This discussion is intended to assist in understanding the consolidated financial condition and results of operations of the Company. This should be read in conjunction with the consolidated financial statements and accompanying notes contained in this report. Forward-Looking Statements This report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts; rather they are statements based on the Company's current expectations regarding its business strategies and their intended results and its future performance. Forward-looking statements are preceded by terms such as "expects," "believes," "anticipates," "intends" and similar expressions. Forward-looking statements are not guarantees of future performance. Numerous risks and uncertainties could cause or contribute to the Bank's actual results, performance and achievements being materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to these differences include, without limitation, general economic conditions, including changes in market interest rates and changes in monetary and fiscal policies of the federal government; legislative and regulatory changes; the quality and composition of the loan and investment securities portfolio; loan demand; deposit flows; competition; and changes in accounting principles and guidelines. Additional factors that may affect our results are discussed in the Company's 2013 Annual Report on Form 10-K under the section titled "Item 1A.- Risk Factors." These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company assumes no obligation and disclaims any obligation to update any forward-looking statements. Critical Accounting Policies We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. 21 --------------------------------------------------------------------------------
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Allowance for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. 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.
The allowance for loan losses is evaluated on a regular basis, at least quarterly, by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. 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: owner and non-owner occupied residential real estate, home equity, multi-family commercial real estate, construction, commercial 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: levels/trends in delinquencies; 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; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no changes in the Company's policies or methodology pertaining to the general component of the allowance for loan losses for the three months ended
December 31, 2013. 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: Residential real estate includes owner and non-owner occupied real estate loans and home equity loans. The Company originates most of the loans in this segment according to FNMA/FHLMC underwriting guidelines. Most loans in this segment are collateralized by 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. There are some non-owner occupied residential real estate loans with multiple investment properties that are evaluated as commercial real estate property. Commercial real estate: Commercial real estate includes multi-family and certain non-owner occupied residential real estate. Loans in this segment are primarily income-producing properties throughout Massachusetts. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment. Management periodically obtains rent rolls and continually monitors the cash flows of these loans. Construction loans: Loans in this segment primarily include speculative real estate development loans for which payment is derived from sale of the property. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.
Commercial 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 generally unsecured and repayment is dependent on the credit quality of the individual borrower.
The allocated component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis for commercial, commercial real estate and construction 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, the Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement. 22 --------------------------------------------------------------------------------
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A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring ("TDR"). All TDRs are classified as impaired.
An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio.
Deferred Tax Assets. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. Management reviews deferred tax assets on a quarterly basis to identify any uncertainties pertaining to realization of such assets. In determining whether a valuation allowance is required against deferred tax assets, management assesses historical and forecasted operating results, including a review of eligible carryforward periods, tax planning opportunities and other relevant considerations. We believe the accounting estimate related to the valuation allowance is a critical estimate because the underlying assumptions can change from period to period. For example, tax law changes or variances in future projected operating performance could result in a change in the valuation allowance. Should actual factors and conditions differ materially from those used by management, the actual realization of net deferred tax assets could differ materially from the amounts recorded in the financial statements. If we were not able to realize all or part of our deferred tax assets in the future, an adjustment to the related valuation allowance would be charged to income tax expense in the period such determination was made and could have a negative impact on earnings. In addition, if actual factors and conditions differ materially from those used by management, we could incur penalties and interest imposed by taxing authorities.
Comparison of Financial Condition at
Total Assets. Total assets increased by
$5.4 million, from $77.1 millionat September 30, 2013to $82.5 millionat December 31, 2013, primarily due to an increase in loans held-for-sale of $2.5 million, an increase in loans, net, of $2.9 million, and an increase in investments in available-for-sale securities of $1.6 million. This increase was primarily offset by a decrease in cash and cash equivalents of $2.2 million. Cash and Cash Equivalents. Cash and cash equivalents decreased by $2.2 million, from $4.7 millionat September 30, 2013to $2.5 millionat December 31, 2013, in order to fund new loan originations. Federal funds sold and interest-bearing demand deposit balances decreased by $1.4 million, from $1.5 millionat September 30, 2013to $43,000at December 31, 2013, in order to fund new loan originations.
Interest-Bearing Time Deposits in Other Banks. These deposits increased by
Securities. Our securities portfolio consists primarily of residential mortgage-backed securities issued by U.S. government agencies and government sponsored enterprises. Investments in available-for-sale securities increased by
$1.6 million, from $5.3 millionat September 30, 2013to $6.9 millionat December 31, 2013. The increase is primarily due to purchases, net of repayments, of mortgage-backed securities.
Loans, Net. Loans, net, increased by
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Loans Held-for-Sale. Loans held-for-sale increased by
Deposits. Our primary sources of funds are retail deposit accounts held primarily by individuals and businesses within our primary market area. Total deposits increased by
$1.6 million, from $66.2 millionat September 30, 2013to $67.8 millionat December 31, 2013, primarily due to a $470,000increase in noninterest-bearing accounts and a $760,000increase in certificates of deposit. The following table sets forth the balances of our deposit products at the dates indicated. December 31, September 30, (Dollars in thousands) 2013 2013 (unaudited) Noninterest-bearing demand deposits $ 11,48516.95 % $ 11,01516.64 % Interest bearing deposits: Money market 10,101 14.91 9,799 14.80 Regular and other savings 9,602 14.17 9,569 14.46 Certificates of deposit 36,569 53.97 35,809 54.10 Total $ 67,757100.00 % $ 66,192100.00 % Borrowings. We generally use borrowings from the Federal Home Loan Bank of Bostonto supplement our supply of funds for originating loans and purchasing securities. No Federal Home Loan Bank of Bostonborrowings were outstanding at September 30, 2013. Total borrowings at December 31, 2013were $4.1 million.
Comparison of Results of Operations for the Three Months Ended
Net (Loss) Income. Net income decreased by
$101,000, from $34,000in the three months ended December 31, 2012to $(67,000)in the three months ended December 31, 2013, primarily due to a decrease in non-interest income of $223,000and an increase in noninterest expense of $53,000, offset by an increase in net interest and dividend income of $94,000and a decrease in income tax expense of $66,000. Non-Interest Income. Non-interest income decreased by $223,000, from $355,000in the three months ended December 31, 2012to $132,000in the three months ended December 31, 2013, primarily due to a decrease in gains on secondary market activities of $230,000, from $260,000in the three months ended December 31, 2012to $30,000in the three months ended December 31, 2013. This decrease is attributed to a reduction in gains on loans sold due to a reduced volume of loans sold. This was primarily offset by an increase in customer service fees of $16,000, from $73,000in the three months ended December 31, 2012to $89,000in the three months ended December 31, 2013. Net Interest and Dividend Income. Net interest and dividend income increased by $94,000, from $486,000in the three months ended December 31, 2012to $580,000in the three months ended December 31, 2013, primarily due to an increase in loan volume. The average yield on interest-earning assets increased from 3.62% in the three months ended December 31, 2012to 3.86% in the three months ended December 31, 2013, with a corresponding increase in the average balance of interest-earning assets from $68.5 millionto $74.2 million. The average rate paid on interest-bearing liabilities decreased from 0.99% in the three months ended December 31, 2012to 0.92% in the three months ended December 31, 2013. The interest rate spread increased from 2.63% in the three months ended December 31, 2012to 2.94% in the three months ended December 31, 2013. Average Balances and Yields. The following table (unaudited) presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Average balances have been calculated using daily balances. Loan fees are included in interest income on loans and are insignificant. 24 --------------------------------------------------------------------------------
Table of Contents Three months ended December 31, 2013 2012 Average Interest Average Average Interest Average Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ (Dollars in thousands) Balance Paid Rate (4) Balance Paid Rate (4) Interest-earning assets: Securities (1)
$ 6,885 $ 341.98 % $ 6,041 $ 422.78 % Loans, net (2) 62,530 674 4.31 % 51,642 562 4.35 % Other interest earning assets (3) 4,819 8 0.66 % 10,794 15 0.56 % Total interest-earning assets 74,234 716 3.86 % 68,477 619 3.62 % Non-interest earning assets 8,908 10,503 Total assets $ 83,142 $ 78,980Interest bearing liabilities: Regular savings accounts $ 9,694 $ 40.17 % $ 8,971 $ 60.27 % Money market accounts 9,817 13 0.53 % 8,806 11 0.50 % Time deposits 36,842 116 1.26 % 36,224 116 1.28 % Total interest bearing deposits 56,353 133 0.94 % 54,001 133 0.99 % Federal Home Loan Bankadvances 2,401 3 0.50 % - - - Total interest-bearing liabilities 58,754 136 0.92 % 54,001 133 0.99 % Demand deposits 10,976 16,870 Other liabilities 200 110 Stockholders' equity 13,212 7,999 Total liabilities and stockholders' equity $ 83,142 $ 78,980Net interest income $ 580 $ 486Interest rate spread 2.94 % 2.63 % Net yield on earning assets 3.13 % 2.84 %
(2) Includes non-accrual loans and interest received on such loans, and loans held-for-sale.
(3) Includes short-term investments.
(4) Yields and rates for the three month periods ended
Table of Contents Rate/Volume Analysis. The following table (unaudited) sets forth the effects of changing rates and volumes on our net interest and dividend income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total increase (decrease) column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume. Three Months Ended December 31, 2013 Compared to Three Months Ended December 31, 2012 Increase (Decrease) Due to (In thousands) Volume Rate Net Interest income: Securities (1) $ 7
$ (15 ) $ (8 )Loans, net (2) 117 (5 ) 112 Other interest-earning assets (3) (11 ) 4 (7 ) Total interest-earning assets 113 (16 ) 97 Interest expense: Deposits $ 6 $ (6 )$ - Federal Home Loan Bank advances 3 - 3 Total interest-bearing liabilities 9 (6 ) 3
Increase (decrease) in net interest income
(2) Includes non accruing loan balances and interest received on such loans, and loans held-for-sale.
(3) Includes short-term investments.
Provision for Loan Losses. The provision for loan losses decreased by
$15,000, from $4,000for the three months ended December 31, 2012to $(11,000)for the three months ended December 31, 2013. The decrease in the provision was due to the annual review of the loan portfolio resulting in several classification upgrades.
Analysis of Loan Loss Experience. The following table (unaudited) sets forth an analysis of the allowance for loan losses for the periods indicated.
Table of Contents For the Three Months Ended December 31, (Dollars in thousands) 2013 2012 Allowance beginning of period $ 435 $ 334 (Benefit) provision for loan losses (11 ) 4 Charge-offs - (3 ) Recoveries - - Allowance at end of period $ 424 $ 335 Allowance for loan losses as a percent of non- performing loans 1,927.27 % 1,763.16 % Allowance for loan losses as a percent of total loans 0.70 % 0.76 % Net (charge-offs) recoveries to average loans outstanding during the period - % (0.01 )% Noninterest Income. Noninterest income decreased by
$223,000, from $355,000in the three months ended December 31, 2012to $132,000in the three months ended December 31, 2013, primarily due to a decrease in gain on secondary market activities from $260,000to $30,000. The decrease in gain on secondary market activities was primarily due to decreased volume of loans sold in the secondary market due to an increase in market interest rates. Noninterest Expense. Noninterest expense increased by $53,000, from $784,000in the three months ended December 31, 2012to $837,000in the three months ended December 31, 2013primarily due to increases in occupancy and equipment expense and professional fees. Professional fees expenses increased $27,000, primarily due to legal fees and holding company expenses. Occupancy and equipment expenses increased $34,000, primarily due to increased expenses related to the opening of a branch in Roslindale. Income Tax (Benefit) Expense. Income tax expense decreased by $66,000, from $19,000in the three months ended December 31, 2012to $(47,000)in the three months ended December 31, 2013, due to the pre-tax loss for the three months ended December 31, 2013. The effective tax rate was 36% for the three months ended December 31, 2012and (41)% for the three months ended December 31, 2013. Analysis of Nonperforming and Classified Assets. We consider repossessed assets and loans that are 90 days or more past due to be non-performing assets. Residential real estate loans are generally placed on nonaccrual status when they become 90 days past due or are in the process of foreclosure, at which time the accrual of interest ceases and the allowance for any uncollectible accrued interest is established and charged against interest revenue. All closed-end consumer loans 90 days or more past due and equity lines in the process of foreclosure are placed on nonaccrual status. Secured consumer loans are written down to realizable value and unsecured consumer loans are charged-off upon reaching 120 or 180 days past due depending on the type of loan. Commercial real estate loans and commercial business loans and leases which are 90 days or more past due are placed on nonaccrual status, unless secured by sufficient cash or other assets immediately convertible to cash. Typically, when a loan has been placed on nonaccrual status, previously accrued and uncollected interest is reversed against interest on loans. A loan can be returned to accrual status when collectability of principal is reasonably assured based on our determination that the event of delinquency was a one-time incident. Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired it is recorded at fair market value at the date of foreclosure. Any holding costs and changes in fair value after acquisition of the property are reflected in income. 27
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The following table provides information with respect to our nonperforming assets, including troubled debt restructurings, at the dates indicated.
December 31, September 30, (Dollars in thousands) 2013 2013 (unaudited) Nonaccrual loans: Real estate loans: Residential $ - $ 46 Commercial - - Total real estate - 46 Consumer loans 22 - Total 22 46 Accruing loans past due 90 days or more - - Total nonaccrual loans and accruing loans past due 90 days 22 46 Other real estate owned - - Total nonperforming assets 22 46 Troubled debt restructurings - - Total nonperforming assets and troubled debt restructurings $ 22 $
Total nonperforming loans to total loans 0.04 % 0.08 % Total nonperforming loans to total assets 0.03 % 0.06 % Total nonperforming assets and troubled debt restructurings to total assets 0.03 % 0.06 %
Liquidity and Capital Resources
Liquidity Management. Liquidity is the ability to meet current and future financial obligations of a short-term and long-term nature. The Bank's primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities, borrowings from the Federal Home Loan Bank of
Bostonand securities sold under agreements to repurchase. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and prepayments on loans are greatly influenced by general interest rates, economic conditions and competition. Management regularly adjusts its investments in liquid assets based upon an assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of our interest-rate risk and investment policies. The Bank's most liquid assets are cash and cash equivalents, interest-bearing deposits in other banks, and corporate bonds. The levels of these assets depend on the Bank's operating, financing, lending and investing activities during any given period. At December 31, 2013, cash and cash equivalents totaled $2.5 million. Securities classified as available-for-sale provide additional sources of liquidity and had a market value of $6.9 millionat December 31, 2013. In addition, at December 31, 2013, the Bank had the ability to borrow a total of approximately $12.3 millionfrom the Federal Home Loan Bank of Boston. At December 31, 2013, the Bank had borrowings outstanding of $4.1 million. In addition, at December 31, 2013, the Bank had the ability to borrow $3.3 millionfrom the Co-operative Central Bank, none of which was outstanding at that date. In addition, the Bank had a $500,000line of credit available from Bankers' Bank Northeast. At December 31, 2013, the Bank had no borrowings outstanding under this credit facility. 28
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December 31, 2013, the Bank had $6.8 millionin loan commitments outstanding, which consisted of commitments to originate loans, available lines of credit and unadvanced funds on construction loans. Certificates of deposit due within one year after December 31, 2013totaled $24.9 million, or 68% of total time deposits. If these maturing deposits are not renewed, the Bank will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, the Bank may be required to pay higher rates on such deposits or other borrowings than the Bank currently pays on the certificates of deposit. Management believes, however, based on past experience that a significant portion of our certificates of deposit will be renewed. The Bank has the ability to attract and retain deposits by adjusting the interest rates offered. The Company is a separate legal entity from the Bank and must provide for its own liquidity to pay its operating expenses and other financial obligations, to pay any dividends and to repurchase any of its outstanding common stock. The Company's primary source of income is dividends received from the Bank. Under Massachusettsbanking law, the amount of dividends that the Bank may declare and pay to the Company in any calendar year, without receipt of prior approval from the Commissioner of Banks of Massachusetts, cannot exceed the total of its net profits for that year combined with its retained net profits of the preceding two years, less any required transfer to surplus or a fund for the retirement of any preferred stock. At December 31, 2013, the Company had liquid assets of $2.3 million.
Contractual Obligations. The Company has entered into a non-cancellable lease agreement pertaining to the
Capital Management. The Bank is subject to various regulatory capital requirements administered by the
Federal Deposit Insurance Corporationand the MassachusettsCommissioner of Banks, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2013, the Bank exceeded all of its regulatory capital requirements to be considered "well capitalized" under regulatory guidelines. See note 8 of the notes to consolidated financial statements.
Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers' requests for funding and take the form of loan commitments and lines of credit. The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but usually includes income-producing commercial properties or residential real estate. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company's outstanding letters of credit generally have a term of less than one year. If a letter of credit is drawn upon, the Company may seek recourse through the 29 --------------------------------------------------------------------------------
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customer's underlying line of credit. If the customer's line of credit is also in default, the Company may take possession of the collateral, if any, securing the line of credit.
Notional amounts of financial instrument liabilities with off-balance sheet credit risk are as follows (in thousands):
December 31, September 30, 2013 2013 (unaudited) Commitments to originate loans
$ 2,912$ 1,880 Unadvanced funds on lines of credit 3,626 2,803 Standby letters of credit 149 149 Unadvanced funds on construction loans 115 307 $ 6,802$ 5,139
There is no material difference between the notional amount and the estimated fair value of the off-balance sheet liabilities.