The Company may be required, from time to time, to measure certain other financial assets on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets:
Other-Than-Temporary Impairment of Securities. One of the significant estimates related to investment securities is the evaluation of other-than-temporary impairments. The evaluation of securities for other-than- temporary impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period of unrealized losses. Securities that are in an unrealized loss position are reviewed at least quarterly to determine if other-than-temporary impairment is present based on certain quantitative and qualitative factors and measures. The primary factors considered in evaluating whether a decline in value of securities is other-than-temporary include: (a) the length of time and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments, (d) the volatility of the securities market price, (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred, including the expectation of receipt of all principal and interest due.
Mortgage Servicing Rights. The valuation of mortgage servicing rights is a critical accounting policy which requires significant estimates and assumptions. The Company often sells mortgage loans it originates and retains the ongoing servicing of such loans, receiving a fee for these services, generally 1% of the outstanding balance of the loan per annum. Mortgage servicing rights are recognized when they are acquired through the sale of loans, and are reported in other assets. They are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Management uses an independent firm which specializes in the valuation of mortgage servicing rights to determine the fair value. The Company uses the amortization method for financial reporting. The most important assumption is the anticipated loan prepayment rate, and increases in prepayment speeds result in lower valuations of mortgage servicing rights. Management evaluates for impairment based upon the fair value of the rights, which can vary depending upon current interest rates and prepayment expectations, as compared to amortized cost. The use of different assumptions could produce a different valuation. All of the assumptions are based on standards the Company believes would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources.
Valuation of Other Real Estate Owned (“OREO”). Periodically, we acquire property through foreclosure or acceptance of a deed in lieu-of-foreclosure as OREO. OREO is recorded at fair value less costs to sell. The valuation of this property is accounted for individually based on its net realizable value on the date of acquisition. At the acquisition date, if the net realizable value of the property is less than the book value of the loan, a charge or reduction in the allowance for loan losses is recorded. If the value of the property becomes subsequently impaired, as determined by an appraisal or an evaluation in accordance with our appraisal policy, we will record the decline by a charge against current earnings. Upon acquisition of a property, a current appraisal or broker’s opinion must substantiate market value for the property.
Comparison of Financial Condition at September 30, 2012 and December 31, 2011
Total assets decreased $8.3 million, or 1.4%, from $616.3 million at December 31, 2011 to $608.0 million at September 30, 2012. The decrease in total assets was primarily due to a decrease in investments of $11.7 million, or 15.8%, and a decrease in cash and cash equivalents of $19.6 million, or 32.1%, partially offset by the increase in net loans of $25.0 million, or 5.6%, from $443.5 million, or 72.0% of total assets at December 31, 2011 to $468.5 million, or 77.1% of total assets at September 30, 2012.
The Company’s net loan portfolio increased $25.0 million, or 5.6%, during the first nine months of 2012. The significant components of the increase in net loans was an increase of $7.1 million, or 19.0%, in construction loans, an increase of $10.9 million, or 6.2%, in commercial real estate loans and an increase of $6.3 million, or 7.9%, in commercial and industrial loans. These increases were partially offset by a decrease of $1.3 million, or 1.0%, in one-to-four-family residential real estate loans. The increase in construction loans was due to the $7.2 million, or 22.6%, increase in the commercial construction portfolio to existing commercial relationships for the expansion of their facilities. Upon completion, these loans will be transferred to the commercial real estate portfolio. The decrease in one-to-four-family residential real estate loans was primarily due to prepayments and refinancing activity attributed to the historically low interest rates. In accordance with the Company’s asset/liability management strategy and in an effort to reduce interest rate risk, the Company continues to sell fixed rate, low coupon residential real estate loans to the secondary market. During the first nine months of 2012, the Company sold $15.9 million in low coupon residential real estate loans and currently services $84.6 million in loans sold to the secondary market. In order to service our customers, the servicing rights will continue to be retained on all loans written and sold in the secondary market.
The investment securities portfolio, including held to maturity and available for sale securities, decreased $11.7 million, or 15.8%, to $62.9 million at September 30, 2012 from $74.5 million at December 31, 2011. The decrease in investments was primarily due to a decrease of $11.3 million, or 41.8%, in U.S. Treasuries and a decrease of $3.0 million, or 22.5%, in certificates of deposit. These decreases were partially offset by an increase in tax-exempt bonds from $31.6 million at September 30, 2011 to $35.1 million at September 30, 2012.
Total deposits increased $21.7 million, or 4.8%, to $475.1 million at September 30, 2012 from $453.4 million at December 31, 2011. Core deposits increased $48.2 million, or 20.1%, from $240.3 million, or 53.0% of total deposits, at December 31, 2011 to $288.5 million, or 60.7% of total deposits, at September 30, 2012. Money market accounts increased $28.4 million, or 29.1%, to $126.0 million, regular savings accounts increased $2.2 million, or 4.7%, to $49.3 million, demand deposits increased $9.8 million, or 14.2%, to $78.6 million, and NOW accounts increased $7.8 million, or 29.2%, to $34.6 million. These increases were offset by a decrease in certificates of deposit of $26.4 million, or 12.4%, to $186.7 million. The decrease in certificates of deposits was mainly attributed to management’s strategic run-off of high cost accounts by allowing higher cost, short-term time deposits to mature without renewals.
Stockholders’ equity decreased $1.5 million, or 1.6%, from $90.7 million, or 14.7% of total assets, at December 31, 2011 to $89.3 million, or 14.7% of total assets, at September 30, 2012. The decrease of $1.5 million, or 1.6%, in stockholders’ equity was primarily due to the repurchase of the Company’s stock at a cost of $3.9 million, partially offset by an increase in stock-based compensation of $750,000 or 15.9%, and a decrease in additional paid-in-capital due to the exercise of stock options of $181,000, and net income of $1.5 million. Pursuant to the Company’s Stock Repurchase Programs previously announced, in the first nine months of 2012, the Company repurchased 275,209 shares of Company stock at an average price per share of $14.17. The Company’s book value per share increased $0.52, or 3.3%, from $15.83 at December 31, 2011 to $16.35 at September 30, 2012.
Allowance for Loan LossesLoans are placed on nonaccrual status either when reasonable doubt exists as to the timely collection of principal and interest or when a loan becomes 90 days past due unless an evaluation clearly indicates that the loan is well-secured and in the process of collection. At September 30, 2012, there were no loans that were over 90 days delinquent and still accruing interest.
As of September 30, 2012, nonperforming loans decreased $1.2 million, or 25.1%, to $3.5 million compared to $4.7 million as of December 31, 2011. The decrease in nonperforming loans is primarily due to the decrease in nonperforming residential real estate loans of $787,000, or 35.4%, a decrease of $739,000, or 56.6%, in nonperforming commercial and industrial loans, a decrease of $83,000, or 27.1%, in nonperforming home equity loans, and a decrease of $29,000, or 36.7%, in nonperforming consumer loans. These decreases were partially offset by an increase of $123,000, or 15.4%, in nonperforming commercial real estate loans, and an increase of $331,000, in nonperforming construction loans. Loans that are less than 90 days past due and were previously on nonaccrual continue to be on nonaccrual status until the borrower can demonstrate their ability to make payments according to their loan terms. The following loan segments were not accruing interest as of September 30, 2012: 12 residential real estate loans with an outstanding balance of $1.4 million, one construction loan with an outstanding balance of $331,000, four commercial real estate loans with an outstanding balance of $921,000, seven commercial loans with an outstanding balance of $567,000, two consumer loans with an outstanding balance of $50,000 and four home equity loans with an outstanding balance of $223,000.
Deposits
The following table sets forth the Company’s deposit accounts at the dates indicated:
| | | September 30, 2012 | | | December 31, 2011 | |
| | | Balance | | | Percent of Total Deposits | | | Balance | | | Percent of Total Deposits | |
| | | | | | (Dollars In Thousands) | | | | |
| | | | | | | | | | | | | |
| Demand deposits | | $ | 78,563 | | | | 16.5 | % | | $ | 68,799 | | | | 15.2 | % |
| NOW accounts | | | 34,563 | | | | 7.3 | % | | | 26,747 | | | | 5.9 | % |
| Savings accounts | | | 49,345 | | | | 10.4 | % | | | 47,122 | | | | 10.4 | % |
| Money market deposit accounts | | | 125,983 | | | | 26.5 | % | | | 97,606 | | | | 21.5 | % |
| Total transaction accounts | | | 288,454 | | | | 60.7 | % | | | 240,274 | | | | 53.0 | % |
| Certificates of deposit | | | 186,655 | | | | 39.3 | % | | | 213,103 | | | | 47.0 | % |
| Total deposits | | $ | 475,109 | | | | 100.0 | % | | $ | 453,377 | | | | 100.0 | % |
Total deposits increased $21.7 million, or 4.8%, to $475.1 million at September 30, 2012 from $453.4 million at December 31, 2011. Core deposits increased $48.2 million, or 20.1%, from $240.3 million, or 53.0% of total deposits, at December 31, 2011 to $288.5 million, or 60.7% of total deposits, at September 30, 2012. Money market accounts increased $28.4 million, or 29.1%, to $126.0 million, regular savings accounts increased $2.2 million, or 4.7%, to $49.3 million, demand deposits increased $9.8 million, or 14.2%, to $78.6 million, and NOW accounts increased $7.8 million, or 29.2%, to $34.6 million. These increases were offset by a decrease in certificates of deposit of $26.4 million, or 12.4%, to $186.7 million, or 39.3% of total deposits. The decrease in certificates of deposits was mainly attributed to management’s strategic run-off of high cost accounts by allowing higher cost, short-term time deposits to mature without renewals.
Borrowings
The following sets forth information concerning our borrowings for the periods indicated:
| | | September 30, | | | December 31, | |
| | | 2012 | | | 2011 | |
| Maximum amount of borrowings outstanding at any month-end during the period: | | (In Thousands) | |
| FHLB advances | | $ | 58,308 | | | $ | 70,564 | |
| Securities sold under agreements to repurchase | | | 12,982 | | | | 24,560 | |
| Average borrowings outstanding during the period: | | | | | | | | |
| FHLB advances | | $ | 51,202 | | | $ | 64,777 | |
| Securities sold under agreements to repurchase | | | 9,283 | | | | 17,554 | |
| Weighted average interest rate during the period: | | | | | | | | |
| FHLB advances | | | 2.56 | % | | | 2.57 | % |
| Securities sold under agreements to repurchase | | | 0.16 | % | | | 0.21 | % |
| Balance outstanding at end of period: | | | | | | | | |
| FHLB advances | | $ | 35,635 | | | $ | 59,265 | |
| Securities sold under agreements to repurchase | | | 7,208 | | | | 12,340 | |
| Weighted average interest rate at end of period: | | | | | | | | |
| FHLB advances | | | 2.50 | % | | | 2.51 | % |
| Securities sold under agreements to repurchase | | | 0.12 | % | | | 0.18 | % |
We utilize borrowings from a variety of sources to supplement our supply of funds for loans and investments. FHLB advances decreased $23.6 million, or 39.9%, from $59.3 million at December 31, 2011 to $35.6 million at September 30, 2012 due to payments on long-term advances of $6.8 million, and maturities on long-term advances of $16.8 million. Securities sold under agreements to repurchase decreased $5.1 million, or 41.6%, to $7.2 million at September 30, 2012 primarily due to fluctuations in the balances of these accounts.
Comparison of Operating Results for the Three Months Ended September 30, 2012 and 2011
General
The Company reported net income for the three months ended September 30, 2012 of $623,000, or $0.12 earnings per share, compared to net income of $371,000, or $0.07 earnings per share, for the same period in 2011. The increase in net income for the three months ended September 30, 2012 compared to the three months ended September 30, 2011, was primarily due to an increase in net interest income of $209,000, or 4.6%, a decrease in the provision for loan losses of $54,000, or 24.2%, and a decrease in non-interest expense of $299,000, or 6.4%. These increases were partially offset by a decrease in non-interest income of $77,000, or 11.0%, and an increase in income tax expense of $233,000, or 582.5%.
Analysis of Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.
The following table sets forth average balances, interest income and expense and yields earned or rates paid on the major categories of assets and liabilities for the periods indicated. The average yields and costs are derived by dividing interest income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively. The yields and costs are annualized. Average balances are derived from average daily balances. The yields and costs include fees which are considered adjustments to yields. Loan interest and yield data does not include any accrued interest from non-accruing loans.
| | | For the Three Months Ended September 30, | |
| | | 2012 | | | 2011 | |
| | | | | | | | | Average | | | | | | | | | Average | |
| | | Average | | | | | | Yield/ | | | Average | | | | | | Yield/ | |
| | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| | | (Dollars in Thousands) | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Investments (1) | | $ | 65,681 | | | $ | 695 | | | | 4.21 | % | | $ | 72,220 | | | $ | 684 | | | | 3.76 | % |
| Loans: | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential real estate loans | | | 148,118 | | | | 1,752 | | | | 4.71 | % | | | 153,195 | | | | 1,915 | | | | 4.96 | % |
| Commercial real estate loans | | | 198,414 | | | | 2,675 | | | | 5.36 | % | | | 179,341 | | | | 2,615 | | | | 5.78 | % |
| Consumer loans | | | 33,818 | | | | 340 | | | | 4.00 | % | | | 32,440 | | | | 373 | | | | 4.56 | % |
| Commercial loans | | | 84,262 | | | | 893 | | | | 4.22 | % | | | 84,764 | | | | 898 | | | | 4.20 | % |
| Loans, net (2) | | | 464,612 | | | | 5,660 | | | | 4.85 | % | | | 449,740 | | | | 5,801 | | | | 5.12 | % |
| Other | | | 23,587 | | | | 15 | | | | 0.25 | % | | | 11,804 | | | | 6 | | | | 0.20 | % |
| Total interest-earning assets | | | 553,880 | | | | 6,370 | | | | 4.58 | % | | | 533,764 | | | | 6,491 | | | | 4.82 | % |
| Noninterest-earning assets | | | 42,122 | | | | | | | | | | | | 40,279 | | | | | | | | | |
Total assets | | $ | 596,002 | | | | | | | | | | | $ | 574,043 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Money market accounts | | $ | 116,318 | | | $ | 93 | | | | 0.32 | % | | $ | 77,729 | | | $ | 71 | | | | 0.36 | % |
| Savings accounts (3) | | | 49,185 | | | | 13 | | | | 0.11 | % | | | 46,853 | | | | 12 | | | | 0.10 | % |
| NOW accounts | | | 33,411 | | | | 93 | | | | 1.11 | % | | | 19,612 | | | | 26 | | | | 0.53 | % |
| Certificates of deposit | | | 193,539 | | | | 908 | | | | 1.87 | % | | | 209,393 | | | | 1,183 | | | | 2.24 | % |
| Total interest-bearing deposits | | | 392,453 | | | | 1,107 | | | | 1.12 | % | | | 353,587 | | | | 1,292 | | | | 1.45 | % |
| FHLB advances | | | 41,285 | | | | 264 | | | | 2.54 | % | | | 63,146 | | | | 414 | | | | 2.60 | % |
| Securities sold under agreement to | | | | | | | | | | | | | | | | | | | | | | | | |
| repurchase | | | 7,182 | | | | 2 | | | | 0.11 | % | | | 15,467 | | | | 8 | | | | 0.21 | % |
| Total interest-bearing borrowings | | | 48,467 | | | | 266 | | | | 2.18 | % | | | 78,613 | | | | 422 | | | | 2.13 | % |
| Total interest-bearing liabilities | | | 440,920 | | | | 1,373 | | | | 1.24 | % | | | 432,200 | | | | 1,714 | | | | 1.57 | % |
| Demand deposits | | | 65,208 | | | | | | | | | | | | 50,358 | | | | | | | | | |
| Other noninterest-bearing liabilities | | | 541 | | | | | | | | | | | | 443 | | | | | | | | | |
| Total liabilities | | | 506,669 | | | | | | | | | | | | 483,001 | | | | | | | | | |
| Total stockholders' equity | | | 89,333 | | | | | | | | | | | | 91,042 | | | | | | | | | |
| Total liabilities and stockholders' equity | | $ | 596,002 | | | | | | | | | | | $ | 574,043 | | | | | | | | | |
| Net interest-earning assets | | $ | 112,960 | | | | | | | | | | | $ | 101,564 | | | | | | | | | |
| Tax equivalent net interest income/ | | | | | | | | | | | | | | | | | | | | | | | | |
| interest rate spread (4) | | | | | | | 4,997 | | | | 3.34 | % | | | | | | | 4,777 | | | | 3.25 | % |
Tax equivalent net interest margin (net interest income as a percentage of interest-earning assets) | | | | 3.59 | % | | | | | | | | | | | 3.55 | % |
| Ratio of interest-earning assets | | | | | | | | | | | | | | | | | | | | | | | | |
| to interest-bearing liabilities | | | | | | | | | | | 125.62 | % | | | | | | | | | | | 123.50 | % |
| Less: tax equivalent adjustment (1) | | | | | | | (270 | ) | | | | | | | | | | | (259 | ) | | | | |
| Net interest income as reported on income statement | | | $ | 4,727 | | | | | | | | | | | $ | 4,518 | | | | | |
| (1) | Municipal securities income and net interest income are presented on a tax equivalent basis using a tax rate of 41%. |
| | The tax equivalent adjustment is deducted from the tax equivalent net interest income to agree to the amount reported |
| | on the statement of income. See 'Explanation of Use of Non-GAAP Financial Measurements'. |
| (2) | Loans, net excludes loans held for sale and the allowance for loan losses and includes nonperforming loans. |
| (3) | Savings accounts include mortgagors' escrow deposits. |
| (4) | Tax equivalent interest rate spread represents the difference between the weighted average yield on interest-earning |
| | assets and the weighted average cost of interest-bearing liabilities. See 'Explanation of Use of Non-GAAP Financial Measurements'. |
The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's tax equivalent interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
| | | Three Months Ended September 30, | |
| | | 2012 compared to 2011 | |
| | | Increase (Decrease) | |
| | | Due to | |
| | | Volume | | | Rate | | | Net | |
| | | (Dollars in Thousands) | |
| | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | |
| Investment securities (1) | | $ | (205 | ) | | $ | 216 | | | $ | 11 | |
| Loans: | | | | | | | | | | | | |
| Residential real estate loans | | | (64 | ) | | | (99 | ) | | | (163 | ) |
| Commercial real estate loans | | | 709 | | | | (649 | ) | | | 60 | |
| Consumer loans | | | 15 | | | | (48 | ) | | | (33 | ) |
| Commercial loans | | | (7 | ) | | | 2 | | | | (5 | ) |
| Total loans | | | 653 | | | | (794 | ) | | | (141 | ) |
| Other | | | 7 | | | | 2 | | | | 9 | |
| Total interest-earning assets (2) | | $ | 455 | | | $ | (576 | ) | | $ | (121 | ) |
| | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | |
| Money market accounts | | $ | 32 | | | $ | (10 | ) | | $ | 22 | |
| Savings accounts (2) | | | 1 | | | | - | | | | 1 | |
| NOW accounts | | | 26 | | | | 41 | | | | 67 | |
| Certificates of deposit | | | (86 | ) | | | (189 | ) | | | (275 | ) |
| Total interest-bearing deposits | | | (27 | ) | | | (158 | ) | | | (185 | ) |
| FHLB advances | | | (141 | ) | | | (9 | ) | | | (150 | ) |
| Securities sold under agreement | | | | | | | | | |
| to repurchase | | | (3 | ) | | | (3 | ) | | | (6 | ) |
| Total interest-bearing borrowings | | | (144 | ) | | | (12 | ) | | | (156 | ) |
| Total interest-bearing liabilities | | | (171 | ) | | | (170 | ) | | | (341 | ) |
| Increase in net interest income (3) | | $ | 626 | | | $ | (406 | ) | | $ | 220 | |
| | (1) | The changes in state and municipal income are reflected on a tax equivalent basis using a tax rate of 41%. |
| | (2) | Includes interest on mortgagors’ escrow deposits. |
| | (3) | The changes in interest income and net interest income are reflected on a tax equivalent basis and thus do not correspond to the statement of operations. |
Net interest income, on a tax equivalent basis, increased $220,000, or 4.6%, to $5.0 million for the three months ended September 30, 2012, primarily due to the decrease in the cost of interest bearing liabilities outweighing the decrease in the yield on average interesting-earning assets. Net interest margin, on a tax equivalent basis, increased four basis points from 3.55% for the three months ended September 30, 2011 to 3.59% for the three months ended September 30, 2012.
Interest and dividend income, on a tax equivalent basis, decreased $121,000, or 1.9%, to $6.4 million for the three months ended September 30, 2012. Average interest-earning assets increased $20.1 million, or 3.8%, from $533.8 million at September 30, 2011 to $553.9 million at September 30, 2012. Average loans increased $14.9 million, or 3.3%, primarily due to strong commercial real estate loan originations. Average investment securities decreased $6.5 million, or 9.1%, for the period due to the decrease in the U.S. Treasury portfolio partially offset by the $11,000, or 0.02%, increase in tax equivalent investment securities interest income primarily due to the increase in tax-exempt industrial revenue bond income. The yield on average interest-earning assets decreased 24 basis points to 4.58% for the three months ended September 30, 2012, primarily as a result of lower market rates of interest.
Total interest expense decreased $341,000, or 19.9%, to $1.4 million for the three months ended September 30, 2012 from $1.7 million for the three months ended September 30, 2011, due to lowering deposit costs by $185,000, or 14.3%, and a decrease in cost of borrowings of $156,000 or 37.0%. Average interest-bearing liabilities increased $8.7 million, or 2.0%, to $440.9 million for the three months ended September 30, 2012 from $432.2 million for the three months ended September 30, 2011. Rates paid on average interest-bearing liabilities declined 33 basis points from 1.57% for the three months ended September 30, 2011 to 1.24% for the three months ended September 30, 2012. The lower interest rate environment and management’s decision not to renew higher cost short term time deposits led to a decrease in rates paid for certificates of deposit of 37 basis points from 2.24% at September 30, 2011 to 1.87% at September 30, 2012.
Provision for Loan Losses
The provision for loan losses was $169,000 for the three months ended September 30, 2012 compared to $223,000 for the three months ended September 30, 2011, a decrease of $54,000, or 24.2%. Non-performing loans decreased $423,000, or 10.7%, from $4.0 million, or 0.89% of total loans, at September 30, 2011, to $3.5 million, or 0.75% of total loans, at September 30, 2012. Total non-performing assets decreased $940,000, or 18.7%, from $5.0 million, or 0.85% of total assets, at September 30, 2011 to $4.1 million, or 0.67% of total assets, at September 30, 2012.
Non-Interest Income
Non-interest income decreased $77,000, or 11.0%, from $697,000 at September 30, 2011 to $620,000 at September 30, 2012. Income from customer service fees and commissions increased $72,000, or 13.1%, as income from loan sales and servicing, net decreased $33,000, or 64.7%, income from bank owned life insurance decreased $8,000, or 7.9%, and the loss on the sale of OREO increased $76,000.
Non-Interest Expenses
Non-interest expense decreased $299,000, or 6.4%, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. Non-interest expense decreased primarily due to the decrease in salaries and benefits of $272,000, or 10.0%, a decrease in FDIC insurance expense of $56,000, or 38.6%, a decrease of $34,000, or 32.7%, in stationery, supplies and postage, a decrease in advertising expense of $19,000, or 11.9%, and a decrease in data processing of $14,000, or 4.7%. These decreases were partially offset by an increase in occupancy expense of $9,000, or 2.5%, an increase in professional fees of $7,000, or 5.4%, and an increase in other non-interest expense of $87,000, or 18.3%. The decrease in salaries and benefits was directly attributed to the decrease in the expense related to the 2007 Equity Incentive Plan. The final expense on the restricted stock awards and stock options granted in 2007 was recorded on July 27, 2012.
Comparison of Operating Results for the Nine Months Ended September 30, 2012 and 2011
General
The Company reported an increase in net income of $750,000, or 104.0%, from $721,000, or $0.13 earnings per share, for the nine months ended September 30, 2011 to $1.5 million, or $0.29 earnings per share, for the nine months ended September 30, 2012. The increase in net income was primarily due to an increase in net interest income of $573,000, or 4.3%, a decrease in non-interest expense of $67,000, or 0.5%, an increase in non-interest income of $129,000, or 6.6%, and a decrease in the provision for loan losses of $335,000, or 58.3%. These improvements were partially offset by an increase in income tax expense of $354,000.
Analysis of Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.
The following table sets forth average balances, interest income and expense and yields earned or rates paid on the major categories of assets and liabilities for the periods indicated. The average yields and costs are derived by dividing interest income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively. The yields and costs are annualized. Average balances are derived from average daily balances. The yields and costs include fees which are considered adjustments to yields. Loan interest and yield data does not include any accrued interest from non-accruing loans.
| | | For the Nine Months Ended September 30, | |
| | | 2012 | | | 2011 | |
| | | | | | | | | Average | | | | | | | | | Average | |
| | | Average | | | | | | Yield/ | | | Average | | | | | | Yield/ | |
| | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| | | (Dollars in Thousands) | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Investments (1) | | $ | 69,001 | | | $ | 2,014 | | | | 3.90 | % | | $ | 72,916 | | | $ | 1,875 | | | | 3.44 | % |
| Loans: | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential real estate loans | | | 148,912 | | | | 5,444 | | | | 4.88 | % | | | 154,491 | | | | 5,922 | | | | 5.13 | % |
| Commercial real estate loans | | | 194,422 | | | | 7,957 | | | | 5.47 | % | | | 178,383 | | | | 7,762 | | | | 5.82 | % |
| Consumer loans | | | 33,012 | | | | 1,016 | | | | 4.11 | % | | | 32,271 | | | | 1,111 | | | | 4.60 | % |
| Commercial loans | | | 80,507 | | | | 2,600 | | | | 4.31 | % | | | 81,704 | | | | 2,683 | | | | 4.39 | % |
| Loans, net (2) | | | 456,853 | | | | 17,017 | | | | 4.98 | % | | | 446,849 | | | | 17,478 | | | | 5.23 | % |
| Other | | | 33,395 | | | | 54 | | | | 0.22 | % | | | 18,484 | | | | 27 | | | | 0.20 | % |
| Total interest-earning assets | | | 559,249 | | | | 19,085 | | | | 4.56 | % | | | 538,249 | | | | 19,380 | | | | 4.81 | % |
| Noninterest-earning assets | | | 40,551 | | | | | | | | | | | | 37,658 | | | | | | | | | |
| Total assets | | $ | 599,800 | | | | | | | | | | | $ | 575,907 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Money market accounts | | $ | 104,030 | | | $ | 261 | | | | 0.34 | % | | $ | 73,905 | | | $ | 198 | | | | 0.36 | % |
| Savings accounts (3) | | | 48,497 | | | | 38 | | | | 0.10 | % | | | 46,461 | | | | 36 | | | | 0.10 | % |
| NOW accounts | | | 30,472 | | | | 229 | | | | 1.00 | % | | | 17,064 | | | | 42 | | | | 0.33 | % |
| Certificates of deposit | | | 201,782 | | | | 2,852 | | | | 1.89 | % | | | 213,407 | | | | 3,741 | | | | 2.34 | % |
| Total interest-bearing deposits | | | 384,781 | | | | 3,380 | | | | 1.17 | % | | | 350,837 | | | | 4,017 | | | | 1.53 | % |
| FHLB advances | | | 51,202 | | | | 982 | | | | 2.56 | % | | | 66,304 | | | | 1,283 | | | | 2.59 | % |
| Securities sold under agreement to | | | | | | | | | | | | | | | | | | | | | | | | |
| repurchase | | | 9,283 | | | | 11 | | | | 0.16 | % | | | 17,655 | | | | 27 | | | | 0.20 | % |
| Total interest-bearing borrowings | | | 60,485 | | | | 993 | | | | 2.19 | % | | | 83,959 | | | | 1,310 | | | | 2.09 | % |
| Total interest-bearing liabilities | | | 445,266 | | | | 4,373 | | | | 1.31 | % | | | 434,796 | | | | 5,327 | | | | 1.64 | % |
| Demand deposits | | | 64,220 | | | | | | | | | | | | 48,922 | | | | | | | | | |
| Other noninterest-bearing liabilities | | | 383 | | | | | | | | | | | | 308 | | | | | | | | | |
| Total liabilities | | | 509,869 | | | | | | | | | | | | 484,026 | | | | | | | | | |
| Total stockholders' equity | | | 89,931 | | | | | | | | | | | | 91,881 | | | | | | | | | |
| Total liabilities and stockholders' equity | | $ | 599,800 | | | | | | | | | | | $ | 575,907 | | | | | | | | | |
| Net interest-earning assets | | $ | 113,983 | | | | | | | | | | | $ | 103,453 | | | | | | | | | |
| Tax equivalent net interest income/ | | | | | | | | | | | | | | | | | | | | | | | | |
| interest rate spread (4) | | | | | | | 14,712 | | | | 3.25 | % | | | | | | | 14,053 | | | | 3.17 | % |
Tax equivalent net interest margin (net interest income as a percentage of interest-earning assets) | | | 3.51 | % | | | | | | | | | | | 3.49 | % |
| Ratio of interest-earning assets | | | | | | | | | | | | | | | | | | | | | | | | |
| to interest-bearing liabilities | | | | | | | | | | | 125.60 | % | | | | | | | | | | | 123.79 | % |
| Less: tax equivalent adjustment (1) | | | | | | | (766 | ) | | | | | | | | | | | (680 | ) | | | | |
| Net interest income as reported on income statement | | | $ | 13,946 | | | | | | | | | | | $ | 13,373 | | | | | |
| (1) | Municipal securities income and net interest income are presented on a tax equivalent basis using a tax rate of 41%. The tax equivalent adjustment is deducted from the tax equivalent net interest income to agree to the amount reported on the statement of income. See 'Explanation of Use of Non-GAAP Financial Measurements'. |
| (2) | Loans, net excludes loans held for sale and the allowance for loan losses and includes nonperforming loans. |
| (3) | Savings accounts include mortgagors' escrow deposits. |
| (4) | Tax equivalent interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. See 'Explanation of Use of Non-GAAP Financial Measurements'. |
The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's tax equivalent interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
| | | Nine Months Ended September 30, | |
| | | 2012 compared to 2011 | |
| | | Increase (Decrease) | |
| | | Due to | |
| | | Volume | | | Rate | | | Net | |
| | | (Dollars in Thousands) | |
| | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | |
| Investment securities (1) | | $ | (104 | ) | | $ | 243 | | | $ | 139 | |
| Loans: | | | | | | | | | | | | |
| Residential real estate loans | | | (207 | ) | | | (271 | ) | | | (478 | ) |
| Commercial real estate loans | | | 678 | | | | (483 | ) | | | 195 | |
| Consumer loans | | | 26 | | | | (121 | ) | | | (95 | ) |
| Commercial loans | | | (38 | ) | | | (45 | ) | | | (83 | ) |
| Total loans | | | 459 | | | | (920 | ) | | | (461 | ) |
| Other | | | 24 | | | | 3 | | | | 27 | |
| Total interest-earning assets (2) | | $ | 379 | | | $ | (674 | ) | | $ | (295 | ) |
| | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | |
| Money market accounts | | $ | 77 | | | $ | (14 | ) | | $ | 63 | |
| Savings accounts (2) | | | 2 | | | | - | | | | 2 | |
| NOW accounts | | | 52 | | | | 135 | | | | 187 | |
| Certificates of deposit | | | (195 | ) | | | (694 | ) | | | (889 | ) |
| Total interest-bearing deposits | | | (64 | ) | | | (573 | ) | | | (637 | ) |
| FHLB advances | | | (288 | ) | | | (13 | ) | | | (301 | ) |
| Securities sold under agreement | | | | | | | | | |
| to repurchase | | | (11 | ) | | | (5 | ) | | | (16 | ) |
| Total interest-bearing borrowings | | | (299 | ) | | | (18 | ) | | | (317 | ) |
| Total interest-bearing liabilities | | | (363 | ) | | | (591 | ) | | | (954 | ) |
| Increase in net interest income (3) | | $ | 742 | | | $ | (83 | ) | | $ | 659 | |
(1) The changes in state and municipal income are reflected on a tax equivalent basis using a tax rate of 41%.
(2) Includes interest on mortgagors’ escrow deposits.
(3) The changes in interest income and net interest income are reflected on a tax equivalent basis and thus do not correspond to the statement of operations.
Net interest income, on a tax equivalent basis, increased $659,000, or 4.7%, to $14.7 million for the nine months ended September 30, 2012, primarily due to the decrease in the cost of interest bearing liabilities outweighing the decrease in the yield on average interesting-earning assets. Net interest margin, on a tax equivalent basis, increased two basis points from 3.49% for the nine months ended September 30, 2011 to 3.51% for the nine months ended September 30, 2012.
Interest and dividend income, on a tax equivalent basis, decreased $295,000, or 1.5%, to $19.1 million for the nine months ended September 30, 2012. Average interest-earning assets increased $21.0 million, or 3.9%, from $538.2 million at September 30, 2011 to $559.2 million at September 30, 2012. Average loans increased $10.0 million, or 2.2%, primarily due to strong commercial originations. Average investment securities decreased $3.9 million, or 5.4%, for the period due to the decrease in U.S. Treasury securities. Tax equivalent investment securities interest income increased $139,000, or 7.4%, primarily due to the increase in tax-exempt industrial revenue bond income. The yield on average interest-earning assets decreased 25 basis points to 4.56% for the nine months ended September 30, 2012, primarily as a result of lower market rates of interest.
Total interest expense decreased $657,000, or 17.9%, to $4.4 million for the nine months ended September 30, 2012 from $5.3 million for the nine months ended September 30, 2011, due to lowering deposit costs by $637,000, or 15.9%, and a decrease in cost of borrowings of $317,000, or 24.2%. Average interest-bearing liabilities increased $10.5 million, or 2.4%, to $445.3 million for the nine months ended September 30, 2012 from $434.8 million for the nine months ended September 30, 2011. Rates paid on average interest-bearing liabilities declined 33 basis points from 1.64% for the nine months ended September 30, 2011 to 1.31% for the nine months ended September 30, 2012. The lower interest rate environment and management’s decision not to renew higher cost short term time deposits led to a decrease in rates paid for certificates of deposit of 45 basis points.
Provision for Loan Losses
The provision for loan losses was $240,000 for the nine months ended September 30, 2012 compared to $575,000 for the nine months ended September 30, 2011, a decrease of $335,000, or 58.3%. Non-performing loans decreased $423,000, or 10.7%, from $4.0 million, or 0.89% of total loans, at September 30, 2011, to $3.5 million, or 0.75% of total loans, at September 30, 2012. Total non-performing assets decreased $940,000, or 18.7%, from $5.0 million, or 0.85% of total assets, at September 30, 2011 to $4.1 million, or 0.67% of total assets, at September 30, 2012. The allowance for loan losses as a percentage of total loans decreased from 0.97% at September 30, 2011 to 0.93% at September 30, 2012 and the allowance for loan losses as a percentage of non-performing loans increased from 109.4% at September 30, 2011 to 124.8% at September 30, 2012.
Non-Interest Income
Non-interest income increased $129,000, or 6.6%, from $2.0 million at September 30, 2011 to $2.1 million at September 30, 2012. Income from customer service fees and commissions increased $235,000, or 16.1%, income from loan sales and servicing, net increased $36,000, or 14.4%. These increases were partially offset by an increase of $121,000, or 122.2%, in net losses on sale of OREO, a decrease of $12,000, or 100%, in net gain on sales of securities available for sale, and a decrease of $11,000, or 3.7%, income from bank owned life insurance.
Non-Interest Expenses
Non-interest expense decreased $67,000, or 0.5%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. Non-interest expense decreased primarily due to the decrease in salaries and benefits of $153,000, or 1.9%, a decrease of $142,000, or 34.3%, in FDIC insurance expense, a decrease of $62,000, or 5.2%, in occupancy expense, a decrease of $62,000, or 7.1%, in data processing expense and a decrease of $31,000, or 11.1%, in stationery, supplies and postage expense. These decreases were partially offset by an increase in advertising expense of $27,000, or 6.5%, an increase in professional fees of $25,000, or 5.9%, an increase of $56,000, or 7.2%, in furniture and equipment and an increase of $275,000, or 18.5%, in other non-interest expense. The increase in other non-interest expense was attributed to an $80,000, or 83.5%, increase in foreclosure related expenses, an increase of $67,000, or 18.3%, increase in equipment and software maintenance costs, an increase of $44,000, or 43.5%, increase in armored car expense, and a $51,000 non-recurring expense for the termination of a contract with a third party vendor.
Explanation of Use of Non-GAAP Financial Measurements
We believe that it is common practice in the banking industry to present interest income and related yield information on tax exempt securities on a tax-equivalent basis and that such information is useful to investors because it facilitates comparisons among financial institutions. However, the adjustment of interest income and yields on tax exempt securities to a tax equivalent amount may be considered to include financial information that is not in compliance with GAAP. A reconciliation from GAAP to non-GAAP is provided below.
| | | Three Months Ended | | | Nine Months Ended | |
| | | September 30, | | | September 30, | |
| | | 2012 | | | 2011 | | | 2012 | | | 2011 | |
| | | (Dollars in Thousands) | | | (Dollars in Thousands) | |
| | | | | | Average | | | | | | Average | | | | | | Average | | | | | | Average | |
| | | Interest | | | Yield | | | Interest | | | Yield | | | Interest | | | Yield | | | Interest | | | Yield | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Investment securities (no tax adjustment) | | $ | 425 | | | | 2.57 | % | | $ | 425 | | | | 2.33 | % | | $ | 1,248 | | | | 2.42 | % | | $ | 1,195 | | | | 2.19 | % |
| Tax equivalent adjustment (1) | | | 270 | | | | | | | | 259 | | | | | | | | 766 | | | | | | | | 680 | | | | | |
| Investment securities (tax equivalent basis) | | $ | 695 | | | | 4.21 | % | | $ | 684 | | | | 3.76 | % | | $ | 2,014 | | | | 3.90 | % | | $ | 1,875 | | | | 3.44 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income (no tax adjustment) | | $ | 4,727 | | | | | | | $ | 4,518 | | | | | | | $ | 13,946 | | | | | | | $ | 13,373 | | | | | |
| Tax equivalent adjustment (1) | | | 270 | | | | | | | | 259 | | | | | | | | 766 | | | | | | | | 680 | | | | | |
| Net interest income (tax equivalent basis) | | $ | 4,997 | | | | | | | $ | 4,777 | | | | | | | $ | 14,712 | | | | | | | $ | 14,053 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest rate spread (no tax adjustment) | | | | | | | 3.14 | % | | | | | | | 3.06 | % | | | | | | | 3.07 | % | | | | | | | 3.01 | % |
| Net interest margin (no tax adjustment) | | | | | | | 3.40 | % | | | | | | | 3.36 | % | | | | | | | 3.33 | % | | | | | | | 3.32 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) The tax equivalent adjustment is based on a combined federal and state tax rate of 41% for all periods presented. | | | | | |
Liquidity Management
Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities, borrowings from the FHLB and securities sold under agreements to repurchase. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Prepayment rates can have a significant impact on interest income. Because of the large percentage of loans we hold, rising or falling interest rates have a significant impact on the prepayment speeds of our earning assets that, in turn, affect the rate sensitivity position. When interest rates rise, prepayments tend to slow. When interest rates fall, prepayments tend to rise. Our asset sensitivity would be reduced if prepayments slow and vice versa. While we believe these assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual loan repayment activity. Our short-term securities are primarily consisted of U.S. Treasury and government agencies, which we use primarily for the collateral purposes for sweep accounts maintained by commercial customers. The balances of these securities fluctuate as the aggregate balance of our sweep accounts fluctuate.
We regularly adjust our investments in liquid assets based upon our assessment of: (1) expected loan demands; (2) expected deposit flows; (3) yields available on interest-earning deposits and securities; and (4) the objectives of our asset/liability management policy.
Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At September 30, 2012, total cash and cash equivalents totaled $40.3 million, net of reserve requirements. Securities classified as available for sale whose market value exceeds our cost, which provides additional sources of liquidity, totaled $31,000 at September 30, 2012. Other liquid assets as of September 30, 2012 included: U.S. Treasury securities and collateralized mortgages, net of pledged securities, totaling $4.4 million, and certificates of deposit of $10.2 million. At September 30, 2012, the Company had an over collateralized securities pledging position of $5.5 million.
In addition, at September 30, 2012, we had the ability to borrow a total of approximately $92.8 million from the FHLB, subject of pledging requirements. On September 30, 2012, we had $35.7 million of borrowings outstanding. We have the ability to increase our borrowing capacity with the FHLB by pledging additional loans. The Company’s unused borrowing capacity with the Federal Reserve Bank of Boston was approximately $49.6 million at September 30, 2012. As of July 19, 2012 Banker’s Bank approved an increase of $1.0 million for the line of credit, this will increase the line of credit from $3.0 million to $4.0 million bringing the total available lines of credit to use as contingency funding sources to $7.0 million.
Certificates of deposit due within one year of September 30, 2012 totaled $95.7 million, or 51.3%, of our certificates of deposit. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before September 30, 2013. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
Capital Management
We are subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2012, the Company exceeded all of its regulatory capital requirements. The Company is considered “well capitalized” under regulatory guidelines. The Company is subject to the Federal Reserve Board’s capital adequacy guidelines for bank holding companies (on a consolidated basis) substantially similar to those of the FDIC. The Company exceeded these requirements at September 30, 2012.
The Company’s and Bank’s actual capital amounts and ratios as of September 30, 2012 and December 31, 2011 are presented in the following table:
| | | | | | | | | | | | | | | Minimum | |
| | | | | | | | | | | | | | | to be Well | |
| | | | | | | | | | | | | | | Capitalized Under | |
| | | | | | | | | Minimum for Capital | | | Prompt Corrective | |
| | | Actual | | | Adequacy Purposes | | | Action Provisions | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| | | (Dollars In Thousands) | |
| As of September 30, 2012 | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Total Capital to Risk Weighted Assets | | | | | | | | | | | | | | | | | | |
| Company | | $ | 92,935 | | | | 19.1 | % | | $ | 39,012 | | | | 8.0 | % | | | N/A | | | | N/A | |
| Bank | | $ | 84,575 | | | | 17.4 | % | | $ | 38,923 | | | | 8.0 | % | | $ | 48,653 | | | | 10.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 Capital to Risk Weighted Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Company | | $ | 88,534 | | | | 18.2 | % | | $ | 19,506 | | | | 4.0 | % | | | N/A | | | | N/A | |
| Bank | | $ | 80,174 | | | | 16.5 | % | | $ | 19,461 | | | | 4.0 | % | | $ | 29,192 | | | | 6.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 Capital to Average Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Company | | $ | 88,534 | | | | 14.9 | % | | $ | 23,809 | | | | 4.0 | % | | | N/A | | | | N/A | |
| Bank | | $ | 80,174 | | | | 13.5 | % | | $ | 23,770 | | | | 4.0 | % | | $ | 29,712 | | | | 5.0 | % |
| | | | | | | | | | | | | | | Minimum | |
| | | | | | | | | | | | | | | to be Well | |
| | | | | | | | | | | | | | | Capitalized Under | |
| | | | | | | | | Minimum for Capital | | | Prompt Corrective | |
| | | Actual | | | Adequacy Purposes | | | Action Provisions | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| | | (Dollars In Thousands) | |
| | | | | | | | | | | | | | | | | | | |
| As of December 31, 2011 | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Total Capital to Risk Weighted Assets | | | | | | | | | | | | | | | | | | |
| Company | | $ | 94,009 | | | | 19.6 | % | | $ | 38,362 | | | | 8.0 | % | | | N/A | | | | N/A | |
| Bank | | $ | 81,606 | | | | 17.0 | % | | $ | 38,291 | | | | 8.0 | % | | $ | 47,864 | | | | 10.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 Capital to Risk Weighted Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Company | | $ | 89,433 | | | | 18.7 | % | | $ | 19,181 | | | | 4.0 | % | | | N/A | | | | N/A | |
| Bank | | $ | 77,030 | | | | 16.1 | % | | $ | 19,146 | | | | 4.0 | % | | $ | 28,718 | | | | 6.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier 1 Capital to Average Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Company | | $ | 89,433 | | | | 14.8 | % | | $ | 24,148 | | | | 4.0 | % | | | N/A | | | | N/A | |
| Bank | | $ | 77,030 | | | | 12.8 | % | | $ | 24,096 | | | | 4.0 | % | | $ | 30,120 | | | | 5.0 | % |
Restrictions on Dividends
Dividends from Chicopee Bancorp, Inc. may depend, in part, upon receipt of dividends from the Bank. The subsidiary may pay dividends to its parent out of so much of its net income as the Bank’s directors deem appropriate, subject to the limitation that the total of all dividends declared by the Bank in any calendar year may not exceed the total of its net income of that year combined with its retained net income of the preceding two years and subject to minimum regulatory capital requirements. The approval of the Massachusetts Commissioner of Banks is required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years. Net profits for this purpose means the remainder of all earnings from current operations plus actual recoveries on loans and investments and other assets after deducting from the total thereof all current operating expenses, actual losses, accrued dividends on preferred stock, if any and all federal and state taxes.
A total of $1.4 million in dividends was declared in June 2012 from Chicopee Funding Corporation (“CFC”) to the Company. CFC paid the dividend in June 2012; there have been no other dividends during the year.
Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, letters of credit and lines of credit. We currently have no plans to engage in hedging activities in the future.
Credit-Related Financial Instruments
The Company is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and various financial instruments with off-balance-sheet risk. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
The following financial instruments were outstanding whose contract amounts represent credit risk:
| | | September 30, | | | December 31, | |
| | | 2012 | | | 2011 | |
| | | | | | | |
| Commitments to grant loans | | $ | 29,311 | | | $ | 16,957 | |
| Unfunded commitments for construction loans | | | 10,325 | | | | 18,665 | |
| Unfunded commitments under lines of credit | | | 71,255 | | | | 72,466 | |
| Standby letters of credit | | | 1,370 | | | | 1,139 | |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer. Collateral held varies but may include cash, securities, accounts receivable, inventory, property, plant and equipment, and real estate.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized, usually do not contain a specified maturity date, and may not be drawn upon to the total extent to which the Company is committed.
“Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”, requires certain disclosures and liability recognition for the fair value at issuance of guarantees that fall within its scope. The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. The Company has issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled $1.4 million at September 30, 2012 and $1.1 million at December 31, 2011, respectively, and represent the maximum potential future payments the Company could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. The Company’s policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral. The fair value of the Company’s standby letters of credit at September 30, 2012 and December 31, 2011 was not significant.
Qualitative Aspects of Market Risk
We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. To reduce the potential volatility of our earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Our strategy for managing interest rate risk emphasizes: adjusting the maturities of borrowings; adjusting the investment portfolio mix and duration; increasing our focus on shorter-term, adjustable-rate commercial and multi-family lending; selling fixed-rate mortgage loans; and periodically selling available for sale securities. We currently do not participate in hedging programs, interest rate swaps or other activities involving the use of derivative financial instruments.
We have an Asset/Liability Committee, which includes members of management, to communicate, coordinate and control all aspects involving asset/liability management. The committee reports to the Board of Directors of the Bank quarterly and establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.
Quantitative Aspects of Market Risk
We analyze our interest rate sensitivity to manage the risk associated with interest rate movements through the use of interest income simulation. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive.” An asset or liability is said to be “interest rate sensitive” within a specific time period if it will mature or reprice within that time period.
Our goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest income. Interest income simulations are completed quarterly and presented to the Asset/Liability Committee and Board of Directors of the Bank. The simulations provide an estimate of the impact of changes in interest rates on net interest income under a range of assumptions. The numerous assumptions used in the simulation process are reviewed by the Asset/Liability Committee and the Board of Directors of the Bank on a quarterly basis. Changes to these assumptions can significantly affect the results of the simulation. The simulation incorporates assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different market rates. The simulation analysis incorporates management’s current assessment of the risk that pricing margins will change adversely over time due to competition or other factors.
Simulation analysis is only an estimate of our interest rate risk exposure at a particular point in time. We continually review the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.
The table below sets forth an approximation of our exposure as a percentage of estimated net interest income for the next 12 month period using interest income simulation. The simulation uses projected repricing of assets and liabilities at September 30, 2012 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rates can have a significant impact on interest income simulation. Because of the large percentage of loans we hold, rising or falling interest rates have a significant impact on the prepayment speeds of our earning assets that, in turn, affect the rate sensitivity position. When interest rates rise, prepayments tend to slow. When interest rates fall, prepayments tend to rise. Our asset sensitivity would be reduced if prepayments slow and vice versa. While we believe such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate future mortgage-backed security and loan repayment activity.
The following table reflects changes in estimated net interest income for the Company at September 30, 2012 through September 30, 2013 under varying assumptions:
Changes in Interest Rates (Basis Points) | | Percentage Change in Estimated Net Interest Income over Twelve Months |
| Up 500 - 24 months | | 3.0% | |
| Up 400 - 24 months | | 2.0% | |
| Up 300 - 12 months | | 4.0% | |
| Up 200 - 12 months | | 9.0% | |
| Up 100 - 12 months | | 4.0% | |
| Base | | 0.0% | |
| Down 100 | | -2.0% | |
As indicted in the table above, the results of a 100 and 200 basis instantaneous increase in interest rates is estimated to increase net interest income over a 12-month time horizon by 4.0% and 9.0%, respectively. A 300 basis point gradual increase over 12-months is estimated to increase net interest income by 4.0%. A 400 and 500 basis point increase in market interest rates over a 24-month time horizon is estimated to increase net interest income by 2.0% and 3.0% in the first twelve months.
The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Company.
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, which could materially affect our business, financial condition or future results. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations. At September 30, 2012, the risk factors for the Company have not changed materially from those reported in our 2011 Annual Report on Form 10-K. However, the risks described in our 2011 Annual Report on Form 10-K are not the only risks that we face.
On September 30, 2011, the Company announced that the Board of Directors authorized a Sixth Stock Repurchase Program (the “Sixth Stock Repurchase Program”) for the purchase of up to 287,000, or 5%, of the shares of the Company's common stock outstanding. During the nine months ended September 30, 2012, the Company repurchased 271,609 shares of Company stock for $3.9 million, at an average price of $14.26 per share. During the third quarter of 2012, the Company repurchased 1,230 shares of Company stock, at an average price per share of $14.05. The repurchases made in the third quarter of 2012 were as follows:
| | | | | | | | | (c) | | | (d) | |
| | | | | | | | | Total Number of | | | Maximum Number | |
| | | | | | | | | Shares | | | (or Approximate | |
| | | (a) | | | (b) | | | (or Units) | | | Dollar Value) of | |
| | | Total Number | | | Average Price | | | Purchased as Part | | | Shares (or Units) that | |
| | | of Shares | | | Paid Per | | | of Publicly | | | May Yet Be | |
| | | (or Units) | | | Share | | | Announced Plans | | | Purchased Under the | |
| Period | | Purchased | | | (or Unit) | | | or Programs | | | Plans or Programs | |
| | | | | | | | | | | | | |
| July 1-31, 2012 | | | 1,230 | | | $ | 14.05 | | | | 275,209 | | | | 283,791 | |
| | | | | | | | | | | | | | | | | |
| August 1-31, 2012 | | | - | | | | - | | | | 275,209 | | | | 283,791 | |
| | | | | | | | | | | | | | | | | |
| September 1-30, 2012 | | | - | | | | - | | | | 275,209 | | | | 283,791 | |
| | | | | | | | | | | | | | | | | |
| Total | | | 1,230 | | | $ | 14.05 | | | | | | | | | |
In addition, on June 1, 2012, the Company announced that the Board of Directors authorized a Seventh Stock Repurchase Program (the “Seventh Stock Repurchase Program”) for the purchase of up to 272,000, or 5%, of the shares of the Company’s outstanding common stock. The Company will commence its Seventh Stock Repurchase Program immediately upon the completion of its Sixth Repurchase Program. The Company intends to repurchase its shares under both the Sixth and Seventh Repurchase Programs from time to time at prevailing prices in the open market, in block transactions or in privately negotiated transactions. Repurchases will be made under rule 10b-5(1) repurchase plans. The repurchased shares will be held by the Company as treasury stock and will be available for general corporate purposes.
None.
Not applicable.
None.
| 3.1 | Articles of Incorporation of Chicopee Bancorp, Inc. (1) |
| 3.2 | Bylaws of Chicopee Bancorp, Inc. (2) |
| 4.0 | Stock Certificate of Chicopee Bancorp, Inc. (1) |
| 31.1 | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer (3) |
| 31.2 | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (3) |
| 32.0 | Section 1350 Certification (3) |
| 101.0 | The following financial information from Chicopee Bancorp Inc.’s Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2012, formatted in XBRL (Extensible Business Reporting Language) includes: (i) the Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011, (ii) the Consolidated Statements of Income for each of the three and nine month periods ended September 30, 2012 and 2011, (iii) the Consolidated Statement of Comprehensive Income for each of the three and nine month periods ended September 30, 2012 and 2011, (iv) the Consolidated Changes in Stockholders’ Equity for each of the nine month periods ended September 30, 2012 and 2011, (v) the Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2012 and 2011, and (vi) the Notes to Consolidated Financial Statements, tagged in summary and detail. (3) |
| (1) | Incorporated herein by reference to the Exhibits to the Company’s Registration Statement on Form S-1 (File No. 333-132512), as amended, initially filed with the Securities and Exchange Commission on March 17, 2006. |
| (2) | Incorporated herein by reference to Exhibit 3.2 to the Company’s 8-K (File No. 000-51996) filed with the Securities and Exchange Commission on August 1, 2007. |
| (3) | This information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized
| | CHICOPEE BANCORP, INC. | |
| | | | |
| | | | |
| Dated: November 8, 2012 | By: | /s/ William J. Wagner | |
| | | William J. Wagner | |
| | | Chairman of the Board, President and | |
| | | Chief Executive Officer | |
| | | (principal executive officer) | |
| | | | |
| Dated: November 8, 2012 | | /s/ Guida R. Sajdak | |
| | By: | Guida R. Sajdak | |
| | | Senior Vice President, | |
| | | Chief Financial Officer and Treasurer | |
| | | (principal financial and chief accounting officer) | |
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