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EX-32 - EXHIBIT 32 - SALISBURY BANCORP, INC.ex32.htm
EX-31.1 - EXHIBIT 31.1 - SALISBURY BANCORP, INC.ex31_1.htm
EX-31.2 - EXHIBIT 31.2 - SALISBURY BANCORP, INC.ex31_2.htm


SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

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

For the quarterly period ended March 31, 2011

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

Commission file number 0-24751
SALISBURY BANCORP, INC.
(Exact name of registrant as specified in its charter)
Connecticut
06-1514263
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
5 Bissell Street, Lakeville, CT
06039
(Address of principal executive offices)
(Zip code)
(860) 435-9801
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) 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. See the definitions of “large accelerated filer, accelerated filer” and “smaller reporting company in Rule 12b-2 of the Exchange Act).  (Check one):
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o No x
The number of shares of Common Stock outstanding as of May 16, 2011, is 1,687,661.



 
1

 

TABLE OF CONTENTS

   
Page
     
PART I  FINANCIAL INFORMATION
     
Item 1.
Financial Statements:
 
     
 
Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010
3
     
 
Consolidated Statements of Income for the three month periods
 
 
ended March 31, 2011 and March 31, 2010 (unaudited)
4
     
 
Consolidated Statements of Changes in Shareholders' Equity for the three month
 
 
periods ended March 31, 2011 and March 31, 2010 (unaudited)
5
     
 
Consolidated Statements of Cash Flows for the three month periods ended
 
 
March 31, 2011 and March 31, 2010 (unaudited)
6
     
 
Notes to Consolidated Financial Statements
7
     
Item 2.
Management's Discussion and Analysis of Financial Condition
 
 
and Results of Operations
20
     
Item 3.
Quantitative and Qualitative Disclosure of Market Risk
32
     
Item 4.
Controls and Procedures
33
     
PART II Other Information
     
Item 1.
Legal Proceedings
33
Item 1A.
Risk Factors
34
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
34
Item 3.
Defaults upon Senior Securities
34
Item 4.
Removed and Reserved
34
Item 5.
Other information
34
Item 6.
Exhibits
34
 

PART I - FINANCIAL INFORMATION
Salisbury Bancorp, Inc. and Subsidiary

 in thousands (except share data) unaudited
 
March 31,
2011
   
December 31,
2010
 
ASSETS
           
Cash and due from banks
  $ 5,349     $ 6,694  
Interest bearing demand deposits with other banks
    37,742       20,214  
Total cash and cash equivalents
    43,091       26,908  
Interest bearing time deposits with other banks
    5,000       5,000  
Securities
               
Available-for-sale at fair value
    125,223       147,422  
Held-to-maturity at amortized cost (fair value: $56 and $58)
    55       56  
Federal Home Loan Bank of Boston stock at cost
    6,032       6,032  
Loans held-for-sale
    187       1,184  
Loans receivable, net (allowance for loan losses: $3,978 and $3,920)
    361,238       352,449  
Investment in real estate
    75       75  
Other real estate owned
    866       610  
Bank premises and equipment, net
    12,303       12,190  
Goodwill
    9,829       9,829  
Intangible assets (net of accumulated amortization: $1,357 and $1,301)
    1,186       1,242  
Accrued interest receivable
    2,002       2,132  
Cash surrender value of life insurance policies
    3,893       3,854  
Deferred taxes
    2,260       2,540  
Other assets
    3,654       3,947  
Total Assets
  $ 576,894     $ 575,470  
LIABILITIES and SHAREHOLDERS' EQUITY
               
Deposits
               
Demand (non-interest bearing)
  $ 74,690     $ 71,565  
Demand (interest bearing)
    59,311       63,258  
Money market
    106,468       77,089  
Savings and other
    97,407       93,324  
Certificates of deposit
    114,503       125,053  
Total deposits
    452,379       430,289  
Repurchase agreements
    8,241       13,190  
Federal Home Loan Bank of Boston advances
    55,888       72,812  
Accrued interest and other liabilities
    4,438       4,163  
Total Liabilities
    520,946       520,454  
Commitments and contingencies
    -       -  
Shareholders' Equity
               
Preferred stock - $.01 per share par value
               
Authorized: 25,000; Shares issued: 8,816;
               
Liquidation preference: $1,000 per share
    8,743       8,738  
Common stock - $.10 per share par value
               
Authorized: 3,000,000;
               
Issued: 1,686,701 and 1,685,861
    168       168  
Common stock warrants outstanding
    112       112  
Paid-in capital
    13,200       13,200  
Retained earnings
    36,923       36,567  
Accumulated other comprehensive loss, net
    (3,198 )     (3,769 )
Total Shareholders' Equity
    55,948       55,016  
Total Liabilities and Shareholders' Equity
  $ 576,894     $ 575,470  

See accompanying notes to consolidated financial statements.


Salisbury Bancorp, Inc. and Subsidiary

Three months ended March 31, (in thousands except per share amounts) unaudited
 
2011
   
2010
 
Interest and dividend income
           
Interest and fees on loans
  $ 4,664     $ 4,487  
Interest on debt securities
               
Taxable
    783       926  
Tax exempt
    554       560  
Other interest and dividends
    38       46  
Total interest and dividend income
    6,039       6,019  
Interest expense
               
Deposits
    871       1,198  
Repurchase agreements
    15       27  
Federal Home Loan Bank of Boston advances
    646       758  
Total interest expense
    1,532       1,983  
Net interest income
    4,507       4,036  
Provision for loan losses
    330       180  
Net interest and dividend income after provision for loan losses
    4,177       3,856  
Non-interest income
               
Trust and wealth advisory
    667       545  
Service charges and fees
    499       453  
Gains on securities
    11       -  
Gains on sales of mortgage loans, net
    133       42  
Mortgage servicing, net
    32       33  
Other
    59       56  
Total non-interest income
    1,401       1,129  
Non-interest expense
               
Salaries
    1,729       1,571  
Employee benefits
    634       630  
Premises and equipment
    583       515  
Data processing
    377       408  
Professional fees
    280       402  
FDIC insurance
    223       171  
Marketing and community support
    68       62  
Amortization of intangibles
    56       56  
Other
    474       497  
Total non-interest expense
    4,424       4,312  
Income before income taxes
    1,154       673  
Income tax provision
    211       79  
Net income
  $ 943     $ 594  
Net income available to common shareholders
  $ 828     $ 479  
                 
Basic and diluted earnings per share
  $ 0.49     $ 0.28  
Common dividends per share
    0.28       0.28  

See accompanying notes to consolidated financial statements.


Salisbury Bancorp, Inc. and Subsidiary
 
   
Common Stock
     Preferred           Paid-in      Retained     Accumulated
other comp-
   
Total
share-holders'
 
(dollars in thousands) unaudited
 
Shares
   
Amount
   
 Stock
   
Warrants
   
capital
   
earnings
   
rehensive loss
   
equity
 
Balances at December 31, 2009
    1,686,701     $ 168     $ 8,717     $ 112     $ 13,177     $ 35,259     $ (5,078 )   $ 52,355  
Net income for period
    -       -       -       -       -       594       -       594  
Other comprehensive income, net of tax
    -       -       -       -       -       -       656       656  
Total comprehensive income
                                                            1,250  
Amortization (accretion) of preferred stock
    -       -       5       -       -       (5 )     -       -  
Common stock dividends paid
    -       -       -       -       -       (472 )     -       (472 )
Preferred stock dividends paid
    -     -     -     -     -     (110 )   -     (110 )
Balances at March 31, 2010
    1,686,701       168       8,722       112       13,177       35,266       (4,422 )     53,023  
Balances at December 31, 2010
    1,687,661     168     8,738     112     13,200     36,567     (3,769 )   55,016  
Net income for period
    -       -       -       -       -       943       -       943  
Other comprehensive income, net of tax
    -       -       -       -       -       -       571       571  
Total comprehensive income
                                                            1,514  
Amortization (accretion) of preferred stock
    -       -       5       -       -       (5 )     -       -  
Common stock dividends paid
    -       -       -       -       -       (472 )     -       (472 )
Preferred stock dividends paid
    -       -       -       -       -       (110 )     -       (110 )
Balances March 31, 2011
    1,687,661     $ 168     $ 8,743     $ 112     $ 13,200     $ 36,923     $ (3,198 )   $ 55,948  

See accompanying notes to consolidated financial statements.
 
Salisbury Bancorp, Inc. and Subsidiary

Three months ended March 31, (in thousands) unaudited
 
2011
   
2010
 
Operating Activities
           
Net income
  $ 943     $ 594  
Adjustments to reconcile net income to net cash provided by operating activities:
               
(Accretion), amortization and depreciation
               
Securities
    62       174  
Bank premises and equipment
    206       193  
Core deposit intangible
    56       56  
Mortgage servicing rights
    58       31  
Fair value adjustment on loans
    11       11  
Sales and calls of securities available-for-sale
    (11 )     -  
Write down of other real estate owned
    57       -  
Provision for loan losses
    330       180  
Decrease (increase) in loans held-for-sale
    998       (513 )
Increase in deferred loan origination fees and costs, net
    (57 )     (41 )
Mortgage servicing rights originated
    (77 )     (28 )
Decrease in mortgage servicing rights impairment reserve
    (2 )     (2 )
Decrease in interest receivable
    130       85  
Deferred tax benefit
    (14 )     (8 )
Decrease in prepaid expenses
    73       68  
Increase in cash surrender value of life insurance policies
    (39 )     (42 )
Decrease in income tax receivable
    224       69  
Decrease (increase) in other assets
    25       (25 )
Increase in accrued expenses
    537       431  
Decrease in interest payable
    (101 )     (40 )
Decrease in other liabilities
    (143 )     (111 )
Net cash provided by operating activities
    3,266       1,082  
Investing Activities
               
Purchases of securities available-for-sale
    -       (33,985 )
Proceeds from calls of securities available-for-sale
    22,997       1,550  
Proceeds from maturities of securities available-for-sale
    -       12,089  
Proceeds from maturities of securities held-to-maturity
    1       1  
Loan originations and principle collections, net
    (9,394 )     (2,499 )
Recoveries of loans previously charged-off
    7       6  
Capital expenditures
    (327 )     (1,068 )
Net cash provided (utilized) by investing activities
    13,284       (23,906 )
Three months ended March 31, (in thousands) unaudited
 
2011
   
2010
 
Financing Activities
           
Increase in deposit transaction accounts, net
    32,640       11,352  
Decrease in time deposits, net
    (10,550 )     (7,065 )
Decrease in securities sold under agreements to repurchase, net
    (4,949 )     (3,442 )
Principal payments on Federal Home Loan Bank of Boston advances
    (16,925 )     (1,008 )
Common stock dividends paid
    (473 )     (472 )
Preferred stock dividends paid
    (110 )     (110 )
Net cash utilized by financing activities
    (367 )     (745 )
Net increase (decrease) in cash and cash equivalents
    16,183       (23,569 )
Cash and cash equivalents, beginning of period
    26,908       43,298  
Cash and cash equivalents, end of period
  $ 43,091     $ 19,729  
Cash paid during period
               
Interest
  $ 633     $ 2,023  
Income taxes
    449       139  
Non-cash transfers
               
Transfer from loans to other real estate owned
    314       -  

See accompanying notes to consolidated financial statements.


(unaudited)

 
NOTE 1 - BASIS OF PRESENTATION
 
The interim (unaudited) consolidated financial statements of Salisbury Bancorp, Inc. ("Salisbury") include those of Salisbury and its wholly owned subsidiary, Salisbury Bank and Trust Company (the "Bank"). In the opinion of management, the interim unaudited consolidated financial statements include all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of Salisbury and the statements of income, shareholders’ equity and cash flows for the interim periods presented.
 
The financial statements have been prepared in accordance with generally accepted accounting principles.  In preparing the financial statements, management is required to make extensive use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet, and revenues and expenses for the period. Actual results could differ significantly from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans.  In connection with the determination of the allowance for loan losses and valuation of real estate, management obtains independent appraisals for significant properties.
 
Certain financial information, which is normally included in financial statements prepared in accordance with generally accepted accounting principles, but which is not required for interim reporting purposes, has been condensed or omitted. Operating results for the three month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.  The accompanying condensed financial statements should be read in conjunction with the financial statements and notes thereto included in Salisbury's 2010 Annual Report on Form 10-K for the period ended December 31, 2010.
 
The allowance for loan losses is a significant accounting policy and is presented in the Notes to Consolidated Financial Statements and in Management’s Discussion and Analysis, which provide information on how significant assets are valued in the financial statements and how those values are determined.  Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for loan losses to be the accounting area that requires the most subjective judgments, and as such could be most subject to revision as new information becomes available.
 
Impact of New Accounting Pronouncements Issued
 
In April 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” This ASU provides additional guidance or clarification to help creditors determine whether a restructuring constitutes a troubled debt restructuring. For public entities, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption.  As a result of applying these amendments, an entity may identify receivables that are newly considered impaired, and should measure impairment on those receivables prospectively for the first interim or annual period beginning on or after June 15, 2011.  Additional disclosures are also required under this ASU.  Salisbury is currently evaluating the impact of this ASU.  The ASU is expected to cause more loan modifications to be classified as TDRs and Salisbury is evaluating its modification programs and practices in light of the new ASU.
 
In April 2011, the FASB issued ASU 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.”  The objective of this ASU is to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.  This ASU prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements.  The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011.  Early adoption is not permitted.
 
In December 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-28, “Intangibles - Goodwill and Other.”  This ASU addresses when to perform step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For public entities, the amendments in this ASU are effective for fiscal years and interim periods beginning after December 15, 2010.
 
In December 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.”  This ASU addresses diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations.  This ASU is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.
 
 
In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.”  This ASU is created to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables.  This ASU is intended to provide additional information to assist financial statement users in assessing the entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses.  The amendments in this ASU are effective as of the end of a reporting period for interim and annual reporting periods ending on or after December 15, 2010.  The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.
 
In April 2010, the FASB issued ASU 2010-18, “Effect of a Loan Modification When the Loan is Part of a Pool That is Accounted for as a Single Asset.”  As a result of this ASU, modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity continues to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change.  The amendments in this ASU are effective for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010, with the amendments to be applied prospectively.  This ASU did not have a significant impact on Salisbury’s financial position or results of operations.
 
In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements.”  The ASU requires disclosing the amounts of significant transfers in and out of Level 1 and 2 of the fair value hierarchy and describing the reasons for the transfers.  The disclosures are effective for reporting periods beginning after December 15, 2009.  Salisbury adopted ASU 2010-06 as of January 1, 2010.  The required disclosures are included in Note 10, “Fair Value Measurements,” to the consolidated Financial Statements. Additionally, disclosures of the gross purchases, sales, issuances and settlements activity in the Level 3 of the fair value measurement hierarchy are effective for interim and annual reporting periods beginning after December 15, 2010.
 
In March 2010, the FASB issued ASU 2010-11, “Scope Exception Related to Embedded Credit Derivatives.”  The ASU clarifies that certain embedded derivatives, such as those contained in certain securitizations, CDOs and structured notes, should be considered embedded credit derivatives subject to potential bifurcation and separate fair value accounting. The ASU allows any beneficial interest issued by a securitization vehicle to be accounted for under the fair value option at transition. The requirements are effective July 1, 2010.  This standard did not have a significant impact on Salisbury’s financial position or results of operations.
 
NOTE 2 - SECURITIES
 
The composition of securities is as follows:
 
(in thousands)
 
Amortized
cost (1)
   
Gross un-
realized gains
   
Gross un-realized losses
   
Fair value
 
March 31, 2011
                       
Available-for-sale
                       
U.S. Treasury notes
  $ 5,000     $ 186     $ -     $ 5,186  
U.S. Government Agency notes
    22,587       306       (79 )     22,814  
Municipal bonds
    51,359       236       (4,903 )     46,692  
Mortgage backed securities
                               
U.S. Government Agencies
    17,665       567       (26 )     18,206  
Collateralized mortgage obligations
                               
U.S. Government Agencies
    8,602       9       (42 )     8,569  
Non-agency
    17,609       708       (293 )     18,024  
SBA bonds
    4,353       73       -       4,426  
Corporate bonds
    1,092       38       -       1,130  
Preferred Stock
    20       156       -       176  
Total securities available-for-sale
  $ 128,287     $ 2,279     $ (5,343 )   $ 125,223  
Held-to-maturity
                               
Mortgage backed security
  $ 55     $ 1     $ -     $ 56  
Non-marketable securities
                               
Federal Home Loan Bank of Boston stock
  $ 6,032     $ -     $ -     $ 6,032  
 
(1)  
Net of other-than-temporary impairment write-down recognized in earnings.
 
 
(in thousands)
 
Amortized
cost (1)
   
Gross un-
realized gains
   
Gross un-realized losses
   
Fair value
 
December 31, 2010
                       
Available-for-sale
                       
U.S. Treasury notes
  $ 4,999     $ 197     $ -     $ 5,196  
U.S. Government Agency notes
    41,590       380       (92 )     41,878  
Municipal bonds
    51,330       139       (5,371 )     46,098  
Mortgage backed securities
                               
U.S. Government Agencies
    19,190       566       (20 )     19,736  
Collateralized mortgage obligations
                               
U.S. Government Agencies
    9,283       29       (1 )     9,311  
Non-agency
    19,002       714       (599 )     19,117  
SBA bonds
    4,831       70       -       4,901  
Corporate bonds
    1,089       41       -       1,130  
Preferred Stock
    20       35       -       55  
Total securities available-for-sale
  $ 151,334     $ 2,171     $ (6,083 )   $ 147,422  
Held-to-maturity
                               
Mortgage backed security
  $ 56     $ 2     $ -     $ 58  
Non-marketable securities
                               
Federal Home Loan Bank of Boston stock
  $ 6,032     $ -     $ -     $ 6,032  
 
(1)  
Net of other-than-temporary impairment write-down recognized in earnings.
 
Salisbury did not sell any securities available-for-sale during the three month periods ended March 31, 2011 and 2010.
 
Included in non-agency Collateralized Mortgage Obligations (“CMOs”) are seven securities issued by Wells Fargo with an aggregate amortized cost basis and fair value of $6,020,000 and $6,342,000, respectively, that exceeded 10% of shareholders’ equity as of March 31, 2011.
 
The following table summarizes, for all securities in an unrealized loss position, including debt securities for which a portion of other-than-temporary impairment has been recognized in other comprehensive income, the aggregate fair value and gross unrealized loss of securities that have been in a continuous unrealized loss position as of the date presented:
 
   
Less than 12 Months
   
12 Months or Longer
   
Total
 
(in thousands)
 
Fair
value
   
Unrealized 
losses
   
Fair
value
   
Unrealized 
losses
   
Fair
value
   
Unrealized
losses
 
March 31, 2011
                                   
Available-for-sale
                                   
U.S. Government Agency notes
  $ 9,921     $ 79     $ -     $ -     $ 9,921     $ 79  
Municipal Bonds
    26,099       1,535       14,351       3,368       40,450       4,903  
Mortgage backed securities
    1,171       26       -       -       1,171       26  
Collateralized mortgage obligations
                                               
U.S. Government Agencies
    4,180       42       -       -       4,180       42  
Non-agency
    -       -       2,171       185       2,171       185  
Total temporarily impaired securities
    41,371       1,682       16,522       3,553       57,893       5,235  
Other-than-temporarily impaired securities
                                               
Collateralized mortgage obligations
                                               
Non-agency
    1,030       80       784       28       1,814       108  
Total temporarily impaired and other-than-
                                               
temporarily impaired securities
  $ 42,401     $ 1,762     $ 17,306     $ 3,581     $ 59,707     $ 5,343  
 
 
Salisbury evaluates securities for Other Than Temporary Impairment (“OTTI”) where the fair value of a security is less than its amortized cost basis at the balance sheet date. As part of this process, Salisbury considers its intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, Salisbury recognizes an OTTI charge to earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities that meet neither of these conditions, an analysis is performed to determine if any of these securities are at risk for OTTI.
 
The following summarizes, by security type, the basis for evaluating if the applicable securities were OTTI at March 31, 2011.
 
U.S Government Agency notes, U.S. Government Agency mortgage-backed securities and U.S. Government Agency CMOs: The contractual cash flows are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Changes in fair values are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities.  Furthermore, Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity.  Therefore, management does not consider these securities to be OTTI at March 31, 2011.
 
Municipal bonds: Contractual cash flows are performing as expected. The decline in fair values at March 31, 2011 as compared with December 31, 2010, is primarily due to an increase in interest rates and risk premium spreads for municipal bonds in 2011 compared to 2010. Late in 2010 and continuing into 2011 the municipal bond market experienced significant price declines as uncertainty about the health of local and state government finances caused investors to exit the market. Salisbury purchased substantially all of these securities during 2006-to-2008 as bank qualified, insured, AAA rated general obligation or revenue bonds. Salisbury’s portfolio is mostly comprised of tax-exempt general obligation bonds or public-purpose revenue bonds for schools, municipal offices, sewer infrastructure and fire houses, for small towns and municipalities across the United States. In the wake of the financial crisis, most monoline bond insurers had their ratings downgraded or withdrawn because of excessive exposure to insurance for collateralized debt obligations. Salisbury has performed credit underwriting reviews of certain issuers, including those that have had their ratings withdrawn and those that are insured by insurers that have had their ratings withdrawn, to assess their default risk. For all completed reviews pass credit risk ratings have been assigned. Management believes that unrealized losses on its municipal bonds are a function of interest rate movements and changes in investor spreads for credit sensitive securities. Management expects to recover the entire amortized cost basis of these securities.  Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis, which may be maturity.  Management does not consider these securities to be OTTI at March 31, 2011.
 
Non-agency CMOs: Salisbury performed a detailed cash flow analysis of its non-agency CMOs at March 31, 2011 to assess whether any of the securities were OTTI. Salisbury uses third party provided cash flow forecasts of each security based on a variety of market driven assumptions and securitization terms, including prepayment speed, default or delinquency rate, and default severity for losses including interest, legal fees, property repairs, expenses and realtor fees, that, together with the loan amount are subtracted from collateral sales proceeds to determine severity. In 2009 Salisbury determined that five non-agency CMO securities reflected OTTI and recognized losses for deterioration in credit quality of $1,128,000. Salisbury judged these five securities not to have additional OTTI and all other CMO securities not to be OTTI as of March 31, 2011. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI for further deterioration in credit quality. Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis.
 
The following table presents activity related to credit losses recognized into earnings on the non-agency CMOs held by Salisbury for which a portion of an OTTI charge was recognized in accumulated other comprehensive income:
 
Three months ended March 31 (in thousands)
 
2011
   
2010
 
Balance, beginning of period
  $ 1,128     $ 1,128  
Credit component on debt securities in which OTTI was not previously recognized
    -       -  
Balance, end of period
  $ 1,128     $ 1,128  
 
Federal Home Loan Bank of Boston (“FHLBB”): The Bank is a member of the FHLBB. The FHLBB is a cooperative that provides services, including funding in the form of advances, to its member banking institutions. As a requirement of membership, the Bank must own a minimum amount of FHLBB stock, calculated periodically based primarily on its level of borrowings from the FHLBB. No market exists for shares of the FHLBB and therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB. In 2008, the FHLBB announced to its members that it is focusing on preserving capital in response to ongoing market volatility including the extension of a moratorium on excess stock repurchases and in 2009 announced the suspension of its quarterly dividends. On February 22, 2011, the FHLBB declared a modest cash dividend payable to its members on March 2, 2011. The FHLBB also announced that it expects to continue to declare modest cash dividends through 2011. Based on the capital adequacy and the liquidity position of the FHLBB, management believes there is no impairment related to the carrying amount of the Bank’s FHLBB stock as of March 31, 2011. Further deterioration of the FHLBB’s capital levels may require the Bank to deem its restricted investment in FHLBB stock to be OTTI. If evidence of impairment exists in the future, the FHLBB stock would reflect fair value using either observable or unobservable inputs. The Bank will continue to monitor its investment in FHLBB stock.
 
 
NOTE 3 - LOANS
 
The composition of loans receivable and loans held-for-sale is as follows:
 
(in thousands)
 
March 31,
2011
   
December 31,
2010
 
Residential 1-4 family
  $ 183,194     $ 176,892  
Residential 5+ multifamily
    3,271       2,889  
Construction of residential 1-4 family
    4,564       5,988  
Home equity credit
    34,608       34,164  
Residential real estate
    225,637       219,933  
Commercial
    74,519       75,495  
Construction of commercial
    7,777       7,312  
Commercial real estate
    82,296       82,807  
Farm land
    5,221       5,690  
Vacant land
    12,757       12,979  
Real estate secured
    325,911       321,409  
Commercial and industrial
    29,289       25,123  
Municipal
    4,563       4,338  
Consumer
    4,574       4,677  
Loans receivable, gross
    364,337       355,547  
Deferred loan origination fees and costs, net
    879       822  
Allowance for loan losses
    (3,978 )     (3,920 )
Loans receivable, net
  $ 361,238     $ 352,449  
Loans held-for-sale
               
Residential 1-4 family
  $ 187     $ 1,184  
 
The composition of loans receivable by delinquency status is as follows:
 
          Past due        
    Current     1-29     30-59     60-89      90-179     180 days     30 days     Accruing 90     Non-accural  
         
 days
   
 days
   
days
   
 days
   
 and over
   
and over
   
 days and over
       
Residential 1-4 family
  $ 175,498     $ 3,018     $ 1,663     $ 822     $ 1,152     $ 1,041     $ 4,678     $ 100     $ 2,524  
Residential 5+ multifamily
    3,111       -       160       -       -       -       160       -       -  
Residential 1-4 family construction
    4,564       -       -       -       -       -       -       -       -  
Home equity credit
    33,582       199       788       14       -       25       827       -       359  
Residential real estate
    216,755       3,217       2,611       836       1,152       1,066       5,665       100       2,883  
Commercial
    71,057       1,737       834       541       351       -       1,726       -       3,061  
Construction of commercial
    7,756       -       21       -       -       -       21       -       -  
Commercial real estate
    78,813       1,737       855       541       351       -       1,747       -       3,061  
Farm land
    4,523       383       -       315       -       -       315       -       -  
Vacant land
    8,637       564       159       -       -       3,397       3,556       -       3,933  
Real estate secured
    308,728       5,901       3,625       1,692       1,503       4,463       11,283       100       9,877  
Commercial and industrial
    28,441       140       45       492       171       -       708       50       848  
Municipal
    4,563       -       -       -       -       -       -       -       -  
Consumer
    4,383       132       50       9       -       -       59       -       -  
Loans receivable, gross
  $ 346,115     $ 6,173     $ 3,720     $ 2,193     $ 1,674     $ 4,463     $ 12,050     $ 150     $ 10,725  

 
Allowance for Loan Losses
 
Changes in the allowance for loan losses are as follows:
 
   
March 31, 2011
 
Three months ended
(in thousands)
 
Beginning balance
   
Provision
   
Charge-offs
   
Reco-veries
   
Ending balance
 
Residential
  $ 1,504     $ 60     $ (101 )   $ -     $ 1,463  
Commercial
    1,132       291       (80 )     -       1,343  
Land
    392       (18 )     (79 )     -       295  
Real estate
    3,028       333       (260 )     -       3,101  
Commercial & industrial
    541       (9 )     -       -       532  
Municipal
    51       4       -       -       55  
Consumer
    164       16       (19 )     7       168  
Unallocated
    136       (14 )     -       -       122  
Total
  $ 3,920     $ 330     $ (279 )   $ 7     $ 3,978  
 
The composition of loans receivable and the allowance for loan losses at March 31, 2011 is as follows:
 
   
Collectively evaluated
   
Individually evaluated
   
Total portfolio
 
March 31, 2011
(in thousands)
 
Loan
balance
   
Allowance
   
Loan
balance
   
Allowance
   
Loan
Balance
   
Allowance
 
Residential 1-4 family
  $ 176,460     $ 768     $ 6,734     $ 283     $ 183,194     $ 1,051  
Residential 5+ multifamily
    3,271       27       -       -       3,271       27  
Construction of residential 1-4 family
    4,564       18       -       -       4,564       18  
Home equity credit
    34,249       367       359       -       34,608       367  
Residential real estate
    218,544       1,180       7,093       283       225,637       1,463  
Commercial
    66,873       865       7,646       425       74,519       1,290  
Construction of commercial
    7,777       53       -       -       7,777       53  
Commercial real estate
    74,650       918       7,646       425       82,296       1,343  
Farm land
    5,221       54       -       -       5,221       54  
Vacant land
    8,665       97       4,092       144       12,757       241  
Real estate secured
    307,080       2,249       18,831       852       325,911       3,101  
Commercial and industrial
    28,167       395       1,122       137       29,289       532  
Municipal
    4,563       55       -       -       4,563       55  
Consumer
    4,574       168       -       -       4,574       165  
Unallocated allowance
    -       122       -       -       -       122  
Totals
  $ 344,384     $ 2,989     $ 19,953     $ 989     $ 364,337     $ 3,978  
 
Credit Quality Information
 
The composition of loans receivable by risk rating grade is as follows:
 
March 31, 2011 (in thousands)
 
Pass
   
Special mention
   
Substandard
   
Doubtful
   
Loss
   
Total
 
Residential 1-4 family
  $ 161,295     $ 13,306     $ 8,593     $ -     $ -     $ 183,194  
Residential 5+ multifamily
    2,189       994       88       -       -       3,271  
Construction of residential 1-4 family
    3,450       1,114       -       -       -       4,564  
Home equity credit
    31,723       1,696       1,189       -       -       34,608  
Residential real estate
    198,657       17,110       9,870       -       -       225,637  
Commercial
    52,414       9,926       12,179       -       -       74,519  
Construction of commercial
    6,814       492       471       -       -       7,777  
Commercial real estate
    59,228       10,418       12,650       -       -       82,296  
Farm land
    3,164       884       1,173       -       -       5,221  
Vacant land
    8,315       262       4,180       -       -       12,757  
Real estate secured
    269,364       28,674       27,873       -       -       325,911  
Commercial and industrial
    19,129       8,430       1,730       -       -       29,289  
Municipal
    4,563       -       -       -       -       4,563  
Consumer
    4,342       159       65       8       -       4,574  
Loans receivable, gross
  $ 297,398     $ 37,263     $ 29,668     $ 8     $ -     $ 364,337  
 
 
Concentrations of Credit Risk
 
Salisbury's loans consist primarily of residential and commercial real estate loans located principally in northwestern Connecticut and nearby New York and Massachusetts towns, which constitute Salisbury's service area. Salisbury offers a broad range of loan and credit facilities to borrowers in its service area, including residential mortgage loans, commercial real estate loans, construction loans, working capital loans, equipment loans, and a variety of consumer loans, including home equity lines of credit, and installment and collateral loans.  All residential and commercial mortgage loans are collateralized by first or second mortgages on real estate.  The ability of single family residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the market area and real estate values. The ability of commercial borrowers to honor their repayment commitments is dependent on the general economy as well as the health of the real estate economic sector in Salisbury’s market area.
 
Impaired loans
 
Impaired loans are loans for which it is probable that Salisbury will not be able to collect all amounts due according to the contractual terms of the loan agreements and loans restructured in a troubled debt restructuring. Impaired loans do not include large groups of smaller-balance homogenous loans that are collectively evaluated for impairment, which consist of most residential mortgage loans and consumer loans. The components of impaired loans are as follows:
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Non-accrual loans, excluding troubled debt restructured loans
  $ 7,080     $ 5,791  
Non-accrual troubled debt restructured loans
    3,645       4,254  
Accruing troubled debt restructured loans
    5,323       5,330  
Total impaired loans
  $ 16,048     $ 15,375  
Commitments to lend additional amounts to impaired borrowers
  $ -     $ -  
 
Certain data with respect to loans individually evaluated for impairment at March 31, 2011 is as follows:
 
   
Impaired loans with specific allowance
   
Impaired loans with no specific allowance
 
   
Loan balance
   
Specific
allowance
   
Income
recognized
   
Loan balance
   
Income
recognized
 
   
Book
   
Note
   
Average
   
Book
   
Note
   
Average
 
Residential 1-4 family
  $ 2,048     $ 2,217     $ 1,657     $ 150     $ 6     $ 3,853     $ 3,852     $ 4,278     $ 29  
Home equity credit
    -       -       -       -       -       359       361       361       3  
Residential real estate
    2,048       2,217       1,657       150       6       4,212       4,213       4,639       32  
Commercial
    2,701       2,803       2,395       179       41       2,032       2,380       2,429       11  
Vacant land
    670       774       787       64       -       3,263       3,627       3,202       -  
Real estate secured
    5,419       5,794       4,839       393       47       9,507       10,220       10,270       43  
Commercial and industrial
    396       403       229       137       1       726       1,252       673       3  
Totals
  $ 5,815     $ 6,197     $ 5,068     $ 530     $ 48     $ 10,233     $ 11,472     $ 10,943     $ 46  
 
NOTE 4 - MORTGAGE SERVICING RIGHTS
 
Loans serviced for others are not included in the Consolidated Balance Sheets. The balance of loans serviced for others and the fair value of mortgage servicing rights are as follows:
 
March 31, (in thousands)
 
2011
   
2010
 
Residential mortgage loans serviced for others
  $ 101,636     $ 75,414  
Fair value of mortgage servicing rights
    948       493  
 
Changes in mortgage servicing rights are as follows:
 
Three months ended March 31, (in thousands)
 
2011
   
2010
 
Loan Servicing Rights
           
Balance, beginning of period
  $ 683     $ 427  
Originated
    77       28  
Amortization (1)
    (59 )     (31 )
Balance, end of period
    701       424  
Valuation Allowance
               
Balance, beginning of period
    (10 )     (30 )
Decrease in impairment reserve (1)
    2       2  
Balance, end of period
    (8 )     (28 )
Loan servicing rights, net
  $ 693     $ 396  
 
(1)  
Amortization expense and changes in the impairment reserve are recorded in loan servicing fee income.
 
 
NOTE 5 - PLEDGED ASSETS
 
The following securities and loans were pledged to secure public and trust deposits, securities sold under agreements to repurchase, FHLBB advances and credit facilities available.
 
 in thousands)
 
March 31, 2011
   
December 31, 2010
 
Securities available-for-sale (at fair value)
  $ 61,866     $ 62,764  
Loans receivable
    116,489       114,424  
Total pledged assets
  $ 178,355     $ 177,188  
 
At March 31, 2011, securities were pledged as follows: $46.1 million to secure public deposits and Treasury Tax and Loan deposits, $12.5 million to secure repurchase agreements and $3.4 million to secure FHLBB advances. Loans receivable were pledged to secure FHLBB advances and credit facilities.
 
NOTE 6 – EARNINGS PER SHARE
 
The calculation of earnings per share is as follows:
 
Three months ended March 31, (in thousands, except per share amounts)
 
2011
   
2010
 
Net income
  $ 943     $ 594  
Preferred stock net accretion
    5       5  
Preferred stock dividends paid
    110       110  
Net income available to common shareholders
  $ 828     $ 479  
Weighted average common stock outstanding - basic
    1,688       1,687  
Weighted average common and common equivalent stock outstanding- diluted
    1,688       1,687  
Earnings per common and common equivalent share
               
Basic
  $ 0.49     $ 0.28  
Diluted
    0.49       0.28  
 
NOTE 7 – SHAREHOLDERS’ EQUITY
 
Capital Requirements
 
Salisbury and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional and discretionary actions by the regulators that, if undertaken, could have a direct material effect on Salisbury and the Bank's financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Salisbury and the Bank must meet specific guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  Salisbury and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
 
Quantitative measures established by regulation to ensure capital adequacy require Salisbury and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital (as defined) to average assets (as defined) and total and Tier 1 capital (as defined) to risk-weighted assets (as defined).  Management believes, as of March 31, 2011, that Salisbury and the Bank meet all of their capital adequacy requirements.
 
The Bank was classified, as of its most recent notification, as "well capitalized".  The Bank's actual regulatory capital position and minimum capital requirements as defined "To Be Well Capitalized Under Prompt Corrective Action Provisions" and "For Capital Adequacy Purposes" are as follows:
 
   
Actual
   
For Capital Adequacy Purposes
   
To be Well Capitalized Under Prompt Corrective Action Provisions
 
(dollars in thousands)
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
March  31, 2011
                                   
Total Capital (to risk-weighted assets)
                                   
Salisbury
  $ 52,209       14.01 %   $ 29,810       8.0 %     n/a       -  
Bank
    42,628       11.23       30,366       8.0     $ 37,957       10.0 %
Tier 1 Capital (to risk-weighted assets)
                                               
Salisbury
    48,131       12.92       14,905       4.0       n/a       -  
Bank
    38,551       10.16       15,183       4.0       22,774       6.0  
Tier 1 Capital (to average assets)
                                               
Salisbury
    48,131       8.60       22,394       4.0       n/a       -  
Bank
    38,551       6.90       22,349       4.0       27,936       5.0  
March 31, 2010
                                               
Total Capital (to risk-weighted assets)
                                               
Salisbury
    49,916       12.75       31,311       8.0       n/a       -  
Bank
    40,420       10.36       31,227       8.0       38,034       10.0  
Tier 1 Capital (to risk-weighted assets)
                                               
Salisbury
    46,207       11.81       15,656       4.0       n/a       -  
Bank
    36,712       9.41       15,613       4.0       23,420       6.0  
Tier 1 Capital (to average assets)
                                               
Salisbury
    46,207       8.40       22,387       4.0       n/a       -  
Bank
    36,712       6.68       21,996       4.0       27,494       5.0  
 
 
Restrictions on Cash Dividends to Common Shareholders
 
Salisbury's ability to pay cash dividends is dependent on the Bank's ability to pay cash dividends to Salisbury. There are certain restrictions on the payment of cash dividends and other payments by the Bank to Salisbury. Under Connecticut law, the Bank cannot declare a cash dividend except from net profits, defined as the remainder of all earnings from current operations.  The total of all cash dividends declared by the Bank in any calendar year shall not, unless specifically approved by the Banking Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.
 
Federal Reserve Board (“FRB”)  Supervisory Letter SR 09-4, February 24, 2009, revised March 27, 2009, notes that, as a general matter, the Board of Directors of a Bank Holding Company (“BHC”) should inform the Federal Reserve and should eliminate, defer, or significantly reduce dividends if (1) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition; or (3) the BHC will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Moreover, a BHC should inform the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the BHC capital structure.
 
Further restrictions on cash dividends are imposed on Salisbury because of Salisbury’s participation in the United States Treasury Department’s (“Treasury”) Troubled Asset Relief Program’s Capital Purchase Program (the “CPP”). These preclude the payment of any common stock cash dividends if Salisbury is not paying the preferred stock dividend.  Additionally, the common stock dividend may not be increased without prior approval from the Treasury for the first three years Salisbury is a CPP participant unless all CPP preferred shares are redeemed or transferred to third parties.
 
Preferred Stock
 
In March 2009, Salisbury issued to the Treasury $8,816,000 of Preferred Stock under the CPP.
 
The Preferred Stock qualifies as Tier 1 capital for regulatory purposes and ranks senior to the Common Stock. The Preferred Stock pays a cumulative dividend of 5 percent per annum for the first five years it is outstanding and thereafter at a rate of 9 percent per annum. The Preferred Stock is non-voting, other than voting rights on matters that could adversely affect the Preferred Stock. The Preferred Stock is redeemable at one hundred percent of the issue price plus any accrued and unpaid dividends.
 
As part of the CPP, Salisbury issued to the Treasury a 10-year Warrant to purchase 57,671 shares of Common Stock at an exercise price of $22.93 per share. If the Warrant were fully exercised, Salisbury estimates that the ownership percentage of the current shareholders would be diluted by approximately 3.3% percent.
 
NOTE 8 – PENSION AND OTHER BENEFITS
 
The components of net periodic cost for Salisbury’s insured noncontributory defined benefit retirement plan were as follows:
 
Three months ended March 31, (in thousands)
 
2011
   
2010
 
Service cost
  $ 95     $ 100  
Interest cost on benefit obligation
    93       91  
Expected return on plan assets
    (106 )     (100 )
Amortization of prior service cost
    -       -  
Amortization of net loss
    17       18  
Net periodic benefit cost
  $ 99     $ 109  
 
Salisbury’s 401(k) Plan contribution expense was $43,000 and $41,000, respectively, for the three month periods ended March 31, 2011 and 2010. Other post-retirement benefit obligation expense for endorsement split-dollar life insurance arrangements was $12,000 and $12,000, respectively, for the three month periods ended March 31, 2011 and 2010.
 
NOTE 9 - COMPREHENSIVE INCOME
 
Comprehensive income includes net income and any changes in equity from non-owner sources that are not recorded in the income statement (such as changes in net unrealized gains (losses) on securities).  The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners.
 
 
The components of comprehensive income are as follows:
 
Three months ended March 31, (in thousands)
 
2011
   
2010
 
Net income
  $ 943     $ 594  
Other comprehensive income
               
Net unrealized gains  on securities available-for-sale
    848       975  
Reclassification of net realized gains in net income
    -       -  
Unrealized gains on securities available-for-sale
    848       975  
Income tax (expense)
    (288 )     (331 )
Unrealized gains (losses) on securities available-for-sale, net of tax
    560       644  
Pension plan income
    17       18  
Income tax expense
    (6 )     (6 )
Pension plan income, net of tax
    11       12  
Other comprehensive income,  net of tax
    571       656  
Comprehensive income
  $ 1,514     $ 1,250  
 
The components of accumulated other comprehensive loss are as follows:
 
Three months ended March 31, (in thousands)
 
2011
   
2010
 
Unrealized losses on securities available-for-sale, net of tax
  $ (2,022 )   $ (3,186 )
Unrecognized pension plan expense, net of tax
    (1,176 )     (1,236 )
Accumulated other comprehensive loss, net
  $ (3,198 )   $ (4,422 )
 
NOTE 10 – FAIR VALUE OF ASSETS AND LIABILITIES
 
Salisbury uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, other assets are recorded at fair value on a nonrecurring basis, such as loans held for sale, collateral dependent impaired loans, property acquired through foreclosure or repossession and mortgage servicing rights. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or-market accounting or write-downs of individual assets.
 
Salisbury adopted ASC 820-10, “Fair Value Measurements and Disclosures,” which provides a framework for measuring fair value under generally accepted accounting principles, in 2008. This guidance permitted Salisbury the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis.  Salisbury did not elect fair value treatment for any financial assets or liabilities upon adoption.
 
In accordance with ASC 820-10, Salisbury groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
 
GAAP specifies a hierarchy of valuation techniques based on whether the types of valuation information (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Salisbury’s market assumptions. These two types of inputs have created the following fair value hierarchy
 
 
·
Level 1. Quoted prices in active markets for identical assets. Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.  Level 1 also includes U.S. Treasury, other U.S. Government and agency mortgage-backed securities that are traded by dealers or brokers in active markets.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
 
 
·
Level 2. Significant other observable inputs. Valuations for assets and liabilities traded in less active dealer or broker markets.  Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.
 
 
·
Level 3. Significant unobservable inputs. Valuations for assets and liabilities that are derived from other methodologies, including option pricing models, discounted cash flow models and similar techniques, and are not based on market exchange, dealer, or broker traded transactions.  Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities.
 
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
 
The following is a description of valuation methodologies for assets recorded at fair value, including the general classification of such assets and liabilities pursuant to the valuation hierarchy.
 
 
·
Securities available-for-sale. Securities available-for-sale are recorded at fair value on a recurring basis. Level 1 securities include exchange-traded equity securities. Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes obligations of the U.S. Treasury and U.S. government-sponsored enterprises, mortgage-backed securities, collateralized mortgage obligations, municipal bonds, SBA bonds, corporate bonds and certain preferred equities. Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence.  In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.
 
 
·
Collateral dependent loans that are deemed to be impaired are valued based upon the fair value of the underlying collateral less costs to sell. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. Management may adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values resulting from its knowledge of the property. Internal valuations are utilized to determine the fair value of other business assets. Collateral dependent impaired loans are categorized as Level 3.
 
 
·
Other real estate owned acquired through foreclosure or repossession is adjusted to fair value less costs to sell upon transfer out of loans. Subsequently, it is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally based upon independent market prices or appraised values of the collateral. Management adjusts appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of the property, and such property is categorized as Level 3.
 
Assets measured at fair value are as follows:
 
   
Fair value measurements using
   
Assets at
 
(in thousands)
 
Level 1
   
Level 2
   
Level 3
   
fair value
 
March 31, 2011
                       
Assets at fair value on a recurring basis
                       
Securities available-for-sale
  $ 176     $ 125,047     $ -     $ 125,223  
Assets at fair value on a non-recurring basis
                               
Collateral dependent impaired loans
    -       -       5,285       5,285  
Other real estate owned
    -       -       500       500  
 
Changes in Level 3 assets measured at fair value are as follows:
 
 (in thousands)
 
Securities available-for-sale
   
Collateral dependent impaired Loans
   
Other real estate owned
   
Level 3
assets at
fair value
 
Balance, December 31, 2010
  $ -     $ 4,768     $ 557     $ 5,325  
Gains and losses (realized/unrealized)
                               
Included in earnings
    -       -       -       -  
Included in other comprehensive income
    -       -       -       -  
Principal paydowns of securities, net of accretion
    -       -       -       -  
Write-down of other real estate owned
                    (57 )        
Transfers in and/or out of Level 3
    -       517       -       460  
Balance, March 31, 2011
  $ -     $ 5,285     $ 500     $ 5,785  
Amount of total gains or losses for the period
                               
attributable to the change in unrealized gains or losses
                               
Relating to assets still held at the reporting date
  $ -     $ -     $ -     $ -  
 
 
Carrying values and estimated fair values of financial instruments are as follows:
 
   
March 31, 2011
   
December 31, 2010
 
(in thousands)
 
Carrying
value
   
Estimated
fair value
   
Carrying
value
   
Estimated
fair value
 
Financial Assets
                       
Cash and due from banks
  $ 43,091     $ 43,091     $ 26,908     $ 26,908  
Interest bearing time deposits with other banks
    5,000       5,000       5,000       5,000  
Securities available-for-sale
    125,223       125,223       147,422       147,422  
Security held-to-maturity
    55       56       56       58  
Federal Home Loan Bank stock
    6,032       6,032       6,032       6,032  
Loans held-for-sale
    187       188       1,184       1,193  
Loans receivable net
    361,238       361,791       352,449       351,628  
Accrued interest receivable
    2,002       2,002       2,132       2,132  
Financial Liabilities
                               
Demand (non-interest-bearing)
  $ 74,690     $ 74,690     $ 71,565     $ 71,565  
Demand (interest-bearing)
    59,311       59,311       63,258       63,258  
Money market
    106,468       106,471       77,089       77,089  
Savings and other
    97,407       97,407       93,324       93,324  
Certificates of deposit
    114,503       114,589       125,053       125,172  
Deposits
    452,379       452,468       430,289       430,408  
FHLBB advances
    55,888       61,065       72,812       78,317  
Repurchase agreements
    8,241       8,241       13,190       13,190  
Accrued interest payable
    334       334       435       435  
 
The carrying amounts of financial instruments shown in the above table are included in the consolidated balance sheets under the indicated captions.
 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Management's discussion and analysis of financial condition and results of operations of Salisbury and its subsidiary should be read in conjunction with Salisbury's Annual Report on Form 10-K for the year ended December 31, 2010.
 
BUSINESS
 
Salisbury Bancorp, Inc. ("Salisbury"), a Connecticut corporation, formed in 1998, is a bank holding company for Salisbury Bank and Trust Company ("Bank"), a Connecticut-chartered and Federal Deposit Insurance Corporation (the "FDIC") insured commercial bank headquartered in Lakeville, Connecticut.  Salisbury's principal business consists of the business of the Bank.  The Bank, formed in 1848, is engaged in customary banking activities, including general deposit taking and lending activities to both retail and commercial markets, and trust and wealth advisory services. The Bank conducts its banking business from eight full-service offices in the towns of Canaan, Lakeville, Salisbury and Sharon, Connecticut, South Egremont and Sheffield, Massachusetts, Millerton and Dover Plains, New York, and its trust and wealth advisory services from offices in Lakeville, Connecticut.
 
Application of Critical Accounting Policies
 
Salisbury’s consolidated financial statements follow GAAP as applied to the banking industry in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event.
 
Salisbury’s significant accounting policies are presented in Note 1 of Notes to Consolidated Financial Statements in Salisbury's 2010 Annual Report on Form 10-K for the period ended December 31, 2010 and, along with this Management’s Discussion and Analysis, provide information on how significant assets are valued in the financial statements and how those values are determined. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating Salisbury’s reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain.
 
The allowance for loan losses represents management’s estimate of credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet. Note 1 of Notes to Consolidated Financial Statements in Salisbury's 2010 Annual Report on Form 10-K for the period ended December 31, 2010 describes the methodology used to determine the allowance for loan losses. A discussion of the factors driving changes in the amount of the allowance for loan losses are included in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis.
 
Management evaluates goodwill and identifiable intangible assets for impairment annually using valuation techniques that involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors.  Future events or changes in the estimates, which are used to determine the carrying value of goodwill and identifiable intangible assets or which otherwise adversely affects their value or estimated lives could have a material adverse impact on the results of operations.
 
Management evaluates securities for other-than-temporary impairment giving consideration to the extent to which the fair value has been less than cost, estimates of future cash flows, delinquencies and default severity, and the intent and ability of Salisbury to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The consideration of the above factors is subjective and involves estimates and assumptions about matters that are inherently uncertain. Should actual factors and conditions differ materially from those used by management, the actual realization of gains or losses on investment securities could differ materially from the amounts recorded in the financial statements.
 
 
The determination of the obligation and expense for pension and other postretirement benefits is dependent on certain assumptions used in calculating such amounts. Key assumptions used in the actuarial valuations include the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation and health care costs. Actual results could differ from the assumptions and market driven rates may fluctuate. Significant differences in actual experience or significant changes in the assumptions may materially affect the future pension and other postretirement obligations and expense.
 
RESULTS OF OPERATIONS
 
For the three month periods ended March 31, 2011 and 2010
 
Overview
 
Net income available to common shareholders was $828,000, or $0.49 per common share, for the first quarter ended March 31, 2011 compared with $479,000, or $0.28 per common share, for the first quarter of 2010.
 
Net income available to common shareholders for the first quarters of 2011 and 2010 is net of preferred stock dividends of $115,000 per quarter.
 
Tax equivalent net interest income for the first quarter of 2011 increased $470,000, or 10.9%, versus the first quarter of 2010. Average total deposits increased $18.3 million, or 4.4%, versus the first quarter of 2010. Average earning assets increased $6.95 million, or 1.3%, versus the first quarter of 2010. The net interest margin increased 31 basis points to 3.56% for first quarter 2011.
 
The provision for loan losses for the first quarter of 2011 was $330,000, compared with $180,000 for the first quarter of 2010. Net loan charge-offs were $272,000 and $4,000 for the respective periods.
 
Non-interest income for the first quarter of 2011 increased $272,000, or 24%, due primarily to increased Trust and Wealth Advisory revenues, due to both growth in and higher valuations of managed assets, and a higher volume of mortgage loan sales.
 
Non-interest expense for the first quarter of 2011 increased $112,000 versus the first quarter of 2010 due to increases in compensation, premises and equipment, an OREO write-down and FDIC insurance, offset in part by decreases in data processing, professional fees and other operating expenses.
 
The effective income tax rates for the first quarters of 2011 and 2010 were 18.27% and 11.80%, respectively.
 
Net Interest Income
 
Net interest income, on a tax equivalent basis, increased $470,000, or 10.9%, to $4.8 million for the first quarter of 2011 as compared with the first quarter of 2010, and the net interest margin increased 31 basis points to 3.56% from 3.25%, for the respective periods.

 
The following table sets forth the components of Salisbury's tax-equivalent net interest income and yields on average interest-earning assets and interest-bearing funds.
 

Three months ended March 31,
 
Average Balance
   
Income / Expense
   
Average Yield / Rate
 
(dollars in thousands)
 
2011
   
2010
   
2011
   
2010
   
2011
   
2010
 
Loans (a)
  $ 362,436     $ 333,347     $ 4,664     $ 4,487       5.15 %     5.38 %
Securities (c)(d)
    145,216       150,385       1,594       1,745       4.39       4.64  
FHLBB stock
    6,032       6,032       6       -       0.42       -  
Short term funds (b)
    23,753       40,747       33       46       0.56       0.45  
Total earning assets
    537,437       530,511       6,297       6,278       4.69       4.73  
Other assets
    33,436       32,865                                  
Total assets
  $ 570,873     $ 563,376                                  
Interest-bearing demand deposits
  $ 63,094     $ 49,158       116       147       0.74       1.20  
Money market accounts
    84,306       66,413       110       95       0.52       0.57  
Savings and other
    95,454       87,644       97       143       0.41       0.65  
Certificates of deposit
    120,688       148,941       548       813       1.82       2.18  
Total interest-bearing deposits
    363,542       352,156       871       1,198       0.96       1.36  
Repurchase agreements
    12,077       12,601       15       27       0.50       0.86  
FHLBB advances
    63,080       75,752       646       758       4.10       4.00  
Total interest-bearing liabilities
    438,699       440,509       1,532       1,983       1.40       1.80  
Demand deposits
    72,989       66,122                                  
Other liabilities
    3,995       3,791                                  
Shareholders’ equity
    55,190       52,954                                  
Total liabilities & shareholders’ equity
  $ 570,873     $ 563,376                                  
Net interest income
                  $ 4,765     $ 4,295                  
Spread on interest-bearing funds
                                    3.29       2.93  
Net interest margin (e)
                                    3.56       3.25  
 
(a)
Includes non-accrual loans.
(b)
Includes interest-bearing deposits in other banks and federal funds sold.
(c)
Average balances of securities are based on historical cost.
(d)
Includes tax exempt income of $258,000 and $259,000, respectively for 2011 and 2010 on tax-exempt securities whose income and yields are calculated on a tax-equivalent basis.
(e)
Net interest income divided by average interest-earning assets.
 
The following table sets forth the changes in FTE interest due to volume and rate.
 
Three months ended March 31, (in thousands)
 
2011 versus 2010
 
Change in interest due to
 
Volume
   
Rate
   
Net
 
Interest-earning assets
                 
Loans
  $ 383     $ (206 )   $ 177  
Securities
    (58 )     (93 )     (151 )
FHLBB stock
    -       6       6  
Short term funds
    (21 )     8       (13 )
Total
    304       (285 )     19  
Interest-bearing liabilities
                       
Deposits
    (73 )     (254 )     (327 )
Repurchase agreements
    (1 )     (11 )     (12 )
FHLBB advances
    (128 )     16       (112 )
Total
    (202 )     (249 )     (451 )
Net change in net interest income
  $ 506     $ (36 )   $ 470  
 
Interest Income
 
Tax equivalent interest income increased $19,000, or 0.3%, to $6.3 million for the first quarter of 2011 as compared with the first quarter of 2010.  Loan income increased $177,000, or 3.9%, primarily due to a $29.0 million, or 8.7%, increase in average loans offset by a 23 basis points decline in the average loan yield. The increase in the average loan volume resulted from strong loan growth during the past year.
 
Income from securities, on a tax equivalent basis, decreased $145,000, or 8.3%, for the first quarter of 2011 as compared with the first quarter of 2010, as a result of a 23 basis points decline in the average yield and a $5.2 million, or 3.4%, decrease in average volume. The lower yield resulted from the effect of lower market interest rates on securities purchases, calls of agency bonds and prepayments of mortgage backed securities. The decline in volume resulted from the redeployment of some of the cash flows from securities maturities, principal payments and calls, into new loans.
 
Income from short term funds decreased $13,000 for the first quarter of 2011 as compared with the first quarter of 2010 as a result of a $17.0 million decrease in the average balance, and partially offset by a higher average yield.
 
 
Interest Expense
 
Interest expense decreased $451,000, or 22.7%, to $1.5 million for the first quarter of 2011 as compared with the first quarter of 2010.
 
Interest on deposit accounts and retail repurchase agreements decreased $339,000, or 27.7%, as a result of a lower average rate, down 39 basis points to 0.95%, offset in part by a $10.9 million, or 3.0%, increase in the average balance. The lower average rate resulted from the effect of lower market interest rates on rates paid and changes in product mix. The higher average volume resulted from deposit growth.
 
Interest expense on FHLBB borrowings decreased $112,000 as a result of lower average borrowings, down $12.7 million, offset in part by a higher average borrowing rate, up 10 basis points as compared with 2010. The decline in advances resulted from maturities that were not replaced with new advances.
 
Provision and Allowance for Loan Losses
 
The provision for loan losses was $330,000 for the first quarter of 2011, compared with $180,000 for the first quarter of 2010. Net loan charge-offs were $272,000 and $4,000, for the respective quarters. The following table sets forth changes in the allowance for loan losses and other selected statistics:
 
As of or for the three months ended (dollars in thousands)
 
March 31, 2011
   
December 31, 2010
   
March 31, 2010
 
Balance, beginning of period
  $ 3,920     $ 3,847     $ 3,473  
Provision (benefit) or loan losses
    330       380       180  
Charge-offs
                       
Real estate mortgages
    (260 )     (202 )     -  
Commercial & industrial
    -       (95 )     -  
Consumer
    (19 )     (18 )     (10 )
Total charge-offs
    (279 )     (315 )     (10 )
Recoveries
                       
Real estate mortgages
    -       -       -  
Commercial & industrial
    -       -       -  
Consumer
    7       8       6  
Total recoveries
    7       8       6  
Net (charge-offs) recoveries
    (272 )     (307 )     (4 )
Balance, end of period
  $ 3,978     $ 3,920     $ 3,649  
Loans receivable, gross
  $ 364,337     $ 355,547     $ 332,622  
Non-performing loans
    10,875       10,141       12,064  
Accruing loans past due 30-89 days
    3,991       1,917       5,383  
Ratio of allowance for loan losses:
                       
to loans receivable, gross
    1.09 %     1.10 %     1.10 %
to non-performing loans
    36.58       38.65       30.25  
Ratio of non-performing loans
                       
to loans receivable, gross
    2.98       2.85       3.62  
Ratio of accruing loans past due 30-89 days
                       
to loans receivable, gross
    1.10       0.54       1.62  
 
Reserve coverage at March 31, 2011, as measured by the ratio of allowance for loan losses to gross loans, remained substantially unchanged at 1.09%, as compared with 1.10% at December 31, 2010 and 1.10% a year ago at March 31, 2010. Non-performing loans (non-accrual loans and accruing loans past-due 90 days or more) increased $0.7 million in the first quarter of 2011 to $10.9 million, or 2.98% of gross loans receivable, while accruing loans past due 30-89 days increased $2.1 million to $4.0 million, or 1.10% of gross loans receivable. See “Financial Condition – Loan Credit Quality” for further discussion and analysis.
 
 
The allowance for loan losses represents management’s estimate of the probable credit losses inherent in the loan portfolio as of the reporting date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by loan charge-offs. Loan charge-offs are recognized when management determines a loan or portion of a loan to be uncollectible. The allowance for loan losses is computed by segregating the portfolio into three components: (1) loans collectively evaluated for impairment: general loss allocation factors for non-impaired loans are segmented into pools of loans based on similar risk characteristics such as loan product, collateral type and loan-to-value, loan risk rating, historical loss experience, delinquency factors and other similar economic indicators, (2) loans individually evaluated for impairment: individual loss allocations for loans deemed to be impaired based on discounted cash flows or collateral value, and (3) unallocated: general loss allocations for other environmental factors.
 
Management assesses the adequacy of the allowance, and the provisions for loan losses, based on an ongoing review of numerous factors, including the growth and composition of the loan portfolio, historical loss experience over a 10-to-15 year economic cycle, probable credit losses based upon internal and external portfolio reviews, credit risk concentrations, changes in lending policy, current economic conditions, analysis of current levels and asset quality, delinquency levels and trends, estimates of the current value of underlying collateral, the performance of individual loans in relation to contract terms, and other pertinent factors. Determining the adequacy of the allowance at any given period is difficult, particularly during deteriorating or uncertain economic periods, and therefore management takes a relatively long view of loan loss asset quality measures.  Management must make estimates using assumptions and information that are often subjective and changing rapidly.  The review of the loan portfolio is a continuing event in light of a changing economy and the dynamics of the banking and regulatory environment.  Should the economic climate deteriorate, borrowers could experience difficulty and the level of non-performing loans, charge-offs and delinquencies could rise and require increased provisions.  In management's judgment, Salisbury remains adequately reserved both against total loans and non-performing loans at March 31, 2011.
 
Management’s loan risk rating assignments, loss percentages and specific reserves are subjected annually to an independent credit review by an external firm. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses.  Such agencies could require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.  The Bank was examined by the Connecticut Department of Banking in April 2010 and by the FDIC in February 2009. No additions to the allowance were requested as a result of these examinations.
 
Non-interest income
 
The following table details the principal categories of non-interest income.
 
Three months ended March 31, (dollars in thousands)
 
2011
   
2010
   
2011 vs. 2010
 
Gains on securities, net
  $ 11     $ -     $ 11       (100.00 )%
Trust and wealth advisory fees
    667       545       122       22.38  
Service charges and fees
    499       453       46       10.15  
Gains on sales of mortgage loans, net
    133       42       91       216.66  
Mortgage servicing, net
    32       33       (1 )     (3.03 )
Other
    59       56       3       5.36  
Total non-interest income
  $ 1,401     $ 1,129     $ 272       24.09  
 
Gains on securities result from the accretion of discounts on called securities. The increase in Trust and Wealth Advisory revenues resulted primarily from both growth in and higher valuation of managed assets. The increase in service charges relates primarily to higher interchange activity. Sales of mortgage loans were $6.1 million for the first quarter of 2011 versus $4.2 million for the first quarter of 2010.
 
Non-interest expense
 
The following table details the principal categories of non-interest expense.
 
Three months ended March 31, (dollars in thousands)
 
2011
   
2010
   
2011 vs. 2010
 
Salaries
  $ 1,729     $ 1,571     $ 158       (10.06 )%
Employee benefits
    634       630       4       0.63  
Premises and equipment
    583       515       68       13.20  
Data processing
    377       408       (31 )     7.60  
Professional fees
    280       402       (122 )     30.35  
FDIC insurance
    223       171       52       30.41  
Marketing and community contributions
    68       62       6       9.68  
Amortization of intangible assets
    56       56       -       -  
Other
    474       497       (23 )     (4.63 )
Non-interest expense
  $ 4,424     $ 4,312     $ 112       2.60  
 
 
Salary expense increased primarily due to year-over-year merit increases and changes in staffing levels and mix. Increased health benefits costs, due to premium increases and increased staff utilization, were substantially offset by a decline in the net periodic pension expense. Higher premises expense resulted from the Sheffield branch relocation in August 2010 and the Sharon branch renovation. The decrease in data processing expense resulted from a $10,000 per month decrease in Salisbury’s core processing contract. Professional fees include legal, consulting, audit and investment management services. The decrease results from lower usage in all categories. FDIC insurance premiums increased as a result of both deposit growth and higher premiums. The decrease in other operating expenses is due to lower spending on printing, loan related services, telecommunications, consumable supplies and other operational items.
 
Income taxes
 
The effective income tax rates for the first quarters of 2011 and 2010 were 18.27% and 11.80%, respectively. The increase in the effective rate resulted from a higher proportion of taxable income to total income in the 2011 period versus 2010. Salisbury’s effective tax rate is generally less than the 34% federal statutory rate due to holdings of tax-exempt municipal bonds and bank owned life insurance.
 
Salisbury did not incur Connecticut income tax in 2011 or 2010, other than minimum state income tax, as a result of its utilization of Connecticut tax legislation that permits banks to shelter certain mortgage income from the Connecticut corporation business tax through the use of a special purpose entity called a Passive Investment Company (“PIC”). In accordance with this legislation, in 2004 the Bank formed a PIC, SBT Mortgage Service Corporation. Salisbury's income tax provision reflects the full impact of the Connecticut legislation. Salisbury does not expect to pay other than minimum state income tax in the foreseeable future unless there is a change in the State of Connecticut corporate tax law.
 
FINANCIAL CONDITION
 
Overview
 
Total assets were $577 million at March 31, 2011, up $1,424,000 from December 31, 2010.  Loans receivable, net, were $361 million at March 31, 2011, up $8.8 million, or 2.5%, from December 31, 2010.  Non-performing assets were $11.7 million at March 31, 2011, up $1.0 million from $10.7 million at December 31, 2010. Reserve coverage, as measured by the ratio of the allowance for loan losses to gross loans, was 1.09%, 1.10% and 1.10%, at March 31, 2011, December 31, 2010 and March 31, 2010, respectively. Deposits were $452 million, up $22 million from $430 million at December 31, 2010.
 
At March 31, 2011, book value and tangible book value per common share were $27.92 and $21.39, respectively. Salisbury’s Tier 1 leverage and total risk-based capital ratios were 8.60% and 14.01%, respectively, and above the “well capitalized” limits as defined by the FRB.
 
Securities and Short Term Funds
 
During the first quarter of 2011, securities decreased $22 million to $123 million, and FHLBB advances decreased $17 million, while cash and cash-equivalents (interest-bearing deposits with other banks, money market funds and federal funds sold) increased $16 million to $43 million as Salisbury increased its liquidity position in light of historically low interest rates and growth in volatile deposits.
 
Salisbury evaluates securities for OTTI where the fair value of a security is less than its amortized cost basis at the balance sheet date. As part of this process, Salisbury considers its intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, Salisbury recognizes an OTTI charge to earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities that meet neither of these conditions, an analysis is performed to determine if any of these securities are at risk for OTTI.
 
Salisbury does not intend to sell any of its securities and it is not more likely than not that Salisbury will be required to sell any of its securities before recovery of their cost basis, which may be maturity.  Therefore, management does not consider any of its securities, other than the five non-agency CMO securities reflecting OTTI, to be OTTI at March 31, 2011.
 
 
In 2009 Salisbury determined that five non-agency CMO securities reflected OTTI and recognized losses for deterioration in credit quality of $1,128,000. Salisbury judged these five securities not to have additional OTTI and all other CMO securities not to be OTTI as of March 31, 2011. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI for further deterioration in credit quality. Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis.
 
Accumulated other comprehensive income at March 31, 2011 included net unrealized holding losses, net of tax, of $2.0 million that management deems as temporary impairment.
 
Loans
 
During the first quarter of 2011, net loans receivable grew $8.8 million, or 2.49%, to $361.2 million at March 31, 2011, despite soft loan demand and competition for loans in Salisbury’s market area. First quarter 2011 loan growth compares with loan growth of $1.6 million, or 0.5%, in the first quarter of 2010.
 
The composition of loans receivable and loans held-for-sale is as follows:
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Residential 1-4 family
  $ 183,194     $ 176,892  
Residential 5+ multifamily
    3,271       2,889  
Construction of residential 1-4 family
    4,564       5,988  
Home equity credit
    34,608       34,164  
Residential real estate
    225,637       219,933  
Commercial
    74,519       75,495  
Construction of commercial
    7,777       7,312  
Commercial real estate
    82,296       82,807  
Farm land
    5,221       5,690  
Vacant land
    12,757       12,979  
Real estate secured
    325,911       321,409  
Commercial and industrial
    29,289       25,123  
Municipal
    4,563       4,338  
Consumer
    4,574       4,677  
Loans receivable, gross
    364,337       355,547  
Deferred loan origination fees and costs, net
    879       822  
Allowance for loan losses
    (3,978 )     (3,920 )
Loans receivable, net
  $ 361,238     $ 352,449  
Loans held-for-sale
               
Residential 1-4 family
  $ 187     $ 1,184  
 
Loan Credit Quality
 
Loan credit quality indicators deteriorated during the first quarter of 2011 versus the fourth quarter of 2010, reflecting the persistent weakness in the local and regional economies and seasonal factors. Non-performing assets increased $990,000 during first quarter 2011 to $11.7 million, or 2.03% of assets, compared with $10.8 million at December 31, 2010, and decreased $0.6 million compared with $12.3 million, or 2.19% of assets, at March 31, 2010. Loans past due 30 days or more increased $3.1 to $12.0 million, or 3.3% of loans, at March 31, 2011, compared with $8.9 million, or 2.5% of loans, at December 31, 2010.
 
Non-Performing Assets
 
Salisbury pursues the resolution of all non-performing assets through collections, restructures, voluntary liquidation of collateral by the borrower and legal action. When all attempts to work with a customer to bring the loan current or restructure and bring the loan back to performing status are unsuccessful, Salisbury will initiate appropriate legal action to either foreclose the property, to acquire it by deed in lieu of foreclosure, or to liquidate business assets.
 
Non-performing assets increased $1.0 million to $11.7 million, or 2.03% of assets, at March 31, 2011, up from $10.7 million, or 1.87% of assets at December 31, 2010. After deteriorating in the first quarter 2010, reflecting the weakness in the local and regional economies, loan credit quality remained relatively stable thereafter. The components of non-performing assets are as follows:
 
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Residential 1-4 family
  $ 2,524     $ 2,534  
Home equity credit
    359       362  
Commercial
    3,061       2,923  
Vacant land
    3,933       4,018  
Real estate secured
    9,877       9,837  
Commercial and industrial
    848       208  
Total non-accruing loans
    10,725       10,045  
Accruing loans past due 90 days and over
    150       96  
Total non-performing loans
    10,875       10,141  
Real estate acquired in settlement of loans
    866       610  
Total non-performing assets
  $ 11,741     $ 10,751  
 
Changes in non-performing assets during the first quarter of 2011 included $1.4 million of loans placed on non-accruing status, $0.1 million of loan repayments and payoffs, a $0.3 million loan foreclosure, and $259,000 of loan charge-offs.
 
Substantially all non-performing loans are collateralized with real estate and the repayment of such loans is largely dependent on the sale of the underlying real estate.
 
The past due status of non-performing loans is as follows:
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Current
  $ 2,188     $ 2,931  
Past due 001-029 days
    829       219  
Past due 030-059 days
    728       541  
Past due 060-089 days
    993       1,050  
Past due 090-179 days
    1,674       683  
Past due 180 days and over
    4,463       4,717  
Total non-performing loans
  $ 10,875     $ 10,141  
 
At March 31, 2011, 20.4% of non-accrual loans were current with respect to loan payments, compared with 28.9% at December 31, 2010. Loans past due 180 days include a $3.0 million loan secured by residential building lots where Salisbury has initiated a foreclosure action. See Item 1 of Part II, Legal Proceedings, for additional information.
 
Troubled Debt Restructured Loans
 
Troubled debt restructured loans include those for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments, extension of maturity dates, or reduction of principal balance or accrued interest, have been granted due to a borrower’s financial condition. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit Salisbury by increasing the ultimate probability of collection.
 
Troubled debt restructured loans are classified as accruing or non-accruing based on management’s assessment of the collectability of the loan. Loans which are already on nonaccrual status at the time of the troubled debt restructuring generally remain on nonaccrual status for approximately six months before management considers such loans for return to accruing status. Accruing troubled debt restructured loans are generally placed into nonaccrual status if and when the borrower fails to comply with the restructured terms.
 
Troubled debt restructured loans decreased $0.6 million to $9.0 million at March 31, 2011, down from $9.6 million at December 31, 2010. The components of troubled debt restructured loans are as follows:
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Residential 1-4 family
  $ 3,377     $ 3,377  
Commercial
    1,672       1,677  
Real estate secured
    5,049       5,054  
Commercial and industrial
    274       276  
Accruing troubled debt restructured loans
    5,323       5,330  
Residential 1-4 family
    450       552  
Commercial
    2,520       2,923  
Vacant land
    536       621  
Real estate secured
    3,506       4,096  
Commercial and Industrial
    140       158  
Non-accrual troubled debt restructured loans
    3,646       4,254  
Troubled debt restructured loans
  $ 8,969     $ 9,584  
 
 
Changes in troubled debt restructured loans during the first quarter of 2011 included $42,000 of loan repayments, a $0.3 million loan foreclosure, and $259,000 of loan charge-offs.
 
The past due status of troubled debt restructured loans is as follows:
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Current
  $ 4,478     $ 4,798  
Past due 001-029 days
    688       375  
Past due 030-059 days
    157       157  
Accruing troubled debt restructured loans
    5,323       5,330  
Current
    1,782       2,585  
Past due 001-029 days
    829       169  
Past due 030-059 days
    402       378  
Past due 090-179 days
    351       346  
Past due 180 days and over
    282       776  
Non-accrual troubled debt restructured loans
    3,646       4,254  
Total troubled debt restructured loans
  $ 8,969     $ 9,584  
 
At March 31, 2011, 59.4% of troubled debt restructured loans were accruing, of which 84.1% were current with respect to loan payments, as compared with 55.6% and 90.0%, respectively, at December 31, 2010.
 
Past Due Loans
 
Loans past due 30 days or more increased $3.1 million during first quarter 2011 to $12.0 million, or 3.3% of gross loans receivable, compared with $8.9 million, or 2.5% of loans, at December 31, 2010, and $11.9 million, or 3.6% of loans at March 31, 2010.
 
The components of loans past due 30 days or greater are as follows:
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Past due 030-059 days
  $ 2,991     $ 1,188  
Past due 060-089 days
    1,200       730  
Past due 090-179 days
    150       96  
Accruing loans
    4,341       2,014  
Past due 030-059 days
    729       541  
Past due 060-089 days
    993       1,050  
Past due 090-179 days
    1,524       587  
Past due 180 days and over
    4,463       4,716  
Non-accrual loans
    7,709       6,894  
Total loans past due 30 days or greater
  $ 12,050     $ 8,908  
 
Potential Problem Loans
 
Salisbury uses credit risk ratings to categorize loans by common financial and structural characteristics that measure the credit strength of a borrower. The rating model has eight risk rating grades, with each grade corresponding to a progressively greater risk of default. Grades 1 through 4 are pass ratings and 5 through 8 are criticized as defined by the regulatory agencies. Risk ratings are assigned to differentiate risk within the portfolio and are reviewed on an ongoing basis and revised, if needed, to reflect changes in the borrowers' current financial position and outlook, risk profiles and the related collateral and structural positions.
 
Loans rated as "substandard" are loans where the Bank’s position is clearly not protected adequately by borrower current net worth or payment capacity.  These loans have well defined weaknesses based on objective evidence and include loans where future losses to the Bank may result if deficiencies are not corrected, and loans where the primary source of repayment such as income is diminished and the Bank must rely on sale of collateral or other secondary sources of collection.
 
Potential problem loans consist of performing loans rated as substandard, and exclude all non-performing and impaired loans. Management cannot predict the extent to which economic or other factors may impact such borrowers future payment capacity and there can be no assurance that such loans will not become 90 days or more past due, be placed on nonaccrual status, restructured, or require increased allowance coverage and provision for loan losses.
 
 
Potential problem loans increased $5.7 million during first quarter 2011 to $13.6 million, or 3.7% of gross loans receivable, compared with $7.9 million, or 2.2% of loans, at December 31, 2010.
 
The components of potential problem loans are as follows:
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Residential 1-4 family
  $ 2,692     $ 2,483  
Residential 5+ multifamily
    88       89  
Construction of residential 1-4 family
    -       75  
Home equity credit
    829       817  
Residential real estate
    3,609       3,464  
Commercial
    7,446       2,327  
Construction of commercial
    471       47  
Commercial real estate
    7,917       2,374  
Farm land
    1,173       881  
Vacant land
    247       249  
Real estate secured
    12,946       6,968  
Commercial and Industrial
    608       897  
Consumer
    65       67  
Potential problem loans
  $ 13,619     $ 7,932  
 
The $5.7 million increase in potential problem loans during the first quarter of 2011 resulted from the classification of $7.1 million of performing loans as substandard, offset in part by $1.2 million of loans placed on non-accruing status and $0.2 million of loan repayments, payoffs and risk rating up-grades. Loans newly classified as substandard include two relationships totaling $5.2 million.  The downgrades were based on the customers’ current financial position and outlook. Management continues to work closely with these and all potential problem loan customers to remediate financial performance deficiencies.
 
The past due status of potential problem loans is as follows:
 
(in thousands)
 
March 31, 2011
   
December 31, 2010
 
Current
  $ 11,502     $ 5,757  
Past due 001-029 days
    511       1,233  
Past due 001-029 days
    359       357  
Past due 030-059 days
    1,097       534  
Past due 090-179 days
    150       51  
Total potential problem loans
  $ 13,619     $ 7,932  
 
At March 31, 2011, 84.4% of potential problem loans were current with respect to loan payments, as compared with 72.6% at December 31, 2010.
 
Deposits and Borrowings
 
During the three-month period ended March 31, 2011 deposits grew $22 million, or 5.13%, to $452 million, while retail repurchase agreements decreased $5 million to $8 million.
 
During this period Salisbury’s Federal Home Loan Bank of Boston (FHLBB) advances decreased by $17 million from scheduled loan repayments.
 
Liquidity
 
Salisbury manages its liquidity position to ensure that there is sufficient funding availability at all times to meet both anticipated and unanticipated deposit withdrawals, loan originations and advances, securities purchases and other operating cash outflows. Salisbury's primary sources of liquidity are principal payments and maturities of securities and loans, short-term borrowings through repurchase agreements and Federal Home Loan Bank advances, net deposit growth and funds provided by operations.  Liquidity can also be provided through sales of loans and available-for-sale securities.
 
Salisbury manages its liquidity in accordance with a liquidity funding policy, and also maintains a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. At March 31, 2011, Salisbury's liquidity ratio, as represented by cash, short term available-for-sale securities and marketable assets to net deposits and short term unsecured liabilities, was 25.9%, down from 28.4% at December 31, 2010. Management believes Salisbury’s funding sources will meet anticipated funding needs.
 
 
Operating activities for the three-month period ended March 31, 2011 provided net cash of $3.3 million.  Investing activities provided net cash of $13.3 million, principally from $23.0 million in securities repayments, maturities and calls, offset by funding of $9.4 million of net loan advances. Financing activities utilized net cash of $367,000, principally for $16.9 million of scheduled FHLB advance repayments, a $4.9 million decrease in repurchase agreements and $583,000 of cash dividends, offset in part by a $22.0 million net increase in deposits.
 
At March 31, 2011, Salisbury had outstanding commitments to fund new loan originations of $8.5 million and unused lines of credit of $47.3 million. Salisbury believes that these commitments can be met in the normal course of business.  Salisbury believes that its liquidity sources will continue to provide funding sufficient to support operating activities, loan originations and commitments, and deposit withdrawals.
 
CAPITAL RESOURCES
 
Shareholders’ equity was $55.9 million at March 31, 2011, up $932,000 from December 31, 2010. Book value and tangible book value per share were $27.92 and $21.39, respectively, compared with $27.37 and $20.81, respectively, at December 31, 2010. Contributing to the increase in shareholders’ equity for the first quarter of 2011 was net income of $943,000, other comprehensive income of $571,000, less common and preferred stock dividends of $472,000 and $110,000, respectively. Other comprehensive income includes unrealized gains on securities available-for-sale, net of tax, of $(2,022,000) and pension plan income, net of tax, of $(1,176,000).
 
Capital Requirements
 
Salisbury and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Under current regulatory definitions, Salisbury and the Bank are considered to be “well capitalized” for capital adequacy purposes. As a result, the Bank pays lower federal deposit insurance premiums than banks that are not “well capitalized.” Salisbury and the Bank's regulatory capital ratios are as follows:
 
   
Well
   
March 31, 2011
   
December 31, 2010
 
   
capitalized
   
Salisbury
   
Bank
   
Salisbury
   
Bank
 
Total Capital (to risk-weighted assets)
    10.00 %     14.01 %     11.23 %     13.91 %     11.11 %
Tier 1 Capital (to risk-weighted assets)
    6.00       12.92       10.16       12.84       10.06  
Tier 1 Capital (to average assets)
    5.00       8.60       6.90       8.39       6.72  
 
A well capitalized institution, which is the highest capital category for an institution as defined by the Prompt Corrective Action  Regulations issued by the FDIC and the FRB, is one which maintains a Total Risk-Based ratio of 10% or above, a Tier 1 Risk-Based ratio of 6% or above and a Leverage ratio of 5% or above, and is not subject to any written order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level. Maintaining strong capital is essential to Salisbury’s and the Bank’s safety and soundness.  However, the effective management of capital resources requires generating attractive returns on equity to build value for shareholders while maintaining appropriate levels of capital to fund growth, meet regulatory requirements and be consistent with prudent industry practices.
 
Dividends
 
During the three month period ended March 31, 2011 Salisbury paid $110,000 in preferred stock dividends to the U.S. Treasury’s TARP CPP, and $472,000 in common stock dividends.
 
The Board of Directors of Salisbury declared a common stock dividend of $0.28 per common share payable on May 25, 2011 to shareholders of record on May 11, 2011. Common stock dividends, when declared, will generally be paid the last business day of February, May, August and November, although Salisbury is not obligated to pay dividends on those dates or at any other time.
 
Salisbury's ability to pay cash dividends is substantially dependent on the Bank's ability to pay cash dividends to Salisbury. There are certain restrictions on the payment of cash dividends and other payments by the Bank to Salisbury. Under Connecticut law the Bank cannot declare a cash dividend except from net profits, defined as the remainder of all earnings from current operations.  The total of all cash dividends declared by the Bank in any calendar year shall not, unless specifically approved by the Commissioner of Banking, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.
 
 
FRB Supervisory Letter SR 09-4, February 24, 2009 revised March 27, 2009 notes that, as a general matter, the board of directors of a bank holding company (“BHC”) should inform the Federal Reserve and should eliminate, defer, or significantly reduce dividends if (1) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2)  the prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition; or (3) the BHC will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Moreover, a BHC should inform the FRB reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the BHC capital structure.
 
Further restrictions on cash dividends are imposed on Salisbury because of Salisbury’s participation in the CPP. The terms upon which the preferred stock was issued to the Treasury  preclude the payment of any common stock cash dividends if Salisbury is not paying the preferred stock dividend.  Additionally, the common stock dividend may not be increased without prior approval from the Treasury for the first three years Salisbury is a CPP participant unless all CPP preferred shares are redeemed or transferred to third parties.
 
Salisbury believes that the payment of common stock cash dividends is appropriate, provided that such payment considers Salisbury's capital needs, asset quality, and overall financial condition and does not adversely affect the financial stability of Salisbury or the Bank.  The continued payment of common stock cash dividends by Salisbury will be dependent on Salisbury's future core earnings, financial condition and capital needs, regulatory restrictions, and other factors deemed relevant by the Board of Directors of Salisbury.
 
IMPACT OF INFLATION AND CHANGING PRICES
 
Salisbury’s consolidated financial statements are prepared in conformity with generally accepted accounting principles that require the measurement of financial condition and operating results in terms of historical dollars without considering changes in the relative purchasing power of money, over time, due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of Salisbury are monetary and as a result, interest rates have a greater impact on Salisbury’s performance than do the effects of general levels of inflation, although interest rates do not necessarily move in the same direction or with the same magnitude as the prices of goods and services. Although not a material factor in recent years, inflation could impact earnings in future periods.
 
FORWARD-LOOKING STATEMENTS
 
This Form 10-Q and future filings made by Salisbury with the Securities and Exchange Commission, as well as other filings, reports and press releases made or issued by Salisbury and the Bank, and oral statements made by executive officers of Salisbury and the 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 Salisbury and the Bank do business; and
 
(b)
expectations for revenues and earnings for Salisbury and the Bank.
 
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, Salisbury claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Act of 1995.
 
Salisbury 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 effect the operation, performance, development and results of Salisbury’s and the 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 impacts Salisbury and Bank through increased operating expenses;
 
(c)
increased competition from other financial and non-financial institutions;
 
(d)
the impact of technological advances; and
 
(e)
other risks detailed from time to time in Salisbury’s filings with the Securities and Exchange Commission.
 
Such developments could have an adverse impact on Salisbury’s and the Bank’s financial position and results of operations.
 
 
 
Salisbury manages its exposure to interest rate risk through its Asset/Liability Management Committee (“ALCO”) using risk limits and policy guidelines to manage assets and funding liabilities to produce financial results that are consistent with Salisbury’s liquidity, capital adequacy, growth, risk and profitability targets. Interest rate risk is the risk of loss to future earnings due to changes in interest rates.
 
The ALCO manages interest rate risk using income simulation to measure interest rate risk inherent in Salisbury’s financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 24-month horizon. In management’s March 31, 2011 analysis, three of the simulations incorporate management’s growth assumptions over the simulation horizons, with allowances made for loan, deposit and security product mix shifts in selected interest rate scenarios, such as movements between lower rate savings and money market deposit accounts and higher rate time deposits, and changes in the reinvestment of loan and securities cash flows. The fourth simulation incorporates a static balance sheet scenario. Additionally, the simulations take into account the specific re-pricing, maturity and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios.
 
The ALCO reviews the simulation results to determine whether Salisbury’s exposure to change in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. Salisbury’s tolerance levels for changes in net interest income in its income simulations varies depending on the magnitude of interest rate changes and level of risk-based capital. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where interest rates remain stable over the forecast horizon. The ALCO also evaluates the directional trends of net interest income, net interest margin and other financial measures over the forecast horizon for consistency with its liquidity, capital adequacy, growth, risk and profitability targets.
 
The ALCO uses four interest rate scenarios to evaluate interest risk exposure and may vary these interest rate scenarios to show the effect of steepening or flattening changes in yield curves as well as parallel changes in interest rates. At March 31, 2011 the ALCO used the following interest rate scenarios: (1) unchanged interest rates; (2) immediately rising interest rates – immediate non-parallel upward shift in market interest rates ranging from 300 basis points for short term rates to 150 basis points for the 10-year Treasury; (3) immediately falling interest rates – immediate non-parallel downward shift in market interest rates ranging from 0 basis points for short term rates to 100 basis points for the 10-year Treasury; and (4) gradually rising interest rates – gradual non-parallel upward shift in market interest rates ranging from 400 basis points for short term rates to 185 basis points for the 10-year Treasury. Deposit rates are assumed to shift by lesser amounts due to their relative historical insensitivity to market interest rate movements. Further, deposits are assumed to have certain minimum rate levels below which they will not fall. Because income simulations assume that Salisbury’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.
 
As of March 31, 2011 net interest income simulations indicated that the Bank’s exposure to changing interest rates over the simulation horizons remained within its tolerance levels. The following table sets forth the estimated change in net interest income from an unchanged interest rate scenario over the periods indicated for changes in market interest rates using the Bank’s financial instruments as of March 31, 2011:
 
As of March 31, 2011
 
Months 1-12
   
Months 13-24
 
Immediately rising interest rates (management’s growth assumptions)
    (13.91 )%     (13.53 )%
Immediately falling interest rates (management’s growth assumptions)
    0.77       (1.25 )
Gradually rising interest rates (static balance sheet)
    (14.84 )     (18.18 )
 
The negative exposure of net interest income to immediately and gradually rising rates as compared to the unchanged rate scenario results from a faster projected rise in the cost of funds versus income from earning assets, as relatively rate-sensitive money market and time deposits re-price faster than longer duration earning assets.  The negative exposure of net interest income to immediately falling rates as compared to an unchanged rate scenario results from a greater decline in earning asset yields compared to rates paid on funding liabilities, as a result of faster prepayments on existing assets and lower reinvestment rates on future loans originated and securities purchased.
 
While the ALCO reviews simulation assumptions and back-tests simulation results to ensure that they are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin. Over time, the re-pricing, maturity and prepayment characteristics of financial instruments and the composition of Salisbury’s balance sheet may change to a different degree than estimated. Simulation modeling assumes a relatively static balance sheet that does not necessarily reflect Salisbury’s expectation for future balance sheet growth, which is a
 
 
function of the business environment and customer behavior. Another significant simulation assumption is the sensitivity of core savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. The assumed relationship between short-term interest rate changes and core deposit rate and balance changes used in income simulation may differ from the ALCO’s estimates. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.
 
Salisbury also monitors the potential change in market value of its available-for-sale debt securities in changing interest rate environments. The purpose is to determine market value exposure that may not be captured by income simulation, but which might result in changes to Salisbury’s capital and liquidity position. Results are calculated using industry-standard analytical techniques and securities data. Available-for-sale equity securities are excluded from this analysis because the market value of such securities cannot be directly correlated with changes in interest rates. The following table summarizes the potential change in market value of available-for-sale debt securities resulting from immediate parallel rate shifts:
 
As of March 31, 2011 (in thousands)
 
Rates up 100bp
   
Rates up 200bp
 
U.S. Treasury notes
  $ (257 )   $ (500 )
U.S. Government agency notes
    (769 )     (1,613 )
Municipal bonds
    (3,965 )     (7,522 )
Mortgage backed securities
    (408 )     (990 )
Collateralized mortgage obligations
    (749 )     (1,624 )
SBA pools
    (17 )     (30 )
Total available-for-sale debt securities
  $ (6,165 )   $ (12,279 )
 
 
Evaluation of Disclosure Controls and Procedures
 
Salisbury’s management, including its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the disclosure controls and procedures as of March 31, 2011.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective.
 
Disclosure controls and procedures are controls and other procedures that are designed to ensure that the information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports filed under the Exchange Act is accumulated and communicated to management, including the principle executive officer and principle financial officer, as appropriate to allow timely decisions regarding required disclosure. 
 
In addition, based on an evaluation of its internal controls over financial reporting, no change in Salisbury’s internal control over financial reporting occurred during the quarter ended March 31, 2011 that has materially affected, or is reasonably likely to materially affect, Salisbury’s internal control over financial reporting.
 
PART II.
OTHER INFORMATION
 
 
The Bank is involved in various claims and legal proceedings arising out of the ordinary course of business.
 
The Bank, individually and in its capacity as a former Co-Trustee of the Erling C. Christophersen Revocable Trust (the “Trust”), has been named as a defendant in litigation currently pending in the Connecticut Complex Litigation Docket in Stamford, captioned John Christophersen v. Erling Christophersen, et al., X05-CV-08-5009597S (the “First Action”).  The Bank also is a counterclaim-defendant in a related mortgage foreclosure litigation also pending in the Connecticut Complex Litigation Docket in Stamford, captioned Salisbury Bank & Trust Company v. Erling C. Christophersen, et al., X05-CV-10-6005847-S (the “Foreclosure Action,” together with the First Action, the “Actions”).  The other parties to the Actions are John R. Christophersen; Erling C. Christophersen, individually and as Co-Trustee of the Trust; Bonnie Christophersen and Elena Dreiske, individually and as Co-Trustees of the Mildred B. Blount Testamentary Trust; People’s United Bank; Law Offices of Gary Oberst, P.C.; Rhoda Rudnick; and Hinckley Allen & Snyder LLP.
 
 
The Actions involve a dispute over title to certain real property located in Westport, Connecticut that was conveyed by Erling Christophersen, as grantor, to the Trust on or about August 8, 2007.  Subsequent to this conveyance, the Bank loaned $3,386,609 to the Trust, which was secured by an open-end commercial mortgage in favor of the Bank on the Westport property.  This mortgage is the subject of the Foreclosure Action brought by the Bank.
 
The gravamen of the plaintiff/counterclaim-plaintiff John Christophersen’s claims in the Actions is that he has an interest in the Westport real property transferred to the Trust of which he was allegedly wrongfully divested on account of the actions of the defendants.  In the Actions plaintiff seeks to quiet title to the property and to recover money damages from the defendants for the alleged wrongful divestiture of his claimed interest in the property.
 
 
In addition to the mortgage on the property, the Bank, at the time of the financing referenced above, acquired a lender’s title insurance policy from the Chicago Title & Insurance Company, which is providing a defense to the Bank in the First Action under a reservation of rights.  The Bank denies any wrongdoing, and is actively defending the case.  The First Action presently is stayed, by Court order, pending resolution of a parallel action pending in New York Surrogate’s Court to which the Bank is not a party.  The Foreclosure Action remains in its early pleading stage.  No discovery has been taken to date.
 
There are no other material pending legal proceedings, other than ordinary routine litigation incident to the registrant’s business, to which Salisbury is a party or of which any of its property is subject.
 
Item 1A.
 
Not applicable.
 
 
None
 
 
None
 
 
 
None
 
Item 6.
 
Rule 13a-14(a)/15d-14(a) Certification.

Rule 13a-14(a)/15d-14(a) Certification.

Section 1350 Certifications
 
 

Pursuant to the requirements 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.
 
SALISBURY BANCORP, INC.

May 16, 2011
by    /s/ Richard J. Cantele, Jr.
 
Richard J. Cantele, Jr.,
 
Chief Executive Officer
   
May 16, 2011
by    /s/ B. Ian McMahon
 
B. Ian McMahon,
 
Chief Financial Officer
 
 
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