News Column

HAMPDEN BANCORP, INC. - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations

May 14, 2014

This section is intended to help investors understand the financial performance of Hampden Bancorp, Inc. and its subsidiaries, through a discussion of the factors affecting our financial condition at March 31, 2014 and June 30, 2013 and our consolidated results of operations for the three and nine months ended March 31, 2014 and 2013, and should be read in conjunction with the Company's unaudited consolidated interim financial statements and notes thereto, appearing in Part I, Item 1 of this Quarterly Report on Form 10-Q.



Forward-Looking Statements

Certain statements herein constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on the beliefs and expectations of management, as well as the assumptions made using information currently available to management. Since these statements reflect the views of management concerning future events, these statements involve risks, uncertainties and assumptions. As a result, actual results may differ from those contemplated by these statements. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words like "believe", "expect", "anticipate", "estimate", and "intend" or future or conditional verbs such as "will", "would", "should", "could", or "may." Certain factors that could have a material adverse effect on the operations Hampden Bank include, but are not limited to, increased competitive pressure among financial service companies, national and regional economic conditions, changes in interest rates, changes in consumer spending, borrowing and savings habits, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and Federal Reserve Board, the quality and composition of our loan or investment portfolio, demand for financial services in our market area, changes in real estate values in our market area, adverse changes in the securities markets, inability of key third-party providers to perform their obligations to Hampden Bank, and changes in relevant accounting principles and guidelines. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. The Company disclaims any intent or obligation to update any forward-looking statements, whether in response to new information, future events or otherwise. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain important factors, including those set forth below under Item 2 -"Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this the Quarterly Report on Form 10-Q, as well as in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2013, including the section titled Item 1A -"Risk Factors". You should carefully review those factors and also carefully review the risks outlined in other documents that the Company files from time to time with the SEC. The Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as may be required under applicable securities laws.



Critical Accounting Policies

We consider accounting policies that require management to exercise significant judgment or discretion, or make significant assumptions that have or could have a material impact on the carrying value of certain assets, liabilities, revenue, expenses, or related disclosures, to be critical accounting policies. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management's most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board.



Allowance for Loan Losses

Critical Estimates. 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 uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a quarterly basis 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 analysis of the allowance for loan losses has two components: specific and general allocations, which are described on pages 17-18.

25 -------------------------------------------------------------------------------- Judgment and Uncertainties. The qualitative factors are assessed based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are described on page 18. Effect if Actual Results Differ from Assumptions. Although we believe we have established and maintained the allowance for loan losses at adequate levels, additions may be necessary if the current operating environment deteriorates. Management uses the best information available; however, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change. In addition, the FDIC and the Massachusetts Division of Banks, as an integral part of their examination process, will periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination.



Income Taxes

Critical Estimates. 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 the deferred tax assets on a quarterly basis to identify any uncertainties to the collectability of the components of the deferred tax asset.

Judgment and Uncertainties. In determining the realizability of the deferred tax asset, we use historical and forecasted operating results, based upon approved business plans, including a review of the eligible carryforward periods, tax planning opportunities and other relevant considerations to determine if a valuation allowance is warranted. Management believes that the accounting estimate related to the valuation allowance is a critical accounting 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. Effect if Actual Results Differ from Assumptions. Should actual factors and conditions differ materially from those used by management, the actual realization of net deferred tax assets or deferred tax liabilities could differ materially from the amounts recorded in the financial statements. If we were not able to realize all or part of our net deferred tax assets in the future, an adjustment to our deferred tax assets valuation allowance would be charged to income tax expense in the period such determination was made and would have a negative impact on the Company's earnings. In addition, if actual factors and conditions differ materially from those used by management, the Company could incur penalties and interest imposed by the Internal Revenue Service.



Comparison of Financial Condition at March 31, 2014 and June 30, 2013

Overview

Total Assets. The Company's total assets increased $64.6 million, or 9.9%, from $653.0 million at June 30, 2013 to $717.6 million at March 31, 2014. Net loans, including loans held for sale, increased $47.4 million, or 10.5%, from $451.6 million at June 30, 2013 to $499.0 million at March 31, 2014. Securities available for sale increased $7.1 million, or 5.1%, to $145.8 million and cash and cash equivalents increased $7.9 million, or 30.7%, to $33.5 million at March 31, 2014. Deposits increased $28.7 million, or 6.0%, from $474.8 million at June 30, 2013 to $503.5 million at March 31, 2014. Investment Activities. The composition and fair value of the Company's investment portfolio is included in Note 7 to the Company's accompanying unaudited consolidated financial statements. Current period purchases of municipal bonds were partially offset by the principal payments and unrealized losses on residential mortgage-backed securities during the nine months ended March 31, 2014. Net Loans. The composition of the Company's loan portfolio is included in Note 8 to the Company's accompanying unaudited consolidated financial statements. The increases in commercial real estate, commercial, and commercial construction loans were due to the Company's increased emphasis on obtaining commercial lending relationships. During the origination of fixed rate mortgages, each loan is analyzed to determine if the loan will be sold into the secondary market or held in portfolio. The Company retains servicing for loans sold to Fannie Mae and earns a fee equal to 0.25% of the loan amount outstanding for providing these services. Loans which the Company originates to the standards of the buyer, which may differ from the Company's underwriting standards, are generally sold to a third party along with the servicing rights without recourse. For the nine months ended March 31, 2014, loans sold totaled $14.5 million. Of the $14.5 million of loans sold, $6.4 million were sold on a servicing-released basis and $8.1 million were sold on a servicing-retained basis. 26 --------------------------------------------------------------------------------



Non-Performing Assets. The following table sets forth the amounts of our non-performing assets at the dates indicated. The categories of our non-performing loans are included in Note 8 to the Company's accompanying unaudited consolidated financial statements.

At March 31, At June 30, 2014 2013 (Dollars in Thousands) Total non-performing loans $ 4,628$ 3,979 Other real estate owned 1,240 1,221 Total non-performing assets $ 5,868$ 5,200



Performing troubled debt restructurings, not reported above $ 4,733

$ 7,258

Ratios:

Non-performing loans to total loans 0.92 % 0.88 % Non-performing assets to total assets 0.82 % 0.80 % Generally, loans are placed on non-accrual status either when reasonable doubt exists as to the full collection of interest and principal or when a loan becomes 90 days past due, unless an evaluation clearly indicates that the loan is well-secured and in the process of collection. Past due status is based on the contractual terms of the loans. From June 30, 2013 to March 31, 2014, commercial non-performing loans have decreased $481,000; residential mortgage non-performing loans have increased $965,000; consumer, including home equity and manufactured homes, non-performing loans have decreased $235,000. In addition, commercial real estate non-performing loans have increased $400,000. The increase in residential mortgage non-performing loans is due to one loan totaling $1.4 million. This loan is adequately collateralized and the property is currently for sale. At March 31, 2014, the Company had fourteen troubled debt restructurings (TDRs) totaling approximately $5.3 million, of which $550,000 is on non-accrual status. All loans that are modified and a concession granted by the Company in light of the borrower's financial difficulty are considered a TDR and are classified as impaired loans by the Company. The interest income recorded from these loans amounted to $263,000 for the nine month period ended March 31, 2014. At June 30, 2013, the Company had sixteen TDRs consisting of commercial and mortgage loans totaling approximately $7.8 million, of which $580,000 was on non-accrual status. The interest income recorded from the restructured loans amounted to $239,000 for the year ended June 30, 2013. As of March 31, 2014, loans on non-accrual status totaled $4.6 million which consisted of $4.0 million in loans that were 90 days or greater past due and $600,000 in loans that are current or less than 30 days past due. It is the Company's policy to keep loans on non-accrual status subsequent to becoming current until the borrower can demonstrate their ability to make payments according to their loan terms for six months. As of March 31, 2014, there were no commercial real estate non-accrual loans less than 90 days past due. 1-4 family residential non-accrual loans less than 90 days past due were $379,000, commercial non-accrual loans less than 90 days past due were $135,000, manufactured homes non-accrual less than 90 days past due were $35,000 and home equity second lien non-accrual loans less than 90 days past due were $51,000. All non-accrual loans, TDRs, and loans with risk ratings of six or higher are assessed by the Company for impairment. In the normal course of business, the Company may modify a loan for a credit-worthy borrower where the modified loan is not considered a TDR. In these cases, the modified terms are consistent with loan terms available to credit worthy borrowers and within normal loan pricing. The modifications to such loans are done according to our existing underwriting standards. These modified loans are not considered impaired loans by the Company. Non-accrual loans, including TDRs, return to accrual status once the borrower has shown the ability and an acceptable history of repayment. The borrower must be current with their payments in accordance with the loan terms for six months. The Company may also return a loan to accrual status if the borrower evidences sufficient cash flow to service the debt and provides additional collateral to support the collectability of the loan. For non-accrual loans that make payments, the Company recognizes cash interest payments as interest income when the Company does not have a collateral shortfall for the loan and the loan has not been charged off. If there is a collateral shortfall for the loan or it has been charged off, then the Company applies the entire payment to the principal balance on the loan. 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, the collateral, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan-by-loan basis by the present value of expected future cash flows discounted at the loan's effective interest rate or fair value of collateral if the loan is collateral dependent and any change in present value is recorded within the provision for loan loss. Impaired loans decreased to $11.7 million at March 31, 2014 from $ 15.0 million at June 30, 2013. The Company established specific reserves aggregating $12,000 and $32,000 for impaired loans at March 31, 2014 and June 30, 2013, respectively. Such reserves relate to one impaired loan relationships with a carrying value of $540,000, and are based on management's analysis of the expected cash flows for troubled debt restructurings as of March 31, 2014. 27

-------------------------------------------------------------------------------- We believe that the determination of our allowance for loan losses, including amounts required for impaired loans, is consistent with generally accepted accounting principles and current regulatory guidance. While the Company believes that it has established adequate specifically allocated and general allowances for losses on loans, adjustments to the allowance may be necessary if future conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Company's regulators periodically review the allowance for loan losses. These regulatory agencies may require the Company to recognize additions to the allowance based on their judgments of information available to them at the time of their examination, thereby negatively affecting the Company's financial condition and earnings. It is also possible that, in this current economic environment, additional loans will become impaired in future periods. The Company classifies property acquired through foreclosure or acceptance of a deed in lieu of foreclosure as OREO in its consolidated financial statements. When property is placed into OREO, it is recorded at the fair value less estimated costs to sell at the date of foreclosure or acceptance of deed in lieu of foreclosure. At the time of transfer to OREO, any excess of carrying value over fair value is charged to the allowance for loan losses. Management, or its designee, inspects all OREO property periodically. Holding costs and declines in fair value result in charges to expense after the property is acquired. At March 31, 2014, the Company had nine properties with a carrying value of $1.2 million classified as OREO. Two of these properties were commercial properties valued at $562,000, one property was a residential property valued at $155,000, two properties were home equity second-lien properties valued at $468,000 and four properties were manufactured homes valued at $55,000 in aggregate. Allowance for Loan Losses. The following table sets forth ratios relating to the Company's allowance for loan losses for the periods indicated. The activity in the Company's allowance for loan losses is included in Note 8 to the Company's accompanying unaudited consolidated financial statements. Three Months Ended Nine Months Ended March 31, March 31, 2014 2013 2014 2013 Ratios: Net charge-offs to average loans outstanding 0.00 % 0.01 % 0.04 % 0.05 % Allowance for loan losses to non-performing loans at end of period 121.39 % 133.49 % 121.39 % 133.49 % Allowance for loan losses to total loans at end of period 1.12 % 1.19 % 1.12 % 1.19 % It is the Company's policy to classify all non-accrual loans as impaired loans. All impaired loans are measured on a loan-by-loan basis to determine if any specific allowance is required for the allowance for loan loss 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. If the impaired loan has a shortfall in the expected future cash flows then a specific allowance will be placed on the loan in that amount. However, the Company may consider collateral values where it feels there is greater risk and the expected future cash flow allowance is not sufficient. Residential, commercial real estate and construction loans are secured by real estate. Except for one, all commercial loans are secured by all business assets and many also include primary or secondary mortgage positions on business and/or personal real estate. The other commercial loan is secured by shares of stock of a subsidiary of a borrower. When calculating the general allowance component of the allowance for loan losses, the Company analyzes the trend in delinquencies, among other things as further described in Note 8 to the accompanying unaudited consolidated financial statements. If there is an increase in the amount of delinquent loans in a particular loan category this may cause the Company to increase the general allowance requirement for that loan category. A partial charge-off on a non-performing loan will decrease the amount of non-performing and impaired loans, as well as any specific allowance requirement that loan may have had. This will also decrease our allowance for loan losses, as well as our allowance for loan losses to non-performing loans ratio and our allowance for loan losses to total loans ratio. The Company incorporates historical charge-offs, including the greater of charge-offs recognized in the current quarter, which are annualized, or projected annual charge-offs when calculating the general allowance component of the allowance for loan losses. Loan Servicing. In the ordinary course of business, the Company sells residential real estate loans to the secondary market. The Company retains servicing on certain loans sold and earns servicing fees of 0.25% per annum based on the monthly outstanding balance of the loans serviced. The Company recognizes servicing assets each time it undertakes an obligation to service loans sold. The Company's mortgage servicing asset valuation is performed on a quarterly basis by an independent third party, using a statistical valuation model representing the projection into the future of a single interest rate/market environment. The projected cash flows are then discounted back to present value. Discount rates, estimate of servicing costs and ancillary income, estimates of float earnings rates and delinquency information as well as an estimate of prepayments are used to calculate the value of the mortgage servicing asset. For the nine months ended March 31, 2014, the increase in the fair market value of mortgage servicing assets was $44,000. The changes in servicing assets measured using fair value are on page 12. There are no recourse provisions for the loans that are serviced for others. The risks inherent in mortgage servicing assets relate primarily to changes in prepayments that result from shifts in mortgage interest rates. For the nine months ended March 31, 2014 and 2013, amounts recognized for loan servicing fees amounted to $254,000 and $271,000, respectively, which are included in other non-interest income in the consolidated statements of net income. The unpaid principal balance of mortgages serviced for others was $70.1 million and $67.7 million at March 31, 2014 and June 30, 2013, respectively. 28 --------------------------------------------------------------------------------



Deposits and Borrowed Funds. The following table sets forth the Company's deposit accounts (excluding escrow deposits) for the periods indicated.

At March 31, At June 30, 2014 2013 Balance Percent Balance Percent Change % Change (Dollars in Thousands) Deposit type: Demand deposits $ 85,633 17.01 % $ 74,081 15.60 % $ 11,552 15.59 % Savings deposits 104,162 20.69 104,893 22.09 (731 ) (0.70 ) Money market 97,286 19.32 84,277 17.75 13,009 15.44 NOW accounts 46,144 9.16 46,220 9.73 (76 ) (0.16 )



Total transaction accounts 333,225 66.18 309,471 65.18 23,754

7.68 Certificates of deposit 170,273 33.82 165,327 34.82 4,946 2.99 Total deposits $ 503,498 100.00 % $ 474,798 100.00 % $ 28,700 6.04 %



Deposits increased $28.7 million, or 6.04%, to $503.5 million at March 31, 2014 from $474.8 million at June 30, 2013.

Borrowings include advances from the FHLB and have increased $34.4 million, or 39.6%, to $121.4 million at March 31, 2014 from $87.0 million at June 30, 2013. The Company primarily used these FHLB borrowings to fund its loan demand. Stockholders' Equity. Stockholders' equity increased $2.2 million, or 2.6%, to $85.9 million at March 31, 2014 from $83.7 million at June 30, 2013. During the nine months ended March 31, 2014, the Company purchased 17,622 shares of Company stock for $270,000 at an average price of $15.30 per share pursuant to the Company's previously announced stock repurchase programs. In addition, the Company repurchased 260 shares of Company stock, at an average price of $15.52 per share, in the nine months ended March 31, 2014 in connection with the vesting of certain restricted stock grants issued pursuant to our 2008 Equity Incentive Plan. The Company repurchased these shares from an employee plan participant for settlement of tax withholding obligations. In addition, there was a $528,000 decrease in accumulated other comprehensive income from June 30, 2013 to March 31, 2014 due to the continued impact of the rising interest rate environment on the fair value of securities available for sale. Offsets to the increase in treasury stock and decrease in accumulated other comprehensive income were a $2.3 million increase in retained earnings, a $387,000 increase in additional paid-in capital, a $318,000 decrease in ESOP unearned compensation and a $6,000 decrease in equity incentive plan unearned compensation. Our ratio of capital to total assets decreased to 12.0% at March 31, 2014 compared to 12.8% at June 30, 2013. The Company's book value per share as of March 31, 2014 was $15.19 compared to $14.86 at June 30, 2013.



Comparison of Operating Results for the Three Months Ended March 31, 2014 and March 31, 2013

Net Income. The Company had a $196,000 increase in net income for the three months ended March 31, 2014 to $1.0 million, or $0.19 per fully diluted share, as compared to $825,000, or $0.15 per fully diluted share, for the same period in 2013. The Company had an increase in net interest income of $564,000, or 12.3%, for the three months ended March 31, 2014 compared to the same period in 2013 due to an increase in interest and dividend income of $510,000, or 8.6%, and a decrease in total interest expense of $54,000 or 4.0%. The provision for loan losses increased $50,000 for the three months ended March 31, 2014 compared to the same period in 2013 primarily due to the increase in loan growth. For the three months ended March 31, 2014 there was a decrease in total non-interest income of $390,000 compared to the three months ended March 31, 2013. Non-interest expense decreased $162,000, or 3.7%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. Our combined federal and state effective tax rate was 36.0% for the three months ended March 31, 2014 compared to 37.0% for the same period in 2013.



Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. The yields set forth below include the effect of deferred costs, and discounts and premiums that are amortized or accreted to interest income or expense. The Company does not accrue interest on loans on non-accrual status; however, the balance of these loans is included in the total average balance, which has the effect of lowering average loan yields. 29 -------------------------------------------------------------------------------- Three Months Ended March 31, 2014 2013 Average Average Outstanding Yield Outstanding Yield Balance Interest /Rate (1) Balance Interest /Rate (1) (Dollars in Thousands) Interest-earning assets: Loans (2) $ 502,626$ 5,699 4.54 % $ 438,407$ 5,268 4.81 % Investment securities 151,224 728 1.93 152,208 645 1.70 Federal funds sold and other short-term investments 13,691 7 0.20 17,640 11 0.25 Total interest earning assets 667,541 $ 6,434 3.86 % 608,255 $ 5,924 3.90 % Allowance for loan losses (5,540 ) (5,152 ) Total interest-earning assets less allowance for loan losses 662,001 603,103 Non-interest-earning assets 42,908 43,889 Total assets $ 704,909$ 646,992 Interest-bearing liabilities: Savings deposits $ 104,279$ 32 0.12 % $ 100,104$ 50 0.20 % Money market 91,201 79 0.35 81,327 79 0.39 NOW accounts 48,555 33 0.27 40,109 31 0.31 Certificates of deposit 166,026 582 1.40 170,384 735 1.73 Total deposits 410,061 726 0.71 391,924 895 0.91 Borrowed funds 125,599 566 1.80 96,042 451 1.88 Total interest-bearing liabilities 535,660 $ 1,292 0.96 % 487,966 $ 1,346 1.09 % Demand deposits 78,248 66,168 Other non-interest-bearing liabilities 5,282 5,985 Total liabilities 619,190 560,119 Equity 85,719 86,873 Total liabilities and equity $ 704,909$ 646,992 Net interest income $ 5,142$ 4,578 Interest rate spread (3) 2.90 % 2.79 % Net interest-earning assets (4) $ 131,881$ 120,289 Net interest margin (5) 3.08 % 3.01 % Average interest-earning assets to interest-bearing liabilities 124.62 % 124.65 % (1) Yields and rates for the three months ended March 31, 2014 and 2013 are annualized. (2) Includes loans held for sale. (3) Interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities for the period indicated. (4) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities. (5) Net interest margin represents net interest income divided by average total interest-earning assets. The following table presents the dollar amount of changes in interest income and interest expense for the major categories of the Company's interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate. 30

-------------------------------------------------------------------------------- Three Months Ended March 31, 2014 vs. 2013 Increase (Decrease) Due to Total Increase Volume Rate (Decrease) (Dollars in Thousands) Interest income: Loans (1) $ 740$ (309 ) $ 431 Investment securities (4 ) 87 83 Federal funds sold and other short- term investments (2 ) (2 ) (4 ) Total interest income 734 (224 ) 510 Interest expense: Savings deposits 2 (20 ) (18 ) Money market 9 (9 ) - NOW accounts 6 (4 ) 2 Certificates of deposits (18 ) (135 ) (153 ) Total deposits (1 ) (168 ) (169 ) Borrowed funds 134 (19 ) 115 Total interest expense 133 (187 ) (54 ) Change in net interest income $ 601$ (37 ) $ 564 (1) Includes loans held for sale.



Interest Income. Interest income for the three months ended March 31, 2014 increased $510,000, or 8.6%, to $6.4 million over the same period of 2013, primarily as a result of a $431,000 increase in loan interest income due to an increase in average loan balances of $64.2 million. The average yield on interest-earning assets decreased four basis points to 3.86% for the three months ended March 31, 2014, compared to 3.90% for the same period in 2013 reflective of the current interest environment.

Interest Expense. Interest expense decreased $54,000, or 4.0%, to $1.3 million for the three months ended March 31, 2014 compared to the same period in 2013. This decrease was primarily caused by a decrease in deposit interest expense of $169,000 due to a decrease in rates, offset by an increase in average balances. This was partially offset by an increase in borrowing interest expense of $115,000 due to an increase in the average balances of $29.6 million and a decrease borrowing rates of eight basis points. The average cost of funds decreased to 0.96% for the three months ended March 31, 2014, a decrease of 13 basis points from a cost of funds of 1.09% for the same period in 2013. The decrease in the cost of funds is partially due to the current low interest rate environment and management's focus on obtaining core deposits. Net Interest Income. Net interest income for the three months ended March 31, 2014 was $5.1 million, an increase of $564,000, or 12.3%, over the same period of 2013. This was due to an increase in interest income of $510,000 and a $54,000 decrease in interest expense for the three months ended March 31, 2014 compared to the same period in 2013. Provision for Loan Losses. The Company's provision for loan loss expense was $150,000 for the three months ended March 31, 2014 compared to $100,000 for the three months ended March 31, 2013. The increase in the provision was due to the increase in loan growth. As of March 31, 2014, the Company's total allowance for loan losses of $5.6 million increased $204,000 compared to June 30, 2013. The decrease in the allowance for loan losses to 1.12% of total loans as of March 31, 2014 compared to 1.19% of total loans as of March 31, 2013 was deemed appropriate due to an overall improvement in the economy. The allowance for loan losses covers 121.39% of our non-performing loans at March 31, 2014, compared to 136.1% at June 30, 2013 and 133.49% at March 31, 2013. Non-interest Income. Total non-interest income was $788,000 for the three months ended March 31, 2014, a decrease of $390,000 or 33.1% from the same period of 2013. The decrease in non-interest income was primarily due to a decrease on the gain on sales of loans, net, of $191,000, or 82.7%, for the three months ended March 31, 2014 compared to the same period in 2013 due to decreases in volume and refinance activity. In addition there was a decrease in sales of securities of $114,000 and a decrease of $113,000, or 47.9%, in other non-interest income. These decreases were partially offset by an increase in customer service fees of $35,000, or 7.5%, for the three months ended March 31, 2014 compared to the same period for 2013 due to a new fee structure. 31 -------------------------------------------------------------------------------- Non-interest Expense Total non-interest expense decreased $162,000, or 3.7%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. During the three months ended March 31, 2014 there was a $259,000, or 25.9%, decrease in other general and administrative expenses, a $25,000 decrease in occupancy and equipment, and a $7,000 decrease in data processing services reflective of the Company's cost reduction strategy. These increases were offset by a $38,000, or 1.6%, increase in salaries and employee benefits which reflects the increase in ESOP expense due to an increase in the Company's stock price. In the three months ended March 31, 2014 there was a $50,000 write-down on other real estate owned compared to a $19,000 gain on OREO for the three months ended March 31, 2013. Income Taxes. Income tax expense increased $90,000 for the three months ended March 31, 2014 compared to the same period for 2013. Our combined federal and state effective tax rate was 36.0% for the three months ended March 31, 2014 compared to 37.0% for the three months ended March 31, 2013.



Comparison of Operating Results for the Nine Months Ended March 31, 2014 and March 31, 2013

Net Income. The Company had an $893,000 increase in net income for the nine months ended March 31, 2014 to $3.2 million, or $0.60 per fully diluted share, as compared to $2.4 million, or $0.42 per fully diluted share, for the same period in 2013. For the nine months ended March 31, 2014, net income included non-recurring charges of $410,000 related to a proxy contest included in non-interest expense. The Company had an increase in net interest income of $1.0 million, or 7.4%, for the nine months ended March 31, 2014 compared to the same period in 2013 due to an increase in interest and dividend income of $757,000, or 4.2% and a decrease in total interest expense of $284,000 or 6.8%. The provision for loan losses increased $75,000 for the nine months ended March 31, 2014 compared to the same period in 2013 primarily due to the increase in loan growth. For the nine months ended March 31, 2014 there was a decrease in total non-interest income of $414,000 compared to the nine months ended March 31, 2013. Non-interest expense decreased $742,000 or 5.6%, for the nine months ended March 31, 2014 compared to the nine months ended March 31, 2013. Our combined federal and state effective tax rate was 36.0% for the nine months ended March 31, 2014 compared to 37.8% for the same period in 2013.



Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. The yields set forth below include the effect of deferred costs, and discounts and premiums that are amortized or accreted to interest income or expense. The Company does not accrue interest on loans on non-accrual status; however, the balance of these loans is included in the total average balance, which has the effect of lowering average loan yields. 32 -------------------------------------------------------------------------------- Nine Months Ended March 31, 2014 2013 Average Average Outstanding Yield Outstanding Yield Balance Interest /Rate (1) Balance Interest /Rate (1) (Dollars in Thousands) Interest-earning assets: Loans (2) $ 488,078$ 16,936 4.63 % $ 429,236$ 16,124 5.01 % Investment securities 147,393 2,046 1.85 149,717 2,105 1.87 Federal funds sold and other short-term investments 15,461 29 0.25 17,191 25 0.19 Total interest earning assets 650,932 $ 19,011 3.89 % 596,144 $ 18,254 4.08 % Allowance for loan losses (5,507 ) (5,132 ) Total interest-earning assets less allowance for loan losses 645,425 591,012 Non-interest-earning assets 44,252 44,737 Total assets $ 689,677$ 635,749 Interest-bearing liabilities: Savings deposits $ 108,411$ 107 0.13 % $ 98,343$ 156 0.21 % Money market 86,108 223 0.35 70,633 215 0.41 NOW accounts 46,411 93 0.27 40,039 98 0.33 Certificates of deposit 164,293 1,850 1.50 173,613 2,330 1.79 Total deposits 405,223 2,273 0.75 382,628 2,799 0.98 Borrowed funds 117,496 1,611 1.83 94,761 1,369 1.93 Total interest-bearing liabilities 522,719 $ 3,884 0.99 % 477,389 $ 4,168 1.16 % Demand deposits 77,035 65,052 Other non-interest-bearing liabilities 5,217 5,848 Total liabilities 604,971 548,289 Equity 84,706 87,460 Total liabilities and equity $ 689,677$ 635,749 Net interest income $ 15,127$ 14,086 Interest rate spread (3) 2.90 % 2.92 % Net interest-earning assets (4) $ 128,213$ 118,755 Net interest margin (5) 3.10 % 3.15 % Average interest-earning assets to interest-bearing liabilities 124.53 % 124.88 % (1) Yields and rates for the nine months ended March 31, 2014 and 2013 are annualized. (2) Includes loans held for sale. (3) Interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities for the period indicated. (4) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities. (5) Net interest margin represents net interest income divided by average total interest-earning assets. 33

-------------------------------------------------------------------------------- The following table presents the dollar amount of changes in interest income and interest expense for the major categories of the Company's interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate. Nine Months Ended March 31, 2014 vs. 2013 Increase (Decrease) Due to Total Increase Volume Rate (Decrease) (Dollars in Thousands) Interest income: Loans (1) $ 2,102$ (1,290 ) $ 812 Investment securities (32 ) (27 ) (59 ) Federal funds sold and other short- term investments (3 ) 7 4 Total interest income 2,067 (1,310 ) 757 Interest expense: Savings deposits 15 (64 ) (49 ) Money market 43 (35 ) 8 NOW accounts 14 (19 ) (5 ) Certificates of deposits (120 ) (360 ) (480 ) Total deposits (48 ) (478 ) (526 ) Borrowed funds 315 (73 ) 242 Total interest expense 266 (550 ) (284 ) Change in net interest income $ 1,800$ (759 ) $ 1,041 (1) Includes loans held for sale. Interest Income. Interest income for the nine months ended March 31, 2014 increased $757,000, or 5.04%, to $19.0 million over the same period of 2013, primarily as a result of an $812,000 increase in loan interest income due to an increase in the average loan balances of $58.8 million offset by a decrease in rates. The increase in loan interest income was partially offset by a $77,000 decrease in debt security income for the nine months ended March 31, 2014 compared to the nine months ended March 31, 2013 due to a decrease in average balances and rate. Interest Expense. Interest expense decreased $284,000, or 6.8%, to $3.9 million for the nine months ended March 31, 2014. This decrease was primarily caused by a decrease in deposit interest expense of $526,000 due to a decrease in rates offset by an increase in average balances. This was partially offset by an increase in borrowing interest expense of $242,000 due to an increase in average balances, offset by a decline in rates. The average cost of funds decreased to 0.99% for the nine months ended March 31, 2014, a decrease of 17 basis points from a cost of funds of 1.16% for the same period in 2013. Net Interest Income. Net interest income for the nine months ended March 31, 2014 was $15.1 million, an increase of $1.0 million or 7.4%, over the same period of 2013. This was due to an increase of $757,000 in interest income and a $284,000 decrease in interest expense for the nine months ended March 31, 2014 compared to the same period in 2013. Provision for Loan Losses. The Company's provision for loan loss expense was $400,000 for the nine months ended March 31, 2014 compared to $325,000 for the nine months ended March 31, 2013. The increase in the provision was due to an increase in loan growth. The decrease in the allowance for loan losses to 1.12% of total loans as of March 31, 2014 compared to 1.19% of total loans as of March 31, 2013 was deemed appropriate due to an overall improvement in the economy. In comparing March 31, 2014 to June 30, 2013, impaired loans have decreased to $11.7 million from $15.0 million. The allowance for loan losses covers 121.39% of our non-performing loans at March 31, 2014, compared to 136.1% at June 30, 2013 and 133.49% at March 31, 2013. Non-interest Income. Total non-interest income was $2.8 million for the nine months ended March 31, 2014, a decrease of $414,000, or 12.9%, from the same period a year ago. There was a decrease on the gain on sales of loans, net of $523,000 or 69.9% for the nine months ended March 31, 2014 compared to the same period a year ago due to a decrease in the volume of loan refinances, and a decrease in the cash surrender value of bank-owned life insurance of $19,000 or 4.8% for the nine months ended March 31, 2014 compared to the same period in 2013. In addition there was a decrease of $114,000 in gains on the sales of securities. These decreases were partially offset by increases in customer service fees of $145,000 or 9.7% due to change in fee structure, and an increase in other non-interest income of $97,000 which was primarily due to an increase in the fair value of mortgage servicing rights. In addition, the nine months ended March 31, 2014 there was a $69,000 loss on OREO which was due to a $50,000 write-down on that occurred during the third quarter compared to a $31,000 gain on OREO for the nine months ended March 31, 2013. 34 -------------------------------------------------------------------------------- Non-interest Expense. Non-interest expense decreased $742,000, or 5.6%, to $12.4 million for the nine months ended March 31, 2014 compared to the same period for 2013. This included $410,000 of non-recurring charges due to a proxy contest as previously described. There was a $482,000, or 6.5%, decrease in salaries and employee benefits due to the Company's restructuring of its senior management team, as well as a significant reduction in expenses related to grants under the 2008 Equity Incentive Plan. There were also decreases in data processing services expense of $97,000 due to a change in the contract, advertising expenses of $5,000, and other general and administrative expenses of $291,000. Income Taxes. Income tax expense increased $401,000 for the nine months ended March 31, 2014 compared to the same period for 2013. Our combined federal and state effective tax rate was 36.0% for the nine months ended March 31, 2014 compared to 37.8% for the nine months ended March 31, 2013. Minimum Regulatory Capital Requirements. As of March 31, 2014, the most recent notification from the Federal Deposit Insurance Corporation categorized Hampden Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes has changed Hampden Bank's category. The Company's and Bank's capital amounts and ratios as of March 31, 2014 and June 30, 2013 are presented in the following table. Minimum To Be Well Minimum Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio (Dollars in Thousands) As of March 31, 2014:



Total capital (to risk weighted assets):

Consolidated $ 91,195 17.7 % $ 41,167 8.0 % N/A N/A Bank 84,840 16.6 40,916 8.0 $ 51,145 10.0 %



Tier 1 capital (to risk weighted assets):

Consolidated 85,566 16.6 $ 20,583 4.0 N/A N/A Bank 79,211 15.5 20,458 4.0 30,687 6.0



Tier 1 capital (to average assets):

Consolidated 85,566 12.2 $ 28,165 4.0 N/A N/A Bank 79,211 11.3 28,071 4.0 34,411 5.0 As of June 30, 2013:



Total capital (to risk weighted assets):

Consolidated $ 88,670 19.1 % $ 37,077 8.0 % N/A N/A Bank 80,350 17.5 36,788 8.0 $ 45,985 10.0 %



Tier 1 capital (to risk weighted assets):

Consolidated 83,248 18.0 18,538 4.0 N/A N/A Bank 74,928 16.3 18,394 4.0 27,591 6.0



Tier 1 capital (to average assets):

Consolidated 83,248 12.7 26,240 4.0 N/A N/A Bank 74,928 11.6 25,827 4.0 32,284 5.0 35

-------------------------------------------------------------------------------- Liquidity Risk Management. Liquidity risk, or the risk to earnings and capital arising from an organization's inability to meet its obligations without incurring unacceptable losses, is managed by the Company's Senior Vice President and Director of Finance, who monitors on a daily basis the adequacy of the Company's liquidity position. Oversight is provided by the Asset/Liability Committee, which reviews the Company's liquidity on a monthly basis, and by the Board of Directors of the Company, which reviews the adequacy of our liquidity resources on a quarterly basis. The Company's primary sources of funds are from deposits, amortization of loans, prepayments and the maturity of mortgage-backed securities and other investments, and other funds provided by operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing loans and investment securities are relatively predictable sources of funds, deposit flows and loan prepayments can be greatly influenced by general interest rates, economic conditions and competition. We maintain excess funds in cash and short-term interest-bearing assets that provide additional liquidity. At March 31, 2014, cash and cash equivalents totaled $33.5 million, or 4.7% of total assets. The Company also relies on outside borrowings from the FHLB as an additional funding source. The Company uses FHLB borrowings to fund growth in the balance sheet and to assist in the management of its interest rate risk by match funding longer term fixed rate loans. The Company uses its liquidity to fund existing and future loan commitments, to fund maturing certificates of deposit and borrowings, to fund other deposit withdrawals, to invest in other interest-earning assets and to meet operating expenses. The Company anticipates that it will continue to have sufficient funds and alternative funding sources to meet its commitments. Off-Balance Sheet Arrangements. In the normal course of business, there are outstanding commitments which are not reflected in the accompanying consolidated balance sheets. 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 and generally have fixed expiration dates or other termination clauses. The following table presents certain information about the Company's loan commitments and other contingencies outstanding as of March 31, 2014 and June 30, 2013. March 31, 2014 June 30, 2013 (In Thousands) Commitments to grant loans (1) $ 33,134 $ 63,607 Commercial loan lines-of-credit (2) 40,757 29,882 Unused portions of home equity lines-of-credit (3) 35,284 34,498 Unused portion of construction loans (4) 20,378 25,164 Unused portion of mortgage loans 12 26 Unused portion of personal lines-of-credit (5) 1,860 1,852 Standby letters of credit (6) 530 548 Total loan commitments $ 131,955$ 155,577



(1) Commitments for loans are generally extended to customers for up to 60 days

after which they expire. (2) The majority of Commercial lines-of-credit are written on a demand basis. (3) Unused portions of home equity lines-of-credit are available to the borrower



for up to 20 years. (4) Unused portions of construction loans are generally available to the borrower

for up to eighteen months for development loans and up to one year for other

construction loans. (5) Unused portions of personal lines-of-credit are available to customers in



"good standing" indefinitely. (6) Standby letters of credit are generally available for one year or less.

36



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