and the purchase of assets from an affiliate. Section 23A also establishes specific collateral requirements for loans or extensions of credit to, or guarantees, acceptances on letters of credit issued on behalf of an affiliate. Section 23B requires that covered transactions and a broad list of other specified transactions be on terms substantially the same, or no less favorable, to the savings bank or its subsidiary as similar transactions with non-affiliates.

 

Loans to Insiders: Further, Section 22(h) of the FRA restricts an institution with respect to loans to directors, executive officers, and principal stockholders (“insiders”). Under Section 22(h), loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s unimpaired capital and unimpaired surplus. Loans to insiders above specified amounts must receive the prior approval of the board of directors. Further, under Section 22(h), loans to directors, executive officers and principal stockholders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to the bank’s employees and does not give preference to the insider over the employees. Section 22(g) of the FRA places additional limitations on loans to executive officers.

 

Enforcement: The FDIC has extensive enforcement authority over insured savings banks, including Farmington Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices.

 

The FDIC has authority under Federal law to appoint a conservator or receiver for an insured bank under limited circumstances. The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state non-member bank if that bank was “critically undercapitalized” on average during the calendar quarter beginning 270 days after the date on which the institution became “critically undercapitalized.” The FDIC may also appoint itself as conservator or receiver for an insured state non-member institution under specific circumstances on the basis of the institution’s financial condition or upon the occurrence of other events, including: (1) insolvency; (2) substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices; (3) existence of an unsafe or unsound condition to transact business; and (4) insufficient capital, or the incurring of losses that will deplete substantially all of the institution’s capital with no reasonable prospect of replenishment without federal assistance.

 

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Insurance of Deposit Accounts: The FDIC has adopted a risk-based insurance assessment system. The FDIC assigns an institution to one of three capital categories based on the institution’s financial condition consisting of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution’s primary federal regulator and information which the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the Deposit Insurance Fund. An institution’s assessment rate depends on the capital category and supervisory category to which it is assigned. Effective April 1, 2011, the FDIC revised its assessment schedule so that it ranges from 2.5 basis points for the least risky institutions to 45 basis points for the riskiest. The rule changed the assessment base used for calculating deposit insurance assessments from deposits to average consolidated total assets less average tangible equity capital. Since the new base is larger than the previous base, the FDIC also lowered assessment rates so that the rule would not significantly alter the total amount of revenue collected from the industry. FDIC members are also required to assist in the repayment of bonds issued by the Financing Corporation (FICO) in the late 1980’s to recapitalize the Federal Savings and Loan Insurance Corporation.

 

The FDIC provides insurance up to $250,000 per depositor for each account ownership category. Additionally, the FDIC approved a plan for rebuilding the Deposit Insurance Fund after several bank failures in 2008. The FDIC plan aims to rebuild the Deposit Insurance Fund within five years; the first assessment increase was a uniform seven basis points effective January 2009. For the years ended December 31, 2015, 2014, and 2013, the Bank’s total FDIC assessments were $1.7 million, $1.4 million and $1.3 million, respectively.

 

The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. In setting the assessments necessary to achieve the 1.35% ratio, the FDIC is supposed to offset the effect of the increased ratio on insured institutions with assets of less than $10 billion. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC. The FDIC has recently exercised that discretion by establishing a long range fund ratio of 2%.

 

The FDIC may terminate insurance of deposits if it finds that the institution is in an unsafe or unsound condition to continue operations, has engaged in unsafe or unsound practices, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not know of any practice, condition or violations that might lead to termination of deposit insurance.

 

Federal Reserve System: The Federal Reserve Board regulations require depository institutions to maintain non-interest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations generally require that reserves be maintained against aggregate transaction accounts. We are in compliance with these requirements.

 

Federal Home Loan Bank System: Farmington Bank is a member of the FHLBB, which is one of the regional Federal Home Loan Banks composing the Federal Home Loan Bank System. Each Federal Home Loan Bank serves as a central credit facility primarily for its member institutions. Farmington Bank, as a member of the FHLBB, is required to acquire and hold shares of capital stock in the FHLBB. While the required percentages of stock ownership are subject to change by the FHLBB, we were in compliance with this requirement with an investment in FHLBB stock of $21.7 million and $19.8 million at December 31, 2015 and 2014, respectively. The FHLBB paid dividends totaling $522,000 and $208,000 for the years ended December 31, 2015 and 2014, respectively. There can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks also will not cause a decrease in the value of the FHLBB stock held by us.

 

Financial Modernization: The Gramm-Leach-Bliley Act permits greater affiliation among banks, securities firms, insurance companies, and other companies under a new type of financial services company known as a “financial holding company.” A financial holding company essentially is a bank holding company with significantly expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and merchant banking activities. The act also permits the Federal Reserve Board and the Treasury Department to authorize additional activities for financial holding companies if they are “financial in nature” or “incidental” to financial activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, well managed, and has at least a “satisfactory” Community Reinvestment Act rating. A financial holding company must provide notice to the Federal Reserve Board within 30 days after commencing activities previously determined by statute or by the Federal Reserve Board and Department of the Treasury to be permissible. We are not currently a financial holding company and are not precluded from submitting a notice in the future should we wish to engage in activities only permitted to financial holding companies.

 

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Miscellaneous Regulation

 

Sarbanes-Oxley Act of 2002: Following our public offering in June 2011, we are subject to the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate wrongdoing. In general, the Sarbanes-Oxley Act mandated important new corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It established new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process, and it created a new regulatory body to oversee auditors of public companies. It backed these requirements with new Securities and Exchange Commission enforcement tools, increased criminal penalties for federal mail, wire and securities fraud, and created new criminal penalties for document and record destruction in connection with federal investigations. It also increased the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection.

 

Section 402 of the Sarbanes-Oxley Act prohibits the extension of personal loans to directors and executive officers of issuers (as defined in the Sarbanes-Oxley Act). The prohibition, however, does not apply to loans advanced by an insured depository institution, such as those that are subject to the insider lending restrictions of Section 22(h) of the Federal Reserve Act.

 

The Sarbanes-Oxley Act also required that the various securities exchanges, including The Nasdaq Global Select Market, prohibit the listing of the stock of an issuer unless that issuer complies with various requirements relating to their committees and the independence of their directors that serve on those committees.

 

Community Reinvestment Act: Under the Community Reinvestment Act (“CRA”), as implemented by FDIC regulations, a bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA does require the FDIC, in connection with its examination of a bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution, including applications to acquire branches and other financial institutions. The CRA requires the FDIC to provide a written evaluation of an institution’s CRA performance utilizing a four-tiered descriptive rating system. Farmington Bank’s latest FDIC CRA rating was “satisfactory.”

 

Connecticut has its own statutory counterpart to the CRA which is also applicable to Farmington Bank. The Connecticut version is generally similar to the CRA but utilizes a five-tiered descriptive rating system. Connecticut law requires the Connecticut Banking Commissioner to consider, but not be limited to, a bank’s record of performance under Connecticut law in considering any application by the bank to establish a branch or other deposit-taking facility, to relocate an office or to merge or consolidate with or acquire the assets and assume the liabilities of any other banking institution. Farmington Bank’s most recent rating under Connecticut law was “satisfactory.”

 

Consumer Protection and Fair Lending Regulations: We are subject to a variety of federal and Connecticut statutes and regulations that are intended to protect consumers and prohibit discrimination in the granting of credit. These statutes and regulations provide for a range of sanctions for non-compliance with their terms, including imposition of administrative fines and remedial orders, and referral to the Attorney General for prosecution of a civil action for actual and punitive damages and injunctive relief. Certain of these statutes authorize private individual and class action lawsuits and the award of actual, statutory and punitive damages and attorneys’ fees for certain types of violations.

 

The USA PATRIOT Act: On October 26, 2001, the USA PATRIOT Act (the “PATRIOT Act”) was enacted. The PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. The PATRIOT Act also requires the federal banking regulators to take into consideration the effectiveness of controls designed to combat money-laundering activities in determining whether to approve a merger or other acquisition application of an FDIC-insured institution. As such, if FCB or Farmington Bank were to engage in a merger or other acquisition, the effectiveness of its anti-money-laundering controls would be considered as part of the application process. We have established policies, procedures and systems to comply with the applicable requirements of the law. The PATRIOT Act was reauthorized and modified with the enactment of the USA PATRIOT Improvement and Reauthorization Act of 2005.

 

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Privacy Laws and Regulations: The federal Gramm-Leach-Bliley Act generally prohibits financial institutions, including Farmington Bank, from disclosing nonpublic personal financial information pertaining to consumer customers to third parties for certain purposes unless such customers have the opportunity to “opt out” of such disclosure and have not exercised this right. Connecticut law contains provisions that generally restrict the disclosure of customer financial records to third parties. The federal Fair Credit Reporting Act restricts information sharing among affiliates for marketing purposes.

 

Federal Securities Laws: The common stock of FCB is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934 and is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.

 

Federal and State Taxation

 

Federal Taxation

 

General: We are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to us.

 

Method of Accounting: For Federal income tax purposes, we report income and expenses on the accrual method of accounting and use tax year ending December 31 for filing federal income tax returns.

 

Bad Debt Reserves: Prior to the Small Business Protection Act of 1996 (the “1996 Act”), Farmington Bank was permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at our taxable income. As a result of the 1996 Act, Farmington Bank was required to use the specific charge-off method in computing its bad debt deduction beginning with its 1996 federal tax return. Savings institutions were required to recapture any excess reserves over those established as of December 31, 1987 (base year reserve). At December 31, 2015, Farmington Bank had no reserves subject to recapture in excess of its base year.

 

Taxable Distributions and Recapture: Prior to the 1996 Act, bad debt reserves created before January 1, 1988 were subject to recapture into taxable income if Farmington Bank failed to meet certain thrift asset and definitional tests. Federal legislation has eliminated these thrift-related recapture rules. At December 31, 2015, our total federal pre-1988 base year reserve was $3.4 million. However, under current law, pre-1988 base year reserves remain subject to recapture if Farmington Bank makes certain non-dividend distributions, repurchases any of its stock, pays dividends in excess of tax earnings and profits, or ceases to maintain a bank charter.

 

Alternative Minimum Tax: The Internal Revenue Code of 1986, as amended (the “Code”), imposes an alternative minimum tax (“AMT”) at a rate of 20.0% on a base of regular taxable income plus certain tax preferences which we refer to as “alternative minimum taxable income.” The AMT is payable to the extent such alternative minimum taxable income is in excess of an exemption amount and the AMT exceeds the regular income tax. Net operating losses can offset no more than 90.0% of alternative minimum taxable income. Certain AMT payments may be used as credits against regular tax liabilities in future years. We have not been subject to the AMT and have no such amounts available as credits for carryover.

 

Net Operating Loss Carryovers: A corporation may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At December 31, 2015, we had no net operating loss carryforwards for federal income tax purposes.

 

Charitable Contribution Carryforward: As part of the Plan of Conversion and Reorganization completed on June 29, 2011, the Company contributed shares of Company common stock to the Farmington Bank Community Foundation, Inc. This contribution resulted in a charitable contribution deduction for federal income tax purposes. Use of that charitable contribution deduction is limited under Federal tax law to 10% of federal taxable income without regard to charitable contributions, net operating losses, and dividend received deductions. Annually, a corporation is permitted to carry over to the five succeeding tax years, contributions that exceeded the 10% limitation, but also subject to the maximum annual limitation. As a result, approximately $4.3 million of charitable contribution carryforward remains at December 31, 2015 resulting in a deferred tax asset of approximately $1.5 million. The Company believes it is more likely than not that this carryforward will not be fully utilized before expiration in 2016. Therefore, a $771,000 valuation allowance has been recorded against this deferred tax asset. Some of this charitable contribution carryforward would likely expire unutilized if the Company does not generate sufficient taxable income over the next year. The Company monitors the need for a valuation allowance on a quarterly basis.

 

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Corporate Dividends-Received Deduction: FCB may exclude from its income 100.0% of dividends received from Farmington Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is 80.0% in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, and corporations which own less than 20.0% of the stock of a corporation distributing a dividend may deduct only 70.0% of dividends received or accrued on their behalf.

 

State Taxation

 

Connecticut

 

We are subject to the Connecticut corporation business tax. The Connecticut corporation business tax is based on the federal taxable income before net operating loss and special deductions and makes certain modifications to federal taxable income to arrive at Connecticut taxable income. Connecticut taxable income is multiplied by the state tax rate (7.5% for the fiscal years ending December 31, 2015 and 2014) (plus an additional 20% surtax applies for tax years 2015 and 2014) to arrive at Connecticut income tax.

 

In 1998, the State of Connecticut enacted legislation permitting the formation of passive investment companies by financial institutions. This legislation exempts qualifying passive investment companies from the Connecticut corporation business tax and excludes dividends paid from a passive investment company from the taxable income of the parent financial institution. Farmington Bank established a passive investment company in 1999 and substantially eliminated the state income tax expense of Farmington Bank since the passive investment company’s organization through December 31, 2015.

 

We believe we are in compliance with the state passive investment company requirements and that no state taxes relating from Farmington Bank are due for the years ended December 31, 2013 through December 31, 2015; however, we have not been audited by the Department of Revenue Services for such periods. If the state were to determine that the passive investment company was not in compliance with statutory requirements, a material amount of taxes could be due. The State of Connecticut continues to be under pressure to find new sources of revenue, and therefore could enact legislation to eliminate the passive investment company exemption. If such legislation were enacted, we would be subject to additional state income taxes in Connecticut.

 

Farmington Bank and FCB are not currently under audit with respect to their state tax returns, and their state tax returns have not been audited for the past five years.

 

Massachusetts

 

We are subject to the Massachusetts income excise tax. The Massachusetts income excise tax is based on the federal taxable income before net operating loss and special deductions and makes certain modifications to federal taxable income to arrive at Massachusetts taxable income. Massachusetts apportioned taxable income is multiplied by the state tax rate (9.0% for the fiscal years ending December 31, 2015 and 2014).

 

Maryland

 

As a Maryland business corporation, First Connecticut Bancorp, Inc. is required to file an annual income tax return with the State of Maryland.

 

New York

 

We are subject to the New York corporate franchise tax. The New York corporate franchise tax is based on the federal taxable income before net operating loss and special deductions and makes certain modifications to federal taxable income to arrive at New York taxable income. New York apportioned taxable income is multiplied by the state tax rate (7.1% for the fiscal year ending December 31, 2015).

 

 34 

 

 

Item 1A.  Risk Factors

 

A substantial portion of our loan portfolio consists of commercial real estate loans and commercial loans, which expose us to increased risks and could adversely impact our earnings.

 

Our executive management team has brought an increased focus to transitioning Farmington Bank’s balance sheet to be more like a commercial bank. At December 31, 2015 and 2014, our commercial loan portfolio totaled $1.3 billion and $1.1 billion, or 56.3% and 53.0%, respectively, of our total loan portfolio. These types of loans generally expose a lender to greater risk of non-payment and loss than one-to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and business of the borrowers and the collateral securing these loans may not be sold as easily as residential real estate. In addition, commercial real estate and commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to four-family residential mortgage loans. Also, many of our commercial real estate and commercial loan borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to four-family residential mortgage loan.

 

Due to the slow economic recovery, the real estate market and local economy has not returned to pre-recession conditions. While the value of our real estate collateral securing loans has not been substantially impacted, further deterioration in the real estate market or a prolonged economic recovery could adversely affect the value of the properties securing the loans or revenues from borrowers’ businesses, thereby increasing the risk of non-performing loans. A continued deterioration in the economy and slow economic recovery may also have a negative effect on the ability of our commercial borrowers to make timely repayments of their loans, which could have an adverse impact on our earnings.

 

All of these factors could have a material adverse effect on our financial condition and results of operations.

 

Our loan portfolio possesses increased risk due to its rapid expansion and unseasoned nature.

 

From December 31, 2011 to December 31, 2015, our total loan portfolio increased by $1.0 billion or 80.0%.  As a result of this rapid expansion, a significant portion of our portfolio is unseasoned. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. As a result, it may be difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our expectations, which could adversely affect our future performance.

 

Our lack of geographic diversification increases our risk profile.

 

Our operations are located principally in central Connecticut and western Massachusetts. As a result of this geographic concentration, our results depend largely upon economic and business conditions in these areas. Deterioration in economic and business conditions in our service areas could have a material adverse impact on the quality of our loan portfolio and the demand for our products and services, which in turn may have a material adverse effect on our results of operations. During the fourth quarter of 2015, we opened two de novo branches in western Massachusetts and a loan production office in Branford, CT. No assurance can be given as to when, if ever, our expansion into western Massachusetts will become profitable.

 

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.

 

We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. Recent declines in real estate values have impacted the collateral values that secure our real estate loans. The impact of these declines on the original appraised values of secured collateral is difficult to estimate. In determining the amount of the allowance for loan losses, we review our loss and delinquency experience on different loan categories, and we evaluate existing economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance, which would decrease our net income.  Our loan loss allowance for the years ended December 31, 2015 and 2014 was $20.2 million and $19.0 million, respectively.  Although we are currently unaware of any specific problems with our loan portfolio that would require any increase in our allowance at the present time, it may need to be increased further in the future due to our emphasis on loan growth and on increasing our portfolio of commercial business and commercial real estate loans.

 

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In addition, banking regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in the allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our results of operations and financial condition.

 

Future changes in interest rates may reduce our profits which could have a negative impact on the value of our stock.

 

Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between the interest income Farmington Bank earns on its interest-earning assets, such as loans and securities, and the interest expense Farmington Bank pays on its interest-bearing liabilities, such as deposits and borrowings. Increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans. In addition, as market interest rates rise, we will have competitive pressures to increase the rates paid on deposits, which may result in a decrease in our net interest income.

 

In addition, changes in interest rates can affect the average life of loans and mortgage-backed and related securities. A reduction in interest rates results in increased prepayments of loans and mortgage-backed and related securities, as borrowers refinance their debt in order to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest prepayments at rates that are comparable to the rates earned on the prepaid loans or securities.

 

We opened new branches in 2015 and 2014, which may result in losses at those branches as they generate new deposit and loan portfolios, and negatively impact our earnings.

 

We opened new branch offices in West Springfield, MA and East Longmeadow, MA in the fourth quarter of 2015 and opened a branch office in Rocky Hill, CT in 2014. In addition, we opened a loan production office in Branford, CT during the fourth quarter in 2015. We opened a loan production office in Fairfield, CT in February 2016 and anticipate opening two new branch offices in Connecticut during 2016. Losses are expected in connection with these new branches for some time, as the expenses and costs of acquisition associated with them are largely fixed and are typically greater than the income earned at the outset as the branches build up their customer bases. No assurance can be given as to when, if ever, new branches will become profitable.

 

Strong competition within Farmington Bank’s market area may limit our growth and profitability.

 

Competition in the banking and financial services industry is intense. In addition, we recently expanded into western Massachusetts opening two de novo branches in the fourth quarter of 2015. In our market area, we compete with commercial banks, savings institutions, mortgage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have substantially greater resources and lending limits than we have and offer certain services that we do not or cannot provide. Our profitability depends upon our continued ability to compete successfully in our market area. The greater resources and deposit and loan products offered by our competitors may limit our ability to increase our interest-earning assets.

 

If our government banking deposits were lost within a short period of time, this could negatively impact our liquidity and earnings.

 

Our government banking group provides deposit services to municipalities throughout Connecticut.  Our municipal deposits as of December 31, 2015 and 2014 were $368.0 million, or 18.5%, and $300.3 million, or 17.3%, of our total deposits outstanding, respectively. If a significant amount of these deposits were withdrawn within a short period of time, it could have a negative impact on our short term liquidity and have an adverse impact on our earnings.

 

The loss of our Chief Executive Officer could adversely impact our business.

 

Our future success and profitability are substantially dependent upon the vision, management and banking abilities of our Chief Executive Officer, who has substantial background and significant experience in banking and financial services, as well as personal contacts in central Connecticut and the region generally. The loss of our Chief Executive Officer may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations.

 

 36 

 

 

The local and national economies remain uncertain. An economic downturn will adversely affect our business and financial results.

 

During the past year, general economic conditions continued to improve nationally as well as in our market area but there remains an economic uncertainty. Worsening of unemployment and housing conditions may adversely affect our business by materially decreasing our net interest income or materially increasing our loan losses. There can be no assurance that we will not be affected by the current economic conditions in a way we cannot currently predict or mitigate.

 

Passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act has increased our operational and compliance costs.

 

On July 21, 2010, the President of the United States signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). This law significantly changed the current bank regulatory structure and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies were given significant discretion in drafting the rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years. Among other things, the Dodd-Frank Act created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws, weakens the federal preemption rules that have been applicable for national banks and federal savings associations, imposes certain capital requirements on financial institutions, eliminated the federal prohibitions on paying interest on demand deposits, broadened the base for FDIC deposit insurance assessments, required publicly traded companies to provide non-binding votes on executive compensation and so-called “golden parachute” payments, and directed the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives. As a result, our revenue may be reduced due to fee income limitations and we may be required to maintain higher minimum capital ratios. It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. However, at a minimum they have increased our operating and compliance costs and could increase our interest expense.

 

Higher Federal Deposit Insurance Corporation insurance premiums and special assessments will adversely affect our earnings.

 

We are generally unable to control the amount of premiums and special assessments that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures we may be required to pay even higher FDIC premiums than the recently increased levels. Such increases and any future increases or required prepayments of FDIC insurance premiums may adversely impact our earnings.

 

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

 

We are subject to extensive regulation, supervision and examination by the Connecticut Banking Commissioner, as Farmington Bank’s chartering authority, by the FDIC, as insurer of deposits, and by the Federal Reserve Board, as the regulator of FCB. Such regulation and supervision govern the activities in which a financial institution and its holding company may engage and are intended primarily for the protection of the insurance fund and depositors. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution’s allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, may have a material impact on our operations.

 

We face various technological risks that could adversely affect our business.

 

We rely on communication and information systems to conduct business. Potential failures, interruptions or breaches in system security could result in disruptions or failures in our key systems, such as general ledger, deposit or loan systems. The risk of electronic fraudulent activity within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting bank accounts and other customer information is on the rise. We have developed policies and procedures aimed at preventing and limiting the effect of failure, interruption or security breaches, including cyber attacks of information systems; however, there can be no assurance that these incidences will not occur, or if they do occur, that they will be appropriately addressed. The occurrence of any failures, interruptions or security breaches, including cyber attacks of our information systems could damage our reputation, result in the loss of business, subject us to increased regulatory scrutiny or subject us to civil litigation and possible financial liability, any of which could have an adverse effect on our results of operation and financial condition.

 

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Third parties with whom we do business or that facilitate our business activities, including exchanges, clearing houses, financial intermediaries or vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.

 

Although to date we have not experienced any material losses relating to cyber attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains heightened and as a result the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. As an additional layer of protection, we have purchased cyber and privacy liability insurance coverage which includes risks such as; privacy liability, unauthorized fund transfer liability, business interruption liability, social media liability and regulatory action liability. Additionally, we have purchased first party coverage for digital asset loss, network security, network extortion and data breach expenses (e.g. investigation, remediation, notification, etc.). As cyber threats continue to evolve, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate any information security vulnerabilities.

 

Item 1B. Unresolved Staff Comments

 

Not applicable

 

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Item 2. Properties

 

We operate through our 23 full service branch offices, four limited services offices, three stand-alone ATM facilities and one loan production office. Various leases have renewal options up to an additional 30 years.

 

Our full service branch offices, limited service offices and loan production office are located as follows:

 

Branch   Address   Owned or Leased
         
Avon West   427 West Avon Road, Avon, CT 06001   Lease (Expires 2019)
         
Avon 44   310 West Main Street, Avon, CT 06001   Own
         
Berlin   1191 Farmington Avenue, Berlin, CT 06037   Lease (Expires 2020)
         
Bristol   475 Broad Street, Bristol, CT 06010   Own
         
Burlington   253 Spielman Highway, Burlington, CT 06013   Own
         
Main Street   32 Main Street, Farmington, CT 06032   Own
         
Gables (1) (3)   20 Devonwood Drive, Farmington, CT 06032   n/a
         
Village Gate (1) (3)   88 Scott Swamp Road, Farmington, CT 06032   n/a
         
Westwoods   282 Scott Swamp Road, Farmington, CT 06032   Own
         
Farm Glen (1)(2)   One Farm Glen Boulevard, Farmington, CT 06032   Lease (Expires 2019)
         
Glastonbury   669 Hebron Avenue, Glastonbury, CT 06033   Own
         
New Britain   73 Broad Street, New Britain, CT 06053   Own
         
Plainville - Route 10   117 East Street, Plainville, CT 06062   Lease (Expires 2020)
         
Plainville 372   129 New Britain Avenue, Plainville, CT 06062   Lease (Expires 2025)
         
Southington   One Center Street, Southington, CT 06489   Lease (Expires 2020)
         
Southington Drive-Thru (1)   17 Center Place, Southington, CT 06489   Lease (Expires 2019)
         
Unionville   1845 Farmington Avenue, Unionville, CT 06085   Own
         
West Hartford   962 Farmington Avenue, West Hartford, CT 06110   Lease (Expires 2019)
         
Elmwood   176 Newington Road, West Hartford, CT 06110   Lease (Expires 2026)
         
Wethersfield   486 Silas Deane Highway, Wethersfield, CT 06129   Own
         
Bloomfield   782 Park Avenue, Bloomfield, CT 06002   Lease (Expires 2022)
         
South Windsor   350 Buckland Road, South Windsor, CT 06074   Lease (Expires 2032)
         
Newington   1095 Main Street, Newington, CT 06111   Lease (Expires 2033)
         
East Hartford   957 Main Street, East Hartford, CT 06108   Lease (Expires 2033)
         
Rocky Hill   366 Cromwell Avenue, Rocky Hill, CT 06067   Lease (Expires 2033)
         
West Springfield   85 Elm Street, West Springfield, MA 01089   Lease (Expires 2022)
         
East Longmeadow   61 North Main Street, East Longmeadow, MA 01028 Lease (Expires 2035)
         
Branford (4)   28 School Street, Branford, CT 06405   Lease (month to month)

 

(1) Limited Service Office

(2) Executive Office

(3) Bank provided space at no cost

(4) Loan production office

 

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Item 3. Legal Proceedings

 

In the ordinary course of business, the Company and its subsidiary are routinely defendants in or parties to pending and threatened legal actions and proceedings. After reviewing pending and threatened actions with legal counsel, the Company believes that the outcome of such actions will not have a material adverse effect on the consolidated financial statements.

 

Item 4. Mine Safety Disclosures

None

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

(A)

The shares of common stock of First Connecticut Bancorp, Inc. are quoted on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “FBNK.” As of December 31, 2015, First Connecticut Bancorp had 1,837 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 15,881,663 shares outstanding.

 

Market Price and Dividends. The following table sets forth market price and dividend information for the common stock for the past two fiscal years.

 

Quarter Ended  High  Low  Cash
Dividend
Declared
December 31, 2015  $18.40   $15.26   $0.06 
September 30, 2015   17.28    15.25    0.06 
June 30, 2015   16.24    14.54    0.05 
March 31, 2015   16.44    14.43    0.05 
December 31, 2014   16.75    14.23    0.05 
September 30, 2014   16.60    14.47    0.05 
June 30, 2014   16.49    14.64    0.04 
March 31, 2014   16.50    15.09    0.03 

 

Payment of dividends on First Connecticut Bancorp’s common stock is subject to determination and declaration by the Board of Directors and depends on a number of factors, including capital requirements, legal, and regulatory limitations on the payment of dividends, the results of operations and financial condition, tax considerations and general economic conditions. No assurance can be given that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends will continue. See Item 1 “Supervision and Regulations” for information relating to restrictions on dividends. Repurchases of the Company’s shares of common stock during the fourth quarter of the year ended December 31, 2015 are detailed in (C) below. There were no sales of unregistered securities during the quarter ended December 31, 2015.

 

Set forth below is a stock performance graph comparing the annual total return on our shares of common stock, commencing with the closing price on June 30, 2011, the date the Company went public, with (a) the cumulative total return on stocks included in the Russell 2000 Index, (b) the cumulative total return on stocks included in the SNL New England U.S. Bank Index and (c) the cumulative total return on stocks included in the SNL U.S. Thrift Index. Cumulative return assumes the reinvestment of dividends, and is expressed in dollars based on an assumed investment of $100.

 

There can be no assurance that our stock performance in the future will continue with the same or similar trend depicted in the graph below. We will not make or endorse any predictions as to future stock performance.

 

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   Period Ending 
Index   06/30/11    12/31/11    12/31/12    12/31/13    12/31/14    12/31/15 
First Connecticut Bancorp, Inc.   100.00    117.70    125.54    148.38    151.89    164.27 
Russell 2000   100.00    90.23    104.98    145.73    152.86    146.12 
SNL New England U.S. Bank   100.00    92.43    107.80    166.68    183.91    176.54 
SNL New England U.S. Thrift   100.00    97.83    103.88    131.08    138.67    157.11 

 

(B)

Not Applicable

 

(C)

During the quarter ending December 31, 2015, the Company made the following repurchases of its common stock:

 

Period  (a) Total
Number of
Shares (or
Units)
Purchased
  (b) Average
Price Paid
per Share (or
Unit)
  (c) Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced
Plans or Programs
  (d) Maximum Number
(or Approximate Dollar
Value) of Shares (or
Units) that May Yet Be
Purchased Under the
Plans or Programs
October 1-31, 2015   15,000   $15.80    918,707    757,745 
November 1-30, 2015   -    -    918,707    757,745 
December 1-31, 2015   -    -    918,707    757,745 

 

 41 

 

 

On July 21, 2013, the Company received regulatory approval to repurchase up to 1,676,452 shares, or 10% of its current outstanding common stock. Shares repurchased under that approval are shown above. Repurchased shares will be held as treasury stock and will be available for general corporate purposes.

 

Item 6. Selected Financial Data

 

The following financial condition data and operating data are derived from the audited consolidated financial statements of First Connecticut Bancorp, Inc. Additional information is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related notes included as Item 7 and Item 8 of this report, respectively.

 

   At December 31,
   2015  2014  2013  2012  2011
Selected Financial Condition Data:  (Dollars in thousands)
Total assets  $2,708,546   $2,485,360   $2,110,028   $1,823,153   $1,618,129 
Cash and cash equivalents   59,139    42,863    38,799    50,641    90,296 
Held to maturity securities   32,246    16,224    12,983    3,006    3,216 
Available for sale securities   132,424    188,041    150,886    138,241    135,003 
Federal Home Loan Bank of Boston stock   21,729    19,785    13,136    8,939    7,449 
Loans receivable, net   2,341,598    2,119,917    1,800,987    1,520,170    1,295,177 
Deposits   1,991,358    1,733,041    1,513,501    1,330,455    1,176,682 
Federal Home Loan Bank advances   377,600    401,700    259,000    128,000    63,000 
Total stockholders' equity   245,721    234,563    232,209    241,795    252,499 
Allowance for loan losses   20,198    18,960    18,314    17,229    17,533 
Non-accrual loans   14,913    15,468    14,800    13,782    15,501 

 

   At December 31,
   2015  2014  2013  2012  2011
Selected Operating Data:  (Dollars in thousands)
Interest income  $81,884   $72,774   $62,886   $62,860   $59,025 
Interest expense   13,375    10,080    9,733    9,628    10,826 
Net Interest Income   68,509    62,694    53,153    53,232    48,199 
Provision for loan losses   2,440    2,588    1,530    1,380    4,090 
Net interest income after provision for loan losses   66,069    60,106    51,623    51,852    44,109 
Noninterest income   13,447    9,104    11,012    9,261    5,525 
Noninterest expense, excluding contribution to charitable foundation (**)   61,210    57,048    57,762    56,106    49,573 
Contribution to charitable foundation (**)   -    -    -    -    6,877 
Total noninterest expense   61,210    57,048    57,762    56,106    56,450 
Income (loss) before income taxes   18,306    12,162    4,873    5,007    (6,816)
Income tax expense (benefit)   5,727    2,827    1,169    1,300    (2,577)
                          
Net income (loss)   12,579    9,335    3,704    3,707    (4,239)

 

(**)In connection with the Conversion and Reorganization on June 29, 2011, the Company established Farmington Bank Community Foundation, Inc., a non-profit charitable organization, which was funded with a contribution of 687,000 shares of the Company's common stock.

 

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   At or For the Years Ended December 31,
   2015  2014  2013  2012  2011
Selected Financial Ratios and Other Data:               
Performance Ratios:  (Dollars in thousands, except per share amounts)
Return on average assets   0.48%   0.41%   0.19%   0.22%   (0.27)%
Return on average equity   5.20%   3.98%   1.57%   1.49%   (2.35)%
Interest rate spread (1)   2.66%   2.80%   2.80%   3.16%   3.05%
Net interest margin (2)   2.81%   2.94%   2.97%   3.35%   3.23%
Non-interest expense to average assets   2.34%   2.51%   3.04%   3.29%   3.58%
Efficiency Ratio (3)   74.69%   79.46%   90.02%   89.78%   105.07%
Efficiency ratio, excluding foundation contribution   74.69%   79.46%   90.02%   89.78%   92.27%
Average interest-earning assets to average interest-bearing liabilities   126.94%   127.56%   131.34%   132.07%   125.24%
                          
Asset Quality Ratios:                         
Allowance for loan losses as a percent of total loans   0.86%   0.89%   1.01%   1.12%   1.34%
Allowance for loan losses as a percent of non-performing loans   135.44%   122.58%   123.74%   125.01%   113.11%
Net charge-offs to average loans   0.05%   0.10%   0.03%   0.12%   0.61%
Non-performing loans as a percent of total loans   0.63%   0.72%   0.81%   0.90%   1.18%
Non-performing loans as a percent of total assets   0.55%   0.62%   0.70%   0.76%   0.96%
                          
Per Share Related Data:                         
Basic earnings per share (4)  $0.84   $0.62   $0.24   $0.22   $(0.29)
Diluted earnings per share (4)  $0.83   $0.62   $0.24   $0.22   $(0.29)
Dividends per share (5)  $0.22   $0.17   $0.12   $0.12   $0.03 
Dividend payout ratio   26.19%   27.42%   50.00%   54.55%   (10.34)%
                          
Capital Ratios:                         
Equity to total assets at end of period   9.07%   9.44%   11.01%   13.26%   15.60%
Average equity to average assets   9.24%   10.32%   12.41%   14.55%   11.45%
Total Capital (to Risk Weighted Assets)   12.88%   13.73%   15.50%   18.80%   22.41%
Tier I Capital (to Risk Weighted Assets)   11.91%   12.70%   14.36%   17.55%   21.16%
Common Equity Tier I Capital (to Risk Weighted Assets)   11.91%   n/a    n/a    n/a    n/a 
Tier I Leverage Capital (to Average Assets)   9.39%   9.86%   11.47%   13.89%   15.55%
Total capital to total average assets   9.38%   10.33%   12.22%   14.18%   16.01%
                          
Other Data:                         
Number of full service offices   23    22    21    19    17 
Number of limited service offices   4    4    4    4    4 

 

(1)Represents the difference between the weighted-average yield on average interest-earning assets and the weighted-average cost of the interest-bearing liabilities.

 

(2)Represents net interest income as a percent of average interest-earning assets

 

(3)Represents non-interest expense divided by the sum of net interest income and non-interest income

 

(4)Net loss per share for the year ended December 31, 2011 reflects earnings for the period from June 29, 2011, the date the Company completed a Plan of Conversion and Reorganization to December 31, 2011.

 

(5)Represents dividends per share divided by basic earnings per share.

 

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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

In 2015, despite the challenging operating environment, we were able to accomplish another year of double digit organic loan and deposit growth. During the year, we repositioned and strengthened our balance sheet as we continue to manage through one of the lowest interest rate environments in history. The current interest rate climate, combined with increased regulatory and compliance costs related to the regulations implementing the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, has resulted in compressed net interest margins and earnings pressures. To counter these external factors, we continue to focus on efficiencies and process improvement which are embedded within our Company’s culture to become a high performing company. During the fourth quarter of 2015, we successfully opened branch offices in West Springfield, MA and East Longmeadow, MA as we expand into the western Massachusetts market. We also opened a loan production office in Branford, CT. Financial highlights for First Connecticut Bancorp for the year ended December 31, 2015 are as follows:

 

·Strong Regulatory Capital Ratios: Our total Risk Based Capital ratio at December 31, 2015 is 12.88%. The minimum ratio to remain Well Capitalized is 10.00%. Our Common Equity Tier I Capital is 11.91 at December 31, 2015. The minimum ratio to remain Well Capitalized is 6.50%. Our total Leverage Ratio or Tier I Capital to Average Assets Ratio at December 31, 2015 is 9.39%. The minimum ratio to remain Well Capitalized is 5.00%.
·Strong Asset Growth: Total assets increased $223.2 million or 9.0% to $2.7 billion at December 31, 2015.
·Strong Loan Growth: Total loans increased $222.9 million or 10.4% to $2.4 billion at December 31, 2015.
·Commercial loan portfolio experienced very strong loan growth increasing $195.7 million or 17.3% to $1.3 billion at December 31, 2015.
·Overall deposits increased $258.3 million or 14.9% to $2.0 billion at December 31, 2015.
·Checking accounts grew by 12.8% or 5,786 net new accounts for the year ended December 31, 2015.
·Noninterest expense to average assets was 2.34% for the year ended December 31, 2015 compared to 2.51% in the prior year.
·Asset quality improved as loan delinquencies 30 days and greater decreased to 0.63% of total loans at December 31, 2015 compared to 0.75% at December 31, 2014. Non-accrual loans represented 0.63% of total loans compared to 0.72% of total loans at December 31, 2014.
·The allowance for loan losses represented 0.86% of total loans at December 31, 2015 compared to 0.89% at December 31, 2014.
·The Company paid a cash dividend of $0.22 per share for the year, an increase of $0.05 compared to the prior year.

 

Business Strategy

 

Our business strategy is to operate as a well-capitalized and profitable community bank for businesses, individuals and local governments, with an ongoing commitment to provide quality customer service.

 

·Maintaining a strong capital position in excess of the well-capitalized standards set by our banking regulators to support our current operations and future growth. The FDIC’s requirement for a “well-capitalized” bank is a total risk-based capital ratio of 10.0% or greater. As of December 31, 2015 our total risk-based capital ratio was 12.88%.

 

·Increasing our focus on commercial lending and continuing to expand commercial banking operations. We will continue to focus on commercial lending and the origination of commercial loans using prudent lending standards. We plan to continue to grow our commercial lending portfolio, while enhancing our complementary business products and services.

 

·Continuing to focus on residential and consumer lending in conjunction with our secondary market residential lending program. We offer traditional residential and consumer lending products and plan to continue to build a strong residential and consumer lending program that supports our secondary market residential lending program. Under our expanding secondary market residential lending program, we may sell a portion of our fixed rate residential originations while retaining the loan servicing function and mitigating our interest rate risk.

 

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·Maintaining asset quality and prudent lending standards. We will continue to originate all loans utilizing prudent lending standards in an effort to maintain strong asset quality. While our delinquencies and charge-offs have decreased, we continue to diligently manage our collection function to minimize loan losses and non-performing assets. We will continue to employ sound risk management practices as we continue to expand our lending portfolio.

 

·Expanding our existing products and services and developing new products and services to meet the changing needs of consumers and businesses in our market area. We will continue to evaluate our consumer and business customers’ needs to ensure that we continue to offer relevant, up-to-date products and services.

 

·Continue expansion through de novo branching. We recently expanded into western Massachusetts opening two de novo branches in the fourth quarter of 2015 and plan to open two de novo branches in Connecticut in 2016.

 

·Continuing to control non-interest expenses. As part of our strategic plan, we have implemented several programs designed to control costs. We monitor our expense ratios and plan to reduce our efficiency ratio by controlling expenses and increasing net interest income and noninterest income. We plan to continue to evaluate and improve the effectiveness of our business processes and our efficiency, utilizing information technology when possible.

 

·Taking advantage of acquisition opportunities that are consistent with our strategic growth plans. We intend to continue to evaluate opportunities to acquire other financial institutions and financial service related businesses in our current market area or contiguous market areas that will enable us to enhance our existing products and services and develop new products and services. We have no specific plans, agreements or understandings with respect to any expansion or acquisition opportunities.

 

Critical Accounting Policies

 

The accounting policies followed by us conform with the accounting principles generally accepted in the United States of America. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policies, which involve the most complex subjective decisions or assessments, relate to allowance for loan losses, other-than-temporary impairment of investment securities, income taxes and pension and other post-retirement benefits. The following is a description of our critical accounting policies and an explanation of the methods and assumptions underlying their application.

 

Allowance for Loan Losses: The allowance for loan losses is maintained at a level believed adequate by management to absorb potential losses inherent in the loan portfolio as of the statement of condition date. The allowance for loan losses consists of a formula allowance following FASB ASC 450 – “Contingencies” and FASB ASC 310 – “Receivables”. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a quarterly basis by management. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, allocated and unallocated components, as further described below. All reserves are available to cover any losses regardless of how they are allocated.

 

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General component:

 

The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, construction, installment, commercial, collateral, home equity line of credit, demand, revolving credit and resort. Construction loans include classes for commercial investment real estate construction, commercial owner occupied construction, residential development, residential subdivision construction and residential owner occupied construction loans. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies and nonaccrual loans; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no material changes in the Company’s policies or methodology pertaining to the general component of the allowance for loan losses during the year ended December 31, 2015.

 

The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

 

Residential real estate – Residential real estate loans are generally originated in amounts up to 95.0% of the lesser of the appraised value or purchase price of the property, with private mortgage insurance required on loans with a loan-to-value ratio in excess of 80.0%. The Company does not grant subprime loans. All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. All residential mortgage loans are underwritten pursuant to secondary market underwriting guidelines which include minimum FICO standards. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.

 

Commercial real estate – Loans in this segment are primarily income-producing properties throughout the northeastern states. The underlying cash flows generated by the properties may be adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, may have an effect on the credit quality in this segment. Management generally obtains rent rolls and other financial information, as appropriate on an annual basis and continually monitors the cash flows of these loans.

 

Construction loans – Loans in this segment include commercial construction loans, real estate subdivision development loans to developers, licensed contractors and builders for the construction and development of commercial real estate projects and residential properties. Construction lending contains a unique risk characteristic as loans are originated under market and economic conditions that may change between the time of origination and the completion and subsequent purchaser financing of the property. In addition, construction subdivision loans and commercial and residential construction loans to contractors and developers entail additional risks as compared to single-family residential mortgage lending to owner-occupants. These loans typically involve large loan balances concentrated in single borrowers or groups of related borrowers. Real estate subdivision development loans to developers, licensed contractors and builders are generally speculative real estate development loans for which payment is derived from sale of the property. Credit risk may be affected by cost overruns, time to sell at an adequate price, and market conditions. Construction financing is generally considered to involve a higher degree of credit risk than longer-term financing on improved, owner-occupied real estate. Residential construction credit quality may be impacted by the overall health of the economy, including unemployment rates and housing prices.

 

Commercial – Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.

 

Home equity line of credit – Loans in this segment include home equity loans and lines of credit underwritten with a loan-to-value ratio generally limited to no more than 80%, including any first mortgage. Our home equity lines of credit have ten-year terms and adjustable rates of interest which are indexed to the prime rate. The overall health of the economy, including unemployment rates and housing prices, may have an effect on the credit quality in this segment.

 

Installment, Collateral, Demand, Revolving Credit and Resort – Loans in these segments include loans principally to customers residing in our primary market area with acceptable credit ratings. Our installment and collateral consumer loans generally consist of loans on new and used automobiles, loans collateralized by deposit accounts and unsecured personal loans. The overall health of the economy, including unemployment rates and housing prices, may have an effect on the credit quality in this segment. Excluding collateral loans which are fully collateralized by a deposit account, repayment for loans in these segments is dependent on the credit quality of the individual borrower. The resort portfolio consists of a direct receivable loan outside the Northeast which is amortizing to its contractual obligations. The Company has exited the resort financing market with a residual portfolio remaining.

 

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Allocated component:

 

The allocated component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis for commercial real estate, construction, commercial and resort loans by the present value of expected cash flows discounted at the effective interest rate; the fair value of the collateral, if applicable; or the observable market price for the loan. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan. The Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement or they are nonaccrual loans with outstanding balances greater than $100,000.

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. Management updates the analysis quarterly. The assumptions used in appraisals are reviewed for appropriateness. Updated appraisals or valuations are obtained as needed or adjusted to reflect the estimated decline in the fair value based upon current market conditions for comparable properties.

 

The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring ("TDR"). All TDRs are classified as impaired.

 

Unallocated component:

 

An unallocated component is maintained, when needed, to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio. The Company’s Loan Policy allows management to utilize a high and low range of 0.0% to 5.0% of our total allowance for loan losses when establishing an unallocated allowance, when considered necessary. The unallocated allowance is used to provide for an unidentified loss that may exist in emerging problem loans that cannot be fully quantified or may be affected by conditions not fully understood as of the balance sheet date. There was no unallocated allowance at December 31, 2015 and 2014.

 

Other-than-Temporary Impairment of Securities: In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“FASB ASC”) 320-Debt and Equity Securities, a decline in market value of a debt security below amortized cost that is deemed other-than-temporary is charged to earnings for the credit related other-than-temporary impairment (“OTTI”) resulting in the establishment of a new cost basis for the security, while the non-credit related OTTI is recognized in other comprehensive income if there is no intent or requirement to sell the security. Management reviews the securities portfolio on a quarterly basis for the presence of OTTI. An assessment is made as to whether the decline in value results from company-specific events, industry developments, general economic conditions, credit losses on debt or other reasons. After the reasons for the decline are identified, further judgments are required as to whether those conditions are likely to reverse and, if so, whether that reversal is likely to result in a recovery of the fair value of the investment in the near term. If it is judged not to be near-term, a charge is taken which results in a new cost basis. Credit related OTTI for debt securities is recognized in earnings while non-credit related OTTI is recognized in other comprehensive income if there is no intent to sell or will not be required to sell the security. If an equity security is deemed other-than-temporarily impaired, the full impairment is considered to be credit-related and a charge to earnings would be recorded. Management believes the policy for evaluating securities for other-than-temporary impairment is critical because it involves significant judgments by management and could have a material impact on our net income.

 

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Gains and losses on sales of securities are recognized at the time of sale on a specific identification basis. Marketable equity and debt securities are classified as either trading, available-for-sale, or held-to-maturity (applies only to debt securities). Management determines the appropriate classifications of securities at the time of purchase. At December 31, 2015 and 2014, we had no debt or equity securities classified as trading. Held-to-maturity securities are debt securities for which we have the ability and intent to hold until maturity. All other securities not included in held-to-maturity are classified as available-for-sale. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Available-for-sale securities are recorded at fair value. Unrealized gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported in accumulated other comprehensive income, a separate component of equity, until realized.

 

Premiums and discounts on debt securities are amortized or accreted into interest income over the term of the securities using the level yield method.

 

Income Taxes: Deferred income taxes are provided for differences arising in the timing of income and expenses for financial reporting and for income tax purposes. Deferred income taxes and tax benefits 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 basis. 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. The Company provides a deferred tax asset valuation allowance for the estimated future tax effects attributable to temporary differences and carryforwards when realization is determined not to be more likely than not.

 

FASB ASC 740-10 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. Pursuant to FASB ASC 740-10, the Company examines its financial statements, its income tax provision and its federal and state income tax returns and analyzes its tax positions, including permanent and temporary differences, as well as the major components of income and expense to determine whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. The Company recognizes interest and penalties arising from income tax settlements as part of its provision for income taxes.

 

As part of the Plan of Conversion and Reorganization completed on June 29, 2011, the Company contributed shares of Company common stock to the Farmington Bank Community Foundation, Inc. This contribution resulted in a charitable contribution deduction for federal income tax purposes. Use of that charitable contribution deduction is limited under Federal tax law to 10% of federal taxable income without regard to charitable contributions, net operating losses, and dividend received deductions. Annually, a corporation is permitted to carry over to the five succeeding tax years, contributions that exceeded the 10% limitation, but also subject to the maximum annual limitation. As a result, approximately $4.3 million of charitable contribution carryforward remains at December 31, 2015 resulting in a deferred tax asset of approximately $1.5 million. The Company believes it is more likely than not that this carryforward will not be fully utilized before expiration in 2016. Therefore, a valuation allowance has been recorded against this deferred tax asset. Some of this charitable contribution carryforward would likely expire unutilized if the Company does not generate sufficient taxable income over the next year. The Company monitors the need for a valuation allowance on a quarterly basis.

 

In December 1999, we created and have since maintained a “passive investment company” (“PIC”), as permitted by Connecticut law. At December 31, 2015 there were no material uncertain tax positions related to federal and state income tax matters. We are currently open to audit under the statute of limitations by the Internal Revenue Service and state taxing authorities for the years ended December 31, 2011 through 2014. If the state taxing authority were to determine that the PIC was not in compliance with statutory requirements, a material amount of taxes could be due.

 

As of December 31, 2015, management believes it is more likely than not that the deferred tax assets will be realized through future reversals of existing taxable temporary differences and future taxable income. At December 31, 2015, our net deferred tax asset was $15.4 million with a $771,000 valuation allowance.

 

Pension and Other Postretirement Benefits: The Company’s non-contributory defined-benefit pension plan and certain defined benefit postretirement plans were frozen as of February 28, 2013 and no additional benefits will accrue.

 

The Company has a non-contributory defined benefit pension plan that provides benefits for substantially all employees hired before January 1, 2007 who meet certain requirements as to age and length of service. The benefits are based on years of service and average compensation, as defined in the Plan Document. The Company’s funding practice is to meet the minimum funding standards established by the Employee Retirement Income Security Act of 1974.

 

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In addition to providing pension benefits, we provide certain health care and life insurance benefits for retired employees. Participants or eligible employees hired before January 1, 1993 become eligible for the benefits if they retire after reaching age 62 with fifteen or more years of service. A fixed percent of annual costs are paid depending on length of service at retirement. The Company accrues for the estimated costs of these other post-retirement benefits through charges to expense during the years that employees render service. The Company makes contributions to cover the current benefits paid under this plan. The Company believes the policy for determining pension and other post-retirement benefit expenses is critical because judgments are required with respect to the appropriate discount rate, rate of return on assets and other items. The Company reviews and updates the assumptions annually. If the Company’s estimate of pension and post-retirement expense is too low it may experience higher expenses in the future, reducing its net income. If the Company’s estimate is too high, it may experience lower expenses in the future, increasing its net income.

 

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Comparison of Financial Condition at December 31, 2015 and December 31, 2014

 

Our total assets increased $223.2 million or 9.0%, to $2.7 billion at December 31, 2015, from $2.5 billion at December 31, 2014, primarily due to an increase of $221.7 million in net loans.

 

Our investment portfolio totaled $164.7 million or 6.1% of total assets, and $204.3 million or 8.2% of total assets at December 31, 2015 and 2014, respectively. Available-for-sale investment securities totaled $132.4 million at December 31, 2015 compared to $188.0 million at December 31, 2014. Securities held-to-maturity increased $16.0 million to $32.2 million at December 31, 2015 from $16.2 million at December 31, 2014 as a result of purchasing U.S. Government agency obligations and U.S. Government sponsored residential mortgage-backed securities. The Company purchases short term U.S. Treasury and agency securities in order to meet municipal and repurchase agreement pledge requirements and to minimize interest rate risk during the sustained low interest rate environment.

 

Net loans increased $221.7 million or 10.5% at December 31, 2015 to $2.3 billion compared to December 31, 2014 primarily driven by increases in commercial loans, commercial real estate and residential real estate, which combined, increased $244.9 million, offset by a $26.5 million decrease in construction real estate. The allowance for loan losses increased $1.2 million or 6.5% to $20.2 million at December 31, 2015 from $19.0 million at December 31, 2014. At December 31, 2015, the allowance for loan losses represented 0.86% of total loans and 135.44% of non-performing loans, compared to 0.89% of total loans and 122.58% of non-performing loans as of December 31, 2014.

 

Total liabilities increased $212.0 million, or 9.4%, to $2.5 billion at December 31, 2015 compared to $2.3 billion at December 31, 2014, primarily due to increases in deposits. Deposits increased $258.3 million or 14.9% to $2.0 billion at December 31, 2015 which includes increases in interest-bearing deposits of $187.5 million and increases in non-interest bearing deposits of $70.9 million due to our continued efforts to obtain more individual, commercial and municipal account relationships. Federal Home Loan Bank of Boston advances decreased $24.1 million to $377.6 million at December 31, 2015 from $401.7 million at December 31, 2014 due to our increased deposits funding our organic loan and securities growth.

 

Stockholders’ equity increased $11.2 million to $245.7 million compared to December 31, 2014 primarily due to $12.6 million in net income and $3.1 million in share based compensation offset by the repurchase of 147,020 shares of common stock at an average price per share of $14.97 at a cost of $2.2 million and a $651,000 increase in other comprehensive loss. The Company paid cash dividends totaling $3.3 million or $0.22 per share during the year ended December 31, 2015. Repurchased shares are held as treasury stock and are available for general corporate purposes.

 

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Net Interest Income Analysis: Average Balance Sheets, Interest and Yields/Costs

 

The following tables present the average balance sheets, average yields and costs and certain other information for the periods indicated therein on a fully tax-equivalent basis. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero percent yield. Loans held for sale average balance are included in loans average balance. The yields set forth below include the effect of net deferred costs and premiums that are amortized to interest income or expense.

 

   For The Years Ended December 31, 
   2015   2014   2013 
   Average Balance   Interest and
Dividends (1)
   Yield/Cost   Average Balance   Interest and
Dividends (1)
   Yield/Cost   Average Balance   Interest and
Dividends (1)
   Yield/Cost 
(Dollars in thousands)                                    
Interest-earning assets:                                             
Loans  $2,279,418   $81,177    3.56%  $1,962,239   $71,967    3.67%  $1,647,517   $62,136    3.77%
Securities   188,004    1,832    0.97%   181,317    1,429    0.79%   129,977    927    0.71%
Federal Home Loan Bank of Boston stock   21,187    522    2.46%   15,911    208    1.31%   8,981    33    0.37%
Federal funds and other earning assets   11,947    26    0.22%   4,947    15    0.30%   8,398    15    0.18%
Total interest-earning assets   2,500,556    83,557    3.34%   2,164,414    73,619    3.40%   1,794,873    63,111    3.52%
Noninterest-earning assets   119,857              105,474              105,279           
Total assets  $2,620,413             $2,269,888             $1,900,152           
                                              
Interest-bearing liabilities:                                             
NOW accounts  $472,644   $1,351    0.29%  $380,936   $976    0.26%  $277,698   $638    0.23%
Money market   453,017    3,592    0.79%   420,456    3,112    0.74%   362,914    2,878    0.79%
Savings accounts   213,383    226    0.11%   200,948    205    0.10%   182,952    206    0.11%
Certificates of deposit   407,071    4,203    1.03%   338,590    3,076    0.91%   353,677    3,460    0.98%
Total interest-bearing deposits   1,546,115    9,372    0.61%   1,340,930    7,369    0.55%   1,177,241    7,182    0.61%
Federal Home Loan Bank of Boston advances   356,539    3,449    0.97%   260,432    1,841    0.71%   98,486    1,651    1.68%
Repurchase agreement borrowings   12,629    448    3.55%   21,000    719    3.42%   21,000    713    3.40%
Repurchase liabilities   54,600    106    0.19%   60,082    151    0.25%   56,891    187    0.33%
Total interest-bearing liabilities   1,969,883    13,375    0.68%   1,682,444    10,080    0.60%   1,353,618    9,733    0.72%
Noninterest-bearing deposits   357,156              315,177              266,217           
Other noninterest-bearing liabilities   51,312              37,909              44,532           
Total liabilities   2,378,351              2,035,530              1,664,367           
Stockholders' equity   242,062              234,358              235,785           
Total liabilities and stockholders' equity  $2,620,413             $2,269,888             $1,900,152           
                                              
Tax-equivalent net interest income       $70,182             $63,539             $53,378      
Less: tax-equivalent adjustment        (1,673)             (845)             (225)     
Net interest income       $68,509             $62,694             $53,153      
                                              
Net interest rate spread (2)             2.66%             2.80%             2.80%
Net interest-earning assets (3)  $530,673             $481,970             $441,255           
Net interest margin (4)             2.81%             2.94%             2.97%
Average interest-earning assets to average interest-bearing liabilities        126.94%             128.65%             132.60%     

 

(1) On a fully-tax equivalent basis.

(2) Net interest rate spread represents the difference between the yield on average interest-earning assets and the

cost of average interest-bearing liabilities.

(3) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(4) Net interest margin represents tax-equivalent net interest income divided by average total interest-earning assets.

 

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Rate Volume Analysis

 

The following table sets forth the effects of changing rates and volumes on tax-equivalent net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the volume and rate columns. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

 

   2015 vs. 2014   2014 vs. 2013 
   Increase (decrease) due to   Increase (decrease) due to 
(Dollars in thousands)  Volume   Rate   Total   Volume   Rate   Total 
Interest-earning assets:                              
Loans  $11,347   $(2,137)  $9,210   $11,584   $(1,753)  $9,831 
Securities   54    349    403    397    105    502 
Federal Home Loan Bank of Boston stock   86    228    314    41    134    175 
Federal funds and other earning assets   16    (5)   11    (8)   8    - 
Total interest-earning assets   11,503    (1,565)   9,938    12,014    (1,506)   10,508 
                               
Interest-bearing liabilities:                              
NOW accounts   253    122    375    258    80    338 
Money market   250    230    480    435    (201)   234 
Savings accounts   13    8    21    19    (20)   (1)
Certificates of deposit   673    454    1,127    (144)   (240)   (384)
Total interest-bearing deposits   1,189    814    2,003    568    (381)   187 
Federal Home Loan Bank of Boston advances   805    803    1,608    1,553    (1,363)   190 
Repurchase agreement borrowing   (296)   25    (271)   -    6    6 
Repurchase liabilities   (13)   (32)   (45)   10    (46)   (36)
Total interest-bearing liabilities   1,685    1,610    3,295    2,131    (1,784)   347 
Increase (decrease) in net interest income  $9,818   $(3,175)  $6,643   $9,883   $278   $10,161 

 

Summary of Operating Results for the Years Ended December 31, 2015 and 2014

 

The following discussion provides a summary and comparison of our operating results for the years ended December 31, 2015 and 2014:

 

   For the Year Ended December 31, 
   2015   2014   $ Change   % Change 
(Dollars in thousands)                    
Net interest income  $68,509   $62,694   $5,815    9.3%
Provision for loan losses   2,440    2,588    (148)   (5.7)
Noninterest income   13,447    9,104    4,343    47.7 
Noninterest expense   61,210    57,048    4,162    7.3 
Income before taxes   18,306    12,162    6,144    50.5 
Income tax expense   5,727    2,827    2,900    102.6 
Net income  $12,579   $9,335   $3,244    34.8%

 

For the year ended December 31, 2015, net income increased $3.2 million compared to the year ended December 31, 2014. The increase in net income was driven by an increase in net interest income due to organic loan growth and an increase in noninterest income, offset by an increase in noninterest expense and an increase in income tax expense.

 

Comparison of Operating Results for the Years Ended December 31, 2015 and 2014

 

Our results of operations depend primarily on net interest income, which is the difference between the interest income on earning assets, such as loans and investments, and the interest expense incurred on interest-bearing liabilities, such as deposits and borrowings. We also generate noninterest income; including service charges on deposit accounts, gain on sale of securities, income from mortgage banking activities, bank-owned life insurance income, brokerage fees, insurance commissions and other miscellaneous fees. Our noninterest expense primarily consists of salary and employee benefits, occupancy expense, furniture and equipment expenses, FDIC assessments, marketing and other general and administrative expenses. Our results of operations are also affected by our provision for loan losses.

 

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Net Interest Income: Net interest income is determined by the interest rate spread (i.e., the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income before the provision for loan losses was $68.5 million and $62.7 million for the years ended December 31, 2015 and December 31, 2014, respectively. Net interest income increased primarily due to a $317.2 million increase in the average loan balance offset by a $3.3 million increase in interest expense. The yield on average interest-earning assets decreased 6 basis points to 3.34% for the year ended 2015 from 3.40% for the year ended 2014. The decline was primarily due to an 11 basis point decrease in the yield on total average net loans to 3.56% due to a low interest rate environment. The cost of average interest-bearing liabilities increased 8 basis points to 0.68% for the year ended 2015. The increase was primarily due to money market and certificate of deposit promotions and a 26 basis point increase in the average cost of Federal Home Loan Bank of Boston borrowings. Net interest margin decreased to 2.81% for the year ended 2015 compared to 2.94% for the year ended 2014.

 

Interest expense increased $3.3 million to $13.4 million for the year ended 2015 compared to $10.1 million for the year ended 2014. The cost of interest-bearing liabilities increased 8 basis points to 68 basis points for the year ended 2015 compared to 60 basis points for the year ended 2014. The increase was primarily due to money market and certificate of deposit promotions and a 26 basis point increase in the average cost of Federal Home Loan Bank of Boston borrowings.

 

Provision for Loan Losses:  The allowance for loan losses is maintained at a level management determines to be appropriate to absorb estimated credit losses that are both probable and reasonably estimable at the dates of the financial statements. Management evaluates the adequacy of the allowance for loan losses on a quarterly basis and charges any provision for loan losses needed to current operations. The assessment considers historical loss experience, historical and current delinquency statistics, the loan portfolio segment and the amount of loans in the loan portfolio, the financial strength of the borrowers, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions and other credit quality indicators.

 

Management recorded a provision for loan losses of $2.4 million and $2.6 million for the years ended December 31, 2015 and 2014, respectively. The provision recorded is based upon management’s analysis of the allowance for loan losses necessary to absorb the estimated credit losses in the loan portfolio for the period. Net charge-offs for the year ended 2015 were $1.2 million or 0.05% to average loans compared to $1.9 million or 0.10% to average loans for the year ended 2014.

 

At December 31, 2015, the allowance for loan losses represented 0.86% of total loans and 135.44% of non-accrual loans, compared to 0.89% of total loans and 122.58% of non-accrual loans at December 31, 2014.

 

Noninterest Income: Sources of noninterest income primarily include service charges on deposit accounts, gain on sale of securities, mortgage banking activities, bank-owned life insurance income, brokerage fees, insurance commissions and other miscellaneous fees.

 

The following table summarizes noninterest income for the years ended December 31, 2015 and 2014:

 

   For the Year Ended December 31, 
   2015   2014   $ Change   % Change 
(Dollars in thousands)                    
Fees for customer services  $5,975   $5,488   $487    8.9%
Gain on sales of investments   1,523    -    1,523    100.0 
Net gain on loans sold   2,492    1,419    1,073    75.6 
Brokerage and insurance fee income   215    192    23    12.0 
Bank owned life insurance income   1,672    1,130    542    48.0 
Other   1,570    875    695    79.4 
Total noninterest income  $13,447   $9,104   $4,343    47.7%

 

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Noninterest income increased $4.3 million to $13.4 million for the year ended 2015 compared to the year ended 2014. Fees for customer services increased $487,000 to $6.0 million for the year ended 2015 compared to the year ended 2014 driven by our growth in checking accounts and debit card fees. Gain on sale of investments was $1.5 million for the year ended 2015 due to the sale of trust preferred securities. There was no gain on sale of investments for the year ended 2014. Net gain on loans sold increased $1.1 million to $2.5 million for the year ended 2015 compared to the year ended 2014 as a result of an increase in volume of loans sold. Bank owned life insurance income increased $542,000 to $1.7 million for the year ended 2015 compared to the year ended 2014 primarily due to a $10.0 million purchase of bank owned life insurance and $379,000 in bank owned life insurance proceeds in 2015. Other income increased $695,000 to $1.6 million for the year ended 2015 compared to the year ended 2014 primarily due to a $709,000 increase in swap fee income.

 

Noninterest Expense: The following table summarizes noninterest expense for the years ended December 31, 2015 and 2014:

 

   For the Year Ended December 31, 
   2015   2014   $ Change   % Change 
(Dollars in thousands)                    
Salaries and employee benefits  $36,855   $34,416   $2,439    7.1%
Occupancy expense   5,115    5,080    35    0.7 
Furniture and equipment expense   4,204    4,342    (138)   (3.2)
FDIC assessment   1,657    1,396    261    18.7 
Marketing   2,149    1,590    559    35.2 
Other operating expenses   11,230    10,224    1,006    9.8 
Total noninterest expense  $61,210   $57,048   $4,162    7.3%

 

Noninterest expense increased $4.2 million to $61.2 million for the year ended 2015 compared to $57.0 million for the year ended 2014. Salaries and employee benefits increased $2.4 million to $36.9 million for the year ended 2015 compared to the year ended 2014. The increase is primarily due to an increase in staff to support our compliance areas, our expansion into western Massachusetts and to maintain the Bank’s growth. Marketing increased $559,000 to $2.1 million for the year ended 2015 compared to the prior year primarily due to our expansion into western Massachusetts and an increase in premiums and giveaways to obtain new customers in the geographical areas we serve. Other operating expenses increased $1.0 million to $11.2 million for the year ended 2015 compared to the prior year primarily due to a $246,000 increase in service bureau fees and a general increase in office expenses to support the Bank’s growth.

 

Income Tax Expense: Income tax expense was $5.7 million for the year ended 2015 compared to $2.8 million for the year ended 2014. The increase in income tax expense for the year ended 2015 was primarily due to a $771,000 valuation allowance related to a deferred tax asset associated with the establishment of the Bank’s foundation in 2011 and a $6.1 million increase in income before taxes. The income tax expense for the year ended 2014 was also lower by $441,000 due to adjusting the tax rate on our deferred tax assets from 34% to 35%.

 

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

 

The following discussion provides a summary and comparison of our operating results for the years ended December 31, 2014 and 2013:

 

   For the Year Ended December 31, 
   2014   2013   $ Change   % Change 
(Dollars in thousands)                    
Net interest income  $62,694   $53,153   $9,541    18.0%
Provision for loan losses   2,588    1,530    1,058    69.2 
Noninterest income   9,104    11,012    (1,908)   (17.3)
Noninterest expense   57,048    57,762    (714)   (1.2)
Income before taxes   12,162    4,873    7,289    149.6 
Income tax expense   2,827    1,169    1,658    141.8 
Net income  $9,335   $3,704   $5,631    152.0%

 

For the year ended December 31, 2014, net income increased $5.6 million compared to the year ended December 31, 2013. The increase in net income was driven by an increase in net interest income due to organic loan growth, offset by a decrease in noninterest income and increases in the provision for loan losses and income tax expense.

 

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