UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark one)

x

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

 

For the quarterly period ended March 31, 2020

 

OR

 

¨

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		(I.R.S. Employer Identification No.)
organization)

 

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

 

                              (781) 235-2550                                

(Registrant’s telephone number, including area code)

 

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

 

As of April 30, 2020, there were 2,625,899 shares of the registrant’s common stock outstanding.

 

 

 

WELLESLEY BANCORP, INC.

 

Table of Contents

 

				Page No.
Part I.   Financial Information
Item 1.		Financial Statements (Unaudited)
		Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019		1
		Consolidated Statements of Comprehensive Income for the Three  Months Ended March 31, 2020 and 2019		2
		Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2020 and 2019		3
		Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019		4
		Notes to Consolidated Financial Statements		5
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		30
Item 4.		Controls and Procedures		31
Part II.   Other Information
Item 1.		Legal Proceedings		32
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		34
Item 3.		Defaults Upon Senior Securities		34
Item 4.		Mine Safety Disclosures		34
Item 5.		Other Information		34
Item 6.		Exhibits		34
Signatures				35

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

 

CONSOLIDATED BALANCE SHEETS

 

		March 31, 2020				December 31, 2019
		(Dollars in thousands)
Assets
Cash and due from banks		$	20,595			$	7,886
Short-term investments			14,331				34,208
Total cash and cash equivalents			34,926				42,094
Certificates of deposit			100				100
Securities available for sale, at fair value			24,369				29,815
Federal Home Loan Bank of Boston stock, at cost			6,202				4,906
Loans held for sale			2,089				3,354
Loans			863,735				842,113
Less allowance for loan losses			(8,208	)			(7,653	)
Loans, net			855,527				834,460
Bank-owned life insurance			8,063				8,005
Operating lease,right-of-use asset			7,489				6,473
Premises and equipment, net			3,228				3,508
Accrued interest receivable			2,595				2,525
Net deferred tax asset			2,911				2,713
Other assets			13,416				7,265
Total assets		$	960,915			$	945,218
Liabilities and Stockholders’ Equity
Deposits:
Non-interest-bearing		$	152,887			$	139,969
Interest-bearing			582,139				612,498
Total deposits			735,026				752,467
Short-term borrowings			45,000				20,000
Long-term borrowings			72,859				74,196
Subordinated debt			9,868				9,861
Lease liability			7,578				6,543
Accrued expenses and other liabilities			15,278				8,700
Total liabilities			885,609				871,767
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value; 1,000,000 shares authorized, none issued			--				--
Common stock, $0.01 par value; 14,000,000 shares authorized, 2,608,872 and 2,599,105 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively			26				26
Additional paid-in capital			28,447				28,169
Retained earnings			47,011				45,625
Accumulated other comprehensive income (loss)			492				530
Unearned compensation – ESOP			(867	)			(899	)
Total stockholders' equity			75,109				73,451
Total liabilities and stockholders' equity		$	960,915			$	945,218

 

See accompanying notes to consolidated financial statements.

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

		Three Months Ended March 31,
		2020				2019
		(Dollars in thousands, except per share data)
Interest and dividend income:
Interest and fees on loans and loans held for sale		$	9,703			$	8,727
Debt securities:
Taxable			162				378
Tax-exempt			55				82
Short-term investments and certificates of deposit			107				164
FHLB stock			74				79
Total interest and dividend income			10,101				9,430
Interest expense:
Deposits			2,053				2,489
Short-term borrowings			171				110
Long-term debt			480				243
Subordinated debt			157				157
Total interest expense			2,861				2,999
Net interest income			7,240				6,431
Provision for loan losses			555				240
Net interest income, after provision for loan losses			6,685				6,191
Non-interest income:
Customer service fees			54				39
Mortgage banking activities			7				28
Income on bank-owned life insurance			58				58
Wealth management fees			365				434
Miscellaneous			572				123
Total non-interest income			1,056				682
Non-interest expense:
Salaries and employee benefits			3,196				3,040
Occupancy and equipment			915				804
Data processing			302				297
FDIC insurance			180				135
Professional fees			498				190
Other general and administrative			472				629
Total non-interest expense			5,563				5,095
Income before income taxes			2,178				1,778
Provision for income taxes			637				476
Net income			1,541				1,302
Other comprehensive income:
Net unrealized holding (loss) gain  on available-for-sale securities			(52	)			858
Income tax benefit (expense)			14				(215	)
Total other comprehensive (loss) gain income			(38	)			643
Comprehensive income		$	1,503			$	1,945
Earnings per common share:
Basic		$	0.61			$	0.54
Diluted		$	0.60			$	0.52
Weighted average shares outstanding:
Basic			2,510,907				2,431,324
Diluted			2,587,643				2,523,907

 

See accompanying notes to consolidated financial statements.

 

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Three Months Ended March 31, 2020 and 2019

 

		Common Stock								Additional Paid-in				Retained				Accumulated Other Comprehensive				Unearned Compensation-				Total Stockholders’
		Shares				Amount				Capital				Earnings				Income (Loss)				ESOP				Equity
		(Dollars in thousands)
Balance at December 31, 2018			2,525,611			$	25			$	26,462			$	40,203			$	(533	)		$	(1,027	)		$	65,130
Comprehensive income			--				--				--				1,302				643				--				1,945
Restricted stock awards grant			11,500				--				--				--				--				--				--
Stock options exercised			2,553				--				48				--				--				--				48
Restricted stock forfeitures			(2,000	)			--				--				--				--				--				--
Dividends paid to common stockholders ($0.055 per share)			--				--				--				(140	)			--				--				(140	)
Share-based compensation- equity incentive plan			--				--				102				--				--				--				102
ESOP shares committed to be allocated (3,209)			---				--				64				--				--				32				96
Balance at March 31, 2019			2,537,664			$	25			$	26,676			$	41,365			$	110			$	(995	)		$	67,181
Balance at December 31, 2019			2,599,105				26			$	28,169			$	45,625			$	530			$	(899	)		$	73,451
Comprehensive income			--				--				--				1,541				(38	)			--				1,503
Stock options exercised			10,527				--				162				--				--				--				162
Common stock repurchased for restricted stock awards			(760	)			--				(34	)			--				--				--				(34	)
Dividends paid to common stockholders ($0.06 per share)			--				--				--				(155	)			--				--				(155	)
Share-based compensation- equity incentive plan			--				--				61				--				--				--				61
ESOP shares committed to be allocated (3,209)			---				--				89				--				--				32				121
Balance at March 31, 2020			2,608,872			$	26			$	28,447			$	47,011			$	492			$	(867	)		$	75,109

 

See accompanying notes to consolidated financial statements.

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Three  Months Ended March 31,
		2020				2019
		(In thousands)
Cash flows from operating activities:
Net income		$	1,541			$	1,302
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Provision for loan losses			555				240
Depreciation and amortization			211				187
Net amortization of securities			15				42
Gains on sales of securities, net			--				--
Principal balance of loans sold			6,129				1,228
Loans originated for sale			(4,864	)			(1,228	)
Accretion of net deferred loan fees			(162	)			(142	)
Amortization of subordinated debt issuance costs			7				8
Income on bank-owned life insurance			(58	)			(58	)
Deferred income tax provision			(111	)			96
ESOP expense			121				96
Share-based compensation			61				102
Net change in other assets and liabilities			579				(1,524	)
Net cash provided by operating activities			4,024				349
Cash flows from investing activities:
Activity in securities available for sale:
Maturities, prepayments and calls			5,379				3,563
Purchase (redemption) of Federal Home Loan Bank stock			(1,296	)			905
Net loan originations			(21,460	)			(41,599	)
Additions to premises and equipment			(10	)			(116	)
Net cash used by investing activities			(17,387	)			(37,247	)
Cash flows from financing activities:
Net increase (decrease) in deposits			(17,441	)			32,992
Proceeds from issuance of long-term debt			7,000				3,000
Repayments of long-term debt			(8,337	)			(8,331	)
Increase in short-term borrowings			25,000				3,000
Stock options exercised			162				48
Common stock repurchased			(34	)			--
Cash dividends paid on common stock			(155	)			(140	)
Net cash provided by financing activities			6,195				30,569
Net change in cash and cash equivalents			(7,168	)			(6,329	)
Cash and cash equivalents at beginning period			42,094				42,650
Cash and cash equivalents at end of period		$	34,926			$	36,321
Supplementary information:
Interest paid		$	2,486			$	2,718
Income taxes paid			--				330

 

See accompanying notes to consolidated financial statements.

 

 

WELLESLEY BANCORP, INC. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 – BASIS OF PRESENTATION AND CONSOLIDATION

 

On December 5, 2019, Cambridge Bancorp (“Cambridge”) and Wellesley Bancorp, Inc. (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.

 

The accompanying unaudited interim consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Wellesley Bank (the “Bank”), the principal operating entity, and its wholly-owned subsidiaries: Wellesley Securities Corporation, which engages in the business of buying, selling and dealing in securities exclusively on its own behalf; Wellesley Investment Partners, LLC, formed to provide investment management services for individuals, not-for-profit entities and businesses; and Central Linden, LLC, to hold, manage and sell foreclosed real estate. All significant intercompany balances and transactions have been eliminated in consolidation. Assets under management at Wellesley Investment Partners, LLC are not included in these consolidated financial statements because they are not assets of the Company. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements.

 

In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s 2019 Annual Report on Form 10-K. The results for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020 or for any other period.

 

NOTE 2 – LOAN POLICIES

 

The loan portfolio consists of real estate, commercial and other loans to the Company’s customers in our primary market areas in eastern Massachusetts. The ability of the Company’s debtors to honor their contracts is dependent upon the economy in general and the state of real estate and construction sectors within our markets.

 

Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred loan origination fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

 

Interest is generally not accrued on loans that are identified as impaired or loans which are ninety days or more past due. Past due status is based on the contractual terms of the loan. Interest income previously accrued on such loans is reversed against current period interest income. Interest income on non-accrual loans is recognized only to the extent of interest payments received and is first applied to the outstanding principal balance when collectibility of principal is in doubt. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured through sustained payment performance for at least six months.

 

Allowance for loan losses

 

The allowance for loan losses is established through a provision for loan losses charged to earnings as losses are estimated to occur. Loan losses are charged against the allowance when management believes the uncollectibility of the loan balance is confirmed. Subsequent recoveries are credited to the allowance.

 

 

The allowance for loan losses is evaluated on a regular basis by management. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, allocated and unallocated components.

 

General component

 

The general component is based on the following loan segments: residential real estate, commercial real estate, construction, commercial, home equity lines of credit and other consumer. Management considers a rolling average of historical losses for each segment based on a time frame appropriate to capture relevant loss data for each loan segment, generally three and 10 years. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; trends in volume, concentrations and terms of loans; level of collateral protection; effects of changes in risk selection and underwriting standards; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no significant changes to the Company’s policies or methodology pertaining to the general component of the allowance during 2020 or 2019.

 

The qualitative factor adjustments are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

 

Residential real estate – The Company generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not originate subprime loans. Most loans in this segment are collateralized by one-to-four family residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality of this segment.

 

Commercial real estate – Loans in this segment are primarily income-producing properties in the Company’s primary market areas in eastern Massachusetts. The underlying cash flows generated by the properties may be adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which, in turn, will have an effect on the credit quality in this segment. Management typically obtains rent rolls annually and continually monitors the cash flows of these loans.

 

Construction – Loans in this segment include speculative construction loans primarily on residential properties for which payment is derived from the sale of the property. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.    Residential construction loans in this segment also include loans to build one-to-four family owner-occupied properties which are subject to the same credit quality factors as residential real estate.

 

Commercial – Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.

 

Home equity lines of credit – Loans in this segment are collateralized by one-to-four family residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.

 

Other consumer – Loans in this segment are generally unsecured and repayment is dependent on the credit quality of the individual borrower.

 

Allocated component

 

The allocated component relates to loans that are classified as impaired. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the fair value of the loan or, if the loan is collateral dependent, by the fair value of the collateral less estimated costs to sell. An allowance is established when the discounted cash flows or collateral value of the impaired loan are lower than the carrying value of that loan. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify performing individual residential and consumer loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement.

 

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

 

The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring ("TDR"). All TDRs are initially classified as impaired.

 

Unallocated component

 

An unallocated component is maintained to cover additional uncertainties in management’s estimation of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio.

 

NOTE 3 – COMPREHENSIVE INCOME

 

Accounting principles generally require that recognized revenue, expenses, and gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the stockholders’ equity section of the consolidated balance sheets, such items, along with net income, are components of comprehensive income/loss.

 

The components of accumulated other comprehensive income (loss) and related tax effects are as follows:

 

		March 31,				December 31,
		2020				2019
		(In thousands)
Unrealized holding  gains (losses)  on securities available for sale		$	644			$	696
Tax effect			(152	)			(166	)
Net-of tax amount		$	492			$	530

 

NOTE 4 – RECENT ACCOUNTING AND REGULATORY PRONOUNCEMENTS

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments-Credit Losses (Topic 326), which requires entities to measure expected credit losses based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. Entities will now use forward-looking information to better form their credit loss estimates. Credit losses on available-for-sale debt securities should be measured in a manner similar to current GAAP; however, recognized credit losses will be presented as an allowance rather than as a write-down. This ASU was scheduled to be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. However, the FASB recently voted to propose delaying the standard by three years for smaller reporting companies, which included Wellesley Bank. The Board of Directors voted to delay implementation of the standard.

 

 

NOTE 5 – SECURITIES AVAILABLE FOR SALE

 

The amortized cost and fair value of securities available for sale, with gross unrealized gains and losses, follows:

 

		Amortized				Gross Unrealized				Gross Unrealized				Fair
		Cost				Gains				Losses				Value
		(In thousands)
March 31, 2020
Residential mortgage-backed securities:
Government National Mortgage Association		$	2,694			$	88			$	(44	)		$	2,738
Government-sponsored enterprises			1,181				20				(4	)			1,197
SBA and other asset-backed securities			3,805				138				(25	)			3,918
State and municipal bonds			7,433				355				--				7,788
Government-sponsored enterprise obligations			1,864				40				--				1,904
Corporate bonds			6,748				113				(37	)			6,824
		$	23,725			$	754			$	(110	)		$	24,369

 

		Amortized				Gross Unrealized				Gross Unrealized				Fair
		Cost				Gains				Losses				Value
		(In thousands)
December 31, 2019
Residential mortgage-backed securities:
Government National Mortgage Association		$	2,770			$	61			$	(16	)		$	2,815
Government-sponsored enterprises			2,224				51				(9	)			2,266
SBA and other asset-backed securities			4,082				112				(2	)			4,192
State and municipal bonds			7,446				375				--				7,821
Government-sponsored enterprise obligations			4,000				--				(6	)			3,994
Corporate bonds			8,597				139				(9	)			8,727
		$	29,119			$	738			$	(42	)		$	29,815

 

There were no sales of available-for-sale securities for the three months ended March 31, 2020 and 2019.

 

The amortized cost and fair value of debt securities by contractual maturity at March 31, 2020 are as follows:

 

		Amortized Cost				Fair Value
		(In thousands)
Within 1 year		$	--			$	--
After 1 year to 5 years			6,654				6,723
After 5 years to 10 years			7,019				7,316
After 10 years			2,372				2,477
			16,045				16,516
Mortgage- and asset-backed securities			7,680				7,853
		$	23,725			$	24,369

 

Expected maturities may differ from contractual maturities because the issuer, in certain instances, has the right to call or prepay obligations with or without call or prepayment penalties.

 

 

Information pertaining to securities with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

		Less Than Twelve Months								Over Twelve Months
		Gross Unrealized Losses				Fair Value				Gross Unrealized Losses				Fair Value
		(In thousands)
March 31, 2020
Residential mortgage-backed securities:
Government National Mortgage Association		$	--			$	--			$	(44	)		$	876
Government-sponsored enterprises			(4	)			359				--				--
SBA and other asset-backed securities			(5	)			856				(20	)			259
Corporate bonds			(3	)			997				(34	)			974
		$	(12	)		$	2,212			$	(98	)		$	2,109

 

		Less Than Twelve Months								Over Twelve Months
		Gross Unrealized Losses				Fair Value				Gross Unrealized Losses				Fair Value
		(In thousands)
December 31, 2019
Residential mortgage-backed securities:
Government National Mortgage Association		$	--			$	--			$	(16	)		$	908
Government-sponsored enterprises			--				--				(9	)			342
SBA and other asset-backed securities			--				--				(2	)			290
Government-sponsored enterprise obligations			(6	)			2,994				--				--
Corporate bonds			--				--				(9	)			1,000
		$	(6	)		$	2,994			$	(36	)		$	2,540

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluations. At March 31, 2020, various debt securities have unrealized losses with aggregate depreciation of 2.5% from their aggregate amortized cost basis. These unrealized losses relate principally to the effect of interest rate changes on the fair value of debt securities and not an increase in credit risk of the issuers. As the Company does not intend to sell the securities and it is more likely than not that the Company will not be required to sell the securities before recovery of their amortized cost, which may be maturity, the Company does not consider these securities to be other-than-temporarily impaired at March 31, 2020.

 

 

NOTE 6 – LOANS AND ALLOWANCE FOR LOAN LOSSES

 

A summary of the ending balances of loans is as follows:

 

		March 31,				December 31,
		2020				2019
		(In thousands)
Real estate loans:
Residential – fixed		$	89,954			$	77,679
Residential – variable			311,826				310,646
Commercial			180,393				181,928
Construction			139,265				138,007
			721,438				708,260
Commercial loans:
Secured			100,276				92,347
Unsecured			4,818				4,934
			105,094				97,281
Consumer loans:
Home equity lines of credit			37,456				36,693
Other			126				171
			37,582				36,864
Total loans			864,114				842,405
Net deferred originations costs			(379	)			(292	)
Total loans, net of deferred fees			863,735				842,113
Less:
Allowance for loan losses			(8,208	)			(7,653	)
Loans, net		$	855,527			$	834,460

 

 

The following table summarizes the changes in the allowance for loan losses by portfolio segment for the three months ended March 31, 2020 and 2019:

 

		Residential Real Estate				Commercial Real Estate				Construction				Commercial				Home Equity				Other Consumer				Unallocated				Total
		(In thousands)
Three Months Ended March 31, 2020
Allowance at December 31, 2019		$	2,100			$	1,626			$	1,823			$	1,864			$	235			$	4			$	1			$	7,653
Provision (credit) for loan losses			239				162				266				(147	)			27				(1	)			9				555
Allowance at March 31, 2020		$	2,339			$	1,788			$	2,089			$	1,717			$	262			$	3			$	10			$	8,208
Three Months Ended March 31, 2019
Allowance at December 31, 2018		$	2,216				1,602			$	1,462			$	1,124			$	257			$	3			$	74			$	6,738
Provision (credit) for loan losses			(14	)			(241	)			347				157				5				--				(14	)			240
Allowance at March 31, 2019		$	2,202			$	1,361			$	1,809			$	1,281			$	262			$	3			$	60			$	6,978

 

Further information pertaining to the allowance for loan losses is as follows:

 

		Residential Real Estate				Commercial Real Estate				Construction				Commercial				Home Equity				Other Consumer				Unallocated				Total
		(In thousands)
March 31, 2020
Allowance related to impaired loans		$	--			$	--			$	--			$	--			$	--			$	--			$	--			$	--
Allowance related to non-impaired loans			2,339				1,788				2,089				1,717				262				3				10				8,208
Total allowance		$	2,339			$	1,788			$	2,089			$	1,717			$	262			$	3			$	10			$	8,208
Impaired loan balances		$	715			$	548			$	--			$	553			$	500			$	--			$	--			$	2,316
Non-impaired loan balances			401,065				179,845				139,265				104,541				36,956				126				--				861,798
Total loans		$	401,780			$	180,393			$	139,265			$	105,094			$	37,456			$	126			$	--			$	864,114
December 31, 2019
Allowance related to impaired loans		$	--			$	--			$	--			$	350			$	--			$	--			$	--			$	350
Allowance related to non-impaired loans			2,100				1,626				1,823				1,514				235				4				1				7,303
Total allowance		$	2,100			$	1,626			$	1,823			$	1,864			$	235			$	4			$	1			$	7,653
Impaired loan balances		$	721				2,565			$	--			$	1,993			$	500			$	--			$	--			$	5,779
Non-impaired loan balances			387,604				179,363				138,007				95,288				36,193				171				--				836,626
Total loans		$	388,325			$	181,928			$	138,007			$	97,281			$	36,693			$	171			$	--			$	842,405

 

 

The following is a summary of past due and non-accrual loans at March 31, 2020 and December 31, 2019:

 

		30-59 Days Past Due				60-89 Days Past Due				Past Due 90 Days or More				Total Past Due				Past Due 90 Days or More and Still Accruing				Non-accrual Loans
		(In thousands)
March 31, 2020
Residential real estate		$	532			$	--			$	--			$	532			$	--			$	558
Commercial real estate			3,434				--				548				3,982				--				548
Home equity lines of credit			118				--				500				618				--				500
Total		$	4,084			$	--			$	1,048			$	5,132			$	--			$	1,606

 

December 31, 2019
Residential real estate		$	--			$	--			$	--			$	--			$	--			$	562
Commercial real estate			--				--				548				548				--				548
Commercial loans			--				--				--				--				--				883
Home equity lines of credit			--				--				500				500				--				500
Total		$	--			$	--			$	1,048			$	1,048			$	--			$	2,493

 

The following is a summary of impaired loans:

 

		March 31, 2020												December 31, 2019
		Recorded Investment				Unpaid Principal Balance				Related Allowance				Recorded Investment				Unpaid Principal Balance				Related Allowance
						(In thousands)
Impaired  loans without a valuation allowance:
Residential real estate		$	715			$	732			$	--			$	721			$	738			$	--
Commercial real estate			548				674				--				2,565				2,691				--
Commercial loans			553				553				--				1,110				1,110				--
Home equity lines of credit			500				500				--				500				500				--
Total			2,316				2,459				--				4,896				5,039				--
Impaired  loans with a valuation allowance:
Commercial loans			--				--				--				883				883				350
Total impaired loans		$	2,316			$	2,459			$	--			$	5,779			$	5,922			$	350

 

 

Further information pertaining to impaired loans follows:

 

		Three Months Ended March 31, 2020												Three  Months Ended March 31, 2019
		Average Recorded Investment				Interest Income Recognized				Interest Income Recognized on Cash Basis				Average Recorded Investment				Interest Income Recognized				Interest Income Recognized on Cash Basis
		(In thousands)
Residential real estate		$	718			$	9			$	6			$	744			$	6			$	4
Commercial real estate			1,053				8				--				2,809				33				8
Commercial loans			1,386				27				15				--				--				--
Home equity lines of credit			500				--				--				--				--				--
Total		$	3,657			$	44			$	21			$	3,553			$	39			$	12

 

There were no new troubled debt restructurings recorded during the three months ended March 31, 2020 and 2019.

 

There were no TDRs that defaulted, generally considered 90 days past due or longer, during the three months ended March 31, 2020 and 2019, and for which default was within one year of the restructure date. TDRs did not have a material impact on the allowance for loan losses for the three months ended March 31, 2020 and 2019.

 

Credit Quality Information

 

The Company utilizes an eleven-grade internal loan rating system for commercial real estate, construction and commercial loans.

 

Loans rated 1-4: Loans in these categories are considered “pass” rated loans with low to average risk.

 

Loans rated 5: Loans in this category are considered “special mention.” These loans are starting to show signs of potential weakness and are being closely monitored by management.

 

Loans rated 6: Loans in this category are considered “substandard.” Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.

 

Loans rated 7: Loans in this category are considered “doubtful.” Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.

 

Loans rated 8: Loans in this category are considered uncollectible “loss” and of such little value that their continuance as loans is not warranted.

 

Loans rated 9: Loans in this category only include commercial loans under $25 thousand with no other outstandings or relationships with the Company.

 

Loans rated 10: Loans in this category include loans which otherwise require rating but which have not been rated, or loans for which the Company’s loan policy does not require rating.

 

Loans rated 11: Loans in this category include credit commitments/relationships that cannot be rated due to a lack of financial information or inaccurate financial information. If within 60 days of the assignment of an 11 rating, information is still not available to allow a standard rating, the credit will be rated 6.

 

On an annual basis, or more often if needed, the Company formally reviews the ratings on all commercial real estate, construction and commercial loans. During each calendar year, the Company engages an independent third party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its annual review process. On a monthly basis, the Company reviews the residential real estate and consumer loan portfolio for credit quality primarily through the use of delinquency reports.

 

 

The following table presents the Company’s loans by risk rating:

 

		March 31, 2020																December 31, 2019
		Commercial Real Estate				Construction				Commercial				Total				Commercial Real Estate				Construction				Commercial				Total
		(In thousands)
Loans rated 1-4		$	178,979			$	139,265			$	104,541			$	422,785			$	178,488			$	138,007			$	95,287			$	411,782
Loans rated 5			866				--				--				866				875				--				--				875
Loans rated 6			--				--				553				553				2,017				--				1,994				4,011
Loans rated 7			548				--				--				548				548				--				--				548
Total		$	180,393			$	139,265			$	105,094			$	424,752			$	181,928			$	138,007			$	97,281			$	417,216

 

NOTE 7 - DERIVATIVE INSTRUMENTS

 

Certain derivative instruments do not meet the requirements to be accounted for as hedging instruments. These undesignated derivative instruments are recognized on the consolidated balance sheet at fair value, with changes in the fair value recorded in miscellaneous income.

 

Derivative Loan Commitments

 

Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding. The Company enters into commitments to fund residential mortgage loans at specified rates and times in the future, with the intention that these loans will subsequently be sold in the secondary market.

 

Outstanding derivative loan commitments expose the Company to the potential for changes in the fair value of the underlying loans as interest rates change, along with the value of the loan commitment. If interest rates increase, the value of these loan commitments will decrease. Conversely, if interest rates decrease, the value of these loan commitments will increase. The notional amount of undesignated derivative loan commitments was $320 thousand at March 31, 2020. The fair value of these commitments was a liability of $9 thousand. The notional amount of undesignated derivative loan commitments was $350 thousand at December 31, 2019. The fair value of these commitments was a liability of $1 thousand at December 31, 2019.

 

Forward Loan Sale Commitments

 

To protect against the price risk inherent in derivative loan commitments, the Company utilizes “best efforts” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments. With a “best efforts” contract, the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. Generally, the price the investor will pay the seller for an individual loan is specified prior to the loan being funded.

 

The Company expects that these forward loan sale commitments will experience changes in fair value opposite to the change in fair value of derivative loan commitments. The notional amount of undesignated forward loan sale commitments was $2.5 million at March 31, 2020. The fair value of these commitments was an asset of $34 thousand at March 31, 2020. . The notional amount of undesignated forward loan sale commitments was $3.7 million at December 31, 2019. The fair value of these commitments was a liability of $4 thousand at December 31, 2019.

 

 

Interest Rate Swap Agreements

 

The Company has entered into derivative financial instruments in the normal course of business to manage exposure to fluctuations in interest rates for its commercial customers. Typically these agreements have generally been limited to loan level interest rate swap agreements, which are entered into with borrowers and a third party. Typically, the Company enters into a floating-rate loan and a fixed-rate swap directly with a loan customer. The Company offsets the fixed-rate interest rate risk with an identical offsetting swap with a swap dealer. This is referred to as a “back-to-back” swap structure. As this structure has equal and offsetting interest rate contracts, fair value gains and losses recorded each month are offsetting.

 

The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. The primary risk associated with these transactions is the ability of the counterparties to meet the terms of the contract. The fair value of the derivative instruments is reflected on the Company’s consolidated balance sheet as other assets and other liabilities as appropriate. At March 31, 2020, cash in the amount of $11.7 million is pledged as collateral by the Company to its third-party financial institution counterparty. Changes in fair values are recorded in miscellaneous income in the consolidated statements of comprehensive income. There is no credit valuation adjustment at March 31, 2020.

 

A summary of the interest rate swaps is as follows:

 

		With commercial								With  third-party
		loan borrowers								financial institutions
		March 31,				December 31,				March 31,				December 31,
		2020				2019				2020				2019
		(dollars in thousands)
Notional amount			$88,152				$71,941				$88,152				$71,941
Receive (pay) fixed rate weighted average			4.25%				4.43%				(4.25%)				(4.43%)
Receive (pay) variable rate weighted average			(3.01%)				(3.79%)				3.01%				3.79%
Weighted average remaining years			12.6 years				11.0 years				12.6 years				11.0 years
Unrealized fair value gain (loss)			$10,181				$3,472				$(10,181)				$(3,472)

 

NOTE 8 – FAIR VALUES OF FINANCIAL INSTRUMENTS

 

Fair value hierarchy

 

The Company groups its assets measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

 

Level 1 – Valuation is based on quoted market prices in active exchange markets for identical assets and liabilities. Valuations are obtained from readily available pricing sources.

 

Level 2 – Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets and liabilities. Valuations are obtained from readily available pricing sources.

 

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. Level 3 assets include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as those for which the determination of fair value requires significant management judgment or estimation.

 

Transfers between levels are recognized at the end of a reporting period, if applicable.

 

 

Determination of fair value

 

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances there are no quoted market prices for the Company’s various assets and liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the assets and liabilities.

 

Assets and liabilities measured at fair value on a recurring basis

 

Assets and liabilities measured at fair value on a recurring basis at March 31, 2020 and December 31, 2019 are summarized below.

 

		Level 1				Level 2				Level 3				Total Fair Value
		(In thousands)
March 31, 2020
Assets
Securities available for sale		$	--			$	22,841			$	1,528			$	24,369
Interest rate swap agreements			--				10,181				--				10,181
Forward loan sale commitments			--				--				34				34
		$	--			$	33,022			$	1,562			$	34,584
Liabilities
Interest rate swap agreements		$	--			$	10,181			$	--			$	10,181
Derivative loan commitments			--				--				9				9
		$	--			$	10,181			$	9			$	10,190
December 31, 2019
Assets
Securities available for sale		$	--			$	28,293			$	1,522			$	29,815
Interest rate swap agreements			--				3,472				--				3,472
		$	--			$	31,765			$	1,522			$	33,287
Liabilities
Derivative loan commitments		$	--			$	--			$	1			$	1
Forward loan sale commitments			--				--				4				4
Interest rate swap agreements			--				3,472				--				3,472
		$	--			$	3,472			$	5			$	3,477

 

Fair value measurements for securities available for sale are obtained from a third-party pricing service and are not adjusted by management. All securities are measured at fair value in Level 2 based on valuation models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.

 

The fair values of interest rate swap agreements are based on a valuation model that uses primarily observable inputs, such as benchmark yield curves and interest rates and also the value associated with the counterparty risk. Credit risk adjustments consider factors such as the likelihood of default by the Company and its counterparties, its net exposure and remaining contractual life.

 

 

The fair value of forward loan sale commitments and derivative loan commitments are based on fair values of the underlying mortgage loans, including servicing values as applicable. The fair value of derivative loan commitments also considers the probability of such commitments being exercised.

 

Assets measured at fair value on a non-recurring basis

 

The Company may also be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from application of lower-of-cost-or-market (“LOCOM”) accounting or write-downs of individual assets. Fair values for loans held for sale are based on commitments in effect from investors or prevailing market rates.

 

		March 31, 2020												December 31, 2019
		Level 1				Level 2				Level 3				Level 1				Level 2				Level 3
		(In thousands)
Loans held for sale		$	--			$	--			$	2,089			$	--			$	--			$	3,354

 

There were no liabilities measured at fair value on a non-recurring basis at March 31, 2020 and December 31, 2019.

 

Summary of fair values of financial instruments

 

The estimated fair values and related carrying amounts of the Company’s financial instruments are outlined in the table below. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.

 

		Fair Value
		Carrying Amount				Level 1				Level 2				Level 3				Total
	(In thousands)
March 31, 2020
Financial assets:
Cash and cash equivalents		$	34,926			$	34,926			$	--			$	--			$	34,926
Certificates of deposit			100				100				--				--				100
Securities available for sale			24,369				--				22,841				1,528				24,369
FHLB stock			6,202				--				--				6,202				6,202
Loans held for sale			2,089				--				--				2,089				2,089
Loans, net			855,527				--				--				857,026				857,026
Accrued interest receivable			2,595				--				--				2,595				2,595
Interest rate swap agreements			10,181				--				10,181				--				10,181
Forward loan sale commitments			34				--				--				34				34
Financial liabilities:
Deposits		$	735,026			$	--			$	--			$	736,809			$	736,809
Short-term borrowings			45,000				--				45,000				--				45,000
Long-term debt			72,859				--				74,716				--				74,716
Subordinated debt			9,868				--				--				9,812				9,812
Accrued interest payable			506				--				--				506				506
Interest rate swap agreements			10,181				--				10,181				--				10,181
Derivative loan commitments			9				--				--				9				9

 

 

						Fair Value
		Carrying Amount				Level 1				Level 2				Level 3				Total
	(In thousands)
December 31, 2019
Financial assets:
Cash and cash equivalents		$	42,094			$	42,094			$	--			$	--			$	42,094
Certificates of deposit			100				100				--				--				100
Securities available for sale			29,815				--				28,293				1,522				29,815
FHLB stock			4,906				--				--				4,906				4,906
Loans held for sale			3,354				--				--				3,354				3,354
Loans, net			834,460				--				--				839,084				839,084
Accrued interest receivable			2,525				--				--				2,525				2,525
Interest rate swap agreements			3,472				--				3,472				--				3,472
Financial liabilities:
Deposits		$	752,467			$	--			$	--			$	752,699			$	752,699
Short-term borrowings			20,000				--				20,000				--				20,000
Long-term debt			74,196				--				75,256				--				75,256
Subordinated debt			9,861				--				--				9,788				9,788
Interest rate swap agreements			3,472				--				3,472				--				3,472
Accrued interest payable			692				--				--				692				692
Derivative loan commitments			1				--				--				1				1
Forward loan sale commitments			4				--				--				4				4

 

NOTE 9 – EMPLOYEE STOCK OWNERSHIP PLAN

 

The Bank maintains an Employee Stock Ownership Plan (the “ESOP”) to provide eligible employees the opportunity to own Company stock. This plan is a tax-qualified retirement plan for the benefit of all Company employees. Contributions are allocated to eligible participants on the basis of compensation, subject to federal tax limits.

 

The Company granted a loan to the ESOP to purchase shares of the Company’s common stock on the closing date of the Company’s mutual-to-stock conversion in 2012. As of March 31, 2020, the ESOP held 174,852 shares or 6.7% of the common stock outstanding on that date. The loan is payable annually over 15 years at the rate of 3.25% per annum. The loan can be prepaid without penalty. Loan payments are expected to be funded by cash contributions from the Bank. The loan is secured by the shares purchased, which are held in a suspense account for allocation among participants as the loan is repaid. Cash dividends paid on allocated shares are reinvested into shares to participants and cash dividends paid on unallocated shares will be used to repay the outstanding debt of the ESOP. Shares used as collateral to secure the loan are released and available for allocation to eligible employees as the principal and interest on the loan is paid.

 

 

Shares held by the ESOP at March 31, 2020 include the following:

 

Allocated			84,984
Committed to be allocated			3,209
Unallocated			86,659
			174,852

 

The fair value of unallocated shares was $2.4 million at March 31, 2020.

 

Total compensation expense recognized in connection with the ESOP for the three months ended March 31, 2020 and 2019 was $121 thousand and $96 thousand, respectively.

 

NOTE 10 – EQUITY INCENTIVE PLANS

 

Under the Company’s 2016 Equity Incentive Plan, the Company may grant restricted stock awards to its employees and directors for up to 75,000 shares of its common stock. A restricted stock award (the “award”) is a grant of shares of Company common stock for no consideration, subject to a vesting schedule or the satisfaction of market conditions or performance criteria. Awarded shares are held in reserve for each grantee by the Company’s transfer agent, and will be issued from previously authorized but unissued shares upon vesting. The fair value of the stock awards, based on the market price at the grant date, will be recognized over the five-year vesting period. At March 31, 2020, there remain 20,550 shares available to award under the Plan.

 

Under the Company’s 2012 Equity Incentive Plan the Company granted stock options to its employees and directors in the form of incentive stock options and non-qualified stock options totaling 231,894 shares of its common stock. The exercise price of each stock option was not less than the fair market value of the Company’s common stock on the date of grant, and the maximum term of each option is 10 years from the date of each award. The vesting period was five years from the date of grant, with vesting at 20% per year.

 

Under the 2012 Equity Incentive Plan, the Company also granted stock awards to management, employees and directors. Awarded shares are held in reserve for each grantee by the Company’s transfer agent, and were issued from previously authorized but unissued shares upon vesting. The fair value of the stock awards, based on the market price at the grant date, is recognized over the five-year vesting period. The Company’s 2012 Equity Incentive Plan was terminated upon approval of the 2016 Equity Incentive Plan.

 

Stock Options

 

A summary of option activity under the 2012 Equity Incentive Plan for the three months ended March 31, 2020 is presented below:

 

			Outstanding
			Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term				Aggregate Intrinsic Value
			(In thousands)								(In years)				(In thousands)
Balance at January 1, 2020				124			$	16.09
Exercised				(10	)			15.35
Balance at March 31, 2020				114			$	15.82				2.77			$	1,324
Exercisable at  March 31, 2020				112			$	15.78				2.73			$	1,337

 

 

		Non-vested
		Shares				Weighted Average Grant Date Fair Value
		(In thousands)
Balance at January 1, 2020			1			$	19.14
Balance at March 31, 2020			1			$	19.14

 

For the three months ended March 31, 2020 and 2019, compensation expense applicable to the stock options was $1 thousand and $7 thousand, respectively. There was no recognized tax benefit related to this expense for the period ended March 31, 2020 and March 31, 2019, respectively.

 

Unrecognized compensation expense for non-vested stock options totaled $3 thousand as of March 31, 2020, which will be recognized over the remaining weighted average vesting period of 0.5 years.

 

Stock Awards

 

There were no restricted stock awards granted for the three months ended March 31, 2020.

 

The following table presents the activity in non-vested stock awards under the equity incentive plans for the three months ended March 31, 2020:

 

		Number of Shares				Grant-date Fair Value
		(In thousands)
Balance at January 1, 2020			28			$	23.97
Restricted shares vested			(6	)			28.25
Balance at March 31, 2020			22			$	26.48

 

For the three months ended March 31, 2019, there were 11,500 restricted stock awards granted with a weighted average grant date fair value of $28.25

 

For the three months ended March 31, 2020 and 2019, compensation expense applicable to the stock awards was $60 thousand and $95 thousand, respectively, and the recognized tax benefit related to this expense was $17 thousand and $27 thousand, respectively.

 

Unrecognized compensation expense for non-vested restricted stock totaled $484 thousand as of March 31, 2020, which will be recognized over the remaining weighted average vesting period of 2.24 years.

 

 

NOTE 11 – EARNINGS PER COMMON SHARE

 

Basic earnings per share represents net income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Unallocated ESOP shares are not deemed outstanding for earnings per share calculations. Under the Company’s 2012 and 2016 Equity Incentive Plans, stock awards contain non-forfeitable dividend rights. Accordingly, these shares are considered outstanding for computation of basic earnings per share. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method.

 

		Three Months Ended March 31,
		2020				2019
		(In thousands)
Net income applicable to common stock		$	1,541			$	1,302
Average number of common shares issued			2,599				2,532
Less: Average unallocated ESOP shares			(88	)			(101	)
Average number of common shares outstanding used to calculate basic earnings per common share			2,511				2,431
Effect of  dilutive stock options			77				93
Average number of common shares outstanding used to calculate diluted earnings per share			2,588				2,524
Earnings per common share:
Basic		$	0.61			$	0.54
Diluted		$	0.60			$	0.52

 

There were no anti-dilutive options that would have been excluded from the computations of diluted earnings per share for the three months ended March 31, 2020 and 2019. Anti-dilutive shares are common stock equivalents with exercise prices in excess of the strike price of the Company’s stock for the periods presented.

 

NOTE 12 – LEASES

 

Effective January 1, 2019, operating leases are included in operating lease right-of-use (“ROU”) asset and liabilities in our consolidated balance sheet. These operating leases provide the physical facilities for our sales and service locations, administration and operations offices, and ATMs. The Company recorded an increase in assets of $7.8 million and an increase in liabilities of $7.8 million on the Consolidated Balance Sheets as a result of recognizing the right-of-use assets and lease liabilities.

 

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities were recognized at the accounting adoption date based on the present value of lease payments over the remaining lease term. As the Company’s leases do not provide an implicit rate, the Company used the Federal Home Loan Bank borrowing rates that best align with the lease term in determining the present value of lease payments. The Company’s lease terms may include options to extend or terminate the lease, which we include when it is reasonably certain that we will exercise that option. For operating leases, the lease expense is recognized on a straight-line basis over the lease term. The operating lease expense for the three months ended March 31, 2020 was $464 thousand.

 

 

The table below summarizes other information related to our operating leases as of March 31, 2020:

 

Cash flows from operating leases, in thousands, year to date 2020		$	459
Weighted average remaining lease term, in years			5.2
Weighted average discount rate			3.13	%

 

The table below summarizes the maturity of the operating lease liabilities as of March 31, 2020:

 

		(In thousands)
2020		$	1,400
2021			1,714
2022			1,417
2023			1,340
2024			1,136
Thereafter			1,309
Total lease payments			8,316
Less imputed interest			(738	)
Present value of lease liabilities		$	7,578

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

Safe Harbor Statement for Forward-Looking Statements

 

This report contains certain forward-looking statements about the Company and the Bank. 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. 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 COVID-19 (coronavirus) pandemic or the outbreak of 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. Further, statements about the potential effects of the COVID-19 pandemic on our business and financial results and condition may constitute forward-looking statements and are subject to the risk that the actual effects may differ, possibly materially, from what is reflected in those forward-looking statements due to factors and future developments that are uncertain, unpredictable and in many cases beyond our control, including the scope and duration of the pandemic, actions taken by governmental authorities in response to the pandemic, and the direct and indirect impact of the pandemic on our customers, third parties and us. Additional factors that may affect our results that could cause actual results to differ materially from historical results and those presently anticipated or projected are discussed in the Company’s 2019 Annual Report on Form 10-K under the section titled “Item 1A.–Risk Factors.”

 

Except as required by applicable law or regulation, the Company assumes no obligation and disclaims any obligation to update any forward-looking statements. 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.

 

 

Critical Accounting Policies

 

We consider critical accounting policies to be 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: the likelihood of loan 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 qualitative 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 at a level that represents management’s best estimate of losses in the loan portfolio at the balance sheet date, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, there can be no assurance that the FDIC or the Massachusetts Commissioner of Banks, in reviewing our loan portfolio, will not require us to increase our allowance for loan losses based on judgments different from ours. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. 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. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operation.

 

COVID-19. In response to the rapidly evolving COVID-19 pandemic, the Company focused first on the well-being of its people, customers and communities. Preventative health measures were put in place including work from home for all employees able to do so, social distancing precautions for all employees in the office and customers visiting branches, and preventative cleaning at offices and branches. The Company also focused on business continuity measures, including monitoring potential business interruptions, making improvements to our remote working technology, and conducting regular discussions with our technology vendors.

 

The Company has also taken measures to both support customers affected by the pandemic and to maintain strong asset quality, including the following: helping business customers through the Small Business Administration’s Paycheck Protection Program (the “PPP”); offering flexible repayment options for consumer and business clients through a streamlined loan modification process, when appropriate; maintaining prudent underwriting standards; and, monitoring portfolio risk and related mitigation strategies.

 

The Company is participating in the PPP, which provides forgivable loans to small businesses to enable them to maintain payroll, rehire employees who have been laid-off, and cover applicable overhead. After the PPP was announced, the Company mobilized resources to maximize the ability of clients to access this program. As of April 30, 2020, the Company had processed and approved 164 loans under the PPP for a total of $35.0 million.

 

As a further relief to qualified commercial and residential mortgage and consumer loan clients, the Company has developed guidelines to provide for forbearance of certain loan payments for up to 90 days. As of April 30, 2020, the Company had granted approvals for payment deferrals on seven commercial loans with an aggregate balance of $3.0 million, and five residential mortgage loans with an aggregate balance of $3.5 million.

 

 

Comparison of Financial Condition at March 31, 2020 and December 31, 2019

 

General. Total assets increased $15.7 million, or 1.7%, from $945.2 million at December 31, 2019 to $960.9 million at March 31, 2020. Total asset growth was primarily related to an increase in the net loan portfolio of $21.1 million or 2.5%, along with the quarterly mark-to-market increase of $6.7 million on client swaps, partially offset by a reduction in short-term investments and cash of $7.2 million and investments of $5.4 million.

 

Loans. The net loan portfolio increased $21.1 million. We have had continued success growing our commercial loan portfolio. Commercial and industrial loans increased $7.8 million, or 12.2%, to $105.1 million. Construction loans increased $1.3 million to $139.3 million. Commercial real estate loans decreased $1.5 million to $180.4 million. Residential real estate loans increased $13.5 million, or 3.5%, to $401.8 million, compared to $388.3 million at December 31, 2019.

 

At March 31, 2020, past due loans totaled $5.1 million as compared to $1.0 million at December 31, 2019. The increase is exclusively due to borrowers who have recently become 30-59 days past due. All delinquent loans are secured by real estate collateral with values exceeding outstanding loan principal. As of April 15, 2020, $2.7 million of the past due loans at March 31, 2020 had been brought current. There were no charge-offs on delinquent loans during the three months ended March 31, 2020 and March 31, 2019.

 

Securities. Total securities decreased from $29.8 million at December 31, 2019 to $24.4 million at March 31, 2020 primarily due to maturities and calls on securities in the current, low interest rate environment.

 

Deposits. Total deposits decreased $17.4 million, or 2.3%, from $752.5 million at December 31, 2019 to $735.0 million at March 31, 2020. Demand deposits and NOW accounts increased $17.4 million, or 9.7%, to $196.2 million as growth was realized in both retail and commercial accounts. Money market accounts decreased $24.3 million, or 8.8% as depositors moved funds to more liquid alternatives in these uncertain markets. Certificates of deposit decreased $6.1 million, to $230.2 million, which included a decrease of $3.0 million in brokered accounts. Savings account balances also decreased $4.5 million to $73.5 million at March 31, 2020.

 

Borrowings. We use borrowings, primarily from the FHLB, to supplement our supply of funds for loans and securities, and to support short-term liquidity needs of the institution. Long-term debt, consisting entirely of FHLB advances, decreased $1.3 million, or 1.8%, for the three months ended March 31, 2020. Short-term borrowings also consist entirely of advances from the FHLB with initial maturities less than one year. Balances of short-term borrowings increased $25.0 million, or 125.0%, from December 31, 2019 to meet liquidity needs. Subordinated debt was $9.8 million at March 31, 2020 and December 31, 2019.

 

Stockholders’ Equity. Stockholders’ equity increased $1.7 million, or 2.3%, from $73.5 million at December 31, 2019 to $75.1 million at March 31, 2020. The increase was primarily due to retained earnings and the exercise of stock options, partially offset by a decrease in the fair values of available-for-sale securities and by dividends paid. At March 31, 2020, the Company’s ratio of stockholders’ equity-to-total assets was 7.82%, compared to 7.77% at December 31, 2019.

 

Results of Operations for the Three Months Ended March 31, 2020 and 2019

 

Overview. Net income for the three months ended March 31, 2020 was $1.5 million, compared to net income of $1.3 million for the three months ended March 31, 2019, an increase of $239 thousand or 18.4%. The increase in net income was due to increases in net interest income and non-interest income, partially offset by an increase in the provision for loan losses and an increase in non-interest expense. Net interest income increased $809 thousand to $7.2 million and non-interest income increased $374 thousand to $1.1 million. The provision for loan loss increased $315 thousand to $555 thousand in the 2020 quarter. Non-interest expense increased $468 thousand and totaled $5.6 million for the three months ended March 31, 2020. Income tax expense increased $161 thousand to $637 thousand, as compared to the 2019 period.

 

Net Interest Income. Net interest income for the three months ended March 31, 2020 increased $809 thousand, or 12.6%, as compared to the three months ended March 31, 2019. The increase in interest income was due to increases in the average balances of loans offset by a decreasing yield. Interest expense decreased, driven by overall deposit decreases, lower rates offered on certificates of deposit and money market accounts, and lower rates on borrowings. The net interest margin improved from 3.02% in the first quarter of 2019 to 3.15% in the first quarter of 2020.

 

 

Interest and dividend income increased $671 thousand, or 7.1%, from $9.4 million for the three months ended March 31, 2019 to $10.1 million for the three months ended March 31, 2020. The average balance of interest-earning assets increased 6.9%, while the average rate earned on these assets decreased by three basis points (“bps”). Interest and fees on loans increased $976 thousand, or 11.2%, due, in part, to an 11.3% increase in the average balance of loans. The average rate earned on loans decreased four bps to 4.55%. Interest income from debt securities decreased $243 thousand, or 52.8%, due primarily to a decrease in the average balances associated with a sale of almost half of the portfolio in late 2019.

 

Interest expense decreased $138 thousand, or 4.6% primarily due to a decrease in average balances of interest-bearing deposits and a decrease in rates. Our funding costs have responded more quickly than loan income to the change in interest rates. Deposit expense decreased $436 thousand or 17.5%. The average balance of interest-bearing deposits decreased $17.5 million, or 2.9%, in the three months ended March 31, 2020, compared to the same period in 2019 and the average rate paid on interest bearing deposits decreased 26 bps. The cost of term certificates of deposit decreased $387 thousand to $1.1 million as average balances decreased $73.1 million. Rates paid on certificates of deposit balances decreased to 2.10%, down from 2.12% in the same period last year. In the 2020 period, interest expense on money market accounts decreased by $26 thousand to $849 thousand. The rate paid on money market accounts decreased 37 bps primarily due to lower interest rates offered on these accounts. The average balance of money market accounts of $274.3 million is compared to $220.8 million in the prior year period.

 

Interest expense increased for borrowings. Interest expense on short-term borrowings totaled $171 thousand in the three month period ended March 31, 2020, compared to $110 thousand in the three months ended March 31, 2019, primarily due to increases in average balances. Rates paid on short-term borrowings decreased by 103 bps during the 2020 period. Long-term debt expense totaled $480 thousand in the three month period ended March 31, 2020 compared to $243 thousand in the three months ended March 31, 2019. The average balance of long-term FHLB advances increased from $56.2 million to $73.3 million, while rates paid on long-term FHLB advances increased from 1.75% to 2.63%.

 

 

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 Three Months Ended March 31,
		2020												2019
(Dollars in thousands)		Average Outstanding Balance				Interest Earned/ Paid				Average Yield/ Rate (1)				Average Outstanding Balance				Interest Earned/ Paid				Average Yield/ Rate (1)
Interest-earning assets:
Short-term investments		$	32,810			$	107				1.32	%		$	24,151			$	164				2.76	%
Debt securities:
Taxable			19,589				162				3.31				52,043				378				2.94
Tax-exempt			7,900				55				2.78				12,993				82				2.55
Total loans and loans held for sale			858,249				9,703				4.55				770,975				8,727				4.59
FHLB stock			5,445				74				5.45				3,882				79				8.27
Total interest-earning assets			923,993				10,101				4.40				864,044				9,430				4.43
Allowance for loan losses			(7,724	)											(6,831	)
Total interest-earning assets less allowance for loan losses			916,269												857,213
Non-interest-earning assets			35,987												30,626
Total assets		$	952,256											$	887,839
Interest-bearing liabilities:
Regular savings accounts		$	75,604				90				0.48			$	79,201				119				0.61
NOW checking accounts			39,199				34				0.35				33,574				28				0.34
Money market accounts			274,268				849				1.24				220,764				875				1.61
Certificates of deposit			207,168				1,080				2.10				280,242				1,467				2.12
Total interest-bearing deposits			596,239				2,053				1.38				613,781				2,489				1.64
Short-term borrowings			37,255				171				1.84				15,592				110				2.87
Long-term debt			73,262				480				2.63				56,232				243				1.75
Subordinated debt			9,864				157				6.40				9,835				157				6.49
Total interest-bearing liabilities			716,620				2,861				1.61				695,440				2,999				1.75
Non-interest-bearing demand deposits			142,607												115,629
Other non-interest-bearing liabilities			17,837												10,269
Total liabilities			877,064												821,338
Stockholders’ equity			75,192												66,501
Total liabilities and stockholders’ equity		$	952,256											$	887,839
Net interest income						$	7,240											$	6,431
Net interest rate spread (2)											2.79	%											2.68	%
Net interest-earning assets (3)		$	207,374											$	168,604
Net interest margin (4)											3.15	%											3.02	%
Average total interest-earning assets to average total interest-bearing liabilities			128.94	%											124.24	%

 

 

(1)

Ratios for the three month period have been annualized.

(2)

Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.

(3)

Represents total average interest-earning assets less total average interest-bearing liabilities.

(4)

Represents net interest income as a percent of average interest-earning assets.

 

 

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.

 

		Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019
		Increase (Decrease) Due to								Total Increase
(In thousands)		Volume				Rate				(Decrease)
Interest-earning assets:
Short-term investments		$	130			$	(187	)		$	(57	)
Debt securities:
Taxable			(281	)			65				(216	)
Tax-exempt			(37	)			10				(27	)
Total loans and loans held for sale			918				58				976
FHLB stock			(30	)			25				(5	)
Total interest-earning assets			700				(29	)			671
Interest-bearing liabilities:
Regular savings			(5	)			(23	)			(28	)
NOW checking			5				1				6
Money market			(218	)			191				(27	)
Certificates of deposit			(393	)			7				(386	)
Total interest-bearing deposits			(611	)			176				(435	)
Short-term borrowings			80				(20	)			60
Long-term debt			86				151				237
Subordinated debt			--				--				--
Total interest-bearing liabilities			(445	)			307				(138	)
Increase (decrease) in net interest income		$	1,145			$	(336	)		$	809

 

Provision for Loan Losses. The provision for loan losses was $555 thousand for the three months ended March 31, 2020, compared to $240 thousand for the three month period ended March 31, 2019. The additional provision is in anticipation of the economy slowing in coming quarters associated with the COVID-19 outbreak. No charge-offs were recorded in the first quarter 2020. A specific reserve of $350 thousand that was established at the end of 2019 was reversed when the related loan paid off in the first quarter. The 2020 first quarter’s reserve is based upon the assumption that U. S. and local gross domestic product will fall and unemployment will rise.

 

 

Analysis of Loan Loss Experience. The following table sets forth an analysis of the allowance for loan losses for the periods indicated.

 

		Three Months Ended
		March 31,
(Dollars in thousands)		2020				2019
Allowance at beginning of period		$	7,653			$	6,738
Provision for loan losses			555				240
Charge-offs			--				--
Recoveries			--				--
Net charge-offs			--				--
Allowance at end of period		$	8,208			$	6,978
Allowance for loan losses to nonperforming loans at end of period			511.09	%			619.10	%
Allowance for loan losses to total loans at end of period			0.95	%			0.88	%
Net charge-offs to average loans outstanding during the period			0.00	%			0.00	%

 

Non-interest Income. Non-interest income totaled $1.1 million, an increase of $374 thousand or 54.8%. Other miscellaneous income increased $449 thousand due to increases in fees on customer loan interest rate swaps associated with commercial loan originations of $283 thousand, and income of $160 thousand realized due to the merger of The Co-operative Central Bank and its Share Insurance Fund with the Depositors Insurance Fund. Wealth management fees decreased by $69 thousand to $365 thousand as assets under management (“AUM”) were $332.9 million as of March 31, 2020, compared to $419.3 million at March 31, 2019. The reduction in AUM is mainly due to market value fluctuations and partly due to the sale of $28.4 million during 2019 of the Bank’s investment portfolio. Income from mortgage banking activities in 2020 decreased $21 thousand as sales of residential mortgage loans were lower as compared to the prior year.

 

Non-interest Expense. Non-interest expense totaled $5.6 million for the three months ended March 31, 2020, compared to $5.1 million for the three months ended March 31, 2019, an increase of $468 thousand, or 9.2%. Salaries and employee benefits increased $156 thousand to $3.2 million due to various employee benefit cost increases. Professional fees increased $308 thousand due mainly to higher corporate legal expense and professional fees associated with the proposed merger with Cambridge Bancorp. Occupancy and equipment costs increased $111 thousand due to annual rent adjustments and additional space taken at our home office facility. FDIC insurance expense increased $45 thousand primarily due to higher assessment balances and rates. Other general and administrative expenses decreased $157 thousand due to a decline in advertising along with various efforts to contain discretionary expenses.

 

Income Taxes. An income tax provision of $637 thousand was recorded during the quarter ended March 31, 2020, compared to a provision of $476 thousand in the comparable 2019 quarter. The effective tax rate for the 2020 three month period was 29.3%, compared to 26.8% for the 2019 three month period. The tax rate increase is due to a reduction in some tax-advantaged investments.

 

Liquidity and Capital Resources

 

Liquidity Management. Liquidity is the ability to meet current and future financial obligations of a short-term and long-term nature. The Bank’s primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities, and borrowings from the FHLB. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, calls of securities and prepayments on loans are greatly influenced by seasonal events, general interest rates, economic conditions and competition.

 

Management regularly adjusts our investments in liquid assets based upon an assessment of the following: expected loan demand; expected deposit flows; yields available on interest-earning deposits and securities; and, the objectives of our interest-rate risk and investment policies.

 

 

Our most liquid assets are cash and cash equivalents, interest-bearing deposits in other banks, and securities available for sale. The level of these assets depends on our operating, financing, lending and investing activities during any given period. At March 31, 2020, cash and cash equivalents, which include short-term investments, totaled $35.0 million. Securities classified as available-for-sale, whose aggregate fair value is $24.4 million, provide additional sources of liquidity.

 

At March 31, 2020, we had $45.0 million in short-term borrowings outstanding, represented entirely by FHLB advances, and $72.9 million in long-term debt, also consisting entirely of FHLB advances. At March 31, 2020, we had a total of $71.8 million in unused borrowing capacity from the FHLB. Short-term borrowings are generally used to fund temporary cash needs due to the timing of loan originations and deposit gathering activities. Long-term debt is generally used to provide for longer-term funding needs of the Company, including the match funding of loans originated for portfolio. At March 31, 2020, we also had the ability to borrow on a credit line of $5.0 million with a correspondent bank, and $8.7 million from the Federal Reserve Bank under a collateralized borrowing program, none of which was outstanding at that date.

 

At March 31, 2020, we had $185.4 million in loan commitments outstanding, which included $59.9 million in unadvanced funds on construction loans, $42.9 million in unadvanced home equity lines of credit, $58.3 million in unadvanced commercial lines of credit, and $22.7 million in new loan originations.

 

Term certificates of deposit due within one year of March 31, 2020 amounted to $174.2 million, or 82.7%, of total term certificates, an increase of $4.6 million from $169.6 million at December 31, 2019. Balances of term certificates maturing in more than one year totaled $36.5 million at March 31, 2020, down from $47.1 million balances at December 31, 2019. Balances of term certificates that mature within one year reflect customer preferences for greater liquidity of personal funds, while longer-dated certificates reflect a willingness among customers to accept current interest rates for extended time periods. If maturing deposits are not renewed, we will be required to seek other sources of funds, including new term certificates and other borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the existing funds. We have the ability to attract and retain deposits by adjusting the interest rates offered.

 

The Company is a separate legal entity from the Bank and will have to provide for its own liquidity to pay its operating expenses and other financial obligations. The Company’s primary source of income will be dividends received from the Bank. Massachusetts banking law and FDIC regulations limit distributions of capital. In addition, the Company is subject to the policy of the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) that dividends to stockholders should be paid only out of current earnings and only if the prospective rate of earnings retention by the Company appears consistent with its capital needs, asset quality and overall financial condition. At March 31, 2020, the Company had $758 thousand of liquid assets as represented by cash and cash equivalents on an unconsolidated basis.

 

Capital Management. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

Federal banking regulations require a minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6%, a minimum ratio of total capital to risk-weighted assets of 8% and a minimum leverage ratio of 4% for all banking organizations. Additionally, community banking institutions must maintain a capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets above adequately capitalized levels to avoid being subject to limitations on capital distributions and discretionary bonuses. Management believes that the Company’s capital levels will remain as “well-capitalized,” and above the buffer-enhanced levels.

 

 

Off-Balance Sheet Arrangements

 

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For information about our loan commitments and unused lines of credit see Liquidity Management herein.

 

For the three months ended March 31, 2020, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material effect on the Company’s financial condition, results of operations or cash flows.

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk

 

Qualitative Aspects of Market Risk

 

One significant risk affecting the financial condition and operating results of the Company and the Bank is interest rate risk. We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. To reduce the potential volatility of our earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Our strategy for managing interest rate risk emphasizes the following: originating adjustable-rate loans for retention in our loan portfolio; selling in the secondary market newly originated, conforming longer-term fixed rate residential mortgage loans; promoting core deposit products; adjusting the maturities of borrowings; and, adjusting the investment portfolio mix and duration.

 

We have an Asset/Liability Committee, which includes members of management, to communicate, coordinate and control all aspects involving asset-liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.

 

Quantitative Aspects of Market Risk

 

We analyze our interest rate sensitivity position to manage the risk associated with interest rate movements through the use of interest income and equity simulations. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest sensitive.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period.

 

Our goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest income and the present value of our equity. Interest income and equity simulations are completed quarterly and presented to the Asset/Liability Committee and the Board of Directors. The simulations provide an estimate of the impact of changes in interest rates on net interest income and the present value of our equity under a range of assumptions. The simulation incorporates assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and changes spreads between different market rates. The simulation analysis incorporates management’s current assessment of the risk that pricing margins will change adversely over time due to competition or other factors.

 

Simulation analysis is only an estimate of our interest rate risk exposure at a particular point in time. We continually review the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.

 

The table below sets forth an approximation of our exposure as a percentage of estimated net interest income for the next 12 month period using interest income and equity simulations. The simulations use projected repricing of assets and liabilities at March 31, 2020 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rates can have a significant impact on the simulations. Because of the large percentage of loans we hold, rising or falling interest rates have a significant impact on the prepayment speeds of our earning assets that, in turn, affect the rate sensitivity position. When interest rates rise, loan prepayments tend to slow. When interest rates fall, loan prepayments tend to rise. Our asset sensitivity would be reduced if prepayments slowed and would increase if prepayments accelerated. While we believe such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity.

 

 

The following table reflects the estimated effects of changes in interest rates on the present value of our equity at March 31, 2020 and on our projected net interest income from March 31, 2020 through March 31, 2021. These estimates are in compliance with our internal policy limits.

 

				As of March 31, 2020												Over the Next 12 Months Ending March 31, 2021
Basis Point (“bp”)				Present Value of Equity												Projected Net Interest Income
Change in Rates				$ Amount				$ Change				% Change				$ Amount				$ Change				% Change
(Dollars in thousands)
	300 bp			$	71,319			$	(7,572	)			(9.60	)%		$	30,619			$	(1,085	)			(3.42	)%
	200				78,130				(761	)			(0.96	)			30,811				(893	)			(2.82	)
	0				78,891				--				--				31,704				--				--
	(100)				76,210				(2,681	)			(3.40	)			30,593				(1,111	)			(3.50	)

 

Item 4. Controls and Procedures

 

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the quarter ended March 31, 2020 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

As previously disclosed, on February 25, 2020, one purported stockholder of the Company filed a putative derivative and class action lawsuit against the Company, the members of the Company’s board of directors, Wellesley Bank, 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, among other things, that the Company’s board of directors breached its fiduciary obligations by approving the Merger Agreement and 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.

  

The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. 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. The Company’s management believes that such routine legal proceedings, in the aggregate, are immaterial to the Company’s financial condition, results of operations and cash flows.

 

Item 1A. Risk Factors

 

The information below updates, and should be read in conjunction with, the risk factors disclosed in Part I, “Item 1 A- Risk Factors” in the Form 10-K for the year ended December 31, 2019 that we filed with the Securities and Exchange Commission on March 27, 2020. Except as presented below, there have been no material changes in the risk factors as discussed in our Form 10-K.

 

The widespread outbreak of the novel coronavirus ("COVID-19") has adversely affected, and will likely continue to adversely affect, our business, financial condition, and results of operations. Moreover, the longer the pandemic persists, the more material the ultimate effects are likely to be.

 

The COVID-19 pandemic is negatively impacting economic and commercial activity and financial markets, both globally and within the United States. In our market area, the governor of Massachusetts has issued orders that, among other things, require residents to stay in their homes and permit them to leave only to conduct certain essential activities or to travel to work. At this time, the governor has closed all non-essential businesses to the general public, and closed certain businesses such as senior centers, restaurants, bars, fitness centers and shopping malls. These stay-at-home orders and travel restrictions – and similar orders imposed across the United States to restrict the spread of COVID-19 – have resulted in significant business and operational disruptions, including business closures, supply chain disruptions, and mass layoffs and furloughs.

 

As an essential business, we have implemented business continuity plans and continue to provide financial services to clients, while taking health and safety measures such as transitioning most in-person customer transactions to our drive-thru facilities and limiting access to the interior of our facilities. We have also instituted frequent cleaning of our facilities and use of a remote workforce where possible. Despite these safeguards, we may nonetheless experience business disruptions.

 

The COVID-19 pandemic has negatively affected our business and is likely to continue to do so. However, the extent to which COVID-19 will negatively affect our business is unknown and will depend on the geographic spread of the virus, the overall severity of the disease, the duration of the pandemic, the actions undertaken by national, state and local governments and health officials to contain the virus or treat its effects, and how quickly and to what extent economic conditions improve and normal business and operating conditions resume. The longer the pandemic persists, the more material the ultimate effects are likely to be.

 

 

The continued spread of COVID-19 and the efforts to contain the virus, including stay-at-home orders and travel restrictions could:

 

·

cause changes in consumer and business spending, borrowing and saving habits, which may affect the demand for loans and other products and services we offer, as well as the creditworthiness of potential and current borrowers;

·

cause our borrowers to be unable to meet existing payment obligations, particularly those borrowers that may be disproportionately affected by business shut downs and travel restrictions, such as those operating in the travel, lodging, retail, and entertainment industries, resulting in increases in loan delinquencies, problem assets, and foreclosures;

·

cause the value of collateral for loans, especially real estate, to decline in value;

·

reduce the availability and productivity of our employees;

·

require us to increase our allowance for credit losses;

·

cause our vendors and counterparties to be unable to meet existing obligations to us;

·

negatively impact the business and operations of third party service providers that perform critical services for our business;

·

cause a material decrease in the market value of assets under management, which would have a negative impact on our wealth management revenues due to the fact that our wealth management fees are based on the market value of client assets;

·

impede our ability to close mortgage loans, if appraisers and title companies are unable to perform their functions;

·

cause the value of our securities portfolio to decline; and

·

cause the net worth and liquidity of loan guarantors to decline, impairing their ability to honor commitments to us.

 

Any one or a combination of the above events could have a material, adverse effect on our business, financial condition, and results of operations. Moreover, our success and profitability is substantially dependent upon the management skills of our executive officers, many of whom have held officer positions with us for many years. The unanticipated loss or unavailability of key employees due to COVID-19 could harm our ability to operate our business or execute our business strategy. We may not be successful in finding and integrating suitable successors in the event of key employee loss or unavailability.

 

Certain actions taken by U.S. or other governmental authorities, including the Federal Reserve, that are intended to ameliorate the macroeconomic effects of COVID-19, may cause additional harm to our business. Decreases in short-term interest rates, such as those announced by the Federal Reserve during the first fiscal quarter of 2020, have a negative impact on our results, as we have certain assets and liabilities that are sensitive to changes in interest rates.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Not applicable.

 

Item 3. Defaults Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable.

 

Item 6. Exhibits

 

3.1

Amended and Restated Articles of Incorporation of Wellesley Bancorp, Inc. (1)

 

3.2

Amended and Restated Bylaws of Wellesley Bancorp, Inc. (2)

 

4.1

Form of 6.00% Fixed to Floating Subordinated Note Due 2025 (3)

 

31.1

Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

 

31.2

Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

 

32.0

Section 1350 Certification

 

101.1

The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Comprehensive Income, (iii) the Consolidated Statements of Changes in Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements.

 

(1)

Incorporated herein by reference to the exhibits to Wellesley Bancorp, Inc.’s Pre-Effective Amendment No. 2 to the Registration Statement on Form S-1 (File No. 333-176764), filed with the Securities and Exchange Commission on May 8, 2011.

 

(2)

Incorporated herein by reference to the exhibits to Wellesley Bancorp, Inc.’s Annual Report on Form 10-K (File No. 001-35352), filed with the Securities and Exchange Commission on March 29, 2019.

 

(3)

Incorporated herein by reference to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on December 17, 2015 (included as Exhibit A to the Purchase Agreement filed as Exhibit 10.1 thereto).

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		WELLESLEY BANCORP, INC.
Dated:     May 8, 2020	By:	/s/ Thomas J. Fontaine
		Thomas J. Fontaine
		President and Chief Executive Officer
		(Principal Executive Officer)
Dated:     May 8, 2020	By:	/s/ Michael W. Dvorak
		Michael W. Dvorak
		Chief Financial Officer and Treasurer
		(Principal Accounting and Financial Officer)