Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Managements discussion and analysis, which follows, focuses on the factors affecting the Companys consolidated results of operations for the three months ended March 31, 2016 and 2015, and financial condition at March 31, 2016 and December 31, 2015, and where appropriate, factors that may affect
35
future financial performance. The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this report on Form 10-Q.
Amounts in the prior period financial statements are reclassified whenever necessary to conform to current period presentation.
Unless otherwise noted, all dollars are expressed in thousands except share data.
Use of Non-GAAP Financial Measures:
Certain information discussed below is presented on a fully taxable equivalent basis. Specifically, included in interest income in the first quarter of 2016 and 2015 was $1,056 and $898 respectively, of tax-exempt interest income from certain investment securities and loans.
An amount equal to the tax benefit derived from this tax exempt income has been added back to the interest income totals discussed in certain sections of this Managements Discussion and Analysis, representing tax equivalent adjustments of $537 and $453 in the first quarter of 2016 and 2015, respectively, which increased net interest income accordingly. The analysis of net interest income tables included in this report on Form 10-Q provide a reconciliation of tax equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.
Management believes the disclosure of tax equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations. Other financial institutions commonly present net interest income on a tax equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from their earning asset portfolios. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices.
The Company presents its efficiency ratio using non-GAAP information. The GAAP efficiency ratio is computed by dividing non-interest expense by the sum of tax-equivalent net interest income and non-interest income. The non-GAAP efficiency ratio is computed by dividing non-interest expense by the sum of tax-equivalent net interest income and non-interest income other than net securities gains and OTTI, and other significant non-recurring expenses.
FORWARD LOOKING STATEMENTS DISCLAIMER
Certain statements, as well as certain other discussions contained in this quarterly report on Form 10-Q, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Readers can identify these forward-looking statements by the use of words like "strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. Readers can also identify them by the fact that they do not relate strictly to historical or current facts.
Investors are cautioned that forward-looking statements are inherently uncertain. Forward-looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operation, financial condition, and the business of the Company which are subject to
36
change based on the impact of various factors that could cause actual results to differ materially from those projected or suggested due to certain risks and uncertainties. Those factors include but are not limited to:
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(i)
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The Company's success is dependent to a significant extent upon general economic conditions in Maine, and Maine's ability to attract new business, as well as factors that affect tourism, a major source of economic activity in the Companys immediate market areas;
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(ii)
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The Company's earnings depend to a great extent on the level of net interest income (the difference between interest income earned on loans and investments and the interest expense paid on deposits and borrowings) generated by the Companys wholly-owned banking subsidiary, Bar Harbor Bank & Trust (the Bank), and thus the Companys results of operations may be adversely affected by increases or decreases in interest rates;
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(iii)
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The banking business is highly competitive and the profitability of the Company depends on the Bank's ability to attract loans and deposits in Maine, where the Bank competes with a variety of traditional banking and non-traditional institutions, such as credit unions and finance companies;
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(iv)
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A significant portion of the Bank's loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other intangible factors which are considered in making commercial loans and, accordingly, the Company's profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults, and the ability of certain borrowers to repay such loans during a downturn in general economic conditions;
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(v)
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Adverse changes in repayment performance and fair value of underlying residential mortgage loan collateral, that differ from the Companys current estimates, could change the Companys expectations that it will recover the amortized cost of its private label mortgage backed securities portfolio and/or its conclusion that such securities were not other-than temporarily impaired as of the date of this report;
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(vii)
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Significant changes in the Companys internal controls, or internal control failures;
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(viii)
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Acts or threats of terrorism and actions taken by the United States or other governments as a result of such threats, including military action, could further adversely affect business and economic conditions in the United States generally and in the Companys markets, which could have an adverse effect on the Companys financial performance and that of borrowers and on the financial markets and the price of the Companys common stock;
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(ix)
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Significant changes in the extensive laws, regulations, and policies governing bank holding companies and their subsidiaries could alter the Company's business environment or affect its operations;
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(x)
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Changes in general, national, international, regional or local economic conditions and credit markets which are less favorable than those anticipated by Company management that could impact the Company's securities portfolio, quality of credits, or the overall demand for the Company's products or services;
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(xi)
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The integrity of information systems are under significant threat from cyber attacks by third-parties, including thorough coordinated attacks sponsored by foreign nations and criminal organizations to disrupt business operations and other compromises to data and systems for political or criminal purposes; and
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(xii)
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The Companys success in managing the risks involved in all of the foregoing matters.
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Readers should carefully review all of these factors as well as the risk factors set forth in Item 1A- Risk Factors, contained in the Companys Annual Report on Form 10-K for the year ended December 31, 2015. There may be other risk factors that could cause differences in future periods from those anticipated by management.
The forward-looking statements contained herein represent the Company's judgment as of the date of this quarterly report on Form 10-Q and the Company cautions readers not to place undue reliance on such statements. The Company disclaims any obligation to publicly update or revise any forward-looking statement contained in the succeeding discussion, or elsewhere in this quarterly report on Form 10-Q, except to the extent required by federal securities laws.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Companys significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of its December 31, 2015, report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Companys financial performance is reported.
Managements discussion and analysis of the Companys financial condition and results of operations are based on the Consolidated Financial Statements, which are prepared in accordance with U.S. generally accepted accounting principles. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management evaluates its estimates on an ongoing basis. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from managements estimates and assumptions under different assumptions or conditions. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, other than temporary impairment on securities, income tax estimates, and the evaluation of intangible assets. The use of these estimates is more fully described in Part I, Item 1, Note 3 of the consolidated financial statements in this quarterly report on Form 10-Q.
SUMMARY FINANCIAL RESULTS
For the three months ended March 31, 2016, the Company reported net income of $4,406, compared with $3,881 for the first quarter of 2015, representing an increase of $525, or 13.5%. The Companys diluted earnings per share amounted to $0.72 for the quarter representing an increase of $0.08, or 12.5%, compared with the first quarter of 2015. The Companys annualized return on average shareholders equity amounted to 11.18% for the quarter, compared with 10.57% for the first quarter of 2015. The Companys first quarter return on average assets amounted to 1.10%, compared with 1.06% for the first quarter of 2015.
As more fully enumerated in the following management discussion and analysis, the Companys first quarter operating results were highlighted by a $422, or 3.7%, increase in tax-equivalent net interest income, despite an eighteen basis point decline in the tax-equivalent net interest margin compared with
38
the first quarter of 2015. Led by an $817 increase in realized securities gains, total non-interest income increased $986, or 42.1%, compared with the three months ended March 31, 2015. The Company continued to focus on the management of its operating expenses, posting a first quarter efficiency ratio of 57.4%.
Led by growth in the loan and securities portfolios, total assets ended the first quarter at $1,622,493, representing an increase of $42,438, or 2.7%, compared with December 31, 2015. Total loans ended the first quarter at $1,006,562, representing an increase of $16,492, or 1.7%, compared with December 31, 2015. The credit quality of the loan portfolio remained stable during the first quarter of 2016, highlighted by a $699, or 10.0%, decline in non-performing loans compared with December 31, 2015. Net loan charge-offs amounted to $90 in the first quarter, or annualized net charge-offs to average loans outstanding of 0.04%.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the principal component of the Company's income stream and represents the difference or spread between interest generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest income is entirely generated by the Bank. Fluctuations in market interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.
Total Net Interest Income:
For the three months ended March 31, 2016, net interest income on a tax-equivalent basis amounted to $11,873, compared with $11,451 for the first quarter of 2015, representing an increase of $422, or 3.7%. The increase in first quarter 2016 tax-equivalent net interest income compared with the first quarter of 2015 was attributed to average earning asset growth of $123,979, or 8.7%, as the tax-equivalent net interest margin declined eighteen basis points.
Factors contributing to the changes in net interest income and the net interest margin are more fully enumerated in the following discussion and analysis.
Net Interest Income Analysis:
The following table summarizes the Companys average balance sheet and components of net interest income, including a reconciliation of tax-equivalent adjustments, for the three months ended March 31, 2016, and 2015:
39
AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
MARCH 31, 2016 AND 2015
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, net interest income and net interest margin are reported on a tax-equivalent basis.
For the three months ended March 31, 2016, the weighted average yield on average earning assets amounted to 3.83%, compared with 3.99% in the first quarter of 2015, representing a decline of sixteen basis points. As more fully discussed below, this decline was attributed to a lower weighted average yields on the Banks loan and securities portfolios, which declined twenty and sixteen basis points, respectively, compared with the first quarter of 2015.
For the three months ended March 31, 2016, the weighted average cost of interest bearing liabilities amounted to 0.83%, compared with 0.82% for the first quarter of 2015, representing an increase of one basis point. As more fully discussed below, this increase was attributed to a higher weighted average rate on borrowed funds.
Interest and Dividend Income:
For the three months ended March 31, 2016, total interest and dividend income on a tax-equivalent basis amounted to $14,701, compared with $13,986 in the first quarter of 2015, representing an increase of $715, or 5.1%. The increase in interest and dividend income was principally attributed to average earning asset growth of $123,979, or 8.7%, as the weighted average earning asset yield declined sixteen basis points to 3.83%.
For the three months ended March 31, 2016, total tax-equivalent interest income from the securities portfolio amounted to $4,383, compared with $4,153 in the first quarter of 2015, representing an increase of $230, or 5.5%. The increase in interest income from securities was principally attributed to a $44,892, or 9.7%, increase in total average securities, which was largely offset by a seventeen basis point decline in the weighted average securities yield to 3.46%. The decline in the weighted average securities yield was principally attributed to the ongoing replacement of MBS cash flows as well as incremental securities growth in a historically low interest rate environment.
41
For the three months ended March 31, 2016, total tax-equivalent interest income from the loan portfolio amounted to $10,142, compared with $9,739 in the first quarter of 2015, representing an increase of $403, or 4.1%. The increase in interest income from loans was principally attributed to a $78,226, or 8.4% increase in the average loan portfolio, which was largely offset by a twenty basis point decline in the weighted average loan yield to 4.03%. The decline in the weighted average loan yield principally reflected the origination and competitive re-pricing of certain commercial loans, as well as residential mortgage loan origination and refinancing activity, during a period of still-historically low interest rates.
Interest Expense:
For the three months ended March 31, 2016, total interest expense amounted to $2,828, compared with $2,535 in the first quarter of 2015, representing an increase of $293, or 11.6%. The increase in interest expense was principally attributed to an $114,883, or 9.2% increase in total average interest bearing liabilities and, to a lesser extent, a one basis point increase in the weighted average cost of interest bearing liabilities, compared with the first quarter of 2015.
The increase in the first quarter weighted average cost of interest bearing liabilities compared with the first quarter in 2015 was principally attributed to a higher weighted average rate on borrowings, largely reflecting the December 2015 Fed Funds increase by the Federal Reserve. For the three months ended March 31, 2016, the total weighted average cost of interest bearing liabilities amounted to 0.83%, compared with 0.82% in the first quarter of 2015. The weighted average cost of borrowed funds increased ten basis points to 1.03%, while the weighted average cost of interest bearing deposits declined three basis points to 0.72%, compared with the first quarter of 2015.
Rate/Volume Analysis:
The following tables set forth a summary analysis of the relative impact on net interest income of changes in the average volume of interest earning assets and interest bearing liabilities, and changes in average rates on such assets and liabilities. The income from tax-exempt assets has been adjusted to a fully tax equivalent basis, thereby allowing uniform comparisons to be made. Because of the numerous simultaneous volume and rate changes during the periods analyzed, it is not possible to precisely allocate changes to volume or rate. For presentation purposes, changes which are not solely due to volume changes or rate changes have been allocated to these categories in proportion to the relationships of the absolute dollar amounts of the change in each.
ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
THREE MONTHS ENDED MARCH 31, 2016 and 2015
INCREASES (DECREASES) DUE TO:
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|
|
|
|
Average
Volume
|
Average
Rate
|
Total
Change
|
|
|
|
|
Loans (1,3)
|
$ 815
|
$(412)
|
$403
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Securities (2,3)
|
401
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(171)
|
230
|
Federal Home Loan Bank stock
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4
|
78
|
82
|
TOTAL EARNING ASSETS
|
$1,220
|
$(505)
|
$715
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|
|
|
|
Interest bearing deposits
|
186
|
(62)
|
124
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Borrowings
|
34
|
135
|
169
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TOTAL INTEREST BEARING LIABILITIES
|
$ 220
|
$ 73
|
$293
|
|
|
|
|
NET CHANGE IN NET INTEREST INCOME
|
$1,000
|
$(578)
|
$422
|
(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax-equivalent basis.
42
Provision for Loan Losses
The provision for loan losses (the provision) reflects the amount necessary to maintain the allowance for loan losses at a level that, in managements judgment, is appropriate for the amount of inherent risk of probable loss in the Banks current loan portfolio.
The overall credit quality of the Banks loan portfolio remained stable during the three months ended March 31, 2016, highlighted by a $699, or 10.0%, decline in non-performing loans. Total non-performing loans expressed as a percentage of total loans ended the quarter at 0.63%, down from 0.71% at December 31, 2015. Similarly, the allowance for loan losses expressed as a ratio to non-performing loans ended the quarter at 155.6%, up from 134.7% at December 31, 2015. For the three months ended March 31, 2016, total net loan charge-offs amounted to $90, or annualized net charge-offs to average loans outstanding of 0.04%.
For the three months ended March 31, 2016, the Bank recorded a provision of $465, compared with $495 in the first quarter of 2015, representing a decline of $30, or 6.1%.
Refer below to Item 2 of this Part I, Financial Condition, Loans,
Non-Performing Loans, Potential Problem Loans
and
Allowance for Loan Losses,
in this report on Form 10-Q
for further discussion and analysis related to the provision for loan losses.
Non-interest Income
For the three months ended March 31, 2016, total non-interest income amounted to $3,328, compared with $2,342 in the first quarter of 2015, representing an increase of $986, or 42.1%.
Factors contributing to the changes in non-interest income are enumerated in the following discussion and analysis.
Trust and Other Financial Services:
Income from trust and other financial services is principally derived from fee income based on a percentage of the fair market value of client assets under management and held in custody with Bar Harbor Trust Services, the Companys second tier non-depository trust company subsidiary, and, to a lesser extent, revenue from brokerage services conducted through Bar Harbor Financial Services, an independent third-party broker.
For the three months ended March 31, 2016, trust and other financial service fees amounted to $948, compared with $945 in the first quarter of 2015, representing an increase of $3, or 0.3%. At March 31, 2016, total assets under management stood at $373,928, compared with $377,533 at December 31, 2015, representing a decline of $3,605, or 1.0%. The decline in assets under management was attributed to broad declines in the equities market since year end 2015.
Service Charges on Deposit Accounts:
Service charges on deposits are principally derived from customer overdraft fees. For the three months ended March 31, 2016, income from service charges on deposit accounts amounted to $211, compared with $198 in the first quarter of 2015, representing an increase of $13, 6.6%. The Bank has not been aggressive in selling its fee based overdraft products as a cautionary measure in light of continued regulatory pressure on the banking industry including the Consumer Financial Protection Bureau, which was established by the Wall Street Reform and Consumer Protection Act (the Dodd Frank Act).
43
Debit Card Service Charges and Fees:
For the three months ended March 31, 2016, income generated from debit card service charges and fees amounted to $400, compared with $366 in the first quarter of 2015, representing an increase of $34, or 9.3%. This increase was attributed to continued growth of the Banks retail deposit base and continued success with a program that offers rewards for certain debit card transactions.
Net Securities Gains:
For the three months ended March 31, 2016, the Bank recorded realized securities gains of $1,436, compared with $619 in the first quarter of 2015, representing an increase of $817, or 132.0%. The realized securities gains largely reflected Bank managements strategy of lowering the duration of the securities portfolio and its overall interest rate risk profile, while simultaneously generating income. Additionally, U.S. Treasury yields declined significantly during the quarter, creating opportunities for meaningful realized gains.
Other Operating Income:
Other operating income principally includes income from bank-owned life insurance, representing increases in the cash surrender value of life insurance policies on the lives of certain current and retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Other operating income also includes a variety of miscellaneous service charges and fees including fees for non-customer ATM transactions.
For the three months ended March 31, 2016, total other operating income amounted to $333, compared with $214 for the first quarter of 2015, representing an increase $119, or 55.6%. The increase in other operating income was almost entirely attributed to the Banks purchase of Bank Owned Life Insurance (BOLI) late in the first quarter of 2015. Further information regarding BOLI is incorporated by reference to the below
Financial Condition
management discussion and analysis covering
Bank Owned Life Insurance
in this report on Form 10-Q.
Non-interest Expense
For the three months ended March 31, 2016, total non-interest expense amounted to $7,997, compared with $7,333 in the first quarter of 2015, representing an increase of $664, or 9.1%.
Factors contributing to the changes in non-interest expense are more fully enumerated in the following discussion and analysis.
Salaries and Employee Benefits:
For the three months ended March 31, 2016, total salaries and employee benefits expense amounted to $5,017, compared with $4,352 in the first quarter of 2015, representing an increase of $665, or 15.3%. The increase in salaries and employee benefits was attributed to a variety of factors including normal increases in base salaries and higher levels of employee health insurance, higher levels of employee incentive and equity compensation, as well as increases in staffing levels and strategic changes in staffing mix.
Furniture and Equipment Expense:
For the three months ended March 31, 2016, total furniture and equipment expense amounted to $589, compared with $565 in the first quarter of 2015 representing an increase of $24, or 4.2%. This increase was largely attributed to a variety of technology upgrades and certain new technology systems and applications.
Debit Card Expenses:
These expenses relate to the Banks Visa debit card processing activities. For the three months ended March 31, 2016, total debit card expense amounted to $117, compared with $96 in the first quarter of 2015, representing an increase of $21, or 21.9%. These increases were principally attributed to higher transaction volumes and were more than offset with higher revenues from debit card activity.
44
Other Operating Expenses:
For the three months ended March 31, 2016, total other operating expenses amounted to $1,488, compared with $1,539 in the first quarter of 2015, representing a decline of $51, or 3.3%.
This decline was largely attributed to lower levels of loan collection expenses and fees for professional services.
Efficiency Ratio
The Companys efficiency ratio measures the relationship of operating expenses to revenues. The efficiency ratio is calculated by dividing non-interest operating expenses by the sum of tax-equivalent net interest income and non-interest income other than net securities gains, other-than-temporary impairments, and other significant non-recurring expenses. For the three months ended March 31, 2016, the Companys efficiency ratio amounted to 57.4%, compared with 55.3% for the first quarter of 2015.
Income Taxes
For the three months ended March 31, 2016, total income taxes amounted to $1,796, compared with $1,631 for the first quarter of 2015, representing an increase of $165, or 10.1%.
The Company's effective tax rate for the three months ended March 31, 2016 amounted to 29.0%, compared with 29.6% in the first quarter of 2015. The income tax provisions for these periods were less than the expense that would result from applying the federal statutory rate of 35% to income before income taxes, principally because of the impact of tax exempt interest income on certain investment securities, loans and bank owned life insurance. Fluctuations in the Companys effective tax rate are generally attributed to changes in the relationship between non-taxable income and non-deductible expense, and income before income taxes, during any given reporting period.
FINANCIAL CONDITION
Total Assets
The Companys assets principally consist of loans and securities, which at March 31, 2016 represented 62.0% and 32.8%, respectively, of total assets, compared with 62.7% and 32.0%, respectively, at December 31, 2015.
At March 31, 2016, the Companys total assets stood at $1,622,493, compared with $1,580,055 at December 31, 2015, representing an increase of $42,438, or 2.7%.
Securities
The securities portfolio is comprised of mortgage-backed securities (MBS) issued by U.S. Government agencies, U.S. Government sponsored enterprises and, to a much lesser extent, other non-agency, private label issuers. The portfolio also includes tax-exempt obligations of state and political subdivisions.
Management considers securities as a relatively attractive means to effectively leverage the Banks strong capital position, as securities are typically assigned significantly lower risk weightings compared with the Banks other earning assets for the purpose of calculating the Banks and the Companys risk-based capital ratios. The overall objectives of the Companys strategy for the securities portfolio include maintaining appropriate liquidity reserves, diversifying earning assets, managing interest rate risk, leveraging the Companys strong capital position, and generating acceptable levels of net interest income.
45
Securities available for sale represented 100% of total securities at March 31, 2016, and December 31, 2015. Securities available for sale are reported at their fair value with unrealized gains or losses, net of taxes, excluded from earnings but shown separately as a component of shareholders equity. As of March 31, 2016, total net unrealized securities gains amounted to $14,718, compared with net unrealized gains of $8,790 at December 31, 2015. The increase in unrealized gains was attributed to market interest rates, which declined significantly during the current quarter.
Total Securities:
At March 31, 2016, total securities amounted to $532,919, compared with $504,969 at December 31, 2015, representing an increase of $27,950, or 5.5%. The securities purchased during the first quarter consisted of MBS issued and guaranteed by U.S. Government agencies and sponsored-enterprises, as well as obligations of states and political subdivisions thereof (municipal securities).
The following tables summarize the securities available for sale portfolio as of March 31, 2016 and December 31, 2015:
|
|
|
|
|
March 31, 2016
Available for Sale:
|
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
Estimated
Fair Value
|
|
|
|
|
|
Mortgage-backed securities:
|
|
|
|
|
US Government-sponsored enterprises
|
$312,854
|
$ 8,566
|
$ 600
|
$320,820
|
US Government agency
|
83,060
|
1,882
|
145
|
84,797
|
Private label
|
2,503
|
660
|
20
|
3,143
|
Obligations of states and
political subdivisions thereof
|
119,784
|
4,713
|
338
|
124,159
|
Total
|
$518,201
|
$15,821
|
$1,103
|
$532,919
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
Available for Sale:
|
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
|
Estimated
Fair Value
|
|
|
|
|
|
Mortgage-backed securities:
|
|
|
|
|
US Government-sponsored enterprises
|
$304,106
|
$ 5,042
|
$2,155
|
$306,993
|
US Government agency
|
78,408
|
1,269
|
547
|
79,130
|
Private label
|
2,713
|
762
|
11
|
3,464
|
Obligations of states and
political subdivisions thereof
|
110,952
|
4,758
|
328
|
115,382
|
Total
|
$496,179
|
$11,831
|
$3,041
|
$504,969
|
Impaired Securities:
The securities portfolio contains certain securities where amortized cost exceeds fair value, which March 31, 2016, amounted to an excess of $1,103, or 0.2% of the amortized cost of the total securities portfolio. At December 31, 2015 this amount represented an excess of $3,041, or 0.6% of the amortized cost of the total securities portfolio. As of March 31, 2016, unrealized losses on securities in a continuous unrealized loss position more than twelve-months amounted to $560, compared with $1,161 at December 31, 2015.
As a part of the Companys ongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired (OTTI). If a decline in the fair value of an available for sale security is judged to be OTTI, a charge is recorded in pre-tax earnings equal to the estimated credit losses inherent in the security.
Further information regarding impaired securities, OTTI securities and evaluation of securities for impairment is incorporated by reference to above Note 3 under the caption
Other Than Temporary Impairments on Investment Securities
of the interim unaudited consolidated financial statements in Part I, Item 1 of this report on Form 10-Q.
46
Loans
Total Loans:
At March 31, 2016, total loans stood at $1,006,562, compared with $990,070 at December 31, 2015, representing an increase of $16,492, or 1.7%.
The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington, Knox, Kennebec and Sagadahoc, Maine.
The following table summarizes the components of the Bank's loan portfolio as of the dates indicated.
LOAN PORTFOLIO SUMMARY
|
|
|
|
March 31,
2016
|
December 31,
2015
|
|
|
|
Commercial real estate mortgages
|
$ 393,519
|
$371,002
|
Commercial and industrial
|
78,640
|
79,911
|
Commercial construction and land development
|
25,195
|
24,926
|
Agricultural and other loans to farmers
|
32,087
|
31,003
|
Total commercial loans
|
529,441
|
506,842
|
|
|
|
Residential real estate mortgages
|
402,391
|
406,652
|
Home equity loans
|
49,568
|
51,530
|
Other consumer loans
|
7,393
|
9,698
|
Total consumer loans
|
459,352
|
467,880
|
|
|
|
Tax exempt loans
|
16,034
|
15,244
|
|
|
|
Net deferred loan costs and fees
|
1,735
|
104
|
Total loans
|
1,006,562
|
990,070
|
Allowance for loan losses
|
(9,814)
|
(9,439)
|
Total loans net of allowance for loan losses
|
$ 996,748
|
$980,631
|
Commercial Loans:
At March 31, 2016, total commercial loans stood at $529,441, compared with $506,842 at December 31, 2015, representing an increase of $22,599, or 4.5%.
Commercial loan growth has generally been challenged by a still-soft economy, continued economic uncertainty, diminished demand, and strong competition for quality loans. Bank management attributes the growth of commercial loans to an effective business banking team, deep local market knowledge, sustained new business development efforts, and a resilient local economy that has been faring better than the nation as a whole.
Consumer Loans:
At March 31, 2016, total consumer loans, which principally consisted of residential real estate mortgage loans, amounted to $459,352, compared with $467,880 at December 31, 2015, representing a decline of $8,528, or 1.8%. Loans originated and closed by the Bank during the first quarter of 2016 were more than offset by loan re-financings and scheduled principal amortization from the existing residential real estate loan portfolio.
Credit Risk:
Credit risk is managed through loan officer authorities, loan policies, and oversight from the Banks Chief Credit Officer, the Bank's Management Loan Committee, the Directors Loan Committee, and the Bank's Board of Directors. Management follows a policy of continually identifying, analyzing and grading credit risk inherent in the loan portfolio. An ongoing independent review, subsequent to management's review, of individual credits is performed by an independent loan review consulting firm, which reports to the Audit Committee of the Board of Directors.
47
As a result of managements ongoing review of the loan portfolio, loans are placed on non-accrual status, either due to the delinquent status of principal and/or interest, or a judgment by management that, although payments of principal and or interest are current, such action is prudent because collection in full of all outstanding principal and interest is in doubt. Loans are generally placed on non-accrual status when principal and or interest is 90 days overdue, or sooner, if judged appropriate by management. Consumer loans are generally charged-off when principal and/or interest payments are 120 days overdue, or sooner, if judged appropriate by management.
Non-performing Loans:
Non-performing loans include loans on non-accrual status and loans past due 90 days or more and still accruing interest. The following table sets forth the details of non-performing loans as of the dates indicated:
TOTAL NON-PERFORMING LOANS
|
|
|
|
March 31,
2016
|
December 31,
2015
|
|
|
|
Commercial real estate mortgages
|
$ 982
|
$1,279
|
Commercial and industrial loans
|
190
|
292
|
Commercial construction and land development
|
1,111
|
1,111
|
Agricultural and other loans to farmers
|
---
|
16
|
Total commercial loans
|
2,283
|
2,698
|
|
|
|
Residential real estate mortgages
|
3,734
|
3,452
|
Home equity loans
|
282
|
820
|
Other consumer loans
|
9
|
10
|
Total consumer loans
|
4,025
|
4,282
|
|
|
|
Total non-accrual loans
|
6,308
|
6,980
|
Accruing loans contractually past due 90 days or more
|
1
|
28
|
Total non-performing loans
|
$6,309
|
$7,008
|
|
|
|
|
|
|
Allowance for loan losses to non-performing loans
|
155.6%
|
134.7%
|
Non-performing loans to total loans
|
0.63%
|
0.71%
|
Allowance to total loans
|
0.98%
|
0.95%
|
At March 31, 2016, total non-performing loans amounted to $6,309, compared with $7,008 at December 31, 2015, representing a decline of $699, or 10.0%.
Non-performing commercial real estate mortgages totaled $982 at March 31, 2016, representing a decline of $297, or 23.2%, compared with December 31, 2015. At March 31, 2016, non-performing commercial real estate mortgages were represented by seven business relationships, with outstanding balances ranging from $31 to $286.
Non-performing commercial and industrial loans totaled $190 at March 31, 2016, representing a decline of $102, or 34.9%, compared with December 31, 2015. At March 31, 2016, non-performing commercial and industrial loans were represented by three business relationships, with outstanding balances ranging from less than $1 to $170.
Non-performing commercial construction and land development loans totaled $1,111 at March 31, 2016, unchanged compared with December 31, 2015. At March 31, 2016, non-performing commercial construction and land development loans were entirely represented by a commercial real estate loan to a local, non-profit affordable housing authority in support of an affordable housing project. This loan is
48
principally secured by the housing units from the project. The project is fully constructed and there is no construction risk associated with the loan. The primary source of repayment is the sale of the remaining housing units.
Non-performing residential real estate mortgages totaled $3,734 at March 31, 2016, representing an increase of $282, or 8.2%, compared with December 31, 2015. At March 31, 2016, non-performing residential real estate loans were represented by 39, conventional, 1-4 family mortgage loans, with outstanding balances ranging from $6 to $680.
Non-performing home equity loans totaled $282 at March 31, 2016, representing a decline of $538, or 65.6%, compared with December 31, 2015. At March 31, 2016, non-performing home equity loans were represented by seven relationships with outstanding balances ranging from $3 to $173.
While the level and mix of non-performing loans continued to reflect favorably on the overall quality of the Banks loan portfolio as of
March 31, 2016
, Bank management is cognizant of the still-recovering real estate market, elevated unemployment rates and soft economic conditions overall. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Banks customers, including debt service levels, collateral values, tourism activity, consumer confidence and other factors existing at the time. Management believes the economic activity and conditions in the local real estate markets will continue to be significant determinants of the quality of the loan portfolio in future periods and, thus, the Companys results of operations and financial condition.
Delinquencies and Potential Problem Loans:
In addition to the non-performing loans discussed above, the Bank also has loans that are 30 to 89 days delinquent and still accruing. These loans amounted to $2,501 and $1,857 at March 31, 2016 and December 31, 2015, or 0.24% and 0.19% of total loans, respectively, net of any loans classified as non-performing that are within these delinquency categories. These loans and delinquency trends in general are considered in the evaluation of the allowance for loan losses and the related determination of the provision for loan losses.
Periodically, the Bank reviews the commercial loan portfolio for evidence of potential problem loans. Potential problem loans are loans that are currently performing in accordance with contractual terms, but where known information about possible credit problems of the borrower causes doubt about the ability of the borrower to comply with the loan payment terms and may result in disclosure of such loans as non-performing at some time in the future.
In addition to the non-performing and delinquent loans discussed above, at March 31, 2016, the Bank identified 35 commercial relationships totaling $18,978 as potential problem loans, or 1.9% of total loans (i.e., substandard loans that are current and performing). At December 31, 2015, the Bank identified 32
commercial relationships totaling $19,774 as potential problem loans, or 2.0% of total loans. Factors such as payment history, value of supporting collateral, and personal or government guarantees led the Bank to conclude that the current risk exposure on these potential problem loans did not warrant accounting for the loans as non-performing. Although in a performing status as of quarter-end, these loans exhibited certain risk factors, which have the potential to cause them to become non-performing at some point in the future.
Allowance for Loan Losses:
At March 31, 2016, the allowance for loan losses (the allowance) stood at $9,814, compared with $9,439 at December 31, 2015, representing an increase of $375, or 4.0%. The increase in the allowance from December 31, 2015 was largely attributed to loan growth, changes in the overall mix of non-performing and potential problem loans, and other qualitative considerations.
49
The allowance is available to absorb probable losses on loans. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated quarterly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration.
The allowance is maintained at a level that, in managements judgment, is appropriate for the amount of risk inherent in the current loan portfolio, and adequate to provide for estimated, probable losses. Allowances are established for specific impaired loans, a pool of reserves based on historical net loan charge-offs by loan types, and supplemental reserves that adjust historical net loss experience to reflect current economic conditions, industry specific risks, and other qualitative and environmental considerations impacting the inherent risk of loss in the current loan portfolio.
Specific allowances for impaired loans are determined based upon a discounted cash flows analysis, or as appropriate, a collateral shortfall analysis. The amount of collateral dependent impaired loans totaled $3,006 as of March 31, 2016, compared with $1,999 as of December 31, 2015. The related allowances for loan losses on these loans amounted to $3461 as of March 31, 2016, compared with $312 as of December 31, 2015.
Management recognizes that early and accurate recognition of risk is the best means to reduce credit losses. The Bank employs a comprehensive risk management structure to identify and manage the risk of loss. For consumer loans, the Bank identifies loan delinquency beginning at 10-day delinquency and provides appropriate follow-up by written correspondence or personal contact. Non-residential mortgage consumer loan losses are recognized no later than the point at which a loan is 120 days past due. Residential mortgage losses are recognized during the foreclosure process, or sooner, when that loss is quantifiable and reasonably assured. For commercial loans, the Bank applies a risk grading system, which stratifies the portfolio and allows management to focus appropriate efforts on the highest risk components of the portfolio. The risk grades include ratings that correlate substantially with regulatory definitions of Pass, Other Assets Especially Mentioned, Substandard, Doubtful, and Loss.
While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.
50
The following table details changes in the allowance and summarizes loan loss experience by loan type for the three months ended March 31, 2016 and 2015.
ALLOWANCE FOR LOAN LOSSES
THREE MONTHS ENDED
MARCH 31, 2016 AND 2015
|
|
|
|
2016
|
2015
|
|
|
|
Balance at beginning of period
|
$9,439
|
$8,969
|
Charge-offs:
|
|
|
Commercial real estate mortgages
|
34
|
25
|
Commercial and industrial
|
89
|
75
|
Commercial construction and land development
|
---
|
---
|
Agricultural and other loans to farmers
|
---
|
18
|
Residential real estate mortgages
|
31
|
---
|
Other consumer loans
|
10
|
11
|
Home equity loans
|
---
|
40
|
Tax exempt loans
|
---
|
---
|
Total charge-offs
|
164
|
169
|
|
|
|
Recoveries:
|
|
|
Commercial real estate mortgages
|
$ 6
|
$ 34
|
Commercial and industrial loans
|
1
|
1
|
Commercial construction and land development
|
---
|
---
|
Agricultural and other loans to farmers
|
40
|
12
|
Residential real estate mortgages
|
20
|
129
|
Other consumer loans
|
6
|
7
|
Home equity loans
|
1
|
---
|
Tax exempt loans
|
---
|
---
|
Total recoveries
|
74
|
183
|
|
|
|
Net charge-offs
|
90
|
(14)
|
Provision charged to operations
|
465
|
495
|
Balance at end of period
|
$9,814
|
$9,478
|
For the three months ended March 31, 2016, total net loan charge-offs amounted to $90, or annualized net charge-offs to average loans outstanding of 0.04%, compared with total net recoveries of $183 in the first quarter of 2015.
General allowances for loan losses account for the risk and estimated loss inherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There were no material changes in loan concentrations during the three months ended March 31, 2016.
Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, Company management believes the allowance for loan losses at March 31, 2016 is appropriate for the amount of risk inherent in the current loan portfolio and adequate to provide for estimated probable losses.
Further information regarding loans and the allowance for loan losses, is incorporated by reference to above Note 5,
Loans and Allowance for Loan Losses
, of the interim unaudited consolidated financial statements in Part I, Item 1 of this report on Form 10-Q.
51
Bank Owned Life Insurance
Bank-owned life insurance (BOLI) represents life insurance on the lives of certain current and retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received in excess of the cash value, are recorded in other non-interest income, and are not subject to income taxes. The cash surrender value of the BOLI is included on the Companys consolidated balance sheet.
The Company reviews the financial strength of the insurance carrier prior to the purchase of BOLI and quarterly thereafter. At March 31, 2016, the Bank had four BOLI carriers which were credit rated by Standard & Poors as AA- or higher (i.e., high grade investments).
At March 31, 2016, the cash surrender value of BOLI amounted to $23,972, compared with $23,747 at December 31, 2015, representing an increase of $225, or 0.9%. The increase in BOLI was attributed to increases in the cash surrender value of the BOLI policies.
Deposits
Historically, the banking business in the Banks market area has been seasonal, with lower deposits in the winter through late spring and higher deposits in summer and autumn. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Seasonal swings in deposits have been typically absorbed by the Banks strong liquidity position, including borrowing capacity from the FHLB of Boston, brokered certificates of deposit obtained from the national market and cash flows from the securities portfolio.
At March 31, 2016, total deposits stood at $962,575, compared with $942,787 at December 31, 2015, representing an increase of $19,788, or 2.1%. The Banks demand deposits and NOW accounts posted a combined seasonal decline of $11,388, or 4.6%, while savings and money market accounts increased $27,181, or 9.1%, Total time deposits increased $3,995, or 1.0%, compared with December 31, 2015.
Borrowed Funds
Borrowed funds principally consist of advances from the FHLB of Boston (the FHLB) and, to a lesser extent, securities sold under agreements to repurchase and Fed funds purchased. Advances from the FHLB are secured by stock in the FHLB, investment securities, blanket liens on qualifying mortgage loans and home equity loans, and certain commercial real estate loans.
The Bank utilizes borrowed funds to leverage its strong capital position and support its earning asset portfolios. Borrowed funds are principally utilized to support the Banks investment securities portfolio and, to a lesser extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet interest rate risk, given the Banks ability to select desired amounts, terms and maturities on a daily basis.
At March 31, 2016, total borrowings amounted to $492,253, compared with $474,791 at December 31, 2015, representing an increase of $17,462, or 3.7%. The increase in borrowings was utilized to help support first quarter earning asset growth as well as replacing seasonal deposit outflows.
52
Capital Resources
Consistent with its long-term goal of operating a sound and profitable organization, the Company maintained its strong capital position and continued to be a well-capitalized bank holding company according to applicable regulatory standards. Management believes this to be vital in promoting depositor and investor confidence and providing a solid foundation for future growth.
Capital Ratios:
The Company and the Bank are subject to the risk-based capital guidelines administered by the Companys and the Bank's principal regulators. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of risk-weighted assets and off-balance sheet items. Effective January 1, 2015, the Company and the Bank adopted the Basel III capital adequacy rules which, among other changes added a new risk-weighted capital measure Common Equity Tier I (CETI), as well as a phased in capital conservation buffer. For further information regarding the Basel III capital rules as they related to our Annual Report on Form 10-K, Item I, Supervision and Regulation,
Capital Adequacy and Prompt Corrective Action.
The new Basel III capital adequacy guidelines require all banks and bank holding companies to maintain minimum capital ratios of:
·
Common Equity Tier I of 5.125%
·
Total risk-based capital to risk-weighted assets of 8.625%
·
Tier I capital to total risk-weighted assets of 6.625%
·
Tier I capital to average assets (Leverage Ratio) of 4.0%
Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the Company's financial statements.
As depicted in the table below, as of March 31, 2016, the Company and the Bank were considered
well
-
capitalized
under the regulatory framework for prompt corrective action. Under the Basel III capital adequacy guidelines, a
well-capitalized
institution must maintain the following capital ratios:
·
Common Equity Tier I of 6.5%
·
Total risk-based capital to risk-weighted assets of 10.0%
·
Tier I capital to total risk-weighted assets of 8.0%
·
Tier I capital to average assets (Leverage Ratio) of 5.0%
53
The following tables set forth the Company's and the Banks regulatory capital at March 31, 2016 and December 31, 2015, under the rules applicable at that date.
Trends, Events or Uncertainties:
There are no known trends, events or uncertainties, nor any recommendations by any regulatory authority, that are reasonably likely to have a material effect on the Companys capital resources, liquidity, or financial condition.
Cash Dividends:
The Company's principal source of funds to pay cash dividends and support its commitments is derived from Bank operations.
The Company paid a regular cash dividend of 26.5 cents per share of common stock in the first quarter of 2016, representing an increase of 2.0 cents, or 8.2%, compared with the first quarter of 2015.
54
The Company's Board of Directors recently declared a second quarter 2016 regular cash dividend of 27.0 cents per share of Company common stock, representing an increase of 2.0 cents, or 8.0%, compared with the second quarter of 2015. The quarterly cash dividend is payable to all Company stockholders of record as of the close of business May 16, 2016, and will be paid on June 15, 2016. This represented the twentieth consecutive quarter where the Company increased its quarterly cash dividend to shareholders.
Stock Repurchase Plan:
In August 2008, the Companys Board of Directors approved a program to repurchase up to 450,000 shares of the Companys common stock, or approximately 10.2% of the shares then currently outstanding. The stock repurchase program became effective as of August 21, 2008, and was authorized to continue for a period of up to twenty-four consecutive months. In August of 2010, the Companys Board of Directors authorized the continuance of this program through August 17, 2012. In August of 2012, the Companys Board of Directors authorized the continuance of this program through August 17, 2014. In July of 2014, the Companys Board of Directors authorized the continuance of this program through August 17, 2016. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time to time, without prior notice and may be made in the open market or through privately negotiated transactions.
As of March 31, 2016, the Company had repurchased 164,665 shares of stock under this plan, at a total cost of $3,158 and an average price of $19.18 per share. During the three months ended March 31, 2016, the Company repurchased 6,252 shares under the plan. The Company records repurchased shares as treasury stock.
Off-Balance Sheet Arrangements
The Company is, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be considered material to investors.
Standby Letters of Credit:
The Bank guarantees the obligations or performance of certain customers by issuing standby letters of credit to third parties. These letters of credit are sometimes issued in support of third party debt. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.
At March 31, 2016 and December 31, 2015, commitments under existing standby letters of credit totaled $385. The fair value of the standby letters of credit was not significant as of the foregoing dates.
Off-Balance Sheet Risk
The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and certain financial derivative instruments; namely, interest rate cap agreements.
Commitments to Extend Credit:
Commitments to extend credit represent agreements by the Bank to lend to a customer provided there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each
55
customer's creditworthiness on a case-by-case basis using the same credit policies as it does for its balance sheet instruments, such as loans. The amount of collateral obtained, if deemed necessary by the Bank upon the issuance of commitment, is based on management's credit evaluation of the customer.
The following table summarizes the Banks commitments to extend credit as of March 31, 2016 and December 31, 2015:
|
|
|
|
|
March 31,
2016
|
|
December 31,
2015
|
|
|
|
|
Commitments to originate loans
|
$ 42,709
|
|
$ 41,529
|
Unused lines of credit
|
96,075
|
|
97,283
|
Un-advanced portions of construction loans
|
12,001
|
|
12,719
|
Total
|
$150,785
|
|
$151,531
|
Financial Derivative Instruments:
As part of its overall asset and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank's interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that change in interest rates does not have a significant adverse effect on net interest income. Derivative instruments that management periodically uses as part of its interest rate risk management strategy include interest rate swap agreements, interest rate floor agreements, and interest rate cap agreements.
At March 31, 2016 and December 31, 2015, the Bank had four outstanding, off-balance sheet, derivative instruments. These derivative instruments were interest rate cap agreements, with notional principal amounts totaling $90,000. The notional amounts of the financial derivative instruments do not represent exposure to credit loss. The bank is exposed to credit loss only to the extent the counter-party defaults in its responsibility to pay interest under the terms of the agreements. The credit risk in derivative instruments is mitigated by entering into transactions with highly-rated counterparties that management believes to be creditworthy and by limiting the amount of exposure to each counter-party. At March 31, 2016, the Banks derivative instrument counterparties were credit rated AA by the major credit rating agencies. The interest rate cap agreements were purchased by the Bank to limit its exposure to rising interest rates and were designated as cash flow hedges.
Further information covering the Banks derivative instruments is incorporated by reference to Part I, Item 1, Note 9 of the Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
Liquidity
Liquidity is measured by the Companys ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer-initiated needs. Many factors affect the Companys ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.
The Bank actively manages its liquidity position through target ratios established under its asset liability management policy. Continual monitoring of these ratios, both historical and through forecasts under multiple rate scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity. A portion of the Banks deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Banks liquidity position tightens.
56
The Bank uses a basic surplus model to measure its liquidity over 30 and 90-day time horizons. The relationship between liquid assets and short-term liabilities that are vulnerable to non-replacement are routinely monitored. The Banks general policy is to maintain a liquidity position of 4% or higher of total assets over the 30-day horizon. At March 31, 2016, liquidity, as measured by the basic surplus/deficit model, was 12.0% over the 30-day horizon and 10.5% over the 90-day horizon.
At March 31, 2016, the Bank had unused lines of credit and net unencumbered qualifying collateral availability to support its credit line with the FHLB of Boston approximating $248 million. The Bank also had capacity to borrow funds on a secured basis utilizing the Borrower-In-Custody (BIC) program and the Discount Window at the Federal Reserve Bank of Boston. At March 31, 2016, the Banks available secured line of credit at the Federal Reserve Bank of Boston stood at $143,963, or 8.9% of the Banks total assets. The Bank also has access to the national brokered deposit market, and periodically uses this funding source to bolster its on-balance sheet liquidity position.
The Bank maintains a liquidity contingency plan approved by the Banks Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company. The Company believes that the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Companys liquidity position.
Recent Accounting Developments
The following information presents a summary of Accounting Standards Updates (ASUs) that were recently adopted by the Company, as well as those that will be subject to implementation in future periods.
ASU 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20) Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.
ASU 2015-01 eliminates from U.S. GAAP the concept of extraordinary items, which, among other things, required an entity to segregate extraordinary items considered to be unusual and infrequent from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. ASU 2015-01 became effective for us on January 1, 2016 and did not have a significant impact on the Companys financial statements.
ASU 2015-16, Business Combinations (Topic 805) Simplifying the Accounting for Measurement-Period Adjustments.
ASU 2015-16 requires that adjustments to provisional amounts that are identified during the measurement period of a business combination be recognized in the reporting period in which the adjustment amounts are determined. Furthermore, the income statement effects of such adjustments, if any, must be calculated as if the accounting had been completed at the acquisition date. Any amounts that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date should be recorded in current-period earnings. Under previous guidance, adjustments to provisional amounts identified during the measurement period were to be recognized retrospectively. ASU 2015-16 became effective for us on January 1, 2016 and did not have a significant impact on the Companys financial statements.
ASU 2016-01 Financial InstrumentsOverall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities
, which updates certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The new guidance requires equity investments to be measured at fair value with changes in fair value recognized in net income, excluding equity investments that are consolidated or accounted for under the equity method of accounting. The new guidance allows
equity investments without readily determinable fair values to be measured at cost minus impairment, with a qualitative assessment required to identify impairment. The new guidance also requires public companies to use exit prices to measure the fair value of financial instruments, eliminates the disclosure requirements related to measurement assumptions for the fair value of instruments measured at amortized cost and requires separate presentation of financial assets and liabilities based on form and measurement category. In addition, for liabilities measured at fair value under the fair value option, the changes in fair value due to changes in instrument-specific credit risk should be recognized in OCI. This guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company is currently evaluating this guidance to determine the impact on its consolidated financial statements.
ASU 2016-02, Leases (Topic 842)
. The guidance in this ASU supersedes the leasing guidance in Topic 840,
Leases
. Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating this guidance to determine the impact on its consolidated financial statements.
ASU 2016-05Derivatives and Hedging (Topic 815) Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships.
ASU 2016-05 clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under ASC Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. ASU 2016-05 will be effective for us on January 1, 2017 and is not expected to have a significant impact on the Companys our financial statements.
ASU 2016-07, Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting.
The amendments affect all entities that have an investment that becomes qualified for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence. ASU 2016-07 simplifies the transition to the equity method of accounting by eliminating retroactive adjustment of the investment when an investment qualifies for use of the equity method, among other things. ASU 2016-07 will be effective for the Company on January 1, 2017 and is not expected to have a significant impact on our financial statements.
ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.
Under ASU 2016-09 all excess tax benefits and tax deficiencies related to share-based payment awards should be recognized as income tax expense or benefit in the income statement during the period in which they occur. Previously, such amounts were recorded in the pool of excess tax benefits included in additional paid-in capital, if such pool was available. Because excess tax benefits are no longer recognized in additional paid-in capital, the assumed proceeds from applying the treasury stock method when computing earnings per share should exclude the amount of excess tax benefits that would have previously been recognized in additional paid-in capital. Additionally, excess tax
benefits should be classified along with other income tax cash flows as an operating activity rather than a financing activity, as was previously the case. ASU 2016-09 also provides that an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. ASU 2016-09 changes the threshold to qualify for equity classification (rather than as a liability) to permit withholding up to the maximum statutory tax rates (rather than the minimum as was previously the case) in the applicable jurisdictions. ASU 2016-09 will be effective on January 1, 2017 and is not expected to have a significant impact the Companys financial statements.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk do not arise in the normal course of the Companys business activities.
Interest Rate Risk:
Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promote sufficient reward for understood and controlled risk.
The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by the Asset Liability Management Committee (ALCO) and the Banks Board of Directors.
The Bank's Asset Liability Management Policy, approved annually by the Banks Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.
The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense of all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.
The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product specific assumptions for deposit accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. Prepayment assumptions for mortgage loans and mortgage backed securities are developed from industry median estimates of prepayment speeds, based upon similar coupon ranges and seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions including:
·
A flat interest rate scenario in which current prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption.
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·
A 200 basis point rise or decline in interest rates applied against a parallel shift in the yield curve over a twelve-month period together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.
·
Various non-parallel shifts in the yield curve, including changes in either short-term or long-term rates over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.
·
An extension of the foregoing simulations to each of two, three, four and five year horizons to determine the interest rate risk with the level of interest rates stabilizing in years two through five. Even though rates remain stable during this two to five year time period, re-pricing opportunities driven by maturities, cash flow, and adjustable rate products will continue to change the balance sheet profile for each of the rate conditions.
Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken to maintain the balance sheet interest rate risk within established policy guidelines.
The following table summarizes the Bank's net interest income sensitivity analysis as of March 31, 2016, over one and two-year horizons and under rising and declining interest rate scenarios. In light of the Federal Funds rate of 0.25% to 0.50% and the two-year U.S. Treasury Note of 0.63% on the date presented, the analysis incorporates a declining interest rate scenario of 100 basis points, rather than the 200 basis points, as would traditionally be the case.
INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
MARCH 31, 2016
|
|
|
|
-100 Basis Points
Parallel
Yield Curve Shift
|
+200 Basis Points
Parallel
Yield Curve Shift
|
Year 1
|
|
|
Net interest income ($)
|
$ (202)
|
$ (688)
|
Net interest income (%)
|
-0.44%
|
-1.50%
|
Year 2
|
|
|
Net interest income ($)
|
$(3,749)
|
$(3,620)
|
Net interest income (%)
|
-8.17%
|
-7.89%
|
As more fully discussed below, the March 31, 2016, interest rate sensitivity modeling results indicate that the Banks balance sheet was moderately liability sensitive over the one and two-year horizons (i.e., moderately exposed to rising interest rates).
Assuming short-term and long-term interest rates decline 100 basis points from current levels (i.e., a parallel yield curve shift) and the Banks balance sheet structure and size remain at current levels, management believes net interest income will remain relatively stable over the one year horizon followed by a meaningful decline over the two-year horizon, as declining earning assets yields outpace reductions in funding costs. Should the yield curve steepen as rates fall, the model suggests that accelerated earning asset prepayments will slow, resulting in a more stabilized level of net interest income. Management anticipates that moderate to strong earning asset growth will be needed to meaningfully increase the Banks current level of net interest income should both long-term and short-term interest rates decline in parallel.
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Assuming the Banks balance sheet structure and size remain at current levels and the Federal Reserve increases short-term interest rates by 200 basis points with the balance of the yield curve shifting in parallel with these increases, management believes net interest income will remain relatively stable over the one year horizon, followed by a meaningful decline over the two year horizon as increased funding costs outpace increases in earning asset yields. The interest rate sensitivity simulation model suggests that as interest rates rise, the Banks funding costs will initially re-price disproportionately with earning asset yields to a moderate degree. As funding costs begin to stabilize early in the third year of the simulation, the model suggests that the earning asset portfolios will continue to re-price at prevailing interest rate levels and cash flows from the Banks earning asset portfolios will be reinvested into higher yielding earning assets, resulting in a widening of spreads and a stabilization of net interest income over the three year horizon and beyond. Management believes moderate to strong earning asset growth will be necessary to meaningfully increase the current level of net interest income over the one-year and two-year horizons should short-term and long-term interest rates rise in parallel.
Interest rates plummeted during 2008 and have remained historically low ever since, as the global economy slowed at unprecedented levels, unemployment levels soared, delinquencies on all types of loans increased along with decreased consumer confidence and dramatic declines in housing prices. Management believes the most significant ongoing factor affecting market risk exposure and the impact on net interest income continues to be the slow and extended recovery from the severe nationwide recession and the U.S. Governments extraordinary responses, including a variety of government stimulus programs and quantitative easing strategies.
The Federal Reserve has maintained short-term interest rates at historically low levels for an extended period of time, threatening net interest income. Net interest income exposure is also significantly affected by the shape and level of the U.S. Government securities and interest rate swap yield curve, and changes in the size and composition of the Banks loan, investment and deposit portfolios.
The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows, and renegotiated loan terms with borrowers. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment and refinancing levels deviating from those assumed; the impact of interest rate change caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis also does not reflect additional actions that the Banks SET and Board of Directors might take in responding to or anticipating changes in interest rates, and the anticipated impact on the Banks net interest income.
Item 4. CONTROLS AND PROCEDURES
Company management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report. Based on such evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company's disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under
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the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and regulations and are operating in an effective manner.
No change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management based upon currently available information will have no material adverse effect on the Company's consolidated financial statements.
Item 1A: Risk Factors
We believe the risk factors identified in our Annual Report on Form 10-K for the year ended December 31, 2015, continue to represent the most significant risks to our future results of operations and financial conditions, without modification or amendment. Please refer to such risk factors listed in Part 1, Item 1A of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2015.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
(a) None.
(b) None.
(c) Shares purchase activity during the three months ended March 31, 2016 was as follows: