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EX-32 - EXHIBIT 32 - Naugatuck Valley Financial Corpv385062_ex32.htm

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, DC 20549

 

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended June 30, 2014

 

OR

 

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

 

For the transition period from ______________ to _____________

 

Commission file number: 0-54447

 

                  NAUGATUCK VALLEY FINANCIAL CORPORATION                  

(Exact name of registrant as specified in its charter)

 

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

 

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

 

                                 (203) 720-5000                                

(Registrant’s telephone number, including area code)

 

N/A

 

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

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x      No ¨

 

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

 

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

 

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

 

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

Yes ¨      No x

 

As of August 12, 2014, there were 7,002,208 shares of the registrant’s common stock outstanding.

 

 
 

 

NAUGATUCK VALLEY FINANCIAL CORPORATION

 

Table of Contents

 

  Page No.
       
Part I.  Financial Information  
   
  Item 1. Consolidated Financial Statements (Unaudited)  
       
    Consolidated Statements of Financial Condition at June 30, 2014 and December 31, 2013  3
       
    Consolidated Statements of Operations for the three and six months ended June 30, 2014 and 2013  4
       
    Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2014 and 2013  5
       
    Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2014 and 2013  6
       
    Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013  7
       
    Notes to Unaudited Consolidated Financial Statements  8
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 35
       
    Liquidity and Capital Resources 48
       
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 50
       
  Item 4. Controls and Procedures 51
       
Part II.  Other Information  
       
  Item 1. Legal Proceedings 51
       
  Item 1A. Risk Factors 52
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 52
       
  Item 3. Defaults Upon Senior Securities 52
       
  Item 4. Mine Safety Disclosures 52
       
  Item 5. Other Information 52
       
  Item 6. Exhibits 53
       
Signatures 54
   
Exhibits  

 

2
 

 

Part I - FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements (Unaudited)

 

 

Consolidated Statements of Financial Condition (unaudited)

 

(Dollars in thousands)  June 30, 
2014
   December
31, 2013
 
     
ASSETS          
Cash and due from depository institutions  $8,699   $26,330 
Federal funds sold   18    44 
Cash and cash equivalents   8,717    26,374 
Investment securities available-for-sale, at fair value   86,386    49,771 
Investment securities held-to-maturity, at amortized cost   15,480    18,149 
Loans held for sale   5,052    1,079 
Loans receivable, net   362,324    360,568 
Accrued income receivable   1,712    1,494 
Foreclosed real estate   536    1,846 
Premises and equipment, net   9,390    9,364 
Bank owned life insurance   10,261    10,132 
Federal Home Loan Bank (“FHLB”) of Boston stock, at cost   5,210    5,444 
Other assets   6,996    2,560 
Total assets  $512,064   $486,781 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Liabilities          
Deposits  $385,980   $390,847 
FHLB advances   54,164    25,293 
Other borrowed funds   3,967    4,173 
Mortgagors' escrow accounts   4,630    4,392 
Other liabilities   4,673    3,842 
Total liabilities   453,414    428,547 
Commitments and contingencies          
Stockholders' equity          
Preferred stock, $.01 par value; 1,000,000 shares authorized; no shares issued or outstanding   -    - 
Common stock, $.01 par value; 25,000,000 shares authorized; 7,002,366 shares issued; 7,002,208 shares outstanding at June 30, 2014 and December 31, 2013, respectively   70    70 
Paid-in capital   58,759    58,757 
Retained earnings   1,607    2,322 
Unearned employee stock ownership plan ("ESOP") shares (326,751 shares at June 30, 2014 and December 31, 2013)   (2,824)   (2,824)
Treasury Stock, at cost (158 shares at June 30, 2014 and December 31, 2013)   (1)   (1)
Accumulated other comprehensive income (loss)   1,039    (90)
Total stockholders' equity   58,650    58,234 
Total liabilities and stockholders' equity  $512,064   $486,781 

 

See accompanying notes to unaudited consolidated financial statements.

 

3
 

 

 

Consolidated Statements of Operations (unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands, except share data)  2014   2013   2014   2013 
                 
Interest income                    
Interest and fees on loans  $4,200   $5,021   $8,412   $10,072 
Interest and dividends on investments and deposits   856    292    1,518    612 
Total interest income   5,056    5,313    9,930    10,684 
Interest expense                    
Interest on deposits   598    752    1,203    1,538 
Interest on borrowed funds   189    249    342    543 
Total interest expense   787    1,001    1,545    2,081 
                     
Net interest income   4,269    4,312    8,385    8,603 
                     
(Credit) Provision for loan losses   (739)   3,550    (739)   3,850 
                     
Net interest income after provision for loan losses   5,008    762    9,124    4,753 
                     
Noninterest income                    
Service charge income   176    182    350    360 
Fees for other services   138    180    232    290 
Mortgage banking income   140    393    276    895 
Income from bank owned life insurance   63    70    129    140 
Net gain (loss) on sale of investments   34    (4)   193    (4)
Income from investment advisory services, net   74    87    168    139 
Other income   33    28    63    53 
Total noninterest income   658    936    1,411    1,873 
                     
Noninterest expense                    
Compensation, taxes and benefits   2,973    2,896    5,989    5,573 
Occupancy   582    456    1,124    946 
Professional fees   323    637    842    1,296 
FDIC insurance premiums   270    249    531    454 
Insurance   117    124    262    282 
Computer processing   327    315    697    631 
Expenses on foreclosed real estate, net   168    202    378    559 
Writedowns on foreclosed real estate   11    49    38    60 
Directors’ compensation   70    77    172    211 
Advertising   118    108    213    195 
Supplies   60    48    129    109 
Expenses related to sale of loans   196    765    196    765 
Other expenses   357    571    679    935 
Total noninterest expense   5,572    6,497    11,250    12,016 
                     
Income (loss) before provision (benefit) for income taxes   94    (4,799)   (715)   (5,390)
                     
Provision (benefit) for income taxes   -    -    -    - 
                     
Net income (loss)  $94   $(4,799)  $(715)  $(5,390)
Earnings (loss) per common share - basic and diluted  $0.01   $(0.72)  $(0.11)  $(0.81)

  

See accompanying notes to unaudited consolidated financial statements.

 

4
 

 

 

Consolidated Statements of Comprehensive Income (Loss) (unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands)  2014   2013   2014   2013 
     
Net income (loss)  $94   $(4,799)  $(715)  $(5,390)
Other comprehensive income (loss):                    
Unrealized gain (loss) on available-for-sale investment securities   1,262    (688)   1,859    (739)
Reclassification adjustment for gains realized in net income (loss)   (34)   4   (193)   4
Other comprehensive income (loss) before tax effect   1,228    (684)   1,666    (735)
Income tax expense benefit related to items in other                    
comprehensive income (loss)   (418)   241    (537)   241 
Other comprehensive income (loss) net of tax effect   810    (443)   1,129    (494)
Total comprehensive income (loss)  $904   $(5,242)  $414   $(5,884)

 

See accompanying notes to unaudited consolidated financial statements.

 

5
 

 

 

Consolidated Statements of Changes in Stockholders’ Equity

 

Six months ended June 30, 2014 and 2013 (Unaudited)

 

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

 

   Common   Paid-in   Retained   Unearned
ESOP
   Unearned
Stock
   Treasury   Accumulated
Other
Comprehensive
     
(In thousands)  Stock   Capital   Earnings   Shares   Awards   Stock   Income (Loss)   Total 
                                         
Balance at December 31, 2012  $70   $58,842   $11,164   $(3,143)  $(3)  $(1)  $(21)  $66,908 
Net income (loss)   -    -    (5,390)   -    -    -    -    (5,390)
Other comprehensive income (loss)   -    -    -    -    -    -    (494)   (494)
                                         
Balance at June 30, 2013  $70   $58,842   $5,774   $(3,143)  $(3)  $(1)  $(515)  $61,024 

 

See accompanying notes to unaudited consolidated financial statements.

 

6
 

 

 

Consolidated Statements of Cash Flows (Unaudited)

 

   Six Months Ended 
   June 30, 
(In thousands)  2014   2013 
Cash flows from operating activities          
Net income (loss)  $(715)  $(5,390)
Adjustments to reconcile net loss to cash provided by operating activities:          
(Credit) Provision for loan losses   (739)   3,850 
Depreciation and amortization expense   369    354 
Net loss on sales of foreclosed assets   59    65 
Writedowns on foreclosed real estate   38    60 
Mortgage banking activity:          
Gain on sale   (271)   (728)
Loans originated for sale   (10,682)   (17,575)
Proceeds from sale of loans   10,937    18,189 
Net amortization of investment premiums and discounts   3    212 
Net gain on sale of investments   (193)   - 
Stock-based compensation   2    - 
Net change in:          
Accrued income receivable   (218)   187 
Deferred loan fees   (7)   (49)
Cash surrender value of life insurance   (129)   (141)
Other assets   (466)   (1,276)
Other liabilities   294    3,647 
Net cash (used in)/provided by operating activities   (1,718)   1,405 
Cash flows from investing activities          
Proceeds from maturities and repayments of available-for-sale securities   17,285    2,487 
Proceeds from sale of available-for-sale securities   7,224    762 
Proceeds from maturities of held-to-maturity securities   2,569    3,910 
Redemption of Federal Home Loan Bank stock   234    473 
Purchase of available-for-sale securities   (59,168)   (772)
Loan originations net of principal payments   (5,938)   26,857 
Purchase of premises and equipment   (395)   (103)
Loan sales proceeds held in escrow   (3,970)   (11,753)
Proceeds from the sale of commercial loans   580    - 
Proceeds from the sale of foreclosed assets   1,604    627 
Net cash (used in)/provided by investing activities   (39,975)   22,488 
Cash flows from financing activities          
Net change in time deposits   (2,851)   (12,881)
Net change in other deposit accounts   (2,016)   9,388 
Proceeds from FHLB advances   38,000    - 
Repayment of FHLB advances   (9,129)   (8,966)
Net change in mortgagors' escrow accounts   238    60 
Change in other borrowings   (206)   (944)
Net cash provided/(used) in by financing activities   24,036    (13,343)
Net change in cash and cash equivalents   (17,657)   10,550 
Cash and cash equivalents at beginning of period   26,374    23,229 
Cash and cash equivalents at end of period  $8,717   $33,779 
Supplementary disclosures of cash flow information:          
Non-cash investing activities:          
Transfer of loans to foreclosed assets  $391   $251 
Transfer of loans to loans held for sale  $3,957   $- 
Cash paid during the period for:          
Interest  $1,529   $2,112 
Unrealized gains (losses) on available for sale securities arising during the period  $1,666   $(735)

 

See accompanying notes to unaudited consolidated financial statements.

 

7
 

 

Notes to Unaudited Consolidated Financial Statements

 

NOTE 1 – DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

 

Description of Business

 

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

 

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

 

Naugatuck Valley Savings has two wholly owned subsidiaries, Naugatuck Valley Mortgage Servicing Corporation and Church Street OREO One, LLC. Naugatuck Valley Mortgage Servicing Corporation qualifies and operates as a passive investment company pursuant to Connecticut regulation. Church Street OREO One, LLC was established in February 2013 to hold properties acquired through foreclosure as well as from nonjudicial proceedings.

 

Basis of Presentation

 

The accompanying consolidated interim financial statements are unaudited and include the accounts of the Company, the Bank, and the Bank’s wholly owned subsidiaries, Naugatuck Valley Mortgage Servicing Corporation and Church Street OREO One, LLC. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements. These consolidated financial statements should be read in conjunction with the December 31, 2013 audited Consolidated Financial Statements and the accompanying Notes included in our Annual Report on Form 10-K. All significant intercompany accounts and transactions have been eliminated in consolidation. These consolidated financial statements reflect, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position and the results of its operations and its cash flows at the dates and for the periods presented.

 

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

 

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

 

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

 

8
 

 

Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

 

Certain reclassifications have been made to the prior period amounts to conform with the June 30, 2014 consolidated financial statement presentation. These reclassifications only changed the reporting categories and did not affect the Company’s results of operations or financial position.

 

Significant Accounting Policies

 

The significant accounting policies used in preparation of our consolidated financial statements are disclosed in our 2013 Annual Report on Form 10-K. There have not been any material changes in our significant accounting policies compared with those contained in our Form 10-K disclosure for the year ended December 31, 2013.

 

Recently Issued Accounting Pronouncements

 

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

 

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

 

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

 

NOTE 2 – REGULATORY MATTERS

 

Effective January 17, 2012, the Bank entered into a written Formal Agreement (the “Agreement”) with the Office of the Comptroller of the Currency (the “OCC”). The Agreement requires the Bank to take various actions, within prescribed time frames, with respect to certain operational areas of the Bank, including the following:

·Restricts the Bank from declaring or paying any dividends or other capital distributions to the Company without prior written regulatory approval. This provision relates to upstreaming intercompany dividends or other capital distributions from the Bank to the Company.
·Provide prior written notice to the OCC before appointing an individual to serve as a senior executive officer or as a director of the Bank.
·Restricts the Bank from entering into, renewing, extending or revising any contractual arrangement relating to the compensation or benefits for any senior executive officer of the Bank, unless the Bank provides the OCC with prior written notice of the proposed transaction.
·Subjects the Bank to six month financial and operational examination review. The most recent examination occurred in January 2014. The next scheduled review is expected in the third quarter 2014.

 

In April and May 2013, additional senior management team members were retained to assist the new CEO (who was hired in September 2012) to address the provisions of the Agreement.

 

The Agreement and each of its provisions will remain in effect until these provisions are amended in writing by mutual consent or waived in writing by the OCC or terminated in writing by the OCC.

 

9
 

 

The OCC regulations require savings institutions to maintain minimum levels of regulatory capital. Effective June 4, 2013, the OCC imposed individual minimum capital requirements (“IMCRs”) on the Bank. The IMCRs require the Bank to maintain a Tier 1 leverage capital to adjusted total assets ratio of at least 9.00% and a total risk-based capital to risk-weighted assets ratio of at least 13.00%. Before the establishment of the IMCRs, the Bank had been operating under these capital parameters by self-imposing these capital levels as part of the capital plan the Bank was required to implement under the terms of the Agreement. The Bank exceeded the IMCRs at June 30, 2014, with a Tier 1 leverage ratio of 10.39% and a total risk-based capital ratio of 17.45%.

 

As a source of strength to its subsidiary bank, the Company had liquid assets of approximately $2.9 million at June 30, 2014, which the Company could contribute to the Bank if needed, to enhance the Bank’s capital levels. If the Company had contributed those assets to the Bank as of June 30, 2014, the Bank would have had a Tier 1 leverage ratio of approximately 10.95%.

 

On May 21, 2013, the Company entered into a Memorandum of Understanding (“MOU”) with the Federal Reserve Bank of Boston. Among other things, the MOU prohibits the Company from paying dividends, repurchasing its stock or making other capital distributions without prior written approval of the Federal Reserve Bank of Boston.

 

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

 

The following tables are summaries of the Company’s consolidated capital amounts and ratios and the Bank’s actual capital amounts and ratios as computed under the standards established by the Federal Deposit Insurance Act at June 30, 2014 and December 31, 2013.

 

At June 30, 2014  Adequately Capitalized
Requirements
   Individual Minimum
Capital Requirements (3)
   Actual 
(Dollars in thousands)  $   %   $   %   $   % 
The Company Consolidated                              
Tier 1  Leverage Capital (1)   N/A    N/A    N/A    N/A   $57,610    11.29%
Tier 1 Risk-Based Capital (2)   N/A    N/A    N/A    N/A    57,610    17.63%
Total Risk-Based Capital (2)   N/A    N/A    N/A    N/A    61,734    18.90%
                               
The Bank                              
Tier 1  Leverage Capital (1)  $20,509    4.00%  $46,146    9.00%  $53,290    10.39%
Tier 1 Risk-Based Capital (2)   13,136    4.00%   N/A    N/A    53,290    16.19%
Total Risk-Based Capital (2)   26,273    8.00%   42,693    13.00%   57,445    17.45%

 

(1) Tier 1 capital to total assets.

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

(3) Effective June 4, 2013.

 

10
 

  

At December 31, 2013  Adequately Capitalized
Requirements
   Individual Minimum
Capital Requirements
   Actual 
(Dollars in thousands)  $   %   $   %   $   % 
The Company Consolidated                              
Tier 1  Leverage Capital (1)    N/A    N/A    N/A    N/A   $58,323    11.98%
Tier 1 Risk-Based Capital (2)    N/A    N/A    N/A    N/A    58,323    18.21%
Total Risk-Based Capital (2)   N/A   N/A    N/A    N/A    62,399    19.49%
                               
The Bank                              
Tier 1  Leverage Capital (1)  $19,545    4.00%  $43,977    9.00%  $53,946    11.04%
Tier 1 Risk-Based Capital (2)   12,891    4.00%   N/A    N/A    53,946    16.74%
Total Risk-Based Capital (2)   25,783    8.00%   41,897    13.00%   58,047    18.01%

  

(1) Tier 1 capital to total assets.

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

 

As of June 30, 2014, the most recent regulatory notifications categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action.

 

NOTE 3 – INVESTMENT SECURITIES

 

At June 30, 2014, the composition of the investment portfolio was:

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Available-for-sale securities:                    
U.S. Government and agency obligations  $40,192   $798   $(56)  $40,934 
U.S. Government agency mortgage-backed securities   28,269    820    (284)   28,805 
U.S. Government agency collateralized mortgage obligations   8,487    170    -    8,657 
Small Business Administration securitized pool of loans   2,014    56    -    2,070 
Obligations of state and municipal subdivisions   5,349    63    -    5,412 
Subtotal   84,311    1,907    (340)   85,878 
Mutual fund - fixed income securities   500    8    -    508 
                     
Total available-for-sale securities  $84,811   $1,915   $(340)  $86,386 

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Held-to-maturity securities:           
U.S. Government agency mortgage-backed securities  $15,480   $225   $(10)  $15,695 
                     
Total held-to-maturity securities  $15,480   $225   $(10)  $15,695 

 

11
 

 

At December 31, 2013, the composition of the investment portfolio was:

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Available-for-sale securities:                    
U.S. Government and agency obligations  $16,601   $35   $(130)  $16,506 
U.S. Government agency mortgage-backed securities   22,874    527    (532)   22,869 
U.S. Government agency collateralized mortgage obligations   3,736    11    (9)   3,738 
Private label collateralized mortgage obligations   258    8    -    266 
Subtotal   43,469    581    (671)   43,379 
Auction-rate trust preferred securities   5,893    -    -    5,893 
Mutual fund - Fixed Income securities   500    -    (1)   499 
                     
Total available-for-sale securities  $49,862   $581   $(672)  $49,771 

 

   Amortized   Gross Unrealized   Fair 
(In thousands)  Cost Basis   Gains   Losses   Value 
Held-to-maturity securities:                    
U.S. Government agency mortgage-backed securities  $18,149   $134   $(40)  $18,243 
                     
Total held-to-maturity securities  $18,149   $134   $(40)  $18,243 

 

12
 

 

The following is a summary of the fair values and related unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2014, and December 31, 2013:

 

At June 30, 2014  Less than 12 Months   12 Months or Greater   Total 
(Dollars in thousands)  Fair
Value
   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
U.S. Government agency obligations  $4,857   $56   $-   $-   $4,857   $56 
U.S. Government agency mortgage-backed securities   8,588    274    1,882    10    10,470    284 
U.S. Government agency collateralized mortgage obligations   -    -    -    -    -    - 
Small Business Administration securitized pool of loans   -    -    -    -    -    - 
Mutual fund - fixed income securities   -    -    -    -    -    - 
Total securities in unrealized loss position  $13,445   $330   $1,882   $10   $15,327   $340 

 

At December 31, 2013  Less than 12 Months   12 Months or Greater   Total 
(Dollars in thousands)  Fair
Value
   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
U.S. Government agency obligations  $9,865   $130   $-   $-   $9,865   $130 
U.S. Government agency mortgage-backed securities   8,075    531    65    1    8,140    532 
U.S. Government agency collateralized mortgage obligations   3,228    9    -    -    3,228    9 
Mutual fund - fixed income securities   499    1    -    -    499    1 
Total securities in unrealized loss position  $21,667   $671   $65   $1   $21,732   $672 

 

The amortized cost and fair value of securities at June 30, 2014 and December 31, 2013, by expected maturity, are set forth below. Actual maturities of mortgage-backed securities and collateralized mortgage obligations may differ from contractual maturities because the mortgages underlying the securities may be prepaid or called with or without call or prepayment penalties. Because these securities are not due at a single maturity date, the maturity information is not presented.

 

   Available-for-Sale   Held-to-Maturity 
At June 30, 2014  Amortized
Cost
   Fair Value   Amortized
Cost
   Fair Value 
   (Dollars in thousands) 
U.S. Government agency mortgage-backed securities  $26,255   $26,735   $15,480   $15,695 
U.S. Government agency collateralized mortgage obligations   8,487    8,657    -    - 
Small Business Administration securitized pool of loans   2,014    2,070    -    - 
Mutual fund - fixed income securities   500    508    -    - 
Subtotal   37,256    37,970    15,480    15,695 
Securities with Fixed Maturities:                    
Due in one year or less   -    -    -    - 
Due after one year through five years   2,954    2,983    -    - 
Due after five years through ten years   1,892    1,900    -    - 
Due after ten years   42,709    43,533    -    - 
Subtotal   47,555    48,416    -    - 
Total  $84,811   $86,386   $15,480   $15,695 

 

   Available-for-Sale   Held-to-Maturity 
At December 31, 2013  Amortized
Cost
   Fair Value   Amortized Cost   Fair Value 
   (Dollars in thousands) 
U.S. Government agency mortgage-backed securities  $22,874   $22,869   $18,149   $18,243 
U.S. Government agency collateralized mortgage obligations   3,736    3,738    -    - 
Private label collateralized mortgage obligations   258    266    -    - 
Mutual fund - fixed income securities   500    499    -    - 
Subtotal   27,368    27,372    18,149    18,243 
Securities with Fixed Maturities:                    
Due in one year or less             -    - 
Due after one year through five years   6,606    6,641    -    - 
Due after five years through ten years   9,995    9,865    -    - 
Due after ten years   5,893    5,893    -    - 
Subtotal   22,494    22,399    -    - 
Total  $49,862   $49,771   $18,149   $18,243 

 

13
 

 

As of June 30, 2014 and December 31, 2013, securities with an amortized cost of $19.31 million and $19.53 million respectively, and a fair value of $21.60 million and $19.67 million, respectively, were pledged as collateral to secure municipal deposits and repurchase agreements.

 

NOTE 4 – LOANS RECEIVABLE

 

A summary of loans receivable at June 30, 2014 and December 31, 2013 is as follows:

 

   June 30,   December 31, 
(Dollars in thousands)  2014   2013 
         
Real estate loans:          
One-to-four family  $182,031   $186,985 
Multi-family and commercial real estate   121,511    123,134 
Construction and land development   4,754    5,609 
Total real estate loans   308,296    315,728 
           
Commercial business loans   24,911    25,506 
Consumer loans:          
Home equity   28,080    26,960 
Other consumer   8,383    2,321 
Total consumer loans   36,463    29,281 
Total loans   369,670    370,515 
           
Less:          
Allowance for loan losses   7,297    9,891 
Deferred loan origination fees, net   49    56 
Loans receivable, net  $362,324   $360,568 

 

In June 2014, the Company offered for sale $11.4 million principal amount of primarily adversely classified loans (i.e. loans classified substandard or doubtful) in connection with its plan to reduce the level of classified loans. $4.9 million of commercial loans were sold in June 2014 in two separate transactions in which the financial assets transferred satisfied all of the criteria to be accounted for as sales of financial assets. The remaining loans (comprised of $2.9 million in residential mortgage loans and $3.1 million in commercial loans) were transferred to loans held for sale at June 30, 2014 because the loan sale process for these loans was in the process of completion pending final buyer due diligence in July 2014. The closing for the sale of these loans occurred in July 2014. The carrying value of these loans held for sale was based on the final bid prices which, in the aggregate, amounted to approximately $4.0 million.

 

The impact of these two sale transactions and the writedown of the carrying value of these loans held for sale amounted to $1.8 million in net charge-offs against the Company’s allowance for loan losses and $196,000 in expenses related to the sale of loans.

 

Furthermore, these transactions resulted in a $10.2 million reduction in adversely classified loans.

 

Credit quality of financing receivables

 

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

 

During the second quarter of 2013, management analyzed the risk concentration within the loan portfolio. As a result of this analysis, the loan portfolio was further disaggregated by expanding the number of loan segments from six segments to ten segments as of June 30, 2013. The commercial real estate loan segment, the second largest grouping of loans after one-to-four family owner occupied loans, was expanded into five segments to increase the granularity of analysis of the risks inherent in the loans in these segments. The expanded commercial loan segments are: investor owned one-to-four family and multi-family properties, industrial and warehouse properties, office buildings, retail properties and special use properties.

 

14
 

 

The Company’s loan portfolio is segregated as follows:

 

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

 

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

 

·Investor owned one-to-four family and multi-family properties;
   
·Industrial and warehouse properties;
   
·Office buildings;
   
·Retail properties; and
   
·Special use properties.

 

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

 

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

 

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

 

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

 

15
 

 

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

 

Credit Quality Indicators

 

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

 

The following tables are a summary of the loan portfolio credit quality indicators, by loan class, as of June 30, 2014 and December 31, 2013:

 

   Credit Risk Profile by Internally Assigned Grade: 
June 30, 2014  One-to-Four
Family
   Multi-Family
and Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business Loans
   Consumer Loans   Total 
Risk Rating:                              
Pass  $178,713   $108,039   $3,169   $20,869   $35,971   $346,761 
Special Mention   784   11,155    314    2,441    265    14,959 
Substandard:                              
- Accruing   20   1,491    -    849    42    2,402 
- Nonaccruing   2,514   826    1,271    664    185    5,460 
Subtotal - substandard   2,534    2,317    1,271    1,513    227    7,862 
Doubtful   -    -    -    88    -    88 
Total  $182,031   $121,511   $4,754   $24,911   $36,463   $369,670 
     
   Multi-Family and Commercial Real Estate 
   Credit Risk Profile by Internally Assigned Grade: 
June 30, 2014  Investor Owned
One-to-Four
family and multi-
family
   Industrial and
Warehouse
Properties
   Office Buildings   Retail Properties   Special Use
Properties
   Total Multi-Family
and Commercial
Real Estate
 
Risk Rating:                              
Pass  $16,216   $22,989   $24,058   $18,307   $26,469   $108,039 
Special Mention   2,398    3,732    2,408    471    2,146    11,155 
Substandard:                              
- Accruing   -    524    465    153    349    1,491 
- Nonaccruing   554    27    206    -    39    826 
Subtotal - substandard   554    551    671    153    388    2,317 
Doubtful   -    -    -    -    -    - 
Total  $19,168   $27,272   $27,137   $18,931   $29,003   $121,511 

 

16
 

 

   Credit Risk Profile by Internally Assigned Grade: 
December 31, 2013  One-to-Four
Family
   Multi-Family
and Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business Loans
   Consumer
Loans
   Total 
Risk Rating:                              
Pass  $180,704   $90,462   $3,102   $18,939   $28,603   $321,810 
Special Mention   500    26,832    946    3,869    262    32,409 
Substandard:                              
- Accruing   349    2,470    -    -    94    2,913 
- Nonaccruing (1)   5,432    3,370    1,561    2,605    322    13,290 
Subtotal - substandard   5,781    5,840    1,561    2,605    416    16,203 
Doubtful   -    -    -    93    -    93 
Total  $186,985   $123,134   $5,609   $25,506   $29,281   $370,515 
                               
   Multi-Family and Commercial Real Estate 
   Credit Risk Profile by Internally Assigned Grade: 
December 31, 2013  Investor Owned
One-to-Four
family and multi-
family
   Industrial and
Warehouse
Properties
   Office Buildings   Retail Properties   Special Use
Properties
   Total Multi-Family
and Commercial
Real Estate
 
Risk Rating:                              
Pass  $10,682   $21,500   $16,821   $16,250   $25,209   $90,462 
Special Mention   4,523    7,310    4,015    6,130    4,854    26,832 
Substandard:                              
- Accruing   -    1,155    370    457    488    2,470 
- Nonaccruing   1,167    31    206    683    1,283    3,370 
Subtotal - substandard   1,167    1,186    576    1,139    1,772    5,840 
Doubtful   -    -    -    -     -    - 
Total  $16,372   $29,996   $21,412   $23,520   $31,834   $123,134 

(1) Non-accrual loans included substandard nonaccruing loans and non-performing consumer loans.

 

Delinquencies

 

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

 

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

 

17
 

 

The following tables set forth certain information with respect to our loan portfolio delinquencies, by loan class, as of June 30, 2014 and December 31, 2013:

 

   Delinquencies 
As of June 30, 2014  31-60 Days
Past Due
   61-90
Days Past
Due
   Greater
Than 90
Days
   Total Past
Due
   Current   Total Loans   Carrying
Amount >
90 Days and
Accruing
 
(In thousands)                                   
Real estate loans                                   
One-to-four family  $443   $140   $1,969   $2,552   $179,479   $182,031   $- 
Construction and land development   -    -    1,101    1,101    3,653    4,754    - 
Multi-family and commercial real estate:                                 - 
Investor owned one-to-four family and multi-family   -    -    389    389    18,779    19,168    - 
Industrial and warehouse   27    -    -    27    27,245    27,272    - 
Office buildings   362    -    206    568    26,569    27,137    - 
Retail properties   -    -    -    -    18,931    18,931    - 
Special use properties   236    -    -    236    28,767    29,003    - 
Subtotal Multi-family and commercial real estate   625    -    595    1,220    120,291    121,511    - 
Commercial business loans   38    -    714    752    24,159    24,911      
Consumer loans:                                   
Home equity loans   74    107    96    277    27,803    28,080    - 
Other consumer loans   3    -    -    3    8,380    8,383    - 
Subtotal Consumer   77    107    96    280    36,183    36,463    - 
Total  $1,183   $247   $4,475   $5,905   $363,765   $369,670   $- 
     
   Delinquencies 
As of December 31, 2013  31-60 Days
Past Due
   61-90 Days
Past Due
   Greater
Than
90 Days
   Total Past
Due
   Current   Total Loans   Carrying
Amount >
90 Days and
Accruing
 
(In thousands)                            
Real estate loans                                   
One-to-four family  $1,217   $397   $2,564   $4,178   $182,807   $186,985   $- 
Construction and land development   970    538    1,799    3,307    2,302    5,609    - 
Multi-family and commercial real estate:                                 - 
Investor owned one-to-four family and multi-family   861    -    621    1,482    14,890    16,372    - 
Industrial and warehouse   -    -    32    32    29,964    29,996    - 
Office buildings   -    108    206    314    21,098    21,412    - 
Retail properties   423    -    -    424    23,096    23,520    - 
Special use properties   346    -    169    514    31,320    31,834    - 
Subtotal Multi-family and commercial real estate   1,630    108    1,028    2,766    120,368    123,134    - 
Commercial business loans   487    153    1,598    2,238    23,268    25,506    - 
Consumer loans:                                   
Home equity loans   155    28    142    325    26,635    26,960    - 
Other consumer loans   2    3    -    5    2,316    2,321    - 
Subtotal Consumer   157    31    142    330    28,951    29,281    - 
Total  $4,461   $1,227   $7,131   $12,819   $357,696   $370,515   $- 

 

Impaired loans and nonperforming assets

 

The following table sets forth certain information with respect to our nonperforming assets as of June 30, 2014 and December 31, 2013:

 

   June 30,   December 31, 
   2014   2013 
Nonperforming Assets  (Dollars in thousands) 
Nonaccrual loans  $3,528   $7,953 
TDRs nonaccruing   2,020    5,430 
Subtotal nonperforming loans   5,548    13,383 
Foreclosed real estate   536    1,846 
Total nonperforming assets  $6,084   $15,229 
           
Total nonperforming loans to total loans   1.50%   3.61%
Total nonperforming assets to total assets   1.19%   3.13%

 

18
 

 

Nonperforming loans (defined as nonaccrual loans and nonperforming TDRs) totaled $5.5 million at June 30, 2014 compared to $13.4 million at December 31, 2013, a decrease of $7.9 million. Of the loans sold in June 2014 and the loans transferred to loans held for sale at June 30, 2014 as a part of a loan sale process, there were $4.7 million in nonaccruing loans. The amount of income that was contractually due but not recognized on nonperforming loans totaled $30,000 and $149,000 for the six months ended June 30, 2014 and June 30, 2013, respectively.

 

At June 30, 2014, the Company had 36 loans on nonaccrual status of which 12 were less than 90 days past due; however, these loans were placed on nonaccrual status due to the uncertainty of their collectability. 

 

At December 31, 2013, the Company had 90 loans on nonaccrual status of which 44 were less than 90 days past due; however, these loans were placed on nonaccrual status due to the uncertainty of their collectability.

 

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

 

The following tables summarize impaired loans by portfolio segment as of June 30, 2014 and December 31, 2013:

 

As of June 30, 2014  Recorded
Investment with
No Specific
Valuation
Allowance
   Recorded
Investment with
Specific
Valuation
Allowance
   Total
Recorded
Investment
   Unpaid
Contractual
Principal
Balance
   Related Specific
Valuation
Allowance
 
   (In thousands) 
Real estate loans                         
One-to four-family  $2,566   $1,495   $4,061   $4,422   $56 
Construction and land development   978    294    1,272    1,580    21 
Multi-family and commercial real estate:                         
Investor owned one-to-four family and multi-family properties   554    -    554    572    - 
Industrial and warehouse properties   27    -    27    30    - 
Office buildings   205    -    205    405    - 
Retail properties   -    -    -    -    - 
Special use properties   39    -    39    52   - 
Subtotal   825    -    825    1,059    - 
Commercial business loans   833    287    1,120    1,181    88 
Consumer loans   234    163    397    426    10 
Total impaired loans  $5,436   $2,239   $7,675   $8,668   $175 

 

19
 

 

As of December 31, 2013  Recorded
Investment with
No Specific
Valuation
Allowance
   Recorded
Investment with
Specific
Valuation
Allowance
   Total
Recorded
Investment
   Unpaid
Contractual
Principal Balance
   Related Specific
Valuation
Allowance
 
   (In thousands) 
Real estate loans                         
One-to four-family  $4,570   $2,431   $7,001   $7,734   $70 
Construction and land development   1,405    449    1,854    2,424    75 
Multi-family and commercial real estate:                         
Investor owned one-to-four family and multi-family properties   1,167    -    1,167    1,274    - 
Industrial and warehouse properties   565    -    565    567    - 
Office buildings   206    -    206    405    - 
Retail properties   158    389    547    621    23 
Special use properties   1,600    -    1,600    2,086    - 
Subtotal   3,696    389    4,085    4,953    23 
Commercial business loans   1,996    584    2,580    2,693    105 
Consumer loans   412    167    579    805    10 
Total impaired loans  $12,079   $4,020   $16,099   $18,609   $283 

 

In the above table, the unpaid contractual principal balance represents the aggregate amounts legally owed to the Bank under the terms of the borrowers’ loan agreements. The recorded investment amounts shown above represent the unpaid contractual principal balance owed to the Bank less any amounts charged off based on collectability assessments by the Bank and less any amounts paid by borrowers on nonaccrual loans which were recognized as principal curtailments.

 

The following table relates to interest income recognized by segment of impaired loans for the six months ended June 30, 2014 and 2013:

   Six Months Ended June 30, 
   2014   2013 
   Average
Recorded
Investments
   Interest Income
Recognized
   Average
Recorded
Investments
   Interest Income
Recognized
 
Real estate loans  (In thousands) 
One-to four-family  $5,951   $175   $6,143   $63 
Construction   1,567    7    6,124    20 
Multi-family and commercial real estate   2,594    90    2,913    15 
Commercial business loans   1,661    40    2,826    42 
Consumer loans   492    8    555    9 
Total  $12,265   $320   $18,561   $149 

 

Interest payments received on nonaccrual loans are accounted for on the cash-basis method or the cost recovery method until qualifying for return to accrual status. The table above shows the interest income recognized on nonaccrual loans on the cash-basis method. Under the cost recovery method, the interest payment is applied to the principal balance of the loan. For the six month periods ended June 30, 2014 and 2013, the amount of interest payments applied to principal under the cost recovery method was $30,000 and $210,000, respectively.

 

Troubled Debt Restructured Loans

 

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

 

20
 

 

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

 

The recorded investment balance of performing and nonperforming TDRs as of June 30, 2014 and December 31, 2013 are as follows:

 

(In thousands)  As of 
June 30, 2014
   As of 
December 31, 2013
 
Aggregate recorded investment of impaired loans performing under terms modified through a troubled debt restructuring:          
Performing (1)  $2,576   $4,195 
Nonperforming (2)   1,467    3,051 
Total  $4,043   $7,246 

 

(1)Of the $2,576,000 in TDRs which were performing under the modified terms of their agreements at June 30, 2014, there were $594,000 in TDRs that remain on nonaccrual status because these TDRs have not yet demonstrated the requisite period of sustained performance. The combination of the $594,000 performing TDRs and the $1,426,000 nonperforming TDRs on nonaccrual status at June 30, 2014 equal the $2,020,000 in TDRs that were on nonaccrual status at June 30, 2014.

 

Of the $4,195,000 in TDRs which were performing under the modified terms of their agreements at December 31, 2013, there were $2,379,000 in TDRs that remain on nonaccrual status because these TDRs have not yet demonstrated the requisite period of sustained performance. The combination of the $2,379,000 in performing TDRs and the $3,051,000 nonperforming TDRs at December 31, 2013 equal the $5,430,000 in TDRs that were on nonaccrual status at December 31, 2013.

 

(2)Of the $1,467,000 in TDRs that were not performing under the modified terms of their agreements at June 30, 2014, all of these loans, except for one loan in the amount of $41,000, were on a nonaccrual status.

 

Of the $3,051,000 in TDRs that were not performing under the modified terms of their agreements at December 31, 2013, all of these loans were on nonaccrual status.

 

As illustrated in the table below, during the six months ended June 30, 2014, the following concessions were made on seven loans totaling $511,000 (measured as a percentage of loan balances on TDRs):

 

·Deferral of principal payments for 68.1% (2 loans for $348,000);
·Reduced interest rate for 12.7% (4 loans for $65,000); and
·Extension of payment terms for 19.2% (1 loan for $98,000).

 

21
 

 

The following tables present a breakdown of the type of concessions made by loan class during the six months ended June 30, 2014 and June 30, 2013:

 

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

 

   For the Six Months Ended June 30, 2013 
(Dollars in thousands)  Number
of Loans
   Pre-
Modification
Recorded
Investment
   Post-
Modification
Recorded
Investment
   % 
Below market interest rate:                    
Real estate loans:                    
One-to-four family   1   $51   $51    3.9%
                     
Extended payment terms:                    
Real estate loans:                    
One-to-four family   1    19    25    1.9%
                     
Commercial real estate loans   3    546    594    45.4%
                     
Commercial business loans   5   $394   $406    31.0%
                     
Subtotal   9    959    1,025    78.4%
                     
Principal payments deferred                    
Commercial business loans   2    232    232    17.7%
                     
Grand totals   12   $1,242   $1,308    100.0%

 

22
 

 

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

 

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

 

There were no TDRs that had been modified during the previous twelve months ended June 30, 2014 that subsequently defaulted or were charged off during the three months ended June 30, 2014.

 

Allowance for Loan Losses

 

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

 

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

 

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

 

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

 

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

 

The ALLL balance decreased from $9.89 million at December 31, 2013 to $7.30 million at June 30, 2014, a decrease of $2.59 million, or 26.2%. The decrease was primarily the result of net chargeoffs of $1.8 million and a $739,000 credit provision for loan losses in the second quarter of 2014. The decrease in the ALLL was consistent with the improvement in the Bank’s asset quality trends during this six month period. The Bank’s nonperforming loans decreased $5.0 million, or 48%, and $7.8 million, or 58%, for the three and six months ended June 30, 2014, respectively. The Bank’s adversely classified loans decreased $11.0 million, or 58% and $8.3 million, or 51%, for the three and six months ended June 30, 2014, respectively, primarily attributable to the more aggressive workout efforts in the three month period ended June 30, 2014. This improvement in adversely classified loans was a continuation of a trend initiated in mid-year 2013 as well as the sale of $10.2 million in adversely classified loans in June 2014.

 

23
 

 

As previously discussed in the Company’s Form 10-K for the year ended December 31, 2013, the Company adopted significant changes to its ALLL methodology as of June 30, 2013, including:

 

·Adoption of a two year weighted average as a basis for the calculation of its historical loss experience;
   
·Further disaggregated the commercial real estate loan segment to increase the granularity of the risks inherent in the loans in the expanded segments; and
   
·Changes in the utilization of qualitative risk adjustment factors (“Q factors”) including an increased number of these Q factors and a change in the calibration and application of the Q factors.

 

The Company also believes it has significantly improved its risk grades (and its risk grading process) over the past year during which the new executive management team has been in place at the Bank. The improvement in the Company’s asset quality metrics has been the result of increased workout efforts and the sales of adversely classified loans in June 2013 and in June 2014.

 

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

 

The following tables set forth the balance of and transactions in the allowance for loan losses at June 30, 2014, December 31, 2013 and June 30, 2013, by portfolio segment, disaggregated by impairment methodology, which is then further segregated by loans evaluated for impairment individually and collectively.

 

   One-to-Four Family   Multi-Family and Commercial Real Estate   Construction and Land Development   Commercial Business Loans   Consumer Loans   Total 
As of and for the Six Months                        
Ended June 30, 2014                        
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $1,849   $5,097   $1,118   $1,443   $384   $9,891 
Provision for loan losses   306    51    (117)   (845)   (134)  (739)
Charge-offs   (541)   (1,306)   (148)   (74)   (13)  (2,082)
Recoveries   10    19    16    96    86    227 
Balance at June 30, 2014  $1,624   $3,861   $869   $620   $323   $7,297 
Allowance related to loans:                              
Individually evaluated for impairment  $56   $-   $21   $88   $10   $175 
Collectively evaluated for impairment   1,568    3,861    848    532    313    7,122 
   $1,624   $3,861   $869   $620   $323   $7,297 
                               
Ending loan balance individually evaluated for impairment  $4,061   $825   $1,272   $1,120   $397   $7,675 
Ending loan balance collectively evaluated for impairment   177,970    120,686    3,482    23,791    36,066    361,995 
Total Loans  $182,031   $121,511   $4,754   $24,911   $36,463   $369,670 

 

24
 

 

 

   Multi-Family and Commercial Real Estate 
As of and for the Six Months  Investor one-to-four family and multi-family   Industrial and Warehouse Properties   Office Buildings   Retail Properties   Special Use Properties   Total Multi-Family and Commercial Real Estate 
Ended June 30, 2014                        
(In thousands)                              
Allowance for loan losses:                              
Beginning balance  $515   $1,034   $563   $856   $2,129   $5,097 
Provision for loan losses   96    (64)   (92)   243    (132)   51 
Charge-offs   (166)   (234)   -    (491)   (415)   (1,306)
Recoveries   -    -    -    -    19    19 
Balance at June 30, 2014  $445   $736   $471   $608   $1,601   $3,861 
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $-   $-   $- 
Collectively evaluated for impairment  $445   $736   $471   $608   $1,601   $3,861 
                               
Ending loan balance individually evaluated for impairment $554   $27   $205   $-   $39   $825 
Ending loan balance collectively evaluated for impairment  18,614    27,245    26,932    18,931    28,964    120,686 
Total loans  $19,168   $27,272   $27,137   $18,931   $29,003   $121,511 

                        
As of and for the Six Months  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business
Loans
   Consumer
Loans
   Total 
Ended June 30, 2013                        
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $1,988   $4,892   $4,468   $2,725   $427   $14,500 
Provision for loan losses   (423)   3,689    (277)   883    (22)   3,850 
Charge-offs   (496)   (4,351)   (1,984)   (1,796)   (44)   (8,671)
Recoveries   -    590    102    374    1    1,067 
Ending balance  $1,069   $4,820   $2,309   $2,186   $362   $10,746 
Allowance related to loans:                              
Individually evaluated for impairment  $75   $138   $629   $681   $32   $1,555 
Collectively evaluated for impairment  $994   $4,682   $1,680   $1,505   $330   $9,191 
                               
Ending loan balance individually evaluated for impairment  $6,092   $2,884   $5,622   $2,803   $550   $17,951 
Ending loan balance collectively evaluated for impairment   199,593    126,905    5,678    25,204    26,795    384,175 
Total loans  $205,685   $129,789   $11,300   $28,007   $27,345   $402,126 
     
   Multi-Family and Commercial Real Estate 
As of and for the Six Months  Investor one-
to-four 
family and
multi-family
   Industrial and
Warehouse
Properties
   Office
Buildings
   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial
Real Estate
 
Ended June 30, 2013                        
(In thousands)                        
Allowance for loan losses:                              
Beginning balance  $-   $-   $-   $-   $-   $4,892 
Provision for loan losses   -    -    -    -    -    3,689 
Charge-offs   -    -    -    -    -    (4,351)
Recoveries   -    -    -    -    -    590 
Ending Balance                            4,820 
Redistributed through segment expansion   526    818    421    519    2,536    4,820 
Segment Ending Balance  $526   $818   $421   $519   $2,536   $4,820 
Allowance related to loans:                              
Individually evaluated for impairment  $18   $-   $82   $-   $38   $138 
Collectively evaluated for impairment  $508   $818   $339   $519   $2,498   $4,682 
                               
Ending loan balance individually evaluated for impairment  $1,198   $156   $356   $-   $1,174   $2,884 
Ending loan balance collectively evaluated for impairment   16,109    33,449    23,039    21,792    32,516    126,905 
Total loans  $17,307   $33,605   $23,395   $21,792   $33,690   $129,789 

 

25
 

 

As of December 31, 2013  One-to-Four
Family
   Multi-Family
and
Commercial
Real Estate
   Construction
and Land
Development
   Commercial
Business
Loans
   Consumer
Loans
   Total 
(In thousands)                              
Allowance related to loans:                              
Individually evaluated for impairment  $70   $23   $75   $105   $10   $283 
Collectively evaluated for impairment   1,779    5,074    1,043    1,338    374    9,608 
Total allowance  $1,849   $5,097   $1,118   $1,443   $384   $9,891 
                               
Ending loan balance individually evaluated for impairment  $7,001   $4,085   $1,854   $2,580   $579   $16,099 
Ending loan balance collectively evaluated for impairment   179,984    119,049    3,755    22,926    28,702    354,416 
Total loans  $186,985   $123,134   $5,609   $25,506   $29,281   $370,515 

 

   Multi-Family and Commercial Real Estate 
As of December 31, 2013  Investor one-
to-four
family and
multi-family
   Industrial and
Warehouse
Properties
   Office
Buildings
   Retail
Properties
   Special Use
Properties
   Total Multi-
Family and
Commercial
Real Estate
 
(In thousands)                              
Allowance related to loans:                              
Individually evaluated for impairment  $-   $-   $-   $23   $-   $23 
Collectively evaluated for impairment   515    1,034    563    833    2,129    5,074 
Total allowance  $515   $1,034   $563   $856   $2,129   $5,097 
                               
Ending loan balance individually evaluated for impairment  $1,167   $565   $206   $547   $1,600   $4,085 
Ending loan balance collectively evaluated for impairment   15,205    29,431    21,206    22,973    30,234    119,049 
Total loans  $16,372   $29,996   $21,412   $23,520   $31,834   $123,134 

 

The allowance for loan losses allocated to each portfolio segment is not necessarily indicative of future losses in any particular portfolio segment and does not restrict the use of the allowance to absorb losses in other portfolio segments. Our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. The examination may require us to make additional provisions for loan losses based on judgments different from ours. The Company also periodically engages an independent consultant to review our credit risk grading process and the risk grades on selected portfolio segments as well as the methodology, analysis and adequacy of the allowance for loan and lease losses.

 

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

 

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NOTE 5 - MORTGAGE BANKING ACTIVITY

 

Mortgage banking includes two components: (1) the origination of residential mortgage loans for sale in the secondary market and (2) the servicing of mortgage loans sold to investors. The following represents the Company’s noninterest income derived from these activities:

 

   For the Three Months 
Ended June 30,
   For the Six Months 
Ended June 30,
 
(In Thousands)  2014   2013   2014   2013 
Gain on sales of loans  $142   $308   $271   $728 
Mortgage servicing income   (2)   85    5    167 
Total   $140   $393   $276   $895 

 

The Bank originates government sponsored residential mortgage loans which are sold servicing released. The Bank also originates conventional residential mortgage loans for its portfolio and for sale, both on a servicing rights retained and released basis. The significant decline in the Bank’s mortgage servicing income for the three and six month periods in 2014 compared with the same periods in 2013 was the result of the Bank selling most of its loans on the secondary market on a servicing released basis such that the amortization of the existing mortgage servicing rights significantly exceeded the value of the newly capitalized mortgage servicing rights.

 

NOTE 6 – FORECLOSED REAL ESTATE

 

Changes in foreclosed real estate during the three and six months ended June 30, 2014 and June 30, 2013 are as follows:

  

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
(In thousands)  2014   2013   2014   2013 
Beginning balance  $1,114   $498   $1,846   $735 
Additions   53    251    391    251 
Proceeds from dispositions   (625)   (441)   (1,604)   (627)
Gain (loss) on sales   5    (25)   (59)   (65)
Writedowns   (11)   (49)   (38)   (60)
Balance at end of period  $536   $234   $536   $234 

  

At June 30, 2014, the Bank held five properties consisting of four single family residences and one unimproved parcel zoned as residential.

 

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

  

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NOTE 7 – DEPOSITS

 

A summary of deposits at June 30, 2014 and December 31, 2013 consisted of the following:

 

   June 30, 2014   December 31, 2013 
(In thousands)  Amount   Percent   Amount   Percent 
Noninterest bearing demand deposits  $66,441    17.3%  $69,147    17.7%
Interest bearing deposits                    
Now accounts and money market accounts   53,951    14.0%   49,514    12.7%
Savings accounts   113,257    29.3%   117,004    29.9%
Certificates of deposit   152,331    39.4%   155,182    39.7%
Total interest bearing deposits   319,539    82.7%   321,700    82.3%
Total deposits  $385,980    100.0%  $390,847    100.0%

 

Scheduled maturities of certificates of deposit are as follows:

 

(In thousands)  At June 30, 2014   At December 31, 2013 
Through twelve months  $71,110   $74,268 
Twelve months through three years   54,982    50,858 
Over three years   26,239    30,056 
   $152,331   $155,182 

 

The aggregate amount of individual certificate of deposit accounts of $100,000 or more at June 30, 2014 and December 31, 2013 was $62.4 million and $62.5 million, respectively. Deposits up to $250,000 are federally insured through the Federal Deposit Insurance Corporation (“FDIC”). The aggregate amount of individual certificate of deposit accounts of $250,000 or more at June 30, 2014 and December 31, 2013 was $13.1 million and $11.5 million, respectively.

 

NOTE 8 – FHLB ADVANCES

 

The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). At June 30, 2014, the Bank had the ability to borrow from the FHLB based on a certain percentage of the value of the Bank’s qualified collateral, as defined in the FHLB Statement of Products Policy, at the time of the borrowing. In accordance with an agreement with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances.

 

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

 

   At June 30, 2014   At December 31, 2013 
(In thousands)  Amount
Due
   Weighted
Average
Cost
   Amount
Due
   Weighted
Average
Cost
 
Year of maturity: (1)                
2014  $10,385    0.59%  $1,377    2.64%
2015   5,528    0.67%   1,500    0.80%
2016   13,717    0.85%   2,800    0.90%
2017 - 2021   23,330    2.23%   18,368    2.56%
2022 - 2026   606    0.27%   638    0.27%
2027 - 2029   598    -    610    - 
                     
Total FHLB advances  $54,164    1.36%  $25,293    2.16%

 

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

 

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

 

NOTE 9 – OTHER BORROWED FUNDS

 

The Bank utilizes securities sold under agreements to repurchase to accommodate its customers’ needs to invest funds short term and as a source of borrowings.

 

The following table presents certain information regarding our repurchase agreements during the year to date periods or at the dates indicated.

 

   At or for the year to date period ended 
(Dollars in thousands)  June 30, 2014   December 31, 2013 
         
Maximum amount of advances outstanding during the period  $8,355   $21,256 
           
Average advances outstanding during the period  $6,031   $10,866 
           
Weighted average interest rate during the period   0.01%   0.24%
           
Balance outstanding at end of period  $3,967   $4,173 
           
Weighted average interest rate at end of period   0.01%   0.01%

 

The Bank maintains a credit facility with the Federal Reserve Bank of Boston for which certain assets are pledged to secure such borrowings. As of June 30, 2014 and December 31, 2013, there were no borrowings outstanding under this facility. In addition, the Federal Reserve Bank of Boston, as one of the Bank’s correspondent banks, requires the Bank to pledge at least $1 million in loans and/or investment securities for potential daylight overdraft exposure. At June 30, 2014 and December 31, 2013, the Bank had $7.6 million and $3.4 million, respectively, in commercial real estate loans pledged with the Federal Reserve Bank of Boston.

 

At June 30, 2014, the Bank had reserve requirements with the Federal Reserve Bank of Boston amounting to $3.2 million. In addition to the Bank’s $2.2 million in vault cash, the use of $0.6 million in balances held at the Federal Reserve Bank of Boston was restricted to meet these reserve requirements.

 

NOTE 10 – STOCKHOLDERS’ EQUITY

 

Income (Loss) Per Share

 

Basic net income (loss) per common share is calculated by dividing the net income (loss) available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed in a manner similar to basic net income (loss) per common share except that the weighted-average number of common shares outstanding is increased to include the incremental common shares (as computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents were issued during the period. The Company’s common stock equivalents relate solely to stock option and restricted stock awards. Anti-dilutive shares are common stock equivalents with weighted-average exercise prices in excess of the weighted-average market value for the periods presented. For the three and six months ended June 30, 2014, anti-dilutive options excluded from the calculations totaled 105,787 options (with an exercise price of $11.12 per share), and 4,290 options (with an exercise price of $12.51 per share). For the three and six months ended June 30, 2013, anti-dilutive options excluded from the calculations totaled 229,723 options (with an exercise price of $11.12 per share) and 4,290 options (with an exercise price of $12.51 per share), respectively. Unreleased common shares held by the ESOP are not included in the weighted-average number of common shares outstanding for purposes of calculating either basic or diluted net income per common share.

 

29
 

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(In thousands except for per share data)  2014   2013   2014   2013 
            
Net income (loss)   $94   $(4,799)  $(715)  $(5,390)
                     
Weighted-average common shares outstanding:                    
Basic   6,675,457    6,643,093    6,675,457    6,643,093 
Diluted   6,676,391    6,643,093    6,675,457    6,643,093 
                     
Earnings (loss) per common share:                    
Basic  $0.01   $(0.72)  $(0.11)  $(0.81)
Diluted  $0.01   $(0.72)  $(0.11)  $(0.81)

 

Dividends

 

The ability of the Company to pay dividends depends, in part, on the ability of the Bank to pay dividends to the Company. Due to current regulatory restrictions, the Company is not allowed to pay dividends to the Company’s shareholders and the Bank is not allowed to pay dividends to the Company.

 

NOTE 11 – STOCK BASED COMPENSATION

 

Stock options generally vest over five years and expire ten years after the date of the grant. The vesting schedule for stock options is 20% annually for years one through five. Restricted stock vests ratably over five years.

 

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

 

A summary of the status of outstanding stock options at June 30, 2014 and changes therein was as follows:

 

   2014 
   Number of Shares   Weighted Average
Exercise Price
 
Options outstanding at the beginning of year   119,786   $11.18 
Granted   110,000    7.74 
Forfeited   (13,299)   11.12 
Exercised   -    - 
Expired   -   - 
Options outstanding at June 30, 2014   216,487   $9.43 
           
Options exercisable at June 30, 2014   106,487   $11.18 
           
Weighted-average fair value of options granted during the year       $2.55 

  

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

 

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

 

           Weighted Average 
           Remaining 
   Outstanding as of       Contractual Life 
  June 30, 2014   Exercise Price   (in years) 
Exercise prices for outstanding options   102,197   $11.12    1.1 
    4,890   $12.51    1.8 
    110,000   $7.74    9.9 
Total   216,487           

 

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

 

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

 

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

 

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

 

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

 

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

 

The Company recorded stock-based compensation expense of $1,984 for the three and six months ended June 30, 2014. At June 30, 2014 the Company has unrecognized option expense of $279,000 to be recognized over the remaining vesting period of the options.

 

30
 

 

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

 

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

 

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

 

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

 

Financial instruments whose contractual amounts represent credit risk at June 30, 2014 and December 31, 2013 were as follows:

 

   June 30,   December 31, 
(In thousands)  2014   2013 
Commitments to extend credit:          
Commercial real estate loan commitments  $19,256   $12,572 
Unused home equity lines of credit   18,909    19,169 
Commercial and industrial loan commitments   9,329    10,153 
Amounts due on other commitments   10,416    6,618 
Commercial letters of credit   1,132    1,371 

  

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

 

NOTE 13 – FAIR VALUE

 

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

 

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

 

Available for sale and held to maturity securitiesWhere quoted prices are available in an active market, the securities are classified within Level 1 of the valuation hierarchy. Examples of such instruments include mutual funds. If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) or quoted prices of securities with similar characteristics and the securities are classified within Level 2 of the valuation hierarchy. Examples of such instruments include U.S. government agency bonds, U.S. government agency mortgage-backed securities and private label collateralized mortgage obligations. The auction rate trust preferred securities (“ARPs”) that were held as of December 31, 2013 were identified as “impermissible” investments under Volcker rule interpretations by the OCC and as such, the Company liquidated these securities in February 2014. Based on management’s assessment as of December 31, 2013 that the ARPs market is not an active one and to liquidate these securities would require a “forced redemption” from the trust to request delivery of the underlying preferred stock collateral for sale, the Company calculated the fair value (and the determination of the OTTI) on these securities at December 31, 2013 utilizing the current market prices of the underlying preferred stock and classified these investments as a Level 2 in the fair value hierarchy. Securities classified within Level 3 of the valuation hierarchy are securities for which significant unobservable inputs are utilized. Available for sale securities are recorded at fair value on a recurring basis and held to maturity securities are only disclosed at fair value.

 

31
 

 

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

 

In June 2014, the Company offered for sale $11.4 million principal amount of primarily adversely classified loans (i.e. loans classified substandard or doubtful) in connection with its plan to reduce the level of classified loans. $4.9 million in commercial loans were sold in June 2014 in two separate transactions in which the financial assets transferred satisfied all of the criteria to be accounted for as sales of financial assets. The remaining loans (comprised of $2.9 million in residential mortgage loans and $3.1 million in commercial loans) were transferred to loans held for sale at June 30, 2014 because the loan sale process for these loans was in the process of completion pending final buyer due diligence in July 2014. The carrying value of these loans held for sale was based on the final bid prices which, in the aggregate, amounted to approximately $4.0 million.

 

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

 

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

 

Mortgage servicing assetsThe fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The Company does not record these assets at fair value on a recurring basis. Servicing assets are classified as Level 2 within the fair value hierarchy.

 

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

 

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

 

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

 

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

  

Accrued interest payable—The carrying amounts approximates fair value. The Co