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EX-10.10 - EXHIBIT 10.10 - Wellesley Bancorp, Inc.tm205297d1_ex10-10.htm
EX-32.1 - EXHIBIT 32.1 - Wellesley Bancorp, Inc.tm205297d1_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Wellesley Bancorp, Inc.tm205297d1_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Wellesley Bancorp, Inc.tm205297d1_ex31-1.htm
EX-23.1 - EXHIBIT 23.1 - Wellesley Bancorp, Inc.tm205297d1_ex23-1.htm
EX-21.1 - EXHIBIT 21.1 - Wellesley Bancorp, Inc.tm205297d1_ex21-1.htm
EX-4.2 - EXHIBIT 4.2 - Wellesley Bancorp, Inc.tm205297d1_ex4-2.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-K

 

(Mark One)

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

 

  for the fiscal year ended December 31, 2019

OR

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

 

  For the transition period from _________ to _________

 

Commission file number: 001-35352

 

WELLESLEY BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Maryland   45-3219901

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

     
100 Worcester Street, Suite 300, Wellesley, Massachusetts   02481
(Address of principal executive offices)   (Zip Code)

 

Issuer’s telephone number, including area code: (781) 235-2550

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, par value $0.01 per share WEBK The NASDAQ Stock Market LLC

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ¨ No x

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

 

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

 

  Large accelerated filer           ¨ Accelerated filer      ¨
  Non-accelerated filer             x Smaller reporting company      x
    Emerging growth company   ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

The aggregate market value of the common stock held by non-affiliates as of June 30, 2019 was $64,061,367, based on a closing price of $32.61.

 

As of March 15, 2020, the registrant had 2,599,845 shares of its common stock outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

 

 

 

 

INDEX

 

      PAGE 
PART I        
Item 1.  Business   1 
Item 1A.  Risk Factors   17 
Item 1B.  Unresolved Staff Comments   25 
Item 2.  Properties   25 
Item 3.  Legal Proceedings   26 
Item 4.  Mine Safety Disclosures   26 
         
PART II        
Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   27 
Item 6.  Selected Financial Data   28 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations   30 
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk   48 
Item 8.  Financial Statements and Supplementary Data   48 
Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure   48 
Item 9A.  Controls and Procedures   48 
Item 9B.  Other Information   49 
         
PART III        
Item 10.  Directors, Executive Officers and Corporate Governance   49 
Item 11.  Executive Compensation   52 
Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   56 
Item 13.  Certain Relationships and Related Transactions, and Director Independence   59 
Item 14.  Principal Accountant Fees and Services   61 
         
PART IV        
Item 15.  Exhibits and Financial Statement Schedules   62 
Item 16.  Form 10-K Summary   63 
         
SIGNATURES      64 

 

 i

 

 

Forward-Looking Statements

 

When used in this Annual Report on Form 10-K, the words or phrases “will likely result,” “are expected to,” “will continue,” ”intends,” ”believes,” “is anticipated,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company’s market area, changes in policies by regulatory agencies, changes in legislation or accounting policies, fluctuations in interest rates, demand for loans in the Company’s market area, competition and information provided by third-party vendors and the matters described herein under “Item 1A. Risk Factors” that could cause actual results to differ materially from historical results and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

 

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors that could affect actual results include, but are not limited to, our ability to complete our previously announced business combination with Cambridge Bancorp, interest rate trends, the general economic climate in our market area, as well as nationwide, the outbreak of the coronavirus or other highly infectious or contagious diseases, our ability to control costs and expenses, competitive products and pricing, loan delinquency rates and changes in federal and state legislation and regulation and tax laws. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Wellesley Bancorp, Inc. assumes no obligation to update any forward-looking statements.

 

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

 

PART I

Item 1. Business

 

General

 

Wellesley Bancorp, Inc. Wellesley Bancorp, Inc. (the “Company” or “Wellesley Bancorp”) was incorporated in September 2011 to be the holding company for Wellesley Bank (the “Bank”) following the Bank’s conversion (the “Conversion”) from the mutual to stock form of ownership. On January 25, 2012, the Conversion was completed and the Bank became the wholly-owned subsidiary of the Company. Also on that date, the Company sold and issued 2,407,151 shares of its common stock at a price of $10.00 per share, through which the Company received net offering proceeds of $21.2 million. The Company’s principal business activity is the ownership of the outstanding shares of common stock of the Bank. The Company does not own or lease any property, but instead uses the premises, equipment and other property of the Bank, with the payment of appropriate rental fees, as required by applicable laws and regulations, under the terms of an expense allocation agreement entered into with the Bank.

 

Wellesley Bank. Founded in 1911, Wellesley Bank is a Massachusetts chartered cooperative bank headquartered in Wellesley, Massachusetts. We operate as a community-oriented financial institution offering traditional financial services to consumers and businesses in our primary market areas of Wellesley, Newton, Needham, Cambridge, Boston and the surrounding communities. We attract deposits from the general public and use those funds to originate residential mortgage loans, commercial real estate loans and construction loans, commercial business loans, and, to a lesser extent, home equity lines of credit and other consumer loans. We conduct our lending and deposit activities primarily with individuals and small businesses in our primary market areas. In addition, we also provide investment management services for high net worth individuals, families, businesses, private partnerships, nonprofit organizations, foundations and trusts through our wholly-owned subsidiary, Wellesley Investment Partners, LLC, (“Wellesley Investment Partners”) a registered investment advisor.

 

The Bank’s and the Company’s executive offices are located at 100 Worcester Street, Suite 300, Wellesley, Massachusetts 02481 and its telephone number is (781) 235-2550.

 

Our website address is www.wellesleybank.com. Information on our website should not be considered a part of this document.

 

1

 

 

Wellesley Bank Charitable Foundation. In connection with the Conversion, the Company established the Wellesley Bank Charitable Foundation (the “Foundation”) through the contribution of $225 thousand in cash and 157,477 shares of common stock. The total contribution expense recognized by the Company in 2012 was $1.8 million pre-tax ($1.1 million after tax). The Foundation makes grants and donations to support charitable purposes within the communities served, currently or in the future, by the Company.

 

Pending Merger with Cambridge Bancorp

 

On December 5, 2019, Cambridge Bancorp (“Cambridge”) and the Company issued a joint press release announcing that Cambridge and the Company have entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which the Company will merge with and into Cambridge, with Cambridge as the surviving entity (the “Merger”).  Under the terms of the Merger Agreement, which has been approved by the boards of directors and stockholders of both companies, stockholders of the Company will receive 0.580 shares of Cambridge common stock for each share of Wellesley common stock.  The transaction is subject to customary closing conditions and is expected to close during the second quarter of 2020.

 

Market Area

 

We conduct our operations from our executive office and six full-service branch offices located in Wellesley, Newton, Needham, and Boston. Our primary lending market is defined by our Community Reinvestment Act assessment area, and generally includes the communities of the greater Boston area. Due to our locations in and around Boston, our primary market area benefits from the presence of numerous institutions of higher learning, medical care and research centers and the corporate headquarters of several investment and financial services companies. The greater Boston metropolitan area also has many life science and high technology companies employing personnel with specialized skills. These factors affect the economic vitality of the region and impact the demand for residential homes, residential construction, office buildings, shopping centers, and other commercial properties in our market area.

 

Our market area is located largely in the Boston-Cambridge-Quincy, Massachusetts/New Hampshire Metropolitan Statistical Area. Based on the 2010 United States census, the Boston metropolitan area is the 10th largest metropolitan area in the United States. Located adjacent to major transportation corridors, the Boston metropolitan area provides a highly diversified economic base, with major employment sectors ranging from services, manufacturing and wholesale/retail trade, to finance, technology and medical care.

 

Competition

 

We face significant competition for deposits and loans. Our most direct competition for deposits has historically come from the financial institutions operating in our primary market area and from other financial service companies such as securities brokerage firms, credit unions and insurance companies. We also face competition for investors’ funds from money market funds and mutual funds. At June 30, 2019, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation (“FDIC”), we held 1.9% of the deposits in Norfolk County, which was the 14th largest market share among the 42 financial institutions with offices in Norfolk County. At June 30, 2019, we also held 13.7% of the deposits in the town of Wellesley, which was the third largest market share among the 14 financial institutions with offices in Wellesley. Some of the banks owned by large national and regional holding companies and other community-based banks that also operate in our primary market area are larger than we are and, therefore, may have greater resources or offer a broader range of products and services.

 

Our competition for loans comes from financial institutions, including credit unions, in our primary market area and from other financial service providers, such as mortgage companies and mortgage brokers. Competition for loans also comes from nondepository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies.

 

We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend toward consolidation within the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the internet, and made it possible for nondepository institutions to offer products and services that traditionally have been provided by banks. Competition for gathering deposits and originating loans could limit our growth in the future.

 

2

 

 

Lending Activities

 

Residential Mortgage Loans. The largest segment of our loan portfolio is residential mortgage loans, which enable borrowers to purchase or refinance existing homes, most of which serve as the primary residence of the owner. At December 31, 2019, residential mortgage loans were $388.3 million, or 46.1%, of our total loan portfolio, consisting of $77.7 million and $310.6 million of fixed-rate and adjustable-rate loans, respectively. We offer fixed-rate and adjustable-rate residential mortgage loans with terms up to 30 years. Generally, our fixed-rate loans conform to Fannie Mae and Freddie Mac underwriting guidelines and are originated with the intention to sell. Our adjustable-rate mortgage loans generally adjust either every year or every three years after an initial fixed period that ranges from three to ten years. Interest rates and payments on our adjustable-rate loans generally are adjusted to a rate equal to a specified percentage above a representative U.S. Treasury index. Depending on the loan type, the maximum amount by which the interest rate may increase or decrease is generally 2% per adjustment period and the lifetime interest rate caps range from 5% to 6% over the initial interest rate of the loan.

 

Borrower demand for adjustable-rate loans, as compared to fixed-rate loans, is a function of the level of interest rates, the expectations of changes in the level of interest rates, the ability of borrowers to qualify for longer-term fixed-rate loans under regulatory guidelines, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans as compared to the interest rates and loan fees for adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment. The loan fees, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria, competitive market conditions and regulatory requirements.

 

While residential mortgage loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans. Additionally, our current practice is generally to (1) sell to the secondary market newly originated 15 year or longer-term conforming fixed-rate residential mortgage loans, and (2) to hold in our portfolio non-conforming loans, shorter-term fixed-rate loans and adjustable-rate loans. Generally, conforming fixed-rate loans are sold to third parties with servicing released, although we have sold residential loans with servicing retained under certain conditions. Wellesley Bank’s portfolio lending generally consists of conforming and non-conforming adjustable-rate loans for owner-occupied and investor properties with loan-to-value ratios of up to 80%. Mortgage amortizations range from 15 to 30 years. We do not originate “interest only” mortgage loans on one-to-four family residential properties nor do we offer loans that provide for negative amortization of principal such as “option ARM” loans where the borrower can pay less than the interest owed on their loan. Additionally, we generally do not offer “subprime loans” (loans that are made with low down payments to borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments or bankruptcies, or borrowers with questionable repayment capacity) or “Alt-A” loans (loans to borrowers having less than full documentation).

 

We will make loans with loan-to-value ratios up to 90% (occasionally to 95% for first time home buyers and other qualified borrowers on an exception basis); however, we generally require private mortgage insurance for loans with a loan-to-value ratio over 80%. We require all properties securing mortgage loans in excess of $250 thousand to be appraised by a licensed real estate appraiser. We generally require title insurance on all first mortgage loans. Exceptions to these lending policies are based on an evaluation of credit risk related to the borrower and the size of the loan. Borrowers must obtain hazard insurance, and flood insurance is required for loans on properties located in a flood zone.

 

In an effort to provide financing for first-time buyers, we offer adjustable-rate and fixed-rate loan programs. We offer mortgage loans through this program to qualified individuals and originate the loans using modified underwriting guidelines, modified loan conditions and reduced closing costs.

 

Commercial Real Estate Loans. We also offer fixed-rate and adjustable-rate mortgage loans secured by commercial real estate properties, including loans secured by multi-family real estate properties. At December 31, 2019, commercial real estate loans were $181.9 million, or 21.6%, of our total loan portfolio, inclusive of $56.3 million in multi-family real estate loans. The commercial real estate loan portfolio consisted of $24.2 million in fixed-rate loans and $157.7 million in adjustable-rate loans at December 31, 2019. Our primary focus is individual commercial real estate loan originations to small and mid-size owner occupants and investors in amounts between $1.0 million and $5.0 million. The average size for loans in this portfolio was $1.2 million at December 31, 2019. Our commercial real estate and multi-family loans are generally secured by properties used for business purposes such as office buildings, warehouses, retail facilities and apartment buildings. In addition to originating these loans, we also occasionally participate in commercial real estate loans with other financial institutions located primarily in Massachusetts.

 

3

 

 

We originate fixed-rate and adjustable-rate commercial real estate and multi-family loans for terms up to 30 years. Interest rates and payments on our adjustable-rate loans generally adjust every three, five, seven or ten years and typically are adjusted to a rate equal to a specified percentage above the corresponding Federal Home Loan Bank Classic Advance borrowing rate. Most of our adjustable-rate commercial real estate and multi-family loans adjust every five years and amortize over a 25 year term. Since 2010, commercial real estate and multi-family loan originations are generally subject to an interest rate floor. Loan amounts do not exceed 80% of the property’s appraised value at the time the loan is originated.

 

At December 31, 2019, our largest commercial real estate loan was $9.8 million and was secured by a memory care facility. At December 31, 2019, our largest multi-family real estate loan was $9.8 million and was secured by multiple income producing properties. These loans are located in communities in our primary lending area and were performing according to their original repayment terms at December 31, 2019.

 

Construction Loans. At December 31, 2019, construction loans were $138.0 million, or 16.4%, of our total loan portfolio. We primarily originate construction loans to contractors and builders, and to a lesser extent, individuals, to finance the construction of residential dwellings. We also make construction loans for commercial development projects, including small industrial buildings and retail and office buildings. Our construction loans generally are fixed-rate, interest-only loans that provide for the payment of interest only during the construction phase, which usually ranges from 12 to 24 months. The interest rates on our construction loans generally give consideration to the prime rate as published in the Wall Street Journal. Construction loans generally are made with a loan-to-value ratio of up to 75% of the appraised market value estimated upon completion of the project, but may be made up to a maximum loan-to-value ratio of 80%. As appropriate to the underwriting and appraisal process for certain property classes, a “discounted cash flow analysis” may be utilized. Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also will require an inspection of the property before disbursement of funds during the term of the construction loan. Generally, our construction loans do not provide for interest payments to be funded by interest reserves.

 

We lend to experienced local builders and our construction loans are primarily secured by properties located within a 25 mile radius of Wellesley, Massachusetts. All borrowers are underwritten and evaluated for creditworthiness based on past experience, debt service ability, net worth analysis including available liquidity, and other credit factors. We require personal guarantees on all construction loans. Advances are only made following an inspection of the property confirming completion of the required progress on the project and an update to the title completed by a bank approved attorney.

 

Most of our loans for the construction of residential properties are for residences being built that have not been sold prior to commencement of construction (speculative loans). Construction loans secured by speculative residential loan projects totaled $83.3 million or 9.9% of our loan portfolio, loans secured by owner-occupied residential real estate totaled $20.5 million, or 2.4% of our loan portfolio, and loans secured by other commercial loan projects totaled $34.1 million or 4.1% of our loan portfolio.

 

At December 31, 2019, our largest outstanding construction loan relationship was for multiple projects aggregating $10.8 million, of which $7.1 million was outstanding. These projects consisted of multiple loans secured by construction mortgages on mixed-use and retail properties located in communities in our primary lending area. This relationship was performing according to its original repayment terms at December 31, 2019.

 

Commercial Business Loans. We make commercial business loans primarily in our market area to a variety of professionals, sole proprietorships and small businesses. At December 31, 2019, commercial business loans were $97.3 million, or 11.5% of our total loan portfolio. Commercial lending products include term loans, revolving lines of credit and equipment loans. Commercial business loans and lines of credit are made with either variable or fixed rates of interest. Variable rates generally are based on the prime rate as published in The Wall Street Journal, plus a margin. Fixed-rate business loans are generally priced by considering the prime rate and the comparable cost of funding, typically from published rates of the Federal Home Loan Bank of Boston. Commercial business loans typically have shorter maturity terms and higher interest spreads than real estate loans, but generally involve more credit risk because of the type and nature of the collateral. We focus our efforts on small- to medium-sized, privately-held companies with local or regional businesses that operate in our market area. In addition, commercial business loans are generally made to existing customers having a business or individual deposit account, or new borrowers who are required to establish appropriate deposit relationships with Wellesley Bank, if not already a depositor.

 

4

 

 

When making commercial loans, we consider the financial statements of the borrower, their borrowing history, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral, primarily accounts receivable, inventory and equipment. These loans are generally supported by personal guarantees. At December 31, 2019, our largest commercial business loan was $9.0 million. The loan is secured by leasehold improvements and revenue from a solar energy project and was performing according to its original terms at December 31, 2019. Our largest commercial lines of credit were $4.0 million and was secured by all business assets of the related companies. At December 31, 2019, there were no outstanding balances on the line of credit.

 

Home Equity Lines of Credit. We offer home equity lines of credit, which are generally secured by owner-occupied residences. At December 31, 2019, home equity lines of credit were $36.7 million, or 4.5% of our total loan portfolio. Home equity lines of credit have adjustable rates of interest with ten-year draws amortized over 15 years that are indexed to the Prime Rate as published by The Wall Street Journal and generally are subject to an interest rate floor. Our home equity lines of credit generally have a monthly variable interest rate. We offer home equity lines of credit with cumulative loan-to-value ratios generally up to 85%, when taking into account both the balance of the home equity loans and first mortgage loan.

 

The procedures for underwriting home equity lines of credit include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral to the proposed loan amount. The procedures for underwriting residential mortgage loans apply equally to home equity loans.

 

Other Consumer Loans. We occasionally make fixed-rate second mortgage loans, automobile loans, loans secured by passbook or certificate accounts and overdraft loans. At December 31, 2019, other consumer loans were $171 thousand or 0.02% of total loans.

The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.

 

Loan Underwriting and Monitoring

 

Fixed-Rate Residential Mortgage Loans. Our fixed-rate mortgage loans conform to Fannie Mae and Freddie Mac underwriting guidelines and are originated with the intention to sell. A small portfolio of fixed-rate loans are held in the Bank’s portfolio, some of which may not conform to secondary market standards, yet are still high credit quality loans. The interest rate spread on these loans, which tend to have longer terms, are susceptible to rising interest rates as they are typically funded with shorter term funding. However, due to the size of our portfolio and the probability for these loans to pre-pay prior to maturity, the interest rate risk is manageable.

 

Adjustable-Rate Residential Mortgage Loans. Our adjustable-rate loans better offset the adverse effects on our net interest income in the event of an increase in interest rates, as compared to fixed-rate mortgages. However, the increased mortgage payments required of adjustable-rate loans in a rising interest rate environment could lead to an increase in delinquencies and defaults. In addition, although adjustable-rate mortgage loans help make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.

 

Commercial Real Estate Loans. Loans secured by commercial real estate, including multi-family real estate, generally have larger balances and involve a greater degree of risk than residential mortgage loans. Of primary concern in commercial real estate lending is the feasibility and cash flow potential of the project and the borrower’s creditworthiness. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy. To monitor cash flows on income properties, we require borrowers and loan guarantors, where applicable, to provide annual financial statements on commercial real estate loans. In reaching a decision on whether to make a commercial real estate loan, we consider the net operating income of the property, the borrower’s expertise and credit history, and a certified appraisal documenting the value of the underlying property. We also require an environmental survey for commercial real estate loans over $500 thousand.

 

5

 

 

Construction Loans. Speculative construction financing of real estate properties is considered to involve a greater risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a speculative construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a project having a value which is insufficient to assure full repayment. As a result of the foregoing, speculative construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. If we are forced to foreclose on a project before or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs. Construction financing of owner-occupied residential properties, while exhibiting some of the risks of speculative construction financing, is considered less risky as repayment of loan principal is generally a function of the borrower’s creditworthiness, and not typically based on the expected sale price of the property.

 

Commercial Business Loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may depend substantially on the success of the business itself. Further, certain collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.

 

Consumer Loans. Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. Such cases often do not warrant further substantial collection efforts against the borrower. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

Loan Originations, Purchases and Sales. Loan originations come from a number of sources. The primary source of loan originations are our in-house loan originators, and to a lesser extent, local mortgage brokers, advertising, and referrals from customers. We occasionally participate with other financial institutions in commercial real estate loan transactions.

 

Our current practice is generally (1) to sell to the secondary market newly originated 15-year or longer-term conforming fixed-rate residential mortgage loans, and (2) to hold in our portfolio non-conforming loans, shorter-term fixed-rate loans and adjustable-rate loans. Our decision to sell loans is influenced by prevailing market interest rate conditions and interest rate risk management. Generally, loans are sold to third parties with servicing released although we have sold residential loans with servicing retained under certain conditions. In addition, we may sell participation interests in commercial real estate loans to local financial institutions, primarily the portion of loans that exceed our borrowing limits or are in an amount that is considered prudent in concert with recognition of credit risk.

 

For the years ended December 31, 2019 and 2018, we originated loans totaling $330.2 million and $309.5 million, respectively. For the year ended December 31, 2019, we sold $25.1 million of loans originated for sale, all of which were residential mortgage loans. For the year ended December 31, 2018, we sold $8.5 million, all of which were residential mortgage loans. At December 31, 2019 and 2018, we had no loans sold with recourse.

 

Loan Approval Procedures and Authority. Our lending activities follow written, nondiscriminatory underwriting standards and loan origination procedures established by our Board of Directors and management. Loans in excess of $8.0 million must be authorized by a member of the Security Committee of the Board of Directors while loans in excess of $10.0 million must be authorized by a majority of the members of the Security Committee.

 

Loans-to-One Borrower Limit and Loan Category Concentration. The maximum amount that we may lend to one borrower and the borrower’s related entities is generally limited by statute to 20% of our capital, which is defined under Massachusetts law as the sum of our capital stock, surplus account and undivided profits. Obligations secured by a first lien residential mortgage are excluded from the total borrower obligations for purposes of this computation. At December 31, 2019, our regulatory limit on loans-to-one borrower was approximately $15.9 million. At that date, our largest single borrower lending relationship was $10.8 million and consisted of multiple loans secured by construction mortgages on mixed-use and retail properties located in communities in our primary lending area. These loans were performing in accordance with their original repayment terms at December 31, 2019.

 

Loan Commitments. We issue commitments for fixed-rate and adjustable-rate residential mortgage loans and other loans conditioned upon the occurrence of certain events. Commitments to originate residential mortgage loans are legally binding agreements to lend to our customers. Generally, these loan commitments expire after 60 days.

 

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Investment Activities

 

We have legal authority to invest in various types of securities, including U.S. Treasury obligations, obligations of various government-sponsored enterprises and municipal governments, deposits at the Federal Home Loan Bank of Boston, certificates of deposit of federally insured institutions, investment grade corporate bonds and investment grade marketable equity securities. We also are required to maintain an investment in Federal Home Loan Bank of Boston stock. While we have the authority under applicable law to invest in derivative securities, we had no investments in derivative securities through December 31, 2019.

 

At December 31, 2019, our investment portfolio consisted primarily of residential mortgage-backed securities and bonds issued by U.S. government agencies and government-sponsored enterprises, state and municipal bonds, SBA and other asset-backed securities, and investment grade corporate bonds.

 

Our investment objectives are to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. Management has the responsibility for the investment portfolio subject to the guidelines established in our investment policy approved by the Board of Directors. Management works with Wellesley Investment Partners, LLC, a wholly-owned subsidiary of Wellesley Bank and a registered investment advisor, in the day-to-day management of the investment portfolio. The Board of Directors reviews the status of the portfolio on a monthly basis. The Asset/Liability Committee, which meets on a quarterly basis, reviews an in-depth analysis of the portfolio including performance risk, credit risk and interest rate risk.

 

Deposit Activities and Other Sources of Funds

 

General. Deposits, borrowings and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and financial market conditions, and competitive pricing behavior within our market.

 

Deposit Accounts. Deposits are attracted from within our market area based on reputation, by advertising and other marketing efforts, through online banking and mobile capabilities, and through the offering of a broad selection of deposit instruments, including noninterest-bearing demand deposits (such as checking accounts), interest-bearing demand accounts (such as NOW and money market accounts), savings accounts and certificates of deposit. In addition, we participate in a national market clearinghouse through which we offer competitively priced certificates of deposit to financial institutions and other corporate members of the clearinghouse. We also utilize brokered deposits. In addition to accounts for individuals, we also offer several commercial checking accounts designed for businesses operating in our market area and strongly encourage commercial borrowers to utilize our commercial business deposit products.

 

Deposit account terms vary according to the minimum balance required, time periods the funds must remain on deposit, and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, our liquidity needs, profitability to us, and customer preferences and concerns. We generally review our deposit mix and pricing on a weekly basis. Our deposit pricing strategy has generally been to offer competitive rates and to periodically offer special rates to attract deposits of a specific type or term.

 

Business Banking and Cash Management Services. We offer a variety of deposit accounts designed for the businesses operating in our market area. Our business banking deposit products include a commercial checking account and checking accounts specifically designed for small businesses. We also offer remote capture products for business customers to meet their online banking needs. Additionally, we offer a commercial NOW account with sweep features, automated clearinghouse (ACH) origination, on-line wire transfer, and money market accounts for businesses. We are seeking to increase our commercial deposits through the offering of these types of cash management products.

 

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Borrowings. We utilize advances from the Federal Home Loan Bank of Boston to supplement our supply of investable funds. The Federal Home Loan Bank functions as a central reserve bank providing credit for its member financial institutions. As a member, we are required to own capital stock in the Federal Home Loan Bank and are authorized to apply for advances utilizing certain of our whole first mortgage loans and other assets as collateral (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness. At December 31, 2019, we had advances outstanding with the Federal Home Loan Bank of Boston totaling $94.2 million, of which, short-term advances, those with original maturities less than one year, totaled $20.0 million. At December 31, 2019, we had the ability to borrow a total of approximately $104.0 million in additional funds from the FHLB. At December 31, 2019, we also had an available line of credit of $1.3 million with the Federal Home Loan Bank of Boston at an interest rate that adjusts daily. We had no overnight advances with the Federal Home Loan Bank on this date. All of our borrowings from the Federal Home Loan Bank are secured by a blanket lien on residential real estate loans.

 

The Co-operative Central Bank provides funds in the form of loans for liquidity purposes which are available to all cooperative member banks. Loan advances will generally be made on an unsecured basis up to $5.0 million provided the following: the aggregate loan balance is less than 5% of total deposits of the member bank; the member bank’s primary capital ratio is in excess of 5%; the member bank meets the required CAMELS rating; and, the quarterly and year-to-date net income before extraordinary items is positive. At December 31, 2019, we had $5.0 million of unsecured borrowing capacity with the Co-operative Central Bank, none of which was outstanding.

 

At December 31, 2019, we had the ability to borrow $9.2 million under a collateralized borrower-in-custody agreement with the Federal Reserve Bank of Boston, none of which was outstanding. We also had a $5.0 million unsecured line of credit with a correspondent bank, none of which was outstanding.

 

In December 2015, the Company issued $10.0 million of 6.0% fixed-to-floating rate, subordinated debentures maturing in 2025 to qualified institutional investors.

 

Personnel

 

As of December 31, 2019, we had 74 full-time employees and six part-time employees, none of whom are represented by a collective bargaining unit. We believe our relationship with our employees is good and productive.

 

Subsidiaries

 

Wellesley Bank is a subsidiary of Wellesley Bancorp. The following are descriptions of Wellesley Bank’s wholly-owned subsidiaries:

 

Wellesley Investment Partners, LLC. Wellesley Investment Partners, LLC, established in 2007, is a Massachusetts limited liability company that offers high net worth individuals customized fee-based wealth management services. Customer securities are held by an independent third party custodian. Wellesley Investment Partners is an SEC-registered investment advisor.

 

Wellesley Securities Corporation. Wellesley Securities Corporation, established in 1992, is a Massachusetts corporation that engages in buying, selling and holding securities on its own behalf. As a Massachusetts securities corporation, the income earned on Wellesley Securities Corporation’s investment securities is subject to a lower state tax rate than that assessed on income earned on investment securities maintained at Wellesley Bank. At December 31, 2019, $12.6 million of securities were held by Wellesley Securities Corporation.

 

Central Linden LLC. Organized in 2010, Central Linden LLC is a Massachusetts limited liability company, formed for the purpose of holding, managing and selling foreclosed real estate. Central Linden is currently inactive.

 

Regulation and Supervision

 

General. Wellesley Bank is a Massachusetts-chartered cooperative bank and is the wholly-owned subsidiary of Wellesley Bancorp, a Maryland corporation, which is a registered bank holding company. Wellesley Bank’s deposits are insured up to applicable limits by the FDIC and by the Share Insurance Fund of the Co-operative Central Bank for amounts in excess of the FDIC limits. Wellesley Bank is subject to extensive regulation by the Massachusetts Commissioner of Banks, as its chartering agency, and by the FDIC, its primary federal regulator and deposit insurer. Wellesley Bank is required to file reports with, and is periodically examined by, the FDIC and the Massachusetts Commissioner of Banks concerning its activities and financial condition and must obtain regulatory approvals prior to entering into certain transactions, including, but not limited to, mergers with or acquisitions of other financial institutions. As a registered bank holding company, Wellesley Bancorp is regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).

 

The regulatory and supervisory structure establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of depositors and, for purposes of the FDIC, the deposit insurance fund, rather than for the protection of stockholders and creditors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies concerning the establishment of deposit insurance assessment fees, classification of assets and establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Massachusetts legislature, the Massachusetts Commissioner of Banks, the FDIC, the Federal Reserve Board or Congress, could have a material adverse impact on the financial condition and results of operations of Wellesley Bancorp and Wellesley Bank. As is further described below, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) significantly changed the current bank regulatory structure and may affect the lending, investment and general operating activities of depository institutions and their holding companies.

 

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Set forth below is a summary of certain material statutory and regulatory requirements applicable to Wellesley Bancorp and Wellesley Bank. The summary is not intended to be a complete description of such statutes and regulations and their effects on Wellesley Bancorp and Wellesley Bank.

 

The Dodd-Frank Act. The Dodd-Frank Act has significantly changed the current bank regulatory structure and will affect future lending and investment activities and general operations of depository institutions and their holding companies.

 

In particular, in 2013, the Federal Reserve Board, the FDIC and the other federal bank regulatory agencies issued a final rule that revises their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. See “—Federal Regulations—Capital Requirements.”

 

The Dodd-Frank Act also created the Consumer Financial Protection Bureau with extensive powers to implement and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings associations, among other things, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings associations with more than $10 billion in assets. Banks and savings associations with $10 billion or less in assets will continue to be examined for compliance with federal consumer protection and fair lending laws by their applicable primary federal bank regulators. The Dodd-Frank Act also weakens the federal preemption available for national banks and federal savings associations and gives state attorneys and state banking regulators certain authority to enforce applicable federal consumer protection laws.

 

On May 24, 2018, the Economic Growth Regulatory Relief, and Consumer Protection Act (EGRRCPA) amended some provisions in the Dodd-Frank Act. The amendments made by EGRRCPA provide for additional tailoring of various provisions of the federal banking laws. Specifically, EGRRPCA is intended to simplify some of the regulatory burden for smaller and mid-sized banking organizations. For example, on August 30, 2018, the Federal Reserve published an interim final rule implementing revisions to the small bank holding company policy statement. The asset threshold was raised from $1 billion to $3 billion to preclude small bank holding companies from maintaining consolidated regulatory capital ratios; allows for non-equity funding, such as subordinated debt, to fund growth; and, allows for an 18 month examination cycle for well-managed, well-capitalized banks.

 

Massachusetts Banking Laws and Supervision

 

General. As a Massachusetts-chartered cooperative bank, Wellesley Bank is subject to supervision, regulation and examination by the Massachusetts Commissioner of Banks and to various Massachusetts statutes and regulations which govern, among other things, investment powers, lending and deposit-taking activities, borrowings, maintenance of surplus and reserve accounts, distribution of earnings and payment of dividends. In addition, Wellesley Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The approval of the Massachusetts Commissioner of Banks or the Massachusetts Board of Bank Incorporation is required for a Massachusetts-chartered bank to establish or close branches, merge with other financial institutions, issue stock and undertake certain other activities.

 

Massachusetts regulations generally allow Massachusetts banks, with appropriate regulatory approvals, to engage in activities permissible for federally chartered banks or banks chartered by another state. The Commissioner also has adopted procedures reducing regulatory burdens and expense and expediting branching by well-capitalized and well-managed banks.

 

Parity Regulation. In January 2015, the Commonwealth of Massachusetts adopted a law modernizing the Massachusetts banking law, which affords Massachusetts chartered banks greater flexibility compared to federally chartered and out-of-state banks. The new provisions of Massachusetts banking law took effect on April 7, 2015.

 

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The Massachusetts banking legislation, among other things, attempts to synchronize Massachusetts laws with certain federal requirements in the same area, streamline the process for an institution to engage in activities permissible for federally chartered and out-of-state institutions, consolidate corporate governance statutes and provide authority for the Commissioner to establish a tiered supervisory system for Massachusetts-chartered institutions based on factors such as asset size, capital level, balance sheet composition, examination rating, compliance and other factors deemed appropriate.

 

Dividends. A Massachusetts stock bank may declare cash dividends from net profits not more frequently than quarterly. Noncash dividends may be declared at any time. No dividends may be declared, credited or paid if the bank’s capital stock is impaired. The approval of the Massachusetts Commissioner of Banks is required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years. Dividends from Wellesley Bancorp may depend, in part, upon receipt of dividends from Wellesley Bank. The payment of dividends from Wellesley Bank would be restricted by federal law if the payment of such dividends resulted in Wellesley Bank failing to meet regulatory capital requirements.

 

Loans to One Borrower Limitations. Massachusetts banking law grants broad lending authority. However, with certain limited exceptions, total obligations to one borrower may not exceed 20% of the total of the bank’s capital, surplus and undivided profits.

 

Loans to a Bank’s Insiders. Massachusetts banking laws require that insider loans, or loans to officers, directors and trustees be made in accordance with Federal regulations. See “—Federal Regulations— Transactions with Affiliates and Loans to Insiders.”

 

Investment Activities. In general, Massachusetts-chartered banks may invest in preferred and common stock of any corporation organized under the laws of the United States, or any state subject to certain conditions. Federal law imposes additional restrictions on Wellesley Bank’s investment activities. See “—Federal Regulations—Business and Investment Activities.”

 

Regulatory Enforcement Authority. Any Massachusetts bank that does not operate in accordance with the regulations, policies and directives of the Massachusetts Commissioner of Banks may be subject to sanctions for noncompliance, including revocation of its charter. The Massachusetts Commissioner of Banks may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the bank’s business in an unsafe or unsound manner or contrary to the depositors’ interests or been negligent in the performance of their duties. Upon finding that a bank has engaged in an unfair or deceptive act or practice, the Massachusetts Commissioner of Banks may issue an order to cease and desist and impose a fine on the bank concerned. The Commissioner also has authority to take possession of a bank and appoint a liquidating agent under certain conditions such as an unsafe and unsound condition to transact business, the conduct of business in an unsafe or unauthorized manner or impaired capital. In addition, Massachusetts consumer protection and civil rights statutes applicable to Wellesley Bank permit private individual and class action law suits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damages and attorney’s fees in the case of certain violations of those statutes.

 

Insurance Fund. All Massachusetts-chartered cooperative banks are required to be members of the Co-operative Central Bank, which maintains the Share Insurance Fund that insures cooperative bank deposits in excess of federal deposit insurance coverage. The Co-operative Central Bank is authorized to charge cooperative banks an annual assessment fee on deposit balances in excess of amounts insured by the FDIC. On February 14, 2020, legislation approving the merger of the Share Insurance Fund into the Depositors Insurance Fund, a private, industry-sponsored fund that insures all deposits above the FDIC limits for Massachusetts-chartered savings banks. Following the merger, which is expected to become effective in March 2020, it is anticipated that the Bank’s deposits in excess of the FDIC insurance limits will be insured by the Depositors Insurance Fund.

 

Protection of Personal Information. Massachusetts has adopted regulatory requirements intended to protect personal information. The requirements are similar to existing federal laws such as the Gramm-Leach-Bliley Act of 1999, discussed below under “—Federal Regulations—Other Regulations,” that require organizations to establish written information security programs to prevent identity theft. The Massachusetts regulation also contains technology system requirements, especially for the encryption of personal information sent over wireless or public networks or stored on portable devices.

 

Massachusetts has other statutes or regulations that are similar to certain of the federal provisions discussed below.

 

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Federal Regulations

 

Capital Requirements. In July 2013, the Federal Reserve Board and the FDIC approved revisions to their capital adequacy guidelines and prompt corrective action rules that implement the revised standards of the Basel Committee on Banking Supervision, commonly called “Basel III,” and address relevant provisions of the Dodd-Frank Act. Basel III refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.

 

The rules included new risk-based capital and leverage ratios, which became effective January 1, 2015, and refined the definition of what constitutes “capital” for purposes of calculating those ratios. The minimum capital level requirements applicable to Wellesley Bank are: (1) a common equity Tier 1 capital ratio of 4.5%; (2) a Tier 1 capital ratio of 6%; (3) a total capital ratio of 8%; and, (4) a Tier 1 leverage ratio of 4%. The rules eliminated the inclusion of certain instruments, such as trust preferred securities, from Tier 1 capital. Instruments issued prior to May 19, 2010 are grandfathered for companies with consolidated assets of $15 billion or less. The rules also established a “capital conservation buffer” of 2.5% above the adequate regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and result in the following minimum ratios: (1) a common equity Tier 1 capital ratio of 7.0%; (2) a Tier 1 capital ratio of 8.5%; and (3) a total capital ratio of 10.5%. The new capital conservation buffer requirement is fully implemented. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

On May 24, 2018, the EGRRPCA amended provisions in the Dodd-Frank Act as well as certain other statutes administered by the federal bank agencies. According to the recently passed EGRRCPA, an alternative capital framework is available for qualifying community banking organizations. For banks with total assets less than $10 billion, simplified calculations and reporting is available as long as the community bank leverage ratio is maintained above 9.0%. Otherwise, the Basel III rules apply. In November 2018, the Federal Reserve Board, the FDIC, and the Office of the Comptroller of the Currency (OCC) issued a joint proposal that simplified regulatory capital requirements for qualifying community banking organizations, as required by the EGRRCPA. Under the proposal, a community banking organization would be eligible to elect the community bank leverage ratio framework if it has less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a community bank leverage ratio greater than 9.0%. A qualifying community banking organization that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements. A firm would also be considered to have met the capital ratio requirements to be well capitalized for the agencies' prompt corrective action rules provided it has a community bank leverage ratio greater than 9.0%.

 

Standards for Safety and Soundness. As required by statute, the federal banking agencies adopted final regulations and Interagency Guidelines Establishing Standards for Safety and Soundness to implement safety and soundness standards. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, the internal audit system, credit underwriting, loan documentation, interest rate exposure, asset growth, asset quality, earnings, compensation, fees and benefits and, more recently, safeguarding customer information. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.

 

Business and Investment Activities. Under federal law, all state-chartered FDIC-insured banks have been limited in their activities as principal and in their debt and equity investments to the type and the amount authorized for national banks, notwithstanding state law. Federal law permits exceptions to these limitations. For example, certain state-chartered cooperative banks may, with FDIC approval, continue to exercise state authority to invest in common or preferred stocks listed on a national securities exchange or the Nasdaq Global Market and in the shares of an investment company registered under the Investment Company Act of 1940, as amended. The maximum permissible investment is the lesser of 100% of Tier 1 capital or the maximum amount permitted by Massachusetts law. Any such grandfathered authority may be terminated upon the FDIC’s determination that such investments pose a safety and soundness risk or upon the occurrence of certain events such as the cooperative bank’s conversion to a different charter.

 

The FDIC is also authorized to permit state banks to engage in state authorized activities or investments not permissible for national banks (other than non-subsidiary equity investments) if they meet all applicable capital requirements and it is determined that such activities or investments do not pose a significant risk to the FDIC insurance fund. The FDIC has adopted regulations governing the procedures for institutions seeking approval to engage in such activities or investments. The Gramm-Leach-Bliley Act of 1999 specified that a state bank may control a subsidiary that engages in activities as principal that would only be permitted for a national bank to conduct in a “financial subsidiary,” if a bank meets specified conditions and deducts its investment in the subsidiary for regulatory capital purposes.

 

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

 

The FDIC has adopted regulations to implement the prompt corrective action legislation. An institution is deemed to be “well capitalized” if it has at least 5% leverage capital, 8% Tier 1 risk-based capital, 10% total risk-based capital and 6.5% common equity Tier 1 risk-based capital. An institution is “adequately capitalized” if it has at least 4% leverage capital, 6% Tier 1 risk-based capital, 8% total risk-based capital and 4.5% common equity Tier 1 risk-based capital. An institution is “undercapitalized” if it has less than 4% leverage capital, 6% Tier 1 risk-based capital, 8% total risk-based capital or 4.5% common equity Tier 1 risk-based capital. An institution is deemed to be “significantly undercapitalized” if it has less than 3% leverage capital, 4% Tier 1 risk-based capital, 6% total risk-based capital or 3% common equity Tier 1 risk-based capital. An institution is considered to be “critically undercapitalized” if it has less than 2% tangible capital.

 

Transactions with Affiliates and Loans to Insiders. Transactions between a bank (and, generally, its subsidiaries) and its related parties or affiliates are limited by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. In a holding company context, the parent bank holding company and any companies which are controlled by such parent holding company are affiliates of the bank. Generally, Sections 23A and 23B of the Federal Reserve Act limit the extent to which the bank or its subsidiaries may engage in “covered transactions” with any one affiliate to 10% of such institution’s capital stock and surplus and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such institution’s capital stock and surplus. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and similar transactions. In addition, loans or other extensions of credit by the institution to the affiliate are required to be collateralized in accordance with specified requirements. The law also requires that affiliate transactions be on terms and conditions that are substantially the same or at least as favorable to the institution, as those provided to non-affiliates.

 

The Sarbanes-Oxley Act of 2002 generally prohibits loans by a company to its executive officers and directors. The law contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws, assuming such loans are also permitted under the law of the institution’s chartering state. Under such laws, a bank’s authority to extend credit to executive officers, directors and 10% stockholders (“insiders”), as well as entities such persons control is restricted. The law limits both the individual and aggregate amount of loans that may be made to insiders based, in part, on the bank’s capital position and requires certain board approval procedures to be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are further limited to loans of specific types and amounts.

 

Enforcement. The FDIC has extensive enforcement authority over insured state banks, including Wellesley Bank. That enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and remove directors and officers. In general, enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices. The FDIC also has authority under federal law to appoint a conservator or receiver for an insured bank under certain circumstances. The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state nonmember bank if that bank was “critically undercapitalized” on average during the calendar quarter beginning 270 days after the date on which the institution became “critically undercapitalized.”

 

Federal Insurance of Deposit Accounts. Deposit accounts in Wellesley Bank are insured by the FDIC’s Deposit Insurance Fund, generally up to a maximum of $250 thousand per separately insured depositor, pursuant to changes made permanent by the Dodd-Frank Act. The FDIC assesses insured depository institutions to maintain the Deposit Insurance Fund. No institution may pay a dividend if in default of its deposit insurance assessment. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned. The FDIC may adjust rates uniformly from one quarter to the next, except that no adjustment can deviate more than three basis points from the base scale without notice and comment rulemaking.

 

A material increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of Wellesley Bank. Management cannot predict what insurance assessment rates will be in the future.

 

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Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not know of any practice, condition or violation that might lead to termination of Wellesley Bank’s deposit insurance.

 

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

 

Massachusetts has its own statutory counterpart to the CRA which is also applicable to Wellesley Bank. The Massachusetts version is generally similar to the CRA but utilizes a five-tiered descriptive rating system. The Massachusetts Commissioner of Banks is required to consider a bank’s record of performance under the Massachusetts law in considering any application by the bank to establish a branch or other deposit-taking facility, relocate an office or to merge or consolidate with or acquire the assets and assume the liabilities of any other banking institution. Wellesley Bank’s most recent rating under Massachusetts law was “Satisfactory.”

 

Federal Reserve System. The Federal Reserve Board regulations require savings institutions to maintain noninterest earning reserves against their transaction accounts, primarily Negotiable Order of Withdrawal (NOW) and regular checking accounts. For 2019, the regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $124.2 million; a 10% reserve ratio is applied above $124.2 million. The first $16.3 million of otherwise reservable balances are exempted from the reserve requirements. Wellesley Bank complies with the foregoing requirements.

 

Federal Home Loan Bank System. Wellesley Bank is a member of the Federal Home Loan Bank System, which consists of twelve regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. As a member of the Federal Home Loan Bank of Boston, Wellesley Bank is required to acquire and hold a specified amount of shares of capital stock in the Federal Home Loan Bank of Boston. As of December 31, 2019, Wellesley Bank was in compliance with this requirement.

 

Other Regulations

 

Some interest and other charges collected or contracted by Wellesley Bank are subject to state usury laws and federal laws concerning interest rates and charges. Wellesley Bank’s operations also are subject to state and federal laws applicable to credit transactions, such as the:

 

·Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

·Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;

 

·Bank Secrecy Act of 1970, requiring financial institutions to assist U.S. government agencies to detect and prevent money laundering;

 

·Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

·Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit;

 

·Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies; and,

 

·Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies.

 

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The deposit operations of Wellesley Bank also are subject to the following state and federal laws:

 

·Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

·Electronic Funds Transfer Act and Regulation E promulgated thereunder, as well as Chapter 167B of the General Laws of Massachusetts, that govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

 

·Electronic Check Clearing for the 21st Century Act (also known as “Check 21”), which allows banks to create and receive “substitute checks” (reproduction of the original check), and discloses the customers rights regarding “substitute checks” pertaining to these items having the “same legal standing as the original paper check;”

 

·Gramm-Leach-Bliley Act privacy statute which requires each depository institution to disclose its privacy policy, identify parties with whom certain nonpublic customer information is shared and provide customers with certain rights to “opt out” of disclosure to certain third parties;

 

·Title III of The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”), which significantly expands the responsibilities of financial institutions in preventing the use of the United States financial system to fund terrorist activities. Among other things, the USA PATRIOT Act and the related regulations requires banks operating in the United States to develop anti-money laundering compliance programs, due diligence policies and controls to facilitate the detection and reporting of money laundering;

 

·The Fair and Accurate Reporting Act of 2003, as an amendment to the Fair Credit Reporting Act, as noted previously, which includes provisions to help reduce identity theft by providing procedures for the identification, detection, and response to patterns, practices, or specific activities—known as “red flags”; and,

 

·Truth in Savings Act, which establishes the requirement for clear and uniform disclosure of terms and conditions regarding deposit interest and fees to help promote economic stability, competition between depository institutions, and allow the consumer to make informed decisions.

 

Holding Company Regulation

 

Wellesley Bancorp, as a bank holding company, is subject to examination, supervision, regulation, and periodic reporting under the Bank Holding Company Act of 1956, as amended, and as administered by the Federal Reserve Board. Wellesley Bancorp is required to obtain the prior approval of the Federal Reserve Board to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior Federal Reserve Board approval would be required for Wellesley Bancorp to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if it would, directly or indirectly, own or control more than 5% of any class of voting shares of the bank or bank holding company.

 

A bank holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of more than 5% of the voting securities of any company engaged in nonbanking activities. One of the principal exceptions to this prohibition is for activities found by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the Federal Reserve Board has determined by regulation to be closely related to banking are: (1) making or servicing loans; (2) performing certain data processing services; (3) providing securities brokerage services; (4) acting as fiduciary, investment or financial advisor; (5) leasing personal or real property under certain conditions; (6) making investments in corporations or projects designed primarily to promote community welfare; and (7) acquiring a savings association.

 

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A bank holding company that meets specified conditions, including that its depository institutions subsidiaries are “well capitalized” and “well managed,” can opt to become a “financial holding company.” A “financial holding company” may engage in a broader array of financial activities than permitted a typical bank holding company. Such activities can include insurance underwriting and investment banking. Wellesley Bancorp does not anticipate opting for “financial holding company” status at this time.

 

The Federal Reserve Board has established capital requirements generally similar to the capital requirements for state member banks described above, for bank holding companies. The Dodd-Frank Act required 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. In 2013, the Federal Reserve Board issued a final rule implementing new capital standards for all bank holding companies with $500 million or more in total consolidated assets. See “—Federal Regulations—Capital Requirements.” On April 9, 2015, the Federal Reserve Board of Governors of the Federal Reserve System adopted final amendments to the Small Bank Holding Company Policy Statement. This final rule raises the asset threshold to qualify under the policy statement from $500 million to $1 billion in total assets, expands the statement’s scope to include savings and loan holding companies, revises the applicability of the board’s regulatory capital rules and revises certain reporting requirements. The policy statement facilitates the transfer of ownership of small community banks by allowing their holding companies to operate with higher levels of debt than would otherwise be permitted. While holding companies that meet the conditions of the policy statement are excluded from consolidated capital requirements, their depository institutions continue to be subject to minimum capital requirements. Eligible companies must also meet certain qualitative requirements with respect to nonbanking activities, off-balance sheet activities, and publicly-registered debt and equity. On August 28, 2018, the Federal Reserve Board issued an interim final rule expanding the applicability of the Federal Reserve Board's Small Bank Holding Company Policy Statement, as required by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018.  The interim final rule raises the policy statement's asset threshold from $1 billion to $3 billion in total consolidated assets.  The policy statement also applies to savings and loan holding companies with less than $3 billion in total consolidated assets.  This interim final rule took effect on August 30, 2018.

 

A bank holding company is generally required to give the Federal Reserve Board prior written notice of any purchase or redemption of then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve Board order or directive, or any condition imposed by, or written agreement with, the Federal Reserve Board. The Federal Reserve Board has adopted an exception to that approval requirement for well-capitalized bank holding companies that meet certain other conditions.

 

The Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserve Board’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The Federal Reserve Board’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by using available resources to provide capital funds during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. The Dodd-Frank Act codified the source of strength policy and requires the promulgation of implementing regulations. Under the prompt corrective action laws, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of Wellesley Bancorp to pay dividends or otherwise engage in capital distributions.

 

The Federal Deposit Insurance Act makes depository institutions liable to the FDIC for losses suffered or anticipated by the insurance fund in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default. That law would have potential applicability if Wellesley Bancorp ever held as a separate subsidiary a depository institution in addition to Wellesley Bank.

 

Wellesley Bancorp and Wellesley Bank will be affected by the monetary and fiscal policies of various agencies of the United States Government, including the Federal Reserve System. In view of changing conditions in the national economy and in the money markets, it is impossible for management to accurately predict future changes in monetary policy or the effect of such changes on the business or financial condition of Wellesley Bancorp or Wellesley Bank.

 

The status of Wellesley Bancorp as a registered bank holding company under the Bank Holding Company Act will not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.

 

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Massachusetts Holding Company Regulation. Under Massachusetts banking laws, a company owning or controlling two or more banking institutions, including a cooperative bank, is regulated by the Massachusetts Division of Banks as a bank holding company. Each such bank holding company: (1) must obtain the approval of the Massachusetts Board of Bank Incorporation before engaging in certain transactions, such as the acquisition of more than 5% of the voting stock of another banking institution; (2) must register, and file reports, with the Massachusetts Division of Banks; and (3) is subject to examination by the Division of Banks. Wellesley Bancorp would become a bank holding company regulated by the Massachusetts Division of Banks if it acquires a second banking institution and holds and operates it separately from Wellesley Bank.

 

Federal Securities Laws. Our common stock is registered with the Securities and Exchange Commission under Section 12(b) of the Securities Exchange Act of 1934, as amended. We are subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Exchange Act.

 

Federal Income Taxation

 

General. We report our income on a calendar year basis using the accrual method of accounting. The federal income tax laws apply to us in the same manner as to other corporations with some exceptions, including particularly our reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us. Our federal income tax returns have not been audited in the most recent five year period. For its 2019 fiscal year, Wellesley Bank’s maximum federal income tax rate was 21.0%. On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was signed into law, which decreased the federal tax rate to 21.0%, from 34.0%, beginning January 1, 2018.

 

Bad Debt Reserves. For taxable years beginning before June 30, 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for non-qualifying loans was computed using the experience method. Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and required savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves. Approximately $820 thousand of our accumulated bad debt reserves would not be recaptured into taxable income unless Wellesley Bank makes a “non-dividend distribution” to Wellesley Bancorp as described below.

 

Distributions. If Wellesley Bank makes “non-dividend distributions” to Wellesley Bancorp, the distributions will be considered to have been made from Wellesley Bank’s unrecaptured tax bad debt reserves, including the balance of its reserves as of December 31, 1987, to the extent of the “non-dividend distributions,” and then from Wellesley Bank’s supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in Wellesley Bank’s taxable income. Non-dividend distributions include distributions in excess of Wellesley Bank’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of Wellesley Bank’s current or accumulated earnings and profits will not be so included in Wellesley Bank’s taxable income.

 

The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if Wellesley Bank makes a non-dividend distribution to Wellesley Bancorp, approximately one and one-half times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 21.0% federal corporate income tax rate. Wellesley Bank does not intend to pay non-dividends that would result in a recapture of any portion of its bad debt reserves.

 

State Taxation

 

Financial institutions in Massachusetts file combined income tax returns with affiliated companies that are not security corporations. The Massachusetts excise tax rate for cooperative banks is currently 9.0% of federal taxable income, adjusted for certain items. Taxable income includes gross income as defined under the Internal Revenue Code, plus interest from bonds, notes and evidences of indebtedness of any state, including Massachusetts, less deductions, but not the credits, allowable under the provisions of the Internal Revenue Code, except for those deductions relating to dividends received and income or franchise taxes imposed by a state or political subdivision. Carryforwards and carrybacks of net operating losses and capital losses are not allowed. Wellesley Bancorp’s state tax returns, as well as those of its subsidiaries, are not currently under audit.

 

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A financial institution or business corporation is generally entitled to special tax treatment as a “security corporation” under Massachusetts law provided that: (1) its activities are limited to buying, selling, dealing in or holding securities on its own behalf and not as a broker; and (2) it has applied for, and received, classification as a “security corporation” by the Commissioner of the Massachusetts Department of Revenue. A security corporation that is also a bank holding company under the Internal Revenue Code must pay a tax equal to 0.33% of its gross income. A security corporation that is not a bank holding company under the Internal Revenue Code must pay a tax equal to 1.32% of its gross income. Wellesley Bank’s wholly-owned subsidiary, Wellesley Securities Corporation, is a Massachusetts securities corporation. As such, it has received security corporation classification by the Massachusetts Department of Revenue, and does not conduct any activities deemed impermissible under the governing statutes and various regulations, directives, letter rulings and administrative pronouncements issued by the Massachusetts Department of Revenue.

 

 

Executive Officers of the Registrant

 

The executive officers of Wellesley Bancorp, Inc. and Wellesley Bank are elected annually by the board of directors and serve at the board’s discretion. The executive officers of Wellesley Bancorp and Wellesley Bank are:

 

Name Position

 

Thomas J. Fontaine

President and Chief Executive Officer of both Wellesley Bancorp and Wellesley Bank
   
Louis P. Crosier President, Wellesley Investment Partners, LLC.
   
Michael W. Dvorak Chief Financial Officer, Chief Operating Officer, Treasurer, and Corporate Secretary of Wellesley Bancorp and Executive Vice President and Chief Financial Officer of Wellesley Bank
   
Ralph L. Letner Executive Vice President, Chief Banking Officer, and Chief Lending Officer of Wellesley Bank
   

 

Below is information regarding our executive officers who are not directors. Ages presented are as of December 31, 2019.

 

Louis P. Crosier has served as President of Wellesley Investment Partners since September 2014. Prior to joining Wellesley Investment Partners, Mr. Crosier was senior managing director at Windhaven Investment Management from October 2011 to December 2012. Prior to Windhaven, Mr. Crosier was Managing Principal of Windward Investment Management from September 2002 to October 2010. Mr. Crosier was also previously a Vice President in the Wealth Management Division of Goldman Sachs & Co. Age 54.

 

Michael W. Dvorak has served as Executive Vice President and Chief Financial Officer of Wellesley Bank since July 2016. Prior to joining Wellesley Bank, Mr. Dvorak served as Senior Vice President of Finance at State Street Corporation. Previous experience includes 15 years at Keycorp where he was Executive Vice President and CFO of both the Community Bank and Consumer Bank. Mr. Dvorak was also an Assistant Vice President at the Federal Reserve Bank of Cleveland. Age 59.

 

Ralph L. Letner has served as Executive Vice President and Chief Lending Officer of Wellesley Bank since May 2014. Mr. Letner served as Senior Vice President/Commercial Team Leader at Boston Private Bank and Trust Company in Boston, Massachusetts from July 2010 to May 2014. Prior to that, Mr. Letner held several positions over 12 years at Citizens’ Bank in Boston, Massachusetts. Age 60.

 

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Item 1A. Risk Factors

 

Completion of our previously announced merger with Cambridge Bancorp is subject to certain conditions, and if these conditions are not satisfied or waived, the Merger will not be completed.

 

We currently expect our previously announced business combination with Cambridge to be completed during the second quarter of 2020.  However, the obligations of Cambridge and us to complete the Merger are subject to the satisfaction or waiver (if permitted) of a number of conditions.  The satisfaction of all of the required conditions could delay the completion of the Merger for a significant period of time or prevent it from occurring.  Any delay in completing the Merger could cause the combined company not to realize some or all of the benefits that the combined company expects to achieve if the Merger is successfully completed within its expected timeframe. Further, there can be no assurance that the conditions to the closing of the Merger will be satisfied or waived or that the merger will be completed.

 

Failure to complete our previously announced merger with Cambridge Bancorp could negatively impact our stock price and our future business and financial results.

 

If our proposed merger with Cambridge is not completed for any reason, our ongoing business may be adversely affected and, without realizing any of the benefits of having completed the Merger, we would be subject to a number of risks, including the following:

 

·We are subject to certain restrictions on the conduct of our business prior to completing the Merger, which may adversely affect our abilities to execute certain of our business strategies;

 

·We may experience negative reactions from the financial markets, including negative impacts on our stock price or from our customers, regulators and employees;

 

·We have incurred and will continue to incur certain costs and fees associated with the Merger and other transactions contemplated by the Merger Agreement; and

 

·Matters relating to the Merger (including integration planning) have required substantial commitments of time and resources by our management, which would otherwise have been devoted to day-to-day operations and other opportunities that may have been beneficial to us as an independent company.

 

In addition, we could be subject to litigation related to any failure to complete the Merger or related to any enforcement proceeding commenced against us to perform our obligations under the Merger Agreement.  If the Merger is not completed, these risks may adversely affect our business, financial condition, results of operations and stock price.

 

We make and hold in our portfolio construction loans, including speculative construction loans, which are considered to have greater credit risk than other types of residential loans.

 

We originate construction loans for residential properties and commercial real estate properties, including properties built on speculative, undeveloped property by builders and developers who have not identified a buyer for the completed residential or commercial real estate property at the time of loan origination. At December 31, 2019, $138.0 million, or 16.4%, of our loan portfolio consisted of construction loans. Construction loans secured by speculative residential loan projects totaled $83.4 million, or 9.9% of our total loan portfolio; loans secured by owner-occupied residential real estate, totaled $20.5 million, or 2.4% of our loan portfolio; and loans that were secured by other commercial loan projects totaled $34.1 million or 4.1% of our loan portfolio.

 

Speculative construction lending involves additional risks when compared with construction financing of owner-occupied residential properties or permanent residential lending because funds are advanced upon the progress of the project, which is of uncertain value prior to its completion. Because of the uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. This type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential mortgage loan. These loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. While we believe we have established adequate allowances in our financial statements to cover the credit risk of our construction loan portfolio, there can be no assurance that losses will not exceed our allowances, which could adversely impact our future earnings.

 

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Our ability to continue to originate a significant amount of construction loans is dependent on the continued strength of the housing market in our market area. Further, if we lost our relationship with several of our larger borrowers building in this area or there is a decline in the demand for new housing in this area, it could be expected that the demand for construction loans would decline and our net income would be adversely affected.

 

Our commercial lending exposes us to greater lending risks.

 

At December 31, 2019, $279.2 million, or 33.1%, of our loan portfolio consisted of commercial real estate and commercial business loans. Commercial loans generally expose a lender to greater risk of nonpayment and loss than residential mortgage loans because repayment of the loans often depends on the successful operation of the business and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential mortgage loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential mortgage loan. Further, unlike residential mortgage loans or commercial real estate loans, commercial business loans may be secured by collateral other than real estate, the value of which may be more difficult to appraise, and may be more susceptible to fluctuation in value.

 

Our level of nonperforming loans and classified assets expose us to increased risk of loss. Also, our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.

 

At December 31, 2019, loans that were internally classified as either special mention, substandard, doubtful or loss totaled $5.4 million, representing 0.7% of total loans. Included in the total of internally classified loans are nonperforming loans of $1.4 million, representing 0.2% of total loans. If these loans do not perform according to their terms and the value of the collateral is insufficient to pay the remaining loan balance or if the economy and/or the real estate market weakens, we could experience loan losses or be required to record additional provisions to our allowance for loan losses, either of which could have a material adverse effect on our operating results. Like all financial institutions, we maintain an allowance for loan losses at a level representing management’s best estimate of inherent losses in the portfolio based upon management’s evaluation of the portfolio’s collectibility as of the corresponding balance sheet date. However, our allowance for loan losses may be insufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results.

 

At December 31, 2019, our allowance for loan losses totaled $7.7 million, which represented 0.9% of total loans and 307.0% of nonperforming loans. Our regulators, as an integral part of their examination process, periodically review the allowance for loan losses and may require us to increase the allowance for loan losses by recognizing additional provisions for loan losses charged to income, or to charge off loans, which, net of any recoveries, would decrease the allowance for loan losses. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies could have a material adverse effect on our operating results. Management decided to delay the implementation of Financial Accounting Standards Board Accounting Standards Update 2016-13, Financial Instruments-Credit Losses (Topic 326) in 2020, consistent with the smaller reporting company schedule.

 

The implementation of a new accounting standard could require the Company to increase its allowance for loan losses and may have a material adverse effect on its financial condition and results of operations.

 

FASB has adopted a new accounting standard that will be effective for the Company’s first fiscal year after December 15, 2022, unless the Company chooses early adoption. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and provide for the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which the Company expects could require it to increase its allowance for loan losses, and will likely greatly increase the data the Company would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in the allowance for loan losses, or expenses incurred to determine the appropriate level of the allowance for loan losses, may have a material adverse effect on the Company’s financial condition and results of operations.

 

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A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.

 

The U.S. economy has long emerged from the severe recession that occurred in 2008 and 2009. A return to prolonged deteriorating economic conditions could significantly affect the markets in which we do business, the value of our loans and investments, our ongoing operations, and profitability. Declines in real estate values and sales volumes and elevated unemployment levels may result in higher than expected loan delinquencies, increases in our non-performing and classified assets and a decline in demand for our products and services. These events may cause us to incur losses and may adversely affect our financial condition and results of operations. Our non-performing assets and troubled debt restructurings totaled $5.2 million, $1.3 million, and $748 thousand at December 31, 2019, 2018 and 2017, respectively. The resolution of problem assets has historically been exacerbated by the lengthy foreclosure process in Massachusetts and extended workout plans with certain borrowers. As we work through the resolution of these assets, economic problems may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.

 

The geographic concentration of our loan portfolio and lending activities makes us vulnerable to a downturn in the local economy.

 

While there is not a single employer or industry in our market area on which a significant number of our customers are dependent, a substantial portion of our loan portfolio is comprised of loans secured by property located in the greater Boston metropolitan area. This makes us vulnerable to a downturn in the local economy and real estate markets. Adverse conditions in the local economy such as unemployment, recession, a catastrophic event or other factors beyond our control could impact the ability of our borrowers to repay their loans, which could impact our net interest income. Decreases in local real estate values caused by economic conditions or other events could adversely affect the value of the property used as collateral for our loans, which could cause us to realize a loss in the event of a foreclosure.

 

Our residential mortgage loans and home equity lines of credit expose us to certain lending risks.

 

At December 31, 2019, $388.3 million, or 46.1% of our loan portfolio, consisted of residential mortgage loans and $36.7 million, or 4.4% of our loan portfolio consisted of home equity lines of credit. We intend to continue to emphasize and grow these categories of loans, in particular residential mortgage loans. Real estate values are susceptible to price volatility during changing economic conditions. Declines in real estate values could cause some of our residential mortgage and home equity lines of credit to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral.

 

Changes in interest rates may hurt our profits and asset values and our strategies for managing interest rate risk may not be effective.

 

Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. Changes in the general level of interest rates can affect our net interest income by affecting the difference between the weighted-average yield earned on our interest-earning assets and the weighted-average rate paid on our interest-bearing liabilities, or interest rate spread, and the average life of our interest-earning assets and interest-bearing liabilities. Changes in interest rates also can affect: (1) the ability to originate loans; (2) the value of our interest-earning assets and our ability to realize gains or avoid losses from the sale of such assets; (3) the ability to obtain and retain deposits in competition with other available investment alternatives; and (4) the ability of our borrowers to repay adjustable or variable rate loans. Interest rates are highly sensitive to many factors, including government monetary policies, domestic and international economic and political conditions and other factors beyond our control. Although we believe that the estimated maturities of our interest-earning assets currently are well balanced in relation to the estimated maturities of our interest-bearing liabilities, our profitability could be adversely affected as a result of changes in interest rates.

 

In order to decrease interest rate risk, we utilize a variety of asset and liability management strategies such as increasing the amount of adjustable-rate loans and short term investments, as well as using longer-term Federal Home Loan Bank advances to fund a portion of our lending activities. In addition, we price longer-term certificates of deposit at an attractive rate to extend the average term of our deposits. Due to market conditions and customer demand, these strategies may not be effective in decreasing our interest rate risk. In addition, our interest rate risk mitigation strategies may be influenced by regulatory guidance and directives. As a result, we may be required to take actions that, while mitigating our interest rate risk, may negatively impact our earnings.

 

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Strong competition within our market area could reduce our profits and slow growth.

 

We face a high level of competition both in making loans and attracting deposits within our primary markets. This competition may make it difficult for us to make new loans and may force us to offer lower loan rates and higher deposit rates. Pricing competition for loans and deposits might result in our earning less on our loans and paying more on our deposits, which would reduce net interest income. Competition also makes it more difficult to grow loans and deposits. At June 30, 2019, which is the most recent date for which data is available from the FDIC, we held 1.9% of the deposits in Norfolk County, which was the 14th largest market share among the 42 financial institutions with offices in Norfolk County. At June 30, 2019, we also held 13.7% of the deposits in the town of Wellesley, which was the third largest market share among the 14 financial institutions with offices in Wellesley. Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area.

 

We may not be able to generate sufficient deposit growth to support our funding needs.

 

The largest contributor to our profitability is net interest income, which is the difference between the interest we earn on loans and investments over the interest we pay on deposits and borrowings. The interest rates we pay on deposits are typically lower than that which we would pay on borrowings. To the extent that we are able to increase deposits to fund our asset growth, our profitability would be higher than it would if those funds come from borrowings. With strong competition for deposits in the Wellesley/Newton/Needham/Cambridge/Boston market areas, and numerous investment alternatives available to potential depositors, we may not be able to generate sufficient deposit growth at acceptable interest rates to support our funding needs. In that event, we may need to increase the interest rates we pay on deposits to generate additional deposit growth. In lieu of lower cost core deposit accounts, we may need to increase borrowings or increase our use of high cost brokered deposits, which adversely affects our results of operations.

 

Our wealth management business is heavily regulated, and the regulators have the ability to limit or restrict our activities and impose fines or suspensions on the conduct of our business.

 

Our wealth management business is highly regulated, primarily at the federal level. The failure of our subsidiary that provides investment management and wealth advisory services to comply with applicable laws or regulations could result in fines, suspensions of individual employees or other sanctions including revocation of such affiliate’s registration as an investment adviser. Changes in the laws or regulations governing our wealth management business could have a material adverse impact on our profitability and operations.

 

Our wealth management businesses may be negatively impacted by changes in economic and market conditions.

 

Our wealth management business may be negatively impacted by changes in general economic and market conditions because the performance of such business is directly affected by conditions in the financial and securities markets. The financial markets and businesses operating in the securities industry are highly volatile (meaning that performance results can vary greatly within short periods of time) and are directly affected by, among other factors, domestic and foreign economic conditions and general trends in business and finance, all of which are beyond our control. Declines in the financial markets or a lack of sustained growth may result in a corresponding decline in our performance and may adversely affect the assets that we manage.

 

We may not be able to attract and retain wealth management clients due to competition.

 

Due to intense competition, our wealth management subsidiary may not be able to attract and retain clients at a rate needed to continue to grow the business. Competition is especially strong in our geographic market areas because there are numerous well-established, well-resourced, well-capitalized, and successful investment management and wealth advisory firms in these areas.

 

Our ability to successfully attract and retain investment management and wealth advisory clients is dependent upon our ability to compete with competitors’ investment products, level of investment performance, client services and marketing and distribution capabilities. If we are not successful, our results of operations and financial condition may be negatively impacted.

 

Our business strategy includes moderate growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.

 

We have experienced significant growth since our initial public offering in January 2012, and we expect growth to continue at a more moderate rate in the future, at levels commensurate with maintaining adequate regulatory capital. Expected growth in our assets, our deposits and the scale of our operations, may come from organic growth or acquisitions. Organic growth will be driven by our growing presence in the Wellesley/Newton/Needham/Cambridge/Boston market areas. We opened our sixth full-service branch in Newton Centre in the second quarter of 2016. We opened our fifth full-service branch in Boston in the fourth quarter of 2013 and relocated our wealth management subsidiary to separate office space in Wellesley in the fourth quarter of 2014. Achieving our growth targets requires us to successfully execute our business strategies. As a full-service community banking institution, our business strategies include continuing to expand our loan portfolio with more residential mortgage lending and larger commercial lending relationships, and increased emphasis on competitive lower cost deposit products, in particular business deposit and checking products. Our ability to successfully grow and achieve our objectives will also depend on the continued availability of lending opportunities that meet our stringent underwriting standards.

 

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The loss of our President and Chief Executive Officer could hurt our operations.

 

We rely heavily on our President and Chief Executive Officer, Thomas J. Fontaine. The loss of Mr. Fontaine could have an adverse effect on us because, as a small community bank, Mr. Fontaine has more responsibility than would be typical at a larger financial institution with more employees. Currently, we are party to a three-year employment contract with Mr. Fontaine. In addition, we have bank-owned life insurance on Mr. Fontaine.

 

Regulation of the financial services industry is undergoing major changes, and we may be adversely affected by changes in laws and regulations.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) enacted in 2010 created a significant shift in the way financial institutions operate. Additionally, the Dodd-Frank Act created the Consumer Financial Protection Bureau to administer consumer protection and fair lending laws, a function that was formerly performed by the depository institution regulators. However, institutions with less than $10.0 billion in assets will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the enforcement authority of, their prudential regulators. As required by the Dodd-Frank Act, the federal banking regulators have proposed new consolidated capital requirements that will limit our ability to borrow at the holding company level and invest the proceeds from such borrowings as capital in Wellesley Bank that could be leveraged to support additional growth. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008 and 2009. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs. Any future legislative changes could have a material impact on our profitability, the value of assets held for investment or the value of collateral for loans. Future legislative changes could also require changes to business practices or force us to discontinue businesses and potentially expose us to additional costs, liabilities, enforcement action and reputational risk.

 

New capital rules generally require insured depository institutions and their holding companies to hold more capital. The impact of new rules on our financial condition and operations is uncertain but could be materially adverse.

 

In 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Under the revised capital standards, to be well-capitalized Wellesley Bank is required to have a total risk-based capital ratio of 10.0%, a common equity to Tier 1 capital ratio of 6.5%, a Tier 1 capital ratio of 8.0%, and a Tier 1 leverage ratio of 5.0%. The final rule became effective for Wellesley Bank on January 1, 2015. In addition, the capital conservation buffer requirement was fully phased in and effective as of January 1, 2019.

 

The application of more stringent capital requirements for Wellesley Bank could, among other things, result in lower returns on invested capital, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Implementation of changes to asset risk weightings for risk-based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy, and could limit our ability to make distributions, including paying out dividends or buying back shares. Specifically, Wellesley Bank’s ability to pay dividends is limited if Wellesley Bank does not have the capital conservation buffer required by the new capital rules, which may limit our ability to pay dividends to stockholders. As of December 31, 2019 the Bank met all capital adequacy requirements to which it is subject. In addition, the Bank meets the 2.50% required capital conservation buffer at December 31, 2019.

 

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The Company may be required to transition from the use of the LIBOR interest rate index in the future. adversely impact the interest rate paid on our outstanding subordinated notes and may also impact some of our loans.

 

The Company has certain loans, investment securities and debt obligations whose interest rate is indexed to the London InterBank Offered Rate (LIBOR). The United Kingdom’s Financial Conduct Authority, which is responsible for regulating LIBOR, has announced that the publication of LIBOR is not guaranteed beyond 2021 and it appears highly likely that LIBOR will be discontinued or modified by 2021. At this time, no consensus exists as to what reference rate or rates or benchmarks may become acceptable alternatives to LIBOR, although the Alternative Reference Rates Committee (a group of private-market participants convened by the Federal Reserve Board and the Federal Reserve Bank of New York) has identified the Secured Overnight Financing Rate, or SOFR, as the recommend alternative to LIBOR. Uncertainty as to the adoption, market acceptance or availability of SOFR or other alternative reference rates, may adversely affect the value of LIBOR-based loans and securities in the Company’s portfolio and may impact the availability and cost of hedging instruments and borrowings. The language in the Company’s LIBOR-based contracts and financial instruments has developed over time and may have various events that trigger when a successor index to LIBOR would be selected. If a trigger is satisfied, contracts and financial instruments may give the Company or the calculation agent, as applicable, discretion over the selection of the substitute index for the calculation of interest rates. The implementation of a substitute index for the calculation of interest rates under the Company’s loan agreements may result in the Company incurring significant expenses in effecting the transition and may result in disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute index, any of which could have an adverse effect on the Company’s results of operations. The Company continues to develop and implement plans to mitigate the risks associated with the expected discontinuation of LIBOR. In particular, the Company has implemented or is in the process of implementing fallback language for LIBOR-linked loans.

 

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

 

Wellesley Bank is subject to extensive government regulation, supervision and examination by the FDIC and the Massachusetts Commissioner of Banks. Wellesley Bancorp is also subject to regulation and supervision by the Federal Reserve Board. Such regulation, supervision and examination govern the activities in which we may engage and are intended primarily for the protection of the deposit insurance fund and our depositors. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

 

A significant percentage of our common stock is held by our directors, executive officers and employee benefit plans which, if voted together, could prevent actions requiring a supermajority vote, such as the amendment of certain provisions of the articles of incorporation and bylaws.

 

As of December 31, 2019, our directors and executive officers, together with their associates, own 8.7% of Wellesley Bancorp’s outstanding shares of common stock. In addition, our employee stock ownership plan owns 6.8% of our outstanding common stock. As a result, approximately 15.5% of our outstanding shares are held by our directors, executive officers and our employee stock ownership plan. The articles of incorporation and bylaws of Wellesley Bancorp contain supermajority voting provisions that require that the holders of at least 75% of Wellesley Bancorp’s outstanding shares of voting stock approve certain actions including, but not limited to, the amendment of certain provisions of Wellesley Bancorp’s articles of incorporation and bylaws. If our directors and executive officers and benefit plans hold more than 25% of our outstanding common stock, the shares held by these individuals and benefit plans could be voted in a manner that would ensure that the 75% supermajority needed to approve such actions could not be attained.

 

The articles of incorporation and bylaws of Wellesley Bancorp and certain regulations may prevent or make more difficult certain transactions, including a sale or merger of Wellesley Bancorp.

 

Provisions of the articles of incorporation and bylaws of Wellesley Bancorp, state corporate law and federal and state banking regulations may make it more difficult for companies or persons to acquire control of Wellesley Bancorp. Consequently, our stockholders may not have the opportunity to participate in such a transaction and the trading price of our common stock may not rise to the level of other institutions that are more vulnerable to hostile takeovers. The following factors may discourage takeover attempts or make them more difficult:

 

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●     Articles of incorporation and bylaws. Provisions of the articles of incorporation and bylaws of Wellesley Bancorp that may make it more difficult and expensive to pursue a takeover attempt that the board of directors opposes include the following:

 

·supermajority voting requirements for changes to certain provisions of the articles of incorporation and bylaws, which makes it more difficult for shareholders to change provisions of our governing documents;

 

·a limitation on the right to vote shares, which prohibits any person who owns in excess of 10% of the outstanding shares of Wellesley Bancorp common stock from any vote with respect to the shares held in excess of the limit;

 

·the election of directors to staggered terms of three years, which makes it more difficult and time consuming for a shareholder group to fully use its voting power to gain control of the board of directors at a single annual meeting of shareholders without the consent of the incumbent board of directors of Wellesley Bancorp;

 

·the removal of directors only for cause, which makes it more difficult for shareholders to remove directors and replace them with their own nominees;

 

·the absence of cumulative voting by stockholders in the election of directors, which may prevent a shareholder from electing nominees opposed by the board of directors of Wellesley Bancorp;

 

·provisions restricting the calling of special meetings of stockholders, which delays consideration of shareholder proposal until the next annual meeting; and

 

·provisions regarding the timing and content of stockholder proposals and nominations, which gives our board of director’s time to consider the qualifications of proposed nominees, the merits of the proposals and, to the extent deemed necessary or desirable by our board of directors, to inform shareholders and make recommendations about those matters.

 

●     Massachusetts and federal banking regulations and Maryland corporate law. State corporate law and federal banking regulations place limitations on the acquisition of certain percentages of our common stock and impose restrictions on certain significant stockholders.

 

We may be adversely affected by recent changes in U.S. tax laws and regulations.

 

Changes in tax laws contained in the Tax Cuts and Jobs Act, which was enacted in December 2017, include a number of provisions that will have an impact on the banking industry, borrowers and the market for residential real estate. Included in this legislation was a reduction of the corporate income tax rate from 34% to 21%. In addition, other changes included: (1) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans; (2) the elimination of interest deductions for home equity loans; (3) a limitation on the deductibility of business interest expense and, (4) a limitation on the deductibility of property taxes and state and local income taxes.

 

The recent changes in the tax laws may have an adverse effect on the market for, and valuation of, residential properties, and on the demand for such loans in the future, and could make it harder for borrowers to make their loan payments. In addition, these changes may also have a disproportionate effect on taxpayers in states with high residential home prices and high state and local taxes, such as Massachusetts. If home ownership becomes less attractive, demand for mortgage loans could decrease. The value of the properties securing loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership, which could require an increase in our provision for loan losses that would reduce our profitability and could materially adversely affect our business, financial condition and results of operations

 

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We are dependent on our information technology and telecommunications systems and third-party servicers; systems failures, interruptions or breaches of security could have a material adverse effect on us.

 

Our business is dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on us.

 

Our third-party service providers may be vulnerable to unauthorized access, computer viruses, phishing schemes and other security breaches. We may be required to expend significant additional resources to protect against the threat of such security breaches and computer viruses, or to alleviate problems caused by such security breaches or viruses. To the extent that the activities of our third-party service providers or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, regulatory scrutiny, litigation and other possible liabilities.

 

Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.

 

In the ordinary course of our business, we collect and store sensitive data, including our proprietary business information and that of our customers, suppliers and business partners; and personally identifiable information of our customers and employees. The secure processing, maintenance and transmission of this information is critical to our operations and business strategy. We, our customers, and other financial institutions with which we interact, are subject to ongoing, continuous attempts to penetrate key systems by individual hackers, organized criminals, and in some cases, state-sponsored organizations. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such unauthorized access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and regulatory penalties; disrupt our operations and the services we provide to customers; damage our reputation; and cause a loss of confidence in our products and services -- all of which could adversely affect our business, revenues and competitive position. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses.

 

To remain competitive, we must keep pace with technological change.

 

Financial products and services have become increasingly technology-driven. Our ability to meet the needs of our customers competitively, and in a cost-efficient manner, is dependent on the ability to keep pace with technological advances and to invest in new technology as it becomes available. The ability to keep pace with technological change is important, and the failure to do so could have a material adverse impact on our business and therefore on our financial condition and results of operations.

 

The outbreak of the recent coronavirus ("COVID-19"), or an outbreak of another highly infectious or contagious disease, could adversely affect the Company’s business, financial condition and results of operations.

 

Our business is dependent upon the willingness and ability of its customers to conduct banking and other financial transactions. The spread of a highly infectious or contagious disease, such as COVID-19, could cause severe disruptions in the U.S. economy, which could in turn disrupt the business, activities, and operations of our customers, as well our business and operations. Moreover, since the beginning of January 2020, the coronavirus outbreak has caused significant disruption in the financial markets both globally and in the United States. The spread of COVID-19, or an outbreak of another highly infectious or contagious disease, may result in a significant decrease in business and/or cause our customers to be unable to meet existing payment or other obligations to us, particularly in the event of a spread of COVID-19 or an outbreak of an infectious disease in our market area. Although we maintain contingency plans for pandemic outbreaks, a spread of COVID-19, or an outbreak of another contagious disease, could also negatively impact the availability of key personnel necessary to conduct our business. Such a spread or outbreak could also negatively impact the business and operations of third party service providers who perform critical services for our business. If COVID-19, or another highly infectious or contagious disease, spreads or the response to contain COVID-19 is unsuccessful, we could experience a material adverse effect on our business, financial condition, and results of operations.

 

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Item 1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Properties

 

At December 31, 2019, we conducted business through our main office, three full-service branch offices located in Wellesley, Massachusetts, one full-service branch office in Boston, one full-service branch office in Newton Centre, and one full-service branch office in Needham, and separately, our wealth management offices located in Wellesley. We own our Central Street main office in Wellesley. We lease our Worcester Street home office (subject to a lease that expires in 2025, with renewable options through 2030), our Linden Street branch office (subject to a lease that expires in 2022), our Washington Street branch office (subject to a lease that expires in 2021, with renewal options through 2031), our wealth management office (subject to a lease that expires in 2021 with renewal options through 2026), our Newton Centre branch office (subject to a lease that expires in 2026), and our Boston branch office (subject to a lease that expires in 2023, with renewal options through 2033). At December 31, 2019, the total net book value of our land, buildings, furniture, fixtures and equipment was $3.5 million.

 

Item 3. Legal Proceedings

 

On February 25, 2020, one purported stockholder of the Company filed a putative derivative and class action lawsuit against Wellesley, the members of the Company’s board of directors, Wellesley Bank, Cambridge Bancorp (“Cambridge”) and Cambridge Trust Company in the Circuit Court for Baltimore City, Maryland, on behalf of himself and similarly situated Wellesley stockholders, and derivatively on behalf of the Company, captioned Parshall v. Fontaine et al., Case No. 24-C-20-001127 (the “Merger Litigation”). The plaintiff generally alleged that the Company’s board of directors breached its fiduciary obligations by approving the terms of the Agreement and Plan of Merger, dated December 5, 2019, by and among the Company, Cambridge, Cambridge Trust Company and Wellesley Bank, which provides for, among other things, the merger of the Company with and into Cambridge. The plaintiff further alleged inadequate merger consideration. Lastly, the plaintiff alleged that the joint proxy statement/prospectus filed with the SEC on February 4, 2020 and first mailed to the Company’s stockholders on February 6, 2020 contained materially incomplete disclosures about the merger. The plaintiff sought injunctive relief, rescission of the merger or rescissory damages, other unspecified damages, and an award of attorneys’ fees and expenses.

 

On March 6, 2020, the Company filed with the SEC a Current Report on Form 8-K making additional disclosures to supplement the disclosures in the allegedly misleading proxy statement as set forth in the complaint. The plaintiff agreed that the Form 8-K mooted his disclosure claims, and accordingly agreed to voluntarily dismiss the complaint.

 

Periodically, there may be various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to our financial condition, results of operations and cash flows.

 

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

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PART II

 

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

 

Market for Common Equity and Related Stockholder Matters

 

Wellesley Bancorp’s common stock is listed on the Nasdaq Capital Market under the trading symbol “WEBK.” The following table sets forth the high and low sales prices of the common stock and dividends paid per share for each of the quarters in the years ended December 31, 2019 and 2018.

 

   High   Low  

Dividends

Paid Per
Share

 
Year Ended December 31, 2019:               
Fourth Quarter  $45.97   $30.60   $0.060 
Third Quarter   33.25    30.11    0.060 
Second Quarter   35.50    30.03    0.060 
First Quarter   33.79    27.95    0.055 

 

   High   Low  

Dividends

Paid Per
Share

 
Year Ended December 31, 2018:               
Fourth Quarter   $34.20   $27.74   $0.055 
Third Quarter    34.50    31.75    0.055 
Second Quarter    34.09    28.50    0.055 
First Quarter    30.70    28.01    0.050 

 

As of March 15, 2020, there were approximately 261 holders of record of the Company’s common stock. We believe the number of beneficial owners of our common stock is greater than the number of registered holders because a large amount of our common stock is held of record through brokerage firms in “street name.”

 

Dividends

 

In February 2014, our Board of Directors adopted a policy of paying cash dividends subject to all applicable statutory and regulatory capital and asset maintenance requirements. We cannot guarantee that we will continue to pay dividends or that, if paid; we will not reduce or eliminate dividends in the future.

 

The Board of Directors may declare and pay periodic special cash dividends in addition to, or in lieu of, regular cash dividends. In determining whether to declare or pay any dividends, whether regular or special, the board of directors will take into account our financial condition and results of operations, tax considerations, capital requirements, industry standards, and economic conditions. We will also consider the regulatory restrictions that affect the payment of dividends by Wellesley Bank to the Company, discussed below.

 

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Wellesley Bancorp is subject to Maryland law, which generally permits a corporation to pay dividends on its common stock unless, after giving effect to the dividend, the corporation would be unable to pay its debts as they become due in the usual course of its business or the total assets of the corporation would be less than its total liabilities.

 

Dividends from Wellesley Bancorp may depend, in part, upon receipt of dividends from Wellesley Bank because Wellesley Bancorp has no source of income other than dividends from Wellesley Bank and earnings from investment of net proceeds from the offering retained by Wellesley Bancorp. Massachusetts banking law and FDIC regulations limit distributions from Wellesley Bank to Wellesley Bancorp. See “Regulation and Supervision—Massachusetts Banking Laws and Supervision—Dividends” and “—Federal Regulations—Prompt Corrective Regulatory Action.” In addition, Wellesley Bancorp is subject to the Federal Reserve Board’s policy that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by Wellesley Bancorp appears consistent with its capital needs asset quality and overall financial condition. See “Regulation and Supervision—Holding Company Regulation.”

 

Any payment of non-dividends by Wellesley Bank to the Company that would be deemed to be drawn out of Wellesley Bank’s bad debt reserves would require Wellesley Bank to pay federal income taxes at the then current income tax rate on the amount deemed distributed. See “Item 1—Federal Income Taxation” and “State Taxation.” Wellesley Bancorp does not contemplate any distribution by Wellesley Bank that would result in this type of tax liability.

 

Item 6. Selected Financial Data

 

The summary consolidated financial information presented below is derived in part from our audited consolidated financial statements. The following is only a summary and you should read it in conjunction with the consolidated financial statements and notes beginning on page 76. The information at December 31, 2019 and for the years then ended is derived in part from the audited consolidated financial statements of Wellesley Bancorp that appear elsewhere in this Annual Report on Form 10-K.

 

   At December 31, 
(In thousands)  2019   2018   2017   2016   2015 

Selected Financial Condition Data:

                         
Total assets  $945,218   $871,420   $805,395   $695,283   $621,182 
Cash and short-term investments   42,094    42,650    28,462    28,425    28,178 
Securities available for sale   29,815    66,770    66,486    64,648    62,434 
Loans held for sale   3,354    --    --    1,454    1,131 
Loans receivable, net   834,460    737,032    686,302    576,131    507,307 
Deposits   752,467    717,931    616,742    522,810    463,738 
Short-term borrowings   20,000    15,000    38,000    21,250    20,000 
Long-term debt   74,196    58,528    77,174    83,020    72,860 
Subordinated debentures   9,861    9,832    9,802    9,769    9,734 
Total stockholders’ equity   73,451    65,130    59,245    55,214    52,178 

 

   Years Ended December 31, 
(In thousands)  2019   2018   2017   2016   2015 

Operating Data:

                         
Interest and dividend income  $40,290   $33,638   $28,366   $24,804   $22,085 
Interest expense   13,204    8,909    5,688    4,899    3,690 
Net interest income   27,086    24,729    22,678    19,905    18,395 
Provision for loan losses   915    585    735    437    475 
Net interest income, after provision for loan losses   26,171    24,144    21,943    19,468    17,920 
Noninterest income    3,109    2,586    1,987    1,710    1,226 
Noninterest expenses    21,178    18,563    17,181    16,404    14,845 
Income before income taxes   8,102    8,167    6,749    4,774    4,301 
Provision for income taxes   2,102    2,176    3,564    1,838    1,652 
Net income  $6,000   $5,991   $3,185   $2,936   $2,649 

 

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At or For the Years Ended

December 31,

 
   2019   2018   2017   2016   2015 
Selected Financial Ratios and Other Data:                         

Performance Ratios:

                         
Return on average assets    0.64%   0.72%   0.43%   0.45%   0.46%
Return on average equity    8.56    9.64    5.47    5.37    5.21 
Interest rate spread (1)   2.59    2.76    2.97    2.99    3.16 
Net interest margin (2)   2.96    3.04    3.16    3.17    3.31 
Noninterest expense to average assets    2.25    2.24    2.34    2.54    2.60 
Efficiency ratio (3)   70.14    67.96    69.66    75.89    75.66 
Average interest-earning assets to average interest-bearing liabilities   125.64    125.32    124.32    122.99    122.34 
Average equity to average total assets   7.44    7.48    7.92    8.46    8.90 
Basic earnings per share  $2.44   $2.49   $1.34   $1.26   $1.14 
Diluted earnings per share   $2.36   $2.40   $1.30   $1.24   $1.14 
Dividends per share   $0.24   $0.22   $0.19   $0.15   $0.12 
Dividend payout ratio    9.63%   8.63%   14.07%   11.85%   10.00 
                          
Asset Quality Ratios:                         
Nonperforming assets to total assets   0.26%   0.13%   0.07%   0.09%   0.24%
Nonperforming loans to total loans   0.30    0.15    0.08    0.10    0.29 
Allowance for loan losses to nonperforming loans   306.9    592.7    1,068.2    918.3    349.2 
Allowance for loan losses to total loans   0.91    0.91    0.89    0.93    1.00 
Net charge-offs to average loans outstanding during the period   0.00    0.00    0.00    0.02    0.02 
                          
Capital Ratios:                         
Total capital to risk-weighted assets (4)   11.61%   12.31%   11.72%   12.58%   14.20%
Common equity Tier 1 capital to risk-weighted assets (4)   10.59    11.27    10.72    11.56    13.03 
Tier 1 capital to risk-weighted assets (4)   10.59    11.27    10.72    11.56    13.03 
Tier 1 capital to total average assets (4)(5)   8.36    8.44    8.37    9.06    9.40 
                          
Other Data:                         
Number of full service offices   6    6    6    6    5 

 

(1)Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities.
(2)Represents net interest income as a percent of average interest-earning assets.
(3)Represents noninterest expense divided by the sum of net interest income and noninterest income, excluding gains or losses on the sale of securities and loss on the early extinguishment of debt.
(4)Capital ratios reflect the Bank-only capital position at the end of all periods presented as the Company is not currently required to report regulatory capital requirements.
(5) Average assets represent average assets for the most recent quarter within the respective period.

 

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

 

On December 5, 2019, Cambridge Bancorp and the Company issued a joint press release announcing that Cambridge and the Company have entered into the Merger Agreement pursuant to which the Company will merge with and into Cambridge, with Cambridge as the surviving entity.  Under the terms of the Merger Agreement, which has been approved by the boards of directors and stockholders of both companies, stockholders of the Company will receive 0.580 shares of Cambridge common stock for each share of Company common stock.  The transaction is subject to customary closing conditions and is expected to close during the second quarter of 2020.

 

Overview

 

Income. Our primary source of income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Other sources of income include fees from investment management services, earnings from customer service fees (mostly from service charges on deposit accounts), bank-owned life insurance, income from mortgage banking activities and fees from customer loan-related interest rate swaps.

 

Provision for Loan Losses. The allowance for loan losses is maintained at a level representing management’s best estimate of inherent losses in the loan portfolio, based upon management’s evaluation of the portfolio’s collectibility. The allowance is established through the provision for loan losses, which is charged against income. Charge-offs, if any, are charged to the allowance. Subsequent recoveries, if any, are credited to the allowance. Allocation of the allowance may be made for specific loans or pools of loans, but the entire allowance is available for the entire loan portfolio.

 

Expenses. The noninterest expenses we incur in operating our business consist of salaries and employee benefits, occupancy and equipment, data processing, federal deposit insurance, professional fees, advertising and marketing, and other general and administrative expenses.

 

Salaries and employee benefits consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits. We recognize annual employee compensation expenses stemming from our Employee Stock Ownership Plan (“ESOP”) and our equity incentive plans. The actual amount of stock-related compensation and benefit expenses related to the ESOP is based on the fair market value of the shares of our common stock at specific points in time.

 

Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, rental expenses, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using a straight-line method based on the estimated useful lives of the related assets, which range from three to 40 years, or the expected lease terms, if shorter.

 

Data processing expense represents the fees associated with all business applications we pay to third parties for the use of their software for recording and managing deposit accounts, loan accounts, investment securities, general ledger, payroll and administrative functions within the organization. Included in this category are primary contracts with vendors, service providers and maintenance agreements in support of these functions.

 

Federal deposit insurance premiums are payments we make to the FDIC for insurance of our deposit accounts.

 

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Professional fees include consulting fees and expenses associated with being a public company which consist primarily of legal and accounting fees, expenses of stockholder communications and meetings, and stock exchange listing fees.

 

Advertising and marketing expense includes costs associated with design and delivery of promotional material through a variety of media related to products and services we make available to our customers.

 

Other general and administrative expenses include office supplies, postage, insurance, board of directors and committee fees, and other miscellaneous operating expenses.

 

Business Strategy and Objectives

 

Wellesley Bank provides comprehensive premier banking and wealth management services to successful people, families, businesses and non-profit organizations. With a legacy spanning over 100 years, we are committed to delivering exceptional service and trusted advice to our clients.

 

At Wellesley Bank, it is all about the people: our employees, our community and most importantly our clients. It’s about hiring great people, developing them and treating them well, which, in turn, is a direct reflection on how we treat our clients. The foundation of our bank is built on integrity, community and exceptional client service, where everyone is treated fairly and with respect. We pride ourselves in having an entrepreneurial spirit, where we continue to evolve, stay open to ideas and make quick, sound decisions. This is our strategy and our source of distinction.

 

Our primary objective is to operate and grow a profitable community-oriented financial institution serving customers in our primary market areas. We seek to achieve this by maintaining a strong capital position and high asset quality. Our operating objectives include the following:

 

Emphasizing lower cost core deposits and accessing a wider network of funding sources to maintain low funding costs. We seek to increase net interest income by controlling our funding costs. Over the past several years, we have sought to reduce our dependence on traditional higher cost certificates of deposits in favor of stable lower cost demand deposits. We have utilized additional product offerings, technology and a focus on customer service in working toward this goal. In addition, we seek demand deposits by growing commercial banking relationships. Core deposits (demand, NOW, money market and savings accounts) comprised 71.2% of our total deposits at December 31, 2019. While our focus and strategy will be to continue to emphasize core deposits and relationship banking, we have occasionally utilized our ability to grow certificates of deposit during times of greater loan demand as a means to support loan growth. We do this through our retail and brokered certificate offerings and we participate in a national market clearinghouse for placing competitively priced certificates of deposits with financial institutions, nonprofits and other corporate participants. National market certificates of deposit are sometimes less costly funds than local market retail certificates, and may provide access to a wider range of maturities than retail funds. In addition, we utilize borrowings from the Federal Home Loan Bank of Boston (“FHLB”) to provide matched funding of commercial loans and short-term liquidity needs at relatively lower cost than retail deposits. Balances of FHLB advances increased $20.7 million from $73.5 million at December 31, 2018 to $94.2 million at December 31, 2019.

 

Increasing our deposit market share within our primary markets in eastern Massachusetts. Since its inception in 1911, Wellesley Bank has primarily served the town of Wellesley, Massachusetts and the immediate surrounding communities. Despite considerable competition from larger financial institutions, we have made significant progress in recent years to increase our market presence in the town of Wellesley and in the greater Boston metropolitan area. Our deposits increased $34.5 million, or 4.8%, from $717.9 million at December 31, 2018 to $752.5 million at December 31, 2019. At June 30, 2019 (the latest data available), we had 13.7% of the deposits in the town of Wellesley, which represented the third largest market share out of 14 financial institutions with branches in the town of Wellesley. Our market position is fortified by three full-service offices in Wellesley. We believe Wellesley and the surrounding market area will continue to provide opportunities for growth. We expanded our market reach into Boston through a full-service office that opened in November 2013 and opened a new full-service banking office in Newton Centre in the spring of 2016.

 

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Continuing to develop our commercial real estate lending, commercial business lending, and construction lending, as well as increasing our commercial business depository relationships in our market area. We have worked to increase our commercial relationships by developing our premier bankers and diversifying our loan portfolio beyond residential mortgage loans along with offering business deposit and checking products. From December 31, 2018 to December 31, 2019, our commercial real estate, construction and commercial business loan portfolio increased $95.6 million, or 29.7%, and at December 31, 2019 was 49.5% of our total loan portfolio. The reason for the increase in the portfolio is due to the development of a successful commercial pipeline over the past few years. In connection with our commercial business loan portfolio, we also have focused on providing a full banking relationship and, as a result, experienced an increase in our business deposit and checking accounts. Our business checking accounts increased $2.8 million, or 2.7% during 2019 and represented 13.7% of our total deposits as of December 31, 2019. In addition, we continue to expand and develop our cash management products, along with on-line and mobile banking solutions to better serve our commercial customers.

 

Increasing our residential mortgage lending in our market area. We believe there are opportunities to increase residential mortgage lending in our market areas. The town of Wellesley and its surrounding communities have a sound economy. As a result, the demand for residential mortgage loans in our market area, in particular larger “jumbo” loans, has been steady. From December 31, 2018 to December 31, 2019, our residential loans increased $5.8 million, or 1.5%, and at December 31, 2019 were 46.1% of our total loan portfolio. In addition to our traditional markets in the town of Wellesley and surrounding communities, our lending territory currently includes sections of Boston in Suffolk County and Cambridge in Middlesex County, which we believe provide additional lending opportunities and further diversifies our residential loan portfolio.

 

Continuing conservative underwriting practices while maintaining a high quality loan portfolio. We believe that strong asset quality is a key to long-term financial success. We have sought to maintain a high level of asset quality and manageable credit risk by using conservative underwriting standards and applying diligent monitoring and collection efforts. Nonperforming loans increased from $1.1 million at December 31, 2018 to $2.5 million at December 31, 2019. At December 31, 2019, nonperforming loans were 0.30% of the total loan portfolio and 0.26% of total assets. The increase in nonperforming loans was the result of slowing payments on a home equity line of credit and a commercial and industrial loan with a deteriorating cash flow situation. We believe both situations will be favorably resolved in the short-term. We intend to increase our commercial real estate, construction and commercial business lending, while continuing our philosophy of managing large loan exposures through conservative loan underwriting and sound credit administration standards.

 

Seeking to enhance fee income by growing investment advisory services. Our profits rely heavily on the spread between the interest earned on loans and securities and interest paid on deposits and borrowings. In order to decrease our reliance on net interest income, we have pursued initiatives to increase noninterest income. In particular, we offer a full array of investment advisory services for individuals, nonprofits, institutions, and endowments through our wholly-owned subsidiary, Wellesley Investment Partners, LLC, a registered investment advisor. We appointed a new president of Wellesley Investment Partners in the fourth quarter of 2014 and have augmented our business development efforts and research and support functions with a number of key individuals as we intend to grow and develop this aspect of our business. Investment management fees relating to our investment advisory services totaled $1.7 million, $1.6 million and $1.3 million for the years ended December 31, 2019, 2018 and 2017, respectively.

 

Critical Accounting Policies

 

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies.

 

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are the following factors: the likelihood of default; the loss exposure at default; the amount and timing of future cash flows on impaired loans; the value of collateral; and the determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectibility of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the current evaluation. In addition, the FDIC and Massachusetts Commissioner of Banks, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See notes 1 and 6 of the notes to consolidated financial statements included in this document.

 

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Deferred Tax Assets. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. Management reviews deferred tax assets on a quarterly basis to identify any uncertainties pertaining to realization of such assets. In determining whether a valuation allowance is required against deferred tax assets, management assesses historical and forecasted operating results, including a review of eligible carryforward periods, tax planning opportunities and other relevant considerations. We believe the accounting estimate related to the valuation allowance is a critical estimate because the underlying assumptions can change from period to period. For example, the 2017 enactment of TCJA, the law that reduced our federal tax rate from 34.0% to 21.0%, caused us to re-value our deferred tax asset.

 

Balance Sheet Analysis

 

General. Total assets increased $73.8 million, or 8.5%, from $871.4 million at December 31, 2018 to $945.2 million at December 31, 2019. Total assets increased primarily due to an increase in net loans of $97.4 million, or 13.2%, along with the addition of an operating lease right-of-use asset of $6.5 million and an increase in loans held for sale of $3.3 million, partially offset by a reduction in investments of $37.0 million. Total liabilities increased $65.5 million due to deposit growth of $34.5 million, additional FHLB borrowings of $20.7 million, and the addition of an operating lease liability of $6.5 million.

 

Loans. Net loans increased $97.4 million, or 13.2%, from $737.0 million at December 31, 2018 to $834.5 million at December 31, 2019. The bank has been successful in emphasizing commercial loans: commercial real estate loans increased $33.9 million to $181.9 million; construction loans increased $31.3 million to $138.0 million; and commercial and industrial loans increased $30.4 million to $97.3 million. The increase in commercial and industrial loans reflects our continued emphasis on originating these types of loans and increased loan demand. Permanent construction loans, or those loans financing construction of owner-occupied residential properties, totaled $20.5 million at December 31, 2019, while speculative construction loans on residential properties, representing loans to builders, totaled $83.3 million at December 31, 2019. The increase in construction loan balances generally was due to the continued strong demand for new home construction within our primary markets.

 

Residential real estate loans increased $5.8 million, or 1.5%, to $388.3 million. Fixed-rate residential loans increased $13.5 million to $77.7 million. Adjustable-rate residential mortgage loans decreased $7.6 million, or 2.4%, to $310.6 million. We continue to sell some conforming longer-term fixed-rate residential loans that we have originated. For the years ended December 31, 2019 and 2018, residential mortgage loans originated and sold to investors totaled $25.1 million and $8.5 million, respectively.

 

The following table sets forth the composition of our loan portfolio, excluding loans held for sale, at the dates indicated.

 

   At December 31, 
   2019   2018   2017 
(Dollars in thousands)  Amount   Percent   Amount   Percent   Amount   Percent 
Real estate loans:                              
Residential mortgage   $388,325    46.10%  $382,510    51.43%  $329,026    47.52%
Commercial real estate    181,928    21.60    148,006    19.90    138,784    20.05 
Construction    138,007    16.38    106,723    14.35    120,004    17.33 
Total real estate loans    708,260    84.08    637,239    85.68    587,814    84.90 
                               
Commercial loans    97,281    11.54    66,890    8.99    67,971    9.82 
Consumer loans:                              
     Home equity lines of credit    36,693    4.36    39,486    5.31    36,378    5.25 
     Other    171    0.02    163    0.02    214    0.03 
Total loans    842,405    100.00%   743,778    100.00%   692,377    100.00%
Less:                              
Net deferred loan origination (fees) costs    (292)        (8)        78      
Allowance for loan losses    (7,653)        (6,738)        (6,153)     
Net loans   $834,460        $737,032        $686,302      

 

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   At December 31, 
   2016   2015 
(Dollars in thousands)  Amount   Percent   Amount   Percent 
Real estate loans:                    
Residential mortgage   $268,059    46.09%  $256,470    50.05%
Commercial real estate    121,134    20.83    103,106    20.11 
Construction    110,390    18.98    94,886    18.52 
Total real estate loans    499,583    85.90    454,462    88.68 
                     
Commercial loans    49,347    8.48    23,681    4.62 
Consumer loans:                    
     Home equity lines of credit    32,437    5.58    34,083    6.65 
     Other    216    0.04    256    0.05 
Total loans    581,583    100.00%   512,482    100.00%
Less:                    
Net deferred loan origination (fees) costs    (20)        (63)     
Allowance for loan losses    (5,432)        (5,112)     
Net loans   $576,131        $507,307      

 

Loan Maturity. The following table sets forth certain information at December 31, 2019 regarding scheduled contractual maturities. The table does not include any estimate of prepayments which could significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. The amounts shown below exclude net deferred loan costs and fees.

 

   December 31, 2019 
(In thousands)  Residential
Mortgage
Loans
   Commercial
Real Estate
Loans
   Construction
Loans
   Commercial
Loans
   Consumer
Loans
   Total
Loans
 
Amounts due in:                              
One year or less   $3,051   $10,571   $84,369   $18,953   $1,979   $118,923 
More than one year to five years    3,098    18,724    32,600    9,029    5,865    69,316 
More than five years    382,176    152,633    21,038    69,299    29,020    654,166 
Total   $388,325   $181,928   $138,007   $97,281   $36,864   $842,405 

 

Fixed vs. Adjustable Rate Loans. The following table sets forth the dollar amount of all scheduled maturities of loans at December 31, 2019 that are due after December 31, 2020 and have either fixed interest rates or adjustable interest rates. The amounts shown below exclude net deferred loan costs and fees.

 

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(In thousands)  Fixed
Rates
   Floating or
Adjustable
Rates
   Total 
Real estate loans:               
    Residential mortgage   $70,039   $315,235   $385,274 
    Commercial real estate    22,628    148,729    171,357 
    Construction    39,002    14,636    53,638 
Commercial loans    21,274    57,054    78,328 
Consumer loans    2,910    31,975    34,885 
Total   $155,853   $567,629   $723,482 

 

Securities. Our securities portfolio consists primarily of residential mortgage-backed securities issued by U.S. government agencies and government sponsored enterprises, corporate bonds, SBA and other asset-backed securities and municipal bonds. Securities available for sale decreased by $37.0 million, or 55.4%, to $29.8 million for the year ended December 31, 2019, primarily due to the sale of lower yielding securities which were used to pay down higher cost borrowings.

The following table sets forth the amortized cost and fair values of our securities portfolio at the dates indicated.

 

   At December 31, 
   2019   2018   2017 
(In thousands)  Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
 
Residential mortgage-backed securities:                              
Government National Mortgage Association  $2,770   $2,815   $3,846   $3,847   $3,358   $3,351 
Government-sponsored enterprises   2,224    2,266    11,382    11,223    11,690    11,649 
SBA and other asset-backed securities    4,082    4,192    11,720    11,627    11,961    11,963 
State and municipal bonds    7,446    7,821    12,908    12,908    13,026    13,287 
Government-sponsored enterprise obligations    4,000    3,994    8,000    7,813    8,000    7,834 
Corporate bonds    8,597    8,727    18,151    17,857    17,166    17,161 
U.S.Treasury bonds   --    --    1,495    1,495    1,241    1,241 
Total securities available for sale   $29,119   $29,815   $67,502   $66,770   $66,442   $66,486 

 

At December 31, 2019, we had no investments in a single company or entity (other than the U.S. Government or an agency of the U.S. Government) that had an aggregate book value in excess of 10% of equity.

 

The following table sets forth the stated maturities and weighted average yields of debt securities at December 31, 2019. Weighted average yields on tax-exempt securities are not presented on a tax equivalent basis. Certain mortgage related securities have adjustable interest rates and will reprice annually within the various maturity ranges. These repricing schedules, as well as monthly principal payments on mortgage- and asset-backed securities, are not reflected in the table below.

 

   One Year or Less   More than One Year
to Five Years
   More than Five
Years
to Ten Years
   More than Ten Years   Total 
(Dollars in thousands)  Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
 
State and municipal bonds    --    --    2,063    3.17    3,029    2.79    2,354    3.09    7,446    2.99 
Government-sponsored
enterprise obligations
   --    --    3,000    1.77    1,000    2.00    --    --    4,000    1.83 
Corporate bonds    1,850    2.09    2,747    2.87    4,000    5.66    --    --    8,597    4.00 
Total debt securities   $1,850    2.09%  $7,810    2.53%  $8,029    4.12%  $2,354    3.09%  $20,043    3.19%

 

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Deposits. Our primary sources of funds are retail deposit accounts held primarily by individuals and businesses within our market area. Deposits increased $34.5 million, or 4.8%, during the year ended December 31, 2019 due primarily to increases in money market accounts of $75.4 million, or 37.0%; noninterest-bearing demand deposits of $23.0 million, or 18.6%; and, NOW accounts of $1.9 million, or 5.2%; partially offset by decreases in certificate of deposit accounts of $61.6 million, or 28.8%; and, in regular and other savings accounts of $4.2 million, or 10.4%. Brokered certificate of deposit accounts decreased $35.5 million to $47.0 million at December 31, 2019 accounting for most of the decline in certificates of deposits. During 2019, we continued our evolution of the premier service relationship-based delivery model. Leveraging our expansion of offices and investments in our premier bankers, we have been able to grow our core, relationship-based deposits significantly. We have continued to upgrade our business and consumer online banking capabilities and focused our business development activities on client relationships across product lines.

 

The following table sets forth the average balances of our deposit products at the dates indicated.

 

   For the Year Ended December 31, 
   2019   2018   2017 
(Dollars in thousands)  Total   Percent   Total   Percent   Total   Percent 
Noninterest-bearing demand deposits  $129,477    17.35%  $115,854    17.78%  $96,011    17.41%
Interest-bearing deposits:                              
     NOW   38,629    5.18    36,627    5.62    35,399    6.42 
     Money market   257,559    34.52    155,439    23.85    119,862    21.74 
     Regular and other savings   74,870    10.04    91,780    14.09    96,454    17.50 
     Term certificates of deposit   245,569    32.91    251,912    38.66    203,645    36.93 
Total  $746,104    100.00%  $651,612    100.00%  $551,371    100.00%

 

The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity at December 31, 2019. Jumbo certificates of deposit require minimum deposits of $250 thousand. Between the FDIC’s and Co-operative Central Bank’s deposit insurance coverage, these funds are fully insured.

 

(In thousands)   Jumbo
Certificates of
Deposits
 
Maturity Period at December 31, 2019:        
Three months or less   $ 17,081  
Over three through six months     18,927  
Over six through twelve months     37,541  
Over twelve months     17,232  
Total   $ 90,781  

 

Borrowings. We primarily use advances from the Federal Home Loan Bank of Boston (“FHLB”) to supplement deposit growth as a source of funds for loans and securities.

 

Long-term debt, consisting entirely of FHLB advances, increased $15.7 million, or 26.8%, for the year ended December 31, 2019. At December 31, 2019 and 2018, short-term borrowings consisted entirely of advances from the FHLB with original maturities less than one year. Balances outstanding at December 31, 2019 were $20.0 million, an increase of $5.0 million over balances at December 31, 2018. Long-term and short-term borrowings were typically used to fund loan growth and support short-term liquidity needs resulting from the timing of loan originations and irregular deposit flows.

 

At December 31, 2019, subordinated debt, net of issuance costs, totaled $9.9 million as a result of the sale by the Company of $10.0 million of subordinated debentures maturing in 2025 to qualified institutional investors in December 2015. The funds received from the sale have been used for general corporate purposes including the down-streaming of substantially all of the funds to the Bank in the form of additional paid-in capital, to support the growth objectives of the Bank.

 

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The following table sets forth selected information regarding borrowings for the periods indicated.

 

   At or For the Year Ended December 31, 
(Dollars in thousands)  2019   2018   2017 
Short-term Borrowings:               
Balance at end of the year  $20,000   $15,000   $38,000 
Average balance during the year   32,855    27,943    23,533 
Maximum outstanding at any month end during the year   54,000    51,000    38,000 
Weighted average interest rate at end of the year   2.10%   2.44%   1.53%
Weighted average interest rate during the year   2.63%   2.08%   1.25%
                
Long-term Debt:               
Balance at end of the year  $74,196   $58,528   $77,174 
Average balance during the year   68,269    75,565    89,319 
Maximum outstanding at any month end during the year   77,643    95,399    100,848 
Weighted average interest rate at end of the year   2.61%   1.65%   1.32%
Weighted average interest rate during the year   2.40%   1.66%   1.32%
                
Subordinated Debt:               
Balance at end of the year  $9,861   $9,832   $9,802 
Average balance during the year   9,846    9,816    9,784 
Maximum outstanding at any month end during the year   9,861    9,832    9,802 
Weighted average interest rate at end of the year   6.12%   6.12%   6.12%
Weighted average interest rate during the year   6.39%   6.43%   6.47%

 

Results of Operations for the Years Ended December 31, 2019 and 2018

 

Overview. Net income was $6.0 million for the year ended December 31, 2019, an increase of $9 thousand, or 0.2% as compared to December, 2018. Earnings were lessened by merger-related expenses. For the year ended December 31, 2019, compared to 2018, net interest income plus non-interest income increased $2.9 million, offset by an increase in non-interest expenses of $2.6 million and an increase in the provision for loan losses of $330 thousand. The tax provision decreased $74 thousand.

 

Net Interest Income. Net interest income for the year ended December 31, 2019 totaled $27.1 million compared to $24.7 million for the year ended December 31, 2018, an increase of $2.4 million, or 9.5%. The increase in net interest income was primarily due to greater interest and dividend income, which increased by $6.7 million, or 19.8%, to $40.3 million for 2019 from $33.6 million for 2018. The average balance of interest-earning assets increased 12.4%, with an average rate earned on these assets of 4.41% for 2019. Interest income from loans and loans held for sale increased $6.6 million, or 21.4%, due to a 14.6% increase in the average balance of loans and loans held for sale and an increase of 26 basis points in the average rate earned on loans and loans held for sale. Most of the remaining increase was from higher balances in short-term investments combined with the rise in short-term interest rates.

 

Interest expense increased $4.3 million, or 48.2%, during this period due to an increase in deposit balances and rates paid on interest-bearing deposits and short- and long-term borrowings. The average rates paid on deposits increased by 43 basis points in 2019 primarily due to a shift in the mix of deposits to higher cost term certificates and money market accounts. Rates paid on money market accounts increased 62 basis points during the period while rates paid on term certificates increased 49 basis points. Average balances of interest-bearing deposits increased $80.9 million or 15.1% in 2019. We experienced an increase in the average balance of money market accounts of 65.7% for the year ended December 31, 2019, as compared to the prior year, while the average balance of savings accounts decreased 18.4% during that period. Balances in lower cost NOW checking accounts and interest free checking accounts increased 8.9% during 2019 and helped to mitigate the interest expense increase.

 

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During 2019, we reduced our average combined use of FHLB short- and long-term borrowings due to their relatively higher interest rate cost as compared to core deposits. FHLB short-term borrowings increased $4.9 million and carried an average rate of 2.63% in 2019, compared to 2.08% in 2018. As a result, interest expense on short-term borrowings increased $285 thousand. Overall interest cost on long-term FHLB advances increased $386 thousand, or 30.7% as compared to the prior year. Average balances of long-term FHLB advances decreased $7.3 million to $68.3 million at December 31, 2019, while the rate paid on FHLB advances increased 74 basis points to 2.40% in 2019.

 

Average Balances and Yields. The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Average balances have been calculated using daily balances. Loan fees are included in interest income on loans and are insignificant. Yields are not presented on a tax-equivalent basis. Any adjustments necessary to present yields on a tax-equivalent basis are insignificant.

   For the Years Ended December 31, 
   2019   2018   2017 
(Dollars in thousands)  Average
Outstanding
Balance
   Interest
Earned/
Paid
   Average
Yield/
Rate
   Average
Outstanding
Balance
   Interest
Earned/
Paid
   Average
Yield/
Rate
   Average
Outstanding
Balance
   Interest
Earned/
Paid
   Average
Yield/
Rate
 
Interest-earning Assets:                                             
Short-term investments  $38,334   $757    1.97%  $29,092   $509    1.75%  $21,602   $220    1.02%
Debt securities:                                             
Taxable   43,484    1,270    2.92    54,106    1,441    2.66    53,706    1,338    2.49 
Tax-exempt   11,514    291    2.53    12,917    327    2.53    12,293    305    2.48 
Total loans and loans held for sale   815,692    37,670    4.62    711,528    31,028    4.36    624,784    26,251    4.20 
FHLB stock   5,095    302    5.93    5,767    333    5.77    6,153    252    4.09 
Total interest-earning assets   914,119    40,290    4.41    813,410    33,638    4.14    718,539    28,366    3.95 
Allowance for loan losses   (7,093)             (6,394)             (5,611)          
Total interest-earning assets less allowance for loan losses   907,026              807,016              712,928           
Noninterest-earning assets   34,198              23,541              22,664           
Total assets  $941,224             $830,557             $735,592           
                                              
Interest-bearing Liabilities:                                             
Regular savings accounts  $74,870    429    0.57   $91,780    524    0.57   $96,454    432    0.45 
NOW checking accounts   38,629    141    0.37    36,627    112    0.31    35,399    93    0.26 
Money market accounts   257,559    4,134    1.61    155,439    1,537    0.99    119,862    640    0.53 
Certificates of deposit   245,569    5,365    2.18    251,912    4,269    1.69    203,645    2,416    1.19 
Total interest-bearing deposits   616,627    10,069    1.63    535,758    6,442    1.20    455,360    3,581    0.79 
Short-term borrowings   32,855    865    2.63    27,943    580    2.08    23,533    293    1.24 
Long-term debt   68,269    1,642    2.40    75,565    1,256    1.66    89,319    1,182    1.32 
Subordinated  debt   9,846    628    6.39    9,816    631    6.43    9,784    632    6.47 
Total interest-bearing liabilities   727,597    13,204    1.81    649,082    8,909    1.37    577,996    5,688    0.98 
Noninterest-bearing demand deposits   129,477              115,854              96,011           
Other noninterest-bearing liabilities   14,087              3,494              3,336           
Total liabilities   871,161              768,430              677,343           
Equity   70,063              62,127              58,249           
Total liabilities and equity  $941,224             $830,557             $735,592           
Net interest income       $27,086             $24,729             $22,678      
Net interest rate spread (1)             2.59%             2.76%             2.97%
Net interest-earning assets (2)  $186,522             $164,328             $140,543           
Net interest margin (3)             2.96%             3.04%             3.16%
Average total interest-earning assets to average total interest-bearing liabilities   125.64%             125.32%             124.32%          

 

(1)Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities.
(2)Represents total average interest-earning assets less total average interest-bearing liabilities.
(3)Represents net interest income as a percent of average interest-earning assets.

 

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Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total increase (decrease) column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.

 

   Year Ended December 31, 2019
Compared to
December 31, 2018
   Year Ended December 31, 2018
Compared to
December 31, 2017
 
   Increase (Decrease)
Due to
   Total
Increase
   Increase (Decrease)
Due to
   Total
Increase
 
(Dollars in thousands)  Volume   Rate   (Decrease)   Volume   Rate   (Decrease) 
Interest-earning Assets:                              
Short-term investments  $176    71   $247   $94    195   $289 
Debt securities:                              
   Taxable   (335)   166    (169)   10    93    103 
   Tax-exempt   (36)   (1)   (37)   15    7    22 
Total loans and loans held for sale   4,734    1,908    6,642    3,753    1,024    4,777 
FHLB stock   (40)   9    (31)   (15)   96    81 
Total interest-earning assets   4,499    2,153    6,652    3,857    1,415    5,272 
Interest-bearing Liabilities:                              
Regular savings   (97)   3    (94)   (20)   111    91 
NOW checking   7    22    29    3    17    20 
Money market   1,333    1,264    2,597    232    665    897 
Certificates of deposit   (105)   1,200    1,095    660    1,193    1,853 
Total interest-bearing deposits   1,138    2,489    3,627    875    1,986    2,861 
Short-term borrowings   113    172    285    63    224    287 
Long-term debt   (106)   492    386    (112)   186    74 
Subordinated debt   1    (4)   (3)   (1)   --    (1)
Total interest-bearing liabilities   1,146    3,149    4,295    825    2,396    3,221 
Increase in net interest income  $3,353   $(996)  $2,357   $3,033   $(982)  $2,051 

 

Provision for Loan Losses. During the year ended December 31, 2019, we recorded a $915 thousand provision to the allowance for loan losses as compared to a provision of $585 thousand for the year ended December 31, 2018. The 2019 provision reflects a change in our mix of loans and favorable loan portfolio performance, along with the establishment of a specific reserve of $350 thousand for a commercial and industrial loan that was downgraded late in 2019.

 

From December 31, 2018 to December 31, 2019, nonperforming loans increased from $1.1 million to $2.5 million. The increase was due to one home equity line of credit and one commercial and industrial loan relationship moving to non-accrual status. Criticized and classified assets were $5.4 million at December 31, 2019 and 2018, respectively. Commercial real estate, construction and commercial business loans, which bear higher risk and generally larger loss reserves than our residential mortgage loans, increased as an overall portion of our loan portfolio from 43.2% of loans at December 31, 2018 to 49.5% at December 31, 2019.

 

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An analysis of the changes in the allowance for loan losses is presented under “—Risk Management—Analysis and Determination of the Allowance for Loan Losses.”

 

Noninterest Income. Noninterest income increased $523 thousand, or 20.2%, to $3.1 million during the year ended December 31, 2019, from $2.6 million for the year ended December 31, 2018. Income from customer interest rate swaps increased $526 thousand from 2018 to 2019 associated with our increase in commercial lending activity. For 2019, wealth management fees totaled $1.7 million, an increase of $59 thousand, or 3.6%, from 2018, resulting from the increase in assets under management within our wealth management subsidiary. Total assets under management, including the bank’s portfolio, were $419.5 million. In 2019, we recorded income from mortgage banking activities of $211 thousand compared to 2018 when income from mortgage banking activities totaled $99 thousand. The volume of loans originated for sale in 2019 totaled $28.4 million as compared to $8.5 million for 2018. A discontinued website development project resulted in a loss $121 thousand with the write-down of the associated fixed asset.

 

Noninterest Expense. Noninterest expense increased $2.6 million, or 14.1%, to $21.2 million during the year ended December 31, 2019, from $18.6 million for the year ended December 31, 2018. Salaries and employee benefits increased $1.4 million, or 13.1%, and totaled $12.3 million, compared to $10.8 million for the year ended December 31, 2018. The compensation increase is attributable to annual merit increases and promotions along with the expansion of staff. Occupancy and equipment expense increased $284 thousand primarily related to annual increases in rent expense and the full year impact of the relocation of business operations to a new home office. Professional fees increased $583 thousand due mainly to higher corporate legal expenses and professional fees associated with the proposed merger with Cambridge trust. Data processing expense was higher by $282 thousand and other general administrative costs and advertising costs increased $97 thousand associated with increased business volumes. FDIC insurance costs decreased $50 thousand, primarily due to a one-time small bank credit.

 

Income Taxes. Income tax provision decreased by $74 thousand for the year ended December 31, 2019 as compared to the year ended December 31, 2018. The effective tax rate for 2019 was 25.9% compared with 26.6% for 2018.

 

Risk Management

 

Overview. Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk, market risk and liquidity risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or security when it is due. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are recorded at fair value. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers when due. Other risks that we face are operational risks and reputation risk. Operational risks include risks related to fraud, cyber security, regulatory compliance, processing errors, and technology and disaster recovery. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base and revenue.

 

Credit Risk Management. Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. This strategy also emphasizes conservative loan-to-value ratios and guarantees of construction and commercial real estate loans by parties with substantial net worth. In addition, annually, we engage an outside loan review firm to perform a thorough review of our commercial portfolio. This review involves analyzing all large borrowing relationships, delinquency trends and loan collateral valuation in order to identify impaired loans. We do not originate “interest only” mortgage loans on one-to-four family residential properties nor do we offer loans that provide for negative amortization of principal such as “option ARM” loans where the borrower can pay less than the interest owed on their loan. Additionally, we generally do not offer “subprime loans” (loans that are made with low down payments to borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments or bankruptcies, or borrowers with questionable repayment capacity) or “Alt-A” loans (loans to borrowers having less than full documentation).

 

When a borrower fails to make a required loan payment, management takes a number of steps to have the borrower cure the delinquency and restore the loan to current status. Management makes initial contact with the borrower when the loan becomes 15 days past due. If payment is not received by the 30th day of delinquency, efforts to contact the borrower are increased, and a plan of collection is pursued for each individual loan. A particular plan of collection may lead to foreclosure, the timing of which depends on the prospects for the borrower bringing the loan current, the financial strength and commitment of any guarantors, and the type and value of the collateral securing the loan and other factors. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. We may consider loan workout arrangements with certain borrowers under certain circumstances, as well as the sale of the nonperforming loans.

 

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Management informs the board of directors on a monthly basis of the amount of loans delinquent more than 30 days. Management also provides detailed reporting of loans greater than 90 days delinquent, all loans in foreclosure and all foreclosed and repossessed property that we own.

 

Analysis of Nonperforming and Classified Assets. We consider foreclosed assets, loans that are maintained on a nonaccrual basis and loans that are past due 90 days or more and still accruing to be nonperforming assets. Loans are generally placed on nonaccrual status when they are classified as impaired or when they become 90 days or more past due. Loans are classified as impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. At the time a loan is placed on nonaccrual status, the accrual of interest ceases and interest income previously accrued on such loans is reversed against current period interest income. Payments received on a nonaccrual loan are first applied to the outstanding principal balance when collectibility of principal is in doubt.

 

Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned until it is sold. When property is acquired it is recorded at the lower of its cost or fair market value at the date of foreclosure. Any holding costs and declines in fair value after acquisition of the property result in charges against income.

 

Troubled debt restructurings (“TDRs”) occur when we grant borrowers concessions that we would not otherwise grant but for economic or legal reasons pertaining to the borrower’s financial difficulties. These concessions may include, but are not limited to, modifications of the terms of the debt, the transfer of assets or the issuance of an equity interest by the borrower to satisfy all or part of the debt, or the substitution or addition of borrower(s). We will not return a TDR to accrual status until the borrower has demonstrated the ability to make principal and interest payments under the restructured terms for at least six consecutive months.

 

The following table provides information with respect to our nonperforming assets, including TDRs, at the dates indicated. We did not have any accruing loans past due 90 days or more at the dates presented.

 

   At December 31, 
(Dollars in thousands)  2019   2018   2017   2016   2015 
Nonaccrual loans:                         
Real estate loans:                         
Residential mortgage  $562   $581   $--   $--   $773 
Commercial real estate   548    556    576    591    645 
Construction   --    --    --    --    -- 
Commercial   883    --    --    --    11 
Consumer   500    --    --    --    34 
Total nonaccrual loans   2,493    1,137    576    591    1,463 
Other real estate owned   --    --    --    --    -- 
Total nonperforming assets   2,493    1,137    576    591    1,463 
Accruing troubled debt restructurings (1)   2,675    165    172    179    185 
Total nonperforming assets and accruing troubled debt restructurings  $5,168   $1,301   $748   $770   $1,648 
Total nonperforming loans to total loans   0.30%   0.15%   0.08%   0.10%   0.29%
Total nonperforming assets to total assets   0.26%   0.13%   0.07%   0.09%   0.24%
Total nonperforming assets and accruing troubled debt restructurings to total assets   0.55%   0.15%   0.09%   0.11%   0.27%

 

(1)    Non-accruing TDRs totaled $548 thousand, $556 thousand, $576 thousand, $214 thousand, and $220 thousand at December 31, 2019, 2018, 2017, 2016, and 2015, respectively. There were no non-accruing TDRs at December 31, 2016.

 

Interest income that would have been recorded for the years ended December 31, 2019 and 2018 had non-accruing loans been current according to their original terms amounted to $61 thousand and $56 thousand, respectively. Income related to nonaccrual loans included in interest income for the years ended December 31, 2019 and 2018 amounted to $42 thousand and $65 thousand, respectively.

 

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Federal regulations require us to review and classify assets on a regular basis. In addition, the FDIC and the Massachusetts Commissioner of Banks have the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high probability of loss. An asset classified as ‘loss” is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. When management classifies an asset as substandard or doubtful, a specific allowance for loan losses may be established. If management classifies an asset as loss, an amount equal to 100% of the portion of the asset classified loss is charged to the allowance for loan losses. The regulations also provide for a “special mention” category, described as assets that do not currently expose the Bank to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving the Bank’s close attention. The Bank also utilizes an eleven grade internal loan rating system for commercial real estate, construction and commercial loans to assist in evaluating individual loans and determining assets classifications. See note 6 in the notes to the consolidated financial statements.

 

The following table shows the aggregate amounts of our criticized and classified assets at the dates indicated.

 

   At December 31, 
(In thousands)  2019   2018   2017 
Special mention assets  $875   $2,562   $1,777 
Substandard assets   4,011    2,290    3,114 
Doubtful assets   548    556    576 
Loss assets   --    --    -- 
Total  $5,434   $5,408   $5,467 

 

At December 31, 2019, 2018 and 2017, none of the special mention loans were in nonaccrual status. The decrease in special mention assets in 2019 was primarily the result of several borrowers’ loans being downgraded to substandard. Total substandard assets included one accruing commercial loan relationship totaling $2.0 million that subsequently paid off in January, 2020.

 

Other than as disclosed in the above tables, there are no other loans where management has serious doubts about the ability of the borrowers to comply with the present loan repayment terms.

 

Delinquencies. The following table provides information about delinquencies in our loan portfolio at the dates indicated.

 

   At December 31, 2019   At December 31, 2018 
(In thousands) 

30 – 59

Days

Past Due

  

60 – 89

Days

Past Due

  

>90 Days

Past Due

  

30 – 59

Days

Past Due

  

60 – 89

Days

Past Due

  

>90 Days

Past Due

 
Real estate loans:                              
Residential mortgage  $--   $--   $--   $1,551   $--   $-- 
Commercial real estate   --    --    548    --    --    556 
Construction   --    --    --    --    --    -- 
Commercial loans   --    --    --    --    --    -- 
Consumer loans   --    --    500    --    --    -- 
Total  $--   $--