UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
1934
For the Quarterly period ended: September 30, 2009
|_| TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________.
Commission File Number: 0-28815
FIRST LITCHFIELD FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact name of Registrant as specified in its Charter)
Delaware 06-1241321
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification No.)
13 North Street, Litchfield, CT 06759
------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (860) 567-8752
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 past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T during the
preceding 12 months (or for such shorter period that the registrant was required
to submit and post such files). Yes [_] No [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company as
defined in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [_]
Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined by
Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 2,356,875 shares of Common
Stock, par value $.01 per share, were outstanding at November 10, 2009.
FIRST LITCHFIELD FINANCIAL CORPORATION
FORM 10-Q
INDEX
Page
Part I - Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets - September 30, 2009 and December 31, 2008
(unaudited) ............................................................ 3
Consolidated Statements of Operations - Three and Nine months ended
September 30, 2009 and 2008 (unaudited) ................................ 4
Consolidated Statements of Changes in Shareholders' Equity - Nine months
ended September 30, 2009 and 2008 (unaudited) .......................... 5
Consolidated Statements of Cash Flows - Nine months ended
September 30, 2009 and 2008 (unaudited) ................................ 6
Notes to Consolidated Financial Statements (unaudited) ................. 7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations .............................................. 33
Item 3 - Quantitative And Qualitative Disclosures About Market Risk .... 53
Item 4 - Controls and Procedures ....................................... 53
Part II - Other Information
Item 1 - Legal Proceedings ............................................. 53
Item 1A - Risk Factors ................................................. 53
Item 2 - Unregistered Sales of Equity Securities and
Use of Proceeds ........................................................ 53
Item 3 - Defaults Upon Senior Securities ............................... 53
Item 4 - Submission of Matters to a Vote of Security Holders ........... 53
Item 5 - Other Information ............................................. 53
Item 6 - Exhibits ...................................................... 54
Signatures .................................................................... 56
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS (Unaudited) September 30, December 31,
2009 2008
------------- -------------
ASSETS
Cash and due from banks $ 43,182,377 $ 9,238,320
Interest - bearing accounts due from banks 61,209 463
------------- -------------
CASH AND CASH EQUIVALENTS 43,243,586 9,238,783
------------- -------------
Securities:
Available for sale securities, at fair value 98,308,680 113,486,201
Held to maturity securities (fair value $15,420 -2009
and $16,553-2008) 15,064 16,550
------------- -------------
TOTAL SECURITIES 98,323,744 113,502,751
------------- -------------
Federal Home Loan Bank stock, at cost 5,427,600 5,427,600
Federal Reserve Bank stock, at cost 225,850 225,850
Other restricted stock, at cost 105,000 100,000
Loans held for sale 95,000 1,013,216
Loan and lease receivables, net of allowance for loan and lease
losses of $6,084,194 -2009, $3,698,820-2008
NET LOANS AND LEASES 376,566,884 366,392,079
Premises and equipment, net 7,098,133 7,370,252
Foreclosed real estate 547,040 --
Deferred income taxes 5,327,407 5,082,957
Accrued interest receivable 1,939,745 2,262,918
Cash surrender value of life insurance 10,710,080 10,416,651
Due from broker for security sales -- 9,590,823
Other assets 1,593,294 1,633,727
------------- -------------
TOTAL ASSETS $ 551,203,363 $ 532,257,607
============= =============
LIABILITIES
Deposits:
Noninterest bearing $ 70,023,494 $ 69,548,261
Interest bearing 312,500,950 273,778,363
------------- -------------
TOTAL DEPOSITS 382,524,444 343,326,624
Federal Home Loan Bank advances 80,000,000 81,608,000
Repurchase agreements with financial institutions 22,500,000 26,450,000
Repurchase agreements with customers 19,409,085 18,222,571
Junior subordinated debt issued by unconsolidated trust 10,104,000 10,104,000
Collateralized borrowings -- 1,375,550
Capital lease obligation 1,051,421 1,065,563
Due to broker for security purchases -- 12,994,945
Accrued expenses and other liabilities 4,225,497 4,643,090
------------- -------------
TOTAL LIABILITIES 519,814,447 499,790,343
------------- -------------
EQUITY
SHAREHOLDERS' EQUITY
Preferred stock $.00001 par value; 1,000,000 shares authorized,
10,000 shares outstanding as of 9/30/09 and 12/31/08 -- --
Common stock $.01 par value
Authorized - 5,000,000 shares
2009 - Issued - 2,506,622 shares, outstanding - 2,356,875 shares
2008 - Issued - 2,506,622 shares, outstanding - 2,356,875 shares 25,044 25,038
Additional paid-in capital 37,937,617 37,892,831
Accumulated deficit (3,781,940) (3,325,920)
Less: Treasury stock at cost- 149,747 as of 9/30/09 and 12/31/08 (1,154,062) (1,154,062)
Accumulated other comprehensive loss, net of taxes (1,786,077) (1,024,498)
------------- -------------
TOTAL FIRST LITCHFIELD FINANCIAL CORPORATION
SHAREHOLDERS' EQUITY 31,240,582 32,413,389
------------- -------------
NONCONTROLLING INTERESTS 148,334 53,875
------------- -------------
TOTAL EQUITY 31,388,916 32,467,264
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 551,203,363 $ 532,257,607
============= =============
See Notes to Consolidated Financial Statements.
3
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2009 2008 2009 2008
------------ ------------- ------------- --------------
INTEREST AND DIVIDEND INCOME
Interest and fees on loans and leases $ 5,328,296 $ 5,363,809 $ 16,217,789 $ 16,200,748
------------ ------------- ------------- --------------
Interest and dividends on securities:
Mortgage-backed securities 450,007 991,860 1,837,716 2,647,249
US Treasury and other securities 87,288 397,073 361,834 1,325,699
State and municipal securities 200,673 279,144 626,860 905,529
Trust Preferred and other securities 17,976 65,299 120,521 285,075
------------ ------------- ------------- --------------
Total interest on securities 755,944 1,733,376 2,946,931 5,163,552
------------ ------------- ------------- --------------
Other interest income 27,219 43,482 47,684 210,868
------------ ------------- ------------- --------------
TOTAL INTEREST AND DIVIDEND INCOME 6,111,459 7,140,667 19,212,404 21,575,168
------------ ------------- ------------- --------------
INTEREST EXPENSE
Interest on deposits:
Savings 65,163 173,193 255,021 479,079
Money market 131,823 363,373 603,929 1,185,540
Time certificates of deposit 937,871 1,130,642 2,774,018 3,976,610
------------ ------------- ------------- --------------
TOTAL INTEREST ON DEPOSITS 1,134,857 1,667,208 3,632,968 5,641,229
Interest on Federal Home Loan Bank advances 850,917 1,013,339 2,616,091 3,035,762
Interest on repurchase agreements 230,128 398,077 785,004 1,147,314
Interest on subordinated debt 139,273 137,523 377,276 453,284
Interest on collateralized borrowings 15,686 25,418 58,837 80,221
Interest on capital lease obligation 13,973 14,220 42,108 42,837
------------ ------------- ------------- --------------
TOTAL INTEREST EXPENSE 2,384,834 3,255,785 7,512,284 10,400,647
------------ ------------- ------------- --------------
NET INTEREST INCOME 3,726,625 3,884,882 11,700,120 11,174,521
PROVISION FOR LOAN AND LEASE LOSSES 2,682,691 155,000 3,470,280 367,000
------------ ------------- ------------- --------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 1,043,934 3,729,882 8,229,840 10,807,521
------------ ------------- ------------- --------------
NONINTEREST INCOME (LOSS)
Banking service charges and fees 412,883 417,803 1,165,371 1,143,723
Trust 345,357 319,049 892,896 992,142
(Losses) gains on available for sale securities (6,490) (6,720,523) 314,584 (6,687,682)
Increase in cash surrender value of life insurance 99,224 101,702 293,429 299,279
Gains on the sale of loans 349,294 17,085 509,552 34,904
Other 14,767 57,356 83,721 200,041
------------ ------------- ------------- --------------
TOTAL NONINTEREST INCOME (LOSS) 1,215,035 (5,807,528) 3,259,553 (4,017,593)
------------ ------------- ------------- --------------
NONINTEREST EXPENSE
Salaries 1,689,178 1,650,937 4,878,218 4,968,276
Employee benefits 440,930 406,287 1,350,877 1,298,126
Net occupancy 290,254 293,833 919,779 898,056
Equipment 137,492 151,144 434,010 465,528
Legal fees 128,647 85,703 370,440 203,323
Directors fees 43,925 51,175 137,900 151,475
Computer services 291,898 259,291 870,125 746,378
Supplies 50,863 58,020 124,537 148,449
Consulting, services and fees 189,554 70,393 442,106 314,431
Postage 37,757 40,056 112,767 113,676
Advertising 36,050 170,839 349,091 465,209
FDIC assessments 210,829 91,395 930,055 183,744
Loss due to dishonored items 768,583 -- 768,583 --
Other 786,524 423,957 1,877,044 1,419,121
------------ ------------- ------------- --------------
TOTAL NONINTEREST EXPENSE 5,102,484 3,753,030 13,565,532 11,375,792
------------ ------------- ------------- --------------
LOSS BEFORE INCOME TAXES (2,843,515) (5,830,676) (2,076,139) (4,585,864)
BENEFIT FOR INCOME TAXES (770,444) (404,786) (705,887) (274,945)
------------ ------------- ------------- --------------
NET LOSS BEFORE NONCONTROLLING INTERESTS (2,073,071) (5,425,890) (1,370,252) (4,310,919)
NET INCOME ATTIBUTABLE TO
NONCONTROLLING INTERESTS 41,832 -- 94,459 --
------------ ------------- ------------- --------------
NET LOSS $ (2,114,903) $ (5,425,890) $ (1,464,711) $ (4,310,919)
DIVIDENDS AND ACCRETION ON PREFERRED SHARES 137,874 -- 412,910 --
------------ ------------- ------------- --------------
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS $ (2,252,777) $ (5,425,890) $ (1,877,621) $ (4,310,919)
============ ============= ============= ==============
LOSS PER SHARE
BASIC NET LOSS PER COMMON SHARE $ (0.96) $ (2.30) $ (0.80) $ (1.82)
============ ============= ============= ==============
DILUTED NET LOSS PER COMMON SHARE $ (0.96) $ (2.30) $ (0.80) $ (1.82)
============ ============= ============= ==============
DIVIDENDS PER SHARE $ -- $ 0.15 $ 0.10 $ 0.45
============ ============= ============= ==============
See Notes to Consolidated Financial Statements.
4
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Retained Accumulated
Additional Earnings Other Total
Noncontrolling Preferred Common Paid-In (Accumulated Treasury Comprehensive Shareholders'
Interests Stock Stock Capital Deficit) Stock Loss Equity
------------- --------- ------ ---------- ----------- -------- ------------- -------------
Nine months ended
September 30, 2008
Balance, December 31, 2007 $ 50,000 $ -- $ 25,012 $27,858,841 $ 2,623,110 $ (926,964) $(1,267,387) $28,362,612
Adoption of EITF issue,
Acccounting for Deferred
Compensation and Postretirement
Benefits Associated
with Endorsement Split Dollar
Arrangements as of
January 1, 2008 -- -- -- -- (12,272) -- -- (12,272)
Comprehensive income (loss):
Net income -- -- -- -- (4,310,919) -- (4,310,919)
Other comprehensive loss, net
of taxes:
Net unrealized holding
loss on available
for sale securities -- -- -- -- -- -- (2,129,230) (2,129,230)
Net actuarial loss and
prior service
cost for
pension benefits (537,088) (537,088)
------------
Other comprehensive loss (2,666,318)
------------
Total comprehensive loss (6,977,237)
Cash dividends declared: $0.30
per share -- -- -- -- (1,063,457) -- -- (1,063,457)
Purchase of treasury shares (227,098) (227,098)
Stock options exercised -
1,893 shares 19 20,464 20,483
Tax benefit on stock options
exercised 2,025 2,025
Restricted stock grants and
expense -- -- 5 6,113 -- -- -- 6,118
-------- ------- -------- ---------- ----------- ----------- ----------- -----------
Balance, September 30, 2008 $ 50,000 $ -- $ 25,036 $27,887,443 $(2,763,538) $(1,154,062) $(3,933,705) $20,111,174
======== ======== ======== =========== =========== =========== =========== ===========
Nine months ended
September 30, 2009
Balance, December 31, 2008 $ 53,875 $ -- $ 25,038 $37,892,831 $(3,325,920) $(1,154,062) $(1,024,498) $32,467,264
Comprehensive income (loss):
Net income (loss) 94,459 -- -- -- (1,464,711) -- -- (1,370,252)
Other comprehensive income
(loss), net of taxes:
Net unrealized holding
gain on available
for sale securities -- -- -- -- -- -- 775,905 775,905
Net unrealized holding
loss on cash
flow hedges -- -- -- -- -- -- (27,462) (27,462)
Net actuarial gain and
prior service
cost for pension
benefits -- -- -- -- -- -- 147,291 147,291
-----------
Other comprehensive income 895,734
-----------
Total comprehensive loss (474,518)
Cumulative effect of adopting
FASB staff position,
Recognition and Presentation
of Other-than-Temporary
Impairments
(net of $853,767 tax effect) -- -- -- -- 1,657,313 -- (1,657,313) --
Cash dividends declared:
$0.10 per share -- -- -- -- (235,712) -- (235,712)
Restricted stock grants
and expense -- -- 6 6,876 -- -- -- 6,882
Preferred stock dividends (375,000) (375,000)
Accretion of discount on
preferred stock -- -- -- 37,910 (37,910) -- -- --
-------- -------- -------- ----------- ----------- ----------- ----------- -----------
Balance, September 30, 2009 $148,334 $ -- $ 25,044 $37,937,617 $(3,781,940) $(1,154,062) $(1,786,077) $31,388,916
======== ======== ======== =========== =========== =========== =========== ===========
See Notes to Consolidated Financial Statements.
5
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) September 30,
2009 2008
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,464,711) $ (4,310,919)
Adjustments to reconcile net loss to net cash provided by operating activities:
Net income attributable to non-controlling interest 94,459 --
Amortization (accretion) of discounts and premiums
on investment securities, net 277,333 (124,184)
Provision for loan and lease losses 3,470,280 367,000
Depreciation and amortization 520,171 550,204
Loss on impairment write-down of available for sale securities -- 6,946,098
Gains on sale of available for sale securities (314,584) (258,416)
Loss on sale of foreclosed real estate 55,640 --
Losses on sales of repossessed assets 185,865 26,275
Loans originated for sale (13,283,029) (2,124,000)
Proceeds from sales of loans held for sale 27,447,044 2,143,887
Gains on sales of loans held for sale (509,552) (34,904)
(Gain) losses on disposals of bank premises and equipment (3,457) 2,188
Deferred income taxes (705,887) --
Stock based compensation 6,883 6,118
Decrease in accrued interest receivable 323,173 309,132
Increase in other assets (39,065) (235,487)
Increase in cash surrender value of life insurance (293,429) (299,279)
Increase in deferred loan origination costs (74,537) (90,048)
Decrease in accrued expenses and other liabilities (911,673) (1,024,395)
------------ ------------
Net cash provided by operating activities 14,780,924 1,849,270
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Available for sale securities:
Proceeds from maturities and principal payments 52,361,754 29,370,830
Purchases (76,402,584) (58,903,339)
Proceeds from sales 37,027,093 43,804,423
Held to maturity mortgage-backed securities:
Proceeds from maturities and principal payments 1,486 2,952
Inrcease in due from broker for security sale -- (11,643,821)
Purchase of restricted stock (5,000) (5,000)
Purchase of Federal Home Loan Bank stock -- (360,200)
Net increase in loans and leases (26,811,335) (22,637,407)
Purchase of bank premises and equipment (248,052) (129,143)
Proceeds from sale of bank premises and equipment 3,457 --
Proceeds from sale of foreclosed real estate 419,360 --
Proceeds from sales of repossessed assets 56,676 214,532
------------ ------------
Net cash used in investing activities (13,597,145) (20,286,173)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in savings, money market and demand deposits 3,733,149 11,907,339
Net increase (decrease) in certificates of deposit 35,464,671 (6,797,900)
Repayments on Federal Home Loan Bank advances -- (4,500,000)
Net (decrease) increase in Federal Home Loan Bank overnight borrowings (1,608,000) 941,000
Net (decrease) increase in repurchase agreements with financial institutions (3,950,000) 4,900,000
Net increase (decrease) in repurchase agreements with customers 1,186,514 (873,356)
Net decrease in collateralized borrowings (1,375,550) (310,166)
Principal repayments on capital lease obligation (14,142) (13,413)
Purchase of treasury shares -- (227,098)
Proceeds from the exercise of stock options -- 20,483
Tax benefit of stock options exercised -- 2,025
Dividends paid on common stock (615,618) (1,065,082)
------------ ------------
Net cash provided by financing activities 32,821,024 3,983,832
------------ ------------
Net increase (decrease) in cash and cash equivalents 34,004,803 (14,453,071)
CASH AND CASH EQUIVALENTS, at beginning of period 9,238,783 21,497,194
------------ ------------
CASH AND CASH EQUIVALENTS, at end of period $ 43,243,586 $ 7,044,123
============ ============
SUPPLEMENTAL INFORMATION
Cash paid during the period for:
Interest on deposits and borrowings $ 7,612,852 $ 10,523,661
============ ============
Income taxes $ 1,000 $ 1,000
============ ============
Noncash investing and financing activities:
Accrued dividends declared $ 375,000 $ 353,603
============ ============
Transfer of loans to repossessed assets $ 90,423 $ 181,400
============ ============
Transfer of loans to OREO $ 1,022,040 $ --
============ ============
Increase in leases and other liabilities for
equipment payable related to financed leases $ 680,533 $ 2,082,719
============ ============
Increase in mortgage servicing assets $ 269,037 $ 15,017
============ ============
Increase in liabilities and decrease in retained earnings for
the adopting FASB staff position, "Accounting for Deferred
Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar-Life Insurance Arrangements" $ -- $ 12,272
============ ============
Change in other liabilities related to the unfunded pension liability $ 223,167 $ 813,770
============ ============
Change in gross unrealized holding losses on available for sale securities $ 1,715,613 $ 3,226,105
============ ============
Transfer of loans to loans held for sale $ 13,005,284 $ --
============ ============
See Notes to Consolidated Financial Statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The consolidated balance sheet at December 31, 2008 of First Litchfield
Financial Corporation (the "Company") has been derived from the audited
financial statements at that date, but does not include all of the
information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial
statements. Certain 2008 amounts have been reclassified to conform with
the 2009 presentation. Such reclassifications had no effect on net income.
2. The accompanying unaudited consolidated financial statements and related
notes have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission. Accordingly, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United
States of America have been omitted pursuant to such rules and
regulations. The accompanying financial statements and related notes
should be read in conjunction with the audited financial statements of the
Company and notes thereto for the fiscal year ended December 31, 2008.
These financial statements reflect, in the opinion of Management, all
adjustments, consisting of only normal recurring adjustments, necessary
for a fair presentation of the Company's financial position and the
results of its operations and its cash flows for the periods presented.
The results of operations for the three and nine months ended September
30, 2009 are not necessarily indicative of the results of operations that
may be expected for all of 2009.
The Financial Accounting Standards Board's (FASB) Accounting Standards
Codification (ASC) became effective on July 1, 2009. At that date, the ASC
became FASB's officially recognized source of authoritative U.S. generally
accepted accounting principles (GAAP) applicable to all public and
non-public non-governmental entities, superseding existing FASB, American
Institute of Certified Public Accountants (AICPA), Emerging Issues Task
Force (EITF) and related literature. Rules and interpretive releases of
the SEC under the authority of federal securities laws are also sources of
authoritative GAAP for SEC registrants. All other accounting literature is
considered non-authoritative. The switch to the ASC affects the way
companies refer to U.S. GAAP in financial statements and accounting
policies. Citing particular content in the ASC involves specifying the
unique numeric path to the content through the Topic, Subtopic, Section
and Paragraph structure.
During the first quarter of 2009, the Company entered into two interest
rate swap agreements to hedge certain interest rate exposures. The Company
does not use derivatives for speculative purposes. The Company applies
"Accounting for Derivative Instruments and Hedging Activities," as
amended, which establishes accounting and reporting standards for
derivative instruments and hedging activities. This accounting guidance
requires the Company to recognize all derivatives as either assets or
liabilities in its Consolidated Balance Sheets and to measure those
instruments at fair value. The estimated fair value is based primarily on
projected future swap rates.
The Company applies cash flow hedge accounting to interest rate swaps
designated as hedges of the variability of future cash flows from floating
rate liabilities due to the benchmark interest rate. The Company uses
regression analysis to perform an ongoing prospective and retrospective
assessment of these hedging relationships. Changes in the fair value of
these interest rate swaps are recorded to "net holding gain on cash flow
hedges" as a component of accumulated other comprehensive income (loss)
("OCI") in Shareholders' equity, to the extent they are effective. Amounts
recorded to accumulated other comprehensive income (loss) are then
reclassified to interest expense as interest on the hedged borrowing is
recognized. Any ineffective portion of the change in fair value of these
instruments is recorded to interest expense.
7
3. The Company is required to present basic income per share and diluted
income per share in its consolidated statements of income. Basic income
per share amounts are computed by dividing net income by the weighted
average number of common shares outstanding. Diluted income per share
assumes exercise of all potential common stock equivalents in weighted
average shares outstanding, unless the effect is anti-dilutive. The
Company is also required to provide a reconciliation of the numerator and
denominator used in the computation of both basic and diluted income per
share. Income attributable to common shareholders has been reduced and
losses have been increased by preferred share dividends and discount
accretion related to the Company`s participation in TARP Capital Purchase
program. For the three and nine month periods ended September 30, 2009
this amount totaled $137,874 and $412,910, respectively.
The following is information about the computation of net loss per share
for the three and nine month periods ended September 30, 2009 and 2008.
The Company had no dilutive securities outstanding at September 30, 2009.
Three Months Ended
September 30, 2009
--------------------------------------
Net Per Share
Loss Shares Amount
----------- --------- ---------
Basic Net Loss Per Share
Loss attributable to common shareholders $(2,252,777) 2,356,875 $ (0.96)
=========
Effect of Dilutive Securities
Options Outstanding -- --
Diluted Net Loss Per Share
Loss attributable to common shareholders
------------ ---------
plus assumed conversions $(2,252,777) 2,356,875 $ (0.96)
============ ========= =========
Three Months Ended
September 30, 2008
--------------------------------------
Net Per Share
Loss Shares Amount
----------- --------- ---------
Basic Net Loss Per Share
Loss attributable to common shareholders $(5,425,890) 2,358,267 $ (2.30)
=========
Effect of Dilutive Securities
Options Outstanding -- --
Diluted Net Loss Per Share
Loss attributable to common shareholders
------------ ---------
plus assumed conversions $(5,425,890) 2,358,267 $ (2.30)
============ ========= =========
Nine Months Ended
September 30, 2009
--------------------------------------
Net Per Share
Loss Shares Amount
----------- --------- ---------
Basic Net Loss Per Share
Loss attributable to common shareholders $(1,877,621) 2,356,875 $ (0.80)
=========
Effect of Dilutive Securities
Options Outstanding -- --
Diluted Net Loss Per Share
Loss attributable to common shareholders
------------ ---------
plus assumed conversions $(1,877,621) 2,356,875 $ (0.80)
============ ========= =========
Nine Months Ended
September 30, 2008
--------------------------------------
Net Per Share
Loss Shares Amount
----------- --------- ---------
Basic Net Loss Per Share
Loss attributable to common shareholders $(4,310,919) 2,364,904 $ (1.82)
=========
Effect of Dilutive Securities
Options Outstanding -- 536
Diluted Net Loss Per Share
Loss attributable to common shareholders
------------ ---------
plus assumed conversions $(4,310,919) 2,365,440 $ (1.82)
============ ========= =========
8
4. Other comprehensive income (loss), which is comprised of the change in
unrealized gains and losses on available for sale securities, net cash
flow hedges, as well as net pension gain, is as follows:
Three Months Ended
September 30, 2009
----------------------------------------
Before-Tax Tax Net-of-Tax
Amount Effect Amount
----------- --------- ---------
Unrealized holding gain arising during the period $ 1,204,164 $(409,416) $ 794,748
Less: reclassification adjustment for loss recognized in net income 6,490 (2,207) 4,283
----------- --------- ---------
Unrealized holding gain on available for sale securities, net of taxes 1,210,654 (411,623) 799,031
Net cash flow hedges, net of taxes (204,165) 69,416 (134,749)
Net pension gain, net of taxes 168,944 (57,440) 111,504
----------- --------- ---------
Total other comprehensive income, net of taxes $ 1,175,433 $(399,647) $ 775,786
=========== ========= =========
Three Months Ended
September 30, 2008
-----------------------------------------
Before-Tax Tax Net-of-Tax
Amount Effect Amount
----------- --------- -----------
Unrealized holding losses arising during the period $(5,602,610) $ 194,688 $(5,407,922)
Add: reclassification adjustment for loss recognized in net income 6,720,523 (574,778) 6,145,745
----------- --------- -----------
Unrealized holding gains on available for sale securities, net of taxes 1,117,913 (380,090) 737,823
Net pension loss, net of taxes (334,418) 113,702 (220,716)
----------- --------- -----------
Total other comprehensive income, net of taxes $ 783,495 $(266,388) $ 517,107
=========== ========= ===========
Nine Months Ended
September 30, 2009
----------------------------------------
Before-Tax Tax Net-of-Tax
Amount Effect Amount
----------- --------- ---------
Unrealized holding gain arising during the period $ 1,490,197 $(506,667) $ 983,530
Less: reclassification adjustment for gain recognized in net income (314,584) 106,959 (207,625)
----------- --------- ---------
Unrealized holding gains on available for sale securities, net of taxes 1,175,613 (399,708) 775,905
Net cash flow hedges, net of taxes (41,609) 14,147 (27,462)
Net pension gain, net of taxes 223,167 (75,876) 147,291
----------- --------- ---------
Total other comprehensive income, net of taxes $ 1,357,171 $(461,437) $ 895,734
=========== ========= =========
Nine Months Ended
September 30, 2008
----------------------------------------
Before-Tax Tax Net-of-Tax
Amount Effect Amount
----------- --------- -----------
Unrealized holding losses arising during the period $(9,913,788) $ 1,660,488 $(8,253,300)
Add: reclassification adjustment for loss recognized in net income 6,687,682 (563,612) 6,124,070
----------- ----------- -----------
Unrealized holding losses on available for sale securities, net of taxes (3,226,106) 1,096,876 (2,129,230)
Net pension loss, net of taxes (813,770) 276,682 (537,088)
----------- ----------- -----------
Total other comprehensive loss, net of taxes $(4,039,876) $ 1,373,558 $(2,666,318)
=========== =========== =============
9
5. The Company's subsidiary, The First National Bank of Litchfield (the
"Bank") has a noncontributory defined benefit pension plan (the "Plan")
that covers substantially all employees who have completed one year of
service and have attained age 21. The benefits are based on years of
service and the employee's compensation during the last five years of
employment. During the first quarter of 2005, the Bank's pension plan was
curtailed. Prior to the Plan's curtailment, the Bank's funding policy was
to contribute amounts to the plan sufficient to meet the minimum funding
requirements set forth in ERISA, plus such additional amounts as the Bank
determined to be appropriate from time to time. The actuarial information
has been calculated using the projected unit credit method.
Components of net periodic benefit cost for the three months ended
September 30:
2009 2008
-------- --------
Service cost $ -- $ --
Interest cost 42,700 46,306
Expected return on plan assets (43,104) (50,363)
Amortization of unrealized loss 19,523 14,812
-------- --------
Net periodic benefit cost $ 19,119 $ 10,755
======== ========
Components of net periodic benefit cost for the nine months ended
September 30:
2009 2008
--------- ---------
Service cost $ -- $ --
Interest cost 128,100 138,919
Expected return on plan assets (129,311) (151,090)
Amortization of unrealized loss 58,569 44,437
--------- ---------
Net periodic benefit cost $ 57,358 $ 32,266
========= =========
6. The Bank is a member of the Federal Home Loan Bank of Boston (the
"FHLBB"). As a member of the FHLBB, the Bank has access to a preapproved
line of credit of up to 2% of its total assets and the capacity to borrow
up to 30% of its total assets. In accordance with an agreement with the
FHLBB, the Bank is required to maintain qualified collateral, as defined
in the FHLBB Statement of Products Policy, free and clear of liens,
pledges and encumbrances for the advances. FHLBB stock and certain loans
which aggregate approximately 100% of the outstanding advance are used as
collateral. The Company views its investment in the FHLBB stock as a
long-term investment. Accordingly, when evaluating for impairment, the
value is determined based on the ultimate recovery of the par value rather
than recognizing temporary declines in value. The determination of whether
a decline affects the ultimate recovery is influenced by criteria such as:
1) the significance of the decline in net assets of the FHLBB as compared
to the capital stock amount and length of time a decline has persisted; 2)
impact of legislative and regulatory changes on the FHLBB; and 3) the
liquidity position of the FHLBB. The FHLBB announced in February 2009 that
it would suspend its dividend for the first quarter of 2009, and will
likely not pay any dividends for the remainder of 2009, and will continue
its moratorium on excess stock repurchases announced in December 2008. The
FHLBB noted their primary concern related to the impact of
other-than-temporary impairment ("OTTI") charges recorded on private label
mortgage-backed securities (MBS) as of December 31, 2008.
While the FHLBB announced that it remained adequately capitalized as of
December 31, 2008 in its February announcement, the Company is unable to
determine if the potential additional charges to earnings will change this
regulatory capital classification. On October 29, 2009, the FHLBB
communicated to its members that the FHLBB recorded a net loss of $105.4
million for the third quarter of 2009. The primary challenge for the FHLBB
continues to be losses due to the other-than-temporary impairment of its
investments in private-label mortgage-backed securities resulting in a
credit loss of
10
$174.2 million during the quarter. The associated non-credit loss on these
securities this quarter was $1.6 million and resulted in an accumulated
other comprehensive loss of $1.0 billion at September 30, 2009. Retained
earnings were $136.3 million at September 30, 2009, down from $241.7
million at June 30, 2009. In spite of these losses, the FHLBB remained in
compliance with all regulatory capital ratios as of September 30, 2009.
The FHLBB explained that the ongoing impact of the economy as well as the
housing and capital markets is likely to continue to provide challenges
for the Bank. The underlying credit quality especially as it relates to
the FHLBB's investments in private-label mortgage-backed securities,
remains vulnerable. Trends in determining future OTTI are still
challenging and include: rising unemployment rates, some further decline
in housing prices, higher default rates, lower voluntary prepayment rates,
and deepened loss severities.
FHLBB's management is focused on the long-term agenda: returning the FHLBB
to profitability, preserving the FHLBB's capital base, and building
retained earnings. They have begun to implement elements of a plan that
will, over time, work to restore the FHLBB to a position where they can
once again repurchase stock, pay members a dividend, and fund the
Affordable Housing Program. The Company does not believe that its
investment in the FHLBB is impaired as of this date. However, this
estimate could change in the near term as a result of any of the following
events: 1) additional significant impairment losses are incurred on the
MBS causing a significant decline in the FHLBB's regulatory capital
status; 2) the economic losses resulting from credit deterioration on the
MBS increases significantly; and 3) capital preservation strategies being
utilized by the FHLBB become ineffective.
Federal Home Loan Bank advances as of September 30, 2009 are as follows:
due 10/02/2009 $ 6,000,000 @ 4.50%
due 11/30/2009 5,000,000 @ 3.95%
due 6/24/2010 5,000,000 @ 4.15%
due 11/02/2010 10,000,000 @ 4.45%
due 5/29/2012 5,000,000 @ 4.32%
due 5/02/2014 7,000,000 @ 4.59% , callable 5/3/2010
due 8/20/2014 7,000,000 @ 4.25% , callable 8/20/2010
due 5/05/2016 10,000,000 @ 4.53% , callable 11/5/2009
due 3/23/2017 10,000,000 @ 4.29% , callable 12/23/2009
due 7/20/2017 10,000,000 @ 4.29% , callable 10/20/2009
due 11/20/2017 5,000,000 @ 4.29% , callable 11/19/2012
--------------
Total $ 80,000,000
==============
As of September 30, 2009, the Bank had borrowings under repurchase
agreements with financial institutions totaling $22,500,000. This amount
includes borrowings:
due 3/12/2013 $ 12,500,000 @ 3.19% , callable 3/12/2011
due 5/23/2013 10,000,000 @ 3.64% , callable 5/23/2011
---------------
Total $ 22,500,000
===============
11
7. A reconciliation of the anticipated income tax expense (computed by
applying the Federal statutory income tax rate of 34% to the income before
taxes) to the (benefit) provision for income taxes as reported in the
statements of operations is as follows:
For the three months ended September 30,
--------------------------------------------
2009 2008
------------------- ---------------------
Provision for income taxes at statutory Federal rate $(966,795) (34)% $(1,982,430) (34)%
Increase (decrease) resulting from:
Tax exempt income (104,392) (2) (148,249) (3)
Nondeductible interest expense 5,234 -- 10,423 --
Increase in valuation allowance -- -- 1,710,200 30
Unrecognized tax benefits 292,014 10 --
Other 3,495 (1) 5,270 --
--------- --- ----------- ---
Benefit for income taxes $(770,444) (27)% $ (404,786) (7)%
========= === =========== ===
For the nine months ended September 30,
--------------------------------------------
2009 2008
------------------- ---------------------
Provision for income taxes at statutory Federal rate $(705,887) (34)% $(1,559,194) (34)%
Increase (decrease) resulting from:
Tax exempt income (320,252) (16) (477,969) (11)
Nondeductible interest expense 17,742 1 36,207 1
Increase in valuation allowance -- -- 1,710,200 37
Unrecognized tax benefits 292,014 14
Other 10,496 1 15,811 1
--------- --- ----------- ---
Benefit for income taxes $(705,887) (34)% $ (274,945) (6)%
========= === =========== ===
As of September 30, 2009 and December 31, 2008, the Company had recorded net
deferred income tax assets of approximately $5.3 million and $5.1 million,
respectively. The determination of the amount of deferred income tax assets
which are more likely than not to be realized is primarily dependent on
projections of future earnings, which are subject to uncertainty and estimates
that may change given economic conditions and other factors. A valuation
allowance related to deferred tax assets is required when it is considered more
likely than not that all or part of the benefit related to such assets will not
be realized. Management has reviewed the deferred tax position of the Company at
September 30, 2009. The deferred tax position has been affected by several
significant transactions in the past three years. These transactions included
other-than-temporary impairment write-offs of certain investments and
significant permanent differences between accounting and tax income such as
non-taxable municipal security income, which securities have been sold and
replaced with assets which will generate taxable income in the future, and
certain specific expenditures not expected to reoccur. As a result, the Company
is in a cumulative net loss position (pretax income (loss) for a three year
period adjusted for permanent items) as of September 30, 2009. However, under
the applicable accounting guidance, the Company has concluded that it is "more
likely than not" that the Company will be able to realize its deferred tax
assets based on the non-recurring nature of these items and the Company's
expectation of future taxable income. In the future, management's conclusion
regarding the need for a deferred tax asset valuation allowance could change,
resulting in the establishment of a valuation allowance for a portion or all of
the deferred tax asset. The Company will continue to analyze the recoverability
of its deferred tax assets quarterly.
Federal tax returns for all years subsequent to 2006 remain open to examination.
For the Company's principal state tax jurisdiction of Connecticut, tax returns
for years subsequent to 2001 remain open to examination. There were no interest
or penalties paid during the nine-month period ended September 30, 2009 or the
twelve-month period ended December 31, 2008. No accrued interest or penalties
were recorded as of September 30, 2009 or December 31, 2008. The Company
believes that it has appropriate support for the income tax positions taken and
to be taken on its tax returns, and that its accruals for tax liabilities are
adequate for all open years based on an assessment of many factors including
past experience and interpretations of tax law applied to the facts of each
matter.
12
8. The amortized cost, gross unrealized gains, gross unrealized losses and
approximate fair values of securities which are classified as available
for sale and held to maturity at September 30, 2009 and December 31, 2008
are as follows:
AVAILABLE FOR SALE September 30, 2009
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ------------ -----------
Debt Securities:
U.S. Treasury securities $ 3,080,963 $ 70,287 $ -- $ 3,151,250
U.S. Government Agency securities 12,227,759 90,220 (41,179) 12,276,800
State and Municipal Obligations 12,441,684 127,478 (155,868) 12,413,294
Trust Preferred Securities (1) 2,994,101 -- (2,114,570) 879,531
----------- ----------- ------------ -----------
30,744,507 287,985 (2,311,617) 28,720,875
----------- ----------- ------------ -----------
Mortgage-Backed Securities:
GNMA 461,783 7,785 (52) 469,516
FNMA 29,490,613 618,691 (12,885) 30,096,419
FHLMC 21,638,206 320,132 (20,918) 21,937,420
----------- ----------- ------------ -----------
51,590,602 946,608 (33,855) 52,503,355
----------- ----------- ------------ -----------
Marketable Equity Securities 17,069,511 14,939 -- 17,084,450
----------- ----------- ------------ -----------
Total available for sale securities $99,404,620 $ 1,249,532 $ (2,345,472) $98,308,680
=========== =========== ============ ===========
(1) Net of other-than-temporary impairment writedowns recognized in
earnings, other than such noncredit-related amounts reclassified on April
1, 2009.
December 31, 2008
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ --------- ------------ ------------
Debt Securities:
U.S. Treasury securities $ 3,110,574 $ 107,876 $ -- $ 3,218,450
U.S. Government Agency securities 26,500,000 65,763 (3,386) 26,562,377
State and Municipal Obligations 19,931,000 77,501 (376,069) 19,632,432
Trust Preferred Securities (2) 493,615 -- -- 493,615
------------ --------- ------------ ------------
50,035,189 251,140 (379,455) 49,906,874
------------ --------- ------------ ------------
Mortgage-Backed Securities:
GNMA 9,495,917 12 (8,094) 9,487,835
FNMA 35,675,421 467,875 (263,567) 35,879,729
FHLMC 14,994,269 210,723 (9,228) 15,195,764
------------ --------- ------------ ------------
60,165,607 678,610 (280,889) 60,563,328
------------ --------- ------------ ------------
Marketable Equity Securities 3,045,878 -- (29,879) 3,015,999
------------ --------- ------------ ------------
Total available for sale securities $113,246,674 $ 929,750 $ (690,223) $113,486,201
============ ========= ============ ============
(2) Net of other-than-temporary impairment writedowns recognized in
earnings.
HELD TO MATURITY September 30, 2009
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ----------- ------------ ------------
Mortgage-Backed Securities:
GNMA $ 15,064 $ 356 $ -- $ 15,420
============ =========== ============ ============
December 31, 2008
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ----------- ------------ ------------
Mortgage-Backed Securities:
GNMA $ 16,550 $ 3 $ -- $ 16,553
============ =========== ============ ============
13
The Company adopted the FASB staff position, "Recognition and Presentation of
Other-Than-Temporary Impairments," for the interim period ended June 30, 2009,
which was applied to existing and new debt securities held by the Company as of
April 1, 2009. For those debt securities for which the fair value of the
security is less than its amortized cost and the Company does not intend to sell
such security and it is more likely than not that it will not be required to
sell such security prior to the recovery of its amortized cost basis less any
credit losses, the accounting principle requires that the credit component of
the other-than-temporary impairment losses be recognized as a loss in earnings
while the noncredit component is recognized in other comprehensive loss, net of
related taxes. As a result of the adoption of the accounting principle, the
Company reclassified the noncredit component of the other-than-temporary
impairment loss previously recognized in earnings during 2008. The
reclassification was reflected as a cumulative effect adjustment of $1,657,313
($2,511,080 before taxes) that increased retained earnings and increased
accumulated other comprehensive loss. The amortized cost basis of these debt
securities for which other-than-temporary impairment losses were recognized
during 2008 were adjusted by the amount of the cumulative effect adjustment
before taxes.
The following table presents the Bank's securities' gross unrealized losses and
fair value, aggregated by the length of time the individual securities have been
in a continuous unrealized loss position at September 30, 2009:
Less than 12 Months 12 Months or More Total
------------------------- ------------------------- -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------------- ------------------------- -------------------------
Investment Securities
U.S. Government Agency Securities $ 4,993,650 $ 41,179 $ -- $ -- $ 4,993,650 $ 41,179
State & Municipal obligations -- -- 4,258,191 155,868 4,258,191 155,868
Trust Preferred Securities (1) 879,531 2,114,570 -- -- 879,531 2,114,570
----------- ---------- ---------- ----------- ----------- ----------
5,873,181 2,155,749 4,258,191 155,868 10,131,372 2,311,617
----------- ---------- ---------- ----------- ----------- ----------
Mortgage-Backed Securities
GNMA -- -- 46,057 52 46,057 52
FNMA 1,407,460 268 1,777,533 12,617 3,184,993 12,885
FHLMC 3,764,485 17,796 75,781 3,122 3,840,266 20,918
----------- ---------- ---------- ----------- ----------- ----------
5,171,945 18,064 1,899,371 15,791 7,071,316 33,855
----------- ---------- ---------- ----------- ----------- ----------
----------- ---------- ---------- ----------- ----------- ----------
Total $11,045,126 $2,173,813 $6,157,562 $ 171,659 $17,202,688 $2,345,472
=========== ========== ========== =========== =========== ==========
(1) Net of other-than-temporary impairment writedowns recognized in earnings,
other than such noncredit-related amounts reclassified on April 1, 2009 in
accordance with the adoption of "Recognition and Presentation of
Other-Than-Temporary Impairments."
The following table presents the Bank's securities' gross unrealized losses and
fair value, aggregated by the length of time the individual securities have been
in a continuous unrealized loss position at December 31, 2008:
Less than 12 Months 12 Months or More Total
------------------------- ------------------------- -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------------- ------------------------- -------------------------
Investment Securities
U.S. Government Agency securities $ 7,996,614 $ 3,386 $ -- $ -- $ 7,996,614 $ 3,386
State & Municipal obligations 8,804,717 303,267 2,574,433 72,802 11,379,150 376,069
----------- ---------- ----------- ----------- ----------- --------
16,801,331 306,653 2,574,433 72,802 19,375,764 379,455
----------- ---------- ----------- ----------- ----------- --------
Mortgage-Backed Securities
GNMA -- -- 465,643 8,094 465,643 8,094
FNMA 10,067,156 112,219 4,209,833 151,348 14,276,989 263,567
FHLMC -- -- 1,351,769 9,228 1,351,769 9,228
----------- ---------- ----------- ----------- ----------- --------
10,067,156 112,219 6,027,245 168,670 16,094,401 280,889
----------- ---------- ----------- ----------- ----------- --------
Marketable Equity Securities -- -- 1,970,122 29,879 1,970,122 29,879
----------- ---------- ----------- ----------- ----------- --------
Total $26,868,487 $ 418,872 $10,571,800 $ 271,351 $37,440,287 $690,223
=========== ========== =========== =========== =========== ========
14
At September 30, 2009, seventeen securities had unrealized losses. At
September 30, 2009, gross unrealized holding losses on available for sale
and held to maturity securities totaled $2,345,472. Of the securities with
unrealized losses, there were nine securities that have been in a
continuous unrealized loss position for a period of twelve months or more.
The unrealized losses on these securities totaled $171,659 at September
30, 2009. The following summarizes by investment security type, the basis
for the conclusion that the applicable investment securities within the
Company's available for sale portfolio were not other-than-temporarily
impaired at September 30, 2009.
Management conducts a formal review of investment securities on a
quarterly basis for the presence of other-than-temporary impairment
("OTTI"). For the second quarter of 2009, the Company adopted the
provisions of FASB staff position, "Recognition and Presentation of
Other-Than-Temporary Impairments." Management assesses whether OTTI is
present when the fair value of a debt security is less than its amortized
cost basis at the balance sheet date. Under these circumstances as
required by the new staff position, OTTI is considered to have occurred
(1) if the Company intends to sell the security; (2) if it is "more likely
than not" that the Company will be required to sell the security before
recovery of its amortized cost basis; or (3) the present value of expected
cash flows is not sufficient to recover the entire amortized cost basis.
The "more likely than not" criteria is a lower threshold than the
"probable" criteria used under previous guidance.
The staff position requires that credit-related OTTI is recognized in
earnings while non-credit related OTTI on securities not expected to be
sold is recognized in OCI. Non-credit related OTTI is caused by other
factors, including illiquidity. For securities classified as
held-to-maturity ("HTM"), the amount of OTTI recognized in OCI is accreted
to the credit-adjusted expected cash flow amounts of the securities over
future periods. Non-credit related OTTI recognized in earnings previous to
April 1, 2009 is reclassified from retained earnings to accumulated OCI as
a cumulative effect adjustment. The Company adopted this staff position
effective April 1, 2009. The adoption of this staff position resulted in
the reclassification of $2,511,080, ($1,657,313, net of tax) of non-credit
related OTTI to accumulated OCI which had previously been recognized as a
loss in earnings.
Management's OTTI evaluation process also follows the guidance of the
standard entitled "Accounting for Certain Investments in Debt and Equity
Securities," "Recognition of Interest Income and Impairment on Purchased
and Retained Beneficial Interests in Securitized Financial Assets," and
"Amendments to the Impairment and Interest Income Measurement Guidance."
This guidance requires the Company to take into consideration current
market conditions, fair value in relationship to cost, extent and nature
of change in fair value, issuer rating changes and trends, volatility of
earnings, current analysts' evaluations, and all available information
relevant to the collectability of debt securities. The Company is also
required to consider its ability and intent to hold investments until a
recovery of fair value, which may be maturity, and other factors when
evaluating the existence of OTTI in its securities portfolio. The
accounting principle was issued on January 12, 2009 and is effective for
reporting periods ending after December 15, 2008. This accounting
principle amends the previous accounting principle by eliminating the
requirement that a holder's best estimate of cash flows be based upon
those that a market participant would use. Instead, the provision requires
that OTTI be recognized as a realized loss through earnings when there has
been an adverse change in the holder's expected cash flows such that it is
"probable" that the full amount will not be received.
In addition, the disclosure and related discussion of unrealized losses is
presented pursuant to the EITF topic entitled, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments." The staff position replaces certain impairment evaluation
guidance of the EITF topic; however, the disclosure requirements of EITF
topic remain in effect. This staff position addresses the determination of
when an investment is considered impaired, whether the impairment is
considered to be other-than-temporary, and the measurement of an
impairment loss. The staff position also supersedes EITF Topic entitled
"Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a
Security Whose Cost Exceeds Fair Value," and clarifies that an impairment
loss should be recognized no
15
later than when the impairment is deemed other-than-temporary, even if a
decision to sell an impaired security has not been made.
For the three and nine months ended September 30, 2009, the Company did
not recognize any OTTI charges.
For all security types discussed below where no OTTI is considered to
exist at September 30, 2009, management applied the criteria of the staff
position to each investment individually. That is, for each security
evaluated, management concluded that it does not intend to sell the
security and it is not more likely than not that management will be
required to sell the security before recovery of its amortized cost basis
and as such OTTI was not recognized as a loss in earnings.
The following summarizes, by investment security type, the basis for the
conclusion that the applicable investment securities within the Company's
available for sale portfolio were not other-than-temporarily impaired at
September 30, 2009:
U.S. Government Agency Securities - The unrealized losses in the Company's
investment in these securities as of September 30, 2009 totaled $41,179.
This compares to unrealized losses of $3,386 at December 31, 2008. As the
unrealized losses in this sector of the portfolio relate mostly to
interest rates, the Company does not consider these investments to be
other-than-temporarily impaired at September 30, 2009.
State and Municipal Obligations - The unrealized losses on the Company's
investment in state and municipal obligations decreased from $376,069 at
December 31, 2008 to $155,868 at September 30, 2009. There were no OTTI
charges for these securities during the third quarter of 2009. These
securities are primarily insured AA and A rated general obligation bonds
with stable ratings. The decrease in the unrealized loss at September 30,
2009 is attributable to sales in this sector of the portfolio during the
third quarter. As of September 30, 2009, all securities are performing,
the Company is receiving all interest and principal payments as
contractually agreed, and all these securities are rated as investment
grade. The Company does not consider these investments to be
other-than-temporarily impaired at September 30, 2009.
Trust Preferred Securities - As of September 30, 2009, the unrealized
losses on the Company's investment in trust preferred securities totaled
$2,114,570. As of September 30, 2009, this portfolio consisted of two
pooled trust preferred securities with a carrying value of $2,994,101 and
a market value of $879,531. These securities are in the form of mezzanine
classes which are comprised of bank and insurance collateral. During the
first quarter of 2009, both securities were downgraded to a rating of Ca
indicating a more severe deterioration in the creditworthiness of the
underlying issuers of these securities. As a result, the Company recorded
OTTI losses effective as of December 31, 2008. Management evaluated
current credit ratings, credit support and stress testing for future
defaults. Management also reviewed analytics provided by the trustee,
reports from third-party sources and internal documents. As previously
indicated, the Company adopted the provisions of the staff position, and
in connection therewith determined that other-than-temporary impairments
at April 1, 2009 consisted of $1,881,573 related to credit losses and
$2,511,080 related to other factors. There were no other-than-temporary
impairments for the three months ended September 30, 2009.
The unrealized losses on the Company's trust preferred securities were
caused by a lack of liquidity and uncertainties facing the banking and
insurance industries. During 2009, the Company was notified that these
securities will not be remitting interest payments and that going forward,
the Company would be receiving payments "in kind." As a result of this,
the Company has discontinued interest accruals on the securities and an
impairment loss has been recorded on one security as discussed above.
Based on the aforementioned valuation analysis to determine expected
credit losses prepared on both of these
16
securities, management expects to fully recover amortized cost of each
security. However, additional interest deferrals and/or defaults could
result in future other-than-temporary impairment charges. Because the
Company does not intend to sell the investments and it is not more likely
than not that the Company will be required to sell the investments before
recovery of their amortized cost bases, which may be maturity, the Company
does not consider the non-credit impairment of these investments to be
recognized in earnings as other-than-temporary impairments at September
30, 2009.
Mortgage-backed securities - The unrealized losses on the Company's
investment in mortgage-backed securities decreased from $280,889 at
December 31, 2008 to $33,855 at September 30, 2009. There were no OTTI
charges for the nine months ended September 30, 2009. These securities are
U.S. Government Agency or sponsored agency securities secured by
residential properties. The contractual cash flows for these investments
are performing as expected. Management believes the increase in fair value
is attributable to investor's perception of improvement in credit and
liquidity in the marketplace. The Company expects to collect all principal
and interest on these securities. Because the Company does not intend to
sell these investments and it is not more likely than not that the Company
will be required to sell these investments until a recovery of amortized
cost, which may be at maturity, the Company does not consider these
investments to be other-than-temporarily impaired at September 30, 2009.
Equity securities - There were no unrealized losses on the Company's
investment which was a decrease from the unrealized losses of $29,879 as
of December 31, 2008. As of September 30, 2009, this portfolio consists of
a marketable investment fund with a fair value of $2,014,939, a money
market fund with a fair value of $15,069,509, and perpetual preferred
stock of government sponsored enterprises which have been written down to
a fair value of $2. Given that there is no unrealized loss remaining in
this segment of the portfolio, no other-than-temporary evaluation was
warranted at September 30, 2009.
The following table presents a roll-forward of the balance of credit-related
impairment losses on debt securities held at September 30, 2009 for which a
portion of the other-than-temporary impairment was recognized in other
comprehensive loss:
For the Three Months ended September 30, 2009:
Balance at July 1, 2009 $1,881,573
Credit component of other-than-temporary impairment not reclassified to other
comprehensive loss in conjunction with the cumulative effect adjustment --
Additions for credit component for which other-than-temporary impairment was
not previously recognized --
----------
Balance at September 30, 2009 $1,881,573
==========
For the Nine Months ended September 30, 2009:
Balance at January 1, 2009 $ --
Credit component of other-than-temporary impairment not reclassified to other
comprehensive loss in conjunction with the cumulative effect adjustment 1,881,573
Additions for credit component for which other-than-temporary impairment was
not previously recognized --
----------
Balance at September 30, 2009 $1,881,573
==========
As of September 30, 2009, debt securities with other-than-temporary
impairment losses related to credit and were recognized in earnings
consisted of pooled trust preferred securities. In accordance with the
staff position regarding other-than-temporary impairment issued in April
2009, the Company estimated the portion of loss attributable to credit
using a discounted cash flow model. Significant inputs for the Trust
17
Preferred Securities included estimated cash flows and prospective
deferrals, defaults and recoveries based on the underlying seniority
status and subordination structure of the pooled trust preferred debt
tranche at the time of measurement. The valuations of trust preferred
securities were based upon fair value guidance issued in April 2009 using
cash flow analysis. Contractual cash flows and a market rate of return
were used to derive fair value for each of these securities. Factors that
affected the market rate of return included (1) any uncertainty about the
amount and timing of the cash flows, (2) the credit risk, (3) liquidity of
the instrument, and (4) observable yields from trading data and bid/ask
indications. Credit risk spreads and liquidity premiums were analyzed to
derive the appropriate discount rate. Prospective deferral, default and
recovery estimates affecting projected cash flows were based on an
analysis of the underlying financial condition of the individual issuers,
with consideration of the issuer's capital adequacy, credit quality,
lending concentrations and other factors. Assumptions for deferral and
constant default rates were 100% for nonperforming in 2011, from 2% to
4.85% for nonperforming during 2010, 3.5% for 2011 and 1% for performing
after 2011. The assumptions for collateral conditional default rates
ranged from 0% to 4% and severity of defaults assumptions ranged from 68%
to 95%. Assumptions for internal rates of return were from 12% to 17% and
prepayment assumptions were from 0% to 2%.
All cash flow estimates were based on the securities' tranche structure
and contractual rate and maturity terms. The Company utilized the services
of a third-party vendor to obtain information about the structure in order
to determine how the underlying collateral cash flows will be distributed
to each security issued from the structure. The present value of the
expected cash flows was compared to the Company's holdings to determine
the credit-related impairment loss.
The amortized cost and fair value of debt securities at September 30, 2009
and December 31, 2008, by contractual maturity, are shown below. Actual
maturities of mortgage-backed securities may differ from contractual
maturities because the mortgages underlying the securities may be called
or prepaid with or without call or prepayment penalties. Because
mortgage-backed securities are not due at a single maturity date, they are
not included in the maturity categories in the following maturity summary.
September 30, 2009
--------------------------------------------------------------
Available-for-Sale Securities Held-to-Maturity Securities
----------------------------- ---------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ----------- ------- -------
Due in one year or less $ 999,178 $ 1,010,938 $ -- $ --
Due after one year through five years 5,226,049 5,294,963 -- --
Due after five years through ten years 10,584,778 10,642,659 -- --
Due after ten years 13,934,502 11,772,315 -- --
----------- ----------- ------- -------
30,744,507 28,720,875 -- --
Mortgage-backed securities 51,590,602 52,503,355 15,064 15,420
----------- ----------- ------- -------
TOTAL DEBT SECURITIES $82,335,109 $81,224,230 $15,064 $15,420
=========== =========== ======= =======
December 31,2008
------------------------------------------------------------
Available-for-Sale Securities Held-to-Maturity Securities
----------------------------- -------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------ ------------ ------- -------
Due in one year or less $ -- $ -- $ -- $ --
Due after one year through five years 25,110,576 25,272,025 -- --
Due after five years through ten years 6,403,590 6,443,810 -- --
Due after ten years 18,521,023 18,191,039 -- --
------------ ------------ ------- -------
50,035,189 49,906,874 -- --
Mortgage-backed securities 60,165,607 60,563,328 16,550 16,553
------------ ------------ ------- -------
TOTAL DEBT SECURITIES $110,200,796 $110,470,202 $16,550 $16,553
============ ============ ======= =======
18
9. A summary of the Bank's loan and lease portfolio at September 30, 2009 and
December 31, 2008 is as follows:
2009 2008
------------- -------------
Real estate--residential mortgage $ 172,572,153 $ 192,561,108
Real estate--commercial mortgage 100,564,068 67,454,925
Real estate--construction 27,262,941 38,153,503
Commercial Loans 41,015,054 46,249,689
Commercial Leases (net of unearned
discount of $3,999,055-2009, $2,501,895-2008) 35,324,433 19,785,870
Installment 4,882,886 5,113,400
Other 372,074 128,574
------------- -------------
TOTAL LOANS AND LEASES 381,993,609 369,447,069
Net deferred loan origination costs 636,779 562,242
Premiums on purchased loans 20,690 81,588
Allowance for loan and lease losses (6,084,194) (3,698,820)
------------- -------------
NET LOANS AND LEASES $ 376,566,884 $ 366,392,079
============= =============
Changes in the allowance for loan and lease losses for the three months
ended September 30, 2009 and 2008 are as shown below:
2009 2008
----------- -----------
Balance at June 30, $ 4,029,790 $ 2,233,578
Provision for loan and lease losses 2,682,691 155,000
Loans and leases charged off (767,429) (123,192)
Recoveries of loans and leases charged off 139,142 1,716
----------- -----------
Balance at the end of the period $ 6,084,194 $ 2,267,102
=========== ===========
Changes in the allowance for loan and lease losses for the nine months
ended September 30, 2009 and 2008 are as shown below:
2009 2008
----------- -----------
Balance at beginning of the year $ 3,698,820 $ 2,151,622
Provision for loan and lease losses 3,470,280 367,000
Loans and leases charged off (1,416,376) (275,457)
Recoveries of loans and leases charged off 331,470 23,937
----------- -----------
Balance at the end of the period $ 6,084,194 $ 2,267,102
=========== ===========
The following information relates to impaired loans and leases, which
include all nonaccrual loans and leases and other loans and leases past
due 90 days or more, and all restructured loans and leases, as of and for
the nine months ended September 30, 2009 and December 31, 2008.
2009 2008
---------- ---------
Loans and leases receivable for which there is a related allowance for loan
and lease losses $4,140,031 $6,225,481
========== ==========
Loans and leases receivable for which there is no related allowance for loan
and lease losses $7,578,146 $2,657,655
========== ==========
Allowance for loan and lease losses related to impaired loans and leases $1,375,040 $ 939,066
========== ==========
19
10. Other real estate owned ("OREO") represents the estimated net realizable
value of real estate received in satisfaction of a non-performing loan
through foreclosure proceedings during 2009. The Bank had no OREO during
2008. A summary of the other real estate owned operations for the nine
months ended September 30, 2009 and 2008 included in other expenses is as
follows:
2009 2008
------- ------
Expense of holding other real estate owned $98,875 $ --
Write-down of other real estate owned property -- --
------- ------
Expense of holding other real estate owned operations, net $98,875 $ --
======= ======
11. A summary of the Bank's deposits at September 30, 2009 and December 31,
2008 is as follows:
2009 2008
------------ ------------
Noninterest bearing:
Demand $ 70,023,494 $ 69,548,261
------------ ------------
Interest bearing:
Savings 72,532,547 58,582,376
Money market 82,392,871 93,085,126
Time certificates of deposit in
denominations of $100,000 or more 76,917,868 41,003,855
Other time certificates of deposit 80,657,664 81,107,006
------------ ------------
Total Interest bearing deposits 312,500,950 273,778,363
------------ ------------
TOTAL DEPOSITS $382,524,444 $343,326,624
============ ============
Included in deposits as of September 30, 2009 and December 31, 2008 are
approximately $29,510,000 and $15,902,000, respectively, of brokered
deposits which have varying maturities through December 2009 and December
2010, respectively.
12. During 2007, the Company approved a restricted stock plan (the "2007
Plan") for senior management. On February 15, 2008, the Company granted
3,500 restricted stock awards to senior management from the 2007 Plan.
These awards vest over a five-year period, or earlier if the senior
manager ceases to be a senior manager for reasons such as retirement or
change in control. The holders of these awards participate fully in the
rewards of stock ownership of the Company, including voting and dividend
rights. The senior managers are not required to pay any consideration to
the Company for the restricted stock awards. The Company measures the fair
value of the awards based on the average of the high price and low price
at which the Company's common stock traded on the date of the grant. For
the three and nine months ended September 30, 2009, $2,294 and $6,882
respectively was recognized as compensation expense under the 2007 Plan.
At September 30, 2009, unrecognized compensation cost of $30,591 related
to these awards is expected to vest over a weighted average period of 4
years.
A summary of unvested shares as of and for the nine months ended September
30, 2009, is as follows:
Weighted Average
Shares Grant Date
(in thousands) Fair Value
------------- ------------
Unvested at January 1, 2009 3,500 $ 13.11
Granted -- --
Vested -- --
Forfeited -- --
----- -------
Unvested at September 30, 2009 3,500 $ 13.11
===== =======
20
13. The Company has two operating segments for purposes of reporting business
line results: Community Banking and Leasing. The Community Banking segment
is defined as all the operating results of the Company and the Bank. The
Leasing segment is defined as the results of First Litchfield Leasing
Corporation. Because First Litchfield Leasing Corporation is a relatively
new subsidiary, methodologies and organizational hierarchies are newly
developed and will be subject to periodic review and revision. The
following presents the operating results and total assets for the segments
of the Company as of and for the three and nine months ended September 30,
2009 and 2008, respectively. The Company uses an internal reporting system
to generate information by operating segment. Estimates and allocations
are used for noninterest expenses and income taxes. The Company uses a
matched maturity funding concept to allocate interest expense to First
Litchfield Leasing Corporation. The matched maturity funding concept
utilizes the origination date and the maturity date of the lease to assign
an interest expense to each lease.
Three Months Ended
September 30, 2009
--------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
------------- ------------ ---------- -------------
Net interest income $ 3,308,163 $ 418,462 $ -- $ 3,726,625
Provision for credit losses 2,660,513 22,178 -- 2,682,691
------------- ------------ ---------- -------------
Net interest income after provision for credit losses 647,650 396,284 -- 1,043,934
Noninterest income 1,215,035 -- -- 1,215,035
Noninterest expense 5,019,960 82,524 -- 5,102,484
------------- ------------ ---------- -------------
(Loss) income before income taxes (3,157,275) 313,760 -- (2,843,515)
Income tax benefit (provision) 875,044 (104,600) -- 770,444
------------- ------------ ---------- -------------
Net (loss) income $ (2,282,231) $ 209,160 $ -- $ (3,613,959)
============= ============ ========== =============
Total assets as of September 30, 2009 $ 513,221,094 $ 38,184,219 $ 201,950 $ 551,203,363
============= ============ ========== =============
Three Months Ended
September 30, 2008
--------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
------------ ------------ ---------- -------------
Net interest income $ 3,713,276 $ 171,606 $ -- $ 3,884,882
Provision for credit losses 119,909 35,091 -- 155,000
------------- ------------ ---------- -------------
Net interest income after provision for credit losses 3,593,367 136,515 -- 3,729,882
Noninterest (loss) income (5,811,556) 4,028 -- (5,807,528)
Noninterest expense 3,672,156 80,874 -- 3,753,030
------------- ------------ ---------- -------------
(Loss) Income before income taxes (5,890,345) 59,669 -- (5,830,676)
Income tax benefit (provision) 423,034 (18,248) -- 404,786
------------- ------------ ---------- -------------
Net (loss) income $ (5,467,311) $ 41,421 $ -- $ (5,425,890)
============= ============ ========== =============
Total assets as of September 30, 2008 $ 484,358,599 $ 22,381,788 $ 201,950 $ 506,538,437
============= ============ ========== =============
21
Nine Months Ended
September 30, 2009
--------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
------------- ------------ ---------- -------------
Net interest income $ 10,626,062 $ 1,074,058 $ -- $ 11,700,120
Provision for credit losses 3,357,959 112,321 -- 3,470,280
------------- ------------ ---------- -------------
Net interest income after provision for credit losses 7,268,103 961,737 -- 8,229,840
Noninterest income 3,256,647 2,906 -- 3,259,553
Noninterest expense 13,307,487 258,045 -- 13,565,532
------------- ------------ ---------- -------------
(Loss) Income before income taxes (2,782,737) 706,598 -- (2,076,139)
Income tax benefit (provision) 940,188 (234,301) -- 705,887
------------- ------------ ---------- -------------
Net (loss) income $ (1,842,549) $ 472,297 $ -- $ (1,370,252)
============= ============ ========== =============
Total assets as of September 30, 2009 $ 513,221,094 $ 38,184,219 $ 201,950 $ 551,203,363
============= ============ ========== =============
Nine Months Ended
September 30, 2008
---------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
------------- ------------ ---------- -------------
Net interest income $ 10,708,773 $ 465,748 $ -- $ 11,174,521
Provision for credit losses 280,226 86,774 -- 367,000
------------- ------------ ---------- -------------
Net interest income after provision for credit losses 10,428,547 378,974 -- --
Noninterest (loss) income (4,021,621) 4,028 -- (4,017,593)
Noninterest expense 11,119,124 256,668 -- 11,375,792
------------- ------------ ---------- -------------
(Loss) income before income taxes (4,712,198) 126,334 -- (15,393,385)
Income tax benefit (provision) 313,270 (38,325) -- 274,945
------------- ------------ ---------- -------------
Net (loss) income $ (4,398,928) $ 88,009 $ -- $ (4,310,919)
============= ============ ========== =============
Total assets as of September 30, 2008 $ 484,358,599 $ 22,381,788 $ 201,950 $ 506,538,437
============= ============ ========== =============
14. The fair value of an asset or liability is the price that would be
received to sell that asset or paid to transfer that liability in an
orderly transaction occurring in the principal market (or most
advantageous market in the absence of a principal market) for such asset
or liability. In estimating fair value, the Company utilizes valuation
techniques that are consistent with the market approach, the income
approach and/or the cost approach. Such valuation techniques are
consistently applied. Inputs to valuation techniques include the
assumptions that market participants would use in pricing an asset or
liability. The standard issued by the FASB entitled, "Fair Value
Measurements" establishes a fair value hierarchy for valuation inputs that
gives the highest priority to quoted prices in active markets for
identical assets or liabilities and the lowest priority to unobservable
inputs. The fair value hierarchy is as follows:
22
Level 1 Quoted prices in active markets for identical assets or liabilities.
Level 1 assets include debt and equity securities that are traded in an
active exchange market, as well as U.S. Treasury securities, that are
highly liquid and are actively traded in over-the-counter markets.
Level 2 Observable inputs other than Level 1 prices such as quoted prices for
similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by
observable market data for substantially the full term of the assets or
liabilities. Level 2 assets and liabilities include debt securities
with quoted prices that are traded less frequently than exchange-traded
instruments whose value is determined using a pricing model with inputs
that are observable in the market or can be derived principally from or
corroborated by observable market data. This category generally
includes other U.S. Government and agency mortgage-backed and debt
securities, state and municipal obligations, and equity securities
quoted in markets that are not active. Also included are interest rate
swaps, certain collateral-dependent impaired loans, loans held for sale
and foreclosed property.
Level 3 Unobservable inputs that are supported by little or no market activity
and that are significant to the fair value of the assets or
liabilities. Level 3 assets and liabilities include financial
instruments whose value is determined using pricing models, discounted
cash flow methodologies, or similar techniques, as well as instruments
for which the determination of fair value requires significant
management judgment or estimation. For example, this category could
include certain private equity investments, trust preferred securities
and certain collateral-dependent impaired loans.
The following table details the financial instruments that are carried at
fair value and measured at fair value on a recurring basis as of September
30, 2009 and December 31, 2008 and indicates the fair value hierarchy of
the valuation techniques utilized by the Company to determine fair value:
Fair Value Measurements at September 30, 2009, Using
Quoted Prices in Significant
September Active Markets Significant Other Unobservable
30, 2009 Identical Assets Observable Inputs Inputs
Total (Level 1) (Level 2) (Level 3)
----------- ------------- ----------- ---------
Assets:
Available for sale securities $98,308,680 $ 20,235,700 $77,193,449 $879,531
=========== ============= =========== ========
Liabilities:
Interest rate swaps $ 41,609 $ -- $ 41,609 $ --
=========== ============= =========== ========
Fair Value Measurements at December 31, 2008, Using
Quoted Prices in Significant
December Active Markets Significant Other Unobservable
31, 2008 Identical Assets Observable Inputs Inputs
Total (Level 1) (Level 2) (Level 3)
------------ ------------- ------------ ---------
Assets:
Available for sale securities $113,486,201 $ 5,188,571 $108,297,630 $ --
============ ============= ============ ========
As of September 30, 2009, U.S. Treasury securities and two equity securities,
with carrying values of $20,235,700 are the only assets whose fair values are
measured on a recurring basis, using Level 1 inputs (active market quotes). At
December 31, 2008, U.S. Treasury securities and one equity security with
carrying values of $5,188,571, are the only assets whose fair values are
measured on a recurring basis using Level 1 inputs.
The fair values of U. S. Government and agency mortgaged backed securities and
debt securities, State and Municipal obligations, and certain equity securities
are measured on a recurring basis, using Level 2 inputs of observable market
data on similar securities. As of September 30, 2009 and December 31, 2008, the
carrying values of these securities totaled $77,193,449 and $108,297,630,
respectively.
23
The fair value of the Bank's interest rate swap derivative instruments are
determined based on inputs that are readily available in public markets or can
be derived from information available in publicly quoted markets. Therefore, the
Bank has categorized these derivative instruments as Level 2 within the fair
value hierarchy.
Securities measured at fair value in Level 3 include certain collateralized debt
obligations that are backed by trust preferred securities issued by banks,
thrifts and insurance companies. Management determined that an orderly and
active market for these securities and similar securities did not exist based on
a significant reduction in trading volume and widening spreads relative to
historical levels.
The following table shows a reconciliation of the beginning and ending
balances for Level 3 assets:
Nine Months Ended
September 30, 2009
------------------
Balance at beginning of period $ --
Increase in fair value of securities included in other comprehensive loss 385,916
Transfers to (from) level 3 - Trust Preferred securities 493,615
----------
Balance at end of period $ 879,531
==========
The following tables detail the assets and liabilities carried at fair
value and measured at fair value on a nonrecurring basis as of September
30, 2009 and December 31, 2008 and indicate the fair value hierarchy of the
valuation techniques utilized by the Company to determine the fair value:
September 30, 2009
---------------------------------------------------------------------------
Quoted Prices in Significant Significant
Balance Active Markets for Observable Unobservable
as of Identical Assets Inputs Inputs
September 30, 2009 (Level 1) (Level 2) (Level 3)
------------------ ---------------- --------- ----------
Financial assets held at fair value
Foreclosed Property (1) $ 547,040 $ -- $ 547,040 $ --
========== ====== ========= ==========
Impaired Loans (1) $8,885,054 $ -- $ -- $8,885,054
========== ====== ========= ==========
Loans held for sale $ 95,000 $ -- $ 95,000 $ --
========== ====== ========= ==========
December 31, 2008
-----------------------------------------------------------------------------
Quoted Prices in Significant Significant
Balance Active Markets for Observable Unobservable
as of Identical Assets Inputs Inputs
December 31, 2008 (Level 1) (Level 2) (Level 3)
------------------- ---------- ----------- ----------
Financial assets held at fair value
Impaired Loans (1) $3,271,452 $ -- $ 694,650 $2,576,802
========== ====== ========== ==========
Loans held for sale $1,013,216 $ -- $1,013,216 $ --
========== ====== ========== ==========
(1) Represents carrying value and related write-downs for which adjustments are
based on the appraised value.
The Company has no other assets or liabilities carried at fair value or
measured at fair value on a non recurring basis.
The Fair Value Measurements standard requires disclosure of fair value
information about financial instruments, whether or not recognized in the
statement of financial condition, for which it is
24
practicable to estimate that value. The Fair Value Measurements standard
excludes certain financial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent
the underlying value of the Company.
In April 2009, the FASB issued a staff position "Interim Disclosures about
Fair Value of Financial Instruments." This staff position amends
"Disclosures about Fair Value of Financial Instruments," to require
disclosures about fair value instruments for interim reporting periods of
publicly traded companies as well as in financial statements. This staff
position also amends "Interim Financial Reporting," to require those
disclosures in summarized financial information at interim reporting
periods. Effective April 1, 2009, the Company adopted this staff position.
Cash and Due From Banks, Federal Funds Sold, Interest Income Receivable,
Accrued Interest Payable, Collateralized Borrowings, and Short-term
Borrowings: These assets and liabilities are short-term, and therefore,
book value is a reasonable estimate of fair value. These financial
instruments are not carried at fair value on a recurring basis.
Federal Home Loan Bank Stock, Federal Reserve Bank Stock and Other
Restricted Stock: Such stock is estimated to equal the carrying value, due
to the historical experience that these stocks are redeemed at par. These
financial instruments are not carried at fair value on a recurring basis.
Available for Sale and Held to Maturity Securities: Where quoted prices
are available in an active market, securities are classified within Level
1 of the valuation hierarchy. Level 1 securities include U.S. Treasury
securities that are traded in an active exchange market. If quoted prices
are not available, then fair values are estimated by using pricing models
(i.e., matrix pricing) or quoted prices of securities with similar
characteristics and are classified within Level 2 of the valuation
hierarchy. Examples of such instruments include U.S. Government agency and
sponsored agency bonds, mortgage-backed and debt securities, state and
municipal obligations, and equity securities in markets that are not
active, and certain collateral dependent loans. Securities measured at
fair value in Level 3 include certain collateralized debt obligations that
are backed by trust preferred securities issued by banks, thrifts and
insurance companies. Management determined that an orderly and active
market for these securities and similar securities did not exist based on
a significant reduction in trading volume and widening spreads relative to
historical levels. Available for sale securities are recorded at fair
value on a recurring basis, and held to maturity securities are only
disclosed at fair value.
Loans: For variable rate loans which reprice frequently and have no
significant change in credit risk, carrying values are a reasonable
estimate of fair values, adjusted for credit losses inherent in the
portfolios. The fair value of fixed rate loans is estimated by discounting
the future cash flows using the current market rates as of the reporting
date, estimated using local market data, at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities, adjusted for credit losses inherent in the portfolios. Loans
are generally not recorded at fair value on a recurring basis. However,
from time to time, nonrecurring fair value adjustments to
collateral-dependent impaired loans are recorded to reflect partial
write-downs based on the observable market price or current appraised
value of collateral.
Loans held for sale: Loans held for sale are required to be carried at the
lower of cost or fair value. Market value is to represent fair value. As
of September 30, 2009, the Company had $95,000 of loans held for sale,
which represented first mortgages committed and subject to settlement
shortly after the end of the period. Due to the short term nature of loans
committed for sale, the carrying value approximates the market price.
Interest rate swap derivatives: The fair value of the Bank's interest rate
swap derivative instruments are determined based on inputs that are
readily available in public markets or can be derived from
25
information available in publicly quoted markets. Therefore, the Bank has
categorized these derivative instruments as Level 2 within the fair value
hierarchy.
Deposits: The fair value of demand deposits, savings and money market
deposits is the amount payable on demand at the reporting date. The fair
value of certificates of deposit is estimated using a discounted cash flow
calculation that applies current market interest rates being offered for
deposits of similar remaining maturities to a schedule of aggregated
expected maturities on such deposits. Deposits are not recorded at fair
value on a recurring basis.
Long-term debt: The fair value of long-term debt is estimated using a
discounted cash flow calculation that applies current interest rates for
borrowings of similar maturity to a schedule of maturities of such
advances. Long-term debt is not recorded at fair value on a recurring
basis.
Off-balance-sheet instruments: Fair values for off-balance-sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and
the counterparties' credit standings. Off-balance sheet instruments are
not recorded at fair value on a recurring basis.
The recorded book balances and estimated fair values of the Company's
financial instruments at September 30, 2009 and December 31, 2008 are
presented in the following table. The estimated fair value amounts for
September 30, 2009 and December 31, 2008 have been measured as of the end
of the respective periods and have not been revaluated or updated for
purposes of these financial statements subsequent to those respective
dates. As such, the estimated fair values of these financial instruments
subsequent to those respective reporting dates may be different than
amounts reported at period-end.
September 30, 2009 December 31, 2008
--------------------------- ----------------------------
Book Estimated Book Estimated
Value Fair Value Value Fair Value
--------------------------- ----------------------------
Financial Assets:
Cash and equivalents $ 43,243,586 43,243,586 $ 9,238,783 9,238,783
Available for sale securities 98,308,680 98,308,680 113,486,201 113,486,201
Held to maturity securities 15,064 15,420 16,550 16,553
Federal Home Loan Bank Stock 5,427,600 5,427,600 5,427,600 5,427,600
Federal Reserve Bank Stock 225,850 225,850 225,850 225,850
Other restricted stock 105,000 105,000 100,000 100,000
Loans held for sale 95,000 95,000 1,013,216 1,013,216
Loans and leases, net 376,566,884 393,828,296 366,392,079 365,191,872
Accrued interest receivable 1,939,745 1,939,745 2,262,918 2,262,918
Interest rate swaps 41,609 41,609 - -
Financial Liabilities:
Savings deposits 72,532,547 72,532,547 58,582,376 58,582,376
Money market and demand deposits 152,416,365 152,416,365 162,633,387 162,633,387
Time certificates of deposit 157,575,532 158,575,338 122,110,861 122,607,975
Federal Home Loan Bank advances 80,000,000 82,950,958 81,608,000 86,044,755
Repurchase agreements with
financial institutions 22,500,000 23,308,788 26,450,000 26,316,528
Repurchase agreements with customers 19,409,085 19,409,085 18,222,571 18,222,571
Subordinated debt 10,104,000 10,104,000 10,104,000 10,104,000
Accrued interest payable 511,261 511,261 611,829 611,829
Collateralized borrowings - - 1,375,550 1,375,550
Loan and lease commitments, rate lock derivative commitments and other
commitments, on which the committed interest rate is less than the current
market rate are insignificant at September 30, 2009 and December 31, 2008.
26
15. Interest Rate Swaps and Derivative Instruments
The Company manages its interest rate risk by using derivative instruments
in the form of interest rate swaps designed to reduce interest rate risk
by effectively converting a portion of floating rate debt into fixed rate
debt. This action reduces the Company's risk of incurring higher interest
costs in periods of rising interest rates. On February 2, 2009, the
Company entered into two interest rate swap agreements through March of
2014 and 2019, respectively; however, the settlements under the swaps
commenced March 30, 2009. Payments under the swap agreements will continue
on the 30th of each quarter end. The Company is accounting for the
interest rate swap agreements as effective cash flow hedges. The notional
principal amounts of these swaps were $6,800,000 and $3,000,000 and the
variable interest rate amounts on related debt were swapped for effective
fixed rates of 5.79% and 4.86%, respectively. These swaps are designated
as cash flow hedges and qualify for hedge accounting treatment under a
standard entitled, "Accounting for Derivative Instruments and Hedging
Activities."
In accordance with this standard, the Company's derivative instruments are
recorded as assets or liabilities at fair value. Changes in fair value
derivatives that have been designated as cash flow hedges are included in
"Unrealized gains (losses) on cash flow hedges" as a component of other
comprehensive income to the extent of the effectiveness of such hedging
instruments. Any ineffective portion of the change in fair value of the
designated hedging instruments would be included in the Consolidated
Statements of Income in interest (income) expense. No such adjustment to
income to reflect hedge ineffectiveness on cash flow hedges was recognized
during the nine months ended September 30, 2009, and Management does not
anticipate the recognition of any such adjustment to income throughout the
terms of the swaps. Gains and losses are reclassified from accumulated
other comprehensive income to the Consolidated Statements of Income in the
period the hedged transaction affects earnings.
Amounts reported in accumulated other comprehensive income related to
derivatives will be reclassified to interest expense as interest payments
are made on the Company's variable-rate debt. Amounts in other
comprehensive income will be reclassified into interest expense over the
term of the swap agreements to achieve the fixed rate on the debt.
Over the next twelve months, the Company estimates that an additional
$221,175 will be reclassified as an increase to interest expense.
The gross carrying values of the interest rate contracts as of September
30, 2009 were $41,609 and were recorded in other liabilities on the
Consolidated Balance Sheets (see Notes 4 and 13). For the nine months
ended September 30, 2009, the amount of income recognized on the effective
portion of these interest rate contracts in accumulated other
comprehensive income on the condensed Consolidated Balance Sheets was
($27,462). For the quarter ended September 30, 2009, there were no losses
on the effective portion of these interest rate contracts reclassified
from accumulated other comprehensive loss into interest expense of the
Consolidated Statement of Financial Condition. These interest rate swap
agreements contain no credit-risk-related contingency features. Associated
with these swaps, as of September 30, 2009, the Company was required to
post collateral with a fair value totaling $300,000 to cover the estimated
peak exposure of these swaps. No additional collateral is or will be
required to be posted.
16. Recent Accounting Pronouncements
As discussed in Note 1 - Significant Accounting Policies, on July 1, 2009,
the Accounting Standards Codification became FASB's officially recognized
source of authoritative U.S. generally accepted accounting principles
applicable to all public and non-public non-governmental entities,
superceding existing FASB, AICPA, EITF and related literature. Rules and
interpretive releases of the SEC under the
27
authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants. All other accounting literature is considered
non-authoritative. The switch to the ASC affects the way companies refer
to U.S. GAAP in financial statements and accounting policies. Citing
particular content in the ASC involves specifying the unique numeric path
to the content through the Topic, Subtopic, Section and Paragraph
structure.
Noncontrolling Interests in Consolidated Financial Statements - In
December 2007, the FASB issued an amendment to previous guidance on
noncontrolling interest. This amendment establishes new accounting and
reporting standards for the noncontrolling interest in a subsidiary and
for the deconsolidation of a subsidiary. Before this statement, limited
guidance existed for reporting noncontrolling interests (minority
interest). As a result, diversity in practice existed. In some cases
minority interest was reported as a liability and in others it was
reported in the mezzanine section between liabilities and equity.
Specifically, this amendment requires the recognition of a noncontrolling
interest (minority interest) as equity in the consolidated financials
statement and separate from the parent's equity. The amount of net income
attributable to the noncontrolling interest is included in consolidated
net income on the face of the income statement. This amendment clarifies
that changes in a parent's ownership interest in a subsidiary that do not
result in deconsolidation are equity transactions if the parent retains
its controlling financial interest. In addition, this statement requires
that a parent recognize gain or loss in net income when a subsidiary is
deconsolidated. Such gain or loss is to be measured using the fair value
of the noncontrolling equity investment on the deconsolidation date. The
amendment also includes expanded disclosure requirements regarding the
interests of the parent and its noncontrolling interests. Earlier adoption
was prohibited. The Company adopted this amendment beginning on January 1,
2009 and with the adoption, presented $74,015 as equity in the Company's
consolidated financial statements and modified the presentation of the
Company's financial statements as of March 31, 2009 and December 31, 2008
and going forward.
Share-Based Payment Transaction - In June 2008, the FASB issued new
guidance on "Determining Whether Instruments Granted in Share-Based
Payment Transactions Are Participating Securities." This new guidance
addresses whether instruments granted in share-based payment transactions
are participating securities prior to vesting and, therefore, need to be
included in the earnings allocation in computing earnings per share (EPS)
under the two-class method. This guidance is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those years. All prior-period EPS data presented
shall be adjusted retrospectively (including interim financial statements,
summaries of earnings, and selected financial data) to conform with the
provisions of this staff position. Early application was not permitted.
The Company adopted the staff position for the quarter ended March 31,
2009. The adoption of this staff position did not have a significant
effect on the Company's financial statements.
Derivatives and Hedging - In March 2008, the FASB issued a new standard
entitled, "Disclosures about Derivative Instruments and Hedging Activities
- an amendment of FASB Statement 133." The standard requires expanded
disclosure to provide greater transparency about (i) how and why an entity
uses derivative instruments, (ii) how derivative instruments and related
hedge items are accounted for under this standard, and (iii) how
derivative instruments and related hedged items affect an entity's
financial position, results of operations and cash flows. To meet those
objectives, the standard requires qualitative disclosures about objectives
and strategies for using derivatives, quantitative disclosures about fair
value amounts of gains and losses on derivative instruments and
disclosures about credit risk-related contingent features in derivative
agreements. The standard became effective for the Company January 1, 2009
and enhanced disclosures are included in the Company's financial
statements for September 30, 2009.
Impairment Guidance - In January 2009, the FASB issued a FASB Staff
Position entitled "Amendments to the Impairment Guidance of EITF Issue No.
99-20," which amends the impairment
28
guidance in the EITF Issue, "Recognition of Interest Income and Impairment
on Purchased Beneficial Interests and Beneficial Interests that Continue
to be Held by a Transferor in Securitized Financial Assets." The FSP
revises the EITF issue's impairment guidance for beneficial interests to
make it consistent with the requirements of the standard entitled,
"Accounting for Certain Investments in Debt and Equity Securities," for
determining whether an impairment of other debt and equity securities has
occurred. The impairment model in the standard enables greater judgment to
be exercised in determining whether an OTTI loss needs to be recorded. The
impairment model previously provided for in the EITF issue limited
management's use of judgment in applying the impairment model. The staff
position was effective as of January 1, 2009. The adoption of the staff
position did not have a material impact on the Company's consolidated
financial statements.
Determining Fair Value When the Volume and Level of Activity for the Asset
or Liability Have Significantly Decreased and Identifying Transactions
That Are Not Orderly - In April 2009 FASB issued this guidance which
addresses concerns that Fair Value Measurements emphasized the use of an
observable market transaction even when that transaction may not have been
orderly or the market for that transaction may not have been active. This
provides additional guidance on: (a) determining when the volume and level
of activity for the asset or liability has significantly decreased; (b)
identifying circumstances in which a transaction is not orderly; and (c)
understanding the fair value measurement implications of both (a) and (b).
The effective date of disclosures for this new standard is for interim and
annual reporting periods ending after June 15, 2009. The Company adopted
this guidance on April 1, 2009. The adoption did not have a material
impact on the Company's consolidated financial statements. See Notes 8 and
13 for disclosure.
Other-Than-Temporary Impairments - In April 2009, the FASB issued a staff
position entitled, "Recognition and Presentation of Other-Than-Temporary
Impairments." The staff position (i) changes existing guidance for
determining whether an impairment is other-than-temporary to debt
securities and (ii) replaces the existing requirement that the entity's
management assert it has both the intent and ability to hold an impaired
security until recovery with a requirement that management assert: (a) it
does not have the intent to sell the security; and (b) it is more likely
than not it will not have to sell the security before recovery of its cost
basis. Under the staff position, declines in the fair value of
held-to-maturity and available-for-sale securities below their cost that
are deemed to be other-than-temporary are reflected in earnings as
realized losses to the extent the impairment is related to credit losses.
The amount of the impairment related to other factors is recognized in
other comprehensive income. The staff position became effective for the
Company in the quarter ended June 30, 2009, and resulted in the
reclassification of $2,511,080 ($1,657,313, net of tax) of non-credit
related OTTI to OCI which had previously been recognized in earnings and
is disclosed in Note 8 - Investment Securities.
Fair Value Measurements and Disclosures - In April 2009, the FASB issued a
staff position entitled, "Determining Fair Value when the Volume and Level
of Activity for the Asset or Liability has Significantly Decreased and
Identifying Transactions that are not Orderly." The staff position affirms
that the objective of fair value when the market for an asset is not
active is the price that would be received to sell the asset in an orderly
transaction, and clarifies and includes additional factors for determining
whether there has been a significant decrease in market activity for an
asset when the market for that asset is not active. The staff position
requires an entity to base its conclusion about whether a transaction was
not orderly on the weight of the evidence and expands certain disclosure
requirements. The staff position became effective for the Company in the
quarter ended June 30, 2009. See Note 13 for disclosure.
Interim Disclosure - Fair Value Measurements - In April 2009, the FASB
issued a new staff position entitled, "Interim Disclosures about Fair
Value of Financial Instruments." The staff position requires a publicly
traded company to include disclosures about the fair value of its
financial instruments
29
whenever it issues summarized financial information for interim reporting
periods. In addition, entities must disclose, in the body or in the
accompanying notes of its summarized financial information for interim
reporting periods and in its financial statements for annual reporting
periods, the fair value of all financial instruments for which it is
practicable to estimate that value, whether recognized or not recognized
in the statement of financial position. The staff position became
effective for the Company in the quarter ended June 30, 2009, and its
adoption did not have a significant effect on the Company's financial
position, results of operations, or cash flows. The Company has included
the disclosures required by the staff position in Note 13.
Subsequent Events - In May 2009, the FASB issued a new standard entitled,
"Subsequent Events." This standard establishes general standards of
accounting for and disclosure of events that occur after the balance sheet
date but before financial statements are issued or available to be issued.
This standard defines (i) the period after the balance sheet date during
which a reporting entity's management should evaluate events or
transactions that may occur for potential recognition or disclosure in the
financial statements, (ii) the circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in
its financial statements, and (iii) the disclosures an entity should make
about events or transactions that occurred after the balance sheet date.
The new standard became effective for the Company's financial statements
for periods ending after June 15, 2009 and did not have a significant
impact on the Company's financial statements.
Transfers and Servicing - In June 2009, the FASB issued a statement
entitled, "Accounting for Transfers of Financial Assets - an amendment of
FASB Statement No. 140." This standard amends prior accounting guidance to
enhance reporting about transfers of financial assets, including
securitizations, and where companies have continuing exposure to the risks
related to transferred financial assets. The new standard eliminates the
concept of a "qualifying special-purpose entity" and changes the
requirements for derecognizing financial assets. The standard also
requires additional disclosures about all continuing involvements with
transferred financial assets including information about gains and losses
resulting from transfers during the period. The standard will be effective
January 1, 2010 and is not expected to have a significant impact on the
Company's financial statements.
17. Reclassification
Certain 2008 amounts have been reclassified to conform with the 2009
presentation. Such reclassifications had no effect on net income.
18. Subsequent Events
The Company has evaluated events or transactions that occurred after
September 30, 2009 and through the time the financial statements were
filed on November 13, 2009 for potential recognition or disclosure in the
interim financial statements.
On October 25, 2009, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") by and among the Company, the Bank and
Union Savings Bank ("Union") that provides for the merger of the Company
and the Bank with and into Union (the "Merger"). Under the terms of the
Merger Agreement, shareholders of the Company will receive $15.00 cash for
each share of Company common stock they own on the date of the Merger. The
transaction is valued at approximately $35 million. No fractional shares
will be issued. Consummation of the Merger is subject to approval by the
shareholders of the Company, as well as customary regulatory approvals
including the Office of the Comptroller of the Currency, the State of
Connecticut Department of Banking and the Federal Deposit Insurance
Corporation. The Merger is expected to close in the first quarter of 2010,
although there can be no assurance that this will occur.
30
On November 9, 2009, the Bank entered into a Formal Agreement (the
"Agreement") with The Office of the Comptroller of the Currency (the
"OCC"). The Agreement is a remedial supervisory action with provisions
intended to improve the Bank's condition and operations. While not
punitive, the Agreement provides a framework for addressing identified
problems, documenting remedial efforts and preventing the reoccurrence of
similar problems so that the Bank's condition will improve and no longer
be considered to be troubled. Management and the Board are of the opinion
that compliance with the Agreement is in the best interest of the Bank but
will require sustained effort and management resources.
To coordinate its compliance efforts pursuant to the Agreement, the Board
of the Bank will appoint a Compliance Committee consisting primarily of
independent Directors. The Compliance Committee will meet at least monthly
to monitor and report the Bank's progress to the Board. The Board will
review the Bank's liquidity plans, capital plans, strategic plans and
management and staffing plans and provide copies of such plans to the OCC
along with copies of the reports of the Compliance Committee and other
relevant information. The Board will assess the adequacy of the Bank's
management and staffing needs to assure that the Bank is well managed and
well staffed. The Bank will also notify the OCC regarding any proposed
changes in the Board, executive management or staff or changes in their
duties or responsibilities.
Pursuant to the Agreement, the Bank will not utilize brokered deposits
without appropriate FDIC and OCC authorization. In this regard, the only
deposits currently utilized by the Bank which could be characterized as
"brokered deposits" are deposits obtained through the CDARS program. The
Agreement with the OCC does not preclude the Bank from participating in
the CDARS program and the Bank has requested authorization from the FDIC
to continue to participate in such program. The Bank has approximately $11
million in CDARS deposits, most of which will mature in January 2010.
The Agreement further requires the Bank to enhance its credit risk
management program within the Bank's loan and lease functions and to
develop and adhere to policies designed to enhance risk rating and risk
monitoring. In addition, the Bank has agreed to take appropriate action to
improve and maintain asset quality. The Bank will prepare written
evaluations of and programs for collecting any loans greater than $750,000
that are subject to criticism, regularly review such loans, and only
extend additional credit on such loans if the Bank determines and
documents that it is consistent with the Bank's plan to collect the loan
or strengthen the assets underlying the loan and the action is necessary
to protect the Bank's interests. In addition, the Bank will enhance and
document the programs it uses to evaluate, maintain and document the
adequacy of the Allowance for Loan and Lease Losses, which enhanced
programs were utilized in the evaluation of the Allowance for Loan and
Lease Losses for the third quarter of 2009, and provide a copy of such
program and documentation to the OCC.
The Agreement precludes the Bank from growing at a rate greater than 5% on
an annual basis. In addition to updating its capital plan with appropriate
contingencies, the Agreement would preclude the payment of any dividends
inconsistent with the capital plan or applicable law and without written
non-objection by the OCC. The Merger Agreement with Union precludes the
payment of dividends to the shareholders of the Company's common stock
pending consummation of the merger.
The Bank understands that the Agreement with the OCC will remain in place
so long as the Bank remains subject to OCC supervision or until such time
as the Agreement is terminated by the OCC, which will generally not occur
until the issues which were the basis of the Agreement have been corrected
and verified through an examination and until there is no basis for
supervisory concern. Failure to comply with the Agreement could result in
more serious supervisory action by the OCC with respect to the Bank, its
officers or directors.
31
In addition to the Agreement, the Bank has been notified that the OCC will
require the Bank to achieve and maintain the following capital ratios by
no later than March 31, 2010:
o Total risk-based capital at least equal to twelve percent (12%) of
risk-weighted assets (as compared with 10.80% maintained by the Bank at
September 30, 2009 and 10% generally required of well-capitalized banks);
o Tier 1 capital at least equal to ten percent (10%) of risk weighted
assets (as compared with 9.54% maintained by the Bank at September 30,
2009, and 6% generally required of well-capitalized banks); and
o Tier 1 capital at least equal to eight percent (8%) of adjusted total
assets (as compared with 6.59% maintained by the Bank at September 30,
2009 and 5% generally required of well-capitalized banks).
The Bank expects to consummate its Merger with and into Union prior to the
date by which it would be required to achieve and maintain such capital
ratios. However, there can be no assurance that the Merger will be
consummated within such timeframe. Accordingly, the Bank will develop
contingency plans to address compliance with such capital requirements in
the event that the Merger is not consummated by March 31, 2010.
There are no other subsequent events requiring recognition or disclosure
in the financial statements.
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
First Litchfield Financial Corporation (the "Company"), a Delaware corporation
formed in 1988, is the one-bank holding company for The First National Bank of
Litchfield (the "Bank"), a national bank supervised and examined by the Office
of the Comptroller of the Currency (the "OCC"). The Bank is the Company's
primary subsidiary and only source of income. The Bank has three subsidiaries,
The Lincoln Corporation and Litchfield Mortgage Service Corporation, which are
Connecticut corporations, and First Litchfield Leasing Corporation ("First
Litchfield Leasing"), which is a Delaware corporation. The purpose of The
Lincoln Corporation is to hold property such as real estate, personal property,
securities, or other assets, acquired by the Bank through foreclosure or
otherwise to compromise a doubtful claim or collect a debt previously
contracted. The purpose of Litchfield Mortgage Service Corporation is to operate
as a passive investment company in accordance with Connecticut law. The purpose
of First Litchfield Leasing is to provide equipment financing and leasing
products to complement the Bank's array of commercial products.
Both the Company and the Bank are headquartered in Litchfield, Connecticut. The
Bank is a full-service commercial bank serving both individuals and businesses
generally within Litchfield County Connecticut. Deposits are insured up to
specific limits of the Federal Deposit Insurance Act by the Deposit Insurance
Fund, which is administered by the Federal Deposit Insurance Corporation. The
Bank's lending activities include loans secured by residential and commercial
mortgages. Other loan products include consumer and business installment
lending, as well as other secured and unsecured lending. The Bank has nine
banking locations located in the towns of Canton, Torrington, Litchfield,
Washington, Marble Dale, Goshen, Roxbury and New Milford, Connecticut. In 1975,
the Bank was granted Trust powers by the OCC. The Bank's Trust Department
provides trust and fiduciary services to individuals, nonprofit organizations
and commercial customers. Additionally, the Bank offers nondeposit retail
investment products such as mutual funds, annuities and insurance through its
relationship with Infinex Investments, Inc.
On June 26, 2003, the Company formed First Litchfield Statutory Trust I for the
purpose of issuing trust preferred securities and investing the proceeds in
subordinated debentures issued by the Company, and on June 26, 2003, the first
series of trust preferred securities were issued. During the second quarter of
2006, the Company formed a second statutory trust, First Litchfield Statutory
Trust II ("Trust II"). The Company owns 100% of Trust II's common stock. Trust
II exists for the sole purpose of issuing trust securities and investing the
proceeds in subordinated debentures issued by the Company. In June 2006, Trust
II issued its first series of trust preferred securities.
On October 25, 2009, the Company entered into an Agreement and Plan of Merger
(the "Merger Agreement") by and among the Company, the Bank and Union Savings
Bank ("Union") that provides for the merger of the Company and the Bank with and
into Union (the "Merger"). Under the terms of the Merger Agreement, shareholders
of the Company will receive $15.00 cash for each share of Company common stock
they own on the date of the Merger. The transaction is valued at approximately
$35 million. No fractional shares will be issued. Consummation of the Merger is
subject to approval by the shareholders of the Company, as well as customary
regulatory approvals including the OCC, the State of Connecticut Department of
Banking and the Federal Deposit Insurance Corporation. The Merger is expected to
close in the first quarter of 2010, although there can be no assurance that this
will occur.
The following discussion and analysis of the Company's consolidated financial
condition and results of operations should be read in conjunction with the
consolidated financial statements and notes to the consolidated financial
statements.
33
FINANCIAL CONDITION
Total assets as of September 30, 2009 were $551,203,363, an increase of
$18,945,756, or 3.56% from year-end 2008 total assets of $532,257,607.
Net loans and leases increased $10,174,805 or 2.78% over the year-end 2008
amount. Net loans and leases as of September 30, 2009 were $376,566,884, as
compared to the year-end 2008 level of $366,392,079. Consistent with
management's strategy to migrate to a more profitable loan composition,
commercial loan and lease growth was strong during the third quarter of 2009.
Leases, net of unearned income, were $35,324,433 at September 30, 2009, which
was an increase of $15,538,563 or 78.53% from the year-end 2008 balance of
$19,785,870. The growth in the leasing portfolio is in relatively short-term
equipment financing. Commercial mortgages totaled $100,564,068 at September 30,
2009, which was an increase of $33,109,143 or 49.08% from year-end 2008. Growth
in commercial mortgages has been in fixed and variable rate products to
commercial customers located in our traditional and contiguous markets.
Construction mortgages totaled $27,262,941 as compared to the year-end balance
of $38,153,503. The decline in this portfolio was due to the soft commercial
construction market. The residential mortgage loan portfolio totaled
$172,572,153, which was a decrease of $19,988,955 from year-end 2008. The
majority of this decrease was attributable to the sale of residential mortgage
loans in the secondary market which settled in the third quarter. This sale was
transacted for the purpose of strengthening the Company's balance sheet in terms
of interest rate risk and liquidity.
As of September 30, 2009, the securities portfolio totaled $98,323,744, as
compared to the year-end 2008 balance of $113,502,751. The decrease in the
investment portfolio is due to calls in agency bonds as well as sales of
mortgage-backed securities. During the first nine months of 2009, approximately
$26 million in U.S. Government agency bonds were called. These bonds were
replaced with mortgage-backed securities with characteristics of shorter
duration and improved liquidity. In the second quarter, the Company sold
approximately $20 million in twenty and thirty year fixed rate mortgage-backed
securities. Similar to the aforementioned sale of residential mortgages, the
sale was also for the purpose of strengthening the balance sheet in terms of
interest rate risk and liquidity.
At year-end 2008, the due from broker for security sales totaled $9,590,823, as
a result of a security traded before December 31, 2008 with proceeds not
received until January 2009. There were no similar transactions at September 30,
2009.
Cash and cash equivalents totaled $43,243,586, as compared to the balance of
$9,238,783 at year-end 2008. Cash and cash equivalents is comprised of vault
cash, Federal funds sold, balances at correspondent banks and the Federal
Reserve Bank. The increase in cash and cash equivalents is due to the funds from
the investment sales and calls temporarily invested at correspondent banks.
Total liabilities were $519,814,447 as of September 30, 2009, which was an
increase of $20,024,104 from total liabilities of $499,790,343 as of year-end
2008. Total deposits increased by $39,197,820, or 11.42% from their year-end
levels. Time certificates of deposit totaled $157,575,532 as of September 30,
2009, which was an increase of 29.04%, or $35,464,671 from year-end 2008. The
increase in time deposits is reflective of the customers' desire for yield and
the shifting of money market deposits into short term certificates of deposit.
Additionally, there has been growth in the Bank's CDARs deposits, which provide
customers with FDIC deposit insurance beyond the $250,000 limit. Savings
deposits totaled $72,532,547 at September 30, 2009 which was an increase of
23.81% from the year-end 2008 balance. Growth in savings deposits has been in
traditional savings, health savings and municipal NOW accounts. Money market
deposits decreased by $10,692,255, or 11.49%, as a result of customers seeking
higher rates and locking in those rates via certificates of deposit.
34
As of September 30, 2009, repurchase agreements with customers totaled
$19,409,085, which was an increase of 6.51% from the year-end 2008 balance.
Because these accounts represent overnight investments by commercial and
municipal cash management customers, fluctuations in the balances of these
accounts are reflective of the temporary nature of these funds. As of September
30, 2009, advances under Federal Home Loan Bank borrowings and repurchase
agreements with financial institutions decreased $1,608,000 and $3,950,000,
respectively. Increases in the loan portfolio were funded by deposit growth and
by the liquidity from investment sales, which enabled management to reduce the
overall level of wholesale borrowings.
35
RESULTS OF OPERATIONS- THREE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THREE
MONTHS ENDED SEPTEMBER 30, 2008
Summary
Net loss available to common shareholders for the third quarter of 2009 totaled
$2,252,777 versus net loss of $5,425,890 for the third quarter of 2008. Basic
and diluted net loss per common share for the third quarter of 2009 were both
$.96 compared to basic and diluted loss per share of $2.30 for the third quarter
of 2008. The decrease in net loss available to common shareholders is due
primarily to the loss on available for sale securities in the third quarter of
2008 which did not occur in 2009, partially offset by increases in the provision
for loans and lease losses, loss due to dishonored items, and increases in other
noninterest expenses. Also in the 2009 quarter, dividends payable and accretion
on preferred shares was incurred, which preferred shares were not outstanding in
the 2008 period.
Net Interest Income
Net interest income is the largest component of the Company's operations. Net
interest income is defined as the difference between interest and dividend
income from earning assets, primarily loans and investment securities, and
interest expense on deposits and borrowed money. Interest income is the product
of the average balances outstanding on loans, securities, and interest-bearing
deposit accounts multiplied by their effective yields. Interest expense is
similarly calculated as the result of the average balances of interest-bearing
deposits and borrowed funds multiplied by the average rates paid on those funds.
The net interest spread represents the difference between the average rate on
interest-earning assets and the average cost of interest-bearing liabilities.
The net interest margin represents net interest income before the provision for
loan and lease losses divided by average interest earning assets. Other
components of operating income are the provision for loan losses, noninterest
income such as service charges and trust fees, noninterest expenses and income
taxes.
Net interest income on a fully tax-equivalent basis is comprised of the
following for the three months ended September 30,
2009 2008
------------- -------------
Interest and dividend income $ 6,111,459 $ 7,140,667
Tax-equivalent adjustments (1) 99,125 156,436
Interest expense (2,384,834) (3,255,785)
------------- -------------
Net interest income $ 3,825,750 $ 4,041,318
============= =============
(1) Interest income is presented on a tax-equivalent basis which reflects a
federal tax rate of 34% for all periods presented.
36
The following table presents on a tax-equivalent basis, the Company's average
balance sheet amounts (computed on a daily basis), net interest income, interest
rates, interest spread, and net interest margin for the three months ended
September 30, 2009 and 2008. Average loans outstanding include nonaccruing
loans.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
Three months ended September 30, 2009 Three months ended September 30, 2008
----------------------------------------- ----------------------------------------
Interest Interest
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ----
Assets
Interest Earning Assets:
Loans and leases $ 386,163,000 $5,331,700 5.52% $ 348,266,000 $ 5,367,408 6.16%
Investment securities 101,142,000 851,665 3.37% 155,762,000 1,886,213 4.84%
Other interest earning assets 26,859,000 27,219 0.41% 9,603,000 43,482 1.81%
------------- ---------- -------------- -----------
Total interest earning assets 514,164,000 6,210,584 4.83% 513,631,000 7,297,103 5.68%
---------- -------- ----------- -------
Allowance for loan and
lease losses (4,029,000) (2,222,000)
Cash and due from banks 29,693,000 11,310,000
Premises and equipment 7,161,000 7,440,000
Net unrealized gains (losses)
on securities 599,000 (6,955,000)
Foreclosed real estate 104,000 -
Other assets 17,078,000 18,117,000
------------- --------------
Total Average Assets $ 564,770,000 $ 541,321,000
============= ==============
Liabilities and Shareholders' Equity
Interest Bearing Liabilities:
Savings deposits $ 73,797,000 65,163 0.35% $ 64,474,000 173,193 1.07%
Money Market deposits 85,544,000 131,823 0.62% 80,602,000 363,373 1.80%
Time deposits 156,343,000 937,871 2.40% 131,370,000 1,130,642 3.44%
Borrowed funds 135,405,000 1,249,977 3.69% 163,604,000 1,588,577 3.88%
------------- ---------- -------------- -----------
Total interest bearing liabilities 451,089,000 2,384,834 2.11% 440,050,000 3,255,785 2.96%
---------- -------- ----------- -------
Demand deposits 73,260,000 72,097,000
Other liabilities 6,873,000 4,446,000
Shareholders' Equity 33,548,000 24,728,000
------------- --------------
Total liabilities and equity $ 564,770,000 $ 541,321,000
============= ==============
Net interest income $3,825,750 $ 4,041,318
========== ===========
Net interest spread 2.72% 2.72%
======== =======
Net interest margin 2.98% 2.99%
======== =======
37
RATE/VOLUME ANALYSIS
The following table, which is presented on a tax-equivalent basis, reflects the
changes for the three months ended September 30, 2009 when compared to the three
months ended September 30, 2008 in net interest income arising from changes in
interest rates and asset and liability volume mix. The change in interest
attributable to both rate and volume has been allocated to the changes in the
rate and the volume on a pro rata basis.
09/30/09 Compared to 09/30/08
Increase (Decrease) Due to
--------------------------
Volume Rate Total
--------- ----------- -----------
Interest earned on:
Loans and leases $ 552,982 $ (588,690) $ (35,708)
Investment securities (553,601) (480,947) (1,034,548)
Other interest earning assets 35,782 (52,045) (16,263)
--------- ----------- -----------
Total interest earning assets 35,163 (1,121,682) (1,086,519)
--------- ----------- -----------
Interest paid on:
Deposits 211,785 (744,136) (532,351)
Borrowed money (263,316) (75,284) (338,600)
--------- ----------- -----------
Total interest-bearing liabilities (51,531) (819,420) (870,951)
--------- ----------- -----------
Increase, (decrease) in net interest income $ 86,694 $ (302,262) $ (215,568)
========= =========== ===========
Tax-equivalent net interest income for the third quarter of 2009 totaled
$3,825,750, a decrease of $215,568, or 5.33% from the third quarter of 2008. The
decreased interest margin caused the decline in net interest income, while the
slight increase in earning asset volume offset the decrease. The effect of
increased volume of earning assets over interest-bearing liabilities increased
net interest income by $86,694. However, for the quarter, the interest earned on
earning assets decreased more than funding costs and resulted in a $302,262
decline in net interest income.
Average earning assets for the third quarter of 2009 totaled $514,164,000, which
was $533,000 or .10% higher than average earning assets for the third quarter of
2008 which totaled $513,631,000. This increase in earning assets, contributed to
an additional $35,163 in interest income. Average loans and leases increased by
$37,897,000, or 10.88%, while average investments and other interest earning
assets decreased by $37,364,000 or 22.59%. The increase in loans and leases came
from organic growth in commercial leasing and mortgage lending. The decrease in
the securities portfolio is the result of the strategy to change the mix of
earning assets from investments to loans. The mix of earning assets for the
third quarter of 2009 was 75% loans to 25% investments and other earning assets
versus the third quarter 2008 mix of 68% loans to 32% investments and other
earning assets.
The tax equivalent net interest margin decreased 1 basis point from 2.99% in the
third quarter of 2008 to 2.98% for the third quarter of 2009. Both funding costs
and the tax equivalent yield on earning assets decreased by 85 basis points when
compared to the third quarter of 2008; however, for the third quarter of 2009,
the ratio of earning assets to total assets was 91% compared to 95% for the
third quarter of 2008. This lower level of earning assets to total assets
contributed to the slight decline in net interest margin. The continued low
interest rate environment has allowed management to decrease its deposit rates
over the last year. Although yields on earning assets have been subject to
similar declines, the aforementioned strategy to shift to a more profitable mix
of earning assets has offset some of this decline. However, continued downward
repricing of interest-earning assets, which are priced off of longer market
indices, as well as declines in yield due to non-performing assets have resulted
in the drop in net interest income. Retail deposits are the primary source of
the Company's funding; therefore, competition for these deposits remains the
biggest threat to the net interest margin.
38
Provision for Loan and Lease Losses
The provision for loan and lease losses for the third quarter of 2009 totaled
$2,682,691, which is an increase of $2,527,691 from the third quarter of 2008.
The provision for loan and lease losses is determined quarterly based on the
calculation of the allowance for loan and lease losses. (See discussion of the
Allowance for Loan and Lease Losses.)
During the third quarter of 2009, the Company recorded net charge-offs of
$628,287 compared to third quarter 2008 net charge-offs of $121,476. The change
in the level of charge-offs from 2008 to 2009 is due to commercial mortgage and
commercial loan charge-offs and higher levels of charge-off activity from the
consumer automobile loan portfolio. The change in the level of charge-offs from
2008 to 2009 is considered by management to be reflective of the challenging
economic environment.
Noninterest Income (Loss)
Noninterest income for the third quarter of 2009 totaled $1,215,035, versus
third quarter 2008 noninterest loss of $5,807,528. The change in noninterest
income is primarily attributable to the OTTI losses totaling $6,946,100 recorded
in the third quarter of 2008.
Trust income totaled $345,357, compared to third quarter 2008 trust income of
$319,049. The increase from third quarter 2008 levels is due to increased assets
under management.
During the third quarter of 2009 the Company originated and sold residential
mortgages in the secondary market which resulted in gains on sales of loans of
$349,294 compared to similar sales transacted during the third quarter of 2008
which resulted in gains of $17,085. These sales were transacted with the purpose
of reducing interest rate risk and improving the Company's liquidity position.
Other noninterest income totaled $14,767, which was a decrease of $42,589, or
74.26% from the third quarter of 2008. The decrease was due to expenses incurred
in holding other real estate owned during the third quarter of 2009, there was
no other real estate owned during the third quarter of 2008.
Noninterest Expense
Third quarter 2009 noninterest expense totaled $5,102,484, increasing 35.96%, or
$1,349,454 from the third quarter 2008 expense of $3,753,030. The majority of
the increase is the result of other noninterest expense and FDIC insurance
assessments. During the third quarter of 2009 the Company recorded an accrual of
$768,583 related to the dishonor of fraudulent items; there were no comparable
items in 2008. Increases in noninterest expenses are also reflected in legal,
computer services, and consulting fees and expenses for the management of
foreclosed properties, loan review, and employment agency fees.
Other noninterest expenses totaled $786,524 which is an increase of $362,567, or
85.52% from the third quarter of 2008. Higher 2009 costs for exam and audit
fees, software, and telephone expenses contributed to the increase in other
noninterest expense.
Income Taxes
The third quarter 2009 income tax benefit totaled $770,444, which is an increase
of $365,658 or 107.76% from the third quarter of 2008 benefit of $404,786. The
effective tax rate for the third quarter of 2009 was 27% as compared to 7% for
the third quarter of 2008. In the third quarter of 2009, the quarterly tax
benefit was limited to the Company's pretax year-to-date loss at the statutory
rate. The third quarter 2008 tax benefit did not relate proportionately to the
pretax loss due to the Company's inability to consider its loss on the Fannie
Mae and Freddie Mac OTTI write-down as ordinary income as of September 30, 2008.
With
39
the October 2008 passage of the Emergency Economic Stabilization Act, banks with
Fannie Mae or Freddie Mac preferred shares and auction rate securities holding
such shares were able treat their losses as ordinary losses for tax purposes.
Pursuant to this change, the Company recognized the tax benefit of approximately
$1,710,000 in the fourth quarter of 2008.
As of September 30, 2009 and December 31, 2008, the Company had recorded net
deferred income tax assets of approximately $5.3 million and $5.1 million,
respectively. The determination of the amount of deferred income tax assets
which are more likely than not to be realized is primarily dependent on
projections of future earnings, which are subject to uncertainty and estimates
that may change given economic conditions and other factors. A valuation
allowance related to deferred tax assets is required when it is considered more
likely than not that all or part of the benefit related to such assets will not
be realized. Management has reviewed the deferred tax position of the Company at
September 30, 2009. The deferred tax position has been affected by several
significant transactions in the past three years. These transactions included
other-than-temporary impairment write-offs of certain investments and
significant permanent differences between accounting and tax income such as
non-taxable municipal security income, which securities have been sold and
replace with assets which will generate taxable income in the future, and
certain specific expenditures not expected to reoccur. As a result, the Company
is in a cumulative net loss position (pretax income (loss) for a three year
period adjusted for permanent items) as of September 30, 2009. However, under
the applicable accounting guidance, the Company has concluded that it is "more
likely than not" that the Company will be able to realize its deferred tax
assets based on the non-recurring nature of these items and the Company's
expectation of future taxable income. If, in the future, management's conclusion
regarding the need for a deferred tax asset valuation allowance could change,
resulting in the establishment of a valuation allowance for a portion or all of
the deferred tax asset. The Company will continue to analyze the recoverability
of its deferred tax assets quarterly.
40
RESULTS OF OPERATIONS- NINE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 2008
Summary
Net loss available to common shareholders for the nine months ended September
30, 2009 totaled $1,877,621 versus the net loss of $4,310,919 for the nine
months ended September 30, 2008. Basic and diluted net loss per common share for
the nine months ended September 30, 2009 were both $0.80, compared to basic and
diluted loss per share of $1.82, for the nine months ended September 30, 2008.
The decrease in net loss available to common shareholders is due primarily to
the loss on available for sale securities in the nine months of 2008 which was
significantly less in the 2009 period, partially offset by increases in the
provision for loan and lease losses and loss due to dishonored items. Also in
the 2009 period, dividends payable and accretion on preferred shares was
accrued, which preferred shares were not outstanding in 2008.
Net Interest Income
Net interest income is the largest component of the Company's operations. Net
interest income is defined as the difference between interest and dividend
income from earning assets, primarily loans and investment securities, and
interest expense on deposits and borrowed money. Interest income is the product
of the average balances outstanding on loans, securities and interest-bearing
deposit accounts multiplied by their effective yields. Interest expense is
similarly calculated as the result of the average balances of interest-bearing
deposits and borrowed funds multiplied by the average rates paid on those funds.
The net interest spread represents the difference between the average rate on
interest earning assets and the average cost of interest-bearing liabilities.
The net interest margin represents net interest income before the provision for
loan and lease losses divided by average interest earning assets. Other
components of operating income are the provision for loan losses, noninterest
income such as service charges and trust fees, noninterest expenses, and income
taxes.
Net interest income on a fully tax-equivalent basis is comprised of the
following for the nine months ended September 30,
2009 2008
--------------- ---------------
Interest and dividend income $ 19,212,404 $ 21,575,168
Tax-equivalent adjustments (1) 307,188 515,164
Interest expense (7,512,284) (10,400,647)
--------------- ---------------
Net interest income $ 12,007,308 $ 11,689,685
=============== ===============
(1) Interest income is presented on a tax-equivalent basis which reflects a
federal tax rate of 34% for all periods presented.
41
The following table presents on a tax-equivalent basis, the Company's average
balance sheet amounts (computed on a daily basis), net interest income, interest
rates, interest spread, and net interest margin for the nine months ended
September 30, 2009 and 2008. Average loans outstanding include nonaccruing
loans.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
Nine months ended September 30, 2009 Nine months ended September 30, 2008
-------------------------------------- ------------------------------------
Interest Interest
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ----
Assets
Interest Earning Assets:
Loans and leases $ 388,081,000 $ 16,227,927 5.58% $ 341,230,000 $ 16,209,373 6.33%
Investment securities 112,176,000 3,243,981 3.86% 150,686,000 5,670,091 5.02%
Other interest earning assets 12,995,000 47,684 0.49% 10,967,000 210,868 2.56%
----------- ----------- ----------- -----------
Total interest earning assets 513,252,000 19,519,592 5.07% 502,883,000 22,090,332 5.86%
----------- ------- ----------- -----
Allowance for loan and
lease losses (3,785,000) (2,184,000)
Cash and due from banks 17,327,000 11,388,000
Premises and equipment 7,239,000 7,586,000
Net unrealized loss on
securities (635,000) (3,473,000)
Foreclosed real estate 188,000 --
Other assets 18,852,000 16,943,000
----------- -----------
Total Average Assets $ 552,438,000 $ 533,143,000
=========== ===========
Liabilities and Shareholders' Equity
Interest Bearing Liabilities:
Savings deposits $ 66,521,000 255,021 0.51% $ 59,062,000 479,079 1.08%
Money Market deposits 86,704,000 603,929 0.93% 81,332,000 1,185,540 1.94%
Time deposits 145,579,000 2,774,018 2.54% 135,138,000 3,976,610 3.92%
Borrowed funds 141,945,000 3,879,316 3.64% 157,692,000 4,759,418 4.02%
----------- ----------- ----------- -----------
Total interest bearing liabilities 440,749,000 7,512,284 2.27% 433,224,000 10,400,647 3.20%
----------- ------- ----------- -----
Demand deposits 71,146,000 68,055,000
Other liabilities 7,413,000 4,864,000
Shareholders' Equity 33,130,000 27,000,000
----------- -----------
Total liabilities and equity $ 552,438,000 $ 533,143,000
=========== ===========
Net interest income $ 12,007,308 $ 11,689,685
=========== ===========
Net interest spread 2.80% 2.66%
======= =====
Net interest margin 3.12% 2.92%
======= =====
42
Rate/Volume Analysis
The following table, which is presented on a tax-equivalent basis, reflects the
changes for the nine months ended September 30, 2009 when compared to the nine
months ended September 30, 2008 in net interest income arising from changes in
interest rates and from asset and liability volume mix. The change in interest
attributable to both rate and volume has been allocated to the changes in the
rate and the volume on a pro rata basis.
09/30/09 Compared to 09/30/08
Increase (Decrease) Due to
---------------------------
Volume Rate Total
----------- ----------- ------------
Interest earned on:
Loans and leases $ 2,083,220 $(2,064,666) $ 18,554
Investment securities (1,273,069) (1,153,041) (2,426,110)
Other interest earning assets 33,124 (196,308) (163,184)
----------- ----------- ------------
Total interest earning assets 843,275 (3,414,015) (2,570,740)
----------- ----------- ------------
Interest paid on:
Deposits 443,154 (2,451,415) (2,008,261)
Borrowed money (452,197) (427,905) (880,102)
----------- ----------- ------------
Total interest bearing liabilities (9,043) (2,879,320) (2,888,363)
----------- ----------- ------------
Increase in net interest income $ 852,318 $ (534,695) $ 317,623
=========== =========== ============
Tax-equivalent net interest income for the nine months ended September 30, 2009
totaled $12,007,308, an increase of $317,623, or 2.72% from the nine months
ended September 30, 2008. The impact of the increase in the volume of earning
assets primarily contributed to the increase in net interest income. The effect
of increased volume of earning assets over the effect of the increase in
interest-bearing liabilities increased net interest income by $852,318.
Additionally, the Company was not able to decrease its cost of deposit interest
to a greater degree than the decrease in interest earned on earning assets,
which resulted in a $534,695 decrease in net interest income.
Average earning assets for the nine months ended September 30, 2009 totaled
$513,252,000, which was $10,369,000 or 2.06% higher than average earning assets
for the nine months ended September 30, 2008 which totaled $502,883,000. The net
increase in earning assets, net of the increased volume of interest bearing
liabilities, contributed to an additional $852,318 in net interest income.
Average loans and leases increased by $46,851,000, or 13.73%, while average
investments decreased by $38,510,000 or 25.56%. The increase in loans and leases
came from organic growth in commercial leasing and mortgage lending. The
decrease in the securities portfolio is the result of the strategy to change the
mix of earning assets from investments to loans. The mix of earning assets for
the nine months ended September 30, 2009 was 76% loans to 24% investments versus
the nine months ended September 30, 2008 mix of 68% loans to 32% investments.
The tax equivalent net interest margin improved 20 basis points from 2.92% for
the nine months ended September 30, 2008 to 3.12% for the nine months ended
September 30, 2009. The improvement in the next interest margin is because
funding costs decreased by 93 basis points while the tax equivalent yield on
earning assets decreased by only 79 basis points. The continued low interest
rate environment has allowed management to continue to decrease its deposit
rates over the last year. Although yields on earning assets have been subject to
similar declines, the aforementioned strategy to shift to a more profitable mix
of earning assets has offset some of this decline. Additionally, many
interest-earning assets are priced off of longer market indices, which are not
as dramatically impacted by decreases in short term rates. Retail deposits are
the primary source of the Company's funding; therefore, competition for these
deposits remains the biggest threat to the net interest margin.
43
Provision for Loan and Lease Losses
The provision for loan and lease losses for the nine months ended September 30,
2009 totaled $3,470,280, which is an increase of $3,103,280 from the nine months
ended September 30, 2008. The provision for loan and lease losses is determined
quarterly based on the calculation of the allowance for loan and lease losses.
The increased provision is reflective of a higher level of net charge-offs and
management's assessment of inherent losses in the portfolio due to the economic
environment. (See discussion of the Allowance for Loan and Lease Losses.)
During the nine months ended September 30, 2009, the Company recorded net
charge-offs of $1,084,906 compared to nine month 2008 net charge-offs of
$251,520. The change in the level of charge-offs from 2008 to 2009 is due to
residential and commercial mortgage charge-offs and higher levels of charge-off
activity from the consumer automobile loan, and commercial loan portfolios. The
change in the level of charge-offs from 2008 to 2009 is considered by management
to be reflective of a weak economic environment.
Noninterest Income (Loss)
Noninterest income for the nine months ended September 30, 2009 totaled
$3,259,553, versus the loss of $4,017,593 for the nine months ended September
30, 2008. The 2008 noninterest income reflected OTTI charges related to the
$6,946,100 third quarter OTTI write down of the Bank's investments in Freddie
Mac and Fannie Mae preferred stock/auction rate securities holding such stock
and one pooled trust preferred security.
Trust income totaled $892,896, compared to the nine months ended September 30,
2008 trust income of $992,142. The decline from nine months ended September 30,
2008 levels is due to market declines of assets under management.
During the first nine months of 2009, the Company sold residential mortgages in
the secondary market which resulted in gains on sales of loans totaling $509,552
compared to sales transacted during the first nine months of 2008 which resulted
in gains totaling $34,904. Included in those sales was a sale of 94 mortgages
totaling $13 million executed during the third quarter of 2009. These sales were
transacted with the purpose of reducing interest rate risk and improving the
Company's liquidity position.
Other noninterest income totaled $83,721, as compared to $200,041 from the nine
months ended September 30, 2008. The decrease is primarily related to the loss
on other real estate owned.
During the first nine months of 2009, the Company sold $37 million of available
for sale securities. The purpose of these sales was to decrease interest rate
risk, improve balance sheet liquidity, and reduce price volatility. The net
gains from these sales totaled $314,584. Similar sales were transacted during
the first nine months of 2008 and resulted in gains totaling $215,416.
Noninterest Expense
For the nine months ended September 30, 2009 noninterest expense totaled
$13,565,532, increasing $2,189,740, or 19.25% from the nine months ended
September 30, 2008 expense of $11,375,792. Increases in noninterest expenses are
reflected in regulatory assessments, legal, computer services and consulting
expenses. The largest of these increases was regulatory assessments which
totaled $930,055 for the first nine months of 2009. This expense has increased
$746,311 over the 2008 costs due to increase premiums and the second quarter
2009 special assessment. Also, during 2009 the Company created an accrual of
$768,583 related to the dishonor of fraudulent items; there were no comparable
items in 2008. The increase in consulting and related expenses was primarily
related to loan review, workout and the
44
management of foreclosed properties, investment banking, and temporary
employment. The impact of these increases was mitigated by cost containment
efforts for salaries, equipment and supplies, director fees, and advertising
expense.
Other noninterest expenses totaled $1,877,044 which is an increase of $457,923,
or 32.27% from the nine months ended September 30, 2008. This increase was due
primarily to 2009 costs for exam and audit fees which totaled $361,372 above the
nine month September 30, 2008 costs. Other increases in this category were OREO,
software, and telephone expense. Offsetting these increases were reduced
expenses for insurance, contributions, directors fees, seminars, and travel.
Income Taxes
The income tax benefit for the nine months ending September 30, 2009 totaled
$705,887, which is an increase of $430,942 or 156.74% from the nine month 2008
benefit of $274,945. The effective tax rates were 34% and 6%, respectively for
the nine months ended September 30, 2009 and 2008. The tax benefit for the nine
months ended September 30, 2009, was limited to the Company's year-to-date
pretax loss at the statutory rate of 34%. The tax benefit for the nine months
ended September 30, 2008 did not relate proportionately to the pretax loss
because of the loss related to a $5 million OTTI write down on Fannie Mae and
Freddie Mac preferred shares. This loss was not considered ordinary income, and
therefore no tax benefit related to the loss could be recognized through
September 30, 2008. With the passage of the Economic Stabilization Act, the
Company recognized the tax benefit of the OTTI loss during the fourth quarter of
2008.
As of September 30, 2009 and December 31, 2008, the Company had recorded net
deferred income tax assets of approximately $5.3 million and $5.1 million,
respectively. The determination of the amount of deferred income tax assets
which are more likely than not to be realized is primarily dependent on
projections of future earnings, which are subject to uncertainty and estimates
that may change given economic conditions and other factors. A valuation
allowance related to deferred tax assets is required when it is considered more
likely than not that all or part of the benefit related to such assets will not
be realized. Management has reviewed the deferred tax position of the Company at
September 30, 2009. The deferred tax position has been affected by several
significant transactions in the past three years. These transactions included
other-than-temporary impairment write-offs of certain investments and
significant permanent differences between accounting and tax income such as
non-taxable municipal security income, which securities have been sold and
replace with assets which will generate taxable income in the future, and
certain specific expenditures not expected to reoccur. As a result, the Company
is in a cumulative net loss position (pretax income (loss) for a three year
period adjusted for permanent items) as of September 30, 2009. However, under
the applicable accounting guidance, the Company has concluded that it is "more
likely than not" that the Company will be able to realize its deferred tax
assets based on the non-recurring nature of these items and the Company's
expectation of future taxable income. If, in the future, management's conclusion
regarding the need for a deferred tax asset valuation allowance could change,
resulting in the establishment of a valuation allowance for a portion or all of
the deferred tax asset. The Company will continue to analyze the recoverability
of its deferred tax assets quarterly.
45
LIQUIDITY
Management's objective is to ensure continuous ability to meet cash needs as
they arise. Such needs may occur from time to time as a result of fluctuations
in loan demand and the level of total deposits. Accordingly, the Bank has a
liquidity policy that provides flexibility to meet cash needs. The liquidity
objective is achieved through the maintenance of readily marketable investment
securities as well as a balanced flow of asset maturities and prudent pricing on
loan and deposit products.
The Bank is a member of the Federal Home Loan Bank system, which provides credit
to its member banks. This enhances the liquidity position of the Bank by
providing a source of available overnight as well as short-term borrowings.
Additionally, federal funds, borrowings through the use of repurchase
agreements, and the sale of mortgage loans in the secondary market are available
to fund short-term cash needs. (See Note 6 to the Consolidated Financial
Statements for information on Federal Home Loan Bank borrowings and repurchase
agreements.)
As of September 30, 2009, the Company had $116,246,290 in loan commitments and
credit lines outstanding. Because some commitments are expected to expire
without being drawn upon, the total commitment amount does not necessarily
represent all future cash requirements. The funding of these commitments is
anticipated to be met through deposits, loan and security amortizations, and
maturities. Management believes liquidity is adequate to meet its present and
foreseeable needs.
CAPITAL
Shareholders' equity totaled $31,388,916 as of September 30, 2009 as compared
with $32,467,264 as of December 31, 2008. The decrease in shareholders' equity
is primarily related to the 2009 net loss, the Company's other comprehensive
income charges related to the recognition of the unfunded pension liability,
cash flow hedges, unrealized holding losses on available for sale securities and
common and preferred dividends. From a regulatory perspective, the capital
ratios of the Company and the Bank place each entity in the "well-capitalized"
categories under applicable regulations. During the third and fourth quarters of
2008, the Company increased its investment in the Bank's equity by a total of
$4,000,000. During the first and second quarters of 2009, the Company increased
its investment in the Bank's equity by an additional $5,500,000. These actions
were executed to insure the Bank maintained capital at levels considered to be
well-capitalized by the federal banking agency capital adequacy guidelines.
The various capital ratios of the Company and the Bank are as follows as of
September 30, 2009:
Well-Capitalized
Capital Levels The Company The Bank
-------------- ----------- --------
TIER 1:
Leverage capital ratio 5.00% 6.96% 6.59%
Risk-based capital ratio 6.00% 10.09% 9.54%
Total risk-based capital ratio 10.00% 11.34% 10.80%
Included in the Company's capital used to determine these ratios at September
30, 2009 is $9.8 million related to the Company's investment in First Litchfield
Statutory Trust I and First Litchfield Statutory Trust II, which is recorded as
subordinated debt in the Company's balance sheets at September 30, 2009 and
December 31, 2008, respectively. Trust preferred securities are currently
considered regulatory capital for purposes of determining the Company's Tier I
capital ratios. On March 1, 2005, the Board of Governors of the Federal Reserve
System, which is the Company's banking regulator, approved final rules that
allow for the continued inclusion of outstanding and prospective issuances of
trust preferred securities in regulatory capital subject to new, stricter
limitations. The Company has until March 31, 2011, (previously March 31,
46
2009), to meet the new limitations. Management does not believe these final
rules will have a significant impact on the Company. On December 12, 2008, the
Company participated in the United States Department of the Treasury's Troubled
Assets Relief Program ("TARP") Capital Purchase Program ("CPP" also known as
TARP capital), and issued $10,000,000 of cumulative perpetual preferred stock
with a common stock warrant attached to the U. S. Treasury. The Company's
purpose in participating in the TARP CPP was to insure that the Company and the
Bank maintained their well-capitalized status given the uncertain economic
environment.
On December 12, 2008, under the TARP CPP, the Company sold 10,000 shares of
senior preferred stock to the U.S. Treasury, having a liquidation amount equal
to $1,000 per share, or $10,000,000. Although the Company is currently
well-capitalized under regulatory guidelines, the Board of Directors believed it
was advisable to take advantage of the TARP CPP to raise additional capital to
ensure that during these uncertain times, the Company is well-positioned to
support its existing operations as well as anticipated future growth. Additional
information concerning the TARP CPP is included in the Company's 2008 Form
10-K/A Amendment Number One, as filed with the Securities Exchange Commission on
April 23, 2009.
The Company expects that it (and the banking industry as a whole) may be
required by market forces and/or regulation to operate with higher capital
ratios than in the recent past. In addition, as the cumulative dividend rate on
the senior preferred stock issued in the TARP CPP increases from 5% to 9% in
2013, the Company will incur increased capital costs if the senior preferred
stock is not redeemed at, or prior to, that time. Therefore, in addition to
maintaining higher levels of capital, the Company's capital structure may be
subject to greater variation over the next few years than has been true
historically.
CERTAIN SUPERVISORY MATTERS
On November 9, 2009, the Bank entered into a Formal Agreement (the "Agreement")
with the OCC. The Agreement is a remedial supervisory action with provisions
intended to improve the Bank's condition and operations. While not punitive, the
Agreement provides a framework for addressing identified problems, documenting
remedial efforts and preventing the reoccurrence of similar problems so that the
Bank's condition will improve and no longer to be considered to be troubled.
Management and the Board are of the opinion that compliance with the Agreement
is in the best interest of the Bank but will require sustained effort and
management resources.
To coordinate its compliance efforts pursuant to the Agreement, the Board of the
Bank will appoint a Compliance Committee consisting primarily of independent
Directors. The Compliance Committee will meet at least monthly to monitor and
report the Bank's progress to the Board. The Board will review the Bank's
liquidity plans, capital plans, strategic plans and management and staffing
plans and provide copies of such plans to the OCC along with copies of the
reports of the Compliance Committee and other relevant information. The Board
will assess the adequacy of the Bank's management and staffing needs to assure
that the Bank is well managed and well staffed. The Bank will also notify the
OCC regarding any proposed changes in the Board, executive management or staff
or changes in their duties or responsibilities.
Pursuant to the Agreement, the Bank will not utilize brokered deposits without
appropriate FDIC and OCC authorization. In this regard, the only deposits
currently utilized by the Bank which could be characterized as "brokered
deposits" are deposits obtained through the CDARS program. The Agreement with
the OCC does not preclude the Bank from participating in the CDARS program and
the Bank has requested authorization from the FDIC to continue to participate in
such program. The Bank has approximately $11 million in CDARS deposits, most of
which will mature in January 2010.
The Agreement further requires the Bank to enhance its credit risk management
program within the Bank's loan and lease functions and to develop and adhere to
policies designed to enhance risk rating and risk monitoring. In addition, the
Bank has agreed to take appropriate action to improve and maintain asset
47
quality. The Bank will prepare written evaluations of and programs for
collecting any loans greater than $750,000 that are subject to criticism,
regularly review such loans, and only extend additional credit on such loans if
the Bank determines and documents that it is consistent with the Bank's plan to
collect the loan or strengthen the assets underlying the loan and the action is
necessary to protect the Bank's interests. In addition, the Bank will enhance
and document the programs it uses to evaluate, maintain and document the
adequacy of the Allowance for Loan and Lease Losses, which enhanced programs
were utilized in the evaluation of the Allowance for Loan and Lease Losses for
the third quarter of 2009, and provide a copy of such program and documentation
to the OCC.
The Agreement precludes the Bank from growing at a rate greater than 5% on an
annual basis. In addition to updating its capital plan with appropriate
contingencies, the Agreement would preclude the payment of any dividends
inconsistent with the capital plan or applicable law and without written
non-objection by the OCC. The Merger Agreement with Union precludes the payment
of dividends to the shareholders of the Company's common stock pending
consummation of the merger.
The Bank understands that the Agreement with the OCC will remain in place so
long as the Bank remains subject to OCC supervision or until such time as the
Agreement is terminated by the OCC, which will generally not occur until the
issues which were the basis of the Agreement have been corrected and verified
through an examination and until there is no basis for supervisory concern.
Failure to comply with the Agreement could result in more serious supervisory
action by the OCC with respect to the Bank, its officers or directors.
In addition to the Agreement, the Bank has been notified that the OCC will
require the Bank to achieve and maintain the following capital ratios by no
later than March 31, 2010:
o Total risk-based capital at least equal to twelve percent (12%) of
risk-weighted assets (as compared with 10.80% maintained by the Bank
at September 30, 2009 and 10% generally required of well-capitalized
banks);
o Tier 1 capital at least equal to ten percent (10%) of risk weighted
assets (as compared with 9.54% maintained by the Bank at September
30, 2009, and 6% generally required of well-capitalized banks); and
o Tier 1 capital at least equal to eight percent (8%) of adjusted
total assets (as compared with 6.59% maintained by the Bank at
September 30, 2009 and 5% generally required of well-capitalized
banks).
The Bank expects to consummate its Merger with and into Union prior to the date
by which it would be required to achieve and maintain such capital ratios.
However, there can be no assurance that the Merger will be consummated within
such timeframe. Accordingly, the Bank will develop contingency plans to address
compliance with such capital requirements in the event that the Merger is not
consummated by March 31, 2010.
CRITICAL ACCOUNTING POLICIES
In the ordinary course of business, the Bank has made a number of estimates and
assumptions relating to the reported results of operations and financial
condition in preparing its financial statements in conformity with accounting
principles generally accepted in the United States of America. Actual results
could differ significantly from those estimates under different assumptions and
conditions.
The Bank utilizes a loan and lease review and rating process which classifies
loans and leases according to the Bank's uniform classification system in order
to identify potential problem loans and leases at an early
48
stage, alleviate weaknesses in the Bank's lending policies, oversee the
individual loan and lease rating system, and ensure compliance with the Bank's
underwriting, documentation, compliance, and administrative policies. Loans and
leases included in this process are considered by management as being in need of
special attention because of some deficiency related to the credit or
documentation, but are still considered collectible and performing. Such
attention is intended to act as a preventative measure and thereby avoid more
serious problems in the future.
Investment securities which are held for indefinite periods of time, which
management intends to use as part of its asset/liability strategy, or which may
be sold in response to changes in interest rates, changes in prepayment risk,
increases in capital requirements, or other similar factors, are classified as
available for sale and are carried at fair value. Net unrealized gains and
losses for such securities, net of tax, are required to be recognized as a
separate component of shareholders' equity and excluded from determination of
net income. Gains or losses on disposition are based on the net proceeds and
cost of the securities sold, adjusted for amortization of premiums and accretion
of discounts, using the specific identification method.
The Company uses the asset and liability method of accounting for income taxes.
Determination of the deferred and current provision requires analysis by
management of certain transactions and the related tax laws and regulations.
Management exercises significant judgment in evaluating the amount and timing of
recognition of the resulting tax liabilities and assets. Those judgments and
estimates are re-evaluated on a continual basis as regulatory and business
factors change. The Company periodically reviews the carrying amount of its
deferred tax assets to determine if the establishment of a valuation allowance
is necessary. If, based on the available evidence in future periods, it is more
likely than not that all or a portion of the Company's deferred tax assets will
not be realized, a deferred tax valuation allowance is established.
Consideration is given to all positive and negative evidence related to the
realization of the deferred tax assets. In evaluating the available evidence,
management considers historical financial performance, expectation of future
earnings, the ability to carryback losses to recoup taxes previously paid,
length of statutory carryforward periods, experience with operating loss and tax
credit carryforwards not expiring unused, tax planning strategies and timing of
reversals of temporary differences. Significant judgment is required in
assessing future earnings trends and the timing of reversals of temporary
differences. The Company's evaluation is based on current tax laws as well as
management's expectations of future performance based on its strategic
initiatives. Changes in existing tax laws and future results that differ from
expectations may result in significant changes in the deferred tax asset
valuation allowance.
ALLOWANCE FOR LOAN AND LEASE LOSSES:
The allowance for loan and lease losses consists of specific, general, and
unallocated components. The specific component relates to loans and leases that
are classified as impaired. For impaired loans and leases an allowance is
established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan or lease is lower than the carrying value of
that loan or lease. The general component covers non-impaired loans and leases
and is based on historical loss experience adjusted for qualitative factors. An
unallocated component is maintained to cover uncertainties that could affect
management's estimate or probable losses. The unallocated component of the
allowance reflects the margin of imprecision inherent in the underlying
assumptions.
The Bank makes provisions for loan and lease losses on a quarterly basis as
determined by a continuing assessment of the adequacy of the allowance for loan
and lease losses. The Bank performs an ongoing review of loans and leases in
accordance with an individual loan and lease rating system to determine the
required allowance for loan and lease losses at any given date. The review of
loans and leases is performed to estimate potential exposure to losses.
Management's judgment in determining the adequacy of the allowance is inherently
subjective and is based on an evaluation of the known and inherent risk
characteristics and size of the loan and lease portfolios, the assessment of
current economic and real estate market conditions, estimates of the current
value of underlying collateral, past loan and lease loss experience, review of
regulatory authority examination reports and evaluations of impaired loans and
leases,
49
and other relevant factors. Loans and leases, including impaired loans and
leases, are charged against the allowance for loan and lease losses when
management believes that the uncollectibility of principal is confirmed. Any
subsequent recoveries are credited to the allowance for loan and lease losses
when received. In connection with the determination of the allowance for loan
and lease losses and the valuation of foreclosed real estate, management obtains
independent appraisals for significant properties, when considered necessary.
Management reassessed the allowance calculation during the third quarter of
2009. As a result of this assessment, loan categories were further segmented.
Historical factors were modified to reflect the Company's loss experience for
loan categories for which the Company has had losses in recent years. Peer data
was used for loan categories for which the Company has not experienced any
losses in the past several years. Qualitative factors were reevaluated and
additional factors were used to more accurately reflect trends in the portfolio.
There were no material changes in loan or lease concentrations that had a
significant effect on the allowance for loan and lease losses calculation at
September 30, 2009. In addition, there were no material reallocations of the
allowance among different parts of the loan or lease portfolio.
As a result of this assessment, as of September 30, 2009, non-performing assets,
loans and leases were $12,225,363 and represented 3.20% of total loans, leases
and OREO. As of December 31, 2008, non-performing assets and loans and leases
totaled $5,639,735 and represented 1.53% of total loans, leases and OREO. The
ratio of the allowance for such loan and lease losses to total loans and leases
at September 30, 2009 and December 31, 2008 was 1.59% and 1.00% respectively. At
September 30, 2009, the allowance for loan and lease losses was equivalent to
50% of total non-performing assets as compared with 66% of total non-performing
assets at December 31, 2008. The ratio of the allowance for loan and lease
losses to non-performing assets decreased over the first nine months of 2009 due
to the increase in non-performing assets and loans and leases despite the
increase to the allowance resulting from commercial loan growth and the increase
to the general allocations. Although the Company did experience an increase in
non-performing assets during the first nine months of the year, the increase in
those non-performing assets was comprised of collateral-based loans which did
not require a specific allocation of the allowance for loan and lease losses
and, therefore, did not result in additional specific allocations with the
allowance. Changes in the allowance for loan and lease losses for the three and
nine month periods ended September 30, 2009 and 2008 are as shown below:
For the three months ended September 30, 2009 2008
----------- -----------
Balance as of June 30, $ 4,029,790 $ 2,233,578
Provision for loan and lease losses 2,682,691 155,000
Loans and leases charged off (767,429) (123,192)
Recoveries of loans and leases charged off 139,142 1,716
----------- -----------
Balance as of September 30, $ 6,084,194 $ 2,267,102
=========== ===========
For the nine months ended September 30, 2009 2008
----------- -----------
Balance at beginning of the year $ 3,698,820 $ 2,151,622
Provision for loan and lease losses 3,470,280 367,000
Loans and leases charged off (1,416,376) (275,457)
Recoveries of loans and leases charged off 331,470 23,937
----------- -----------
Balance as of September 30, $ 6,084,194 $ 2,267,102
=========== ===========
50
The following table summarizes the Bank's Other Real Estate Owned ("OREO"), past
due in excess of 90 days and still accruing interest and non-accrual loans and
leases, and total nonperforming assets as of September 30, 2009 and December 31,
2008.
September 30, 2009 December 31, 2008
------------------ ------------------
Nonaccrual loans and leases $ 11,678,323 $ 5,639,735
Other real estate owned 547,040 --
------------ -----------
Total nonperforming assets $ 12,225,363 $ 5,639,735
============ ===========
Loans and leases past due in excess of 90 days and
accruing interest $ 39,854 $ 19,603
============ ===========
POTENTIAL PROBLEM LOANS
As of September 30, 2009, there were no potential problem loans or leases not
disclosed above which cause management to have serious doubts as to the ability
of such borrowers to comply with their present loan or lease repayment terms.
OTHER-THAN-TEMPORARY IMPAIRMENT: The Company's investment securities portfolio
is comprised of available-for-sale and held-to-maturity investments. The
available-for-sale portfolio is carried at estimated fair value, with any
unrealized gains or losses, net of taxes, reported as accumulated other
comprehensive income or loss in shareholders' equity. The held-to-maturity
portfolio is carried at amortized cost. Management determines the classification
of a security at the time of its purchase.
The Company conducts a periodic review of our investment securities portfolio to
determine if the value of any security has declined below its cost or amortized
cost, and whether such decline is other-than-temporary. If such decline is
deemed other-than-temporary, the security is written down to a new cost basis
and the resulting loss is reported within non-interest income in the
consolidated statement of income.
Significant judgment is involved in determining when a decline in fair value is
other-than-temporary. The factors considered by management include, but are not
limited to:
o Whether the Company intends to sell the security and whether it is
more likely than not that the Company will be required to sell the
security before the recovery of its amortized cost basis, which may
be maturity;
o The length of time and the extent to which the fair value has been
less than the amortized cost basis;
o Adverse conditions specifically related to the security, an industry
or a geographic area;
o The historical and implied volatility of the fair value of the
security;
o The payment structure of the debt security and the likelihood of the
issuer being able to make payment that increase in the future;
o Failure of the issuer of the security to make scheduled interest or
principal payments;
o Any changes to the rating of the security by a rating agency;
o Recoveries or additional declines in fair value subsequent to the
balance sheet date.
Adverse changes in the factors used by management to determine if a
security is OTTI could lead to additional impairment charges. Conditions
affecting a security that the Company determined to be temporary could
become other-than-temporary and warrant an impairment charge.
Additionally, a security that had no apparent risk could be affected by a
sudden or acute market condition and
51
necessitate an impairment charge. During the third and fourth quarters of
2008, the Company recorded OTTI losses totaling $9,422,650 related to the
Company's investments in Freddie Mac and Fannie Mae preferred
stock/auction rate securities holding such stock, and two pooled trust
preferred securities. There have been no OTTI losses during 2009. The
Company adopted the provisions of the FASB staff position issued in April
2009 relating to OTTI during the second quarter of 2009. Adoption of this
staff position resulted in the reclassification of $2,511,080 ($1,657,313,
net of tax) of non-credit related accumulated OTTI to OCI which had
previously been recognized as a loss in earnings and is disclosed in Note
8 - Investment Securities.
OFF-BALANCE SHEET ARRANGEMENTS
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers such
as letters of credit. In the opinion of management, these off-balance sheet
arrangements are not likely to have a material effect on the Company's financial
condition, results of operation, or liquidity.
At September 30, 2009, there have been no significant changes in the Company's
off-balance sheet arrangements from those at December 31, 2008.
FORWARD-LOOKING STATEMENTS
This Quarterly Report and future filings made by the Company with the Securities
and Exchange Commission, as well as other filings, reports and press releases
made or issued by the Company and the Bank, and oral statements made by
executive officers of the Company and Bank, may include forward-looking
statements relating to such matters as (a) assumptions concerning future
economic and business conditions and their effect on the economy in general and
on the markets in which the Company and the Bank do business, and (b)
expectations for increased revenues and earnings for the Company and Bank
through growth resulting from acquisitions, attractions of new deposit and loan
customers and the introduction of new products and services. Such
forward-looking statements are based on assumptions rather than historical or
current facts and, therefore, are inherently uncertain and subject to risk. For
those statements, the Company claims the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995.
The Company notes that a variety of factors could cause the actual results or
experience to differ materially from the anticipated results or other
expectations described or implied by such forward-looking statements. The risks
and uncertainties that may affect the operations, performance, development and
results of the Company's and Bank's business include the following: (a) the risk
of adverse changes in business conditions in the banking industry generally and
in the specific markets in which the Bank operates; (b) changes in the
legislative and regulatory environment that negatively impact the Company and
Bank through increased operating expenses; (c) increased competition from other
financial and nonfinancial institutions; (d) the impact of technological
advances; and (e) other risks detailed from time to time in the Company's
filings with the Securities and Exchange Commission. Such developments could
have an adverse impact on the Company and the Bank's financial position and
results of operations.
52
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that
information required to be disclosed in the Company's Exchange Act report is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to the Company's management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit of possible
controls and procedures.
As of the end of the period covered by this report, the Company's management,
under the supervision and with the participation of the Company's Chief
Executive Officer and the Company's Chief Financial Officer, carried out an
evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures. Based on the foregoing, the Company's Chief
Executive Officer and Chief Financial Officer concluded the Company's disclosure
controls and procedures were effective.
There were no changes in the Company's internal control over financial reporting
that occurred during the Company's third quarter of 2009 that have materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Neither the Company nor the Bank (or any of their properties) is the subject of
any material pending legal proceedings other than routine litigation that is
incidental to its business.
Item 1A. Risk Factors. Not applicable
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. None
Item 3. Defaults Upon Senior Securities. None
Item 4. Submission of Matters to a Vote of Security Holders. None
Item 5. Other Information. None
53
Item 6. Exhibits
EXHIBIT INDEX
Exhibit
No. Exhibit
- -------
2.1 Agreement and Plan of Merger dated as of October 25, 2009 by and among
Union Savings Bank, First Litchfield Financial Corporation and The
First National Bank of Litchfield. Exhibit is incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form 8-K
as filed with the Securities and Exchange Commission on October 28,
2009.
3.1 Certificate of Incorporation of First Litchfield Financial
Corporation, as amended. Exhibit is incorporated by reference to
Exhibit 3.1 set forth in the Company's Registration Statement on Form
10-SB as filed with the Securities and Exchange Commission on January
7, 2000.
3.1.1 Certificate of Designations for the Fixed Rate Cumulative Perpetual
Preferred Stock, Series A, filed December 9, 2008. Exhibit is
incorporated by reference to Exhibit 3.1 to the Company's Current
Report on Form 8-K as filed with the Securities and Exchange
Commission on December 18, 2008.
3.2 Bylaws of First Litchfield Financial Corporation, as amended. Exhibit
is incorporated by reference to Exhibit 3.2 set forth in the Company's
Registration Statement on Form 10-SB as filed with the Securities and
Exchange Commission on January 7, 2000.
4. Specimen Common Stock Certificate. Exhibit is incorporated by
reference to Exhibit 4. set forth in the Company's Registration
Statement on Form 10-SB as filed with the Securities and Exchange
Commission on January 7, 2000.
4.1 Amended and Restated Declaration of Trust of First Litchfield
Statutory Trust I. Exhibit is incorporated by reference to Exhibit
10.52 set forth in the Company's Quarterly Report on Form 10-QSB for
the quarter ended June 30, 2003 as filed with the Securities and
Exchange Commission on August 13, 2003.
4.2 Indenture for the Company's Floating Rate Junior Subordinated
Deferrable Interest Debentures due 2033. Exhibit is incorporated by
reference to Exhibit 10.53 set forth in the Company's Quarterly report
on Form 10-QSB for the quarter ended June 30, 2003 as filed with the
Securities and Exchange Commission on August 13, 2003.
4.3 Indenture dated June 16, 2006, between First Litchfield Financial
Corporation, as issuer, and Wilmington Trust Company, as indenture
trustee. Exhibit is incorporated by reference to Exhibit 4.1 to the
Company's Registration Statement on Form 8-K/A as filed with the
Securities and Exchange Commission on June 30, 2006.
4.4 Guarantee Agreement dated as of June 16, 2006, between First
Litchfield Financial Corporation and Wilmington Trust Company. Exhibit
is incorporated by reference to Exhibit 4.2 to the Company's
Registration Statement on Form 8-K/A as filed with the Securities and
Exchange Commission on June 30, 2006.
54
4.5 Form of Junior Subordinated Note. Exhibit is incorporated by reference
to Exhibit 4.3 to the Company's Registration Statement on Form 8-K/A
as filed with the Securities and Exchange Commission on June 30, 2006.
4.6 Warrant to purchase Common Stock dated December 12, 2008. Exhibit is
incorporated by reference to Exhibit 4.1 to the Company's Current
Report on Form 8-K as filed with the Securities and Exchange
Commission on December 18, 2008.
31.1 Rule 13a-14(a)/15-14(a) Certification of the Chief Executive Officer
of the Company.
31.2 Rule 13a-14(a)/15-14(a) Certification of the Chief Financial Officer
of the Company.
32.0 Certification of the Chief Executive Officer and the Chief Financial
Officer of the Company, pursuant to 18 U.S.C. ss.1350, as adopted
pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: November 13, 2009 FIRST LITCHFIELD
FINANCIAL CORPORATION
By: /s/ Joseph J. Greco
-------------------
Joseph J. Greco,
President and Chief
Executive Officer
Dated: November 13, 2009 By: /s/Carroll A. Pereira
------------------
Carroll A. Pereira
Principal Financial and
Accounting Officer
56