Toggle SGML Header (+)


Section 1: 10-K (10-K 2018 10-K)

Document


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2018
OR
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from             to             
Commission file number 001-36551  
Blue Hills Bancorp, Inc.
(Exact name of registrant as specified in its charter)
 
Maryland
46-5429062
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
500 River Ridge Drive
Norwood, Massachusetts
02062
Zip Code
(Address of Principal Executive Offices)
 
(617) 361-6900
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, $0.01 par value
The NASDAQ Stock Market, LLC
Securities Registered Pursuant to Section 12(g) of the Act:
None  
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  o    No  þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o  No   þ
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  þ    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K.  þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated Filer  
 o
Accelerated Filer  
þ 
Non-Accelerated Filer  
o
Smaller Reporting Company  
o
Emerging Growth Company
 þ
 
 
 
 
 
 
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. þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes   o    No   þ
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the Registrant as of its last completed second fiscal quarter was $546,269,000

As of March 1, 2019, there were 26,910,365 outstanding shares of the Registrant’s common stock.







BLUE HILLS BANCORP, INC.
2018 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
 
 
 
Page 
 
 
PART I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
PART II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
PART III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
PART IV
 
Item 15.
Item 16.
 
SIGNATURES
 
 







PART I
ITEM 1.    BUSINESS

This Annual Report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

statements of our goals, intentions and expectations;
statements regarding our business plans, prospects, growth and operating strategies;
statements regarding the asset quality of our loan and investment portfolios; and
estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We do not undertake any obligation to update any forward-looking statements after the date of this Annual Report, except as required by law.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

general economic conditions, either nationally or in our market areas, that are worse than expected;
competition among depository and other financial institutions;
inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;
changes in monetary policy, changes in government support for housing;
adverse changes in asset quality including an unanticipated credit deterioration in our loan portfolio;
adverse changes in the securities markets which could cause a material decline in our reported equity and/or our net income if we must record impairment charges or a decline in the fair value of our securities;
changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees, capital requirements and the corporate tax rate;
changes in consumer spending, borrowing and savings habits;
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, or the Securities and Exchange Commission;
changes in our organization, compensation and benefit plans;
changes in our financial condition or results of operations that reduce capital available to pay dividends;
and
cyber security attacks or intrusions that could adversely impact our businesses.

Additional factors relating to our proposed merger ("the Merger") with Independent Bank Corp. (“Independent”), include the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement; the risk that the necessary regulatory approvals may not be obtained, may be delayed, or may be obtained subject to conditions that are not anticipated; the risk that Independent is required to issue debt on terms that are less than attractive in order to raise cash to complete the Merger; delays in closing the Merger or other risks that any of the closing conditions to the Merger may not be satisfied in a timely manner or at all; the diversion of management’s time from existing business operations due to time spent related to the Merger or integration efforts; the risk that our business and the business of Independent will not be integrated successfully or such integration may be more difficult, time consuming or costly than expected; expected revenue and other synergies and cost savings from the Merger may not be fully realized or realized within the expected time frame; revenues following the Merger may be lower than expected; and expenses related to the Merger and costs following the Merger that are higher than expected. See Item 1A for additional risk factors.

3





Because of these and a wide variety of other risks and uncertainties, including those included in this annual report under “Item1A. Risk Factors,” our actual future results may be materially different from the results indicated by these forward-looking statements.

Blue Hills Bancorp, Inc.

Blue Hills Bancorp, Inc. (“Blue Hills Bancorp” or the “Company”) is a Maryland corporation that owns 100% of the common stock of Blue Hills Bank (the “Bank”) and Blue Hills Funding Corporation. Blue Hills Bancorp was incorporated in February 2014 to become the holding company of the Bank in connection with the mutual-to-stock conversion of Hyde Park Bancorp, MHC, the Bank’s former holding company. On July 21, 2014, we completed our initial public offering of common stock in connection with the conversion, selling 27,772,500 shares of common stock at $10.00 per share for approximately $277.7 million in gross proceeds, including 2,277,345 shares sold to the Bank’s employee stock ownership plan. In addition, in connection with the conversion, we issued 694,313 shares of our common stock and contributed $57,000 in cash to the Blue Hills Bank Foundation. As of December 31, 2018, we had consolidated assets of $2.8 billion, consolidated deposits of $2.1 billion and consolidated equity of $404.1 million. Other than holding the common stock of Blue Hills Bank, Blue Hills Bancorp has not engaged in any significant business to date.

Merger

On September 20, 2018, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Independent Bank Corp., a Massachusetts corporation ("Independent"), and Rockland Trust Company, a Massachusetts-chartered trust company and wholly owned subsidiary of Independent ("Rockland Trust"). Pursuant to the Merger Agreement, the Company will merge with and into Independent, with Independent being the surviving corporation. Upon completion of the Merger, each outstanding share of Company common stock will convert into the right to receive 0.2308 shares of Independent common stock and $5.25 in cash (the "Merger Consideration"). Each outstanding option to acquire a share of Company common stock, whether or not vested, will be converted into the right to receive cash in an amount equal to the amount by which $26.25 exceeds the exercise price of the option. In addition, each award of Company restricted stock, whether or not vested, that is outstanding immediately prior to the effective time of the Merger will fully vest and be canceled and converted into the right to receive the Merger Consideration. Following the Merger of the Company with and into Independent, Blue Hills Bank will merge with Rockland Trust, with Rockland Trust being the surviving institution. Shareholders of the Company and Independent have approved the pending Merger. Completion of the Merger is subject to customary closing conditions, including receipt of regulatory approvals. The Merger is expected to close early in the second quarter of 2019.

The executive and administrative office of Blue Hills Bancorp, Inc. is located at 500 River Ridge Drive, Norwood, Massachusetts 02062, and its telephone number at this address is (617) 361-6900. Our website address is www.bluehillsbancorp.com. Information on our website is not and should not be considered to be a part of this annual report.

Blue Hills Bank

Blue Hills Bank was organized in 1871 and is a Massachusetts-chartered savings bank headquartered in Hyde Park, Massachusetts. We provide financial services to individuals, families, small to mid-size businesses and government and non-profit organizations online and through our eleven full-service branch offices located in Boston, Dedham, Hyde Park, Milton, Nantucket, Norwood, West Roxbury, and Westwood, Massachusetts. Our three branches in Nantucket were acquired in January 2014 (“Nantucket Bank Acquisition”), and operate under the name Nantucket Bank, a division of Blue Hills Bank. We also operate loan production offices in Boston, Concord, Dorchester, Franklin, Hingham, Lowell, Marblehead, Plymouth, Watertown and Winchester, Massachusetts. Our primary deposit-taking market includes Norfolk, Suffolk and Nantucket Counties in Massachusetts, and our lending market is primarily based in eastern Massachusetts, however, we actively pursue opportunities across New England.

Our business consists primarily of accepting deposits from the general public, commercial businesses and government and non-profit organizations and investing those deposits, together with funds generated from operations and borrowings, in 1-4 family residential mortgage loans, commercial real estate loans, commercial business loans and investment securities. To a much lesser extent, we originate home equity loans and lines of credit, construction loans and consumer loans. We offer a full range of deposit accounts, including passbook and statement savings accounts, certificates of deposit, money market accounts, commercial and regular checking accounts and IRAs. Through our bundled products, we offer reduced fees and higher interest rates on relationship accounts.

Blue Hills Bank’s main banking office is located at 1196 River Street, Hyde Park, Massachusetts 02136. Our telephone number at this address is (617) 361-6900. Our website address is www.bluehillsbank.com. Information on our website is not and should not be considered part of this annual report.


4




Available Information

The Securities and Exchange Commission (“SEC”) maintains an Internet site at www.sec.gov that contains reports, proxy and information statements, and other information that the Company files electronically with the SEC. These documents are also available to the public on the Company’s website at www.bluehills.com. Information on our website is not incorporated into this annual report and should not be considered part of this annual report.
Market Area

    We provide financial services to individuals, families, small to middle-market businesses and government and non-profit organizations online and through our eleven full-service branch offices and through our relationship managers. Our primary deposit taking market includes Norfolk, Suffolk and Nantucket Counties in Massachusetts. Our primary lending market encompasses a broader region of eastern Massachusetts. In addition, we also make loans secured by properties and the assets of businesses located outside of our primary lending market area. These loans are typically made to businesses headquartered or operating in New England.

Due to our proximity to Boston, our market area benefits from the presence of numerous institutions of higher learning, medical care and research centers and the corporate headquarters of several financial investment companies. Eastern Massachusetts also has many high technology companies employing personnel with specialized skills. As a result, healthcare, high-tech and financial services companies constitute major sources of employment in our regional market area, as well as the colleges and universities that populate the Boston Metropolitan Statistical Area (“MSA”). These factors affect the demand for residential homes, apartments, office buildings, shopping centers, industrial warehouses and other commercial properties. Tourism also is a prominent component of our market area’s economy, as Boston annually ranks as one of the nation’s top tourist destinations.

Population and household data indicate that the market surrounding our branches is a mix of urban, suburban and island markets. Suffolk County, where the city of Boston is located, and Norfolk County are two of the largest counties in Massachusetts, with populations of approximately 812,000 and 705,000, respectively. Suffolk County experienced relatively strong demographic growth from 2010 to 2018, at 12.39%, which exceeded both the national and state growth rates of 6.64% and 5.63%, respectively.  Norfolk County, a suburban market with a large commuter population, experienced moderate population growth from 2010 to 2018 of 5.14%. Nantucket County is a popular tourist destination and summer colony and thus has seasonal fluctuations in population. Nantucket County has a full-time population of approximately 11,500 residents, which expands to a population of around 100,000 during the peak of the summer vacation season. From 2010 to 2018, Nantucket County experienced population growth of 12.76%.  Recent population growth trends are generally projected to moderate slightly over the next five years.

Income measures show that Suffolk County is a relatively low-income market, characterized by its urban demographic in the city of Boston. Median household income for Suffolk County falls below the state measure but exceeds the national measure. Comparatively, income measures show that Norfolk and Nantucket counties are relatively affluent markets, as the wealthiest counties in Massachusetts. In particular, Norfolk County is characterized by a high concentration of white collar professionals who work in the Boston area. Nantucket County is a prestigious vacation destination targeted towards high-income visitors, with home values among the highest in the country. Median household and per capita income measures for Norfolk and Nantucket Counties are both well above the comparable U.S. and Massachusetts income measures. Projected income growth measures for Suffolk and Norfolk Counties are somewhat above the comparable projected growth rates for the U.S. and Massachusetts, whereas Nantucket County’s projected income growth rate is somewhat lower.

The December 2018 unemployment rates for Norfolk, Suffolk and Nantucket Counties were 2.4%, 2.4% and 6.1%, respectively. Norfolk, Suffolk and Nantucket Counties, along with the Commonwealth of Massachusetts, all reported higher unemployment rates for December 2018 compared to a year ago.

Competition

We face intense competition in our market area both in making loans and attracting deposits. We compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies and investment banking firms. Some of our competitors have greater name recognition and market presence that benefit them in attracting business and offer certain services that we do not or cannot provide.

5





Our deposit sources are primarily concentrated in the communities surrounding our full-service branch offices. As of June 30, 2018 (the latest date for which information is publicly available from the Federal Deposit Insurance Corporation), we ranked sixteenth of 45 banks and thrift institutions with offices in Norfolk County, Massachusetts, with a 1.49% market share. As of that same date, we ranked tenth of 44 banks and thrift institutions with offices in Suffolk County, Massachusetts, with a 0.66% market share. Also, as of that same date, we ranked first of four banks and thrift institutions with offices in Nantucket County, Massachusetts, with a 40.32% market share.




6




Lending Activities

Our primary lending activities are the origination of 1-4 family residential mortgage loans, commercial real estate loans, commercial business loans, home equity loans and lines of credit, other consumer loans and construction loans. Most loans are to borrowers in our core market of New England but to diversify risk we also have loans to borrowers located outside of New England. We also sell in the secondary market the majority of the fixed-rate conforming 1-4 family residential mortgage loans that we originate, generally on a servicing-released, limited or no recourse basis, while retaining jumbo fixed-rate and adjustable-rate 1-4 family residential mortgage loans to manage the duration and time to re-pricing of our loan portfolio.

 Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio at the dates indicated. Loans held for sale, which amounted to $4.4 million, $9.0 million, $2.8 million, $12.9 million, and $14.6 million at December 31, 2018, 2017, 2016, 2015, and 2014, respectively, are not included below.
 
 
2018
 
2017
 
2016
 
2015
 
2014
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in thousands)
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
$
1,020,321

 
43.75
%
 
$
922,627

 
41.87
%
 
$
851,154

 
44.12
%
 
$
599,938

 
38.98
%
 
$
460,273

 
40.13
%
Home equity
66,945

 
2.87

 
80,662

 
3.66

 
78,719

 
4.08

 
77,399

 
5.03

 
61,750

 
5.38

Commercial
866,478

 
37.16

 
834,264

 
37.86

 
687,289

 
35.63

 
561,203

 
36.46

 
387,807

 
33.81

Construction
74,976

 
3.22

 
91,050

 
4.13

 
76,351

 
3.96

 
79,773

 
5.18

 
53,606

 
4.67

Total real estate loans
2,028,720

 
87.00

 
1,928,603

 
87.52

 
1,693,513

 
87.79

 
1,318,313

 
85.65

 
963,436

 
83.99

Commercial business loans
287,864

 
12.34

 
253,509

 
11.50

 
206,234

 
10.69

 
182,677

 
11.87

 
151,823

 
13.24

Consumer loans
15,454

 
0.66

 
21,698

 
0.98

 
29,281

 
1.52

 
38,186

 
2.48

 
31,778

 
2.77

Total loans
2,332,038

 
100.00
%
 
2,203,810

 
100.00
%
 
1,929,028

 
100.00
%
 
1,539,176

 
100.00
%
 
1,147,037

 
100.00
%
Other items:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
(19,335
)
 
 
 
(20,877
)
 
 
 
(18,750
)
 
 
 
(17,102
)
 
 
 
(12,973
)
 
 
Deferred loan costs (fees) and discounts
3,471

 
 
 
3,214

 
 
 
2,593

 
 
 
1,201

 
 
 
(1,150
)
 
 
Total loans, net
$
2,316,174

 
 
 
$
2,186,147

 
 
 
$
1,912,871

 
 
 
$
1,523,275

 
 
 
$
1,132,914

 
 



7




Loan Portfolio Maturities and Yields. The following table summarizes the dollar amount of loans maturing in our portfolio based on their contractual terms to maturity at December 31, 2018, but does not include scheduled payments, potential payments, or the impact of interest rate swaps. Demand loans, having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. Balances noted below do not reflect fair value adjustments, discounts or deferred costs and fees.
 
 
1-4 Family
Residential Loans
 
Home Equity Loans
and Lines of Credit
 
Commercial Real
Estate Loans
 
Construction Loans
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
(Dollars in thousands)
Due During the Years
Ending December 31,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2019
$
62

 
4.81
%
 
$

 
%
 
$
48,218

 
4.65
%
 
$
20,105

 
5.32
%
2020
149

 
4.52

 
61

 
4.85

 
106,057

 
4.89

 
18,012

 
5.12

2021
82

 
7.33

 
65

 
5.58

 
53,572

 
4.76

 
2,613

 
5.04

2022 to 2023
4,293

 
3.92

 
157

 
4.95

 
178,143

 
4.57

 
5,495

 
5.93

2024 to 2028
18,198

 
3.59

 
1,703

 
4.73

 
434,688

 
4.47

 
23,468

 
5.13

2029 to 2033
51,719

 
3.44

 
5,967

 
5.51

 
33,978

 
4.50

 

 

2034 and beyond
945,818

 
3.83

 
58,992

 
5.34

 
11,822

 
4.05

 
5,283

 
3.90

Total
$
1,020,321

 
3.81
%
 
$
66,945

 
5.34
%
 
$
866,478

 
4.57
%
 
$
74,976

 
5.15
%
 
 
Commercial Business
Loans
 
Consumer Loans
 
Total Loans
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
(Dollars in thousands)
Due During the Years
Ending December 31,
 
 
 
 
 
 
 
 
 
 
 
2019
$
13,435

 
4.65
%
 
$
224

 
11.44
%
 
$
82,044

 
4.83
%
2020
35,213

 
5.48

 
285

 
6.87

 
159,777

 
5.05

2021
45,863

 
4.94

 
687

 
4.15

 
102,882

 
4.85

2022 to 2023
146,832

 
5.55

 
5,010

 
3.26

 
339,930

 
4.99

2024 to 2028
19,017

 
5.82

 
9,224

 
4.88

 
506,298

 
4.53

2029 to 2033
614

 
6.34

 

 

 
92,278

 
3.99

2034 and beyond
26,890

 
5.33

 
24

 
6.32

 
1,048,829

 
3.96

Total
$
287,864

 
5.40
%
 
$
15,454

 
4.46
%
 
$
2,332,038

 
4.38
%

The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at December 31, 2018 that are contractually due after December 31, 2019.
 
Due After December 31, 2019
 
Fixed
 
Adjustable
 
Total
 
(In thousands)
Real estate loans and lines:
 
 
 
 
 
1-4 family residential
$
688,230

 
$
332,029

 
$
1,020,259

Home equity
3,573

 
63,372

 
66,945

Commercial real estate
40,734

 
777,526

 
818,260

Construction
1,282

 
53,589

 
54,871

Total real estate loans and lines
733,819

 
1,226,516

 
1,960,335

Commercial business loans
49,321

 
225,108

 
274,429

Consumer loans

 
15,230

 
15,230

Total loans
$
783,140

 
$
1,466,854

 
$
2,249,994



8




1-4 Family Residential Mortgage Loans. At December 31, 2018, $1.0 billion, or 43.8%, of our loan portfolio, consisted of 1-4 family residential mortgage loans with $59.5 million comprised of non-owner occupied properties. We offer fixed-rate and adjustable-rate residential mortgage loans with maturities up to 30 years.

Some of the housing stock in our primary lending market area comprises two-, three- and four-unit properties, all of which are classified as 1-4 family residential mortgage loans.

Our 1-4 family residential mortgage loans that we originate are generally underwritten according to Fannie Mae and Freddie Mac guidelines, and we refer to loans that conform to such guidelines as “conforming loans”. We generally originate both fixed- and adjustable-rate mortgage loans in amounts up to the maximum conforming loan limits as established by the Federal Housing Finance Agency. We also originate loans above the conforming limits, referred to as “jumbo loans”, which are common in our market area. We generally underwrite jumbo loans in a manner similar to conforming loans. During the year ended December 31, 2018, we originated $472.5 million of 1-4 family residential loans. See “Lending Activities-Loan Originations, Sales, Participations and Servicing”.

We originate our adjustable-rate 1-4 family residential mortgage loans with initial interest rate adjustment periods of three, five, seven and ten years, based on changes in a designated market index. These loans are limited to a 500 basis point initial increase in their interest rate, a 200 basis point increase in their interest rate annually after the initial adjustment, and a maximum upward adjustment of 500 to 600 basis points over the life of the loan. We determine whether a borrower qualifies for an adjustable-rate mortgage loan in conformance with the underwriting guidelines set forth by Fannie Mae and Freddie Mac in the secondary mortgage market. In particular, we determine whether a borrower qualifies for an adjustable-rate mortgage loan with an initial fixed-rate period of five years or less based on the ability to repay both principal and interest using the higher of an interest rate which is 2.0% above the initial interest rate, or the fully indexed rate, including a reasonable estimate of real estate taxes and insurance, and taking into account the maximum debt-to-income ratio stipulated in the underwriting guidelines in the secondary mortgage market. The qualification for an adjustable-rate mortgage loan with an initial fixed-rate period exceeding five years is based on the borrower’s ability to repay at the higher of the initial fixed interest rate or the fully indexed rate.

We originate 1-4 family residential mortgage loans with loan-to-value ratios up to 80% without private mortgage insurance or a state guarantee program. We originate loans with loan-to-value ratios of up to 97% with private mortgage insurance and where the borrower’s debt does not exceed 43% of the borrower’s monthly cash flow. To encourage lending to low- and moderate-income home buyers, we participate in several publicly-sponsored loan programs, including: the Massachusetts Housing Finance Agency program, which provides competitive terms for loans with higher loan-to-value ratios than are available with conventional financing; the Federal Home Loan Banks Equity Builder Program, which provides closing cost and down payment assistance to income-eligible home buyers; and the Mass Housing Partnership’s One program that contains a number of attractive features for low- and moderate-income home buyers. Also, in 2016, we began participation in the governmentally sponsored Federal Housing Administration (FHA) program, which allows first-time home buyers to obtain competitive mortgage rates with low closing costs and minimal down payments.
    
The vast majority of the conforming fixed-rate 1-4 family residential mortgage loans we originate are sold into the secondary market to mortgage investors with servicing released and to the Federal Home Loan Bank of Boston with servicing retained. For the year ended December 31, 2018, we received servicing fees, including credit enhancement fees, of $950,000 on mortgage loans that we serviced for third parties. At December 31, 2018, the unpaid principal balance of loans serviced for others totaled $317.0 million.

We do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on the loan, resulting in an increased principal balance during the life of the loan. Additionally, we generally do not offer “subprime loans” (loans that are made with low down-payments to borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (defined as loans having less than full documentation).

Home Equity Loans and Lines of Credit. In addition to traditional 1-4 family residential mortgage loans, we offer home equity lines of credit and, to a lesser extent, home equity loans, that are secured by the borrower’s primary residence or secondary residence. Home equity loans and lines of credit are generally underwritten with the same criteria that we use to underwrite 1-4 family residential mortgage loans. We offer these products online and through our branch office network.


9




At December 31, 2018, we had $66.9 million in home equity lines and loans outstanding, of which 97.9% were performing in accordance with original terms. The home equity lines of credit that we originate are revolving lines of credit, which generally have a term of 25 years, with draws available for the first ten years. Our 25-year lines of credit are interest only during the first ten years, and amortize on a fifteen-year basis thereafter. We generally originate home equity lines of credit with combined loan-to-value ratios of up to 80% when combined with the principal balance of the existing first mortgage loan, although loan-to-value ratios may occasionally exceed 80% on a case-by-case basis. Maximum loan-to-value ratios are determined based on an applicant’s credit score, property value, loan amount and debt-to-income ratio. Lines of credit above $250,000 require a full appraisal. Rates are adjusted monthly based on changes in a designated market index. We also originate fixed-rate home equity loans with terms up to 15 years, although, in the current interest rate environment, fixed-rate loans with terms greater than five years are not a priority.

Commercial Real Estate. At December 31, 2018, $866.5 million, or 37.2%, of our loan portfolio consisted of commercial real estate loans. At December 31, 2018, the majority of our commercial real estate loans were secured by properties located in eastern Massachusetts. In addition, the vast majority of the commercial real estate loans in our portfolio were originated by us as lead lender, rather than loans that we have obtained through participations.

Our commercial real estate mortgage loans are primarily secured by office buildings, multi-family apartment buildings, owner-occupied businesses and industrial buildings. As of December 31, 2018, our two largest commercial real estate loans totaled $27.0 million and $25.9 million, which financed an office and flex research and development property and an office and retail property, respectively. These loans were performing in accordance with their terms at December 31, 2018. At that date, we had 25 other commercial real estate loans with outstanding principal balances exceeding $10.0 million.

Our commercial real estate loans generally have terms of three to ten years with adjustable, LIBOR-based, Federal Home Loan Bank Classic Advance or Wall Street Journal Prime rates of interest. These loans generally amortize on a 25 to 30-year basis, with a balloon payment due at maturity.

To facilitate qualified commercial customers’ access to fixed-rate financing, we enter into loan-level interest rate swaps through a third party advisor. These swap agreements enable the Bank to write LIBOR-based, adjustable-rate loans, whereas customers ultimately pay a fixed interest rate. Interest rate risk associated with these transactions is controlled by entering into offsetting positions with third parties. Credit risk is minimized by limiting transactions to highly-rated counterparties and through collateral agreements. Collateral is required to be exchanged when the valuation reaches agreed upon thresholds, for certain counterparties. We generally receive fees in offering these interest rate swap agreements. As of December 31, 2018, the notional value of interest rate swaps on loans with commercial real estate loan customers amounted to $628.9 million, and we earned net fee income of $1.6 million from customer swaps in 2018.

In underwriting commercial real estate loans we consider a number of factors, which include the projected net cash flow to the loan’s debt service requirement (generally requiring a minimum of 125%), tenant rollover risk, vacancy, the age and condition of the collateral, a market analysis of particular assets by geographic location, the financial resources and income level of the sponsor and the sponsor’s experience in owning or managing similar properties. Commercial real estate and multi-family real estate loans are generally originated in amounts up to 75% of the appraised value or the purchase price of the property securing the loan, whichever is lower. When circumstances warrant, guarantees are obtained from commercial real estate and multi-family real estate sponsors. In addition, the sponsor’s and guarantor’s financial information on such loans is monitored on an ongoing basis by requiring periodic financial statement updates.

Commercial real estate loans generally entail greater credit risks compared to the 1-4 family residential mortgage loans we originate, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the property, as repayment of the loan generally is dependent, in large part, on sufficient income from the property to cover operating expenses and debt service. Changes in economic conditions that are not in the control of the borrower or lender could affect the value of the collateral for the loan or the future cash flow of the property. Commercial real estate loans are closely underwritten and managed within approved guidelines. In addition, our Risk Management group provides regular follow up via portfolio and loan reviews.


10




Construction Loans. We originate or participate in loans originated by others to established local developers to finance the construction of commercial and multi-family properties. To a lesser extent, we originate loans to local builders and individuals to finance the construction of 1-4 family residential properties. At December 31, 2018, $75.0 million, or 3.2% of our loan portfolio consisted of construction loans. Commercial construction loans totaled $69.3 million. The two largest loans outstanding amounted to $15.2 million and $14.2 million, respectively, which are both secured by multi-family residential properties. As of December 31, 2018, our commitments to fund these two commercial construction projects totaled $39.6 million including the amount outstanding. These loans were performing in accordance with their terms at December 31, 2018.

Our commercial construction loans generally call for the payment of interest only with interest rates that are tied to LIBOR. Construction loans for commercial real estate are originated with principal balances of up to $20.0 million with a loan-to-completed value ratio of 65% to 80%, depending on the type of property. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction. Repayment of construction loans for income-producing properties usually is expected from permanent financing upon completion of construction. In the case of construction loans for 1-4 family residential properties, repayment normally is expected from the sale of units to individual purchasers, or in the case of individuals building their own homes, from a permanent mortgage.

Construction loans are closely underwritten within approved guidelines. Before making a commitment to fund a construction loan, we require an appraisal of the property by a licensed appraiser. The amount of funds disbursed per construction requisitions during the term of the construction loan is generally justified by a Bank-appointed construction engineer.

Construction financing generally involves greater credit risk than long-term financing on improved, tenanted investment real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. The Bank utilizes third party firms to monitor construction completion schedules and draw schedules. If the estimate of construction cost is inaccurate, we may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property. Moreover, if the estimated value of the completed project is inaccurate, the borrower may hold a property with a value that is insufficient to assure full repayment of the construction loan upon the sale of the property. Construction loans also expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated.

Commercial Business Loans. We originate commercial term loans and variable rate lines of credit to businesses in our primary market area. Our commercial loans are generally used for working capital purposes, funding business acquisitions, or for acquiring machinery and equipment. These loans are generally secured by all business assets including business equipment, inventory, accounts receivable, trademarks, and real estate, and are generally originated with maximum loan-to-value ratios of up to 80%. The commercial business loans that we offer are generally adjustable-rate loans with terms ranging from three to five years. At December 31, 2018, we had $287.9 million of commercial business loans, representing 12.3% of our total loan portfolio outstanding.

We also participate in large loans originated by other banks with customers operating in sectors where our commercial lenders have substantial experience. As of December 31, 2018, our two largest commercial business loan relationships outstanding amounted to $15.1 million and $14.3 million, which financed a home heating and propane fuel company and a specialty finance small ticket and micro leasing company, respectively. The specialty finance company was a participation loan syndicated by another bank and our total commitments on these loans were $18.9 million and $20.0 million, respectively, including the amounts outstanding. These loans were performing in accordance with their terms at December 31, 2018.  In addition our largest commitments of $30.0 million and $27.5 million, to a wholesale distributor of refined products and to a steel and mining company, respectively, had $12.7 million and zero outstanding balances at December, 31, 2018. In each case, these were participation arrangements syndicated by other banks. These loans were performing in accordance with their terms at December 31, 2018.

When making commercial business loans, we consider the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral. Many of our loans are guaranteed by the principals of the borrower.


11




Commercial business loans generally have a greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. In addition, at December 31, 2018, we had $10.0 million of unsecured, subordinated loans to financial institutions operating in New England, for which repayment is dependent on the ability of the financial institutions to generate income. We seek to minimize these risks through our underwriting standards and the experience of our lenders and credit department. The commercial lending and risk management units are responsible for the underwriting and documentation of new commercial loans, as well as the quarterly review of credit ratings of existing loans.

Consumer Loans. We offer consumer loans on a limited and selective basis. At December 31, 2018, $15.5 million, or 0.7%, of our loan portfolio, consisted of consumer loans, of which $10.6 million related to classic and collector automobile loans, and only $4.9 million related to other consumer loans.

Our portfolio of classic and collector automobile loans is the result of a 2011 initiative to increase our exposure to higher-yielding loan assets and diversify our credit portfolio, resulting in an agreement to purchase loans from a third-party originator. Pursuant to the terms of this agreement, we elected to purchase loans secured by classic and collector automobiles according to a defined price schedule, which varied according to the terms of the loans and the credit quality of the borrower. Our primary considerations, when we originated these loans, were the borrower’s ability to repay the loan and the value of the underlying collateral. The average FICO score of borrowers for these loans was 746 at origination. We have financed up to the full sales price of the vehicle. In order to mitigate our risk of loss, we have a 50% loss sharing arrangement with the third-party originator of these loans. Since the commencement of the program, we have purchased approximately $50.3 million in classic and collector automobile loans and recorded $129,000 of losses. We did not purchase any loans for this portfolio in 2017 or 2018, and do not anticipate any future purchases.

Loan Originations, Sales, Participations and Servicing. Loans that we originate are generally underwritten pursuant to our policies and procedures, which incorporate standard underwriting guidelines, including those of Freddie Mac and Fannie Mae in the case of residential mortgages, to the extent applicable. We originate both adjustable-rate and fixed-rate loans. Our loan origination and sales activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand and lower pricing in secondary markets.

In 2018, 100.0% of our 1-4 family residential mortgage loan originations were generated by our loan officers or referred by branch managers and employees located in our banking offices. In an effort to manage interest rate risk and generate non-interest income, we sold the majority of fixed-rate 1-4 family residential mortgage loans that we originated. In 2018, we sold $283.9 million of conforming and non-conforming residential mortgage loans to other investors.

We have sold mortgage loans to the Federal Home Loan Bank of Boston through the Mortgage Partnership Finance (“MPF”) program, which generally has required us to retain approximately 5% of credit risk, for which we were paid a credit enhancement fee. To date, we have sold $304.7 million of loans to the Federal Home Loan Bank of Boston through the MPF program with credit risk retention. At December 31, 2018, the credit risk retained by us on loans sold through the MPF program amounted to $11.8 million, or 3.9% of the volume of loans sold through the MPF program. Neither mortgage loans serviced for others nor the contingent liability associated with sold loans is recorded on the consolidated balance sheets. There have been no contingency losses recognized on these loans to date.

We have retained the servicing on all loans sold to the Federal Home Loan Bank of Boston, and we have released the servicing on loans sold to other mortgage investors and banks seeking exposure to non-conforming loans. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent borrowers, supervising foreclosures and property dispositions in the event of unremedied defaults, and making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. We retain a portion of the interest paid by the borrower on the loans we service as consideration for our servicing activities.


12




In 2018, we had $165.4 million in commercial business and commercial real estate originations. In order to have access to larger customers and diversify risk, from time to time we will participate in portions of commercial business and commercial real estate loans with other banks. Pursuant to these loan participations, the Bank and participating lenders share ratably in cash flows and any gains or losses that may result from a borrower’s lack of compliance with contractual terms of the loan. When we are not lead lender, we always follow our customary loan underwriting and approval policies. In cases where the Bank has transferred a portion of its originated commercial loan to participating lenders, the Bank continues to service the loan as agent of the participating lenders and, as such, collects cash payments from the borrowers, remits payments (net of servicing fees, if applicable) to participating lenders and disburses required escrow funds to relevant parties. At December 31, 2018, we held $253.8 million of commercial business, commercial real estate and construction loans in our portfolio that were participation loans obtained from other lenders, and we serviced $93.5 million in loans for other lenders participating in loans originated by us.









































13




The following table shows the loan origination, acquisition, participation, sale and repayment activities for loans and loans held for sale, for the periods indicated. 
 
For the Years Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(In thousands)
Originations by type:
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
1-4 family residential
$
472,528

 
$
488,861

 
$
508,447

 
$
224,316

 
$
154,188

Commercial real estate
102,249

 
202,895

 
170,210

 
217,433

 
125,370

Construction
23,328

 
37,749

 
65,087

 
45,102

 
35,991

Home equity
8,100

 
21,324

 
15,769

 
24,721

 
7,988

Total real estate loans
606,205

 
750,829

 
759,513

 
511,572

 
323,537

Commercial business loans
63,122

 
39,882

 
55,297

 
56,066

 
31,627

Consumer loans
407

 
2,062

 
2,850

 
3,049

 
1,204

Total loans originated
669,734

 
792,773

 
817,660

 
570,687

 
356,368

 
 
 
 
 
 
 
 
 
 
Acquired: (1)
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
Commercial real estate

 

 

 

 
57,967

Home equity

 

 

 

 
39,996

Total real estate loans

 

 

 

 
97,963

Commercial business loans

 

 

 

 
3,862

Consumer loans

 

 

 

 
444

Total loans acquired

 

 

 

 
102,269

 
 
 
 
 
 
 
 
 
 
Participations (2):
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
1-4 family

 
5,745

 
12,955

 
35,917

 
65,091

Commercial real estate
7,997

 
23,786

 
2,168

 

 

Construction
37,352

 
30,932

 
19,203

 
26,163

 
22,262

Total real estate loans
45,349

 
60,463

 
34,326

 
62,080

 
87,353

Commercial business loans
63,729

 
77,024

 
63,949

 
73,362

 
87,502

Consumer loans

 

 

 
14,803

 
15,654

Total loan participations
109,078

 
137,487

 
98,275

 
150,245

 
190,509

Sales (3):
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
1-4 family
(283,911
)
 
(322,911
)
 
(128,945
)
 
(39,080
)
 
(41,417
)
Commercial real estate

 
(22,400
)
 
(13,807
)
 

 

Construction

 

 
(15,830
)
 
(7,517
)
 
(95
)
Home equity

 
(12,218
)
 

 

 

Total real estate loans
(283,911
)
 
(357,529
)
 
(158,582
)
 
(46,597
)
 
(41,512
)
Commercial business loans

 
(661
)
 
(20,902
)
 
(796
)
 
(208
)
Total loans sold
(283,911
)
 
(358,190
)
 
(179,484
)
 
(47,393
)
 
(41,720
)
Principal repayments:
 
 
 
 
 
 
 
 
 
Total principal repayments
(371,272
)
 
(291,122
)
 
(356,715
)
 
(283,114
)
 
(218,798
)
Net increase
$
123,629


$
280,948

 
$
379,736

 
$
390,425

 
$
388,628

_______________________ 
(1)
Includes loans acquired in the Nantucket Bank Acquisition.
(2)
Includes loan purchases and participations by the Bank in loans originated or syndicated by other financial institutions.
(3)
Includes loan sales and participations by other financial institutions in loans originated or syndicated by the Bank.


14




Loan Approval Procedures and Authority. Our lending activities follow written policies approved by our Board of Directors. The loan approval process is intended to assess the borrower’s ability to repay the loan and the value of the collateral, if any, that will secure the loan. To assess the borrower’s ability to repay, we review the borrower’s employment, where applicable, credit history, information on the historical and projected income and expenses, where applicable, balance sheet, profit and loss, and cash flow of the borrower. We require “full documentation” on all of our loan applications. We do not discriminate in our lending decisions based on a borrower’s race, religion, national origin, gender, marital status or age.

Our policies and loan approval limits are approved by our Board of Directors. Aggregate lending relationships in amounts up to $5.0 million can be approved by designated individual officers or officers acting together with specific lending approval authority. Relationships which meet or exceed underwriting standards (Risk Ratings 1-5) between $5.0 million and $30.0 million require the approval of the Management Credit Committee, and those greater than $30.0 million require the approval of the Board of Directors. Relationships above $20.0 million deemed “bankable with care” (Risk Rating 6) require the approval of the Board of Directors. Our Chief Risk Officer generally must approve loans in excess of $3.0 million.

Our Senior Credit Officer is responsible for the underwriting and documentation of new commercial loans to small business customers. Our Chief Risk Officer reviews the servicing and risk rating of all criticized loans and loans rated “bankable with care” on the watch list no less frequently than monthly. Our Senior Credit Officer reviews all construction loans and higher risk commercial business loans quarterly. We consider our Chief Risk Officer and Senior Credit Officer to be objective because they have no loan production goals and have annual performance objectives based on credit quality and credit risk management.

We require appraisals by a third party appraiser based on a comparison with current market sales for all real property securing 1-4 family residential mortgage loans, multi-family loans and commercial real estate loans, although home equity loans and lines of credit may be approved based on an Automated Valuation Model (AVM). All appraisers are independent, state-licensed or state-certified appraisers and are approved by the Board of Directors annually.

Non-Performing and Problem Assets. When a residential mortgage loan or home equity line of credit is 15 days past due, a late payment fee is generally assessed and a notice mailed to the borrower. We will attempt direct contact with the borrower to determine when payment will be made. We will send a letter when a loan is 30 days or more past due and will attempt to contact the borrowers by telephone. By the 36th day of delinquency, we will attempt to contact the borrowers and inform them of loss mitigation options that may be available, providing the borrowers with written notice containing information about those loss mitigation options by the 45th day of delinquency. By the 150th day of delinquency (regardless of accrual status), unless the borrower has made arrangements to bring the loan current on its payments, we will refer the loan to legal counsel to commence foreclosure proceedings. In addition, a property appraisal is made to determine the condition and market value. The account will be monitored on a regular basis thereafter. In attempting to resolve a default on a residential mortgage loan, Blue Hills Bank complies with all applicable Massachusetts laws regarding a borrower’s right to cure.

When automobile finance loans become 10 to 15 days past due, a late fee is charged according to applicable guidelines. When the loan is 11 days past due, the customer will receive a phone call from our servicer requesting a payment. Letters are generated at 15, 25 and 34 days past due. A letter stating our intent to repossess the automobile goes to the customer 21 days prior to repossession, which is triggered at 45 days past due. Vehicles are assigned for repossession at 65 to 70 days past due; the customer has 21 days for right of redemption until the vehicle is sold. Automobile loans are placed on non-accrual status at 90 days past due and charged off at 120 days past due.

Because of the nature of the collateral securing consumer loans, we may commence collection procedures sooner for consumer loans than for residential mortgage loans or home equity lines of credit.

Small business loans that are past due five days are referred to the responsible loan officer, who will after 10 days direct efforts to bring the loan current. After 30 days past due, the loan is reviewed for placement on the Watch List, and if the loan has been downgraded to Special Mention, the Chief Risk Officer will determine whether the Senior Credit Officer will assume day-to-day management of the credit or act in an advisory role with the goal of either bringing the loan current or maximizing recovery of principal and interest. All small business loans that are 30 days or more past due are regularly monitored by the lending unit and the Senior Credit Officer and reviewed monthly or more frequently as necessary by the Chief Risk Officer.


15




Commercial business loans that are past due are immediately referred to the EVP of Commercial Lending, who will direct efforts to bring the loan current. After 30 days past due the loan is placed on the Watch List, and, if the loan has been downgraded to Special Mention, the Chief Risk Officer determines whether the Senior Credit Officer will assume day-to-day management, with the oversight of the Chief Risk Officer, or act in an advisory role with the goal of either bringing the loan current or maximizing our recovery of principal and interest. All commercial loans that are 30 days or more past due, regardless of risk rating, are regularly monitored by the lending unit and the Senior Credit Officer and reviewed monthly or more frequently as necessary by the Chief Risk Officer.

It is the policy of the Company to discontinue the accrual of interest on loans past due in excess of 90 days, unless the loan is well-secured and in the process of collection, or when in the judgment of management, the ultimate collectability of the principal or interest becomes doubtful and to reverse all interest income previously accrued. Past due status is based on contractual terms of the loan. The interest on non-accrual loans is accounted for on the cash-basis until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due have been current for six consecutive months and future payments are reasonably assured.

Non-Performing Assets. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated.
 
At December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(Dollars in thousands)
Non-accrual loans:
 
 
 
 
 
 
 
 
 
1-4 family residential
$
5,627

 
$
5,190

 
$
6,478

 
$
5,688

 
$
3,876

Home equity loans and lines
1,429

 
1,387

 
1,153

 
270

 
578

Commercial real estate
3,310

 
4,744

 
941

 
4,631

 

Commercial business
163

 

 
241

 
10

 

Consumer
65

 
202

 
170

 
145

 
27

Total non-accrual loans
10,594

 
11,523

 
8,983

 
10,744

 
4,481

 
 
 
 
 
 
 
 
 
 
Loans delinquent 90 days or greater and still accruing

 

 

 

 

Other real estate owned
3,649

 

 

 

 

Total non-performing assets
$
14,243

 
$
11,523

 
$
8,983

 
$
10,744

 
$
4,481

 
 
 
 
 
 
 
 
 
 
Ratios:
 
 
 
 
 
 
 
 
 
Non-performing loans to total loans
0.45
%
 
0.52
%
 
0.47
%
 
0.70
%
 
0.39
%
Non-performing assets to total assets
0.51
%
 
0.43
%
 
0.36
%
 
0.51
%
 
0.26
%
    
For the year ended December 31, 2018, gross interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $559,000, of which $474,000 of interest income was recognized on such loans for the year ended December 31, 2018.


16




Troubled Debt Restructurings. We periodically modify loans to extend the term or make other concessions to help a borrower stay current on their loan and to avoid foreclosure. We generally do not forgive principal or interest on loans or modify the interest rates on loans to rates that are below market rates. The table below sets forth the amounts for our residential troubled debt restructurings at the dates indicated.
 
At December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
 
Performing troubled debt restructurings
$
372

 
$
653

 
$
138

 
$
148

 
$
255

Non-accrual troubled debt restructurings
3,614

 
1,533

 
1,274

 
1,183

 
467

Total
$
3,986

 
$
2,186

 
$
1,412

 
$
1,331

 
$
722

 
 
 
 
 
 
 
 
 
 
Performing troubled debt restructurings as a % of total loans
0.02
%
 
0.03
%
 
0.01
%
 
0.01
%
 
0.02
%
Non-accrual troubled debt restructurings as a % of total loans
0.15
%
 
0.07
%
 
0.07
%
 
0.08
%
 
0.04
%
Total troubled debt restructurings as a % of total loans
0.17
%
 
0.10
%
 
0.08
%
 
0.09
%
 
0.06
%

At December 31, 2018, we had $4.0 million of troubled debt restructurings, all of which related to residential mortgage loans, of which $372,000 were performing in accordance with their restructured terms. For the year ended December 31, 2018, gross interest income that would have been recorded had our troubled debt restructurings been performing in accordance with their original terms was $197,000. Interest income recognized on such modified loans for the year ended December 31, 2018 was $172,000.

17




The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.
 
Loans Delinquent For
 
Total
 
60-89 Days
 
90 Days and Over
 
 
Number
 
Amount
 
Number
 
Amount
 
Number
 
Amount
 
(Dollars in thousands)
At December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
3

 
$
597

 
5

 
$
1,783

 
8

 
$
2,380

Home equity

 

 
7

 
1,216

 
7

 
1,216

Commercial business loans

 

 
1

 
163

 
1

 
163

Consumer loans
1

 
9

 
2

 
17

 
3

 
26

Total loans
4

 
$
606

 
15

 
$
3,179

 
19

 
$
3,785

 
 
 
 
 
 
 
 
 
 
 
 
At December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
2

 
$
348

 
7

 
$
2,184

 
9

 
$
2,532

Home equity
1

 
13

 
5

 
656

 
6

 
669

Commercial real estate

 

 
2

 
3,893

 
2

 
3,893

Consumer loans
1

 
7

 
1

 
92

 
2

 
99

Total loans
4

 
$
368

 
15

 
$
6,825

 
19

 
$
7,193

 
 
 
 
 
 
 
 
 
 
 
 
At December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
2

 
$
373

 
14

 
$
2,322

 
16

 
$
2,695

Home equity
4

 
496

 
6

 
775

 
10

 
1,271

Commercial business
1

 
13

 

 

 
1

 
13

Consumer loans
2

 
5

 
1

 
7

 
3

 
12

Total loans
9

 
$
887

 
21

 
$
3,104

 
30

 
$
3,991

 
 
 
 
 
 
 
 
 
 
 
 
At December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential

 
$

 
5

 
$
990

 
5

 
$
990

Home equity
1

 
19

 
2

 
176

 
3

 
195

Commercial real estate (1)
1

 
1,249

 

 

 
1

 
1,249

Consumer loans
1

 
80

 
2

 
120

 
3

 
200

Total loans
3

 
$
1,348

 
9

 
$
1,286

 
12

 
$
2,634

 
 
 
 
 
 
 
 
 
 
 
 
At December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
3

 
$
522

 
8

 
$
1,370

 
11

 
$
1,892

Home equity

 

 
1

 
475

 
1

 
475

Consumer loans

 

 
1

 
5

 
1

 
5

Total loans
3

 
$
522

 
10

 
$
1,850

 
13

 
$
2,372

(1) The commercial real estate loan included in the 60-89 days delinquent buckets above is also included in the non-accrual total.


18




Other Real Estate Owned. Real estate acquired by us as a result of foreclosure or by deed in lieu of foreclosure is classified as other real estate owned. When property is acquired it is recorded at estimated fair market value at the date of foreclosure less the cost to sell, establishing a new cost basis. Estimated fair value generally represents the sales price a buyer would be willing to pay on the basis of current market conditions, including normal terms from other financial institutions. Holding costs and declines in estimated fair market value result in charges to expense after acquisition. At December 31, 2018, we had $3.6 million of other real estate owned related to a single property.

Classification of Assets. Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as substandard, doubtful, or loss assets. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those assets characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets (or portions of assets) classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as special mention.

We maintain an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Our determination as to the classification of our assets and the amount of our loss allowances is subject to review by regulatory agencies, which may require that we establish additional loss allowances. We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations.

The following table sets forth our amounts of classified loans, loans designated as special mention and criticized loans (classified loans and loans designated as special mention) as of the dates indicated.
 
At December 31,
 
2018
 
2017
 
2016
 
(In thousands)
Classified loans:
 
 
 
 
 
Substandard
$
10,712

 
$
10,355

 
$
8,452

Doubtful
241

 
250

 
645

Loss

 

 

Total classified loans
10,953

 
10,605

 
9,097

Special mention
26,147

 
9,896

 
31,857

Total criticized loans
$
37,100

 
$
20,501

 
$
40,954


At December 31, 2018, we had $10.7 million of substandard loans, of which $2.4 million were 1-4 family residential mortgage loans, and $7.0 million were commercial real estate loans. At December 31, 2018, special mention loans amounted to $26.1 million, of which $3.4 million were 1-4 family residential mortgage loans, $1.5 million were home equity, $5.3 million were commercial real estate loans, $16.0 million were commercial business loans and $66,000 were consumer loans. Loans classified as doubtful at December 31, 2018, 2017, and 2016 consist primarily of 1-4 family residential mortgages.

Potential problem loans are loans that are currently performing and are not included in classified loans above, but may be delinquent. These loans require an increased level of management attention, because we have serious doubts as to the ability of the borrower to comply with the present loan repayment terms and as a result such loans may be included at a later date in non-accrual loans. At December 31, 2018, we had no potential problem loans that are not discussed above under “Classification of Assets.”


19




Allowance for Loan Losses. We provide for loan losses based upon the consistent application of our documented allowance for loan loss methodology. All loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Additions to the allowance for loan losses are provided by charges to income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio, including a review of our classified assets, and make provisions for loan losses in order to maintain the allowance for loan losses in accordance with U.S. GAAP.

The allowance for loan losses is based on the size and composition of the loan portfolio, delinquency levels, loss experience, economic conditions and other factors related to the collectability of the loan portfolio. Prior to the second quarter of 2016, for portfolios for which the Company had insufficient loss experience, losses from a national peer group of depository institutions with assets between one and five billion dollars for relevant portfolios dating back to 2009 were used. Commencing in the second quarter of 2016, the Company began to phase in its own loss history by loan type based upon the age and loss experience of the loan portfolio.

The allowance for loan losses is evaluated regularly by management and reflects consideration of all significant factors that affect the collectability of the loan portfolio. Management's evaluation is submitted on a quarterly basis to the Board for approval of the methodology and any changes in qualitative factors described below. The evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. It is the intention of management to maintain an allowance that is prudently commensurate with the growth in the loan portfolio.

We evaluate the loan portfolio on a quarterly basis and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, will periodically review the allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.

The allowance consists of general, allocated and unallocated components, as further described below.

General component. The general component of the allowance for loan losses is based on a combination of our own loss history and an extrapolated historical loss experience based on FDIC data for depository institutions with assets of one billion to five billion dollars for periods ranging from 2010-2018, adjusted for qualitative and environmental factors including changes to lending policies and procedures, economic and business conditions, portfolio characteristics, staff experience, problem loan trends, collateral values, concentrations and the competitive, legal and regulatory environment.

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 do not generally originate loans with a loan-to-value ratio greater than 80 percent and do not generally grant loans that would be classified as subprime upon origination. When we do extend credit either on a first- or second-lien basis at a loan-to-value ratio greater than 80 percent, such loans are supported by either mortgage insurance or state guarantee programs. All loans in this segment are collateralized by owner-occupied 1-4 family residential real estate and repayment is dependent on the credit quality of the individual borrower. The health of the regional economy, including unemployment rates and housing prices, will have an effect on the credit quality of loans in this segment.

Home equity - Loans in this segment are generally secured by first or second liens on residential real estate. Repayment is dependent on the credit quality of the individual borrower. Management evaluates each loan application based on factors including the borrower’s credit score, income, length of employment, and other factors to establish the creditworthiness of the borrower.

Commercial real estate - Loans in this segment include investment real estate and are generally secured by assignments of leases, and real estate collateral. In cases where there is a concentration of exposure to a single large tenant, underwriting standards include analysis of the tenant's ability to support lease payments over the duration of the loan. The underlying cash flows generated by the properties can be adversely impacted by a downturn in the economy due to increased vacancy rates, which in turn can have an effect on credit quality in this segment. Payments on loans secured by income-producing properties often depend on the successful operation and management of properties. Management continually monitors cash flows on these loans.


20




Construction - Loans in this segment primarily include speculative real estate development loans for which payment is derived from sale of the property or permanent financing. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.

Commercial business - Loans in this segment are generally secured by business assets, including accounts receivable, inventory, real estate and intangible assets. Strict underwriting standards include considerations of the borrower’s ability to support the debt service requirements from the underlying historical and projected cash flows of the business, collateral values, the borrower’s credit history and the ultimate collectability of the debt. Economic conditions, real estate values, commodity prices, unemployment trends and other factors will affect the credit quality of loans in these segments.

Consumer - Loans in this segment primarily include classic and collector automobile loans. The classic and collector automobile loan portfolio is primarily comprised of geographically diverse loans originated by and purchased from a third party, who also provides collection services. While this portfolio generated minimal charge-offs during 2018 and 2017, the provisions during the year are based on management’s estimate of inherent losses.

Allocated component. The allocated component relates to loans that are on the watch list (non-accruing loans, partially charged off non-accruing loans and accruing adversely-rated loans) and considered impaired. Impairment is measured 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.

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. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

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

Unallocated component. Through the third quarter of 2016, the Company maintained an unallocated component to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflected the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio. As a large portion of the Company's loan portfolio had seasoned, the unallocated component of the allowance for loan losses was eliminated during the fourth quarter of 2016.




21




The following table sets forth activity in our allowance for loan losses for the periods indicated. 
 
At or For the Years Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(Dollars in thousands)
Balance at beginning of year
$
20,877

 
$
18,750

 
$
17,102

 
$
12,973

 
$
9,671

Charge-offs:
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
1-4 family residential

 
(52
)
 

 

 
(18
)
Commercial real estate
(194
)
 
(73
)
 
(321
)
 

 

Commercial business
(178
)
 

 
(3,098
)
 

 

Consumer loans
(91
)
 
(134
)
 
(56
)
 
(43
)
 
(61
)
Total charge-offs
(463
)
 
(259
)
 
(3,475
)
 
(43
)
 
(79
)
Recoveries:
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
1-4 family residential

 
199

 
100

 
82

 

Commercial real estate

 

 
101

 

 

Commercial business
31

 
74

 
37

 

 

Consumer loans
8

 
15

 

 

 

Total recoveries
39

 
288

 
238

 
82

 

Net (charge-offs) recoveries
(424
)
 
29

 
(3,237
)
 
39

 
(79
)
Provision (credit) for loan losses
(1,118
)
 
2,098

 
4,885

 
4,090

 
3,381

Balance at end of year
$
19,335

 
$
20,877

 
$
18,750

 
$
17,102

 
$
12,973

Ratios:
 
 
 
 
 
 
 
 
 
Net (charge-offs) recoveries to average loans outstanding
(0.02
)%
 
%
 
(0.19
)%
 
%
 
%
Allowance for loan losses to non-performing loans at end of year
183
 %
 
181
%
 
209
 %
 
159
%
 
290
%
Allowance for loan losses to total loans at end of year (1)
0.83
 %
 
0.95
%
 
0.97
 %
 
1.11
%
 
1.13
%
_______________________ 
(1)
Total loans do not include deferred costs and discounts.


22




Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
 
At December 31,
 
2018
 
2017
 
2016
 
Allowance for
Loan Losses
 
Percent of
Loans in Each
Category to
Total Loans
 
Allowance for
Loan Losses
 
Percent of
Loans in Each
Category to
Total Loans
 
Allowance for
Loan Losses
 
Percent of
Loans in Each
Category to
Total Loans
 
(Dollars in thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
$
5,432

 
43.75
%
 
$
5,076

 
41.87
%
 
$
4,846

 
44.12
%
Home equity
542

 
2.87

 
699

 
3.66

 
537

 
4.08

Commercial
8,555

 
37.16

 
9,584

 
37.86

 
8,374

 
35.63

Construction
1,074

 
3.22

 
1,708

 
4.13

 
1,353

 
3.96

Commercial business loans
3,499

 
12.34

 
3,473

 
11.50

 
3,206

 
10.69

Consumer loans
233

 
0.66

 
337

 
0.98

 
434

 
1.52

Total allocated allowance
$
19,335

 
100.00
%
 
$
20,877

 
100.00
%
 
$
18,750

 
100.00
%
Unallocated

 
 
 

 
 
 

 
 
Total
$
19,335

 
 
 
$
20,877

 
 
 
$
18,750

 
 
 
 
At December 31,
 
2015
 
2014
 
Allowance for
Loan Losses
 
Percent of
Loans in Each
Category to
Total Loans
 
Allowance for
Loan Losses
 
Percent of
Loans in Each
Category to
Total Loans
 
(Dollars in thousands)
Real Estate:
 
 
 
 
 
 
 
1-4 family residential
$
3,916

 
38.98
%
 
$
3,222

 
40.13
%
Home equity
636

 
5.03

 
340

 
5.38

Commercial
7,147

 
36.46

 
3,551

 
33.81

Construction
1,364

 
5.18

 
1,056

 
4.67

Commercial business loans
2,839

 
11.87

 
3,410

 
13.24

Consumer loans
772

 
2.48

 
736

 
2.77

Total allocated allowance
$
16,674

 
100.00
%
 
$
12,315

 
100.00
%
Unallocated
428

 
 
 
658

 
 
Total
$
17,102

 
 
 
$
12,973

 
 


23




Investments
    
The objectives of the investment portfolio are: to invest funds not currently required for the Bank’s loan portfolio, cash requirements or other assets essential to our operations; to provide for capital preservation of the funds invested while generating maximum income and capital appreciation in accordance with the objectives of liquidity, quality and diversification; and to employ a percentage of assets in a manner that will balance the market, credit and duration risks of other assets.

Investment management practices are governed by our investment policy, which outlines internal guidelines and parameters. The investment policy is reviewed and approved by the Board of Directors at least annually. Compliance with the investment policy is monitored on a regular basis. The Bank’s Management Investment Committee, consisting of the Chief Executive Officer, Chief Financial Officer and Treasurer, oversees investment portfolio management with day-to-day management responsibility assigned to the Treasurer. Additionally the Bank’s Asset/Liability Management Committee, evaluates portfolio performance from the standpoint of meeting overall income and capital appreciation targets in accordance with the objectives of liquidity, quality and diversification.

At December 31, 2018, our securities portfolio consisted of U.S. government and U.S. government agency obligations, U.S. government-sponsored enterprise obligations including mortgage-backed securities and collateralized mortgage obligations, and equity securities, including CRA-related mutual funds. We only purchase investment grade debt securities. We do not own any trust preferred securities.

    At December 31, 2018, we had no investments in a single company or entity that had an aggregate book value in excess of 10% of our equity, except for U.S. government-sponsored enterprise obligations including mortgage-backed securities. Generally, mortgage-backed securities are more liquid than individual mortgage loans, since there is an active trading market for such securities; their cashflow profiles make them attractive investments for liquidity management purposes. In addition, mortgage-backed securities may be used to collateralize our borrowings. Investments in mortgage-backed securities involve a risk that actual payments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such interests, thereby affecting the net yield on our securities. Prepayment speeds determine whether prepayment estimates require modifications that could cause amortization or accretion adjustments.

At the time of purchase, we designate a security as either held to maturity or available for sale, based upon our intent and ability to hold such security until maturity. Securities available for sale are reported at market value. A periodic review and evaluation of the securities portfolios is conducted to determine if the fair value of any security has declined below its carrying value and whether such decline is other-than-temporary. For securities classified as available for sale, unrealized gains and losses are excluded from earnings and are reported through other comprehensive income (loss). Commencing on January 1, 2018, with the adoption of ASU 2016-01, Financial Instruments – Overall, (Subtopic 825-10) equity investments are required to be measured at fair value with changes in fair value recognized in net income. See Note 1 to the consolidated financial statements. If a security is reclassified from available for sale to held to maturity, the fair value at the time of transfer becomes the security's new cost basis for which it is reported. The unrealized holding gain or loss at the transfer date continues to be reported in other comprehensive income and is amortized over the security's remaining life as an adjustment of yield in a manner similar to a premium or discount. At December 31, 2018, all debt securities are classified as held to maturity.


24




Investment Securities Portfolio. The following tables set forth the composition of our investment securities portfolio at the dates indicated. 
 
At December 31,
 
2018
 
2017
 
2016
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
(In thousands)
Securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
Mortgage and other asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Privately issued commercial mortgage-backed securities
$

 
$

 
$

 
$

 
$
10,530

 
$
10,489

Other asset-backed securities

 

 

 

 
9,174

 
8,985

Total mortgage and other asset-backed

 

 

 

 
19,704

 
19,474

Other bonds and obligations:
 
 
 
 
 
 
 
 
 
 
 
State and political

 

 

 

 
12,730

 
12,693

Financial services:
 
 
 
 
 
 
 
 
 
 
 
Banks

 

 

 

 
20,263

 
20,022

Diversified financial entities

 

 

 

 
17,198

 
17,190

Insurance and REITs

 

 

 

 
18,304

 
18,238

Total financial services

 

 

 

 
55,765

 
55,450

Other corporate:
 
 
 
 
 
 
 
 
 
 
 
Industrials

 

 

 

 
49,217

 
48,964

Utilities

 

 

 

 
24,895

 
25,087

Total other corporate

 

 

 

 
74,112

 
74,051

Total debt securities

 

 

 

 
162,311

 
161,668

 
 
 
 
 
 
 
 
 
 
 
 
Marketable equity securities:

 

 
9,437

 
9,720

 
45,612

 
43,168

Total securities available for sale
$

 
$

 
$
9,437

 
$
9,720

 
$
207,923

 
$
204,836

 
 
 
 
 
 
 
 
 
 
 
 
Securities held to maturity:
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
4,990

 
$
4,991

 
$