UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| S | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the fiscal year ended December 31, 2011 | |
| £ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 0-24751
SALISBURY BANCORP, INC.
(Exact name of registrant as specified in its charter)
| Connecticut | 06-1514263 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 5 Bissell Street, Lakeville, CT | 06039 | |
| (Address of principal executive offices) | (Zip code) |
Registrant’s telephone number, including area code: (860) 435-9801
Securities registered pursuant to Section 12(b) of the Act:
| Common Stock, par value $.10 per share | NYSE Amex Equities | |
| (Title of each class) | (Name of each exchange on which registered) |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. £ Yes S No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. £ Yes S No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes S No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). S Yes £ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer £ Accelerated filer £ Non-accelerated filer £ Smaller reporting company S
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes £ No S
The aggregate market value of common stock held by non-affiliates of the registrant on June 30, 2011 was $41,886,883 based on the closing sales price of $26.44 of such stock. The number of shares of the registrant’s Common Stock outstanding as of March 1, 2012, was 1,688,731.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2012 Annual Meeting of Shareholders to be held on May 16, 2012, which will be filed within 120 days of fiscal year ended December 31, 2011, are incorporated by reference into Part III (Items 10, 11, 12, 13 and 14) of this Form 10-K.
FORM 10-K
SALISBURY BANCORP, INC.
For the Year Ended December 31, 2011
| Description | Page | |
| PART I | ||
| Item 1. | BUSINESS | 3 |
| Item 1A. | RISK FACTORS | 13 |
| Item 1B. | UNRESOLVED STAFF COMMENTS | 16 |
| Item 2. | PROPERTIES | 16 |
| Item 3. | LEGAL PROCEEDINGS | 16 |
| Item 4. | MINE SAFETY DISCLOSURES | 16 |
| PART II | ||
| Item 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | 17 |
| Item 6. | SELECTED FINANCIAL DATA | 18 |
| Item 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 19 |
| Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS | 34 |
| Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | 37 |
| Item 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 73 |
| Item 9A. | CONTROLS AND PROCEDURES | 73 |
| Item 9B. | OTHER INFORMATION | 73 |
| PART III | ||
| Item 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE | 73 |
| Item 11. | EXECUTIVE COMPENSATION | 73 |
| Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS | 74 |
| Item 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE | 74 |
| Item 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES | 74 |
| PART IV | ||
| Item 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES | 74 |
| 2 |
PART I
Forward-Looking Statements
This Annual Report on Form 10-K may contain and incorporates by reference statements relating to future results of Salisbury Bancorp, Inc. (“Salisbury”) that are considered “forward-looking” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to, among other things, expectations concerning loan demand, growth and performance, simulated changes in interest rates and the adequacy of the allowance for loan losses. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties, including, but not limited to, changes in political and economic conditions, interest rate fluctuations, competitive product and pricing pressures within Salisbury’s markets, equity and fixed income market fluctuations, personal and corporate customers’ bankruptcies, inflation, acquisitions and integrations of acquired businesses, technological changes, changes in law and regulations, changes in fiscal, monetary, regulatory and tax policies, monetary fluctuations, success in gaining regulatory approvals when required as well as other risks and uncertainties reported from time to time in Salisbury’s filings with the Securities and Exchange Commission.
Item 1. BUSINESS
Salisbury Bancorp, Inc.
Salisbury Bancorp, Inc. (“Salisbury”), a Connecticut corporation, formed in 1998, is the bank holding company for Salisbury Bank and Trust Company (the “Bank”), a Connecticut-chartered and Federal Deposit Insurance Corporation (the “FDIC”) insured commercial bank headquartered in Lakeville, Connecticut. Salisbury common stock is traded on the NYSE Amex Equities Market under the symbol “SAL”. Salisbury’s principal business consists of the business of the Bank. The Bank, formed in 1848, provides commercial banking, consumer financing, retail banking and trust and wealth advisory services through eight banking offices, ten ATMs and its internet website (www.salisburybank.com).
Abbreviations Used Herein
| ARRA | American Recovery and Reinvestment Act of 2009 | GAAP | Generally Accepted Accounting Principles in the United States of America | |
| Bank | Salisbury Bank and Trust Company | GLBA | Gramm-Leach-Bliley Act | |
| BHCA | Bank Holding Company Act | Interstate Banking Act | Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 | |
| BOLI | Bank Owned Life Insurance | LIBOR | London Interbank Offered Rate | |
| CFPB | Consumer Financial Protection Bureau | OREO | Other Real Estate Owned | |
| CPP | Capital Purchase Program | PIC | Passive Investment Company | |
| CRA | Community Reinvestment Act of 1977 | Salisbury | Salisbury Bancorp, Inc. | |
| CTDOB | State of Connecticut Department of Banking | SBLF | Small Business Lending Fund | |
| Dodd-Frank Act | Dodd-Frank Wall Street Reform and Consumer Protection Act | SEC | Securities and Exchange Commission | |
| FACT Act | Fair and Accurate Credit Transactions Act | SOX | Sarbanes-Oxley Act of 2002 | |
| FASB | Financial Accounting Standards Board | TARP | Troubled Asset Relief Program | |
| EESA | Economic Emergency Stabilization Act | TLGP | FDIC’s Temporary Liquidity Guaranty Program | |
| FDIC | Federal Deposit Insurance Corporation | Treasury | United States Department of the Treasury | |
| FHLBB | Federal Home Loan Bank of Boston | |||
| FRA | Federal Reserve Act | |||
| FRB | Federal Reserve Board |
Lending Activities
General
The Bank originates commercial loans, commercial real estate loans, residential and commercial construction loans, residential real estate loans collateralized by one-to-four family residences, home equity lines of credit and fixed rate loans and other consumer loans predominately in Connecticut’s Litchfield County, Massachusetts’ Berkshire County and New York’s Dutchess County in towns proximate to the Bank’s 8 full service offices.
Real estate secured the majority of the Bank’s loans as of December 31, 2011, including some loans classified as commercial loans. Interest rates charged on loans are affected principally by the Bank’s current asset/liability strategy, the demand for such loans, the cost and supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by general economic and credit conditions, monetary policies of the federal government, including the Federal Reserve Board (the “FRB”), federal and state tax policies and budgetary matters.
Residential Real Estate Loans
A principal lending activity of the Bank is to originate prime loans secured by first mortgages on one-to-four family residences. The Bank typically originates residential real estate loans through commissioned mortgage representatives. The Bank originates both fixed rate and adjustable rate mortgages.
The Bank currently sells the majority of the fixed rate residential mortgage loans it originates to the FHLBB under the Mortgage Partnership Finance program. The Bank typically retains loan servicing. The Bank retains some fixed rate residential mortgage loans and those loans originated under its first time home owner program to borrowers with low to moderate income.
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The retention of adjustable rate residential mortgage loans in the portfolio and the sale of longer term, fixed rate residential mortgage loans helps reduce the Bank’s exposure to interest rate risk. However, adjustable rate mortgages generally pose credit risks different from the credit risks inherent in fixed rate loans primarily because as interest rates rise, the underlying debt service payments of the borrowers rise, thereby increasing the potential for default. Management believes that these risks, which have not had a material adverse effect on the Bank to date, generally are less onerous than the interest rate risks associated with holding long-term fixed rate loans in the loan portfolio.
Commercial Real Estate Loans
The Bank makes commercial real estate loans for the purpose of allowing borrowers to acquire, develop, construct, improve or refinance commercial real estate where the property is the primary collateral securing the loan, and the income generated from the property is the primary repayment source. Office buildings, light industrial, retail facilities or multi-family income properties, normally collateralize commercial real estate loans. Among the reasons for management’s continued emphasis on commercial real estate lending is the desire to invest in assets with yields, which are generally higher than yields on one-to-four family residential mortgage loans, and are more sensitive to changes in interest rates. These loans typically have terms of up to 25 years and interest rates, which adjust over periods of 3 to 10 years, based on one of various rate indices.
Commercial real estate lending generally poses a greater credit risk than residential mortgage lending to owner-occupants. The repayment of commercial real estate loans depends on the business and financial condition of the borrower. Economic events and changes in government regulations, which the Bank and its borrowers do not control, could have an adverse impact on the cash flows generated by properties securing commercial real estate loans and on the market value of such properties.
Construction Loans
The Bank originates both residential and commercial construction loans. Typically, loans are made to owner-borrowers who will occupy the properties as either their primary or secondary residence (residential and commercial construction) and to licensed and experienced developers for the construction of single-family homes.
The proceeds of commercial construction loans are disbursed in stages. Bank officers, appraisers and/or independent engineers inspect each project’s progress before additional funds are disbursed to verify that borrowers have completed project phases.
Residential construction loans to owner-borrowers generally convert to a fully amortizing long-term mortgage loan upon completion of construction. Construction loans generally have terms of six months to two years.
Construction lending, particularly commercial construction lending, poses greater credit risk than mortgage lending to owner occupants. The repayment of commercial construction loans depends on the business and financial condition of the borrower and on the economic viability of the project financed. Economic events and changes in government regulations, which the Bank and its borrowers do not control, could have an adverse impact on the value of properties securing construction loans and on the borrower’s ability to complete projects financed and, if not the borrower’s residence, sell them for amounts anticipated at the time the projects commenced.
Commercial Loans
Commercial loans are generally made on a secured basis and are primarily collateralized by equipment, inventory, accounts receivable and/or leases. Commercial loans primarily provide working capital, equipment financing, financing for leasehold improvements and financing for expansion. The Bank offers both term and revolving commercial loans. Term loans have either fixed or adjustable rates of interest and, generally, terms of between two and seven years. Term loans generally amortize during their life, although some loans require a balloon payment at maturity if the amortization exceeds seven years. Revolving commercial lines of credit typically are renewable annually and have a floating rate of interest, which is normally indexed to the Wall Street Journal’s prime rate of interest and occasionally indexed to the LIBOR.
Commercial lending generally poses a higher degree of credit risk than real estate lending. Repayment of both secured and unsecured commercial loans depends substantially on the success of the borrower’s underlying business, financial condition and cash flows. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is primarily dependent upon the success of the borrower’s business.
Secured commercial loans are generally collateralized by equipment, inventory, accounts receivable and leases. Compared to real estate, such collateral is more difficult to monitor, its value is more difficult to validate, it may depreciate more rapidly and it may not be as readily saleable if repossessed.
Consumer Loans
The Bank originates various types of consumer loans, including home equity loans and lines of credit, auto and personal installment loans. Home equity loans and lines of credit are secured by one-to-four family owner-occupied properties, typically by second mortgages. Home equity loans have fixed interest rates, while home equity lines of credit normally adjust based on the Wall Street Journal’s prime rate of interest. Consumer loans are originated through the branch network with the exception of Home Equity Lines Of Credit, which are originated by licensed Mortgage Lending Originator staff.
Credit Risk Management and Asset Quality
One of the Bank’s key objectives is to maintain a high level of asset quality. The Bank utilizes the following general practices to manage credit risk: limiting the amount of credit that individual lenders may extend; establishing a process for credit approval accountability; careful initial underwriting and analysis of borrower, transaction, market and collateral risks; ongoing servicing of individual loans and lending relationships; continuous monitoring of the portfolio, market dynamics and the economy; and periodically reevaluating the Bank’s strategy and overall exposure as economic, market and other relevant conditions change.
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Credit Administration is responsible for determining loan loss reserve adequacy, preparing monthly and quarterly reports regarding the credit quality of the loan portfolio; which are submitted to Loan Committee to ensure compliance with the credit policy. In addition, Credit Administration is responsible for managing non-performing and classified assets as well as oversight of all collection activity. On a quarterly basis, the Loan Committee reviews commercial and commercial real estate loans that are risk rated as “Special Mention” or worse, focusing on the current status and strategies to improve the credit.
The Bank’s loan review activities are performed by an independent third party firm that evaluates the creditworthiness of borrowers and the appropriateness of the Bank’s risk rating classifications. The firm’s findings are reported to Credit Administration and the Loan Committee.
Trust and Wealth Advisory Services
The Bank provides a range of fiduciary and trust services including general investment management, wealth advisory services to individuals, families and institutions, and estate administration and settlement services.
Securities
Salisbury’s securities portfolio is structured to diversify the earnings, assets and risk structure of Salisbury, provide liquidity consistent with both projected and potential needs, collateralize certain types of deposits, assist with maintaining a satisfactory net interest margin and complying with regulatory capital and liquidity requirements. Securities types include U.S. Government and Agency securities, mortgage-backed securities, collateralized mortgage obligations and bank qualified tax exempt municipal bonds.
Sources of Funds
The Bank uses deposits, proceeds from loan and security maturities, repayments and sales, and borrowings to fund lending, investing and general operations. Deposits represent the Bank’s primary source of funds.
Deposits
The Bank offers a variety of deposit accounts with a range of interest rates and other terms, which are designed to meet customer financial needs. Retail and commercial deposits are received through the Bank’s banking offices. Additional depositor related services provided to customers include ATM, telephone, Internet Banking and Internet Bill Pay services.
The FDIC provides separate insurance coverage of $250,000 per depositor for each account ownership category. On November 9, 2010, the FDIC’s Board of Directors issued a final rule to implement section 343 of the Dodd-Frank Act. Section 343 of the Dodd-Frank Act provides unlimited deposit insurance coverage for “noninterest-bearing transaction accounts” through December 31, 2012. The Act was amended to also provide IOLTAs with unlimited insurance coverage through December 31, 2012.
Deposit flows are significantly influenced by economic conditions, the general level of interest rates and the relative attractiveness of competing deposit and investment alternatives. Deposit pricing strategy is monitored weekly by the Pricing Committee, composed of members of Executive Management. When determining deposit pricing, the Bank considers strategic objectives, competitive market rates, deposit flows, funding commitments and investment alternatives, FHLBB advance rates and rates on other sources of funds.
National, regional and local economic and credit conditions, changes in competitor money market, savings and time deposit rates, prevailing market interest rates and competing investment alternatives all have a significant impact on the level of the Bank’s deposits. Deposit generation is a key focus for the Bank as a source of liquidity and to fund continuing asset growth. Competition for deposits has been and is expected to remain strong.
Borrowings
The Bank is a member of the FHLBB that provides credit facilities for regulated, federally insured depository institutions and certain other home financing institutions. Members of the FHLBB are required to own capital stock in the FHLBB and are authorized to apply for advances on the security of their FHLBB stock and certain home mortgages and other assets (principally securities, which are obligations of, or guaranteed by, the United States Government or its agencies) provided certain creditworthiness standards have been met. Under its current credit policies, the FHLBB limits advances based on a member’s assets, total borrowings and net worth. Long-term and short-term FHLBB advances are utilized as a source of funding to meet liquidity and planning needs when the cost of these funds are favorable as compared to deposits or alternate funding sources.
Additional funding sources are available through securities sold under agreements to repurchase and the Federal Reserve Bank of Boston.
Subsidiaries
Salisbury has one wholly-owned subsidiary, Salisbury Bank and Trust Company. The Bank is Salisbury’s primary subsidiary and accounts for the majority of Salisbury’s income. The Bank has two wholly-owned subsidiaries, SBT Mortgage Service Corporation and SBT Realty, Inc. SBT Mortgage Service Corporation is a passive investment company (“PIC”) that holds loans collateralized by real estate originated or purchased by the Bank. Income of the PIC and its dividends to Salisbury are exempt from the Connecticut Corporate Business Tax. SBT Realty, Inc. was formed to hold New York State real estate and is presently inactive.
Employees
At December 31, 2011, the Bank had 113 full-time employees and 24 part-time employees. None of the employees were represented by a collective bargaining group. The Bank maintains a comprehensive employee benefit program providing, among other benefits, group medical and dental insurance, life insurance, disability insurance, a pension plan and an employee 401(k) investment plan. Management considers relations with its employees to be good.
Market Area
Salisbury and the Bank are headquartered in Lakeville, Connecticut, which is located in the northwestern quadrant of Connecticut’s Litchfield County. The Bank has a total of eight banking offices, four of which are located in Connecticut’s Litchfield County; two of which are located in Massachusetts’ Berkshire County; and two of which are located in New York’s Dutchess County. The Bank’s primary deposit gathering and lending area consists of the communities and surrounding towns that are served by its branch network in Litchfield, Berkshire and Dutchess counties. The Bank also has deposit, lending and trust relationships outside of these areas.
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Competition
The Bank faces strong competition in attracting and retaining deposits and in making loans. The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations, automated services and office hours. Its most direct competition for deposits and loans has come from commercial banks, savings banks and credit unions located in its market area. Competition for deposits also comes from non-banking companies such as brokerage houses that offer a range of deposit and deposit-like products. Although the Bank expects this continuing competition to have an effect upon the cost of funds, it does not anticipate any substantial adverse effect on maintaining the current deposit base. The Bank is competitive within its market area in the various deposit products it offers to depositors. Due to this fact, management believes the Bank has the ability to maintain its deposit base. The Bank does not rely upon any individual, group or entity for a significant portion of its deposits.
The Bank’s competition for real estate loans comes primarily from mortgage banking companies, savings banks, commercial banks, insurance companies, and other institutional lenders. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized service. Factors that affect competition include, among others, the general availability of funds and credit, general and local economic conditions, current interest rate levels and volatility in the mortgage markets.
The banking industry is also experiencing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Technological advances are likely to increase competition by enabling more companies to provide cost effective products and services.
Regulation and Supervision
General
Salisbury is required to file reports and otherwise comply with the rules and regulations of the FRB, the CTDOB and the SEC under the Federal securities laws.
The Bank is subject to extensive regulation by the CTDOB, as its chartering agency, and by the FDIC, as its deposit insurer. The Bank is required to file reports with, and is periodically examined by, the FDIC and the CTDOB concerning its activities and financial condition. It must obtain regulatory approvals prior to entering into certain transactions, such as mergers.
The following discussion of the laws and regulations material to the operations of Salisbury and the Bank is a summary and is qualified in its entirety by reference to such laws and regulations. Any change in such laws or regulations, whether by the CTDOB, the FDIC, the SEC or the FRB, could have a material adverse impact on Salisbury or the Bank.
Bank Holding Company Regulation
Salisbury is a registered bank holding company under the BHCA and is subject to comprehensive regulation and regular examinations by the FRB. The FRB also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. Under Connecticut banking law, no person may acquire beneficial ownership of more than 10% of any class of voting securities of a Connecticut-chartered bank, or any bank holding company of such a bank, without prior notification of, and lack of disapproval by, the CTDOB. The CTDOB will disapprove the acquisition if the bank or holding company to be acquired has been in existence for less than five years, unless the CTDOB waives this five-year restriction, or if the acquisition would result in the acquirer controlling 30% or more of the total amount of deposits in insured depository institutions in Connecticut. Similar restrictions apply to any person who holds in excess of 10% of any such class and desires to increase its holdings to 25% or more of such class.
Under FRB policy, a bank holding company must serve as a source of strength for its subsidiary bank. Under this policy, the FRB may require a holding company to contribute additional capital to an undercapitalized subsidiary bank.
Bank holding companies must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of another bank or bank holding company; (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of any company, which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities, which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the FRB includes, among other things: (i) operating a savings institution, mortgage company, finance company, credit card company or factoring company; (ii) performing certain data processing operations; (iii) providing certain investment and financial advice; (iv) underwriting and acting as an insurance agent for certain types of credit-related insurance; (v) leasing property on a full-payout, non-operating basis; (vi) selling money orders; (vii) real estate and personal property appraising; (viii) providing tax planning and preparation services; (ix) financing and investing in certain community development activities; and (x) subject to certain limitations, providing securities brokerage services for customers.
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Dividends
The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB’s view that a bank holding company should be a “source of strength” to its bank subsidiary and should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, the FRB may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized” or if the dividend would violate applicable law or would be an unsafe or unsound banking practice.
Financial Modernization
GLBA permits greater affiliation among banks, securities firms, insurance companies, and other companies under a type of financial services company known as a “financial holding company”. A financial holding company essentially is a bank holding company with significantly expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and merchant banking activities. The act also permits the FRB and the Treasury to authorize additional activities for financial holding companies if they are “financial in nature” or “incidental” to financial activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, well managed, and has at least a “satisfactory” Community Reinvestment Act rating. A financial holding company must provide notice to the FRB within 30 days after commencing activities previously determined by statute or by the FRB and the Treasury to be permissible. Salisbury is a registered financial holding company.
Under GLBA, all financial institutions are required to establish policies and procedures to restrict the sharing of nonpublic customer data with nonaffiliated parties and to protect customer data from unauthorized access. In addition, the FACT Act includes many provisions concerning national credit reporting standards, and permits consumers, including customers of Salisbury, to opt out of information sharing among affiliated companies for marketing purposes. The FACT Act also requires banks and other financial institutions to notify their customers if they report negative information about them to a credit bureau or if they are granted credit on terms less favorable than those generally available. The Federal Reserve Board and the Federal Trade Commission are granted extensive rulemaking authority under the FACT Act, and Salisbury and the Bank are subject to those provisions. The Bank has developed policies and procedures for itself and its affiliate, Salisbury, and believes it is in compliance with all privacy, information sharing, and notification provisions of GLBA and the FACT Act.
Connecticut Banking Laws and Supervision
The Bank is a state-chartered commercial bank under Connecticut law and as such is subject to regulation and examination by the CTDOB. The CTDOB regulates commercial banks, among other financial institutions, for compliance with the laws and regulations of the State of Connecticut, as well as the appropriate rules and regulations of federal agencies. The approval of the CTDOB is required for, among other things, the establishment of branch offices and business combination transactions. The CTDOB conducts periodic examinations of Connecticut-chartered banks. The FDIC also regulates many of the areas regulated by the CTDOB, and federal law may limit some of the authority provided to Connecticut-chartered banks by Connecticut law.
Lending Activities
Connecticut banking laws grant commercial banks broad lending authority. With certain limited exceptions, total secured and unsecured loans made to any one obligor generally may not exceed 15% of the Bank’s equity capital and reserves for loan and lease losses. However, if the loan is fully secured, such limitations generally may be increased by an additional 10%.
Dividends
The Bank may pay cash dividends out of its net profits. For purposes of this restriction, “net profits” represents the remainder of all earnings from current operations. Further, the total amount of all dividends declared by the Bank in any year may not exceed the sum of its net profits for the year in question combined with its retained net profits from the preceding two years, unless the CTDOB approves the larger dividend. Federal law also prevents the Bank from paying dividends or making other capital distributions that would cause it to become “undercapitalized.” The FDIC may also limit an insured’s ability to pay dividends based upon safety and soundness considerations.
Powers
Connecticut law permits Connecticut banks to sell insurance and fixed- and variable-rate annuities if licensed to do so by the Connecticut Insurance Department. With the prior approval of the CTDOB, Connecticut banks are also authorized to engage in a broad range of activities related to the business of banking, or that are financial in nature or that are permitted under the BHCA, other federal statutes, or the regulations promulgated pursuant to these statutes. Connecticut banks generally are also authorized to engage in any activity permitted for a federal bank or upon filing prior written notice of its intention to engage in such activity with the CTDOB, unless the CTDOB disapproves the activity.
Assessments
Connecticut banks are required to pay assessments to the CTDOB based upon a bank’s asset size to fund the CTDOB’s operations. The assessments are generally made annually.
Enforcement
Under Connecticut law, the CTDOB has extensive enforcement authority over Connecticut banks and, under certain circumstances, affiliated parties, insiders, and agents. The CTDOB’s enforcement authority includes cease and desist orders, fines, receivership, conservatorship, removal of officers and directors, emergency closures, dissolution and liquidation.
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New York and Massachusetts Banking Laws and Supervision
The Interstate Banking Act permits adequately capitalized bank holding companies to acquire banks in any state subject to specified concentration limits and other conditions. The Interstate Banking Act also authorizes the interstate merger of banks. In addition, among other things, the Interstate Banking Act permits banks to establish new branches on an interstate basis provided that such action is specifically authorized by the law of the host state. The Bank conducts activities and operates branch offices in New York and Massachusetts as well as Connecticut. The Bank, with respect to offices in New York and Massachusetts, may conduct any activity that is authorized under Connecticut law that is permissible for either New York or Massachusetts state banks or for an out-of-state national bank, at its New York and Massachusetts branch offices, respectively. The New York State Superintendent of Banks may exercise regulatory authority with respect to the Bank’s New York branch offices and the Bank is subject to certain rules related to community reinvestment, consumer protection, fair lending, establishment of intra-state branches and the conduct of banking activities with respect to its branches located in New York State. The Massachusetts Commissioner of Banks may exercise similar authority and the Bank is subject to similar rules under Massachusetts Banking Law with respect to the Bank’s Massachusetts branch offices.
Federal Regulations
Capital Requirements
Under FDIC regulations, federally insured state-chartered banks, such as the Bank, that are not members of the Federal Reserve System (“state non-member banks”) are required to comply with minimum leverage capital requirements. If the FDIC determines that an institution is not anticipating or experiencing significant growth and is, in general, a strong banking organization, with a composite rating of 1 under the Uniform Financial Institutions Ranking System established by the Federal Financial Institutions Examination Council, the minimum capital leverage requirement is a ratio of Tier 1 capital to total assets of 3%. For all other institutions, the minimum leverage capital ratio is not less than 4%. Tier 1 capital is the sum of common Shareholders’ equity, noncumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships) and certain other specified items.
The FDIC regulations require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of regulatory capital to regulatory risk-weighted assets is referred to as a bank’s “risk-based capital ratio.” Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items (including recourse obligations, direct credit substitutes and residual interests) to four risk-weighted categories ranging from 0% to 100%, and in some instances 200% or assets subject to dollar-for-dollar capital requirements, with higher levels of capital being required for the categories perceived as representing greater risk.
To be considered “well capitalized”, banks are generally expected to maintain a minimum ratio of total capital to risk-weighted assets of at least 8%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items, which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and certain other capital instruments, and a portion of the net unrealized gain on equity securities. The includable amount of Tier 2 capital cannot exceed the amount of the institution’s Tier 1 capital. Banks that engage in specified levels of trading activities are subject to adjustments in their risk based capital calculation to ensure the maintenance of sufficient capital to support market risk.
As a bank holding company, Salisbury is subject to FRB capital adequacy guidelines for bank holding companies similar to those of the FDIC for state-chartered banks.
Prompt Corrective Regulatory Action
Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes five capital categories:
| • | Well capitalized – at least 5% leverage capital, 6% Tier 1 risk based capital and 10% total risk based capital. | |
| • | Adequately capitalized – at least 4% leverage capital, 4% Tier 1 risk based capital and 8% total risk based capital. | |
| • | Undercapitalized – less than 4% leverage capital, 4% Tier 1 risk based capital and less than 8% total risk based capital. “Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. A bank’s compliance with such a plan is required to be guaranteed by any company that controls the undercapitalized institution in an amount equal to the lesser of 5% of the institution’s total assets when deemed undercapitalized or the amount necessary to achieve the status of adequately capitalized. | |
| • | Significantly undercapitalized – less than 3% leverage capital, 3% Tier 1 risk based capital and less than 6% total risk-based capital. “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. | |
| • | Critically undercapitalized – less than 2% tangible capital. “Critically undercapitalized” institutions are subject to additional measures including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status. |
As of December 31, 2011, the Bank was “well capitalized”.
Transactions with Affiliates
Under federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the FRA. In a holding company context, at a minimum, the parent holding company of a bank and any companies which are controlled by such parent holding company are affiliates of the bank. Generally, Sections 23A and 23B are intended to protect insured depository institutions from suffering losses arising from transactions with non-insured affiliates, by limiting the extent to which a bank or its subsidiaries may engage in covered transactions with any one affiliate and with all affiliates of the bank in the aggregate, and by requiring that such transactions be on terms that are consistent with safe and sound banking practices.
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Further, Section 22(h) of the FRA and Regulation O restrict loans to directors, executive officers, and principal shareholders (“insiders”). Under Section 22(h), loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the board of directors. Further, under Section 22(h), loans to directors, executive officers and principal shareholders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to the bank’s employees and does not give preference to the insider over the employees. Section 22(g) of the FRA imposes additional limitations on loans to executive officers.
Enforcement
The FDIC has extensive enforcement authority over insured banks, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices.
Standards for Safety and Soundness
The FDIC, together with the other federal bank regulatory agencies, prescribe standards of safety and soundness by regulations or guidelines, relating generally to operations and management, asset growth, asset quality, earnings, stock valuation and compensation. The federal bank regulatory agencies have adopted a set of guidelines prescribing safety and soundness standards, which establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, the federal bank regulatory agencies adopted regulations that authorize, but do not require, the agencies to order an institution that has been given notice that it is not satisfying the safety and soundness guidelines to submit a compliance plan. The federal bank regulatory agencies have also adopted guidelines for asset quality and earning standards. As a state-chartered bank, the Bank is also subject to state statutes, regulations and guidelines relating to safety and soundness, in addition to the federal requirements.
Insurance of Deposit Accounts
The Bank’s deposit accounts are insured by the FDIC up to applicable legal limits (generally, $250,000 per depositor for each account ownership category and $250,000 for certain retirement plan accounts) and are subject to deposit insurance assessments.
The Dodd-Frank Act permanently raised the current standard maximum deposit insurance amount to $250,000. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category. On November 9, 2010, the FDIC’s Board of Directors issued a final rule to implement section 343 of the Dodd-Frank Act, which provides unlimited deposit insurance coverage for “noninterest-bearing transaction accounts” through December 31, 2012. On December 29, 2010, the President signed legislation that amended the Federal Deposit Insurance Act to include IOLTAs within the definition of a “noninterest” bearing transaction account,” thus expanding the temporary unlimited insurance coverage authorized by section 343 of the Dodd-Frank Act to include IOLTAs. On January 18, 2011, the FDIC issued a final rule revising its deposit insurance regulations to reflect this amendment to the Federal Deposit Insurance Act to also include IOLTAs with unlimited insurance coverage through December 31, 2012.
The FDIC has adopted a risk-based assessment system. The FDIC assigns an institution to one of three capital categories based on the institution’s financial condition consisting of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution’s primary federal regulator and information which the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds. An institution’s assessment rate depends on the capital category and supervisory category to which it is assigned.
FDIC insured institutions are required to pay assessments to the FDIC to fund the Deposit Insurance Fund. The Bank’s current annual assessment rate is approximately 9 basis points of total assets. Additionally, FDIC insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by The Financing Corporation (“FICO”), an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. The assessment rate is adjusted quarterly to reflect changes in the assessment bases of the fund based on quarterly Call Report and Thrift Financial Report submissions. From time to time, the FDIC, may impose a supplemental special assessment in addition to other special assessments and regular premium rates to replenish the deposit insurance funds during periods of economic difficulty. The amount of an emergency special assessment imposed on a bank will be determined by the FDIC if such amount is necessary to provide sufficient assessment income to repay amounts borrowed from the Treasury; to provide sufficient assessment income to repay obligations issued to and other amounts borrowed from insured depository institutions; or for any other purpose the FDIC may deem necessary. The Bank’s last special assessment was in the second quarter of 2009.
The FDIC may terminate insurance of deposits, after notice and a hearing, if it finds that the institution is in an unsafe or unsound condition to continue operations, has engaged in unsafe or unsound practices, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
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The Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Act, enacted in July 2010, revised the statutory authorities governing the FDIC’s management of the Deposit Insurance Fund (the “DIF” or the “Fund”). The Dodd-Frank Act granted the FDIC the ability to achieve goals for Fund management that it has sought to achieve for decades but lacked the tools to accomplish: maintaining a positive Fund balance even during a banking crisis and maintaining moderate, steady assessment rates throughout economic and credit cycles.
Among other things, the Dodd-Frank Act: (1) raised the minimum designated reserve ratio (DRR), which the FDIC must set each year, to 1.35 percent (from the former minimum of 1.15 percent) and removed the upper limit on the DRR (which was formerly capped at 1.5 percent) and therefore on the size of the Fund; (2) required that the Fund reserve ratio reach 1.35 percent by September 30, 2020 (rather than 1.15 percent by the end of 2016, as formerly required); (3) required that, in setting assessments, the FDIC offset the effect of requiring that the reserve ratio reach 1.35 percent by September 30, 2020 rather than 1.15 percent by the end of 2016 on insured depository institutions with total consolidated assets of less than $10,000,000,000; (4) eliminated the requirement that the FDIC provide dividends from the Fund when the reserve ratio is between 1.35 percent and 1.5 percent; and (5) continued the FDIC’s authority to declare dividends when the reserve ratio at the end of a calendar year is at least 1.5 percent, but granted the FDIC sole discretion in determining whether to suspend or limit the declaration or payment of dividends.
The Dodd-Frank Act also required that the FDIC amend its regulations to redefine the assessment base used for calculating deposit insurance assessments. Under the Dodd-Frank Act, the assessment base must, with some possible exceptions, equal average consolidated total assets minus average tangible equity.
Effective April 1, 2011 the FDIC amended 12 CFR 327 to implement revisions to the Federal Deposit Insurance Act made by the Dodd-Frank Act by modifying the definition of an institution’s deposit insurance assessment base; to change the assessment rate adjustments; to revise the deposit insurance assessment rate schedules in light of the new assessment base and altered adjustments; to implement the Dodd-Frank Act’s dividend provisions; to revise the large insured depository institution assessment system to better differentiate for risk and better take into account losses from large institution failures that the FDIC may incur; and to make technical and other changes to the FDIC’s assessment rules. On February 7, 2011, the FDIC Board of Directors adopted the final rule, which redefined the deposit insurance assessment base as required by the Dodd-Frank Act; made changes to assessment rates; implemented the Dodd-Frank Act’s DIF dividend provisions; and revised the risk-based assessment system for all large insured depository institutions (IDIs), generally, those institutions with at least $10 billion in total assets. Nearly all of the 7,600-plus institutions with assets less than $10 billion, including the Bank, have benefited from a reduction in their assessments as a result of this final rule.
Consumer Financial Protection Bureau
The Dodd-Frank Act created a new Consumer Financial Protection Bureau (“CFPB”). As required by the Dodd-Frank Act, jurisdiction for all existing consumer protection laws and regulations has been transferred to the CFPB. In addition, the CFPB is granted authority to promulgate new consumer protection regulations for banks and nonbank financial firms offering consumer financial services or products to ensure that consumers are protected from “unfair, deceptive, or abusive” acts or practices. The CFPB has begun conducting studies of existing consumer protection regulations to gauge their effectiveness and to solicit comment on potential new regulations.
Federal Reserve System
All depository institutions must hold a percentage of certain types of deposits as reserves. Reserve requirements currently are assessed on the depository institution’s net transaction accounts (mostly checking accounts). Depository institutions must also regularly submit deposit reports of their deposits and other reservable liabilities.
For net transaction accounts in 2011, the first $10.7 million (which may be adjusted by the FRB) will be exempt from reserve requirements. A 3 percent reserve ratio will be assessed on net transaction accounts over $10.7 million up to and including $58.8 million (which may be adjusted by the FRB). A 10 percent reserve ratio will be assessed on net transaction accounts in excess of $58.8 million (which may be adjusted by the FRB). The Bank is in compliance with these requirements.
Federal Home Loan Bank System
The Bank is a member of the Boston region of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The FHLBB provides a central credit facility primarily for member institutions. Member institutions are required to acquire and hold shares of capital stock in the FHLBB calculated periodically based primarily on its level of borrowings from the FHLBB. The Bank was in compliance with this requirement. At December 31, 2011, the Bank had FHLBB stock of $6.0 million and FHLBB advances of $54.6 million.
No market exists for shares of the FHLBB and therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB.
In 2008, the FHLBB announced to its members it was focusing on preserving capital in response to ongoing market volatility including the extension of a moratorium on excess stock repurchases and in 2009 announced the suspension of its quarterly dividends. On February 22, 2011, the FHLBB announced the resumption of modest quarterly cash dividends to its members through 2011 and on June 27, 2011 the FHLBB announced the discontinuation of its excess stock pool effective June 28, 2011, and designated December 28, 2011, as the required stock purchase date. Based on the capital adequacy and the liquidity position of the FHLBB, management believes there is no impairment related to the carrying amount of the Bank’s FHLBB stock as of December 31, 2011. Further deterioration of the FHLBB’s capital levels may require the Bank to deem its restricted investment in FHLBB stock to be OTTI. If evidence of impairment exists in the future, the FHLBB stock would reflect fair value using either observable or unobservable inputs. The Bank will continue to monitor its investment in FHLBB stock.
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Troubled Asset Relief Program and Capital Purchase Program
TARP was established as part of EESA in October 2008. The TARP gave the Treasury authority to deploy up to $700 billion into the financial system with the objective of improving liquidity in the capital markets. On October 24, 2008, the Treasury announced plans to direct $250 billion of the $700 billion authorized into preferred stock investments in banks (the “CPP”). The general terms of this preferred stock program for a participant bank that is a public company were as follows: pay 5% dividends on the Treasury’s preferred stock for the first five years and 9% dividends thereafter; cannot increase common dividends for three years while the Treasury is an investor; the Treasury receives warrants entitling the Treasury to buy participating bank’s common stock equal to 15% of the Treasury’s total investment in the participating bank; and participating bank executives must agree to certain compensation restrictions, and restrictions on the amount of executive compensation which is tax deductible and other detailed terms and conditions. In addition to the executive compensation restrictions announced by the Treasury, participants in the CPP are also subject to the more stringent executive compensation limits enacted as part of the ARRA, which was signed into law on February 17, 2009. Among other things, the ARRA more strictly limits the payment of incentive compensation and any severance or golden parachute payments to certain highly compensated employees of CPP participants, expands the scope of employees who are subject to a claw-back of bonus and incentive compensation that is based on results that are later found to be materially inaccurate, adds additional corporate governance requirements, and requires the Treasury to perform a retroactive review of compensation to the five highest compensated employees of all CPP participants.
On March 13, 2009, Salisbury sold to the Secretary of the Treasury (i) 8,816 shares of its Series A Fixed Rate Cumulative Perpetual Preferred Stock, par value $0.01 per share, having a liquidation preference of $1,000 per share (the Series A Preferred Stock) and (ii) a ten-year warrant to purchase up to 57,671 shares of its common stock, par value $0.10 per share, at an exercise price of $22.93 per share (the “Warrant”), for an aggregate purchase price of $8,816,000 in cash. All of the proceeds from the sale of its Series A Preferred Stock was treated as Tier 1 Capital for regulatory purposes.
On August 25, 2011, Salisbury repurchased from the Secretary of the Treasury for $8,816,000 all of its 8,816 shares of Series A Fixed Rate Cumulative Perpetual Preferred Stock and on November 2, 2011, Salisbury repurchased from the Secretary of the Treasury for $205,000 the warrant to purchase up to 57,671 shares of Salisbury’s Common Stock at a purchase price of $22.93 per share.
Small Business Lending Fund
Treasury’s SBLF program is a $30 billion fund established under the Small Business Jobs Act of 2010 to encourage lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion.
Salisbury elected to participate in Treasury’s SBLF program and on August 25, 2011, Salisbury sold to the Secretary of the Treasury $16,000,000 of its Series B Preferred Stock under the SBLF program, and simultaneously repurchased all of its Series A Preferred Stock sold to the Treasury in 2009 under the Capital Purchase Program, a part of TARP. All of the proceeds from the sale of its Series B Preferred Stock is treated as Tier 1 Capital for regulatory purposes.
The Series B Preferred Stock pays noncumulative dividends. The dividend rate on the Series B Preferred Stock for the initial ten quarterly dividend periods, commencing with the period ended September 30, 2011 and ending with the period ended December 31, 2013, is determined each quarter based on the increase in the Bank’s Qualified Small Business Lending over a baseline amount. The dividend rate for the quarterly periods ended September 30, 2011 and December 31, 2011 were 2.10375% and 1.72875%, respectively. For the eleventh quarterly dividend payment through four and one-half years after its issuance, the dividend rate on the Series B Preferred Stock will be fixed at the rate in effect at the end of the ninth quarterly dividend period and after four and one-half years from its issuance the dividend rate will be fixed at 9 percent per annum. The Series B Preferred Stock is non-voting, other than voting rights on matters that could adversely affect the Series B Preferred Stock. The Series B Preferred Stock is redeemable at any time at one hundred percent of the issue price plus any accrued and unpaid dividends.
Other Regulations
Sarbanes-Oxley Act of 2002
The stated goals of SOX are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.
SOX includes very specific disclosure requirements and corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the SEC and the Comptroller General. SOX represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
SOX addresses, among other matters, audit committees; certification of financial statements and internal controls by the Chief Executive Officer and Chief Financial Officer; the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve-month period following initial publication of any financial statements that later require restatement; a prohibition on insider trading during pension plan black-out periods; disclosure of off-balance sheet transactions; a prohibition on certain loans to directors and officers; expedited filing requirements for Forms 4; disclosure of a code of ethics and filing a Form 8-K for significant changes or waivers of such code; “real time” filing of periodic reports; the formation of a public company accounting oversight board; auditor independence; and various increased criminal penalties for violations of securities laws. The SEC has enacted rules to implement various provisions of SOX.
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USA PATRIOT Act
Under the USA PATRIOT Act, all financial institutions are required to take certain measures to identify their customers, prevent money laundering, monitor customer transactions and report suspicious activity to U.S. law enforcement agencies. Financial institutions also are required to respond to requests for information from federal banking regulatory authorities and law enforcement agencies. Information sharing among financial institutions for the above purposes is encouraged by an exemption granted to complying financial institutions from the privacy provisions of GLBA and other privacy laws. Financial institutions that hold correspondent accounts for foreign banks or provide private banking services to foreign individuals are required to take measures to avoid dealing with certain foreign individuals or entities, including foreign banks with profiles that raise money laundering concerns, and are prohibited from dealing with foreign “shell banks” and persons from jurisdictions of particular concern. The primary federal banking regulators and the Secretary of the Treasury have adopted regulations to implement several of these provisions. All financial institutions also are required to establish internal anti-money laundering programs. The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act or the BHCA. Salisbury has in place a Bank Secrecy Act and USA PATRIOT Act compliance program, and engages in very few transactions of any kind with foreign financial institutions or foreign persons.
Community Reinvestment Act and Fair Lending Laws
Salisbury has a responsibility under the CRA to help meet the credit needs of our communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. In connection with its examination, the FDIC assesses the Bank’s record of compliance with the CRA. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit discrimination in lending practices on the basis of characteristics specified in those statutes. The Bank’s failure to comply with the provisions of the CRA could, at a minimum, result in regulatory restrictions on our activities. The Bank’s failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions against the Bank by the FDIC as well as other federal regulatory agencies and the Department of Justice. The Bank’s most recent FDIC CRA rating was “satisfactory”.
The Electronic Funds Transfer Act, Regulation E and Related Laws
The Electronic Funds Transfer Act (the “EFTA”) provides a basic framework for establishing the rights, liabilities, and responsibilities of consumers who use electronic funds transfer (“EFT”) systems. The EFTA is implemented by the Federal Reserve’s Regulation E, which governs transfers initiated through ATMs, point-of-sale terminals, payroll cards, automated clearinghouse (“ACH”) transactions, telephone bill-payment plans, or remote banking services. Regulation E requires consumers to opt in (affirmatively consent) to participation in the Bank’s overdraft service program for ATM and one-time debit card transactions before overdraft fees may be assessed on the consumer’s account. Notice of the opt-in right must be provided to all new customers who are consumers, and the customer’s affirmative consent must be obtained, before charges may be assessed on the consumer’s account for paying such overdrafts.
Regulation E also provides bank customers with an ongoing right to revoke consent to participation in an overdraft service program for ATM and one-time debit card transactions and prohibits banks from conditioning the payment of overdrafts for checks, ACH transactions, or other types of transactions that overdraw the consumer’s account on the consumer’s opting into an overdraft service for ATM and one-time debit card transactions. For customers who do not affirmatively consent to overdraft service for ATM and one-time debit card transactions, a bank must provide those customers with the same account terms, conditions, and features that it provides to consumers who do affirmatively consent, except for the overdraft service for ATM and one-time debit card transactions.
On November 24, 2010, the FDIC issued FIL-81-2010 to provide “guidance” (“Overdraft Guidance”) on automated overdraft service programs to ensure that a bank mitigates the risks associated with offering automated overdraft payment programs and complies with all consumer protection laws and regulations.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and their Notes presented within this document have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of Salisbury’s operations. Unlike the assets and liabilities of industrial companies, nearly all of the assets and liabilities of Salisbury are monetary in nature. As a result, interest rates have a greater impact on Salisbury’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Availability of Securities and Exchange Commission Filings
Salisbury makes available free of charge on its website (www.salisburybank.com) a link to its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as practicable after such reports are electronically filed with or furnished to the SEC. Such reports filed with the SEC are also available on its website (www.sec.gov). The public may also read and copy any materials filed with the SEC at the SEC’s Public Reference Room, 100 F Street, NE, Washington, DC 20549. Information about accessing company filings can be obtained by calling 1-800-SEC-0330. Information on Salisbury’s website is not incorporated by reference into this report. Investors are encouraged to access these reports and the other information about Salisbury’s business and operations on its website. Copies of these filings may also be obtained from Salisbury free of charge upon request.
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Guide 3 Statistical Disclosure by Bank Holding Companies
The following information required by Securities Act Guide 3 “Statistical Disclosure by Bank Holding Companies” is located on the pages noted below.
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| I. | Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differentials | 20-21 | |
| II. | Investment Portfolio | 26, 48-50 | |
| III. | Loan Portfolio | 26-31, 51-55 | |
| IV. | Summary of Loan Loss Experience | 22-23, 54-55 | |
| V. | Deposits | 31-32, 57 | |
| VI. | Return on Equity and Assets | 18 | |
| VII. | Short-Term Borrowings | 31-32, 58 |
Item 1A. RISK FACTORS
Salisbury is the registered bank holding company for the Bank, its wholly-owned subsidiary. Salisbury’s activity is currently limited to the holding of the Bank’s outstanding capital stock and the Bank is Salisbury’s primary investment.
An investment in Salisbury common stock entails certain risks. Salisbury considers the most significant factors affecting risk in Salisbury common stock as those that are set forth below. These are not the only risks of an investment in Salisbury common stock, and none of the factors set forth below relates to the personal circumstances of individual investors. Investors should read this entire Form 10-K, as well as other documents and exhibits that are incorporated by reference in the 10-K and that have been filed with the SEC, in order to better understand these risks and to evaluate investment in Salisbury common stock.
Changes in interest rates and spreads could have a negative impact on earnings.
Salisbury’s earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads, meaning the difference between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings, could adversely affect Salisbury’s earnings and financial condition. Salisbury cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the FRB, affect interest income and interest expense. Salisbury has ongoing policies and procedures designed to manage the risks associated with changes in market interest rates.
However, changes in interest rates still may have an adverse effect on Salisbury’s profitability. For example, high interest rates could also affect the volume of loans that Salisbury originates, because higher rates could cause customers to apply for fewer mortgages, or cause depositors to shift funds from accounts that have a comparatively lower rate, to accounts with a higher rate or experience customer attrition due to competitor pricing. If the cost of interest-bearing deposits increases at a rate greater than the yields on interest-earning assets increase, net interest income will be negatively affected. Changes in the asset and liability mix may also affect net interest income. Similarly, lower interest rates cause higher yielding assets to prepay and floating or adjustable rate assets to reset to lower rates. If Salisbury is not able to reduce its funding costs sufficiently, due to either competitive factors or the maturity schedule of existing liabilities, then Salisbury’s net interest margin will decline.
Weakness in the markets for residential or commercial real estate, including the secondary residential mortgage loan markets, could reduce Salisbury’s net income and profitability.
Declines in home prices, increases in delinquency and default rates, and constrained secondary credit markets affect the mortgage industry generally. Salisbury’s financial results may be adversely affected by changes in real estate values. Decreases in real estate values could adversely affect the value of property used as collateral for loans and investments. If poor economic conditions result in decreased demand for real estate loans, Salisbury’s net income and profits may decrease.
Weakness in the secondary market for residential lending could have an adverse impact upon Salisbury’s profitability. The effects of ongoing mortgage market challenges, combined with the ongoing correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, mortgage loan originations and gains on sale of mortgage loans. Continued declines in real estate values and home sales volumes, and financial stress on borrowers as a result of job losses, or other factors, could have further adverse effects on borrowers that result in higher delinquencies and greater charge-offs in future periods beyond that which is provided for in Salisbury’s allowance for loan losses, which would adversely affect Salisbury’s financial condition or results of operations.
Salisbury’s allowance for loan losses may be insufficient.
Salisbury’s business is subject to periodic fluctuations based on national and local economic conditions. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on Salisbury’s operations and financial condition. For example, recent declines in housing activity including declines in building permits, housing starts and home prices may make it more difficult for Salisbury’s borrowers to sell their homes or refinance their debt. Sales may also slow, which could strain the resources of real estate developers and builders. The current economic uncertainty has affected employment levels and could impact the ability of Salisbury’s borrowers to service their debt. Bank regulatory agencies also periodically review Salisbury’s allowance for loan losses and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses Salisbury will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on Salisbury’s financial condition and results of operations. Salisbury may suffer higher loan losses as a result of these factors and the resulting impact on its borrowers.
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Credit market conditions may impact Salisbury’s investments.
Significant credit market anomalies may impact the valuation and liquidity of Salisbury’s investment securities. The problems of numerous financial institutions have reduced market liquidity, increased normal bid-asked spreads and increased the uncertainty of market participants. Such illiquidity could reduce the market value of Salisbury’s investments, even those with no apparent credit exposure. The valuation of Salisbury’s investments requires judgment and as market conditions change investment values may also change.
If all or a significant portion of the unrealized losses in Salisbury’s portfolio of investment securities were determined to be other-than-temporarily impaired, Salisbury would recognize a material charge to its earnings and its capital ratios would be adversely impacted.
As of December 31, 2011, Salisbury had $1.4 million of after-tax unrealized gains associated with its portfolio of securities available-for-sale, compared with $2.6 million of after-tax unrealized losses at December 31, 2010. The fair value of such securities is supplied by third-party sources.
Management must assess whether unrealized losses are other-than-temporary and relies on data supplied by third-party sources to do so. The determination of whether a decline in fair value is other-than-temporary considers numerous factors, many of which involve significant judgment.
To the extent that any portion of the unrealized losses in Salisbury’s portfolio of investment securities is determined to be other-than-temporarily impaired, Salisbury will recognize a charge to its earnings in the quarter during which such determination is made and its earnings and capital ratios will be adversely impacted. Salisbury did not recognize any other-than-temporary impairment losses in 2011. However, in 2009, Salisbury recognized $744,000 in after-tax charges to earnings as a result of other-than-temporary impairment determinations.
If the goodwill that Salisbury has recorded in connection with its acquisitions becomes impaired, it could have a negative impact on Salisbury’s profitability.
Applicable accounting standards require that the purchase method of accounting be used for all business combinations. Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of the acquired company’s net assets, the excess is carried on the acquirer’s balance sheet as goodwill. At December 31, 2011, Salisbury had $9.8 million of goodwill on its balance sheet. Salisbury must evaluate goodwill for impairment at least annually. Write-downs of the amount of any impairment, if necessary, are to be charged to the results of operations in the period in which the impairment occurs. There can be no assurance that future evaluations of goodwill will not result in findings of impairment and related write-downs, which may have a material adverse effect on Salisbury’s financial condition and results of operations.
Salisbury’s ability to pay dividends substantially depends upon its receipt of dividends from the Bank.
Cash dividends from the Bank and Salisbury’s liquid assets are the principal sources of funds for paying cash dividends on Salisbury’s common stock and preferred stock. Unless Salisbury receives dividends from the Bank or chooses to use its liquid assets, it may not be able to pay dividends. The Bank’s ability to pay dividends to Salisbury is subject to its ability to earn net income and to meet certain regulatory requirements.
Strong competition within Salisbury’s market areas may limit growth and profitability.
Competition in the banking and financial services industry is intense. Salisbury competes with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. As Salisbury grows, it may expand into contiguous market areas where it may not be as well-known as other institutions that have been operating in those areas for some time. In addition, larger banking institutions may become increasingly active in its market areas and may have substantially greater resources and lending limits than it has and may offer certain services that it does not or cannot efficiently provide. Salisbury’s profitability depends upon its continued ability to successfully compete in its market areas. The greater resources and deposit and loan products offered by some competitors may limit its ability to grow profitably.
Salisbury is subject to extensive government regulation and supervision.
Salisbury and the Bank are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not Shareholders. These regulations affect Salisbury’s lending practices, capital structure, investment practices, and dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect Salisbury in substantial and unpredictable ways. Such changes could subject Salisbury to additional costs, limit the types of financial services and products it may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on Salisbury’s business, financial condition and results of operations. While Salisbury has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See the section captioned “Supervision and Regulation” in Item 1 of this report for further information.
Salisbury’s stock price can be volatile.
Salisbury’s stock price can fluctuate widely in response to a variety of factors including:
| • | Actual or anticipated variations in quarterly operating results | |
| • | Recommendations by securities analysts | |
| • | New technology used, or services offered, by competitors | |
| • | Significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving Salisbury or Salisbury’s competitors | |
| • | Failure to integrate acquisitions or realize anticipated benefits from acquisitions |
| 14 |
| • | Operating and stock price performance of other companies that investors deem comparable to Salisbury | |
| • | News reports relating to trends, concerns and other issues in the financial services industry | |
| • | Changes in government regulations | |
| • | Geopolitical conditions such as acts or threats of terrorism or military conflicts | |
| • | Extended recessionary environment |
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations could also cause Salisbury’s stock price to decrease regardless of Salisbury’s operating results.
Salisbury may not be able to attract and retain skilled personnel.
Salisbury’s success depends, in large part, on its ability to attract and retain key people. Competition for people with specialized knowledge and skills can be intense and Salisbury may not be able to hire people or to retain them. The unexpected loss of services of one or more of Salisbury’s key personnel could have a material adverse impact on the business because of their skills, knowledge of the market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
Salisbury continually encounters technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology can increase efficiency and enable financial institutions to better serve customers and to reduce costs. However, some new technologies needed to compete effectively result in incremental operating costs. Salisbury’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in operations. Many of Salisbury’s competitors have substantially greater resources to invest in technological improvements. Salisbury may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on Salisbury’s business and, in turn, its financial condition and results of operations.
Salisbury’s controls and procedures may fail or be circumvented.
Management regularly reviews and updates Salisbury’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on Salisbury’s business, results of operations and financial condition.
Customer information may be misappropriated and used fraudulently.
Risk of theft of customer information resulting from security breaches by third parties exposes banks to reputation risk and potential monetary loss. Like other financial institutions, Salisbury has exposure to fraudulent misuse of its customer’s personal information resulting from its general business operations through loss or theft of the information and through misappropriation of information by third parties in connection with customer use of financial instruments, such as debit cards.
In addition, Salisbury relies upon a variety of computing platforms and networks over the internet for the purposes of data processing, communications and information exchange. Despite the safeguards instituted by Salisbury, any systems are susceptible to a breach of security. In addition, Salisbury relies on the services of a variety of third party vendors to meet Salisbury’s data processing and communication needs. The occurrence of any failures, interruptions or security breaches of Salisbury’s information systems or that of its vendors could damage Salisbury’s reputation, result in a loss of customer business or expose Salisbury to civil litigation and possible financial loss. Such costs and/or losses could materially offset Salisbury’s earnings.
Changes in accounting standards can materially impact Salisbury’s financial statements.
Salisbury’s accounting policies and methods are fundamental to how Salisbury records and reports its financial condition and results of operations. From time to time, the Financial Accounting Standards Board or regulatory authorities change the financial accounting and reporting standards that govern the preparation of Salisbury’s financial statements. These changes can be hard to predict and can materially impact how it records and reports its financial condition and results of operations. In some cases, it could be required to apply a new or revised standard retroactively, resulting in Salisbury restating prior period financial statements.
Changes and interpretations of tax laws and regulations may adversely impact Salisbury’s financial statements.
Local, state or federal tax authorities may interpret tax laws and regulations differently than Salisbury and challenge tax positions that Salisbury has taken on its tax returns. This may result in the disallowance of deductions or differences in the timing of deductions and result in the payment of additional taxes, interest or penalties that could materially affect Salisbury’s performance.
Unprecedented disruption and significantly increased risk in the financial markets may impact Salisbury.
The banking industry has experienced unprecedented turmoil over recent years as some of the world’s major financial institutions collapsed, were seized or were forced into mergers as the credit markets tightened and the economy headed into a recession and has eroded confidence in the world’s financial system. Measures taken by the Government in an effort to stabilize the economy may have unintended consequences and there can be no assurance that Salisbury will not be impacted by current market uncertainty in a way it cannot currently predict or mitigate.
| 15 |
Item 1B. UNRESOLVED SEC STAFF COMMENTS
None.
Item 2. PROPERTIES
Salisbury does not own or lease any properties. The properties described below are owned or leased by the Bank.
The Bank conducts its business at its main office, located at 5 Bissell Street, Lakeville, Connecticut, and through seven full service branch offices located in Canaan, Salisbury and Sharon, Connecticut, Sheffield and South Egremont, Massachusetts, and Dover Plains and Millerton, New York. The Bank’s trust and wealth advisory services division is located in a separate building adjacent to the main office of the Bank in Lakeville, Connecticut. The Bank owns its main office and five of its branch offices and leases two branch offices.
For additional information, see Note 6, “Bank Premises and Equipment,” and Note 18, “Commitments and Contingent Liabilities” To the Consolidated Financial Statements.
The following table includes all property owned or leased by the Bank, but does not include Other Real Estate Owned.
| Offices | Location | Owned/Leased | Lease expiration | |||
| Main Office | 5 Bissell Street, Lakeville, CT | Owned | - | |||
| Trust and Wealth Advisory Services Division | 19 Bissell Street, Lakeville, CT | Owned | - | |||
| Salisbury Office | 18 Main Street, Salisbury, CT | Owned | - | |||
| Sharon Office | 29 Low Road, Sharon, CT | Owned | - | |||
| Canaan Operations | 94 Main Street, Canaan, CT | Owned | - | |||
| Canaan Office | 100 Main Street, Canaan, CT | Owned | - | |||
| Millerton Office | 87 Main Street, Millerton, NY | Owned | - | |||
| South Egremont Office | 51 Main Street, South Egremont, MA | Leased | 9/10/12 | |||
| Sheffield Office | 640 North Main Street, Sheffield, MA | Owned | - | |||
| Dover Plains Office | 5 Dover Village Plaza, Dover Plains, NY | Leased | 3/26/17 |
Item 3. LEGAL PROCEEDINGS
The Bank is involved in various claims and legal proceedings arising out of the ordinary course of business.
The Bank, individually and in its capacity as a former Co-Trustee of the Erling C. Christophersen Revocable Trust (the “Trust”), has been named as a defendant in litigation currently pending in the Connecticut Complex Litigation Docket in Stamford, captioned John Christophersen v. Erling Christophersen, et al., X08-CV-08-5009597S (the “First Action”). The Bank also is a counterclaim-defendant in a related mortgage foreclosure litigation also pending in the Connecticut Complex Litigation Docket in Stamford, captioned Salisbury Bank and Trust Company v. Erling C. Christophersen, et al., X08-CV-10-6005847-S (the “Foreclosure Action,” together with the First Action, the “Actions”). The other parties to the Actions are John R. Christophersen; Erling C. Christophersen, individually and as Co-Trustee of the Trust; Bonnie Christophersen and Elena Dreiske, individually and as Co-Trustees of the Mildred B. Blount Testamentary Trust; People’s United Bank; Law Offices of Gary Oberst, P.C.; Rhoda Rudnick; and Hinckley Allen & Snyder LLP.
The Actions involve a dispute over title to certain real property located in Westport, Connecticut that was conveyed by Erling Christophersen, as grantor, to the Trust on or about August 8, 2007. Subsequent to this conveyance, the Bank loaned $3,386,609 to the Trust, which was secured by an open-end commercial mortgage in favor of the Bank on the Westport property. This mortgage is the subject of the Foreclosure Action brought by the Bank.
The gravamen of the plaintiff/counterclaim-plaintiff John Christophersen’s claims in the Actions is that he has an interest in the Westport real property transferred to the Trust of which he was allegedly wrongfully divested on account of the actions of the defendants. In the Actions plaintiff seeks to quiet title to the property and to recover money damages from the defendants for the alleged wrongful divestiture of his claimed interest in the property.
In addition to the mortgage on the property, the Bank, at the time of the financing referenced above, acquired a lender’s title insurance policy from the Chicago Title & Insurance Company, which is providing a defense to the Bank in the First Action under a reservation of rights. The Bank denies any wrongdoing, and is actively defending the case. The First Action presently is stayed, by Court order, which was entered pending resolution of a parallel action pending in New York Surrogate’s Court to which the Bank is not a party. That New York action was dismissed in November 2011, and as a result the Bank has moved to lift the stay of the First Action. In the Foreclosure Action, the Bank has moved to strike each of the counterclaims asserted by John Christophersen. Both of these motions await a Court hearing. No discovery has been taken to date.
There are no other material pending legal proceedings, other than ordinary routine litigation incident to the registrant’s business, to which Salisbury is a party or of which any of its property is subject.
Item 4. MINE SAFETY DISCLOSURES
None.
| 16 |
PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
For the information required by this item see “Note 23 - Selected Quarterly Consolidated Financial Data (Unaudited)” of Notes to Consolidated Financial Statements.
Holders
There were approximately 1,530 holders of record of the common stock of Salisbury as of March 1, 2012. This number includes brokerage firms and other financial institutions that hold stock in their name, but which is actually beneficially owned by third parties.
Equity Compensation Plan Information
For the information required by this item see “Note 14 – Directors Stock Retainer Plan” of Notes to Consolidated Financial Statements.
Recent Sales of Unregistered Securities
None.
Dividends
For a discussion of Salisbury’s dividend policy and restrictions on dividends see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Dividends”.
| 17 |
Item 6. SELECTED FINANCIAL DATA
The following table contains certain information concerning the financial position and results of operations of Salisbury at the dates and for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements and related notes.
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except ratios and per share amounts)
| At or for the years ended December 31, | 2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
| Statement of Income | ||||||||||||||||||||
| Interest and dividend income | $ | 24,044 | $ | 24,656 | $ | 25,866 | $ | 26,557 | $ | 26,152 | ||||||||||
| Interest expense | 5,559 | 7,497 | 9,032 | 10,825 | 12,432 | |||||||||||||||
| Net interest and dividend income | 18,485 | 17,159 | 16,834 | 15,732 | 13,720 | |||||||||||||||
| Provision (credit) for loan losses | 1,440 | 1,000 | 985 | 1,279 | — | |||||||||||||||
| Trust and wealth advisory | 2,548 | 2,102 | 1,978 | 2,264 | 2,050 | |||||||||||||||
| Service charges and fees | 2,090 | 2,006 | 1,725 | 1,930 | 1,606 | |||||||||||||||
| Gains on sales of mortgage loans, net | 687 | 816 | 488 | 344 | 387 | |||||||||||||||
| Mortgage servicing, net | 65 | 97 | 80 | (124 | ) | (50 | ) | |||||||||||||
| Gains on securities, net | 11 | 16 | 473 | 600 | 295 | |||||||||||||||
| Other-than-temporary impairment losses, net | — | — | (1,128 | ) | (2,955 | ) | — | |||||||||||||
| Other | 255 | 270 | 459 | 182 | 177 | |||||||||||||||
| Non-interest income | 5,656 | 5,307 | 4,075 | 2,241 | 4,465 | |||||||||||||||
| Non-interest expense | 17,639 | 17,113 | 17,506 | 16,009 | 13,515 | |||||||||||||||
| Income before income taxes | 5,062 | 4,353 | 2,418 | 685 | 4,670 | |||||||||||||||
| Income tax (benefit) provision | 950 | 693 | (49 | ) | (421 | ) | 870 | |||||||||||||
| Net income | 4,112 | 3,660 | 2,467 | 1,106 | 3,800 | |||||||||||||||
| Net income available to common shareholders | 3,588 | 3,198 | 2,102 | 1,106 | 3,800 | |||||||||||||||
| Financial Condition | ||||||||||||||||||||
| Total assets | $ | 609,284 | $ | 575,470 | $ | 562,347 | $ | 495,754 | $ | 461,960 | ||||||||||
| Loans receivable, net | 370,766 | 352,449 | 327,257 | 297,367 | 268,191 | |||||||||||||||
| Allowance for loan losses | 4,076 | 3,920 | 3,473 | 2,724 | 2,475 | |||||||||||||||
| Securities | 161,876 | 153,510 | 151,125 | 155,916 | 152,624 | |||||||||||||||
| Deposits | 471,306 | 430,289 | 418,203 | 344,925 | 317,741 | |||||||||||||||
| Federal Home Loan Bank of Boston advances | 54,615 | 72,812 | 76,364 | 87,914 | 95,011 | |||||||||||||||
| Repurchase agreements | 12,148 | 13,190 | 11,415 | 11,203 | — | |||||||||||||||
| Shareholders’ equity | 66,862 | 55,016 | 52,355 | 38,939 | 45,564 | |||||||||||||||
| Non-performing assets | 10,820 | 10,751 | 7,720 | 5,380 | 1,824 | |||||||||||||||
| Per Common Share Data | ||||||||||||||||||||
| Earnings, diluted and basic | $ | 2.12 | $ | 1.90 | $ | 1.25 | $ | 0.66 | $ | 2.26 | ||||||||||
| Cash dividends paid | 1.12 | 1.12 | 1.12 | 1.12 | 1.08 | |||||||||||||||
| Tangible book value | 23.69 | 20.81 | 19.12 | 16.58 | 19.89 | |||||||||||||||
| Statistical Data | ||||||||||||||||||||
| Net interest margin (fully tax equivalent) | 3.51 | % | 3.37 | % | 3.51 | % | 3.74 | % | 3.54 | % | ||||||||||
| Efficiency ratio (fully tax equivalent) | 68.16 | 71.51 | 74.38 | 71.56 | 68.74 | |||||||||||||||
| Effective tax rate | 18.77 | 15.92 | (2.03 | ) | (61.45 | ) | 18.63 | |||||||||||||
| Return on average assets | 0.61 | 0.56 | 0.39 | 0.23 | 0.85 | |||||||||||||||
| Return on average common shareholders’ equity | 7.26 | 6.93 | 5.18 | 2.59 | 8.71 | |||||||||||||||
| Dividend payout ratio | 52.70 | 59.09 | 89.60 | 169.70 | 47.79 | |||||||||||||||
| Allowance for loan losses to total loans | 1.09 | 1.10 | 1.05 | 0.91 | 0.92 | |||||||||||||||
| Non-performing assets to total assets | 1.78 | 1.87 | 1.37 | 1.09 | 0.39 | |||||||||||||||
| Tier 1 leverage capital | 9.45 | 8.39 | 8.39 | 7.74 | 8.24 | |||||||||||||||
| Total risk-based capital | 15.97 | 13.91 | 12.86 | 11.59 | 15.00 | |||||||||||||||
| Weighted average equivalent shares outstanding, diluted | 1,689 | 1,687 | 1,686 | 1,686 | 1,685 | |||||||||||||||
| Common shares outstanding at end of period | 1,689 | 1,688 | 1,687 | 1,686 | 1,685 | |||||||||||||||
| 18 |
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
Salisbury, a Connecticut corporation, formed in 1998, is the bank holding company for the Bank, a Connecticut-chartered and FDIC insured commercial bank headquartered in Lakeville, Connecticut. Salisbury’s principal business consists of the business of the Bank. The Bank, formed in 1848, is engaged in customary banking activities, including general deposit taking and lending activities to both retail and commercial markets, and trust and wealth advisory services. The Bank conducts its banking business from eight full-service offices in the towns of Canaan, Lakeville, Salisbury and Sharon, Connecticut, South Egremont and Sheffield, Massachusetts, and, Dover Plains and Millerton, New York, and its trust and wealth advisory services from offices in Lakeville, Connecticut.
Critical Accounting Policies and Estimates
Salisbury’s consolidated financial statements follow GAAP as applied to the banking industry in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event.
Salisbury’s significant accounting policies are presented in Note 1 of Notes to Consolidated Financial Statements and, along with this Management’s Discussion and Analysis, provide information on how significant assets are valued in the financial statements and how those values are determined. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating Salisbury’s 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.
The allowance for loan losses represents management’s estimate of credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet. Note 1 describes the methodology used to determine the allowance for loan losses. A discussion of the factors driving changes in the amount of the allowance for loan losses are included in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis.
Management evaluates goodwill and identifiable intangible assets for impairment annually using valuation techniques that involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates, which are used to determine the carrying value of goodwill and identifiable intangible assets or which otherwise adversely affects their value or estimated lives could have a material adverse impact on the results of operations.
Management evaluates securities for other-than-temporary impairment giving consideration to the extent to which the fair value has been less than cost, estimates of future cash flows, delinquencies and default severity, and the intent and ability of Salisbury to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The consideration of the above factors is subjective and involves estimates and assumptions about matters that are inherently uncertain. Should actual factors and conditions differ materially from those used by management, the actual realization of gains or losses on investment securities could differ materially from the amounts recorded in the financial statements.
The determination of the obligation and expense for pension and other postretirement benefits is dependent on certain assumptions used in calculating such amounts. Key assumptions used in the actuarial valuations include the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation and health care costs. Actual results could differ from the assumptions and market driven rates may fluctuate. Significant differences in actual experience or significant changes in the assumptions may materially affect the future pension and other postretirement obligations and expense.
OVERVIEW
Net income available to common shareholders for 2011 was $3,588,000, or $2.12 per common share, compared with $3,198,000, or $1.90 per common share, for 2010. Selected 2011 highlights are as follows:
| · | Earnings per common share increased $0.22, or 11.58%, to $2.12. | ||
| - | Common stock dividends were $1.12 per share, unchanged from 2010. | ||
| - | Preferred stock dividends and accretion were $524,000, versus $462,000 for 2010. | ||
| · | Tax equivalent net interest income increased $1,323,000, or 7.27%. | ||
| - | Net interest margin increased 14 basis points to 3.51% from 3.37% | ||
| - | Net loans increased $18.3 million, or 5.20%. | ||
| - | Total deposits increased $41.0 million, or 9.53%. | ||
| - | FHLBB advances decreased $18.2 million, or 24.99%. | ||
| · | Provision for loan losses was $1,440,000, versus $1,000,000 for 2010. Net loan charge-offs were $1,284,000 and $553,000, respectively, for 2011 and 2010. | ||
| - | Non-performing assets declined to 1.78% of total assets at December 31, 2011, down from peak of 2.55% of total assets at June 30, 2011, and versus 1.87% of total assets at December 31, 2010. | ||
| 19 |
| · | Non-interest income increased $349,000, or 6.58%. | ||
| - | Trust and Wealth Advisory assets under management increased $16.0 million, or 4.64%. | ||
| - | Mortgage loan sales totaled $30.9 million, versus $42.7 million for 2010. | ||
| · | Non-interest expense increased $526,000, or 3.07%. | ||
| - | Core efficiency ratio decreased to 68.16%, versus 71.51% for 2010. | ||
| · | Tier 1 capital ratio increased to 9.45% at December 31, 2011, versus 8.39% at December 31, 2010. | ||
| - | Elected to participate in the Treasury’s SBLF program by issuing $16.0 million of preferred stock, and simultaneously repurchased the $8.8 million of preferred stock sold to the Treasury in 2009 under the CPP. | ||
| - | Repurchased warrants issued to the Treasury in 2009 under the CPP. | ||
The following discussion and analysis of Salisbury’s consolidated results of operations should be read in conjunction with the Consolidated Financial Statements and footnotes.
RESULTS OF OPERATIONS
Comparison of the Years Ended December 31, 2011 and 2010
Net Interest and Dividend Income
Net interest and dividend income (presented on a tax-equivalent basis) increased $1,323,000 in 2011 over 2010. The net interest margin increased 14 basis points to 3.51% from 3.37%, due to a 46 basis points decline in the average cost of interest-bearing liabilities, offset in part by a 26 basis point decline in the average yield on interest-earning assets. The net interest margin is affected by changes in the mix of interest-earning assets and funding liabilities, asset and liability growth, and the effects of changes in market interest rates on the pricing and re-pricing of assets and liabilities. The following table sets forth the components of Salisbury’s net interest income and yields on average interest-earning assets and interest-bearing funds. Income and yields on tax-exempt securities are presented on a fully taxable equivalent basis.
| Years ended December 31, | Average Balance | Income / Expense | Average Yield / Rate | |||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2011 | 2010 | 2009 | 2011 | 2010 | 2009 | 2011 | 2010 | 2009 | |||||||||||||||||||||||||||
| Loans (a) | $ | 367,342 | $ | 342,555 | $ | 308,027 | $ | 18,666 | $ | 18,483 | $ | 18,233 | 5.08 | % | 5.40 | % | 5.93 | % | ||||||||||||||||||
| Securities (c)(d) | 144,021 | 155,658 | 166,608 | 6,258 | 7,035 | 8,673 | 4.35 | 4.52 | 5.21 | |||||||||||||||||||||||||||
| FHLBB stock | 6,032 | 6,032 | 5,650 | 24 | — | — | 0.40 | — | — | |||||||||||||||||||||||||||
| Short term funds (b) | 39,185 | 34,822 | 33,346 | 127 | 172 | 114 | 0.32 | 0.49 | 0.34 | |||||||||||||||||||||||||||
| Total earning assets | 556,580 | 539,067 | 513,631 | 25,075 | 25,690 | 27,020 | 4.51 | 4.77 | 5.27 | |||||||||||||||||||||||||||
| Other assets | 35,360 | 33,567 | 25,259 | |||||||||||||||||||||||||||||||||
| Total assets | $ | 591,940 | $ | 572,634 | $ | 538,890 | ||||||||||||||||||||||||||||||
| Interest-bearing demand deposits | $ | 64,625 | $ | 56,727 | $ | 34,060 | 437 | 628 | 266 | 0.68 | 1.11 | 0.78 | ||||||||||||||||||||||||
| Money market accounts | 108,983 | 72,975 | 65,970 | 530 | 379 | 565 | 0.49 | 0.52 | 0.86 | |||||||||||||||||||||||||||
| Savings and other | 96,317 | 90,597 | 80,517 | 379 | 528 | 694 | 0.39 | 0.58 | 0.86 | |||||||||||||||||||||||||||
| Certificates of deposit | 111,042 | 136,980 | 148,954 | 1,819 | 2,829 | 4,265 | 1.64 | 2.07 | 2.86 | |||||||||||||||||||||||||||
| Total interest-bearing deposits | 380,967 | 357,279 | 329,501 | 3,165 | 4,364 | 5,790 | 0.83 | 1.22 | 1.76 | |||||||||||||||||||||||||||
| Repurchase agreements | 12,510 | 12,611 | 11,775 | 63 | 90 | 131 | 0.50 | 0.71 | 1.11 | |||||||||||||||||||||||||||
| FHLBB advances | 57,126 | 74,896 | 78,063 | 2,331 | 3,043 | 3,111 | 4.08 | 4.06 | 3.99 | |||||||||||||||||||||||||||
| Total interest-bearing liabilities | 450,603 | 444,786 | 419,339 | 5,559 | 7,497 | 9,032 | 1.23 | 1.69 | 2.15 | |||||||||||||||||||||||||||
| Demand deposits | 77,577 | 69,028 | 66,202 | |||||||||||||||||||||||||||||||||
| Other liabilities | 3,569 | 3,876 | 5,378 | |||||||||||||||||||||||||||||||||
| Shareholders’ equity | 60,191 | 54,944 | 47,971 | |||||||||||||||||||||||||||||||||
| Total liabilities & shareholders’ equity | $ | 591,940 | $ | 572,634 | $ | 538,890 | ||||||||||||||||||||||||||||||
| Net interest income | $ | 19,516 | $ | 18,193 | $ | 17,988 | ||||||||||||||||||||||||||||||
| Spread on interest-bearing funds | 3.27 | 3.08 | 3.12 | |||||||||||||||||||||||||||||||||
| Net interest margin (e) | 3.51 | 3.37 | 3.51 | |||||||||||||||||||||||||||||||||
| (a) | Includes non-accrual loans. |
| (b) | Includes interest-bearing deposits in other banks and federal funds sold. |
| (c) | Average balances of securities are based on historical cost. |
| (d) | Includes tax exempt income of $1,031,000, $1,034,000 and $1,154,000, respectively for 2011, 2010 and 2009 on tax-exempt securities whose income and yields are calculated on a tax-equivalent basis. |
| (e) | Net interest income divided by average interest-earning assets. |
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The following table sets forth the changes in net interest income (presented on a tax-equivalent basis) due to volume and rate.
| Years ended December 31, (in thousands) | 2011 versus 2010 | 2010 versus 2009 | ||||||||||||||||||||||
| Change in interest due to | Volume | Rate | Net | Volume | Rate | Net | ||||||||||||||||||
| Loans | $ | 1,298 | $ | (1,115 | ) | $ | 183 | $ | 1,953 | $ | (1,703 | ) | $ | 250 | ||||||||||
| Securities | (516 | ) | (261 | ) | (777 | ) | (532 | ) | (1,106 | ) | (1,638 | ) | ||||||||||||
| FHLBB stock | — | 24 | 24 | — | — | — | ||||||||||||||||||
| Short term funds | 18 | (63 | ) | (45 | ) | 6 | 52 | 58 | ||||||||||||||||
| Interest-earning assets | 800 | (1,415 | ) | (615 | ) | 1,427 | (2,757 | ) | (1,330 | ) | ||||||||||||||
| Deposits | (201 | ) | (998 | ) | (1,199 | ) | 40 | (1,465 | ) | (1,425 | ) | |||||||||||||
| Repurchase agreements | (1 | ) | (26 | ) | (27 | ) | 8 | (49 | ) | (41 | ) | |||||||||||||
| FHLBB advances | (724 | ) | 12 | (712 | ) | (127 | ) | 58 | (69 | ) | ||||||||||||||
| Interest-bearing liabilities | (926 | ) | (1,012 | ) | (1,938 | ) | (79 | ) | (1,456 | ) | (1,535 | ) | ||||||||||||
| Net change in net interest income | $ | 1,726 | $ | (403 | ) | $ | 1,323 | $ | 1,506 | $ | (1,301 | ) | $ | 205 | ||||||||||
Net interest and dividend income represents the difference between interest and dividends earned on loans and securities and interest incurred on deposits and borrowings. The level of net interest income is a function of volume, rates and mix of both earning assets and interest-bearing liabilities. Net interest income can be adversely affected by changes in interest rate levels, changes in the volume of assets and liabilities that are subject to re-pricing within different future time periods, and in the level of non-performing assets.
Interest and Dividend Income
Tax equivalent interest and dividend income decreased $615,000, or 2.4%, to $25.1 million in 2011. Loan income increased $183,000, or 1.0%, primarily due to a $24.8 million, or 7.2%, increase in average loans, the benefit from which was substantially offset by a 32 basis point decline in average yield, due to lower market interest rates and their effect on new loan rates, loan re-pricing and loan re-financing activity in 2011.
Tax equivalent interest and dividend income from securities decreased $753,000, or 10.7%, in 2011, as a result of a $11.6 million decrease in average securities, and a 16 basis points decline in average yield, due to lower market interest rates and their effect on new bond yields, bond re-pricing and bond calls in 2011.
Interest from short term funds decreased $45,000 in 2011 as a result of a 17 basis points decline in average yield, offset in part by a $4.3 million increase in average short term funds.
Interest Expense
Interest expense decreased $1.9 million, or 25.9%, to $5.6 million in 2011 as a result of decreases in deposit rates and maturities of FHLBB advances, offset in part by higher average interest bearing deposits.
Interest on interest bearing deposit accounts decreased $1,200,000, or 27.5%, in 2011, as a result a 39 basis point decline in average rate, to 0.83%, offset in part by a $23.7 million, or 6.6%, increase in average interest bearing deposits. The decline in average rate was due to the decline in interest rates and a changes in product mix, as the proportion represented by time deposits decreased to 29.15% from 38.34%, while non-maturity deposits increased to 70.85% from 61.66%.
Interest on retail repurchase agreements decreased $27,000, or 30.0%, as a result of a 21 basis point decline in average rate, to 0.50%, while the average balance was substantially unchanged.
Interest expense on FHLBB advances decreased $712,000, or 23.4%, due to a $17.8 million, or 23.7%, decrease in average advances as a result of scheduled maturities, while the average borrowing rate was substantially unchanged.
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Provision and Allowance for Loan Losses
The provision for loan losses was $1,440,000 for 2011, compared with $1,000,000 for 2010. Net loan charge-offs were $1,284,000 and $553,000, for the respective years. The increased provision for loan losses was necessitated by the increased net charge-offs of non-performing loans. The following table sets forth changes in the allowance for loan losses and other statistical data:
| Years ended December 31, (dollars in thousands) | 2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
| Balance, beginning of period | $ | 3,920 | $ | 3,473 | $ | 2,724 | $ | 2,475 | $ | 2,474 | ||||||||||
| Provision (benefit) or loan losses | 1,440 | 1,000 | 985 | 1,279 | — | |||||||||||||||
| Real estate mortgages | (985 | ) | (437 | ) | (106 | ) | (429 | ) | — | |||||||||||
| Commercial & industrial | (180 | ) | (95 | ) | (82 | ) | (495 | ) | (21 | ) | ||||||||||
| Consumer | (201 | ) | (50 | ) | (78 | ) | (151 | ) | (82 | ) | ||||||||||
| Charge-offs | (1,366 | ) | (582 | ) | (266 | ) | (1,075 | ) | (103 | ) | ||||||||||
| Real estate mortgages | 26 | — | — | 3 | 39 | |||||||||||||||
| Commercial & industrial | 29 | — | 4 | 15 | 15 | |||||||||||||||
| Consumer | 27 | 29 | 26 | 27 | 50 | |||||||||||||||
| Recoveries | 82 | 29 | 30 | 45 | 104 | |||||||||||||||
| Net (charge-offs) recoveries | (1,284 | ) | (553 | ) | (236 | ) | (1,030 | ) | 1 | |||||||||||
| Balance, end of period | $ | 4,076 | $ | 3,920 | $ | 3,473 | $ | 2,724 | $ | 2,475 | ||||||||||
| Loans receivable, gross | $ | 373,838 | $ | 355,547 | $ | 330,144 | $ | 299,698 | $ | 270,361 | ||||||||||
| Non-performing loans | 8,076 | 10,141 | 7,445 | 5,175 | 1,824 | |||||||||||||||
| Accruing loans past due 30-89 days | 2,460 | 1,917 | 4,098 | 4,277 | 4,075 | |||||||||||||||
| Ratio of allowance for loan losses: | ||||||||||||||||||||
| to loans receivable, gross | 1.09 | % | 1.10 | % | 1.05 | % | 0.91 | % | 0.92 | % | ||||||||||
| to non-performing loans | 50.47 | 38.65 | 46.65 | 52.63 | 135.69 | |||||||||||||||
| Ratio of non-performing loans | ||||||||||||||||||||
| to loans receivable, gross | 2.16 | 2.84 | 2.25 | 1.73 | 0.67 | |||||||||||||||
| Ratio of accruing loans past due 30-89 days | ||||||||||||||||||||
| to loans receivable, gross | 0.66 | 0.54 | 1.24 | 1.43 | 1.51 | |||||||||||||||
Reserve coverage at December 31, 2011, as measured by the ratio of allowance for loan losses to gross loans of 1.09%, was substantially unchanged as compared with 1.10% at December 31, 2010. Non-performing loans (non-accrual loans and accruing loans past-due 90 days or more) decreased $2.0 million to $8.1 million, or 2.16% of gross loans receivable, at December 31, 2011, down from 2.84% at December 31, 2010, while accruing loans past due 30-89 days increased $0.6 million to $2.5 million, or 0.66% of gross loans receivable at December 31, 2011. See “Financial Condition – Loan Credit Quality” below for further discussion and analysis.
The credit quality segments of loans receivable and the allowance for loan losses are as follows:
| December 31, 2011 | December 31, 2010 | |||||||||||||||
| (in thousands) | Loans | Allowance | Loans | Allowance | ||||||||||||
| Performing loans | $ | 346,302 | $ | 2,436 | $ | 332,240 | $ | 2,500 | ||||||||
| Potential problem loans | 7,289 | 234 | 5,744 | 169 | ||||||||||||
| Collectively evaluated | 353,591 | 2,670 | 337,984 | 2,669 | ||||||||||||
| Performing loans | 819 | 35 | — | — | ||||||||||||
| Potential problem loans | 6,750 | 255 | 2,188 | 330 | ||||||||||||
| Impaired loans | 12,678 | 874 | 15,375 | 785 | ||||||||||||
| Individually evaluated | 20,247 | 1,164 | 17,563 | 1,115 | ||||||||||||
| Unallocated allowance | — | 242 | — | 136 | ||||||||||||
| Totals | $ | 373,838 | $ | 4,076 | $ | 355,547 | $ | 3,920 | ||||||||
The following table sets forth the allocation of the allowance for loan losses among the broad categories of the loan portfolio and the percentage of loans in each category to total loans. Although the allowance has been allocated among loan categories for purposes of the table, it is important to recognize that the allowance is applicable to the entire portfolio. Furthermore, charge-offs in the future may not necessarily occur in these amounts or proportions.
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| Years ended December 31, | 2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||||||||||||||||||||||
| (dollars in thousands)(a) | Allowance | Loans | Allowance | Loans | Allowance | Loans | Allowance | Loans | Allowance | Loans | ||||||||||||||||||||||||||||||
| Residential | $ | 1,097 | 52.47 | % | $ | 1,115 | 50.56 | % | $ | 488 | 50.91 | % | $ | 689 | 50.53 | % | $ | 515 | 50.97 | % | ||||||||||||||||||||
| Commercial | 1,139 | 23.81 | 1,152 | 22.83 | 1,428 | 20.65 | 1,274 | 19.21 | 1,024 | 18.01 | ||||||||||||||||||||||||||||||
| Construction, land & | ||||||||||||||||||||||||||||||||||||||||
| land development | 409 | 4.75 | 400 | 7.39 | 233 | 8.61 | 281 | 12.88 | 118 | 12.59 | ||||||||||||||||||||||||||||||
| Home equity credit | 382 | 9.26 | 361 | 9.61 | 397 | 10.18 | 73 | 8.54 | 76 | 7.70 | ||||||||||||||||||||||||||||||
| Real estate secured | 3,027 | 90.30 | 3,028 | 90.39 | 2,546 | 90.35 | 2,317 | 91.16 | 1,733 | 89.27 | ||||||||||||||||||||||||||||||
| Commercial & industrial | 704 | 7.85 | 592 | 8.29 | 630 | 7.97 | 272 | 6.99 | 505 | 7.77 | ||||||||||||||||||||||||||||||
| Consumer | 79 | 1.20 | 164 | 1.32 | 117 | 1.38 | 97 | 1.85 | 201 | 2.96 | ||||||||||||||||||||||||||||||
| Municipal | 24 | 0.65 | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
| General unallocated | 242 | — | 136 | — | 180 | — | 38 | — | 36 | — | ||||||||||||||||||||||||||||||
| Total allowance | $ | 4,076 | 100.00 | $ | 3,920 | 100.00 | $ | 3,473 | 100.00 | $ | 2,474 | 100.00 | $ | 2,475 | 100.00 | |||||||||||||||||||||||||
(a) Percent of loans in each category to total loans.
The allowance for loan losses represents management’s estimate of the probable credit losses inherent in the loan portfolio as of the reporting date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by loan charge-offs. Loan charge-offs are recognized when management determines a loan or portion of a loan to be uncollectible. The allowance for loan losses is computed by segregating the portfolio into three components: (1) loans collectively evaluated for impairment: general loss allocation factors for non-impaired loans are segmented into pools of loans based on similar risk characteristics such as loan product, collateral type and loan-to-value, loan risk rating, historical loss experience, delinquency factors and other similar economic indicators, (2) loans individually evaluated for impairment: individual loss allocations for loans deemed to be impaired based on discounted cash flows or collateral value, and (3) unallocated: general loss allocations for other environmental factors.
Impaired loans and certain potential problem loans, where warranted, are individually evaluated for impairment. Impairment is measured for each individual loan, or for a borrower’s aggregate loan exposure, using either the fair value of the collateral if the loan is collateral dependent or the present value of expected future cash flows discounted at the loan’s effective interest rate. An allowance is established when the collateral value or discounted cash flows of the loan is lower than the carrying value of that loan.
The component of the allowance for loan losses for loans collectively evaluated for impairment is estimated by stratifying loans into segments and credit risk ratings and applying management’s general loss allocation factors. The general loss allocation factors are based on expected loss experience adjusted for historical loss experience and other qualitative factors, including levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. The qualitative factors are determined based on the various risk characteristics of each loan segment. There were no significant changes in Salisbury’s policies or methodology pertaining to the general component of the allowance for loan losses during 2011.
The unallocated component of the allowance is maintained to cover uncertainties that could affect management’s estimate of probable losses. It reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio.
Determining the adequacy of the allowance at any given period is difficult, particularly during deteriorating or uncertain economic periods, and management must make estimates using assumptions and information that are often subjective and changing rapidly. The review of the loan portfolio is a continuing event in light of a changing economy and the dynamics of the banking and regulatory environment. Should the economic climate deteriorate, borrowers could experience difficulty and the level of non-performing loans, charge-offs and delinquencies could rise and require increased provisions. In management’s judgment, Salisbury remains adequately reserved both against total loans and non-performing loans at December 31, 2011.
Management’s loan risk rating assignments, loss percentages and specific reserves are subjected annually to an independent credit review by an external firm. In addition, the bank is examined annually on a rotational process by one of its two primary regulatory agencies, the FDIC and CTDOB. As an integral part of their examination process, the FDIC and CTDOB review the Bank’s credit risk ratings and allowance for loan losses. The Bank was examined by the FDIC in May 2011 and by the CTDOB in April 2010.
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Non-Interest Income
The following table details the principal categories of non-interest income.
| Years ended December 31, (dollars in thousands) | 2011 | 2010 | 2009 | 2011 vs. 2010 | 2010 vs. 2009 | |||||||||||||||||||||||
| Trust and wealth advisory | $ | 2,548 | $ | 2,102 | $ | 1,978 | $ | 446 | 21.2 | % | $ | 124 | 6.3 | % | ||||||||||||||
| Service charges and fees | 2,090 | 2,006 | 1,725 | 84 | 4.2 | 281 | 16.3 | |||||||||||||||||||||
| Gains on sales of mortgage loans, net | 687 | 816 | 488 | (129 | ) | (15.8 | ) | 401 | 82.2 | |||||||||||||||||||
| Mortgage servicing, net | 65 | 97 | 80 | (32 | ) | (33.0 | ) | (56 | ) | (70.0 | ) | |||||||||||||||||
| Gains on securities, net | 11 | 16 | 473 | (5 | ) | (31.3 | ) | (457 | ) | (96.6 | ) | |||||||||||||||||
| Other-than-temporary impairment losses | — | — | (1,128 | ) | — | — | 1,128 | 100.0 | ||||||||||||||||||||
| Bank-owned life insurance | 183 | 169 | 394 | 14 | 8.3 | (225 | ) | (57.1 | ) | |||||||||||||||||||
| Other | 72 | 101 | 65 | (29 | ) | (28.7 | ) | 36 | 55.4 | |||||||||||||||||||
| Total non-interest income | $ | 5,656 | $ | 5,307 | $ | 4,075 | $ | 349 | 6.6 | % | $ | 1,232 | 30.2 | % | ||||||||||||||
Non-interest income increased $349,000, or 6.56%, in 2011 versus 2010. Trust and Wealth Advisory revenues increased $446,000 due to growth in managed assets, higher asset valuations and increased estate fee income. Service charges and fees increased $84,000. Income from sales of mortgage loans decreased $129,000 due to lower volume of residential mortgage loan sales. Mortgage loans sales totaled $30.9 million in 2011 versus $42.7 million in 2010. Income from mortgage loan servicing of mortgage loans decreased $32,000 due primarily to higher mortgage rights amortization expense and lower credit enhancement fees, offset in part by higher servicing fees and a mortgage servicing valuation impairment benefit. Loans serviced for others totaled $114.8 million and $98.2 million at December 31, 2011 and 2010, respectively. Gains on securities represent the accretion of discounts on called securities. BOLI cash surrender value increased $14,000. Other income in 2010 included a $28,000 gain from the sale of real estate.
Non-Interest Expense
The following table details the principal categories of non-interest expense.
| Years ended December 31, (dollars in thousands) | 2011 | 2010 | 2009 | 2011 vs. 2010 | 2010 vs. 2009 | |||||||||||||||||||||||
| Salaries | $ | 6,970 | $ | 6,816 | $ | 6,623 | $ | 154 | 2.3 | % | $ | 193 | 2.9 | % | ||||||||||||||
| Employee benefits | 2,493 | 2,253 | 2,527 | 240 | 10.7 | (274 | ) | (10.8 | ) | |||||||||||||||||||
| Premises and equipment | 2,330 | 2,099 | 1,969 | 231 | 11.0 | 130 | 6.6 | |||||||||||||||||||||
| Data processing | 1,410 | 1,452 | 1,473 | (42 | ) | (2.9 | ) | (21 | ) | (1.4 | ) | |||||||||||||||||
| Professional fees | 1,099 | 1,364 | 1,493 | (265 | ) | (19.4 | ) | (129 | ) | (8.6 | ) | |||||||||||||||||
| Collections and OREO | 590 | 191 | 45 | 399 | 208.9 | 146 | 324.4 | |||||||||||||||||||||
| FDIC assessment | 596 | 735 | 914 | (139 | ) | (18.9 | ) | (179 | ) | (19.6 | ) | |||||||||||||||||
| Marketing and community contributions | 343 | 319 | 341 | 24 | 7.5 | (22 | ) | (6.5 | ) | |||||||||||||||||||
| Printing and stationery | 215 | 276 | 298 | (61 | ) | (22.1 | ) | (22 | ) | (7.4 | ) | |||||||||||||||||
| Amortization of intangible assets | 222 | 222 | 164 | — | — | 58 | 35.4 | |||||||||||||||||||||
| Other | 1,371 | 1,386 | 1,659 | (15 | ) | (1.1 | ) | (273 | ) | (16.5 | ) | |||||||||||||||||
| Non-interest expense | $ | 17,639 | $ | 17,113 | $ | 17,506 | $ | 526 | 3.1 | % | $ | (393 | ) | (2.3 | )% | |||||||||||||
Non-interest expense in 2011 increased $526,000, or 3.1%, versus 2010. Salaries increased $154,000 due to changes in staffing levels and mix. Employee benefits increased $240,000 due to higher health and dental benefits expense, caused by year-over-year premium increases and higher staff utilization, and higher 401K Plan expense due to the implementation of a Safe Harbor Plan. The increases were offset in part by lower pension plan expense. Premises and equipment increased $231,000 due primarily to several facilities renovations, equipment replacement and the disposal of assets related to the reorganization of several Bank departments to gain efficiencies. Data processing decreased $42,000 mostly due to lower ATM processing fees in 2011 resulting from vendor rebates. Professional fees decreased $265,000 due to reduced spending on audit, consulting, legal and investment management services. Expenses related to collections and OREO increased $399,000. 2011 included $163,000 of OREO write-downs, OREO carrying costs, and collection related legal and appraisal services. FDIC insurance decreased $139,000 as the Bank benefited from the change in the assessment method. All other operating expenses decreased $52,000.
Income Taxes
The effective income tax rates for 2011 and 2010 were 18.77% and 15.92%, respectively. Fluctuations in the effective tax rate result from changes in the mix of taxable and tax exempt income. Salisbury’s effective tax rate was less than the 34% federal statutory rate due to tax-exempt income, primarily from municipal bonds and bank-owned life insurance. For further information on income taxes, see Note 11 of Notes to Consolidated Financial Statements.
Salisbury did not incur Connecticut income tax in 2011 or 2010, other than minimum state income tax, as a result of its utilization of Connecticut tax legislation that permits banks to shelter certain mortgage income from the Connecticut corporation business tax through the use of a special purpose entity called a PIC. In 2004 Salisbury availed of this legislation by forming a PIC, SBT Mortgage Service Corporation. Salisbury’s income tax provision reflects the full impact of the Connecticut legislation. Salisbury does not expect to pay other than minimum state income tax in the foreseeable future unless there is a change in Connecticut tax law.
| 24 |
Comparison of the Years Ended December 31, 2010 and 2009
Net Interest and Dividend Income
Net interest and dividend income (presented on a tax-equivalent basis) increased $205,000 in 2010 over 2009 due primarily to a $25.4 million, or 5.0%, increase in average earning assets, facilitated by deposit growth, which more than offset a 14 basis point decrease in the net interest margin to 3.37% from 3.51%. The decrease in the net interest margin was mostly due to a 4 basis point decrease in the spread as asset yields declined more than funding rates. The net interest margin was also affected by changes in the mix of earning assets and funding liabilities, asset and liability growth, changes in market interest rates, and the impact of asset and liability re-pricing.
Interest Income
Tax equivalent interest and dividend income decreased $1,330,000, or 5.0%, to $25.7 million in 2010. Loan income increased $250,000, or 1.4%, primarily due to a $34.5 million, or 11.2%, increase in average loans, the impact of which was substantially offset by lower average yields, down 53 basis points. The decline in the average loan yield was caused by lower market interest rates in 2010 and their effect on loan re-pricing and loan re-financing activity. Tax equivalent interest and dividend income from securities decreased $1,638,000, or 18.9%, in 2010, as a result of lower yields due to portfolio re-pricing and changes in portfolio mix versus 2009, and a $10.9 million decrease in average volume. Income from short term funds increased $58,000 in 2010 as a result of higher yields, up 15 basis points, and a slight increase in the average balance, up $1.5 million.
Interest Expense
Interest expense decreased $1.5 million, or 17.0%, to $7.5 million in 2010 as a result of decreases in interest rates paid, offset in part by higher average interest bearing deposits. Interest on interest bearing deposit accounts decreased $1,426,000, or 24.6%, as a result of lower interest rates paid, offset in part by an increase in average balances and changes in product mix. Average interest-bearing deposits increased $27.8 million, or 8.4%, while their average rate decreased 54 basis points to 1.22%. Interest on retail repurchase agreements decreased $41,000, or 31.3%, as a result of lower interest rates paid, down 40 basis points, offset in part by an $0.8 million increase in average balances. Interest expense on FHLBB advances decreased $69,000 as a result of lower average borrowings, down $3.2 million, offset in part by a higher average borrowing rate, up 7 basis points, due to change in mix.
Provision and Allowance for Loan Losses
The provision for loan losses in 2010 was $1,000,000 compared with $985,000 in 2009, reflecting higher net loan charge-offs of $553,000 in 2010, compared with $236,000 in 2009. Reserve coverage at December 31, 2010, as measured by the ratio of allowance for loan losses to gross loans was up slightly, at 1.10%, as compared with 1.05% at December 31, 2009. Non-performing loans (non-accrual loans and accruing loans past-due 90 days or more) increased $2.7 million to $10.1 million, or 2.84% of gross loans receivable, at December 31, 2010, up from 2.25% at December 31, 2009, while accruing loans past due 30-89 days decreased $2.1 million to $1.9 million, or 0.54% of gross loans receivable.
Non-Interest Income
Non-interest income increased $1,232,000 in 2010 due to securities losses in 2009 and higher income in 2010 from sales and servicing of mortgage loans and service charges and fees. Salisbury did not sell any securities in 2010, compared with sales of $37.8 million in 2009. In June 2009, Salisbury recognized a $1,128,000 write-down for Other-Than–Temporary-Impairment (“OTTI”) on five non-agency issued Collateralized Mortgage Obligation (“CMO”) securities. Trust and wealth advisory fees grew slightly in 2010, due mostly to growth in managed assets. The increase in service charges and fees, of which $161,000 related to increased interchange fees, was mostly due to increased transactional activity related to deposit growth. Historically low borrowing rates in 2010 generated significant mortgage refinancing activity in the second half of 2010 that resulted in increased mortgage loan sales and related income. During 2010, Salisbury’s residential mortgage lending department originated and sold $42.7 million of residential mortgage loans, compared with $35.0 million during 2009. Loan servicing is retained on substantially all mortgage loans sold. The decrease in 2010 mortgage servicing income was due to higher mortgage servicing rights amortization expense resulting from increased loan refinancing activity. The decrease in income from bank-owned life insurance (“BOLI”) was to the inclusion in 2009 of benefits from a policy death settlement and a 1035 policy exchange, while income resulting from the increase in BOLI cash surrender value was substantially unchanged.
Non-Interest Expense
Non-interest expense decreased $393,000, or 2.3%, in 2010. Salaries increased in 2010 due to changes in staffing mix, head count and merit increases. The decrease in employee benefits expense resulted from a $530,000 decrease in pension expense, mostly due to the inclusion in 2009 of additional pension expense resulting from the former CEO’s early retirement, offset by increased medical insurance, 401(k) plan and BOLI expenses. Premises and equipment expense increased as a result of the opening of the Millerton, NY, office in January 2010 and the re-location of the Sheffield, MA, office in August 2010 to a larger facility. Professional fees for 2009 included, among other things, services related to the Bank’s participation in TARP and the acquisition of a branch office and related deposits and loans in Canaan, Connecticut. The decrease in FDIC insurance expense was due to a 2009 special assessment, offset in part by a higher 2010 assessment base from deposit growth. The increase in the amortization of core deposit intangibles was due to the December 2009 branch acquisition. Other expense includes postage, telephone, director fees, bank charges and various other deposit, loan and administrative related operating expenses.
Income Taxes
The effective income tax rates for 2010 and 2009 were 15.92%, and (2.04)%, respectively. Net income for 2009 included an income tax benefit of $49,000. Salisbury’s effective tax rate was less than the 34% federal statutory rate due to tax-exempt income, primarily from municipal bonds and bank-owned life insurance. Salisbury did not incur Connecticut income tax in 2010 or 2009, other than minimum state income tax, as a result of its utilization of a PIC.
| 25 |
FINANCIAL CONDITION
Overview
During 2011, Salisbury’s assets grew $33.8 million to $609.3 million at December 31, 2011. Net loans receivable grew $18.3 million, or 5.20%, to $370.8 million. Asset growth was facilitated by deposit growth of $41.0 million, or 9.53%, to $471.3 million at December 31, 2011. At December 31, 2011, Salisbury’s tangible book value per common share was $23.69 and Tier 1 leverage and total risk-based capital ratios were 9.45% and 15.97%, respectively. Both Salisbury and the Bank are categorized as “well capitalized”.
Securities and Short Term Funds
During 2011, securities increased $8.4 million to $161.9 million, while short-term funds (interest-bearing deposits with other banks) increased $6.8 million to $32.1 million as Salisbury increased its liquidity position in light of historically low interest rates and growth in volatile deposits. The carrying values of securities are as follows:
| Years ended December 31, (dollars in thousands) | 2011 | 2010 | 2009 | |||||||||
| Available-for-Sale | ||||||||||||
| U.S. Treasury bills | $ | 5,528 | $ | 5,196 | $ | 2,000 | ||||||
| U.S. Government agency notes | 14,924 | 41,878 | 24,832 | |||||||||
| Municipal bonds | 50,796 | 46,099 | 47,153 | |||||||||
| Mortgage backed securities | 58,300 | 19,736 | 33,927 | |||||||||
| Collateralized mortgage obligations | 21,320 | 28,428 | 29,267 | |||||||||
| SBA pools | 3,706 | 4,901 | 6,640 | |||||||||
| Other | 1,220 | 1,184 | 1,212 | |||||||||
| Held-to-Maturity | ||||||||||||
| Mortgage backed security | 50 | 56 | 62 | |||||||||
| Non-Marketable | ||||||||||||
| FHLBB stock | 6,032 | 6,032 | 6,032 | |||||||||
| Total Securities | $ | 161,876 | $ | 153,510 | $ | 151,125 | ||||||
Salisbury evaluates securities for OTTI where the fair value of a security is less than its amortized cost basis at the balance sheet date. As part of this process, Salisbury considers its intent to sell each debt security and whether it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of these conditions is met, Salisbury recognizes an OTTI charge to earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities that meet neither of these conditions, an analysis is performed to determine if any of these securities are at risk for OTTI.
Salisbury does not intend to sell any of its securities and it is not more likely than not that Salisbury will be required to sell any of its securities before recovery of their cost basis, which may be maturity. Therefore, management does not consider any of its securities, other than four non-agency CMO securities reflecting OTTI, to be OTTI at December 31, 2011.
In 2009 Salisbury determined that five non-agency CMO securities reflected OTTI and recognized losses for deterioration in credit quality of $1,128,000. Salisbury judged the four remaining securities not to have additional OTTI and all other CMO securities not to be OTTI as of December 31, 2011. It is possible that future loss assumptions could change necessitating Salisbury to recognize future OTTI for further deterioration in credit quality. Salisbury does not intend to sell these securities and it is not more likely than not that Salisbury will be required to sell these securities before recovery of their cost basis. The carrying value of such securities judged to be OTTI are as follows:
| Available-for-Sale (dollars in thousands) | Par value | Carrying value | Fair value | |||||||||
| Non-agency CMO | ||||||||||||
| December 31, 2011 | $ | 5,158 | $ | 4,385 | $ | 4,144 | ||||||
| December 31, 2010 | 5,846 | 4,768 | 4,378 | |||||||||
| December 31, 2009 | 6,890 | 5,583 | 4,409 | |||||||||
Accumulated other comprehensive gain at December 31, 2011 included net unrealized holding gains, net of tax, of $1,353,000, a gain of $3,935,000 over December 31, 2010.
Loans
During 2011, net loans receivable increased $18.3 million, or 5.2%, to $370.8 million at December 31, 2011, compared with loan growth of $25.2 million, or 7.7% in 2010.
Salisbury’s retail lending department originates residential mortgage, home equity loans and lines of credit, and consumer loans for the portfolio. During 2011, Salisbury originated $43.7 million of residential mortgage loans and $5.6 million of home equity loans for the portfolio, compared with $43.6 million and $8.1 million, respectively, in 2010. During 2011, total residential mortgage and home equity loans receivable grew by $10.9 million to $230.8 million at December 31, 2011, and represent 62% of loans receivable, substantially unchanged from 2010. During 2011, Salisbury’s residential mortgage lending department also originated and sold $30.9 million of residential mortgage loans, compared with $43.8 million during 2010. Substantially all loans sold were sold through the FHLBB Mortgage Partnership Finance Program with servicing retained by Salisbury. Consumer loans, amounting to $4.5 million at December 31, 2011, and representing 1.2% of loans receivable, remained substantially unchanged from 2010.
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Salisbury’s commercial lending department specializes in lending to small and mid-size companies, businesses and municipalities, and provides short-term and long-term financing, construction loans, commercial mortgages, equipment, working capital, property improvement loans and municipal financing. The department also works with both the SBA and USDA Government Guaranteed Lending Programs, however, such loans represent a very small percent of the commercial loan portfolio. During 2011, total commercial real estate, commercial and industrial and municipal loans increased $8.5 million to $120.8 million at December 31, 2011, and represent 32% of loans receivable, substantially unchanged from December 31, 2010.
The principal categories of loans receivable and loans held-for-sale are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | 2008¹ | 2007² | |||||||||||||||
| Residential 1-4 family | $ | 187,676 | $ | 173,932 | $ | 165,249 | $ | 148,749 | $ | 134,976 | ||||||||||
| Residential 5+ multifamily | 3,187 | 2,889 | 2,643 | 2,691 | 2,807 | |||||||||||||||
| Construction of residential 1-4 family | 5,305 | 8,948 | 2,817 | 6,926 | — | |||||||||||||||
| Home equity credit | 34,621 | 34,164 | 33,569 | 25,608 | 20,818 | |||||||||||||||
| Residential real estate | 230,789 | 219,933 | 204,278 | 183,974 | 158,601 | |||||||||||||||
| Commercial | 81,958 | 75,495 | 68,085 | 57,810 | 48,702 | |||||||||||||||
| Construction of commercial | 7,069 | 7,312 | 8,706 | — | — | |||||||||||||||
| Commercial real estate | 89,027 | 82,807 | 76,791 | 57,810 | 48,702 | |||||||||||||||
| Farm land | 4,925 | 5,690 | 5,577 | 5,297 | 5,121 | |||||||||||||||
| Vacant land | 12,828 | 12,979 | 11,656 | — | — | |||||||||||||||
| Construction, land development and vacant land | — | — | — | 26,106 | 28,927 | |||||||||||||||
| Real estate secured | 337,569 | 321,409 | 298,302 | 273,187 | 241,351 | |||||||||||||||
| Commercial and industrial | 29,358 | 25,123 | 24,014 | 19,597 | 19,970 | |||||||||||||||
| Municipal | 2,415 | 4,338 | 2,284 | 1,363 | 1,035 | |||||||||||||||
| Consumer | 4,496 | 4,677 | 5,544 | 5,551 | 8,005 | |||||||||||||||
| Loans receivable, gross | 373,838 | 355,547 | 330,144 | 299,698 | 270,361 | |||||||||||||||
| Deferred loan origination costs, net | 1,004 | 822 | 586 | 393 | 305 | |||||||||||||||
| Allowance for loan losses | (4,076 | ) | (3,920 | ) | (3,473 | ) | (2,724 | ) | (2,475 | ) | ||||||||||
| Loans receivable, net | $ | 370,766 | $ | 352,449 | $ | 327,257 | $ | 297,367 | $ | 268,191 | ||||||||||
| Loans held-for-sale | ||||||||||||||||||||
| Residential 1-4 family | $ | 948 | $ | 1,184 | $ | 665 | $ | 2,314 | $ | 120 | ||||||||||
¹ Loans for construction of commercial real estate and vacant land are included in loans for construction, land development and vacant land.
² Loans for construction of commercial and residential real estate and vacant land are included in loans for construction, land development and vacant land.
The composition of loans receivable by forecasted maturity distribution is as follows:
| December 31, 2011 (in thousands) | Within 1 year | Within 1-5 years | After 5 years | Total | ||||||||||||
| Residential | $ | 29,061 | $ | 79,116 | $ | 87,991 | $ | 196,168 | ||||||||
| Home equity credit | 7,342 | 16,105 | 11,174 | 34,621 | ||||||||||||
| Commercial | 16,488 | 41,183 | 24,287 | 81,958 | ||||||||||||
| Commercial construction | 1,640 | 2,422 | 3,007 | 7,069 | ||||||||||||
| Land | 2,009 | 4,537 | 11,207 | 17,753 | ||||||||||||
| Real estate secured | 56,540 | 143,363 | 137,666 | 337,569 | ||||||||||||
| Commercial and industrial | 8,571 | 14,223 | 6,564 | 29,358 | ||||||||||||
| Municipal | 1,114 | 711 | 590 | 2,415 | ||||||||||||
| Consumer | 1,457 | 2,034 | 1,005 | 4,496 | ||||||||||||
| Loans receivable, gross | $ | 67,682 | $ | 160,331 | $ | 145,825 | $ | 373,838 | ||||||||
The composition of loans receivable due after one year with fixed and variable or adjustable interest rates is as follows:
| December 31, 2011 (in thousands) | Fixed interest rates | Adjustable interest rates | ||||||
| Residential | $ | 62,063 | $ | 105,044 | ||||
| Home equity credit | — | 27,279 | ||||||
| Commercial | 10,067 | 55,403 | ||||||
| Commercial construction | 1,077 | 4,352 | ||||||
| Land | 2,491 | 17,480 | ||||||
| Real estate secured | 75,698 | 205,330 | ||||||
| Commercial and industrial | 7,648 | 13,140 | ||||||
| Municipal | 644 | 656 | ||||||
| Consumer | 2,303 | 735 | ||||||
| Loans receivable, gross | $ | 86,342 | $ | 219,861 | ||||
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Loan Credit Quality
The persistent weakness in the local and regional economies continues to impact the credit quality of Salisbury’s loans receivable. During 2011 total impaired and potential problem loans increased $3.4 million to $26.7 million, or 7.1% of gross loans receivable at December 31, 2011, from $23.3 million, or 6.6% of gross loans receivable at December 31, 2010.
The credit quality segments of loans receivable and their credit risk ratings are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | ||||||
| Pass | $ | 314,551 | $ | 292,815 | ||||
| Special mention | 32,570 | 39,415 | ||||||
| Performing loans | 347,121 | 332,230 | ||||||
| Substandard | 14,039 | 7,932 | ||||||
| Doubtful | — | 10 | ||||||
| Potential problem loans | 14,039 | 7,942 | ||||||
| Pass | ||||||||
| Troubled debt restructured loans, accruing | 1,379 | — | ||||||
| Special mention | ||||||||
| Troubled debt restructured loans, accruing | 1,413 | — | ||||||
| Substandard | ||||||||
| Troubled debt restructured loans, accruing | 1,810 | 5,330 | ||||||
| Troubled debt restructured loans, non-accrual | 1,753 | 4,254 | ||||||
| All other non-accrual loans | 6,323 | 5,791 | ||||||
| Impaired loans | 12,678 | 15,375 | ||||||
| Loans receivable, gross | $ | 373,838 | $ | 355,547 | ||||
Changes in impaired and potential problem loans are as follows:
| 2011 | ||||||||||||||||
| Impaired loans | ||||||||||||||||
| December 31, (in thousands) | Non-accrual | Accruing | Potential problem loans | Total | ||||||||||||
| Loans placed on non-accrual status | $ | 3,339 | $ | (264 | ) | $ | (2,182 | ) | $ | 893 | ||||||
| Loan risk rating downgrades to substandard | — | — | 11,255 | 11,255 | ||||||||||||
| Loan risk rating upgrades from substandard | — | — | (2,372 | ) | (2,372 | ) | ||||||||||
| Loan repayments | (975 | ) | (18 | ) | (594 | ) | (1,587 | ) | ||||||||
| Loan charge-offs | (1,276 | ) | (30 | ) | — | (1,306 | ) | |||||||||
| Loan no longer classified as troubled debt restructuring | — | (417 | ) | — | (417 | ) | ||||||||||
| Real estate acquired in settlement of loans | (3,057 | ) | — | — | (3,057 | ) | ||||||||||
| Increase (decrease) in loans | $ | (1,969 | ) | $ | (729 | ) | $ | 6,107 | $ | 3,409 | ||||||
During 2011 Salisbury downgraded the risk ratings of $11.3 million of loans to substandard, placed $3.3 million of loans on non-accrual status as a result of deteriorated payment and financial performance and charged-off $1.3 million of losses primarily as a result of collateral deficiencies. Offsetting these deteriorations were loan risk rating upgrades resulting from improved performance, loan repayments, real estate acquired in settlement of loans and a loan restructured in 2010 whose designation as troubled debt restructured was removed due to satisfactory performance.
Salisbury has cooperative relationships with the vast majority of its non-performing loan customers. Substantially all non-performing loans are collateralized with real estate and the repayment of such loans is largely dependent on the return of such loans to performing status or the liquidation of the underlying real estate collateral. Salisbury pursues the resolution of all non-performing loans through collections, restructures, voluntary liquidation of collateral by the borrower and, where necessary, legal action. When attempts to work with a customer to return a loan to performing status, including restructuring the loan, are unsuccessful, Salisbury will initiate appropriate legal action seeking to acquire property by deed in lieu of foreclosure or through foreclosure, or to liquidate business assets.
Credit Quality Segments
Salisbury categorizes loans receivable into the following credit quality segments.
| · | Impaired loans consist of all non-accrual loans and troubled debt restructured loans, and represent loans for which it is probable that Salisbury will not be able to collect all principal and interest amounts due according to the contractual terms of the loan agreements. | |
| · | Non-accrual loans, a sub-set of impaired loans, are loans for which the accrual of interest has been discontinued because, in the opinion of management, full collection of principal or interest is unlikely. | |
| · | Non-performing loans consist of non-accrual loans, and accruing loans past due 90 days and over that are well collateralized, in the process of collection and where full collection of principal and interest is assured. Non-performing assets consist of non-performing loans plus real estate acquired in settlement of loans. |
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| · | Troubled debt restructured loans are loans for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments, extension of maturity dates, or reduction of principal balance or accrued interest, have been granted due to a borrower’s financial condition. Loan restructuring is employed when management believes the granting of a concession will increase the probability of the full or partial collection of principal and interest. | |
| · | Potential problem loans consist of performing loans that have been assigned a substandard credit risk rating and that are not classified as impaired. |
Credit Risk Ratings
Salisbury assigns credit risk ratings to loans receivable in order to manage credit risk and to determine the allowance for loan losses. Credit risk ratings categorize loans by common financial and structural characteristics that measure the credit strength of a borrower. Salisbury’s rating model has eight risk rating grades, with each grade corresponding to a progressively greater risk of default. Grades 1 through 4 are pass ratings and 5 through 8 are ratings (special mention, substandard, doubtful and loss) defined by the bank’s regulatory agencies, the FDIC and CTDOB. Risk ratings are assigned to differentiate risk within the portfolio and are reviewed on an ongoing basis and revised, if needed, to reflect changes in the borrowers’ current financial position and outlook, risk profiles and the related collateral and structural positions.
| · | Loans risk rated as “special mention” possess credit deficiencies or potential weaknesses deserving management’s close attention that if left uncorrected may result in deterioration of the repayment prospects for the loans at some future date. | |
| · | Loans risk rated as “substandard” are loans where the Bank’s position is clearly not protected adequately by borrower current net worth or payment capacity. These loans have well defined weaknesses based on objective evidence and include loans where future losses to the Bank may result if deficiencies are not corrected, and loans where the primary source of repayment such as income is diminished and the Bank must rely on sale of collateral or other secondary sources of collection. | |
| · | Loans risk rated as “doubtful” have the same weaknesses as substandard loans with the added characteristic that the weakness makes collection or liquidation in full, given current facts, conditions, and values, to be highly improbable. The possibility of loss is high, but due to certain important and reasonably specific pending factors, which may work to strengthen the loan, its reclassification as an estimated loss is deferred until its exact status can be determined. | |
| · | Loans risk rated as “loss” are considered uncollectible and of such little value, that continuance as Bank assets is unwarranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather, it is not practical or desirable to defer writing off this basically worthless loan even though partial recovery may be made in the future. |
Management actively reviews and tests its credit risk ratings against actual experience and engages an independent third-party to annually validate its assignment of credit risk ratings. In addition, the Bank’s loan portfolio and risk ratings are examined annually on a rotating basis by its two primary regulatory agencies, the FDIC and CTDOB.
Impaired Loans
Impaired loans decreased $2.7 million during 2011 to $12.7 million, or 3.39% of gross loans receivable at December 31, 2011, from $15.4 million, or 4.32% of gross loans receivable at December 31, 2010. The components of impaired loans are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Troubled debt restructurings, accruing | $ | 4,602 | $ | 5,330 | $ | 4,566 | ||||||
| Troubled debt restructurings, non-accrual | 1,753 | 4,254 | 2,341 | |||||||||
| All other non-accrual loans | 6,323 | 5,791 | 5,098 | |||||||||
| Impaired loans | $ | 12,678 | $ | 15,375 | $ | 12,005 | ||||||
Non-Performing Assets
Non-performing assets remained substantially unchanged at December 31, 2011 at $10.8 million, or 1.87% of assets, as compared with December 31, 2010, after peaking at $15.1 million, or 2.55% of total assets, at June 30, 2011. The components of non-performing assets are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
| Commercial | $ | 2,337 | $ | 2,923 | $ | 2,226 | $ | 4,198 | $ | — | ||||||||||
| Vacant land | 3,658 | 4,018 | 3,535 | — | — | |||||||||||||||
| Residential 1-4 family | 1,240 | 2,534 | 765 | 494 | 948 | |||||||||||||||
| Home equity credit | 173 | 362 | 367 | 75 | 51 | |||||||||||||||
| Real estate secured | 7,408 | 9,837 | 6,893 | 4,767 | 999 | |||||||||||||||
| Commercial and industrial | 668 | 208 | 546 | 308 | 9 | |||||||||||||||
| Non-accrual loans | 8,076 | 10,045 | 7,439 | 5,075 | 1,008 | |||||||||||||||
| Accruing loans past due 90 days and over | — | 96 | 6 | 100 | 816 | |||||||||||||||
| Non-performing loans | 8,076 | 10,141 | 7,445 | 5,175 | 1,824 | |||||||||||||||
| Real estate acquired in settlement of loans, net | 2,744 | 610 | 275 | 205 | — | |||||||||||||||
| Non-performing assets | $ | 10,820 | $ | 10,751 | $ | 7,720 | $ | 5,380 | $ | 1,824 | ||||||||||
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Reductions in interest income associated with non-accrual loans are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Income in accordance with original terms | $ | 811 | $ | 524 | $ | 414 | ||||||
| Income recognized | 111 | 189 | 152 | |||||||||
| Reduction in interest income | $ | 700 | $ | 335 | $ | 262 | ||||||
The past due status of non-performing loans is as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Current | $ | 734 | $ | 2,931 | $ | 3,105 | ||||||
| Past due 1-29 days | 138 | 219 | — | |||||||||
| Past due 30-59 days | 134 | 541 | 349 | |||||||||
| Past due 60-89 days | — | 1,050 | 405 | |||||||||
| Past due 90-179 days | 1,095 | 683 | 321 | |||||||||
| Past due 180 days and over | 5,975 | 4,717 | 3,265 | |||||||||
| Total non-performing loans | $ | 8,076 | $ | 10,141 | $ | 7,445 | ||||||
At December 31, 2011, 9.09% of non-accrual loans were current with respect to loan payments, compared with 28.9% at December 31, 2010. Loans past due 180 days include a $3.0 million loan secured by vacant land (residential building lots) where Salisbury has initiated a foreclosure action that is referred to in Item 3 of Part I, Legal Proceedings.
Troubled Debt Restructured Loans
Troubled debt restructured loans decreased $3.2 million in 2011 to $6.4 million, or 1.70% of gross loans receivable, from $9.6 million, or 2.70% of gross loans receivable at December 31, 2010. The components of troubled debt restructured loans are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Residential 1-4 family | $ | 2,163 | $ | 3,377 | $ | 2,708 | ||||||
| Commercial | 1,970 | 1,677 | 1,857 | |||||||||
| Real estate secured | 4,133 | 5,054 | 4,565 | |||||||||
| Commercial and industrial | 469 | 276 | — | |||||||||
| Accruing troubled debt restructured loans | 4,602 | 5,330 | 4,565 | |||||||||
| Residential 1-4 family | 52 | 552 | 176 | |||||||||
| Commercial | 1,132 | 2,923 | 2,008 | |||||||||
| Vacant land | 461 | 621 | — | |||||||||
| Real estate secured | 1,645 | 4,096 | 2,184 | |||||||||
| Commercial and Industrial | 108 | 158 | 158 | |||||||||
| Non-accrual troubled debt restructured loans | 1,753 | 4,254 | 2,342 | |||||||||
| Troubled debt restructured loans | $ | 6,355 | $ | 9,584 | $ | 6,907 | ||||||
The past due status of troubled debt restructured loans is as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Current | $ | 3,375 | $ | 4,798 | $ | 4,565 | ||||||
| Past due 1-29 days | 1,072 | 375 | — | |||||||||
| Past due 30-59 days | 155 | 157 | — | |||||||||
| Accruing troubled debt restructured loans | 4,602 | 5,330 | 4,565 | |||||||||
| Current | 251 | 2,585 | 1,992 | |||||||||
| Past due 1-29 days | — | 169 | — | |||||||||
| Past due 30-59 days | 98 | 378 | — | |||||||||
| Past due 60-89 days | — | — | 350 | |||||||||
| Past due 90-179 days | 493 | 346 | — | |||||||||
| Past due 180 days and over | 911 | 776 | — | |||||||||
| Non-accrual troubled debt restructured loans | 1,753 | 4,254 | 2,342 | |||||||||
| Total troubled debt restructured loans | $ | 6,355 | $ | 9,584 | $ | 6,907 | ||||||
At December 31, 2011, 57.06% of troubled debt restructured loans were current with respect to loan payments, as compared with 77.03% at December 31, 2010.
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Past Due Loans
Loans past due 30 days or more increased $756,000 during 2011 to $9.7 million, or 2.59% of gross loans receivable at December 31, 2011, compared with $8.9 million, or 2.51% of gross loans receivable at December 31, 2010. The components of loans past due 30 days or greater are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Past due 30-59 days | $ | 1,999 | $ | 1,188 | $ | 2,821 | ||||||
| Past due 60-89 days | 461 | 730 | 1,272 | |||||||||
| Past due 90-179 days | — | 96 | 5 | |||||||||
| Accruing loans | 2,460 | 2,014 | 4,098 | |||||||||
| Past due 30-59 days | 134 | 541 | 349 | |||||||||
| Past due 60-89 days | — | 1,050 | 405 | |||||||||
| Past due 90-179 days | 1,095 | 587 | 315 | |||||||||
| Past due 180 days and over | 5,975 | 4,716 | 3,265 | |||||||||
| Non-accrual loans | 7,204 | 6,894 | 4,334 | |||||||||
| Total loans past due 30 days and over | 9,664 | $ | 8,908 | $ | 8,432 | |||||||
Potential Problem Loans
Potential problem loans increased $6.1 million during 2011 to $14.0 million, or 3.76% of gross loans receivable at December 31, 2011, compared with $7.9 million, or 2.23% of gross loans receivable at December 31, 2010. The components of potential problem loans are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Residential 1-4 family | $ | 3,367 | $ | 2,483 | $ | 2,266 | ||||||
| Residential 5+ multifamily | — | 89 | — | |||||||||
| Construction of residential 1-4 family | — | 75 | 75 | |||||||||
| Home equity credit | 1,154 | 817 | — | |||||||||
| Residential real estate | 4,521 | 3,464 | 2,341 | |||||||||
| Commercial | 7,391 | 2,327 | 7,796 | |||||||||
| Construction of commercial | 450 | 47 | — | |||||||||
| Commercial real estate | 7,841 | 2,374 | 7,796 | |||||||||
| Farm land | 830 | 881 | 1,246 | |||||||||
| Vacant land | 249 | 249 | 365 | |||||||||
| Real estate secured | 13,441 | 6,968 | 11,748 | |||||||||
| Commercial and Industrial | 534 | 897 | 1,640 | |||||||||
| Consumer | 64 | 67 | 2 | |||||||||
| Other classified loans receivable | $ | 14,039 | $ | 7,932 | $ | 13,390 | ||||||
The past due status of potential problem loans is as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | ||||||
| Current | $ | 10,771 | $ | 5,757 | ||||
| Past due 1-29 days | 2,837 | 1,233 | ||||||
| Past due 30-59 days | 385 | 357 | ||||||
| Past due 60-89 days | 46 | 534 | ||||||
| Past due 90-179 days | — | 51 | ||||||
| Total potential problem loans | $ | 14,039 | $ | 7,932 | ||||
At December 31, 2011, 76.73% of potential problem loans were current with respect to loan payments, as compared with 72.59% at December 31, 2010.
Management cannot predict the extent to which economic or other factors may impact such borrowers’ future payment capacity, and there can be no assurance that such loans will not be placed on nonaccrual status, restructured, or require increased provision for loan losses.
Deposits and Borrowings
Deposits increased $41.0 million, or 9.53%, during 2011 to $471.3 million at December 31, 2011, compared with $430.3 million at December 31, 2010. Retail repurchase agreements decreased $1.0 million during 2011 to $12.1 million at December 31, 2011, compared with $13.2 million at December 31, 2010.
Deposit growth resulted primarily from an increase in deposit balances from a single relationship, the Bank’s largest, and which totals $47.3 million, or 10.05% of total deposits at December 31, 2011.
Salisbury has eight full-service offices located in Litchfield, Berkshire and Dutchess Counties in Connecticut, Massachusetts and New York respectively. Scheduled maturities of time certificates of deposit in denominations of $100,000 or more were as follows:
| December 31, 2011 (in thousands) | Within 3 months | Within 3-6 months | Within 6-12 months | Over 1 year | Total | |||||||||||||||
| Certificates of deposit over $100,000 | $ | 6,973 | $ | 6,927 | $ | 7,792 | $ | 19,251 | $ | 40,943 | ||||||||||
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FHLBB advances decreased $18.2 million during 2011 to $54.6 million at December 31, 2011, compared with $72.8 million at December 31, 2010. The decreases were due to scheduled maturities and principal payments.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL CASH OBLIGATIONS
In the normal course of business, Salisbury enters into various contractual obligations that may require future cash payments. Contractual obligations at December 31, 2011 include operating leases, contractual purchases and certain pension and other benefit plans. For further discussion regarding operating leases see Note 18 to the Consolidated Financial Statements.
The accompanying table summarizes Salisbury’s off-balance sheet lending-related financial instruments and significant cash obligations, by remaining maturity, at December 31, 2011. Salisbury’s lending-related financial instruments include commitments that have maturities over one year. Contractual purchases include commitments for future cash expenditures, primarily for services and contracts that reflect the minimum contractual obligation under legally enforceable contracts with contract terms that are both fixed and determinable. Excluded from the following table are a number of obligations to be settled in cash, primarily in under one year. These obligations are reflected in Salisbury’s Consolidated Balance Sheets and include deposits, FHLBB advances and repurchase agreements that settle within standard market timeframes.
| December 31, 2011 (in thousands) By Remaining Maturity | Within 1 year | Within 1-3 years | Within 4-5 years | After 5 years | Total | |||||||||||||||
| Residential | $ | 5 | $ | 521 | $ | — | $ | 1,033 | $ | 1,559 | ||||||||||
| Home equity credit | 1,693 | 149 | 1,163 | 27,924 | 30,929 | |||||||||||||||
| Commercial | 284 | 1,714 | 1,264 | 3,388 | 6,650 | |||||||||||||||
| Land | 290 | — | — | — | 290 | |||||||||||||||
| Real estate secured | 2,272 | 2,384 | 2,427 | 32,345 | 39,428 | |||||||||||||||
| Commercial and industrial | 849 | 2,204 | 436 | 8,226 | 11,715 | |||||||||||||||
| Consumer | 1,313 | — | 25 | 20 | 1,358 | |||||||||||||||
| Unadvanced portions of loans | 4,434 | 4,588 | 2,888 | 40,591 | 52,501 | |||||||||||||||
| Commitments to originate loans | — | — | — | — | — | |||||||||||||||
| Standby letters of credit | 34 | — | — | — | 34 | |||||||||||||||
| Total | $ | 4,468 | $ | 4,588 | $ | 2,888 | $ | 40,591 | $ | 52,535 | ||||||||||
LIQUIDITY
Salisbury manages its liquidity position to ensure it has sufficient funding availability at all times to meet both anticipated and unanticipated deposit withdrawals, loan originations and advances, securities purchases and other operating cash outflows. Salisbury’s primary source of liquidity is deposits and though its preferred funding strategy is to attract and retain low cost deposits, its ability to do so is affected by competitive interest rates and terms in its marketplace, and other financial market conditions. Other sources of funding include cash flows from loan and securities principal payments and maturities, funds provided by operations, and discretionary use of FHLBB advances. Liquidity can also be provided through sales of securities available-for-sale and loans.
Salisbury manages its liquidity in accordance with a liquidity funding policy, and also maintains a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. At December 31, 2011, Salisbury’s liquidity ratio, as represented by cash, short term available-for-sale securities and marketable assets to net deposits and short term unsecured liabilities, was 33.70%, substantially unchanged from 28.4% at December 31, 2010. Management believes Salisbury’s funding sources will meet anticipated funding needs.
Operating activities for 2011 provided net cash of $6.8 million. Investing activities utilized net cash of $23.2 million, principally for securities purchases of $45.8 million and net loan advances of $22.6 million, offset in part by securities repayments and maturities of $43.1 million and the maturity of an interest bearing time deposit with other banks of $5.0 million. Financing activities provided net cash of $26.5 million, principally, from net deposit and repurchase agreement growth of $40.0 million and proceeds from issuance of preferred stock of $16.0 million, offset in part by a net decrease in FHLBB advances of $18.2 million, redemption of preferred stock of $8.8 million and cash dividend payments, on common and preferred stock, of $2.3 million.
Operating activities for 2010 provided net cash of $5.5 million. Investing activities utilized net cash of $29.8 million, principally for securities purchases of $52.9 million, net loan advances of $26.4 million, and capital expenditures of $2.9 million, offset in part by securities repayments and maturities of $53.0 million. Financing activities provided net cash of $8.0 million, principally, from net deposit and repurchase agreement growth of $13.9 million, offset in part by a net decrease in FHLBB advances of $3.6 million and cash dividend payments, on common and preferred stock, of $2.3 million.
Operating activities for 2009 provided net cash of $4.2 million. Investing activities utilized net cash of $27.7 million, principally for securities purchases of $110.7 million, net loan advances of $28.6 million, and capital expenditures of $3.6 million, offset in part by securities repayments, maturities and sales. Financing activities provided net cash of $57.2 million, principally, from net deposit growth of $61.8 million and from the issuance of Preferred Stock of $8.8 million, offset in part by a net decrease in FHLBB advances of $11.5 million and cash dividends paid.
| 32 |
CAPITAL RESOURCES
Shareholders’ Equity
Shareholders’ equity increased $11.8 million in 2011 to $66.9 million at December 31, 2011. Book value and tangible book value per common share increased $2.75 and $2.89, respectively, to $30.12 and $23.69, respectively, compared with $27.37 and $20.81, respectively, at December 31, 2010. Contributing to the increase in shareholders’ equity for 2011 was net income of $4.1 million, other comprehensive gain of $3.1 million, preferred stock issuance to the Treasury of $16.0 million for SBLF participation, less the preferred stock and warrant repurchases from the Treasury of $8.8 million and $205,000, respectively, to exit CPP, and common stock issuance of $28,000, less common and preferred stock dividends and preferred stock accretion of $1.9 million, $446,000 and $78,000, respectively. Other comprehensive income included unrealized gains on securities available-for-sale, net of tax, of $3.9 million, offset in part by pension plan loss, net of tax, of $871,000. The increase in unrealized gains on securities available-for-sale and the pension plan liability resulted from the decline in market interest rates in 2011.
Preferred Stock
In August 2011, Salisbury issued to the Treasury $16 million of its Series B Preferred Stock under the SBLF program. The SBLF program is a $30 billion fund established under the Small Business Jobs Act of 2010 to encourage lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. The Preferred Stock qualifies as Tier 1 capital for regulatory purposes and ranks senior to the Common Stock.
The Series B Preferred Stock pays noncumulative dividends. The dividend rate on the Series B Preferred Stock for the initial quarterly dividend period ended September 30, 2011 and each of the next nine quarterly dividend periods the Series B Preferred Stock is outstanding is determined each quarter based on the increase in the Bank’s Qualified Small Business Lending. The dividend rate for the initial and subsequent quarterly dividend period ended September 30, 2011 and December 31, 2011, were 2.45100% and 1.55925%, respectively. For the tenth quarterly dividend period through four and one-half years after its issuance, the dividend rate on the Series B Preferred Stock will be fixed at the rate in effect at the end of the ninth quarterly dividend period and after four and one-half years from its issuance the dividend rate will be fixed at 9 percent per annum. On December 31, 2011, Salisbury declared a Series B Preferred Stock dividend of $63,756, payable on January 3, 2012. The Series B Preferred Stock is non-voting, other than voting rights on matters that could adversely affect the Series B Preferred Stock. The Series B Preferred Stock is redeemable at any time at one hundred percent of the issue price plus any accrued and unpaid dividends.
Simultaneously with the receipt of the SBLF capital, Salisbury repurchased for $8.8 million all of its Series A Preferred Stock sold to the Treasury in 2009 under the CPP, a part of TARP, and made a payment for accrued dividends. The transaction resulted in net capital proceeds to Salisbury of $7.2 million, of which Salisbury invested $6.5 million, or 90%, in the Bank as Tier 1 Capital.
As part of the CPP, Salisbury had issued to the Treasury a 10-year Warrant to purchase 57,671 shares of Common Stock at an exercise price of $22.93 per share. The Warrant was repurchased for $205,000 on November 2, 2011 and simultaneously cancelled.
Capital Requirements
Salisbury and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Under current regulatory definitions, Salisbury and the Bank are considered to be “well capitalized” for capital adequacy purposes. As a result, the Bank pays lower federal deposit insurance premiums than those banks that are not “well capitalized.” Salisbury and the Bank’s regulatory capital ratios are as follows:
| Well | December 31, 2011 | December 31, 2010 | ||||||||||||||||||
| capitalized | Salisbury | Bank | Salisbury | Bank | ||||||||||||||||
| Total Capital (to risk-weighted assets) | 10.00 | % | 15.97 | % | 13.16 | % | 13.91 | % | 11.11 | % | ||||||||||
| Tier 1 Capital (to risk-weighted assets) | 6.00 | 14.88 | 12.08 | 12.84 | 10.06 | |||||||||||||||
| Tier 1 Capital (to average assets) | 5.00 | 9.45 | 7.77 | 8.39 | 6.72 | |||||||||||||||
A well-capitalized institution, which is the highest capital category for an institution as defined by the Prompt Corrective Action regulations issued by the FDIC and the FRB, is one which maintains a Total Risk-Based ratio of 10% or above, a Tier 1 Risk-Based ratio of 6% or above and a Leverage ratio of 5% or above, and is not subject to any written order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level. Maintaining strong capital is essential to Salisbury and the Bank’s safety and soundness. However, the effective management of capital resources requires generating attractive returns on equity to build value for shareholders while maintaining appropriate levels of capital to fund growth, meet regulatory requirements and be consistent with prudent industry practices.
Dividends
During 2011, Salisbury declared and paid four quarterly common stock dividends of $0.28 per common share each quarter, totaling $1,891,000. The Board of Directors of Salisbury declared a common stock dividend of $0.28 per common share payable on February 24, 2012 to shareholders of record on February 10, 2012. Common stock dividends, when declared, will generally be paid the last business day of February, May, August and November, although Salisbury is not obligated to pay dividends on those dates or at any other time.
| 33 |
During 2010, Salisbury declared three and paid four quarterly common stock dividends of $0.28 each totaling $1.9 million. In November 2009, Salisbury amended its dividend policy to coincide future quarterly common stock dividend declarations with quarterly earnings announcements made approximately four weeks after the end of future quarterly reporting periods. Prior to this amendment, dividend declarations were generally announced prior to the end of a reporting period. The timing of dividend payments remained substantially unchanged. Consequently, on February 4, 2010 Salisbury announced both its financial results for the fourth quarter of 2009 and its declaration on January 29, 2010 of a common stock dividend of $0.28 per common share, payable on February 26, 2010. For the corresponding prior year period, Salisbury announced a common stock dividend of $0.28 per common share on November 26, 2008, payable on January 31, 2009, and announced its financial results for the fourth quarter of 2008 on March 20, 2009.
During 2011 Salisbury declared Preferred Stock Series A and Series B dividends of $343,000 and $103,000, respectively, to the Treasury.
Salisbury’s ability to pay cash dividends is dependent on the Bank’s ability to pay cash dividends to Salisbury. There are certain restrictions on the payment of cash dividends and other payments by the Bank to Salisbury. Under Connecticut law, the Bank cannot declare a cash dividend except from net profits, defined as the remainder of all earnings from current operations. The total of all cash dividends declared by the Bank in any calendar year shall not, unless specifically approved by the Banking Commissioner, exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.
FRB Supervisory Letter SR 09-4, February 24, 2009, revised March 27, 2009, states that, as a general matter, the Board of Directors of a Bank Holding Company (“BHC”) should inform the Federal Reserve and should eliminate, defer, or significantly reduce dividends if (1) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition; or (3) the BHC will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Moreover, a BHC should inform the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the BHC capital position.
Salisbury believes that the payment of common stock cash dividends is appropriate, provided that such payment considers Salisbury’s capital needs, asset quality, and overall financial condition and does not adversely affect the financial stability of Salisbury or the Bank. The continued payment of common stock cash dividends by Salisbury will be dependent on Salisbury’s future core earnings, financial condition and capital needs, regulatory restrictions, and other factors deemed relevant by the Board of Directors of Salisbury.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 1 to the Consolidated Financial Statements for details of recently issued accounting pronouncements and their expected impact on Salisbury’s financial statements.
IMPACT OF INFLATION AND CHANGING PRICES
Salisbury’s consolidated financial statements are prepared in conformity with GAAP that require the measurement of financial condition and operating results in terms of historical dollars without considering changes in the relative purchasing power of money, over time, due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of Salisbury are monetary and as a result, interest rates have a greater impact on Salisbury’s performance than do the effects of general levels of inflation, although interest rates do not necessarily move in the same direction or with the same magnitude as the prices of goods and services. Although not a material factor in recent years, inflation could impact earnings in future periods.
FORWARD-LOOKING STATEMENTS
This Annual Report may contain forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended, relating to such matters as:
| (a) | assumptions concerning future economic and business conditions and their effect on the economy in general and on the markets in which Salisbury and the Bank do business; and |
| (b) | expectations for revenues and earnings for Salisbury and Bank. |
Such forward-looking statements are based on assumptions rather than historical or current facts and, therefore, are inherently uncertain and subject to risk. For those statements, Salisbury claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Act of 1995.
Actual results could differ materially from management expectations, projections and estimates. Factors that could cause future results to vary from current management expectations include, but are not limited to, the following:
| (a) | the risk of adverse changes in business conditions in the banking industry generally and in the specific markets in which the Bank operates; |
| (b) | changes in the legislative and regulatory environment that negatively impacts Salisbury and the Bank through increased operating expenses; |
| (c) | increased competition from other financial and non-financial institutions; |
| (d) | the impact of technological advances; and |
| (e) | other risks detailed from time to time in Salisbury’s filings with the Securities and Exchange Commission. |
Such developments could have an adverse impact on Salisbury’s and the Bank’s financial position and results of operations.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Salisbury manages its exposure to interest rate risk through its Asset/Liability Management Committee (“ALCO”) using risk limits and policy guidelines to manage assets and funding liabilities to produce financial results that are consistent with Salisbury’s liquidity, capital adequacy, growth, risk and profitability targets. Interest rate risk is the risk of loss to future earnings due to changes in interest rates.
| 34 |
The ALCO manages interest rate risk using income simulation to measure interest rate risk inherent in Salisbury’s financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 24-month horizon. In management’s December 31, 2011 analysis, three of the simulations incorporate management’s growth assumptions over the simulation horizons, with allowances made for loan, deposit and security product mix shifts in selected interest rate scenarios, such as movements between lower rate savings and money market deposit accounts and higher rate time deposits, and changes in the reinvestment of loan and securities cash flows. The fourth simulation incorporates management’s balance sheet growth assumptions. Additionally, the simulations take into account the specific re-pricing, maturity and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios.
The ALCO reviews the simulation results to determine whether Salisbury’s exposure to change in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. Salisbury’s tolerance levels for changes in net interest income in its income simulations varies depending on the magnitude of interest rate changes and level of risk-based capital. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where interest rates remain stable over the forecast horizon. The ALCO also evaluates the directional trends of net interest income, net interest margin and other financial measures over the forecast horizon for consistency with its liquidity, capital adequacy, growth, risk and profitability targets.
ALCO uses four interest rate scenarios to evaluate interest risk exposure and may vary these interest rate scenarios to show the effect of steepening or flattening changes in yield curves as well as parallel changes in interest rates. At December 31, 2011 ALCO used the following interest rate scenarios: (1) unchanged interest rates; (2) immediately rising interest rates – immediate non-parallel upward shift in market interest rates ranging from 300 basis points for short term rates to 250 basis points for the 10-year Treasury; (3) immediately falling interest rates – immediate non-parallel downward shift in market interest rates ranging from 25 basis points for short term rates to 75 basis points for the 10-year Treasury; and (4) two step shock rising interest rates – ranging from 400 basis points for short term rates (200 basis points each year) to 305 basis points for the 10-year Treasury (175 basis points for year one and 130 basis points for year two). Deposit rates are assumed to shift by lesser amounts due to their relative historical insensitivity to market interest rate movements. Further, deposits are assumed to have certain minimum rate levels below which they will not fall. Income simulations do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.
As of December 31, 2011 net interest income simulations indicated that Salisbury’s exposure to changing interest rates over the simulation horizons remained within its tolerance levels. The following table sets forth the estimated change in net interest income from an unchanged interest rate scenario over the periods indicated for changes in market interest rates using Salisbury’s financial instruments as of December 31, 2011.
| December 31, 2011 (in thousands) | Months 1-12 | Months 13-24 | ||||||
| Immediately rising interest rates (management’s growth assumptions) | (12.87 | )% | (8.85 | )% | ||||
| Immediately falling interest rates (management’s growth assumptions) | (0.35 | ) | (2.03 | ) | ||||
| Gradually rising interest rates (management’s growth assumptions) | (7.56 | ) | (14.81 | ) | ||||
The negative exposure of net interest income to immediately and gradually rising rates as compared to the unchanged rate scenario results from a faster projected rise in the cost of funds versus income from earning assets, as relatively rate-sensitive money market and time deposits re-price faster than longer duration earning assets. The negative exposure of net interest income to immediately falling rates as compared to an unchanged rate scenario results from a greater decline in earning asset yields compared to rates paid on funding liabilities, as a result of faster prepayments on existing assets and lower reinvestment rates on future loans originated and securities purchased.
While the ALCO reviews simulation assumptions and back-tests simulation results to ensure that they are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin. Over time, the re-pricing, maturity and prepayment characteristics of financial instruments and the composition of Salisbury’s balance sheet may change to a different degree than estimated. Simulation modeling assumes Salisbury’s expectation for future balance sheet growth, which is a function of the business environment and customer behavior. Another significant simulation assumption is the sensitivity of core savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. The assumed relationship between short-term interest rate changes and core deposit rate and balance changes used in income simulation may differ from the ALCO’s estimates. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.
| 35 |
Salisbury also monitors the potential change in market value of its available-for-sale debt securities in changing interest rate environments. The purpose is to determine market value exposure that may not be captured by income simulation, but which might result in changes to Salisbury’s capital and liquidity position. Results are calculated using industry-standard analytical techniques and securities data. Available-for-sale equity securities are excluded from this analysis because the market value of such securities cannot be directly correlated with changes in interest rates. The following table summarizes the potential change in market value of available-for-sale debt securities resulting from immediate parallel rate shifts:
| December 31, 2011 (in thousands) | Rates up 100bp | Rates up 200bp | ||||||
| U.S. Treasury notes | $ | (244 | ) | $ | (475 | ) | ||
| U.S. Government agency notes | (270 | ) | (594 | ) | ||||
| Municipal bonds | (2,738 | ) | (6,364 | ) | ||||
| Mortgage backed securities | (1,874 | ) | (4,174 | ) | ||||
| Collateralized mortgage obligations | (739 | ) | (1,453 | ) | ||||
| SBA pools | (11 | ) | (21 | ) | ||||
| Other | — | — | ||||||
| Total available-for-sale debt securities | $ | (5,873 | ) | $ | (13,081 | ) | ||
| 36 |
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
| Page | |||
| Report of Independent Registered Public Accounting Firm | 38 | ||
| Consolidated Balance Sheets | 39 | ||
| Consolidated Statements of Income | 40 | ||
| Consolidated Statements of Changes in Shareholders’ Equity | 41 | ||
| Consolidated Statements of Cash Flows | 42-43 | ||
| Notes to Consolidated Financial Statements | 44-72 |
| 37 |
To the Board of Directors
Salisbury Bancorp, Inc.
Lakeville, Connecticut
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the accompanying consolidated balance sheets of Salisbury Bancorp, Inc. and Subsidiary as of December 31, 2011 and 2010 and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Salisbury Bancorp, Inc. and Subsidiary as of December 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
| /s/ Shatswell, MacLeod & Company P.C. | |
| West Peabody, Massachusetts | |
| March 9, 2012 |
| 38 |
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED BALANCE SHEETS
| Years ended December 31, (dollars in thousands, except par value) | 2011 | 2010 | ||||||
| ASSETS | ||||||||
| Cash and due from banks | $ | 4,829 | $ | 6,694 | ||||
| Interest bearing demand deposits with other banks | 32,057 | 20,214 | ||||||
| Total cash and cash equivalents | 36,886 | 26,908 | ||||||
| Interest bearing time deposits with other banks | — | 5,000 | ||||||
| Securities | ||||||||
| Available-for-sale at fair value | 155,794 | 147,422 | ||||||
| Held-to-maturity at amortized cost (fair value: $52 and $58) | 50 | 56 | ||||||
| Federal Home Loan Bank of Boston stock at cost | 6,032 | 6,032 | ||||||
| Loans held-for-sale | 948 | 1,184 | ||||||
| Loans receivable, net (allowance for loan losses: $4,076 and $3,920) | 370,766 | 352,449 | ||||||
| Investment in real estate | — | 75 | ||||||
| Other real estate owned | 2,744 | 610 | ||||||
| Bank premises and equipment, net | 12,023 | 12,254 | ||||||
| Goodwill | 9,829 | 9,829 | ||||||
| Intangible assets (net of accumulated amortization: $1,523 and $1,301) | 1,020 | 1,242 | ||||||
| Accrued interest receivable | 2,126 | 2,132 | ||||||
| Cash surrender value of life insurance policies | 7,037 | 3,854 | ||||||
| Deferred taxes | 829 | 2,540 | ||||||
| Other assets | 3,200 | 3,883 | ||||||
| Total Assets | $ | 609,284 | $ | 575,470 | ||||
| LIABILITIES and SHAREHOLDERS’ EQUITY | ||||||||
| Deposits | ||||||||
| Demand (non-interest bearing) | $ | 82,202 | $ | 71,565 | ||||
| Demand (interest bearing) | 66,332 | 63,258 | ||||||
| Money market | 124,566 | 77,089 | ||||||
| Savings and other | 94,503 | 93,324 | ||||||
| Certificates of deposit | 103,703 | 125,053 | ||||||
| Total deposits | 471,306 | 430,289 | ||||||
| Repurchase agreements | 12,148 | 13,190 | ||||||
| Federal Home Loan Bank of Boston advances | 54,615 | 72,812 | ||||||
| Accrued interest and other liabilities | 4,353 | 4,163 | ||||||
| Total Liabilities | 542,422 | 520,454 | ||||||
| Shareholders’ Equity | ||||||||
| Preferred stock - $.01 per share par value | ||||||||
| Authorized: 25,000; issued: 16,000 (Series B) and 8,816 (Series A); | ||||||||
| Liquidation preference: $1,000 per share | 16,000 | 8,738 | ||||||
| Common stock - $.10 per share par value | ||||||||
| Authorized: 3,000,000; | ||||||||
| Issued: 1,688,731 and 1,687,661 | 169 | 168 | ||||||
| Common stock warrants outstanding | — | 112 | ||||||
| Paid-in capital | 13,134 | 13,200 | ||||||
| Retained earnings | 38,264 | 36,567 | ||||||
| Accumulated other comprehensive loss, net | (705 | ) | (3,769 | ) | ||||
| Total Shareholders’ Equity | 66,862 | 55,016 | ||||||
| Total Liabilities and Shareholders’ Equity | $ | 609,284 | $ | 575,470 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
| 39 |
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
| Years ended December 31, (in thousands except per share amounts) | 2011 | 2010 | 2009 | |||||||||
| Interest and dividend income | ||||||||||||
| Interest and fees on loans | $ | 18,666 | $ | 18,483 | $ | 18,233 | ||||||
| Interest on debt securities | ||||||||||||
| Taxable | 3,041 | 3,770 | 5,028 | |||||||||
| Tax exempt | 2,210 | 2,231 | 2,491 | |||||||||
| Other interest and dividends | 127 | 172 | 114 | |||||||||
| Total interest and dividend income | 24,044 | 24,656 | 25,866 | |||||||||
| Interest expense | ||||||||||||
| Deposits | 3,165 | 4,364 | 5,790 | |||||||||
| Repurchase agreements | 63 | 90 | 131 | |||||||||
| Federal Home Loan Bank of Boston advances | 2,331 | 3,043 | 3,111 | |||||||||
| Total interest expense | 5,559 | 7,497 | 9,032 | |||||||||
| Net interest and dividend income | 18,485 | 17,159 | 16,834 | |||||||||
| Provision for loan losses | 1,440 | 1,000 | 985 | |||||||||
| Net interest and dividend income after provision for loan losses | 17,045 | 16,159 | 15,849 | |||||||||
| Non-interest income | ||||||||||||
| Gains on securities, net | 11 | 16 | 473 | |||||||||
| Trust and wealth advisory | 2,548 | 2,102 | 1,978 | |||||||||
| Service charges and fees | 2,090 | 2,006 | 1,725 | |||||||||
| Gains on sales of mortgage loans, net | 687 | 816 | 488 | |||||||||
| Mortgage servicing, net | 65 | 97 | 80 | |||||||||
| Other | 255 | 270 | 459 | |||||||||
| Total non-interest income, excluding other-than-temporary impairment losses | 5,656 | 5,307 | 5,203 | |||||||||
| Other-than-temporary impairment losses on securities | — | — | (2,302 | ) | ||||||||
| Portion of loss recognized in other comprehensive income (before tax) | — | — | 1,174 | |||||||||
| Net other-than-temporary impairment losses recognized in earnings | — | — | (1,128 | ) | ||||||||
| Total non-interest income | 5,656 | 5,307 | 4,075 | |||||||||
| Non-interest expense | ||||||||||||
| Salaries | 6,970 | 6,816 | 6,623 | |||||||||
| Employee benefits | 2,493 | 2,253 | 2,527 | |||||||||
| Premises and equipment | 2,330 | 2,099 | 1,969 | |||||||||
| Data processing | 1,410 | 1,452 | 1,473 | |||||||||
| Professional fees | 1,099 | 1,364 | 1,493 | |||||||||
| Collections and OREO | 590 | 191 | 45 | |||||||||
| FDIC insurance | 596 | 735 | 914 | |||||||||
| Marketing and community support | 343 | 319 | 341 | |||||||||
| Amortization of intangibles | 222 | 222 | 164 | |||||||||
| Other | 1,586 | 1,662 | 1,957 | |||||||||
| Total non-interest expense | 17,639 | 17,113 | 17,506 | |||||||||
| Income before income taxes | 5,062 | 4,353 | 2,418 | |||||||||
| Income tax provision (benefit) | 950 | 693 | (49 | ) | ||||||||
| Net income | $ | 4,112 | $ | 3,660 | $ | 2,467 | ||||||
| Net income available to common shareholders | $ | 3,588 | $ | 3,198 | $ | 2,102 | ||||||
| Basic and diluted earnings per common share | $ | 2.12 | $ | 1.90 | $ | 1.25 | ||||||
| Common dividends per share | 1.12 | 1.12 | 0.84 | |||||||||
The accompanying notes are an integral part of the consolidated financial statements.
| 40 |
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
| Common Stock | ||||||||||||||||||||||||||||||||
| (dollars in thousands) | Shares | Amount | Preferred Stock | Warrants | Paid-in capital | Retained earnings | Accumulated other comp- rehensive loss | Total share-holders’ equity | ||||||||||||||||||||||||
| Balances at December 31, 2008 | 1,685,861 | $ | 168 | $ | — | $ | — | $ | 13,158 | $ | 34,518 | $ | (8,905 | ) | $ | 38,939 | ||||||||||||||||
| Net income for year | — | — | — | — | — | 2,467 | — | 2,467 | ||||||||||||||||||||||||
| Other comprehensive income, net of tax | — | — | — | — | — | — | 3,827 | 3,827 | ||||||||||||||||||||||||
| Total comprehensive income | 6,294 | |||||||||||||||||||||||||||||||
| Issuance of preferred stock and warrants | — | — | 8,704 | 112 | — | — | — | 8,816 | ||||||||||||||||||||||||
| Amortization (accretion) of preferred stock | — | — | 13 | — | — | (13 | ) | — | — | |||||||||||||||||||||||
| Common stock dividends declared | — | — | — | — | — | (1,417 | ) | — | (1,417 | ) | ||||||||||||||||||||||
| Preferred stock dividends paid | — | — | — | — | — | (296 | ) | — | (296 | ) | ||||||||||||||||||||||
| Issuance of common stock for | ||||||||||||||||||||||||||||||||
| directors fees | 840 | — | — | — | 19 | — | — | 19 | ||||||||||||||||||||||||
| Balances at December 31, 2009 | 1,686,701 | 168 | 8,717 | 112 | 13,177 | 35,259 | (5,078 | ) | 52,355 | |||||||||||||||||||||||
| Net income for year | — | — | — | — | — | 3,660 | — | 3,660 | ||||||||||||||||||||||||
| Other comprehensive income, net of tax | — | — | — | — | — | — | 1,309 | 1,309 | ||||||||||||||||||||||||
| Total comprehensive income | 4,969 | |||||||||||||||||||||||||||||||
| Amortization (accretion) of preferred stock | — | — | 21 | — | — | (21 | ) | — | — | |||||||||||||||||||||||
| Common stock dividends declared | — | — | — | — | — | (1,890 | ) | — | (1,890 | ) | ||||||||||||||||||||||
| Preferred stock dividends paid | — | — | — | — | — | (441 | ) | — | (441 | ) | ||||||||||||||||||||||
| Issuance of common stock for | ||||||||||||||||||||||||||||||||
| directors fees | 960 | — | — | — | 23 | — | — | 23 | ||||||||||||||||||||||||
| Balances at December 31, 2010 | 1,687,661 | 168 | 8,738 | 112 | 13,200 | 36,567 | (3,769 | ) | 55,016 | |||||||||||||||||||||||
| Net income for year | — | — | — | — | — | 4,112 | — | 4,112 | ||||||||||||||||||||||||
| Other comprehensive income, net of tax | — | — | — | — | — | — | 3,064 | 3,064 | ||||||||||||||||||||||||
| Total comprehensive income | 7,176 | |||||||||||||||||||||||||||||||
| Amortization (accretion) of preferred stock | — | — | 78 | — | — | (78 | ) | — | — | |||||||||||||||||||||||
| Issuance of Series B preferred stock | — | — | 16,000 | — | — | — | — | 16,000 | ||||||||||||||||||||||||
| Redemption of Series A preferred stock | — | — | (8,816 | ) | — | — | — | — | (8,816 | ) | ||||||||||||||||||||||
| Repurchase of Common Stock Warrants | — | — | — | (112 | ) | (93 | ) | — | — | (205 | ) | |||||||||||||||||||||
| Common stock dividends declared | — | — | — | — | — | (1,891 | ) | — | (1,891 | ) | ||||||||||||||||||||||
| Preferred stock dividends declared | — | — | — | — | — | (446 | ) | — | (446 | ) | ||||||||||||||||||||||
| Issuance of common stock for director fees | 1,070 | 1 | — | — | 27 | — | — | 28 | ||||||||||||||||||||||||
| Balances at December 31, 2011 | 1,688,731 | $ | 169 | $ | 16,000 | $ | — | $ | 13,134 | $ | 38,264 | $ | (705 | ) | $ | 66,862 | ||||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
| 41 |
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Operating Activities | ||||||||||||
| Net income | $ | 4,112 | $ | 3,660 | $ | 2,467 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| (Accretion), amortization and depreciation | ||||||||||||
| Securities | 369 | 483 | 652 | |||||||||
| Bank premises and equipment | 850 | 787 | 709 | |||||||||
| Core deposit intangible | 222 | 222 | 164 | |||||||||
| Mortgage servicing rights | 240 | 197 | 167 | |||||||||
| Fair value adjustment on loans | 42 | 42 | 47 | |||||||||
| Fair value adjustment on deposits and borrowings | — | — | (54 | ) | ||||||||
| (Gains) and losses | ||||||||||||
| Sales and calls of securities available-for-sale, net | (11 | ) | (16 | ) | (473 | ) | ||||||
| Other real estate owned | 231 | 15 | 86 | |||||||||
| Life insurance policies settlement | — | — | (129 | ) | ||||||||
| Loss on sale/disposals of premises and equipment | — | 6 | — | |||||||||
| Impairment loss on securities recognized in earnings | — | — | 1,128 | |||||||||
| Provision for loan losses | 1,440 | 1,000 | 985 | |||||||||
| Decrease (increase) in loans held-for-sale | 236 | (519 | ) | 1,649 | ||||||||
| Increase in deferred loan origination fees and costs, net | (182 | ) | (236 | ) | (193 | ) | ||||||
| Mortgage servicing rights originated | (329 | ) | (453 | ) | (367 | ) | ||||||
| Increase (decrease) in mortgage servicing rights impairment reserve | 12 | (20 | ) | (88 | ) | |||||||
| Decrease in interest receivable | 6 | 45 | 503 | |||||||||
| Deferred tax expense (benefit) | 130 | 71 | (1,060 | ) | ||||||||
| Decrease (increase) in prepaid expenses | 576 | 757 | (2,542 | ) | ||||||||
| Increase in cash surrender value of life insurance policies | (183 | ) | (169 | ) | (265 | ) | ||||||
| Decrease (increase) in income tax receivable | 147 | (824 | ) | 437 | ||||||||
| Decrease (increase) in other assets | 41 | 149 | (63 | ) | ||||||||
| (Decrease) increase in accrued expenses | (442 | ) | 270 | 129 | ||||||||
| (Decrease) increase in interest payable | (164 | ) | (88 | ) | 25 | |||||||
| (Decrease) increase in other liabilities | (587 | ) | 62 | 230 | ||||||||
| Issuance of shares for directors’ fees | 28 | 23 | 19 | |||||||||
| Net cash provided by operating activities | 6,784 | 5,464 | 4,163 | |||||||||
| Investing Activities | ||||||||||||
| Purchase of interest-bearing time deposits with other banks | — | — | (5,000 | ) | ||||||||
| Proceeds from maturities of interest-bearing time deposits with other banks | 5,000 | — | — | |||||||||
| Purchases of Federal Home Loan Bank of Boston stock | — | — | (709 | ) | ||||||||
| Purchases of securities available-for-sale | (45,831 | ) | (52,932 | ) | (110,728 | ) | ||||||
| Proceeds from sales of securities available-for-sale | — | — | 37,818 | |||||||||
| Proceeds from calls of securities available-for-sale | 27,565 | 24,745 | 42,044 | |||||||||
| Proceeds from maturities of securities available-for-sale | 15,498 | 27,221 | 32,207 | |||||||||
| Proceeds from maturities of securities held-to-maturity | 6 | 6 | 4 | |||||||||
| Loan originations and principal collections, net | (22,556 | ) | (26,443 | ) | (28,554 | ) | ||||||
| Recoveries of loans previously charged-off | 82 | 29 | 30 | |||||||||
| Proceeds from sales of other real estate owned | 492 | 66 | 94 | |||||||||
| Proceeds from life insurance policies settlement | — | — | 534 | |||||||||
| Purchase of life insurance policies | (3,000 | ) | — | — | ||||||||
| Proceeds from sales/disposals of premises and equipment | 200 | 382 | — | |||||||||
| Capital expenditures | (821 | ) | (2,906 | ) | (3,565 | ) | ||||||
| Proceeds from sales of investment in real estate | 75 | — | — | |||||||||
| Cash and cash equivalents acquired | ||||||||||||
| Webster Bank N.A. | — | — | 8,121 | |||||||||
| Net cash utilized by investing activities | (23,290 | ) | (29,832 | ) | (27,704 | ) | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
| 42 |
Salisbury Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
| Years ended December 31, (in thousands) | 2011 | 2010 | 2009 | |||||||||
| Financing Activities | ||||||||||||
| Increase in deposit transaction accounts, net | 62,367 | 40,572 | 39,153 | |||||||||
| (Decrease) increase in time deposits, net | (21,350 | ) | (28,486 | ) | 22,679 | |||||||
| (Decrease) increase in securities sold under agreements to repurchase, net | (1,042 | ) | 1,775 | 212 | ||||||||
| Federal Home Loan Bank of Boston advances | — | — | 12,000 | |||||||||
| Principal payments on Federal Home Loan Bank of Boston advances | (18,197 | ) | (3,552 | ) | (2,618 | ) | ||||||
| (Decrease) increase in short term Federal Home Loan Bank of Boston advances, net | — | — | (20,878 | ) | ||||||||
| Proceeds from issuance of Series B preferred stock | 16,000 | — | 8,816 | |||||||||
| Redemption of Series A preferred stock | (8,816 | ) | — | — | ||||||||
| Redemption of common stock warrants | (205 | ) | — | — | ||||||||
| Common stock dividends paid | (1,891 | ) | (1,890 | ) | (1,889 | ) | ||||||
| Series A and Series B preferred stock dividends paid | (382 | ) | (441 | ) | (296 | ) | ||||||
| Net cash provided by financing activities | 26,484 | 7,978 | 57,179 | |||||||||
| Net increase (decrease) in cash and cash equivalents | 9,978 | (16,390 | ) | 33,638 | ||||||||
| Cash and cash equivalents, beginning of year | 26,908 | 43,298 | 9,660 | |||||||||
| Cash and cash equivalents, end of year | $ | 36,886 | $ | 26,908 | $ | 43,298 | ||||||
| Cash paid during year | ||||||||||||
| Interest | $ | 5,723 | $ | 7,585 | $ | 9,064 | ||||||
| Income taxes | 673 | 1,446 | 574 | |||||||||
| Non-cash transfers | ||||||||||||
| From loans to other real estate owned | 3,057 | 610 | 400 | |||||||||
| From other real estate owned to loans | 200 | 194 | 150 | |||||||||
| Webster Bank, N.A. branch acquisition | ||||||||||||
| Cash and cash equivalents acquired | — | — | 8,121 | |||||||||
| Net loans acquired | — | — | 2,455 | |||||||||
| Fixed assets acquired | — | — | 403 | |||||||||
| Accrued interest receivable acquired | — | — | 7 | |||||||||
| Deposits assumed | — | — | 11,446 | |||||||||
| Accrued interest payable assumed | — | — | 3 | |||||||||
| Core deposit intangible | — | — | 463 | |||||||||
The accompanying notes are an integral part of the consolidated financial statements.
| 43 |
Salisbury Bancorp, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Salisbury is the bank holding company for Salisbury Bank, a State chartered commercial bank. Salisbury’s activity is currently limited to the holding of the Bank’s outstanding capital stock and the Bank is Salisbury’s only subsidiary and its primary investment. The Bank is a Connecticut chartered and Federal Deposit Insurance Corporation (the “FDIC”) insured commercial bank headquartered in Lakeville, Connecticut. The Bank’s principal business consists of attracting deposits from the public and using such deposits, with other funds, to make various types of loans and investments. The Bank conducts its business through eight full-service offices located in Litchfield, Berkshire and Dutchess Counties in Connecticut, Massachusetts and New York, respectively. The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles. The following is a summary of significant accounting policies:
Principles of Consolidation
The consolidated financial statements include those of Salisbury and its subsidiary after elimination of all inter-company accounts and transactions.
Basis of Financial Statement Presentation
The financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America. In preparing the financial statements, management is required to make extensive use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of condition, and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.
Certain reclassifications have been made to the 2010 and 2009 financial statements to make them consistent with the 2011 presentation.
Salisbury’s loans collateralized by real estate and all other real estate owned (“OREO”) are located principally in northwestern Connecticut and nearby New York and Massachusetts towns, which constitute Salisbury’s service area. Accordingly, the collectability of a substantial portion of the loan portfolio and OREO is particularly susceptible to changes in market conditions in Salisbury’s service area. While management uses available information to recognize losses on loans and OREO, future additions to the allowance or write-downs of OREO may be necessary based on changes in local economic conditions, particularly in Salisbury’s service area. In addition, various regulatory agencies, as an integral part of their examination process, periodically review Salisbury’s allowance for loan losses and valuation of OREO. Such agencies may require Salisbury to recognize additions to the allowance or write-downs based on their judgments of information available to them at the time of their examination.
Securities
Securities that may be sold as part of Salisbury’s asset/liability or liquidity management or in response to or in anticipation of changes in interest rates and resulting prepayment risk, or for other similar factors, are classified as available-for-sale and carried at their fair market value. Unrealized holding gains and losses on such securities are reported net of related taxes, if applicable, as a separate component of shareholders’ equity. Securities that Salisbury has the ability and positive intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. Realized gains and losses on the sales of all securities are reported in earnings and computed using the specific identification cost basis. Securities are reviewed regularly for other-than-temporary impairment (“OTTI”). Premiums and discounts are amortized or accreted utilizing the interest method over the life or call of the term of the investment security. For any debt security with a fair value less than its amortized cost basis, Salisbury will determine whether it has the intent to sell the debt security or whether it is more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis. If either condition is met, Salisbury will recognize a full impairment charge to earnings. For all other debt securities that are considered OTTI and do not meet either condition, the credit loss portion of impairment will be recognized in earnings as realized losses. The OTTI related to all other factors will be recorded in other comprehensive income. Declines in marketable equity securities below their cost that are deemed other than temporary are reflected in earnings as realized losses.
Federal Home Loan Bank of Boston Stock
The Bank is a member of the Federal Home Loan Bank of Boston (“FHLBB”). The FHLBB is a cooperative that provides services, including funding in the form of advances, to its member banking institutions. As a requirement of membership, the Bank must own a minimum amount of FHLBB stock, calculated periodically based primarily on its level of borrowings from the FHLBB. No market exists for shares of the FHLBB and therefore, they are carried at par value. FHLBB stock may be redeemed at par value five years following termination of FHLBB membership, subject to limitations which may be imposed by the FHLBB or its regulator, the Federal Housing Finance Board, to maintain capital adequacy of the FHLBB. While the Bank currently has no intentions to terminate its FHLBB membership, the ability to redeem its investment in FHLBB stock would be subject to the conditions imposed by the FHLBB. In 2008, the FHLBB announced to its members that it is focusing on preserving capital in response to ongoing market volatility including the extension of a moratorium on excess stock repurchases and in 2009 announced the suspension of its quarterly dividends. On February 22, 2011, the FHLBB declared a modest cash dividend payable to its members on March 2, 2011. The FHLBB continued to declare modest cash dividends through 2011. Based on the capital adequacy and the liquidity position of the FHLBB, management believes there is no impairment related to the carrying amount of the Bank’s FHLBB stock as of December 31, 2011. Further deterioration of the FHLBB’s capital levels may require the Bank to deem its restricted investment in FHLBB stock to be OTTI. If evidence of impairment exists in the future, the FHLBB stock would reflect fair value using either observable or unobservable inputs. The Bank will continue to monitor its investment in FHLBB stock.
| 44 |
Loans
Loans receivable consist of loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off. Loans receivable are reported at their principal outstanding balance, net of unamortized deferred loan origination fees and costs. Interest income is accrued on the unpaid principal balance. Deferred loan origination fees and costs are amortized as an adjustment to yield over the life of the related loans.
Loans held-for-sale consist of residential mortgage loans that management has the intent to sell. Loans held-for-sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis, net of deferred loan origination fees and costs. Changes in the carrying value, deferred loan origination fees and costs, and realized gains and losses on sales of loans held-for-sale are reported in earnings as gains and losses on sales of mortgage loans, net, when the proceeds are received from investors.
The accrual of interest on loans, including troubled debt restructured loans, is generally discontinued when principal or interest is past due by 90 days or more, or earlier when, in the opinion of management, full collection of principal or interest is unlikely, except for loans that are well collateralized, in the process of collection and where full collection of principal and interest is assured. When a loan is placed on non-accrual status, interest previously accrued but not collected is reversed against current income. Income on such loans, including impaired loans, is then recognized only to the extent that cash is received and future collection of principal is probable. Loans, including troubled debt restructured loans, are restored to accrual status when principal and interest payments are brought current and future payments are reasonably assured, following a sustained period of repayment performance by the borrower in accordance with the loan’s contractual terms.
Troubled debt restructured loans include those for which concessions such as reduction of interest rates, other than normal market rate adjustments, or deferral of principal or interest payments, extension of maturity dates, or reduction of principal balance or accrued interest, have been granted due to a borrower’s financial condition. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit Salisbury by increasing the ultimate probability of collection.
Troubled debt restructured loans are classified as accruing or non-accruing based on management’s assessment of the collectability of the loan. Loans which are already on nonaccrual status at the time of the troubled debt restructuring generally remain on nonaccrual status for approximately six months before management considers such loans for return to accruing status. Accruing troubled debt restructured loans are generally placed into nonaccrual status if and when the borrower fails to comply with the restructured terms.
Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of the probable credit losses inherent in the loan portfolio as of the reporting date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by loan charge-offs. Loan charge-offs are recognized when management determines a loan or portion of a loan to be uncollectible.
The determination of the adequacy of the allowance is based on management’s ongoing review of numerous factors, including the growth and composition of the loan portfolio, historical loss experience over an economic cycle, probable credit losses based upon internal and external portfolio reviews, credit risk concentrations, changes in lending policy, current economic conditions, analysis of current levels and asset quality, delinquency levels and trends, estimates of the current value of underlying collateral, the performance of individual loans in relation to contract terms, and other pertinent factors.
While management believes that the allowance for loan losses is adequate the allowance is an estimate, and ultimate losses may vary from management’s estimate. Future additions to the allowance may also be necessary based on changes in assumptions and economic conditions. In addition, various regulatory agencies periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination.
Changes in the estimate are recorded in the results of operations in the period in which they become known, along with provisions for estimated losses incurred during that period.
The allowance for loan losses is computed by segregating the portfolio into three components: (1) loans collectively evaluated for impairment: general loss allocation factors for non-impaired loans based on loan product, collateral type and abundance, loan risk rating, historical loss experience, delinquency factors and other similar economic indicators, (2) loans individually evaluated for impairment: individual loss allocations for loans deemed to be impaired based on discounted cash flows or collateral value, and (3) unallocated: general loss allocations for other environmental factors.
Loans collectively evaluated for impairment
This component of the allowance for loan losses is stratified by the following loan segments: residential real estate secured (residential 1-4 family and 5+ multifamily, construction of residential 1-4 family, and home equity credit) commercial real estate secured (commercial and construction of commercial), secured by land (farm and vacant land), commercial and industrial, municipal and consumer. Management’s general loss allocation factors are based on expected loss experience adjusted for historical loss experience and other qualitative factors, including levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no changes in Salisbury’s policies or methodology pertaining to the general component of the allowance for loan losses during 2011.
The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:
| 45 |
Residential real estate - Salisbury generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not grant subprime loans. All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.
Commercial real estate - Loans in this segment are primarily income-producing properties throughout Salisbury’s market area. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment. For all commercial loans management annually obtains business and personal financial statements, tax returns, and, where applicable, rent rolls, and continually monitors the repayment of these loans.
Construction loans - Loans in this segment primarily include speculative real estate development loans for which payment is derived from sale of the property. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.
Commercial loans - Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.
Consumer loans - Loans in this segment are generally unsecured and repayment is dependent on the credit quality of the individual borrower.
Loans individually evaluated for impairment
This component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis for commercial, commercial real estate and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan.
A loan is considered impaired when, based on current information and events, it is probable that Salisbury will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Salisbury periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (“TDR”). All TDRs are classified as impaired.
Unallocated
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio.
Other Real Estate Owned (“OREO”)
Other real estate owned consists of properties acquired through foreclosure and properties classified as in-substance foreclosures. These properties are carried at the lower of cost or fair value less estimated costs to sell. Any write-down from cost to estimated fair value required at the time of foreclosure or classification as in-substance foreclosure is charged to the allowance for loan losses. A valuation allowance is maintained for declines in market value and for estimated selling expenses. Increases to the valuation allowance, expenses associated with ownership of these properties, and gains and losses from their sale are included in OREO expense.
Loans classified as in-substance foreclosures include only those loans for which Salisbury has taken possession of the collateral, but has not completed legal foreclosure proceedings.
Income Taxes
Deferred income taxes are provided for differences arising in the timing of income and expenses for financial reporting and for income tax purposes using the asset/liability method of accounting for income taxes. Deferred income taxes and tax benefits are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Salisbury provides deferred taxes for the estimated future tax effects attributable to temporary differences and carry-forwards when realization is assured beyond a reasonable doubt.
Bank Premises and Equipment
Bank premises, furniture and equipment are carried at cost, less accumulated depreciation and amortization computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line basis over the shorter of the estimated useful lives of the improvements or the term of the related leases.
Intangible Assets
Intangible assets consist of core deposit intangibles and goodwill. Intangible assets equal the excess of the purchase price over the fair value of the tangible net assets acquired in acquisitions accounted for using the acquisition method of accounting. Salisbury’s assets at December 31, 2011, and 2010, include goodwill of $2,358,000 arising from the purchase of a branch office in 2001, $7,152,000 arising from the 2004 acquisition of Canaan National Bancorp, Inc. and $319,000 arising from the 2007 purchase of a branch office in New York State. See Note 7.
| 46 |
On an annual basis, management assesses intangible assets for impairment and at December 31, 2011, concluded there was no impairment. If a permanent loss in value is indicated, an impairment charge to income will be recognized.
Statement of Cash Flows
For the purpose of the Consolidated Statements of Cash Flows, cash and cash equivalents include cash and due from banks and interest-bearing demand deposits with other financial institutions.
Computation of Earnings per Share
Basic earnings per share is computed using the weighted-average common shares outstanding during the year. The computation of diluted earnings per share is similar to the computation of basic earnings per share except the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. See Note 22.
Recent Accounting Pronouncements
In December 2011, the FASB issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities.” This ASU is to enhance current disclosures. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The amendments in this ASU are effective for annual periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of ASU 2011-11 is not expected to have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.
In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The amendments in this update defer those changes in ASU 2011-05 that relate to the presentation of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. All other requirements in ASU 2011-05 are not affected by this update. The amendments are effective during interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-12 is not expected to have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.
In September 2011, the FASB issued ASU 2011-08, “Intangibles – Goodwill and Other”, an update to ASC 350, “Intangibles – Goodwill and Other.” ASU 2011-08 simplifies how entities, both public and nonpublic, test goodwill for impairment. The amendments in this update permit an entity to first assess qualitative factors to determine whether it is more likely than not the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. For public and nonpublic entities, the amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The adoption of ASU 2011-08 is not expected to have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.
In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. Under this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. An entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. An entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. The amendments in this ASU should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-05 is not expected to have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.
In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards.” The amendments in this ASU explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. The amendments in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.
In April 2011, the FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” This ASU provides additional guidance or clarification to help creditors determine whether a restructuring constitutes a troubled debt restructuring. For public entities, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and were applied retrospectively to the beginning of the 2011 annual period. The adoption of ASU 2011-02 did not have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.
In April 2011, the FASB issued ASU 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.” The objective of this ASU is to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. This ASU prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements. The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011. Early adoption is not permitted. The adoption of ASU 2011-03 is not expected to have a material impact on Salisbury’s consolidated financial position, results of operations or cash flows.
| 47 |
NOTE 2 - SECURITIES
The composition of securities is as follows:
| (in thousands) | Amortized cost (1) | Gross un-realized gains | Gross un-realized losses | Fair value | ||||||||||||
| December 31, 2011 | ||||||||||||||||
| Available-for-sale | ||||||||||||||||
| U.S. Treasury notes | $ | 5,000 | $ | 528 | $ | — | $ | 5,528 | ||||||||
| U.S. Government Agency notes | 14,544 | 380 | — | 14,924 | ||||||||||||
| Municipal bonds | 50,881 | 1,067 | (1,152 | ) | 50,796 | |||||||||||
| Mortgage backed securities | ||||||||||||||||
| U.S. Government Agencies | 57,193 | 1,126 | (19 | ) | 58,300 | |||||||||||
| Collateralized mortgage obligations | ||||||||||||||||
| U.S. Government Agencies | 7,077 | 76 | — | 7,153 | ||||||||||||
| Non-agency | 14,300 | 355 | (488 | ) | 14,167 | |||||||||||
| SBA bonds | 3,629 | 77 | — | 3,706 | ||||||||||||
| Corporate bonds | 1,100 | 4 | — | 1,104 | ||||||||||||
| Preferred Stock | 20 | 96 | — | 116 | ||||||||||||
| Total securities available-for-sale | $ | 153,744 | $ | 3,709 | $ | (1,659 | ) | $ | 155,794 | |||||||
| Held-to-maturity | ||||||||||||||||
| Mortgage backed security | $ | 50 | $ | 2 | $ | — | $ | 52 | ||||||||
| Non-marketable securities | ||||||||||||||||
| Federal Home Loan Bank of Boston stock | $ | 6,032 | $ | — | $ | — | $ | 6,032 | ||||||||
(1) Net of other-than-temporary impairment write-down recognized in earnings.
| (in thousands) | Amortized cost (1) | Gross un-realized gains | Gross un-realized losses | Fair value | ||||||||||||
| December 31, 2010 | ||||||||||||||||
| Available-for-sale | ||||||||||||||||
| U.S. Treasury notes | $ | 4,999 | $ | 197 | $ | — | $ | 5,196 | ||||||||
| U.S. Government Agency notes | 41,590 | 380 | (92 | ) | 41,878 | |||||||||||
| Municipal bonds | 51,330 | 139 | (5,371 | ) | 46,098 | |||||||||||
| Mortgage backed securities | ||||||||||||||||
| U.S. Government Agencies | 19,190 | 566 | (20 | ) | 19,736 | |||||||||||
| Collateralized mortgage obligations | ||||||||||||||||
| U.S. Government Agencies | 9,283 | 29 | (1 | ) | 9,311 | |||||||||||
| Non-agency | 19,002 | 714 | (599 | ) | 19,117 | |||||||||||
| SBA bonds | 4,831 | 70 | — | 4,901 | ||||||||||||
| Corporate bonds | 1,089 | 41 | — | 1,130 | ||||||||||||
| Preferred Stock | 20 | 35 | — | 55 | ||||||||||||
| Total securities available-for-sale | $ | 151,334 | $ | 2,171 | $ | (6,083 | ) | $ | 147,422 | |||||||
| Held-to-maturity | ||||||||||||||||
| Mortgage backed security | $ | 56 | $ | 2 | $ | — | $ | 58 | ||||||||
| Non-marketable securities | ||||||||||||||||
| Federal Home Loan Bank of Boston stock | $ | 6,032 | $ | — | $ | — | $ | 6,032 | ||||||||
Sales of securities available-for-sale and gains realized are as follows:
| Years ended December 31, (in thousands) | 2011 | 2010 | |||||||