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Section 1: 10-Q (QUARTERLY REPORT)

 

 

 

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION  

Washington, D. C. 20549

 

 

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2018

 

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 001-16767

 

Western New England Bancorp, Inc.  

(Exact name of registrant as specified in its charter)

 

Massachusetts 73-1627673
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

141 Elm Street, Westfield, Massachusetts 01086 

(Address of principal executive offices) 

(Zip Code)

 

(413) 568-1911 

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, 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,” “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  
     
Smaller reporting company  ☐ 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 accounting 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 ☒

 

At November 2, 2018, the registrant had 29,315,837 shares of common stock, $0.01 par value, issued and outstanding.

 

 

 

 

 

 

TABLE OF CONTENTS

 

      Page
       
FORWARD-LOOKING STATEMENTS   i
       
PART I – FINANCIAL INFORMATION    
       
Item 1. Financial Statements of Western New England Bancorp, Inc. and Subsidiaries (Unaudited)    
       
  Consolidated Balance Sheets – September 30, 2018 and December 31, 2017   1
       
  Consolidated Statements of Net Income – Three and Nine Months Ended September 30, 2018 and 2017   2
       
  Consolidated Statements of Comprehensive Income – Three and Nine Months Ended September 30, 2018 and 2017   3
       
  Consolidated Statements of Changes in Shareholders’ Equity – Nine Months Ended September 30, 2018 and 2017   4
       
  Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2018 and 2017   5
       
  Notes to Consolidated Financial Statements   6
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   31
       
Item 3. Quantitative and Qualitative Disclosures About Market Risk   45
       
Item 4. Controls and Procedures   45
       
PART II – OTHER INFORMATION    
       
Item 1. Legal Proceedings   46
       
Item 1A. Risk Factors   46
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   46
       
Item 3. Defaults upon Senior Securities   46
       
Item 4. Mine Safety Disclosures   46
       
Item 5. Other Information   46
       
Item 6. Exhibits   47

 

 

 

 

FORWARD–LOOKING STATEMENTS

 

We may, from time to time, make written or oral “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements contained in our filings with the Securities and Exchange Commission (the “SEC”), our reports to shareholders and in other communications by us. This Quarterly Report on Form 10-Q contains “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “would,” “plan,” “estimate,” “potential” and other similar expressions. Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operation and business that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to:

 

changes in the interest rate environment that reduce margins;

 

the effect on our operations of governmental legislation and regulation, including changes in accounting regulation or standards, the nature and timing of the adoption and effectiveness of new requirements under the Dodd-Frank Act Wall Street Reform and Consumer Protection Act of 2010, Basel guidelines, capital requirements and other applicable laws and regulations;

 

the highly competitive industry and market area in which we operate;

 

general economic conditions, either nationally or regionally, resulting in, among other things, a deterioration in credit quality;

 

changes in business conditions and inflation;

 

changes in credit market conditions;

 

the inability to realize expected cost savings or achieve other anticipated benefits in connection with business combinations and other acquisitions;

 

changes in the securities markets which affect investment management revenues;

 

increases in Federal Deposit Insurance Corporation deposit insurance premiums and assessments;

 

changes in technology used in the banking business;

 

the soundness of other financial services institutions which may adversely affect our credit risk;

 

certain of our intangible assets may become impaired in the future;

 

our controls and procedures may fail or be circumvented;

 

new line of business or new products and services, which may subject us to additional risks;

 

changes in key management personnel which may adversely impact our operations;

 

severe weather, natural disasters, acts of war or terrorism and other external events which could significantly impact our business; and

 

other factors detailed from time to time in our SEC filings.

 

Although we believe that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, except to the extent required by law.

 

i  

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1: FINANCIAL STATEMENTS. 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES 

CONSOLIDATED BALANCE SHEETS - UNAUDITED 

(Dollars in thousands, except share data)

 

    September 30,     December 31,  
    2018     2017  
ASSETS                
CASH AND DUE FROM BANKS   $ 27,923     $ 21,607  
FEDERAL FUNDS SOLD     6,259       322  
INTEREST-BEARING  DEPOSITS AND OTHER SHORT-TERM INVESTMENTS     27,817       5,203  
CASH AND CASH EQUIVALENTS     61,999       27,132  
                 
SECURITIES AVAILABLE-FOR-SALE – AT FAIR VALUE     252,984       288,416  
MARKETABLE EQUITY SECURITIES – AT FAIR VALUE     6,319        
FEDERAL HOME LOAN BANK OF BOSTON AND OTHER RESTRICTED STOCK - AT COST     15,480       15,553  
LOANS - Net of allowance for loan losses of $12,235 and $10,831 at September 30, 2018 and
December 31, 2017, respectively
    1,680,333       1,619,850  
PREMISES AND EQUIPMENT, Net     24,460       23,500  
ACCRUED INTEREST RECEIVABLE     5,831       5,946  
BANK-OWNED LIFE INSURANCE     68,801       68,762  
DEFERRED TAX ASSET, Net     10,557       8,784  
GOODWILL     12,487       12,487  
CORE DEPOSIT INTANGIBLE     3,781       4,063  
OTHER ASSETS     7,493       8,577  
TOTAL ASSETS   $ 2,150,525     $ 2,083,070  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY                
LIABILITIES:                
DEPOSITS :                
Non-interest-bearing   $ 357,845     $ 311,851  
Interest-bearing     1,251,174       1,194,231  
Total deposits     1,609,019       1,506,082  
                 
SHORT-TERM BORROWINGS     55,000       144,650  
LONG-TERM DEBT     224,306       164,786  
OTHER LIABILITIES     20,915       20,271  
TOTAL LIABILITIES     1,909,240       1,835,789  
                 
SHAREHOLDERS’ EQUITY:                
Preferred stock - $0.01 par value, 5,000,000 shares authorized, none outstanding at September 30, 2018 and December 31, 2017            
Common stock - $0.01 par value, 75,000,000 shares authorized, 29,453,808 shares issued and outstanding at September 30, 2018; 30,487,309 shares issued and outstanding at December 31, 2017     295       305  
Additional paid-in capital     192,581       203,527  
Unearned compensation – ESOP     (5,325 )     (5,786 )
Unearned compensation – Equity Incentive Plan     (1,010 )     (791 )
Retained earnings     71,402       62,578  
Accumulated other comprehensive loss     (16,658 )     (12,552 )
TOTAL SHAREHOLDERS’ EQUITY:     241,285       247,281  
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY   $ 2,150,525     $ 2,083,070  

 

See accompanying notes to unaudited consolidated financial statements.

 

  1

 

 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF NET INCOME – UNAUDITED 

(Dollars in thousands, except per share data) 

                         
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2018     2017     2018     2017  
INTEREST AND DIVIDEND INCOME:                                
Residential and commercial real estate loans   $ 14,507     $ 13,474     $ 42,850     $ 40,042  
Commercial and industrial loans     2,982       2,883       9,573       8,180  
Consumer loans     88       88       261       260  
Debt securities, taxable     1,709       1,828       5,227       5,529  
Debt securities, tax-exempt     19       25       64       81  
Equity securities     38       35       112       105  
Other investments     228       172       631       501  
Short-term investments     34       11       83       103  
Total interest and dividend income     19,605       18,516       58,801       54,801  
                                 

INTEREST EXPENSE: 

                               
Deposits     3,094       2,111       8,167       6,180  
Long-term debt     1,193       534       3,178       1,633  
Short-term borrowings     713       1,075       2,264       2,946  
Total interest expense     5,000       3,720       13,609       10,759  
Net interest and dividend income     14,605       14,796       45,192       44,042  
                                 
PROVISION FOR LOAN LOSSES     350       200       1,600       850  
Net interest and dividend income after provision for loan losses     14,255       14,596       43,592       43,192  
                                 
NON-INTEREST INCOME (LOSS):                                
Service charges and fees     1,891       1,714       5,167       4,789  
Income from bank-owned life insurance     448       450       1,374       1,369  
Bank-owned life insurance death benefit                 715        
Gain (loss) on securities, net           70       (250 )     52  
Unrealized losses on marketable equity securities, net     (43 )           (190 )      
Gain on sale of other real estate owned           67       48       67  
Other income           111       131       227  
Total non-interest income     2,296       2,412       6,995       6,504  
                                 
NON-INTEREST EXPENSE:                                
Salaries and employee benefits     6,451       6,490       19,548       18,954  
Occupancy     952       891       2,979       2,815  
Furniture and equipment     400       410       1,149       1,149  
Data processing     642       680       1,957       1,740  
Professional fees     767       642       2,107       1,919  
FDIC insurance assessment     158       163       463       466  
Merger related expenses                       526  
Advertising     351       328       1,053       961  
Other expenses     1,851       1,552       5,288       4,892  
Total non-interest expense     11,572       11,156       34,544       33,422  
INCOME BEFORE INCOME TAXES     4,979       5,852       16,043       16,274  
INCOME TAX PROVISION     1,070       2,037       3,476       3,600  
NET INCOME   $ 3,909     $ 3,815     $ 12,567     $ 12,674  
                                 
EARNINGS PER COMMON SHARE:                                
Basic earnings per share   $ 0.14     $ 0.13     $ 0.43     $ 0.42  
Weighted average shares outstanding     28,789,132       30,103,095       29,100,735       29,895,621  
Diluted earnings per share   $ 0.14     $ 0.13     $ 0.43     $ 0.42  
Weighted average diluted shares outstanding     28,937,038       30,219,083       29,242,862       30,074,361  

 

 See accompanying notes to unaudited consolidated financial statements.

 

  2

 

  

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME – UNAUDITED 

(Dollars in thousands)

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2018     2017     2018     2017  
                         
Net income   $ 3,909     $ 3,815     $ 12,567     $ 12,674  
                                 
Other comprehensive income (loss):                                
Unrealized (losses) gains on securities:                                
Unrealized holding (losses) gains on available-for-sale securities     (1,635 )     381       (8,059 )     2,133  
Reclassification adjustment for (gain) loss realized in income(1)           (70 )     250       (52 )
Unrealized (losses) gains on securities     (1,635 )     311       (7,809 )     2,081  
Tax effect     404       (100 )     1,733       (627 )
Net-of-tax amount     (1,231 )     211       (6,076 )     1,454  
                                 
Cash flow hedges:                                
Change in fair value of derivatives used for cash flow hedges     168       (14 )     1,086       (307 )
Reclassification adjustment for loss realized in interest expense(2)     82       228       355       751  
Reclassification adjustment for termination fee realized in interest expense(3)     269       269       799       799  
Unrealized gains on cash flow hedges     519       483       2,240       1,243  
Tax effect     (145 )     (133 )     (629 )     32  
Net-of-tax amount     374       350       1,611       1,275  
                                 
Defined benefit pension plan:                                
Amortization of defined benefit plan actuarial loss(4)     56       51       170       153  
Tax effect     (16 )     28       (48 )     312  
Net-of-tax amount     40       79       122       465  
                                 
Other comprehensive (loss) income     (817 )     640       (4,343 )     3,194  
                                 
Comprehensive income   $ 3,092     $ 4,455     $ 8,224     $ 15,868  

 

(1) Realized gains and losses on available-for-sale securities are recognized as a component of non-interest income. The tax effects applicable to net realized gains were $29,000 for the three months ended September 30, 2017.   The tax effects applicable to net realized (loss) gains were $(70,000) and $21,000 for the nine months ended September 30, 2018 and 2017, respectively.

 

(2) Loss realized in interest expense on derivative instruments is recognized as a component of interest expense on short-term borrowings.  Income tax effects associated with the reclassification adjustments were $23,000 and $93,000 for the three months ended September 30, 2018 and 2017, respectively.  Income tax effects associated with the reclassification adjustments were $100,000 and $307,000 for the nine months ended September 30, 2018 and 2017, respectively.

 

(3) Loss realized in interest expense on derivative instruments is recognized as a component of interest expense on short-term borrowings.  Income tax effects associated with the reclassification adjustments were $76,000 and $110,000 for the three months ended September 30, 2018 and 2017, respectively.  Income tax effects associated with the reclassification adjustments were $225,000 and $326,000 for the nine months ended September 30, 2018 and 2017, respectively.

 

(4) Amounts represent the reclassification of defined benefit plan amortization and have been recognized as a component of non-interest expense.  Income tax effects associated with the reclassification adjustments were $16,000 and $21,000 for the three months ended September 30, 2018 and 2017, respectively.  Income tax effects associated with the reclassification adjustments were $48,000 and $63,000 for the nine months ended September 30, 2018 and 2017, respectively.

 

See accompanying notes to unaudited consolidated financial statements.

 

  3

 

 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY - UNAUDITED
NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017
(Dollars in thousands, except share data)

 

                                                 
    Common Stock     Additional
Paid-in
Capital
    Unearned
Compensation - ESOP
    Unearned
Compensation
- Equity
Incentive Plan
    Retained
Earnings
    Accumulated
Other
Comprehensive Loss
       
    Shares     Par
Value
                Total
                                                 
BALANCE AT DECEMBER 31, 2016     30,380,231     $ 304     $ 205,996     $ (6,418 )   $ (536 )   $ 51,711     $ (12,661 )   $ 238,396  
Comprehensive income                                   12,674       3,194       15,868  
Common stock held by ESOP committed to be released (93,679 shares)                 226       472                         698  
Share-based compensation - equity incentive plan                             490                   490  
Common stock repurchased     (574,309 )     (5 )     (5,667 )                             (5,672 )
Issuance of common stock in connection with stock option exercises     921,849       9       5,456                               5,465  
Issuance of common stock in connection with equity incentive plan     89,042       1       903             (904 )                  
Cash dividends declared and paid ($0.09 per share)                                   (2,690 )           (2,690 )
BALANCE AT SEPTEMBER 30, 2017     30,816,813     $ 309     $ 206,914     $ (5,946 )   $ (950 )   $ 61,695     $ (9,467 )   $ 252,555  
                                                                 
BALANCE AT DECEMBER 31, 2017     30,487,309     $ 305     $ 203,527     $ (5,786 )   $ (791 )   $ 62,578     $ (12,552 )   $ 247,281  
Comprehensive income                                   12,567       (4,343 )     8,224  
Cumulative-effect adjustment due to change in accounting principle (ASU 2016-01)                                   (237 )     237        
Common stock held by ESOP committed to be released (90,978 shares)                 271       461                         732  
Share-based compensation - equity incentive plan                             707                   707  
Common stock repurchased     (1,137,916 )     (11 )     (12,256 )                             (12,267 )
Issuance of common stock in connection with stock option exercises     18,975             114                               114  
Issuance of common stock in connection with equity incentive plan     85,440       1       925             (926 )                  
Cash dividends declared and paid ($0.12 per share)                                   (3,506 )           (3,506 )
BALANCE AT SEPTEMBER 30, 2018     29,453,808     $ 295     $ 192,581     $ (5,325 )   $ (1,010 )   $ 71,402     $ (16,658 )   $ 241,285  

 

See accompanying notes to unaudited consolidated financial statements.

 

  4

 

 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(Dollars in thousands)

 

    Nine Months Ended September 30,  
    2018     2017  
OPERATING ACTIVITIES:                
Net income   $ 12,567     $ 12,674  
Adjustments to reconcile net income to net cash provided by operating activities:                
Provision for loan losses     1,600       850  
Depreciation and amortization of premises and equipment     1,530       1,468  
Accretion of purchase accounting adjustments, net     (1,052 )     (1,431 )
Amortization of core deposit intangible     282       282  
Net amortization of premiums and discounts on securities and mortgage loans     1,839       2,577  
Share-based compensation expense     707       490  
ESOP expense     732       698  
Unrealized losses on marketable equity securities, net     190        
Net loss (gain) on redemption and sales of securities     250       (52 )
Gain on sale of other real estate owned     (48 )     (67 )
Deferred income tax benefit           (973 )
Income from bank-owned life insurance     (1,374 )     (1,369 )
Bank-owned life insurance death benefits     (715 )      
Net change in:                
Accrued interest receivable     115       18  
Other assets     552       (3,578 )
Other liabilities     3,205       1,995  
Net cash provided by operating activities     20,380       13,582  
                 

INVESTING ACTIVITIES: 

               
Securities, available for sale:                
Purchases     (12,146 )     (67,246 )
Proceeds from redemptions and sales     12,501       22,453  
Proceeds from calls, maturities, and principal collections     18,393       46,576  
Purchase of residential mortgages           (48,205 )
Loan originations and principal payments, net     (61,445 )     (4,133 )
Redemption of Federal Home Loan Bank of Boston stock     73       420  
Proceeds from sale of other real estate owned     203       365  
Purchases of premises and equipment     (2,565 )     (1,645 )
Proceeds from sale of premises and equipment     45        
Proceeds from payout on bank-owned life insurance     2,050        
Net cash used in investing activities     (42,891 )     (51,415 )
                 

FINANCING ACTIVITIES: 

               
Net increase (decrease) in deposits     103,164       (2,120 )
Net change in short-term borrowings     (89,650 )     20,114  
Repayment of long-term debt     (53,322 )     (19,700 )
Proceeds from long-term debt     113,000       1,420  
Cash dividends paid     (3,506 )     (2,690 )
Common stock repurchased     (12,422 )     (5,990 )
Issuance of common stock in connection with stock option exercises     114       5,465  
Net cash provided by (used in) financing activities     57,378       (3,501 )
                 
NET CHANGE IN CASH AND CASH EQUIVALENTS:     34,867       (41,334 )
Beginning of period     27,132       70,234  
End of period   $ 61,999     $ 28,900  
                 
Supplemental cash flow information:                
Net change in cash due to broker for common stock repurchased   $ (155 )   $ (318 )
Interest paid     13,433       10,774  
Taxes paid     2,507       3,658  

 

 

See the accompanying notes to unaudited consolidated financial statements

 

  5

 

 

WESTERN NEW ENGLAND BANCORP, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

SEPTEMBER 30, 2018

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of OperationsWestern New England Bancorp, Inc. (“Western New England Bancorp,” “WNEB,” the “Company,” “we” or “us”) is a Massachusetts-chartered stock holding company for Westfield Bank, a federally chartered stock savings bank (the “Bank”).

 

The Bank’s deposits are insured to the limits specified by the Federal Deposit Insurance Corporation (“FDIC”). The Bank operates 22 banking offices in western Massachusetts and northern Connecticut, and its primary sources of revenue are earnings on loans to small and middle-market businesses and to residential property homeowners and income from securities.

 

Wholly-Owned Subsidiaries and Acquisition Elm Street Securities Corporation, WFD Securities, Inc. and CSB Colts, Inc., are Massachusetts-chartered securities corporations, formed for the primary purpose of holding qualified securities. WB Real Estate Holdings, LLC, is a Massachusetts-chartered limited liability company that holds real property acquired as security for debts previously contracted by the Bank.

 

On October 21, 2016, we acquired Chicopee Bancorp, Inc. (“Chicopee”), the holding company for Chicopee Savings Bank. The acquisition added eight full-service banking offices located in western Massachusetts. The primary purpose of the acquisition with Chicopee was to expand our presence in western Massachusetts and diversify our market area. The transaction qualified as a tax-free reorganization for federal income tax purposes. Merger consideration paid in the transaction to shareholders of Chicopee totaled $98.8 million, consisting of 11,919,412 shares of Company common stock, net of shares of Chicopee already owned, and shares of Chicopee’s ESOP liquidated to pay off the ESOP loan.

 

We accounted for the transaction using the acquisition method. The acquisition method requires an acquirer to recognize the assets acquired and the liabilities assumed at fair value as of the acquisition date. Additionally, our results of operations include Chicopee’s operating results from the date of acquisition.

 

Principles of Consolidation – The unaudited consolidated financial statements include the accounts of Western New England Bancorp, the Bank, CSB Colts, Inc., Elm Street Securities Corporation, WB Real Estate Holdings, LLC and WFD Securities, Inc. All material intercompany balances and transactions have been eliminated in consolidation.

 

Estimates – The preparation of unaudited consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of income and expenses for both at the date of the unaudited consolidated financial statements. Actual results could differ from those estimates. Estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses and the realizability of deferred tax assets.

 

Basis of Presentation – In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our financial condition as of September 30, 2018, and the results of operations, changes in shareholders’ equity and cash flows for the interim periods presented. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results of operations for the year ending December 31, 2018. Certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been omitted pursuant to the rules and regulations of the SEC.

 

These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements as of and for the year ended December 31, 2017, included in our Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Annual Report”).

 

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Reclassifications Amounts in the prior period financial statements are reclassified when necessary to conform to the current year presentation.

 

2. EARNINGS PER SHARE

 

Basic earnings per share represent income available to shareholders 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 shares had been issued, as well as any adjustment to income that would result from the assumed issuance. No dilutive potential shares were outstanding during the periods presented. Share-based compensation awards that qualify as participating securities (entitled to receive non-forfeitable dividends) are included in basic earnings per share.

 

Earnings per common share for the three and nine months ended September 30, 2018 and 2017 have been computed based on the following:

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2018     2017     2018     2017  
    (In thousands, except per share data)  
Net income applicable to common stock   $ 3,909     $ 3,815     $ 12,567     $ 12,674  
                                 
Average number of common shares issued     29,627       31,001       29,958       30,799  
Less: Average unallocated ESOP Shares     (745 )     (838 )     (768 )     (861 )
Less: Average unvested equity incentive plan shares     (93 )     (60 )     (90 )     (42 )
                                 
Average number of common shares outstanding used to calculate basic earnings per common share     28,789       30,103       29,100       29,896  
                                 
Effect of dilutive equity incentive plan     49       26       42       12  
Effect of dilutive stock options     99       90       100       166  
                                 
Average number of common shares outstanding used to calculate diluted earnings per common share     28,937       30,219       29,242       30,074  
                                 
Basic earnings per share   $ 0.14     $ 0.13     $ 0.43     $ 0.42  
Diluted earnings per share   $ 0.14     $ 0.13     $ 0.43     $ 0.42  

 

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3. COMPREHENSIVE INCOME/LOSS

 

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income (loss).

 

The components of accumulated other comprehensive loss included in shareholders’ equity are as follows:

 

   

September 30, 2018

    December 31, 2017  
    (In thousands)  
Net unrealized losses on securities available-for-sale   $ (13,167 )   $ (5,358 )
Tax effect     3,286       1,316  
Net-of-tax amount     (9,881 )     (4,042 )
                 
Fair value of derivatives used for cash flow hedges     (712 )     (2,152 )
Termination fees on cancelled cash flow hedges     (2,864 )     (3,664 )
Total derivatives     (3,576 )     (5,816 )
Tax effect     1,006       1,635  
Net-of-tax amount     (2,570 )     (4,181 )
                 
Unrecognized actuarial loss on defined benefit plan     (5,851 )     (6,021 )
Tax effect     1,644       1,692  
    Net-of-tax amount     (4,207 )     (4,329 )
                 
Accumulated other comprehensive loss   $ (16,658 )   $ (12,552 )

 

The following table presents changes in accumulated other comprehensive loss for the periods ended September 30, 2018 and 2017 by component:

 

    Securities     Derivatives     Defined Benefit  Plan     Accumulated Other Comprehensive  Loss  
    (In thousands)  
Balance at December 31, 2016   $ (3,839 )   $ (5,204 )   $ (3,618 )   $ (12,661 )
Current-period other comprehensive income     1,454       1,275       465       3,194  
Balance at September 30, 2017   $ (2,385 )   $ (3,929 )   $ (3,153 )   $ (9,467 )
                                 
Balance at December 31, 2017   $ (4,042 )   $ (4,181 )   $ (4,329 )   $ (12,552 )

Cumulative-effect adjustment due to change in accounting principle (ASU 2016-01)

    237                   237  
Current-period other comprehensive (loss) income     (6,076 )     1,611       122       (4,343 )
Balance at September 30, 2018   $ (9,881 )   $ (2,570 )   $ (4,207 )   $ (16,658 )

 

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4. SECURITIES

 

Securities available-for-sale are summarized as follows:

 

    September 30, 2018  
    Amortized Cost     Gross Unrealized Gains     Gross Unrealized Losses     Fair Value  
    (In thousands)  
Available-for-sale securities:                                
Government-sponsored mortgage-backed securities   $ 167,601     $ 2     $ (8,672 )   $ 158,931  
U.S. government guaranteed mortgage-backed securities     20,507             (1,060 )     19,447  
    Corporate bonds     49,915             (1,533 )     48,382  
State and municipal bonds     2,978       22       (88 )     2,912  
Government-sponsored enterprise obligations     25,150             (1,838 )     23,312  
Total available-for-sale   $ 266,151     $ 24     $ (13,191 )   $ 252,984  

 

 

    December 31, 2017  
    Amortized Cost     Gross Unrealized Gains     Gross Unrealized Losses     Fair Value  
    (In thousands)  
Available-for-sale securities:                                
Government-sponsored mortgage-backed securities   $ 185,769     $ 10     $ (3,778 )   $ 182,001  
U.S. government guaranteed mortgage-backed securities     16,821             (567 )     16,254  
Corporate bonds     56,084       352       (292 )     56,144  
State and municipal bonds     3,222       36       (19 )     3,239  
Government-sponsored enterprise obligations     25,151             (770 )     24,381  
Mutual funds     6,727             (330 )     6,397  
Total available-for-sale securities   $ 293,774     $ 398     $ (5,756 )   $ 288,416  

 

At September 30, 2018, government-sponsored enterprise obligations with a fair value of $6.4 million and mortgage-backed securities with a fair value $70.8 million were pledged to secure public deposits and for other purposes as required or permitted by law. The securities collateralizing public deposits are subject to fluctuations in fair value. We monitor the fair value of the collateral on a periodic basis, and would pledge additional collateral if necessary based on changes in fair value of collateral or the balances of such deposits.

 

In 2018, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2016-01, Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which affects current U.S. GAAP primarily as it relates to the accounting for equity investments. ASU No. 2016-01 also supersedes the guidance that requires (1) classification of equity securities with readily determinable fair values into different categories (i.e., trading or available-for-sale), and (2) recognition of changes in fair value of available-for-sale securities in other comprehensive income.

 

The main significant effect resulting from the adoption of this ASU is that marketable equity securities previously reported within securities available-for-sale are now shown as a single line item (“Marketable equity securities”) in the Company’s balance sheet and the recognition in net income of the changes in fair value of Marketable equity securities. The cumulative-effect adjustment resulting from the adoption of this ASU was to decrease retained earnings and reduce accumulated other comprehensive loss as of January 1, 2018 by $237,000.

 

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The amortized cost and fair value of available-for-sale debt securities at September 30, 2018, by final maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations. Also, because mortgage-backed securities require periodic principal paydowns, they are not included in the maturity categories in the following maturity summary.

 

    September 30, 2018  
    Amortized Cost     Fair Value  
    (In thousands)  
Available-for-sale securities:                
Debt securities:                
     Due in one year or less   $ 240     $ 241  
     Due after one year through five years     40,798       39,714  
     Due after five years through ten years     30,257       28,502  
     Due after ten years     6,748       6,149  
Total securities     78,043       74,606  
Mortgage-backed securities     188,108       178,378  
Total   $ 266,151     $ 252,984  

 

Gross realized gains and losses on sales of securities available-for-sale for the three and nine months ended September 30, 2018 and 2017 are as follows:

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2018     2017     2018     2017  
    (In thousands)  
Gross gains realized   $     $ 71     $     $ 117  
Gross losses realized           (1 )     (250 )     (65 )
Net gain realized   $     $ 70     $ (250 )   $ 52  

 

Proceeds from the sale and redemption of securities available-for-sale amounted to $12.5 million and $22.5 million for the nine months ended September 30, 2018 and 2017, respectively.

 

Information pertaining to securities with gross unrealized losses at September 30, 2018 and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous loss position are as follows:

 

    September 30, 2018  
    Less Than Twelve Months     Over Twelve Months  
    Number of Securities     Fair Value     Gross Unrealized Loss     Depreciation from Amortized Cost Basis (%)     Number of Securities     Fair Value     Gross Unrealized Loss     Depreciation from Amortized Cost Basis (%)  
    (Dollars in thousands)  
                                                 
Government-sponsored mortgage-backed securities   8     $ 18,257     $ 600       3.2 %   70     $ 140,592     $ 8,072       5.4 %
U.S. government guaranteed mortgage-backed securities   3       4,716       81       1.7     7       14,731       979       6.2  
Government-sponsored enterprise obligations   0                       9       23,312       1,838       7.3  
Corporate bonds   9       33,244       788       2.3     6       15,138       745       4.7  
State and municipal bonds   0                       3       1,510       88       5.5  
          $ 56,217     $ 1,469                   $ 195,283     $ 11,722          

 

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    December 31, 2017  
    Less Than Twelve Months     Over Twelve Months  
    Number of Securities     Fair Value     Gross Unrealized Loss     Depreciation from Amortized Cost Basis (%)     Number of Securities     Fair Value     Gross Unrealized Loss     Depreciation from Amortized Cost Basis (%)  
    (Dollars in thousands)  
                                                 
Government-sponsored mortgage-backed securities   21     $ 68,538     $ 613       0.9 %   53     $ 111,595     $ 3,165       2.8 %
U.S. government guaranteed mortgage-backed securities   1       1,205       23       1.8     6       15,049       544       3.5  
Government-sponsored enterprise obligations   0                       9       24,381       770       3.1  
Corporate bonds   9       26,016       292       1.1     0                    
State and municipal bonds   0                       3       1,581       19       1.2  
Mutual funds   0                       3       6,397       330       4.9  
          $ 95,759     $ 928                   $ 159,003     $ 4,828          

 

These unrealized losses are the result of changes in interest rates and not credit quality. Because we do not intend to sell the securities and it is more likely than not that we will not be required to sell the investments before recovery of their amortized cost basis, no declines are deemed to be other-than-temporary.

 

5. LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans consisted of the following amounts:   September 30,     December 31,  
    2018     2017  
    (In thousands)  
Commercial real estate   $ 764,749     $ 732,616  
Residential real estate:                
Residential     574,637       557,752  
Home equity     95,645       92,599  
Commercial and industrial     247,869       238,502  
Consumer     5,105       4,478  
    Total Loans     1,688,005       1,625,947  
Unearned premiums and deferred loan fees and costs, net     4,563       4,734  
Allowance for loan losses     (12,235 )     (10,831 )
    $ 1,680,333     $ 1,619,850  

 

There were no purchases of loans during the nine months ended September 30, 2018. During the nine months ended September 30, 2017, we purchased residential real estate loans aggregating $48.2 million.

 

We have transferred a portion of our originated commercial real estate and commercial and industrial loans to participating lenders. The amounts transferred have been accounted for as sales and are therefore not included in our accompanying unaudited consolidated balance sheets. We share ratably with our participating lenders in any gains or losses that may result from a borrower’s lack of compliance with contractual terms of the loan. We continue to service the loans on behalf of the participating lenders and, as such, collect cash payments from the borrowers, remit payments (net of servicing fees) to participating lenders and disburse required escrow funds to relevant parties. At September 30, 2018 and December 31, 2017, we serviced commercial loans for participants aggregating $35.7 million and $32.6 million, respectively.

 

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Residential real estate loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid balances of these loans totaled $58.1 million and $65.8 million at September 30, 2018 and December 31, 2017, respectively. Net service fee income of $68,000 and $49,000 was recorded for the nine months ended September 30, 2018 and 2017, respectively, and is included in service charges and fees on the consolidated statements of net income.

 

Residential real estate mortgages are originated by the Bank both for its portfolio and for sale into the secondary market. The Bank may sell its loans to institutional investors such as the Federal Home Loan Mortgage Corporation. Under loan sale and servicing agreements with the investor, the Bank generally continues to service the residential real estate mortgages. The Bank pays the investor an agreed upon rate on the loan, which is less than the interest rate received from the borrower. The Bank retains the difference as a fee for servicing the residential real estate mortgages. The Bank capitalizes mortgage servicing rights at their fair value upon sale of the related loans, amortizes the asset over the estimated life of the serviced loan, and periodically assesses the asset for impairment. The significant assumptions used by a third party to estimate the fair value of capitalized servicing rights at September 30, 2018, include weighted average prepayment speed for the portfolio using the Public Securities Association Standard Prepayment Model (122 PSA), weighted average internal rate of return (12.04%), weighted average servicing fee (0.2501%), and average net cost to service loans ($83.84 per loan). The estimated fair value of capitalized servicing rights may vary significantly in subsequent periods primarily due to changing market interest rates, and their effect on prepayment speeds and discount rates.

 

A summary of the activity in the balances of mortgage servicing rights follows:

 

   

Three Months Ended

September 30,

2018

   

Nine Months Ended

September 30,

2018

 
    (In thousands)  
Balance at the beginning of period:   $ 319     $ 352  
Capitalized mortgage servicing rights            
Amortization     (17 )     (50 )
Balance at the end of period   $ 302     $ 302  
Fair value at the end of period   $ 469     $ 469  

 

Loans are recorded at the principal amount outstanding, adjusted for charge-offs, unearned premiums and deferred loan fees and costs. Interest on loans is calculated using the effective yield method on daily balances of the principal amount outstanding and is credited to income on the accrual basis to the extent it is deemed collectable. Our general policy is to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more based on the contractual terms of the loan, or earlier if the loan is considered impaired. Any unpaid amounts previously accrued on these loans are reversed from income. Subsequent cash receipts are applied to the outstanding principal balance or to interest income if, in the judgment of management, collection of the principal balance is not in question. Loans are returned to accrual status when they become current as to both principal and interest and perform in accordance with contractual terms for a period of at least six months, reducing the concern as to the collectability of principal and interest. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income over the estimated average lives of the related loans.

 

The allowance for loan losses is established through provisions for loan losses charged to expense. Loans are charged-off against the allowance when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, 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, as further described below.

 

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General component

 

The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate (includes one-to-four family and home equity), commercial real estate, commercial and industrial, and consumer. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: trends in delinquencies and nonperforming loans; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; and national and local economic trends and industry conditions. There were no changes in our policies or methodology pertaining to the general component of the allowance for loan losses during the periods presented for disclosure.

 

The qualitative factors 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 – We require private mortgage insurance for all loans originated with a loan-to-value ratio greater than 80% and we do not grant subprime loans. All loans in this segment are collateralized by owner-occupied 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. Home equity loans are secured by first or second mortgages on one-to-four family owner occupied properties.

 

Commercial real estate – Loans in this segment are primarily income-producing investment properties and owner-occupied commercial properties throughout New England. The underlying cash flows generated by the properties or operations can be adversely impacted by a downturn in the economy due to increased vacancy rates or diminished cash flows, which in turn, would have an effect on the credit quality in this segment. Management obtains financial information annually and continually monitors the cash flows of these loans.

 

Commercial and industrial loans – 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.

 

Consumer loans – Loans in this segment are secured or 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. Impaired loans are identified by analysis of loan performance, internal credit ratings and watch list loans that management believes are subject to a higher risk of loss. Impairment is measured on a loan-by-loan basis for commercial real estate and commercial and industrial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer and residential real estate 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 we 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. We determine 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.

 

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Unallocated component

 

An unallocated component may be maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance, if any, reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio.

 

An analysis of changes in the allowance for loan losses by segment for the periods ended September 30, 2018 and 2017 is as follows:

 

    Commercial
Real Estate
   

Residential

Real Estate

    Commercial
and
Industrial
    Consumer     Unallocated     Total  
    (In thousands)  
Three Months Ended      
Balance at June 30, 2017   $ 4,472     $ 3,126     $ 2,754     $ 53     $ 13     $ 10,418  
Provision (credit)     (68 )     146       (109 )     83       148       200  
Charge-offs           (107 )           (104 )           (211 )
Recoveries           80       3       28             111  
Balance at September 30, 2017   $ 4,404     $ 3,245     $ 2,648     $ 60     $ 161     $ 10,518  
                                                 
Balance at June 30, 2018   $ 5,458     $ 3,529     $ 2,922     $ 92     $ (15 )   $ 11,986  
Provision (credit)     (389 )     481       211       45       2       350  
Charge-offs           (393 )     (30 )     (40 )           (463 )
Recoveries     334       9       8       11             362  
Balance at September 30, 2018   $ 5,403     $ 3,626     $ 3,111     $ 108     $ (13 )   $ 12,235  
                                                 
Nine Months Ended                                                
Balance at December 31, 2016   $ 4,083     $ 2,862     $ 3,085     $ 38     $     $ 10,068  
Provision (credit)     239       427       (180 )     203       161       850  
Charge-offs     (36 )     (148 )     (285 )     (237 )           (706 )
Recoveries     118       104       28       56             306  
Balance at September 30, 2017   $ 4,404     $ 3,245     $ 2,648     $ 60     $ 161     $ 10,518  
                                                 
Balance at December 31, 2017   $ 4,712     $ 3,311     $ 2,733     $ 71     $ 4     $ 10,831  
Provision (credit)     322       762       415       118       (17 )     1,600  
Charge-offs           (473 )     (55 )     (125 )           (653 )
Recoveries     369       26       18       44             457  
Balance at September 30, 2018   $ 5,403     $ 3,626     $ 3,111     $ 108     $ (13 )   $ 12,235  

 

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Further information pertaining to the allowance for loan losses by segment at September 30, 2018 and December 31, 2017 follows:

 

    Commercial Real Estate     Residential Real Estate     Commercial and Industrial     Consumer     Unallocated     Total  
    (In thousands)  
September 30, 2018                                    
Amount of allowance for impaired loans   $     $     $     $     $     $  
Amount of allowance for non-impaired loans     5,403       3,626       3,111       108       (13 )     12,235  
Total allowance for loan losses   $ 5,403     $ 3,626     $ 3,111     $ 108     $ (13 )   $ 12,235  
                                                 
Impaired loans   $ 2,907     $ 4,525     $ 3,547     $ 61     $     $ 11,040  
Non-impaired loans     750,636       662,534       243,380       5,044             1,661,594  
Loans acquired with deteriorated credit quality     11,206       3,223       942                   15,371  
Total loans   $ 764,749     $ 670,282     $ 247,869     $ 5,105     $     $ 1,688,005  
                                                 
December 31, 2017                                                
Amount of allowance for impaired loans   $     $     $     $     $     $  
Amount of allowance for non-impaired loans     4,712       3,311       2,733       71       4       10,831  
Total allowance for loan losses     4,712     $ 3,311     $ 2,733     $ 71     $ 4     $ 10,831  
                                                 
Impaired loans   $ 3,674     $ 3,964     $ 2,766     $ 120     $     $ 10,524  
Non-impaired loans     716,571       642,787       234,582       4,358             1,598,298  
Loans acquired with deteriorated credit quality     12,371       3,600       1,154                   17,125  
Total loans   $ 732,616     $ 650,351     $ 238,502     $ 4,478     $     $ 1,625,947  

 

15

 

The following is a summary of past due and non-accrual loans by class at September 30, 2018 and December 31, 2017:

 

    30 – 59 Days Past Due     60 – 89 Days Past Due     90 Days or More Past Due     Total Past Due     Past Due 90 Days or More and Still Accruing     Non-Accrual Loans  
    (In thousands)  
September 30, 2018                                    
Commercial real estate   $ 751     $ 2,805     $ 471     $ 4,027     $     $ 2,405  
Residential real estate:                                                
Residential     2,606       582       1,510       4,698             5,891  
Home equity     321       96       60       477             692  
Commercial and industrial     681       253       748       1,682             3,734  
Consumer     58             18       76             60  
Total   $ 4,417     $ 3,736     $ 2,807     $ 10,960     $     $ 12,782  
                                                 
                                                 
December 31, 2017                                                
Commercial real estate   $ 1,951     $ 144     $ 290     $ 2,385     $     $ 2,959  
Residential real estate:                                                
Residential     2,992       1,480       1,911       6,383             5,961  
Home equity     635             48       683             696  
Commercial and industrial     1,731       797       162       2,690             3,019  
Consumer     65             41       106             120  
Total   $ 7,374     $ 2,421     $ 2,452     $ 12,247     $     $ 12,755  

 

The following is a summary of impaired loans by class at September 30, 2018 and December 31, 2017:

 

                Three Months Ended     Nine Months Ended(1)  
    At September 30, 2018(1)     September 30, 2018     September 30, 2018  
    Recorded Investment     Unpaid Principal Balance     Average Recorded Investment     Interest Income Recognized     Average Recorded Investment     Interest Income Recognized  
    (In thousands)  
Impaired Loans(1):                                                
Commercial real estate   $ 14,113     $ 16,967     $ 14,240     $ 186     $ 14,736     $ 558  
Residential real estate     7,008       8,019       7,302       14       6,949       33  
Home equity     740       782       613       1       652       3  
Commercial and industrial     4,489       9,023       4,413       34       4,201       106  
Consumer     61       70       78             93        
Total impaired loans   $ 26,411     $ 34,861     $ 26,646     $ 235     $ 26,631     $ 700  

 

 
(1) Includes loans acquired with deteriorated credit quality and performing troubled debt restructurings.

 

16

 

                Three Months Ended     Nine Months Ended  
    At December 31, 2017     September 30, 2017     September 30, 2017  
    Recorded Investment     Unpaid Principal Balance     Average Recorded Investment     Interest Income Recognized     Average Recorded Investment     Interest Income Recognized  
    (In thousands)  
Impaired Loans(1):                                                
Commercial real estate   $ 16,045     $ 18,773     $ 17,731     $ 199     $ 18,788     $ 650  
Residential real estate     6,816       7,298       7,016       11       6,548       34  
Home equity     748       783       407       1       260       3  
Commercial and industrial     3,920       9,215       4,442       54       4,538       183  
Consumer     120       129       122             83        
                                                 
Total impaired loans   $ 27,649     $ 36,198     $ 29,718     $ 265     $ 30,217     $ 870  

 

 
(1) Includes loans acquired with deteriorated credit quality and performing troubled debt restructurings.

 

No interest income was recognized for impaired loans on a cash-basis method during the three and nine months ended September 30, 2018 or 2017. Interest income recognized on impaired loans during the three and nine months ended September 30, 2018 and 2017 related to performing purchase impaired loans and troubled debt restructuring (“TDRs”).

 

We may periodically 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 TDR. These concessions could include a reduction in the interest rate on the loan, payment extensions, postponement or forgiveness of principal, forbearance or other actions intended to maximize collection. All TDRs are classified as impaired.

 

When we modify loans in a TDR, we measure impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. In periods subsequent to modification, we evaluate all TDRs, including those that have payment defaults, for possible impairment and recognize impairment through the allowance.

 

Nonperforming TDRs are shown as nonperforming assets. There were no loans modified as TDRs during the three and nine months ended September 30, 2018 or 2017.

 

A default occurs when a loan is 30 days or more past due. No TDRs defaulted within twelve months of restructuring during the three and nine months ended September 30, 2018 or 2017.

 

There were no charge-offs on TDRs during the three and nine months ended September 30, 2018 or 2017.

 

17

 

Loans Acquired with Deteriorated Credit Quality

 

The following is a summary of loans acquired with evidence of credit deterioration from Chicopee as of September 30, 2018 and 2017.

 

    Contractual
Required
Payments
Receivable
    Cash Expected
To Be
Collected
    Non-
Accretable
Discount
    Accretable
Yield
    Loans
Receivable
 
    (In thousands)  
Balance at December 31, 2017   $ 29,362     $ 23,158     $ 6,204     $ 6,033     $ 17,125  
Collections     (3,370 )     (2,258 )     (1,112 )     (504 )     (1,754 )
Dispositions                              
Balance at September 30, 2018   $ 25,992     $ 20,900     $ 5,092     $ 5,529     $ 15,371  

 

    Contractual
Required
Payments
Receivable
    Cash Expected
To Be
Collected
    Non-
Accretable
Discount
    Accretable
Yield
    Loans
Receivable
 
    (In thousands)  
Balance at December 31, 2016   $ 37,437     $ 29,040     $ 8,397     $ 7,521     $ 21,519  
Collections     (3,860 )     (3,326 )     (534 )     (1,003 )     (2,323 )
Dispositions     (1,833 )     (1,503 )     (330 )     6       (1,509 )
Balance at September 30, 2017   $ 31,744     $ 24,211     $ 7,533     $ 6,524     $ 17,687  

 

Credit Quality Information

 

We utilize an eight-grade internal loan rating system for commercial real estate and commercial and industrial loans. Performing residential real estate, home equity and consumer loans are grouped with “Pass” rated loans. Nonperforming residential real estate, home equity and consumer loans are monitored individually for impairment and risk rated as “Substandard.”

 

Loans rated 1 – 4 are considered “Pass” or “Pass Watch” rated loans with acceptable risk.

 

Loans rated 5 are considered “Special Mention.” These loans exhibit potential credit weaknesses or downward trends and are being closely monitored by us.

 

Loans rated 6 are considered “Substandard.” Generally, a loan is considered “Substandard” if the borrower exhibits a well-defined weakness that may be inadequately protected by the current net worth and cash flow capacity to pay the current debt.

 

Loans rated 7 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 and that a partial loss of principal is likely.

 

Loans rated 8 are considered uncollectible and of such little value that their continuance as loans is not warranted.

 

On an annual basis, or more often if needed, we formally review the ratings on all commercial real estate and commercial and industrial loans. Construction loans are reported within commercial real estate loans and total $103.6 million and $84.4 million at September 30, 2018 and December 31, 2017, respectively. We engage an independent third party to review a significant portion of loans within these segments on a semi-annual basis. We use the results of these reviews as part of our annual review process. In addition, management utilizes delinquency reports, the watch list and other loan reports to monitor credit quality in other segments.

 

18

 

The following table presents our loans by risk rating at September 30, 2018 and December 31, 2017:

 

    Commercial
Real Estate
    Residential
1-4 Family
    Home
Equity
    Commercial
and Industrial
    Consumer     Total  
    (In thousands)  
September 30, 2018                                    
Loans rated 1 – 4   $ 731,634     $ 567,957     $ 94,720     $ 212,202     $ 5,045     $ 1,611,558  
Loans rated 5     14,506                   11,373             25,879  
Loans rated 6     18,609       6,680       925       24,294       60       50,568  
    $ 764,749     $ 574,637     $ 95,645     $ 247,869     $ 5,105     $ 1,688,005  
                                                 
December 31, 2017                                                
Loans rated 1 – 4   $ 708,992     $ 551,469     $ 91,903     $ 205,537     $ 4,475     $ 1,562,376  
Loans rated 5     15,098                   24,565             39,663  
Loans rated 6     8,526       6,283       696       8,400       3       23,908  
    $ 732,616     $ 557,752     $ 92,599     $ 238,502     $ 4,478     $ 1,625,947  

 

6. GOODWILL AND OTHER INTANGIBLES

 

At September 30, 2018 and December 31, 2017, the Company’s goodwill related to the acquisition of Chicopee in October 2016. No goodwill impairment was recorded for the nine months ended September 30, 2018. Annually, or more frequently if events or changes in circumstances warrant such evaluation, the Company evaluates its goodwill for impairment.

 

Core Deposit Intangibles

In connection with the acquisition of Chicopee, the Bank recorded a core deposit intangible of $4.5 million which is amortized over twelve years using the straight-line method. Amortization expense was $282,000 for the nine months ended September 30, 2018. At September 30, 2018, future amortization of the core deposit intangible totals $375,000 for each of the next five years and $1.9 million thereafter.

 

7. SHARE-BASED COMPENSATION

 

Stock Options – Under the terms of the Chicopee merger agreement dated October 21, 2016, each option to purchase shares of Chicopee common stock issued by Chicopee and outstanding at the effective time of the merger pursuant to the Chicopee 2007 Equity Incentive Plan fully vested and converted into an option to purchase shares of WNEB common stock on the same terms and conditions as were applicable before the merger, except (1) the number of shares of WNEB common stock subject to the new option was adjusted to be equal to the product of the number of shares of Chicopee common stock subject to the existing option and the exchange ratio (rounding fractional shares to the nearest whole share) and (2) the exercise price per share of WNEB common stock under the new option was adjusted to be equal to the exercise price per share of Chicopee common stock of the existing option divided by the exchange ratio (rounded to the nearest whole cent).

 

19

 

A summary of stock option activity for the nine months ended September 30, 2018 is presented below:

 

    Shares     Weighted
Average
Exercise
Price
    Weighted
Average
Remaining
Contractual
Term
(in years)
    Aggregate
Intrinsic
Value
(in thousands)
 
Outstanding at December 31, 2017     257,050     $ 6.31       4.41     $ 1,175  
Exercised     (18,975 )   $ 6.03       3.80     $ 89  
Outstanding at September 30, 2018     238,075     $ 6.33       3.69     $ 1,058  
                                 
Exercisable at September 30, 2018     238,075     $ 6.33       3.69     $ 1,058  

 

Cash received for options exercised during the nine months ended September 30, 2018 was $114,000.

 

Restricted Stock Awards In May 2014, our shareholders approved a stock-based compensation plan under which up to 516,000 shares of our common stock were reserved for grants of stock awards, including stock options and restricted stock, which may be granted to any officer, key employee or non-employee director of WNEB. Authorized but unissued shares are issued to awardees upon vesting of such awards. Any shares not issued because vesting requirements are not met will again be available for issuance under the plans.

 

In January 2015, 48,560 shares were granted under this plan and vest ratably over five years. The fair market value of shares awarded, based on the market price at the date of grant, was recorded as unearned compensation and is being amortized over the applicable vesting period.

 

In 2016, the Compensation Committee (the “Committee”) approved the long-term incentive program (the “LTI Plan”). The LTI Plan provides a periodic award that is both performance and retention based in that it is designed to recognize the executive’s responsibilities, reward demonstrated performance and leadership and to retain such executives. The objective of the LTI Plan is to align compensation for the named executive officers and directors over a multi-year period directly with the interests of our shareholders by motivating and rewarding creation and preservation of long-term financial strength, shareholder value and relative shareholder return.

 

The LTI Plan includes eligible officers of the Company who are nominated by the Company’s Chief Executive Officer and approved by the Committee. The LTI Plan is triggered by the Company’s achievement of satisfactory safety and soundness results from its most recent regulatory examination and additional performance metric as determined upon issuance. Stock grants made through the LTI Plan will be a combination of 50% time-vested restricted stock and 50% performance-based restricted stock.

 

In May 2016, 62,740 shares were granted under the LTI Plan. Of this total, 36,543 shares are retention-based, with 10,352 vesting in one year and 26,191 vesting ratably over a three-year period. The remaining 26,197 shares granted are performance based and are subject to the achievement of the 2016 long-term incentive performance metric before vesting is realized after a three-year period. Performance shares will be earned based upon how the Company performs relative to threshold and target absolute goals (i.e. Company-specific, not relative to a peer index) over the three-year performance period. As a result of the Tax Cuts and Jobs Act of 2017, the return on equity performance metrics were adjusted to incorporate the impact and benefits of the corporate tax rate reductions thereunder. The original and adjusted threshold and target metrics under the LTI Plan for 2016 are as follows:

 

      Return on Equity Metrics  
      Threshold       Target  
Original metrics     5.85 %     6.32 %
Adjusted metrics     6.38 %     6.79 %

 

20

 

Participants will be able to earn between 50% (for threshold performance) and 100% (for target performance) of the performance shares but will not earn additional shares if performance exceeds target performance.

 

In May 2017, 89,042 shares were granted under the LTI Plan. Of this total, 55,159 shares are retention-based, with 21,276 vesting in one year and 33,883 vesting ratably over a three-year period. The remaining 33,883 shares granted are performance based and are subject to the achievement of the 2017 long-term incentive performance metric before vesting is realized after a three-year period. For the performance shares, the primary performance metric for 2017 awards is return on equity. Performance shares will be earned based upon how the Company performs relative to threshold, target and maximum absolute goals (i.e. Company-specific, not relative to a peer index) on an annual performance period, but will be distributed at the end of the three year period. As a result of the Tax Cuts and Jobs Act of 2017, the return on equity performance metrics were adjusted to incorporate the impact and benefits of the corporate tax rate reductions thereunder.

 

The original and adjusted threshold, target and maximum metrics under the LTI Plan for 2017 are as follows:

 

    Return on Equity Metrics  
Performance Period Ending  

Original

Threshold

    Adjusted Threshold     Original Target     Adjusted Target     Original Maximum     Adjusted Maximum  
December 31, 2018     6.30 %     6.87 %     7.00 %     7.63 %     7.60 %     8.28 %
December 31, 2019     6.50 %     7.09 %     7.20 %     7.85 %     7.90 %     8.61 %

 

Participants will be able to earn between 50% (for threshold performance), 100% (for target performance) and 150% (for maximum performance). The fair market value of shares awarded, based on the market price at the date of grant, is recorded as unearned compensation and amortized over the applicable vesting period. Shares granted under performance-based conditions are monitored on a quarterly basis in order to compare actual results to the performance metric established, with any necessary adjustments being recognized through share-based compensation expense and unearned compensation.

 

In January 2018, 83,812 shares were granted under the LTI Plan. Of this total, 50,852 shares are retention-based, with 17,908 vesting in one year and 32,944 vesting ratably over a three-year period. The remaining 32,960 shares granted are performance based and are subject to the achievement of the 2018 long-term incentive performance metric before vesting is realized after a three year period. For the performance shares, the primary performance metric for 2018 awards is return on equity. Performance shares will be earned based upon how the Company performs relative to threshold, target and maximum absolute goals (i.e. Company-specific, not relative to a peer index) on an annual performance period, but will be distributed at the end of the three-year period. The threshold, target and stretch metrics under the LTI Plan for 2018 are as follows:

 

    Return on Equity Metrics  
Performance Period Ending     Threshold       Target       Stretch  
December 31, 2018     6.30 %     6.80 %     7.20 %
December 31, 2019     6.85 %     7.35 %     7.75 %
December 31, 2020     7.40 %     7.90 %     8.30 %

 

Participants will be able to earn between 50% (for threshold performance), 100% (for target performance) and 150% (for maximum performance).The fair market value of shares awarded, based on the market price at the date of grant, is recorded as unearned compensation and amortized over the applicable vesting period. Shares granted under performance-based conditions are monitored on a quarterly basis in order to compare actual results to the performance metrics established, with any necessary adjustments being recognized through share-based compensation expense and unearned compensation.

 

At September 30, 2018, an additional 231,846 shares were available for future grants under the LTI Plan.

 

21

 

Our stock award plan activity for the nine months ended September 30, 2018 and 2017 is summarized below:

 

    Unvested Stock Awards Outstanding  
      Shares       Weighted Average Grant Date Fair Value  
Outstanding at December 31, 2017     138,833     $ 8.98  
Shares granted     83,812       11.05  
Shares vested     (32,476 )     9.13  
Outstanding at September 30, 2018     190,169     $ 9.87  
                 
Outstanding at December 31, 2016     91,371     $ 7.51  
Shares granted     89,042       10.15  
Shares vested     (21,552 )     7.44  
Outstanding at September 30, 2017     158,861     $ 9.00  

 

We recorded compensation cost related to the stock awards of $707,000 and $490,000 for the nine months ended September 30, 2018 and 2017, respectively.

 

8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT

 

We utilize short-term borrowings and long-term debt as an additional source of funds to finance our lending and investing activities and to provide liquidity for daily operations.

 

Short-term borrowings are made up of Federal Home Loan Bank of Boston (“FHLBB”) advances with an original maturity of less than one year and a line of credit with the FHLBB. Short-term borrowings issued by the FHLBB were $55.0 million at September 30, 2018 and $133.0 million at December 31, 2017. We have an “Ideal Way” line of credit with the FHLBB for $9.5 million at September 30, 2018 and December 31, 2017. Interest on this line of credit is payable at a rate determined and reset by the FHLBB on a daily basis. The outstanding principal is due daily, but the portion not repaid will be automatically renewed. There were no advances outstanding on the line of credit at September 30, 2018 and December 31, 2017. There were no customer repurchase agreements at September 30, 2018 while there were $11.7 million at December 31, 2017. The customer repurchase agreements outstanding at December 31, 2017 were collateralized by government-sponsored enterprise obligations with fair value of $6.7 million and mortgage backed securities with a fair value of $58.4 million, respectively. A customer repurchase agreement is an agreement by us to sell to and repurchase from the customer an interest in specific securities issued by or guaranteed by the U.S. government. This transaction settles immediately on a same day basis in immediately available funds. Interest paid is commensurate with other products of equal interest and credit risk. In addition, we have lines of credit of $4.0 million and $50.0 million with Atlantic Community Bankers Bank (“ACBB”) and PNC Bank, respectively. The interest rates on these lines are determined and reset on a daily basis by each respective bank. There were no advances outstanding under these lines of credit at September 30, 2018 or December 31, 2017.  As part of our contract with ACBB, we are required to maintain a reserve balance of $300,000 with ACBB for our use of this line of credit.

 

Long-term debt consists of FHLBB advances with an original maturity of one year or more. At September 30, 2018, we had $224.3 million in long-term debt with the FHLBB. This compares to $164.8 million in long-term debt with the FHLBB at December 31, 2017.

 

All FHLBB advances are collateralized by a blanket lien on our residential real estate loans and eligible commercial real estate loans.

 

22

 

9. PENSION BENEFITS

 

We provide a defined benefit pension plan for eligible employees (the “Plan”). Employees must work a minimum of 1,000 hours per year to be eligible for the Plan. Eligible employees become vested in the Plan after five years of service. We plan to contribute to the Plan the amount required to meet the minimum funding standards under Section 412 of the Internal Revenue Code of 1986, as amended. Additional contributions will be made as deemed appropriate by management in conjunction with the Plan’s actuaries. We have not yet determined how much we expect to contribute to our Plan in 2018. No contributions have been made to the Plan for the nine months ended September 30, 2018. The Plan assets are invested in various pooled separate investment accounts offered by Principal Life Insurance Company, a division of Principal Financial Group, who is the custodian of the Plan (the “Custodian”). The Plan is administered by an officer of Westfield Bank (the “Plan Administrator”). On September 30, 2016, we effected a soft freeze on the Plan and therefore no new participants will be included in the Plan after such effective date.

 

The following table provides information regarding net pension benefit costs for the periods shown:

 

    Three Months Ended
September 30,
    Nine Months Ended,
September 30,
 
    2018     2017     2018     2017  
    (In thousands)  
Service cost   $ 304     $ 245     $ 910     $ 778  
Interest cost     253       254       759       761  
Expected return on assets     (347 )     (298 )     (1,041 )     (895 )
Actuarial loss     56       51       170       153  
Net periodic pension cost   $ 266     $ 252     $ 798     $ 797  

 

10. DERIVATIVES AND HEDGING ACTIVITIES

 

Risk Management Objective of Using Derivatives

 

We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of our assets and liabilities and the use of derivative financial instruments. Specifically, we entered into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments principally related to certain variable rate loan assets and variable rate borrowings.

 

23

 

Fair Values of Derivative Instruments on the Balance Sheet

 

The table below presents the fair value of our derivative financial instruments designated as hedging instruments as well as our classification on the balance sheet as of September 30, 2018 and December 31, 2017.

 

September 30, 2018   Asset Derivatives Liability Derivatives
Balance Sheet
Location
  Fair Value     Balance Sheet
Location
  Fair Value  
    (In thousands)
Interest rate swaps      Other Assets   $ 4     Other Liabilities   $ 715  

 

 

December 31, 2017   Asset Derivatives     Liability Derivatives  
    Balance Sheet
Location
  Fair Value     Balance Sheet
Location
  Fair Value  
    (In thousands)
Interest rate swaps   Other Assets   $     Other Liabilities   $ 2,152  

 

At September 30, 2018 and December 31, 2017, all derivatives were designated as hedging instruments.

 

Cash Flow Hedges of Interest Rate Risk

 

Our objectives in using interest rate derivatives are to add stability to interest income and expense and to manage our exposure to interest rate movements. To accomplish this objective, we entered into interest rate swaps as part of our interest rate risk management strategy. These interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty in exchange for our making fixed payments.

 

The following table presents information about our cash flow hedges at September 30, 2018 and December 31, 2017:

 

September 30, 2018   Notional     Weighted Average     Weighted Average Rate     Estimated Fair  
    Amount     Maturity     Receive     Pay     Value  
    (In thousands)     (In years)                 (In thousands)  
Interest rate swaps on FHLBB borrowings   $ 55,000       2.5       2.34 %     2.93 %   $ (711 )

 

December 31, 2017   Notional     Weighted Average     Weighted Average Rate     Estimated Fair  
    Amount     Maturity     Receive     Pay     Value  
    (In thousands)     (In years)                 (In thousands)  
Interest rate swaps on FHLBB borrowings   $ 55,000       3.3       1.64 %     2.93 %   $ (2,152 )

 

For derivatives that are designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income and subsequently reclassified into interest expense in the same period(s) during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are received on the Company’s variable-rate borrowings. During the next twelve months, the Company estimates that an additional $1.3 million will be reclassified as an increase to interest expense.

 

We are hedging our exposure to the variability in future cash flows for forecasted transactions over a maximum period of six years (excluding forecasted payment of variable interest on existing financial instruments).

 

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The table below presents the pre-tax net losses of our cash flow hedges for the periods indicated.

 

    Amount of Gain (Loss) Recognized in OCI on Derivative  
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2018     2017     2018     2017  
    (In thousands)  
Interest rate swaps   $ 168     $ (14 )   $ 1,086     $ (307 )

 

Amounts reported in accumulated other comprehensive loss related to these derivatives are reclassified to interest expense as interest payments are made on our rate sensitive assets/liabilities. Fees on previously terminated swaps are being amortized as a reclassification of other comprehensive income into interest expense over the terms of the previously hedged borrowings. The amount reclassified from accumulated other comprehensive income into net income for interest rate swaps and termination fees was $351,000 and $497,000 during the three months ended September 30, 2018 and 2017, respectively and $1.2 million and $1.6 million during the nine months ended September 30, 2018 and 2017, respectively.

 

Credit-risk-related Contingent Features

 

By using derivative financial instruments, we expose ourselves to credit risk. Credit risk is the risk of failure by the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. When the fair value of a derivative is negative, we owe the counterparty and, therefore, it does not possess credit risk for us. The credit risk in derivative instruments is mitigated by entering into transactions with highly-rated counterparties that we believe to be creditworthy and by limiting the amount of our exposure to each counterparty.

 

We have agreements with our derivative counterparties that contain a provision where if we default on any of our indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then we could also be declared in default on our derivative obligations. We also have agreements with certain of our derivative counterparties that contain a provision where if we fail to maintain our status as “well capitalized”, then the counterparty could terminate the derivative positions and we would be required to settle our obligations under the agreements. Certain of our agreements with our derivative counterparties contain provisions where if a formal administrative action by a federal or state regulatory agency occurs that materially changes our creditworthiness in an adverse manner, we may be required to fully collateralize our obligations under the derivative instrument.

 

At September 30, 2018 and December 31, 2017, we had a net liability position of $708,000 and $2.2 million with our counterparties, respectively. As of September 30, 2018, we had minimum collateral posting thresholds with certain of our derivative counterparties and had mortgage-backed securities with a fair value of $1.0 million posted as collateral against our obligations under these agreements. If we had breached any of these provisions at September 30, 2018, we could have been required to settle our obligations under the agreements at the termination value.

 

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11. FAIR VALUE OF ASSETS AND LIABILITIES

 

Determination of Fair Value

 

We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument 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 our various financial instruments. 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 instrument.

 

Fair Value Hierarchy – We group our assets and liabilities that are measured at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value.

 

Level 1 – Valuation is based on quoted prices in active markets for identical assets. Level 1 assets generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets.

 

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

 

Level 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. Level 3 assets include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

Methods and assumptions for valuing our financial instruments are set forth below. Estimated fair values are calculated based on the value without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications or estimated transaction cost.

 

Securities and mortgage-backed securities – Fair value of securities are primarily measured using unadjusted information from an independent pricing service. The securities measured at fair value in Level 1 are based on quoted market prices in an active exchange market. These securities include marketable equity securities. All other securities are measured at fair value in Level 2 and are based on pricing 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.

 

Interest rate swaps – The valuation of our interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. We have determined that the majority of the inputs used to value our interest rate derivatives fall within Level 2 of the fair value hierarchy.

 

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Assets and liabilities measured at fair value on a recurring basis are summarized below:

 

    September 30, 2018  
    Level 1     Level 2     Level 3     Total  
Assets:   (In thousands)  
Securities available-for-sale                                
Government-sponsored mortgage-backed securities   $     $ 158,931     $     $ 158,931  
U.S. government guaranteed mortgage-backed securities           19,447             19,447  
Corporate bonds           48,382             48,382  
State and municipal bonds           2,912             2,912  
Government-sponsored enterprise obligations           23,312             23,312  
Marketable equity securities     6,319                   6,319  
Interest rate swaps           4             4  
Total assets   $ 6,319     $ 252,988     $     $ 259,307  
                                 
Liabilities:                                
Interest rate swaps   $     $ 715     $     $ 715  

 

 

    December 31, 2017  
    Level 1     Level 2     Level 3     Total  
Assets:   (In thousands)  
Government-sponsored mortgage-backed securities   $     $ 182,001     $     $ 182,001  
U.S. government guaranteed mortgage-backed securities           16,254             16,254  
Corporate bonds           56,144             56,144  
State and municipal bonds           3,239             3,239  
Government-sponsored enterprise obligations           24,381             24,381  
Mutual funds     6,397                   6,397  
Total assets   $ 6,397     $ 282,019     $     $ 288,416  
                                 
Liabilities:                                
Interest rate swaps   $     $ 2,152     $     $ 2,152  

 

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Also, we may be required, from time to time, to measure certain other assets at fair value on a non-recurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related assets at September 30, 2018. Total losses represent the change in carrying value as a result of fair value adjustments related to assets still held at September 30, 2018. There were no assets measured at fair value on a non-recurring basis at September 30, 2017.

 

    At
September 30, 2018
    Three Months Ended
September 30, 2018
    Nine Months Ended
September 30, 2018
 
                      Total     Total  
    Level 1     Level 2     Level 3     Gains (Losses)     Gains (Losses)  
    (In thousands)              
Impaired Loans   $     $     $ 970     $ (393 )   $ (473 )
Total Assets   $     $     $ 970     $ (393 )   $ (473 )

 

The amount of impaired loans represents the carrying value and related write-down and valuation allowance of impaired loans for which adjustments are based on the estimated fair value of the underlying collateral. The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on real estate appraisals performed by independent licensed or certified appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Management will discount appraisals as deemed necessary based on the date of the appraisal and new information deemed relevant to the valuation. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. The resulting losses were recognized in earnings through the provision for loan losses. Impaired loans with adjustments resulting from discounted cash flows or without a specific reserve are not included in this disclosure.

 

There were no transfers to or from Level 1 and 2 during the three and nine months ended September 30, 2018 and 2017. We did not measure any liabilities at fair value on a non-recurring basis on the consolidated balance sheets.

 

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Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument.  Where quoted market prices are not available, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment. Changes in assumptions could significantly affect the estimates. The estimated fair values of our financial instruments are as follows:

 

    September 30, 2018  
    Carrying Value     Fair Value  
          Level 1     Level 2     Level 3     Total  
    (In thousands)  
Assets:                              
Cash and cash equivalents   $ 61,999     $ 61,999     $     $     $ 61,999  
Securities available-for-sale     252,984             252,984             252,984  
Marketable equity securities     6,319       6,319                   6,319  
Federal Home Loan Bank of Boston and other restricted stock     15,480                   15,480       15,480  
Loans - net     1,680,333                   1,616,600       1,616,600  
Accrued interest receivable     5,831                   5,831       5,831  
Mortgage servicing rights     302             469             469  
Derivative assets     4             4             4  
                                         
Liabilities:                                        
Deposits     1,609,019                   1,603,546       1,603,546  
Short-term borrowings     55,000             66,012             66,012  
Long-term debt     224,306             212,931             212,931  
Accrued interest payable     617                   617       617  
Derivative liabilities     715             715             715  

 

    December 31, 2017  
    Carrying Value     Fair Value  
          Level 1     Level 2     Level 3     Total  
    (In thousands)  
Assets:                              
Cash and cash equivalents   $ 27,132     $ 27,132     $     $     $ 27,132  
Securities available-for-sale     288,416       6,397       282,019             288,416  
Federal Home Loan Bank of Boston and other restricted stock     15,553                   15,553       15,553  
Loans - net     1,619,850                   1,581,929       1,581,929  
Accrued interest receivable     5,946                   5,946       5,946  
Mortgage servicing rights     352             528             528  
                                         
Liabilities:                                        
Deposits     1,506,082                   1,503,311       1,503,311  
Short-term borrowings     144,650             144,650             144,650  
Long-term debt     164,786             164,016             164,016  
Accrued interest payable     441                   441       441  
Derivative liabilities     2,152             2,152             2,152  

 

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12. RECENT ACCOUNTING PRONOUNCEMENTS

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes the requirements in Topic 840, Leases. The objective of Topic 842 is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application of the amendments in this ASU is permitted for all entities. Management is currently evaluating the impact to the consolidated financial statements of adopting this ASU but does not expect adoption to have a material impact on our consolidated financial statements. As of September 30, 2018, the Company had $8.7 million of future lease payments outstanding on operating leases pertaining to banking premises.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts.  The ASU also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements.  This ASU is effective for the first interim period in fiscal years beginning after December 15, 2019. Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is in the process of evaluating the standard.  We have put together a project team that has begun to identify appropriate loan segments along with related historical losses for each segment and potential models that would be most appropriate for each individual segment.  We have not quantified the effects of any models, but do expect the standard to significantly change the approach to calculating our allowance for loan losses.

 

In March 2017, the FASB issued ASU 2017-08—Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. This ASU amends guidance on the amortization period of premiums on certain purchased callable debt securities. Specifically, the amendments shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments affect all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer at the earliest call date (that is, at a premium). The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. We do not expect the application of this guidance to have a material impact on our consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. This ASU removes and modifies the previously required disclosures relating to fair value measurements. Specifically, the ASU removes the required disclosure of amounts and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels, the valuation process for Level 3 fair value measurements and the changes in unrealized gains and losses for the period included in earnings for recurring Level 3 fair value measurements held at the end of a reporting period. It also modifies the required rollforward of Level 3 fair value measurements to a disclosure of any transfers into and out of Level 3, increases disclosure for investments in entities that calculate net asset value, and clarifies the measurement of uncertainty disclosure. The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early application of the amendments in this ASU is permitted for all entities. Management is currently evaluating the impact to the consolidated financial statements of adopting this ASU but does not expect adoption to have a material impact on our consolidated financial statements.

 

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

Overview

 

We strive to remain a leader in meeting the financial service needs of our local community, and to provide quality service to the individuals and businesses in the market areas that we have served since 1853. Historically, we have been a community-oriented provider of traditional banking products and services to business organizations and individuals, including products such as residential and commercial loans, consumer loans and a variety of deposit products. We meet the needs of our local community through a community-based and service-oriented approach to banking.

 

We have adopted a growth-oriented strategy that has focused on increasing commercial lending. Our strategy also calls for increasing deposit relationships and broadening our product lines and services. We believe that this business strategy is best for our long-term success and viability, and complements our existing commitment to high-quality customer service. In connection with our overall growth strategy, we seek to:

  

grow our commercial and industrial and commercial real estate loan portfolios by targeting businesses in our primary market areas of western Massachusetts and northern Connecticut as a means to increase the yield on and diversify our loan portfolio and build transactional deposit account relationships;

 

focus on expanding our retail banking franchise and increase the number of households served within our market area; and

 

supplement the commercial focus, grow the residential loan portfolio to diversify risk and deepen customer relationships.

 

You should read the following financial results for the three and nine months ended September 30, 2018 in the context of this strategy.

 

Net income was $3.9 million, or $0.14 per diluted share, for the three months ended September 30, 2018, compared to $3.8 million, or $0.13 per diluted share, for the same period in 2017. For the nine months ended September 30, 2018, net income was $12.6 million, or $0.43 per diluted share, as compared to net income of $12.7 million, or $0.42 per diluted share, for the same period in 2017.

 

The provision for loan losses was $350,000 and $200,000 for the three months ended September 30, 2018 and 2017, respectively, and $1.6 million and $850,000 for the nine months ended September 30, 2018 and 2017, respectively.

 

Net interest income was $14.6 million and $14.8 million for the three months ended September 30, 2018 and 2017, respectively. The net interest margin was 2.94% for the three months ended September 30, 2018, compared to 3.04% for the same period in 2017. The net interest margin, on a fully tax-equivalent basis, was 2.96% for the three months ended September 30, 2018, compared to 3.09% for the same period in 2017. Net interest income was $45.2 million and $44.0 million for the nine months ended September 30, 2018 and 2017, respectively. The net interest margin was 3.09% and 3.04% for the nine months ended September 30, 2018 and 2017, respectively. The net interest margin, on a tax-equivalent basis, was 3.11% and 3.09% for the nine months ended September 30, 2018 and 2017, respectively.

 

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CRITICAL ACCOUNTING POLICIES

 

Our consolidated financial statements are prepared in accordance with U.S. GAAP and practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Actual results could differ from those estimates.

 

Critical accounting estimates are necessary in the application of certain accounting policies and procedures, and are particularly susceptible to significant change. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. There have been no material changes to our critical accounting policies during the nine months ended September 30, 2018. For additional information on our critical accounting policies, please refer to the information contained in Note 1 of the accompanying unaudited consolidated financial statements and Note 1 of the consolidated financial statements included in our 2017 Annual Report.

 

COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2018 AND DECEMBER 31, 2017

 

At September 30, 2018, total assets of $2.2 billion reflect an increase of $67.5 million, or 3.2%, from December 31, 2017. During the same period, total loans increased $61.9 million, or 3.8%, while cash and cash equivalents increased $34.9 million, or 128.5%, and securities available-for-sale and marketable equity securities decreased $29.1 million, or 10.1%.

 

Total loans increased $61.9 million, or 3.8%, due to an increase in commercial real estate loans of $32.1 million, or 4.4%, an increase in residential loans, including home equity, of $19.9 million, or 3.1%, and an increase in commercial and industrial loans of $9.4 million, or 3.9%.

 

All loans where the payments are 90 days or more in arrears as of the closing date of each month are placed on nonaccrual status. Nonperforming loans were $12.8 million at September 30, 2018 and December 31, 2017, respectively. If all nonaccrual loans had been performing in accordance with their terms, we would have earned additional interest income of $654,000 and $580,000 for the nine months ended September 30, 2018 and 2017, respectively. At September 30, 2018 and December 31, 2017, our nonperforming loans to total loans were 0.76% and 0.78%, respectively, while our nonperforming assets to total assets were 0.59% and 0.62%, respectively. A summary of our nonaccrual and past due loans by class are listed in Note 5 of the accompanying unaudited consolidated financial statements.

 

At September 30, 2018, total deposits were $1.6 billion, an increase of $102.9 million, or 6.8%, from December 31, 2017. Core deposits, which the Company defines as all deposits except time deposits, increased $26.8 million, or 2.8%, from $949.5 million, or 63.0% of total deposits, at December 31, 2017, to $976.3 million, or 60.7% of total deposits, at September 30, 2018. Non-interest-bearing deposits increased $45.9 million, or 14.7%, to $357.8 million, while money market accounts decreased $5.2 million, or 1.3%, to $405.0 million, and interest-bearing checking accounts decreased $2.4 million, or 2.7%, to $85.0 million. Time deposits increased $76.2 million, or 13.7%, from $556.5 million at December 31, 2017 to $632.8 million at September 30, 2018.

 

Borrowings decreased $30.1 million, or 9.7%, to $279.3 million at September 30, 2018 from $309.4 million at December 31, 2017. Short-term borrowings decreased $89.7 million, or 62.0%, to $55.0 million at September 30, 2018 from $144.7 million at December 31, 2017 primarily due to a decrease in short-term FHLBB funding. In addition, customer repurchase agreements decreased $11.7 million. During the three months ended March 31, 2018, the Company eliminated customer repurchase agreements and balances were transferred to the customer’s respective core deposit account. Long-term debt increased $59.5 million, or 36.1%, to $224.3 million at September 30, 2018 from $164.8 million at December 31, 2017. Management reduced a portion of its position in short-term adjustable-rate borrowings and increased its long-term fixed-rate funding in order to better manage rising funding costs due to the increase in the Federal Funds target rate. Additional information regarding short-term borrowings and long-term debt is included in Note 8 of the accompanying unaudited consolidated financial statements.

 

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At September 30, 2018, shareholders’ equity was $241.3 million, or 11.2% of total assets, compared to $247.3 million, or 11.9% of total assets, at December 31, 2017. The decrease in shareholders’ equity during the nine months ended September 30, 2018 reflects $4.3 million net increase in accumulated other comprehensive loss, $12.3 million for the repurchase of shares of the Company’s common stock and $3.5 million for payment of common stock dividends, partially offset by a net increase of $12.6 million in the Company’s retained earnings reflective of current period net income and $1.6 million in share-based compensation.

 

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2018 AND SEPTEMBER 30, 2017

 

General

 

Net income was $3.9 million, or $0.14 per diluted share, for the quarter ended September 30, 2018, compared to $3.8 million, or $0.13 per diluted share, for the same period in 2017. Net interest income was $14.6 million and $14.8 million for the three months ended September 30, 2018 and 2017, respectively.

 

Net Interest and Dividend Income

 

The following tables set forth the information relating to our average balance and net interest income for the three months ended September 30, 2018 and 2017, and reflect the average yield on interest-earning assets and average cost of interest-bearing liabilities for the periods indicated. Yields and costs are derived by dividing interest income by the average balance of interest-earning assets and interest expense by the average balance of interest-bearing liabilities for the periods shown. Average balances are derived from actual daily balances over the periods indicated. Interest income includes fees earned from making changes in loan rates and terms and fees earned when the real estate loans are prepaid or refinanced. For analytical purposes, the interest earned on tax-exempt assets is adjusted to a tax-equivalent basis to recognize the income tax savings which facilitates comparison between taxable and tax-exempt assets.

 

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    Three Months Ended September 30,  
    2018     2017  
    Average Balance     Interest     Average Yield/Cost     Average Balance     Interest     Average Yield/Cost  
    (Dollars in thousands)  
ASSETS:                                    
Interest-earning assets                                                
Loans(1)(2)   $ 1,682,034     $ 17,690       4.21 %   $ 1,605,376     $ 16,681       4.16 %
Securities(2)     263,378       1,772       2.69       302,030       1,901       2.52  
Other investments     17,747       228       5.14       17,748       172       3.88  
Short-term investments(3)     9,083       34       1.50       5,206       11       0.85  
Total interest-earning assets     1,972,242       19,724       4.00       1,930,360       18,765       3.89  
Total non-interest-earning assets     134,708                       141,119                  
Total assets   $ 2,106,950                     $ 2,071,479                  
                                                 
LIABILITIES AND EQUITY:                                                
Interest-bearing liabilities                                                
Interest-bearing checking accounts   $ 86,615     $ 94       0.43 %   $ 82,164     $ 81       0.39 %
Savings accounts     138,112       40       0.12       148,433       43       0.12  
Money market accounts     415,416       489       0.47       400,400       386       0.39  
Time deposit accounts     600,333       2,471       1.65       568,578       1,601       1.13  
Total interest-bearing deposits     1,240,476       3,094       1.00       1,199,575       2,111       0.70  
Short-term borrowings and long-term debt     279,181       1,906       2.73       301,715       1,609       2.13  
Interest-bearing liabilities     1,519,657       5,000       1.32       1,501,290       3,720       0.99  
Non-interest-bearing deposits     328,735                       300,757                  
Other non-interest-bearing liabilities     16,917                       16,147                  
Total non-interest-bearing liabilities     345,652                       316,904                  
                                                 
Total liabilities     1,865,309                       1,818,194                  
Total equity     241,641                       253,285                  
Total liabilities and equity   $ 2,106,950                     $ 2,071,479                  
Less: Tax-equivalent adjustment(2)             (119 )                     (249 )        
Net interest and dividend income           $ 14,605                     $ 14,796          
Net interest rate spread                     2.66 %                     2.85 %
Net interest rate spread, on a tax equivalent basis(4)                     2.68 %                     2.90 %
Net interest margin                     2.94 %                     3.04 %
Net interest margin, on a tax equivalent basis(5)                     2.96 %                     3.09 %
Ratio of average interest-earning assets to average interest-bearing liabilities                     129.78 %                     128.58 %

 

 
(1) Loans, including non-accrual loans, are net of deferred loan origination costs and unadvanced funds.
(2) Loan and securities income are presented on a tax-equivalent basis using a tax rate of 21% for the 2018 period and 35% for the 2017 period, respectively. The tax-equivalent adjustment is deducted from tax-equivalent net interest and dividend income to agree to the amount reported in the unaudited consolidated statements of net income. See “Explanation of Use of Non-GAAP Financial Measurements”.
(3) Short-term investments include federal funds sold.
(4) Net interest rate spread, on a tax-equivalent basis, represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. See “Explanation of Use of Non-GAAP Financial Measurements”.
(5) Net interest margin, on a tax-equivalent basis, represents tax-equivalent net interest and dividend income as a percentage of average interest-earning assets. See “Explanation of Use of Non-GAAP Financial Measurements”.

 

34

 

 

The following table shows how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to:

 

interest income changes attributable to changes in volume (changes in volume multiplied by prior rate);
interest income changes attributable to changes in rate (changes in rate multiplied by current volume); and
the net change.

 

The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

 

   

Three Months Ended September 30, 2018 compared to

Three Months Ended September 30, 2017

 
    Increase (Decrease) Due to        
    Volume     Rate     Net  
Interest-earning assets   (In thousands)  
Loans(1)   $ 797     $ 212     $ 1,009  
Securities(1)     (243 )     114       (129 )
Other investments           56       56  
Short-term investments     8       15       23  
Total interest-earning assets     562       397       959  
                         
Interest-bearing liabilities                        
Interest-bearing checking accounts     4       9       13  
Savings accounts     (3 )           (3 )
Money market accounts     14       89       103  
Time deposit accounts     89       781       870  
Short-term borrowing and long-time debt     (120 )     417       297  
Total interest-bearing liabilities     (16 )     1,296       1,280  
Change in net interest and dividend income(1)   $ 578     $ (899 )   $ (321 )

 

 
(1) Securities, loan income and change in net interest and dividend income are presented on a tax-equivalent basis using a tax rate of 21%. The tax-equivalent adjustment is deducted from tax-equivalent net interest income.

 

Net interest income decreased $191,000, or 1.3%, to $14.6 million, for the three months ended September 30, 2018, from $14.8 million for the three months ended September 30, 2017. The decrease in net interest income was due to a $1.3 million, or 34.4%, increase in interest expense, partially offset by an increase in interest income of $1.1 million, or 5.9%, during the same period. The increase in interest expense of 34.4% from September 30, 2017 was primarily due to an increase of $983,000, or 46.6%, in interest expense on deposits and an increase of $297,000, or 18.5%, in interest expense on borrowings.