Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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o | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended December 31, 2018
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period from _______ to _______
Commission File Number: 0-54241
SI FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
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Maryland | | 80-0643149 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
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803 Main Street, Willimantic, Connecticut | | 06226 |
(Address of principal executive offices) | | (Zip Code) |
(860) 423-4581
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class | | Name of Exchange on which registered |
Common stock, par value $0.01 per share | | The Nasdaq Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 x No o
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 amendment to this Form 10-K. x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, 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). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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Large Accelerated Filer | o | Accelerated Filer | x |
Non-Accelerated Filer | o | Smaller Reporting Company | x |
Emerging Growth Company | o | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes o No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates was $171.8 million, which was computed by reference to the closing price of $14.75, at which the common equity was sold as of June 30, 2018. Solely for the purposes of this calculation, the shares held by the directors and officers of the registrant are deemed to be shares held by affiliates.
As of March 13, 2019, there were 12,054,785 shares of the registrant’s common stock outstanding.
SI FINANCIAL GROUP, INC.
TABLE OF CONTENTS
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PART I. | | | Page No. |
Item 1. | | | |
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Item 1A. | | | |
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Item 1B. | | | |
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Item 2. | | | |
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Item 3. | | | |
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Item 4. | | | |
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PART II. | | | |
Item 5. | | | |
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Item 6. | | | |
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Item 7. | | | |
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Item 7A. | | | |
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Item 8. | | | |
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Item 9. | | | |
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Item 9A. | | | |
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Item 9B. | | | |
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PART III. | | | |
Item 10. | | | |
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Item 11. | | | |
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Item 12. | | | |
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Item 13. | | | |
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Item 14. | | | |
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PART IV. | | | |
Item 15. | | | |
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Item 16. | | | |
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Forward-Looking Statements
This report may contain certain “forward-looking statements” within the meaning of the federal securities laws, which are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts; rather, they are statements based on management’s current expectations regarding our business strategies, intended results and future performance. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends,” “estimates,” “projects” and similar expressions. Management’s ability to predict results of the effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on the operations of SI Financial Group, Inc. (the "Company" or "SI Financial") and its subsidiaries include, but are not limited to, changes in interest rates, corporate tax rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the United States government, including policies of the United States Treasury and the Federal Reserve Board, the quality and composition of the loan and investment portfolios, deposit flows, competition, demand for financial products and services in the Company’s market area, changes in real estate market values in the Company’s market area and changes in relevant accounting or tax principles and guidelines.
Additional factors that may affect the Company’s results are discussed in Item 1A. “Risk Factors” in this Annual Report on Form 10-K and in other reports filed with the Securities and Exchange Commission ("SEC"). These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
On December 11, 2018, the Company entered into an Agreement and Plan of Merger ("Merger Agreement") with Berkshire Hills Bancorp, Inc. ("Berkshire"). Under the Merger Agreement, the Company will merge with and into Berkshire, with Berkshire as the surviving corporation, in an all-stock transaction that we refer to as the "merger". Additional factors relating to our proposed merger with Berkshire include the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement; the risk that the necessary regulatory approvals may not be obtained, may be delayed, or may be obtained subject to conditions that are not anticipated; delays in closing the Merger Agreement or other risks that any of the closing conditions to the Merger Agreement may not be satisfied in a timely manner or at all; the diversion of management’s time from existing business operations due to time spent related to the merger or integration efforts; the risk that our business and the business of Berkshire will not be integrated successfully or such integration may be more difficult, time consuming or costly than expected; expected revenue and other synergies and cost savings from the merger may not be fully realized or realized within the expected time frame; revenues following the merger may be lower than expected; and expenses related to the merger and costs following the merger that are higher than expected.
In connection with the merger, Berkshire has filed with the SEC a Registration Statement on Form S-4 that includes proxy statement/prospectus business and financial information about Berkshire and the Company from documents that Berkshire and the Company have previously filed with the SEC. The Registration Statement was declared effective on February 25, 2019. Shareholders of the Company are urged to read the registration statement and the proxy statement/prospectus regarding the merger and other relevant documents filed with the SEC, as well as any amendments or supplements to those documents.
PART I.
Item 1. Business.
General
In certain instances where appropriate, the terms “we,” “us” and “our” refer to SI Financial Group, Inc. or Savings Institute Bank and Trust Company, or both.
SI Financial Group, Inc. is the parent holding company for Savings Institute Bank and Trust Company (the "Bank" or "Savings Institute"). The Bank operates as a community-oriented financial institution offering a full range of financial services to consumers and businesses in its market area, including life insurance and annuities. The Bank attracts deposits from the general public and uses those funds to originate one- to four-family residential, multi-family and commercial real estate, commercial business (including time share lending, loans to condominium associations and medical loans) and consumer loans. The Bank also purchases commercial business loans, including loans fully guaranteed by the Small Business Administration (the "SBA") and the United States Department of Agriculture (the "USDA"). The Bank sells certain fixed-rate one- to four-family residential conforming loans the Bank originates in the secondary market, primarily with the servicing retained. Such sales generate mortgage banking fee income. The remainder of the Bank’s loan portfolio is originated for investment.
The Bank is a wholly-owned subsidiary of the Company and management of the Company and the Bank are substantially similar. The Company neither owns nor leases any property, but instead uses the premises, equipment and other property of the Bank with the payment of appropriate rental fees, as required by applicable law and regulations. Thus, the financial information and discussion contained herein primarily relates to the activities of the Bank.
Availability of Information
The Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge at www.SEC.gov and on the Company’s website, www.mysifi.com, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. The information on the Company’s website shall not be considered as incorporated by reference into this annual report on Form 10-K.
Market Area and Competition
The Company is headquartered in Willimantic, Connecticut, which is located in eastern Connecticut approximately 30 miles east of Hartford. The Bank operates 23 full-service offices throughout Windham, New London, Tolland, Hartford and Middlesex counties in Connecticut and Newport and Washington counties in Rhode Island. Most of the Bank’s deposit customers reside in the areas surrounding the Bank’s branch offices. The Bank’s primary lending area is eastern Connecticut and Rhode Island with additional concentrations in Massachusetts and New Hampshire. The economy in the Company’s Connecticut market area is relatively diverse and primarily oriented to the educational, service, entertainment, insurance, manufacturing and retail industries. The major employers in our Connecticut market area include several hospitals, institutions of higher education, the Mohegan Sun and Foxwoods casinos, Aetna Insurance Company, Inc. and General Dynamics Defense Systems. In addition, there are also many small to mid-sized businesses that support the local economy. The economy in the Company's Rhode Island market area is primarily oriented to the health care, educational, retail and hospitality industries. The major employers in the Rhode Island area include several hospitals, universities and pharmaceutical manufacturers.
Windham, New London, Tolland, Hartford and Middlesex counties in Connecticut have a total population of 1.6 million and 624,201 total households, according to SNL Financial. For 2018, median household income levels ranged from $67,000 to $87,000 in the five counties we maintain branch offices in Connecticut, compared to $79,000 for Connecticut and $63,000 for the United States, according to published statistics. Newport and Washington counties in Rhode Island have a total population and total households of 209,692 and 85,202,
respectively, according to SNL Financial. Median household income levels in Newport and Washington counties for 2018 ranged from $77,000 to $81,000, compared to $64,000 for Rhode Island, according to published statistics.
The Bank faces significant competition for the attraction of deposits and origination of loans. The most direct competition for deposits has historically come from several financial institutions operating in the Bank’s market area and, to a lesser extent, from other financial service companies, such as brokerage firms, credit unions and insurance companies. The Bank also faces competition for investors’ funds from money market funds and other corporate and government securities. At June 30, 2018, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation (the “FDIC”), the Bank held 24.01% of the deposits in Windham County, Connecticut, which is the largest market share out of the 10 financial institutions with offices in this county. Also, at June 30, 2018, the Bank held 1.09% of the deposits in New London, Tolland, Hartford and Middlesex counties, Connecticut, which is the 14th largest market share out of the 35 financial institutions with offices in these counties. At June 30, 2018, the Bank held 4.85% of the deposits in Newport and Washington counties in Rhode Island, which is the 5th largest market share out of the 11 financial institutions with offices in these counties. Several large national or regional bank holding companies also operate in the Bank’s Connecticut and Rhode Island market areas. These institutions are significantly larger and, therefore, have significantly greater resources and may offer products and services that the Bank does not provide.
The Bank’s competition for loans comes primarily from financial institutions in its market area, and, to a lesser extent, from other financial service providers, such as mortgage companies and mortgage brokers. Competition for loans also comes from the increasing number of non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies.
The Bank expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Changes in federal law permit affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in the financial services industry. Competition for deposits and the origination of loans could limit the Company’s growth in the future.
Risk Management
Overview. Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available for sale securities, that are accounted for on a mark-to-market basis. Other risks the Company faces are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, cyber security, technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers or for the Company to pay its obligations as they become due as a result of unforeseen circumstances. Reputation risk is the risk negative publicity or press, whether true or not, could cause a decline in the Company’s customer base or revenue.
Credit Risk Management. Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. The Company has strengthened its oversight of problem assets by maintaining a Managed Assets Committee. The Committee, which consists of our Chief Executive Officer, Chief Financial Officer and other loan and credit administration officers, meets quarterly to review classified and watch list credits to ensure the appropriateness of the current classification and to attempt to identify any new problem loans. The Board of Directors reviews the Committee’s reports on a quarterly basis.
Lending Activities
General. The Bank’s loan portfolio consists primarily of one- to four-family residential mortgage loans, multi-family and commercial real estate loans and commercial business loans. To a much lesser extent, the loan portfolio includes construction and consumer loans. At December 31, 2018, the Bank had loans held for sale totaling $1.9 million.
The following table summarizes the composition of the Bank’s loan portfolio at the dates indicated. |
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| At December 31, |
| 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
| Amount | | Percent of Total | | Amount | | Percent of Total | | Amount | | Percent of Total | | Amount | | Percent of Total | | Amount | | Percent of Total |
Real estate loans: | (Dollars in Thousands) |
Residential - 1 to 4 family | $ | 384,353 |
| | 29.03 | % | | $ | 397,277 |
| | 31.86 | % | | $ | 417,064 |
| | 33.91 | % | | $ | 417,458 |
| | 35.57 | % | | $ | 430,575 |
| | 40.97 | % |
Multi-family and commercial | 568,889 |
| | 42.96 |
| | 481,998 |
| | 38.66 |
| | 421,668 |
| | 34.29 |
| | 385,341 |
| | 32.84 |
| | 298,320 |
| | 28.38 |
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Construction | 43,320 |
| | 3.27 |
| | 28,765 |
| | 2.31 |
| | 36,026 |
| | 2.93 |
| | 21,786 |
| | 1.86 |
| | 13,579 |
| | 1.29 |
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Total real estate loans | 996,562 |
| | 75.26 |
| | 908,040 |
| | 72.83 |
| | 874,758 |
| | 71.13 |
| | 824,585 |
| | 70.27 |
| | 742,474 |
| | 70.64 |
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Commercial business loans: | | | | | |
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SBA and USDA guaranteed | 68,481 |
| | 5.17 |
| | 89,514 |
| | 7.18 |
| | 116,383 |
| | 9.46 |
| | 145,238 |
| | 12.38 |
| | 118,466 |
| | 11.27 |
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Time share | 39,391 |
| | 2.98 |
| | 50,526 |
| | 4.05 |
| | 51,083 |
| | 4.15 |
| | 55,192 |
| | 4.70 |
| | 45,669 |
| | 4.35 |
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Condominium association | 35,899 |
| | 2.71 |
| | 27,096 |
| | 2.17 |
| | 23,531 |
| | 1.91 |
| | 21,986 |
| | 1.87 |
| | 21,386 |
| | 2.03 |
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Medical loans | 37,454 |
| | 2.83 |
| | 27,803 |
| | 2.23 |
| | 27,180 |
| | 2.21 |
| | 23,445 |
| | 2.00 |
| | 16,507 |
| | 1.57 |
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Other | 97,220 |
| | 7.34 |
| | 88,566 |
| | 7.10 |
| | 79,524 |
| | 6.47 |
| | 45,588 |
| | 3.88 |
| | 49,939 |
| | 4.75 |
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Total commercial business loans | 278,445 |
| | 21.03 |
| | 283,505 |
| | 22.73 |
| | 297,701 |
| | 24.20 |
| | 291,449 |
| | 24.83 |
| | 251,967 |
| | 23.97 |
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Consumer loans: | | | | | |
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Home equity | 47,502 |
| | 3.59 |
| | 53,480 |
| | 4.29 |
| | 55,228 |
| | 4.49 |
| | 53,779 |
| | 4.58 |
| | 51,093 |
| | 4.86 |
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Indirect automobile | — |
| | — |
| | 57 |
| | — |
| | 501 |
| | 0.04 |
| | 1,741 |
| | 0.15 |
| | 3,692 |
| | 0.35 |
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Other | 1,569 |
| | 0.12 |
| | 1,835 |
| | 0.15 |
| | 1,687 |
| | 0.14 |
| | 1,946 |
| | 0.17 |
| | 1,864 |
| | 0.18 |
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Total consumer loans | 49,071 |
| | 3.71 |
| | 55,372 |
| | 4.44 |
| | 57,416 |
| | 4.67 |
| | 57,466 |
| | 4.90 |
| | 56,649 |
| | 5.39 |
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Total loans | 1,324,078 |
| | 100.00 | % | | 1,246,917 |
| | 100.00 | % | | 1,229,875 |
| | 100.00 | % | | 1,173,500 |
| | 100.00 | % | | 1,051,090 |
| | 100.00 | % |
Deferred loan origination costs, net of deferred fees | 3,169 |
| | | | 2,591 |
| | |
| | 2,268 |
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| | 1,735 |
| | | | 1,571 |
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Allowance for loan losses | (14,682 | ) | | | | (12,334 | ) | | |
| | (11,820 | ) | | |
| | (9,863 | ) | | | | (7,797 | ) | | |
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Loans receivable, net | $ | 1,312,565 |
| | | | $ | 1,237,174 |
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| | $ | 1,220,323 |
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| | $ | 1,165,372 |
| | | | $ | 1,044,864 |
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One- to Four-Family Residential Loans. One of the Bank’s primary lending activities is the origination of mortgage loans to enable borrowers to purchase or refinance existing homes or to construct new residential dwellings in its market area. The Bank offers fixed-rate loans with terms of 10, 15, 20 or 30 years. The Bank’s adjustable-rate mortgage loans are based primarily on 30-year amortization schedules. Interest rates and payments on adjustable-rate mortgage loans adjust annually after a one, three, five, seven or ten-year initial fixed period. Borrower demand for adjustable-rate loans versus fixed-rate loans is a function of the level of current and anticipated future interest rates, the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and the initial period interest rates and loan fees for adjustable-rate loans. The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment and the effect each has on the Bank’s interest rate risk. The loan fees charged, interest rates and other provisions of mortgage loans are determined on the basis of the Bank’s pricing criteria and competitive market conditions.
Generally, the Bank does not originate conventional mortgage loans with loan-to-value ratios exceeding 95% and generally originates loans with a loan-to-value ratio in excess of 80% only when secured by first liens on owner-occupied one- to four-family residences. Mortgage loans with loan-to-value ratios in excess of 80% generally
require private mortgage insurance or additional collateral. The Bank requires all properties securing mortgage loans to be appraised by a board approved independent licensed appraiser and requires title insurance on all first mortgage loans. Borrowers must obtain hazard insurance and flood insurance for loans on properties located in a flood zone before closing the loan.
In an effort to provide financing for moderate income and first-time buyers, the Bank offers loans insured by the Federal Housing Administration and the Veterans Administration and participates in the Connecticut Housing Finance Authority Program. The Bank also offers Guaranteed Rural Housing Loans through the USDA. The Bank offers fixed-rate residential mortgage loans through these programs to qualified individuals and originates the loans using modified underwriting guidelines.
Multi-Family and Commercial Real Estate Loans. The origination of multi-family and commercial real estate ("CRE") loans is another primary lending activity of the Bank. Such loans are made throughout its market area and in strategic areas in the surrounding region for the purpose of acquiring, developing, improving or refinancing multi-family and 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. The Bank offers fixed-rate and adjustable-rate multi-family and commercial real estate loans. Adjustable-rate multi-family and commercial real estate loans originate for amortization periods up to 25 years. The Bank may originate loans with 30-year amortization periods in investment commercial real estate and commercial bond finance loan categories only. Interest rates and payments on these loans typically adjust every five years after a five-year initial fixed-rate period. The Bank’s multi-family and commercial real estate loans are generally secured by owner-occupied properties, including churches and retail facilities. These loans are secured by first mortgages that generally do not exceed 75% of the property’s appraised value.
The Bank intends to continue to emphasize making these types of loans, as market conditions permit, as such loans produce yields that are generally higher than one- to four-family residential loans and are more sensitive to changes in market interest rates. At December 31, 2018, the largest outstanding multi-family or commercial real estate loan was $17.0 million. This loan is secured by a single tenant retail property and was performing according to its terms at December 31, 2018.
The Bank maintains an Out-of-Market CRE Market Lending Program. The primary focus of this program is to develop greater investment in commercial real estate loans in the metro-Boston area and the surrounding region. The Bank employs a highly seasoned senior commercial real estate loan officer with significant expertise in lending in this region. Loans originated in this lending area comprise income producing properties representing office, flex, industrial, retail, single credit tenant and residential apartments. These properties have strong income support, favorable demographics and are owned and managed by experienced and financially strong property managers. These loans are predominately shorter-term loan facilities (generally 5-year maturities), which are structured to provide the Bank with strong asset growth, coupled with a focus on credit quality and interest rate risk management. At December 31, 2018, the Bank's exposure in out-of-market CRE market lending was $286.9 million.
Construction and Land Loans. The Bank originates loans to individuals, and to a lesser extent, builders, to finance construction of residential dwellings. The Bank also originates construction loans for commercial development projects, including condominiums, apartment buildings, single-family subdivisions as well as owner-occupied properties used for businesses. Residential construction loans generally provide for the payment of interest only during the construction phase, which is usually twelve months. At the end of the construction phase, the loan generally converts to a permanent mortgage loan. Commercial construction loans generally provide for the payment of interest only during the construction phase, which may range from three to twenty-four months. Loans generally can be made with a maximum loan-to-value ratio of 80% on residential construction, 75% on construction for nonresidential properties and 80% of the lesser of the appraised value or cost of the project on multi-family construction. At December 31, 2018, the largest outstanding commercial construction loan commitment was $13.4 million for the construction of a hotel, of which $3.8 million was outstanding, and the
largest residential construction loan commitment was $688,000, none of which was outstanding. These loans were performing according to their terms at December 31, 2018. Primarily all commitments to fund construction loans require an appraisal of the property by a board approved independent licensed appraiser. Also, inspections of the property are required before the disbursement of funds during the term of the construction loan.
The Bank also originates development land loans to individuals, local contractors and developers to make improvements on approved building lots, subdivisions and condominium projects within two years of the date of the loan. Such loans to individuals generally are written with a maximum loan-to-value ratio based upon the appraised value or purchase price of the land. Maximum loan-to-value ratio on raw land is 50%, while the maximum loan-to-value ratio for land development loans involving approved projects is 65%. The Bank offers fixed-rate land loans and variable-rate land loans that adjust monthly. Land loans totaled $1.4 million at December 31, 2018.
Commercial Business Loans. The Bank originates commercial business loans to a variety of professionals, sole proprietorships and small businesses primarily in its market area. When originating commercial business loans, the Bank considers the financial statements of the borrower, the borrower’s payment history of both corporate and personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, the viability of the industry in which the customer operates and the value of the collateral. At December 31, 2018, the largest outstanding commercial loan was $14.9 million, which is a general obligation bond to a private college and is further secured by a pledge of the unrestricted receipts, revenues, income and other monies of the college. This loan was performing according to its terms at December 31, 2018.
These loans are generally secured by business assets other than real estate, such as business equipment and inventory, in conformance to policy established borrowing base limits. The Bank originates one-year revolving credit facilities to finance short-term working capital needs of businesses to be repaid by business cash flow. In addition, the Bank originates non-revolving credit facilities to provide a period of time during which the business can borrow funds for planned equipment purchases and other improvement expenditures. These loans convert to a term loan at the expiration of a draw period, which is not to exceed twelve months, and will be paid over a predefined amortization period. Additional products such as time notes, letters of credit and equipment lease financing are offered. Additionally, the Bank may purchase the portion of commercial business loans that are fully guaranteed by the SBA or the USDA. At December 31, 2018, purchased SBA and USDA loans totaled $68.5 million.
The Bank utilizes experienced loan officers and staff to offer specialized lending programs to finance capital improvements for residential and commercial condominium associations as well as the time share industry. Condominium association loans are secured with the assigned right to levy and collect special assessments from the individual unit owners. The condominium association loan portfolio consists of 75 loans totaling $35.9 million as of December 31, 2018. The Bank is not involved with the development of time share resorts, but provides financing for investors with loans secured by diverse consumer receivables. The Bank's exposure in time share lending was 16 loans totaling $39.4 million at December 31, 2018.
Consumer Loans. The Bank offers a variety of consumer loans, primarily home equity lines of credit, and, to a lesser extent, loans secured by marketable securities, passbook or certificate accounts, motorcycles, automobiles and recreational vehicles. Generally, the Bank offers automobile loans with a maximum loan-to-value ratio of 100% of the purchase price for new vehicles.
The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and their ability to meet existing obligations and payments on the proposed loans. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount. Home equity lines of credit have adjustable rates of interest that are indexed to the prime rate as reported in The Wall Street Journal. A home equity line of credit may be drawn down by the borrower for a period of nine years and ten months from the date of the loan agreement. During this period, the borrower is only required to make interest-only payments. The borrower has to pay back
the amount outstanding under the line of credit over a term not to exceed fifteen years, beginning at the end of the nine-year and ten month period. The Bank will offer home equity loans with a maximum combined loan-to-value ratio of 80%.
Loan Underwriting Risks. While the Bank anticipates that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate mortgages, the increased mortgage payments required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability and collateral value of the underlying property also may be adversely affected in a high interest rate environment. In addition, although adjustable-rate mortgage loans help make the Bank’s loan portfolio more responsive to changes in interest rates, the extent of this interest sensitivity is limited by annual and lifetime interest rate adjustment limits.
Loans secured by multi-family and commercial real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential mortgage loans. Additionally, many of our multi-family and commercial real estate borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential mortgage loan. Of primary concern in multi-family and commercial real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income-producing properties often depend on the successful operation and management of the properties. As a result, repayment of such loans may be subject, to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy. To monitor cash flows on income-producing properties, the Bank generally requires borrowers and loan guarantors to provide annual financial statements and/or tax returns. In reaching a decision on whether to make a multi-family or commercial real estate loan, consideration is given to the net operating income of the property, the borrower’s expertise, credit history and the profitability and value of the underlying property. The Bank generally requires that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.20. Environmental screens, surveys and inspections are obtained when circumstances suggest the possibility of the presence of hazardous materials. Further, in connection with the ongoing monitoring of the loan, the Bank typically reviews the property, the underlying loan and guarantors annually.
Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction, the estimated cost (including interest) of construction and the ability of the project to be sold upon completion. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, the Bank may be confronted, at or before the maturity of the loan, with a building having a value that is insufficient to assure full repayment. If the Bank is forced to foreclose on a building before or at completion due to a borrower default, the Bank may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property the value of which tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s underlying business. As a result, the availability of funds for the repayment of commercial business loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.
Consumer loans entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. In such cases, repossessed collateral for a defaulted
consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant significant collection efforts against the borrower. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Loan Originations, Purchases, Sales and Servicing. Loan originations come from a number of sources. The primary source of loan originations are the Bank’s in-house loan originators, and, to a lesser extent, advertising and referrals from customers.
The Bank may purchase portions of loans that are fully guaranteed by the SBA or the USDA. The loans are primarily for commercial and agricultural properties located throughout the United States. The Bank did not purchase such loans during the years ended December 31, 2018 or 2017. There were no sales of SBA and USDA loans for the years ended December 31, 2018 and 2017.
The Bank purchased $56.0 million and $36.1 million of multi-family and commercial real estate loans and other commercial business loans in 2018 and 2017, respectively, which included primarily participation loans and medical loans. The Bank performs its own underwriting analysis before purchasing a loan and, therefore, believes there should not be a greater risk of default on these obligations compared to loans the Bank originates itself. However, in a purchased loan, the Bank does not service the loan and thus is subject to the policies and practices of the originating lender with regard to monitoring delinquencies, pursuing collections and instituting foreclosure proceedings. Participation loans are entered into by the Bank with other institutions. Total participation loans entered into by the Bank were $35.0 million for 2018 and $25.0 million for 2017. Medical loans are purchased from a company specializing in medical loan originations. Medical loans are commercial business loans secured by medical equipment and are primarily out of our market area. Total medical loans purchased were $19.4 million and $10.8 million in 2018 and 2017, respectively.
The Bank originates conventional conforming one- to four-family loans which meet Fannie Mae underwriting standards. The Bank sells certain fixed-rate one- to four-family residential conforming loans in the secondary market, primarily on a servicing retained basis. Such loans are sold to Fannie Mae, the Connecticut Housing Finance Authority, the Federal Home Loan Bank of Boston (the "FHLB") under the Mortgage Partnership Finance Program and other third-party correspondents. The decision to sell loans in the secondary market is based on prevailing market interest rate conditions, an analysis of the composition and risk of the loan portfolio, liquidity needs and interest rate risk management. Generally, loans are sold without recourse. The Bank utilizes the proceeds from these sales primarily to meet liquidity needs. Proceeds from the sale of one- to four-family loans totaled $61.1 million and $54.9 million for the years ended December 31, 2018 and 2017, respectively. The Bank intends to continue to originate these types of loans for sale in the secondary market to increase its noninterest income.
At December 31, 2018, the Bank retained the servicing rights on $270.7 million of loans, consisting primarily of fixed-rate mortgage loans sold with or without recourse to third parties. Loan repurchase commitments are agreements to repurchase loans previously sold upon the occurrence of conditions established in the contract, including default by the underlying borrower. At December 31, 2018, there was no exposure amount for loans sold with recourse. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, processing insurance and tax payments on behalf of borrowers, assisting in foreclosures and property dispositions when necessary and general administration of loans.
The following table sets forth the Bank’s loan originations, loan purchases, loan sales, principal repayments, net loan charge-offs and other reductions on loans for the years indicated.
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2018 | | 2017 | | 2016 |
| (In Thousands) |
Total loans at beginning of year | $ | 1,246,917 |
| | $ | 1,229,875 |
| | $ | 1,173,500 |
|
| | | | | |
Originations: | |
| | |
| | |
|
Real estate loans | 276,273 |
| | 175,967 |
| | 194,198 |
|
Commercial business loans | 39,997 |
| | 33,717 |
| | 36,582 |
|
Consumer loans | 19,792 |
| | 24,782 |
| | 26,008 |
|
Total loan originations | 336,062 |
| | 234,466 |
| | 256,788 |
|
| | | | | |
Purchases: | | | | | |
Other commercial loans | 55,951 |
| | 36,123 |
| | 37,702 |
|
Total purchases | 55,951 |
| | 36,123 |
| | 37,702 |
|
| | | | | |
| | | | | |
Deductions: | | | |
| | |
|
Principal loan repayments, prepayments and other, net | 252,925 |
| | 198,315 |
| | 198,309 |
|
Loan sales | 60,910 |
| | 54,099 |
| | 38,227 |
|
Loan charge-offs | 795 |
| | 239 |
| | 450 |
|
Transfers to other real estate owned | 222 |
| | 894 |
| | 1,129 |
|
Total deductions | 314,852 |
| | 253,547 |
| | 238,115 |
|
| | | | | |
Net increase in loans | 77,161 |
| | 17,042 |
| | 56,375 |
|
| | | | | |
Total loans at end of year | $ | 1,324,078 |
| | $ | 1,246,917 |
| | $ | 1,229,875 |
|
Loan Maturity. The following table shows the contractual maturity of the Bank’s loan portfolio at December 31, 2018. The table does not reflect any estimate of prepayments, which significantly shortens the average life of all loans and may cause actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. The amounts shown below exclude deferred loan fees and costs.
|
| | | | | | | | | | | | | | | |
| Amounts Due In |
| One Year or Less | | More Than One Year to Five Years | | More Than Five Years | | Total Amount Due |
| | | |
Real estate loans: | (In Thousands) |
Residential - 1 to 4 family | $ | 139 |
| | $ | 12,873 |
| | $ | 371,341 |
| | $ | 384,353 |
|
Multi-family and commercial | 13,383 |
| | 140,998 |
| | 414,508 |
| | 568,889 |
|
Construction | 4,908 |
| | 3,228 |
| | 35,184 |
| | 43,320 |
|
Total real estate loans | 18,430 |
| | 157,099 |
| | 821,033 |
| | 996,562 |
|
| | | | | | | |
Commercial business loans: | | | | | | | |
SBA and USDA guaranteed | — |
| | 4,435 |
| | 64,046 |
| | 68,481 |
|
Time share | 2,379 |
| | 24,945 |
| | 12,067 |
| | 39,391 |
|
Condominium association | 123 |
| | 3,614 |
| | 32,162 |
| | 35,899 |
|
Medical loans | 378 |
| | 17,166 |
| | 19,910 |
| | 37,454 |
|
Other | 10,615 |
| | 17,235 |
| | 69,370 |
| | 97,220 |
|
Total commercial business loans | 13,495 |
| | 67,395 |
| | 197,555 |
| | 278,445 |
|
| | | | | | | |
Consumer loans: | | | | | | | |
Home equity | 250 |
| | 1,498 |
| | 45,754 |
| | 47,502 |
|
Other | 11 |
| | 194 |
| | 1,364 |
| | 1,569 |
|
Total consumer loans | 261 |
| | 1,692 |
| | 47,118 |
| | 49,071 |
|
| | | | | | | |
Total loans | $ | 32,186 |
| | $ | 226,186 |
| | $ | 1,065,706 |
| | $ | 1,324,078 |
|
While one- to four-family residential real estate loans are normally originated with terms of up to 30 years, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon the sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase, sale and refinancing activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.
The following table sets forth the dollar amount of all scheduled maturities of loans at December 31, 2018 that are due after December 31, 2019, and have either fixed interest rates or adjustable interest rates.
|
| | | | | | | | | | | |
| Due After December 31, 2019 |
| Fixed Rates | | Floating or Adjustable Rates | | Total |
| | |
Real estate loans: | (In Thousands) |
Residential - 1 to 4 family | $ | 294,264 |
| | $ | 89,950 |
| | $ | 384,214 |
|
Multi-family and commercial | 265,582 |
| | 289,924 |
| | 555,506 |
|
Construction | 28,874 |
| | 9,538 |
| | 38,412 |
|
Total real estate loans | 588,720 |
| | 389,412 |
| | 978,132 |
|
| | | | | |
Commercial business loans: | | | | | |
SBA and USDA guaranteed | 33,781 |
| | 34,700 |
| | 68,481 |
|
Time share | 8,606 |
| | 28,406 |
| | 37,012 |
|
Condominium association | 24,570 |
| | 11,206 |
| | 35,776 |
|
Medical loans | 37,076 |
| | — |
| | 37,076 |
|
Other | 53,714 |
| | 32,891 |
| | 86,605 |
|
Total commercial business loans | 157,747 |
| | 107,203 |
| | 264,950 |
|
| | | | | |
Consumer loans: | | | | | |
Home equity | 11,156 |
| | 36,096 |
| | 47,252 |
|
Other | 304 |
| | 1,254 |
| | 1,558 |
|
Total consumer loans | 11,460 |
| | 37,350 |
| | 48,810 |
|
| | | | | |
Total loans | $ | 757,927 |
| | $ | 533,965 |
| | $ | 1,291,892 |
|
Loan Approval Procedures and Authority. The Bank’s lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by the Company’s Board of Directors and management. All residential mortgages and home equity lines of credit in excess of $10.0 million or other consumer loans in excess of $4.0 million require the approval of the Board of Directors. The Loan Committee of the Board of Directors has the authority to approve: (1) residential mortgage loans and consumer home equity lines of credit up to $10.0 million, (2) commercial loans up to the regulatory legal lending limit, and (3) consumer loans up to $4.0 million. The Credit Committee, which consists of members of management, has authority to approve: (1) residential mortgage loans and consumer home equity lines of credit up to $4.0 million, (2) commercial loans up to $8.0 million, and (3) consumer loans up to $2.0 million. The President and Chief Lending Officer have approval authority for: (1) residential mortgage loans that conform to Fannie Mae and Freddie Mac standards up to $4.0 million or $417,000 for those that are nonconforming, (2) home equity lines of credit up to $4.0 million, and (3) consumer loans up to $250,000 individually or $1.0 million jointly. The President and Chief Lending Officer have approval authority for commercial real estate and other commercial loans up to $1.0 million individually or $2.0 million jointly. Additionally, certain loan and branch administration personnel have the authority to approve residential mortgage loans, home equity lines and consumer loans up to certain limits as specified in the Bank's loan policy.
Loans to One Borrower. The maximum amount that the Bank may lend to one borrower and the borrower’s related entities is limited, by regulation, to 15% of the Bank’s stated capital and reserves. At December 31, 2018, the Bank’s general regulatory limit on loans to one borrower was approximately $25.4 million. At that date, the Bank’s largest lending relationship was $20.5 million, representing commercial real estate loans on office buildings. These loans were performing according to their original terms at December 31, 2018.
Loan Commitments. The Bank issues commitments for fixed- and adjustable-rate mortgage loans conditioned upon the occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements
to lend to customers. Generally, our mortgage loan commitments expire in 60 days or less from the date of the application.
Delinquencies. When a borrower fails to make a required loan payment, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status. The Bank makes initial contact with the borrower when the loan becomes 15 days past due. If payment is not then received by the 30th day of delinquency, additional letters and phone calls generally are made. When the loan becomes 90 days past due, a letter is sent notifying the borrower foreclosure proceedings will commence if the loan is not brought current within 30 days. Generally, when the loan becomes 120 days past due, the Bank will commence foreclosure proceedings against any real property that secures the loan or attempt to repossess any personal property that secures a consumer or commercial loan. If a foreclosure action is instituted and the loan is not brought current, paid in full or refinanced before the foreclosure sale, the real property securing the loan is typically sold at foreclosure. The Bank may consider loan repayment arrangements with certain borrowers under certain circumstances.
Management reports monthly to the Board of Directors or a committee of the Board regarding the amount of loans delinquent 30 days or more, all loans in foreclosure and all foreclosed and repossessed property that the Bank owns.
The following table provides information about delinquencies in the Bank’s loan portfolio at the dates indicated.
|
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2018 | | December 31, 2017 |
| 60-89 Days | | 90 Days or More | | 60-89 Days | | 90 Days or More |
| | | | | | | | | | | | | | | |
| Number of Loans | | Principal Balance of Loans | | Number of Loans | | Principal Balance of Loans | | Number of Loans | | Principal Balance of Loans | | Number of Loans | | Principal Balance of Loans |
| | | | | | | |
Real estate loans: | (Dollars in Thousands) |
Residential - 1 to 4 family | 11 | | $ | 1,233 |
| | 15 | | $ | 2,331 |
| | 11 | | $ | 1,582 |
| | 12 | | $ | 1,280 |
|
Multi-family and commercial | 2 | | 295 |
| | 4 | | 1,513 |
| | — | | — |
| | 1 | | 27 |
|
Total real estate loans | 13 | | 1,528 |
| | 19 | | 3,844 |
| | 11 | | 1,582 |
| | 13 | | 1,307 |
|
Commercial business loans: | | | |
| | | | |
| | | | |
| | | | |
|
Medical loans | — | | — |
| | — | | — |
| | 1 | | 99 |
| | — | | — |
|
Other | — | | — |
| | 2 | | 325 |
| | 2 | | 183 |
| | 1 | | 26 |
|
Total commercial business loans | — | | — |
| | 2 | | 325 |
| | 3 | | 282 |
| | 1 | | 26 |
|
Consumer loans: | | | |
| | | | |
| | | | |
| | | | |
|
Home equity | 1 | | 54 |
| | 1 | | 109 |
| | — | | — |
| | — | | — |
|
Indirect automobile | — | | — |
| | — | | — |
| | 1 | | 3 |
| | — | | — |
|
Other | 1 | | 1 |
| | 1 | | 1 |
| | — | | — |
| | — | | — |
|
Total consumer loans | 2 | | 55 |
| | 2 | | 110 |
| | 1 | | 3 |
| | — | | — |
|
Total delinquent loans | 15 | | $ | 1,583 |
| | 23 | | $ | 4,279 |
| | 15 | | $ | 1,867 |
| | 14 | | $ | 1,333 |
|
Classified Assets. Management of the Bank, including the Managed Asset Committee, consisting of a number of the Bank’s officers, review and classify the assets of the Bank on a monthly basis and the Board of Directors reviews the results of the reports on a quarterly basis. Federal regulations and the Bank’s internal policies require that management utilize an internal asset classification system to monitor and evaluate the credit risk inherent in
its loan portfolio. In addition, the Bank's regulators have the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets; substandard, doubtful and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have all the weaknesses inherent in those classified as “substandard” with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high probability of loss. Assets classified as “loss” are those assets considered uncollectible and of such little value that continuance as assets of the institution are not warranted. The regulations also provide for a “special mention” category, described as assets which do not currently expose the Bank to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weakness deserving close attention. If the Bank classifies an asset as a loss, a loan loss allowance in the amount of 100% of the portion of the asset classified as a loss is established or the loan is fully charged-off.
The following table shows the aggregate amounts of the Bank’s criticized and classified assets as of December 31, 2018.
|
| | | | | | | | | | | | | | | |
| | | | | | | Special |
| Loss | | Doubtful | | Substandard | | Mention |
Real estate loans: | (In Thousands) |
Residential - 1 to 4 family | $ | — |
| | $ | — |
| | $ | 7,134 |
| | $ | 1,323 |
|
Multi-family and commercial | — |
| | — |
| | 24,623 |
| | 12,636 |
|
Construction | — |
| | — |
| | — |
| | 9,650 |
|
Total real estate loans | — |
| | — |
| | 31,757 |
| | 23,609 |
|
| | | | | | | |
Commercial business loans: | |
| | |
| | |
| | |
|
Medical Loans | — |
| | — |
| | 15 |
| | — |
|
Other | — |
| | 257 |
| | 218 |
| | 3,750 |
|
Total commercial business loans | — |
| | 257 |
| | 233 |
| | 3,750 |
|
| | | | | | | |
Consumer loans: | |
| | |
| | |
| | |
|
Home equity | — |
| | — |
| | 337 |
| | 121 |
|
Other | — |
| | — |
| | 2 |
| | — |
|
Total consumer loans | — |
| | — |
| | 339 |
| | 121 |
|
Total classified loans | — |
| | 257 |
| | 32,329 |
| | 27,480 |
|
Total criticized and classified assets | $ | — |
| | $ | 257 |
| | $ | 32,329 |
| | $ | 27,480 |
|
| | | | | | | |
At December 31, 2018, total criticized and classified assets were comprised of 47 commercial real estate loans totaling $37.3 million, three construction loans totaling $9.7 million, 51 residential mortgage loans totaling $8.5 million, 13 commercial business loans totaling $4.2 million, seven home equity loans totaling $458,000 and two other consumer loans totaling $2,000. Of the $32.3 million in substandard loans, $9.0 million were nonperforming at December 31, 2018. Substandard loans included residential real estate loans totaling $2.3 million, multi-family and commercial real estate loans totaling $991,000 and other commercial business loans totaling $68,000 that were 90 days or more past due. Doubtful loans included one commercial business loan totaling $257,000 that was 90 days or more past due.
Other than disclosed in the above tables, there were no loans at December 31, 2018 that management has serious doubts about the ability of the borrowers to comply with the present loan repayment terms.
Nonperforming Assets and Restructured Loans. The Bank considers repossessed assets and loans that are 90 days or more past due to be nonperforming assets. Loans are generally placed on nonaccrual status when they become 90 days delinquent at which time the accrual of interest ceases and any previously recorded interest is reversed
and recorded as a reduction of loan interest and fee income. Typically, payments received on a nonaccrual loan are applied to the outstanding principal and interest balance as determined at the time of collection of the loan.
The Bank periodically may agree to modify the contractual terms of loans. When a loan is modified and concessions have been made to the original contractual terms, such as reductions of interest rates or deferral of interest or principal payments, due to the borrower’s financial condition, the modification is considered a troubled debt restructuring (“TDR”). All TDRs are initially classified as impaired. The Bank adheres to its nonaccrual policy for all TDR loans. Loans that were current prior to modification would not require nonaccrual status subsequent to the modification. If the accrual of interest was suspended on the loan prior to the modification or if the payment amount significantly increased subsequent to the modification, the loan would remain on nonaccrual status until the borrower demonstrates the willingness and the ability to make the restructured loan payments for a period of six consecutive months.
Real estate acquired as a result of foreclosure or by deed-in-lieu of foreclosure is classified as a foreclosed asset until it is sold. When property is acquired, it is recorded at fair value, net of estimated selling expenses. Holding costs and declines in fair value after acquisition of the property result in charges to earnings.
The following table provides information with respect to the Bank’s nonperforming assets and TDRs as of the dates indicated.
|
| | | | | | | | | | | | | | | | | | | | |
| | At December 31, |
| | 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
Nonaccrual loans: | (Dollars in Thousands) |
Real estate loans: | | | | | | | | | |
Residential - 1 to 4 family | $ | 3,657 |
| | $ | 2,405 |
| | $ | 3,425 |
| | $ | 3,894 |
| | $ | 3,167 |
|
Multi-family and commercial | 5,104 |
| | 3,482 |
| | 1,056 |
| | 2,167 |
| | 907 |
|
Total real estate loans | 8,761 |
| | 5,887 |
| | 4,481 |
| | 6,061 |
| | 4,074 |
|
Commercial business loans | 325 |
| | 324 |
| | 593 |
| | 339 |
| | 446 |
|
Consumer loans: | | | | | | | | | |
Home equity | 208 |
| | 192 |
| | 353 |
| | 183 |
| | 23 |
|
Other | 2 |
| | 1 |
| | 6 |
| | — |
| | — |
|
Total consumer loans | 210 |
| | 193 |
| | 359 |
| | 183 |
| | 23 |
|
Total nonaccrual loans | 9,296 |
| | 6,404 |
| | 5,433 |
| | 6,583 |
| | 4,543 |
|
| | | | | | | | | |
Accruing loans past due 90 days or more: | | | | | | | | | |
Commercial business loans | 522 |
| | — |
| | — |
| | — |
| | 459 |
|
Total accruing loans past due 90 days or more | 522 |
| | — |
| | — |
| | — |
| | 459 |
|
Total nonperforming loans | 9,818 |
| | 6,404 |
| | 5,433 |
| | 6,583 |
| | 5,002 |
|
| | | | | | | | | |
Other real estate owned, net (1) | 720 |
| | 1,226 |
| | 1,466 |
| | 1,088 |
| | 1,271 |
|
Total nonperforming assets | 10,538 |
| | 7,630 |
| | 6,899 |
| | 7,671 |
| | 6,273 |
|
Accruing troubled debt restructurings | 9,731 |
| | 9,438 |
| | 9,982 |
| | 4,659 |
| | 3,387 |
|
Total nonperforming assets and troubled debt restructurings | $ | 20,269 |
| | $ | 17,068 |
| | $ | 16,881 |
| | $ | 12,330 |
| | $ | 9,660 |
|
| | | | | | | | | |
Total nonperforming loans to total loans | 0.74 | % | | 0.51 | % | | 0.44 | % | | 0.56 | % | | 0.48 | % |
Total nonperforming loans to total assets | 0.60 |
| | 0.41 |
| | 0.35 |
| | 0.44 |
| | 0.37 |
|
Total nonperforming assets and troubled debt restructurings to total assets | 1.23 |
| | 1.08 |
| | 1.09 |
| | 0.83 |
| | 0.72 |
|
| | | | | | | | | | |
| |
(1) | Other real estate owned balances are shown net of related write-downs or valuation allowance. |
The increase in nonperforming assets was primarily due to increases of $1.6 million in nonperforming multi-family and commercial real estate loans and $1.3 million in residential real estate loans. Nonaccrual loans consisted of 26 residential one- to four-family loans, six commercial real estate loans, three home equity loans, two commercial business loans and three consumer loans.
Other real estate owned decreased $506,000 from December 31, 2017 to $720,000 at December 31, 2018. During 2018, the Bank acquired two residential properties with a net carrying value of $222,000 and sold four residential properties with a net carrying value of $515,000 and one commercial property with a net carrying value of $131,000.
At December 31, 2018 and 2017, TDRs totaled $12.6 million and $13.1 million, respectively, as a result of interest rate concessions, deferral of principal payments, extension of maturity or a combination of these items. Of the TDRs at December 31, 2018, $9.7 million continued to accrue interest under the restructured terms of their agreements while the accrual of interest was suspended on loans totaling $2.9 million. As of December 31, 2018, there were no TDRs that were in payment default. All TDRs were performing in accordance with the terms of their restructured loan agreements.
Interest income that would have been recorded for the year ended December 31, 2018 had nonaccruing loans and TDRs been current in accordance with their original terms and had been outstanding throughout the period amounted to $445,000. The amount of interest recognized on impaired loans was $692,000 for the year ended December 31, 2018.
Loans Acquired with Deteriorated Credit Quality. Loans acquired in a transfer, including business combinations, where there is evidence of credit deterioration since origination and it is probable at the date of acquisition the Company will not collect all contractually required principal and interest payments, are accounted for under accounting guidance for purchased credit-impaired loans. This guidance provides that the excess of the cash flows initially expected to be collected over the fair value of the loans at the acquisition date (i.e., the accretable yield) is accreted into interest income over the estimated remaining life of the loans, provided the timing and amount of future cash flows is reasonably estimable. Such loans are considered to be accruing because their interest income relates to the accretable yield and not to contractual interest payments. The difference between the contractually required payments and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. Subsequent to acquisition, probable decreases in expected cash flows are recognized through a provision for loan losses, resulting in an increase to the allowance for loan losses. If the Company has probable and significant increases in cash flows expected to be collected, the Company will first reverse any previously established allowance for loan losses and then increase interest income as a prospective yield adjustment.
Allowance for Loan Losses. The allowance for loan losses, a material estimate which could change significantly in the near-term, is established through a provision for loan losses charged to earnings to account for losses inherent in the loan portfolio and estimated to occur, and is maintained at a level management considers adequate to absorb losses in the loan portfolio. Loan losses are charged against the allowance for loan losses when management believes the uncollectibility of the principal loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for loan losses when received. In the determination of the allowance for loan losses, management obtains independent appraisals for significant properties, when necessary.
Management's judgment in determining the adequacy of the allowance is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses is evaluated on a monthly basis by management and is based on the evaluation of the known and inherent risk characteristics and size and composition of the loan portfolio, the assessment of current economic and real estate market conditions, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, historical loan loss experience, level and trends of nonperforming loans, delinquencies, classified assets and loan charge-offs and evaluations of loans and other relevant factors.
The allowance for loan losses consists of the following key elements:
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◦ | Specific allowance for identified impaired loans. For loans identified as impaired, an allowance is established when the present value of expected cash flows (or observable market price of the loan or fair value of the collateral if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan. |
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◦ | General valuation allowance. The general component represents a valuation allowance on the remainder of the loan portfolio, after excluding impaired loans. For this portion of the allowance, loans are segregated by category and assigned an allowance percentage based on historical loan loss experience adjusted for qualitative factors stratified by the following loan segments: residential one- to four-family, multi-family and commercial real estate, construction, commercial business and consumer. Management uses a rolling average of historical losses based on the time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: changes in lending policies and procedures, including changes in underwriting standards and collections, charge-off and recovery practices; changes in national, regional and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments; changes in the size and composition of the loan portfolio and in the terms of the loans; changes in the experience, ability and depth of lending and underwriting management and other relevant staff; changes in the volume and severity of past due loans, the volume of nonaccrual loans and the volume and severity of adversely classified or graded loans; changes in the quality of the loan review system; changes in the underlying collateral for collateral-dependent loans; the existence and effect of any concentrations of credit and changes in the level of such concentrations; the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the portfolio. |
In computing the allowance for loan losses, we do not assign a general valuation allowance to the SBA and USDA loans we purchase as such loans are fully guaranteed. Such loans accounted for $68.5 million, or 5.2% of the loan portfolio, at December 31, 2018.
The majority of the Company's loans are collateralized by real estate located in eastern Connecticut, Rhode Island and the Boston metro area. Certain commercial real estate loans are secured by collateral located outside of our primary market area. Accordingly, the collateral value of a substantial portion of the Company's loan portfolio and real estate acquired through foreclosure is susceptible to changes in local market conditions.
Although management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and the Company’s results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while management believes it has established the allowance for loan losses in conformity with generally accepted accounting principles ("GAAP") in the United States of America, our regulators, in reviewing the loan portfolio, may require the Company to increase its allowance for loan losses based on judgments different from those of the Company. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate or increases may be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses would adversely affect the Company’s financial condition and results of operations.
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2018 | | 2017 | | 2016 |
| Amount | | % of Allowance in each Category to Total Allowance | | % of Loans in each Category to Total Loans | | Amount | | % of Allowance in each Category to Total Allowance | | % of Loans in each Category to Total Loans | | Amount | | % of Allowance in each Category to Total Allowance | | % of Loans in each Category to Total Loans |
Real estate loans: | (Dollars in Thousands) |
Residential - 1 to 4 family | $ | 1,196 |
| | 8.15 | % | | 29.03 | % | | $ | 1,093 |
| | 8.86 | % | | 31.86 | % | | $ | 1,149 |
| | 9.72 | % | | 33.91 | % |
Multi-family and commercial | 8,140 |
| | 55.44 |
| | 42.96 |
| | 6,627 |
| | 53.73 |
| | 38.66 |
| | 5,724 |
| | 48.43 |
| | 34.29 |
|
Construction | 1,120 |
| | 7.63 |
| | 3.27 |
| | 633 |
| | 5.13 |
| | 2.31 |
| | 952 |
| | 8.05 |
| | 2.93 |
|
Commercial business: | | | | | | | | | | | | | | | | | |
SBA & USDA guaranteed | — |
| | — |
| | 5.17 |
| | — |
| | — |
| | 7.18 |
| | — |
| | — |
| | 9.46 |
|
Time share | 197 |
| | 1.34 |
| | 2.98 |
| | 581 |
| | 4.71 |
| | 4.05 |
| | 639 |
| | 5.41 |
| | 4.15 |
|
Condominium association | 179 |
| | 1.22 |
| | 2.71 |
| | 312 |
| | 2.53 |
| | 2.17 |
| | 294 |
| | 2.49 |
| | 1.91 |
|
Medical loans | 1,107 |
| | 7.53 |
| | 2.83 |
| | 820 |
| | 6.65 |
| | 2.23 |
| | 815 |
| | 6.89 |
| | 2.21 |
|
Other | 2,116 |
| | 14.42 |
| | 7.34 |
| | 1,595 |
| | 12.93 |
| | 7.10 |
| | 1,518 |
| | 12.84 |
| | 6.47 |
|
Consumer loans: | | | | | | | | | | | | | | | | | |
Home equity | 598 |
| | 4.07 |
| | 3.59 |
| | 630 |
| | 5.11 |
| | 4.29 |
| | 685 |
| | 5.80 |
| | 4.49 |
|
Indirect automobile | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 4 |
| | 0.03 |
| | 0.04 |
|
Other | 29 |
| | 0.20 |
| | 0.12 |
| | 43 |
| | 0.35 |
| | 0.15 |
| | 40 |
| | 0.34 |
| | 0.14 |
|
Total allowance for loan losses | $ | 14,682 |
| | 100.00 | % | | 100.00 | % | | $ | 12,334 |
| | 100.00 | % | | 100.00 | % | | $ | 11,820 |
| | 100.00 | % | | 100.00 | % |
|
| | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2015 | | 2014 |
| Amount | | % of Allowance in each Category to Total Allowance | | % of Loans in each Category to Total Loans | | Amount | | % of Allowance in each Category to Total Allowance | | % of Loans in each Category to Total Loans |
Real estate loans: | (Dollars in Thousands) |
Residential - 1 to 4 family | $ | 1,036 |
| | 10.50 | % | | 35.57 | % | | $ | 955 |
| | 12.25 | % | | 40.97 | % |
Multi-family and commercial | 5,033 |
| | 51.03 |
| | 32.84 |
| | 3,607 |
| | 46.26 |
| | 28.38 |
|
Construction | 516 |
| | 5.23 |
| | 1.86 |
| | 254 |
| | 3.26 |
| | 1.29 |
|
Commercial business: | | | | | | | | | | | |
SBA & USDA guaranteed | — |
| | — |
| | 12.38 |
| | — |
| | — |
| | 11.27 |
|
Time share | 690 |
| | 7.00 |
| | 4.70 |
| | 685 |
| | 8.78 |
| | 4.35 |
|
Condominium association | 330 |
| | 3.35 |
| | 1.87 |
| | 321 |
| | 4.12 |
| | 2.03 |
|
Medical loans | 703 |
| | 7.13 |
| | 2.00 |
| | 495 |
| | 6.35 |
| | 1.57 |
|
Other | 902 |
| | 9.14 |
| | 3.88 |
| | 881 |
| | 11.30 |
| | 4.75 |
|
Consumer loans: | | | | | | | | | | | |
Home equity | 595 |
| | 6.03 |
| | 4.58 |
| | 530 |
| | 6.80 |
| | 4.86 |
|
Indirect automobile | 12 |
| | 0.12 |
| | 0.15 |
| | 26 |
| | 0.33 |
| | 0.35 |
|
Other | 46 |
| | 0.47 |
| | 0.17 |
| | 43 |
| | 0.55 |
| | 0.18 |
|
Total allowance for loan losses | $ | 9,863 |
| | 100.00 | % | | 100.00 | % | | $ | 7,797 |
| | 100.00 | % | | 100.00 | % |
The following table sets forth an analysis of the allowance for loan losses for the years indicated.
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| | | | | | | | | | | | | | | | | | | |
| Years Ended December 31, |
| 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
| (Dollars in Thousands) |
Allowance at beginning of year | $ | 12,334 |
| | $ | 11,820 |
| | $ | 9,863 |
| | $ | 7,797 |
| | $ | 6,916 |
|
| | | | | | | | | |
Provision for loan losses | 3,143 |
| | 661 |
| | 2,190 |
| | 2,509 |
| | 1,539 |
|
| | | | | | | | | |
Charge-offs: | | | |
| | |
| | |
| | |
|
Real estate loans: | | | |
| | |
| | |
| | |
|
Residential - 1 to 4 family | (88 | ) | | (102 | ) | | (208 | ) | | (102 | ) | | (335 | ) |
Multi-family and commercial | — |
| | — |
| | (50 | ) | | (289 | ) | | (144 | ) |
Commercial business loans | (780 | ) | | (79 | ) | | (68 | ) | | (165 | ) | | (164 | ) |
Consumer loans: | | | | | | | | | |
Home equity | — |
| | (53 | ) | | (115 | ) | | — |
| | (40 | ) |
Indirect automobile | — |
| | (3 | ) | | (3 | ) | | — |
| | (32 | ) |
Other | (2 | ) | | (2 | ) | | (6 | ) | | (1 | ) | | (8 | ) |
Total charge-offs | (870 | ) | | (239 | ) | | (450 | ) | | (557 | ) | | (723 | ) |
| | | | | | | | | |
Recoveries: | | | |
| | |
| | |
| | |
|
Real estate loans: | | | |
| | |
| | |
| | |
|
Residential - 1 to 4 family | 14 |
| | 3 |
| | 28 |
| | 74 |
| | 38 |
|
Multi-family and commercial | — |
| | — |
| | 110 |
| | 24 |
| | 1 |
|
Commercial business loans | 43 |
| | 81 |
| | 77 |
| | 15 |
| | 5 |
|
Consumer loans: | | | | | | | | | |
Home equity | 15 |
| | — |
| | — |
| | — |
| | — |
|
Indirect automobile | — |
| | 1 |
| | — |
| | — |
| | 17 |
|
Other | 3 |
| | 7 |
| | 2 |
| | 1 |
| | 4 |
|
Total recoveries | 75 |
| | 92 |
| | 217 |
| | 114 |
| | 65 |
|
Net charge-offs | (795 | ) | | (147 | ) | | (233 | ) | | (443 | ) | | (658 | ) |
| | | | | | | | | |
Allowance at end of year | $ | 14,682 |
| | $ | 12,334 |
| | $ | 11,820 |
| | $ | 9,863 |
| | $ | 7,797 |
|
| | | | | | | | | |
Ratios: | | | |
| | |
| | |
| | |
|
Allowance to total loans outstanding at year end | 1.11 | % | | 0.99 | % | | 0.96 | % | | 0.84 | % | | 0.74 | % |
Allowance to nonperforming loans | 149.54 |
| | 192.60 |
| | 217.56 |
| | 149.83 |
| | 155.88 |
|
Net charge-offs to average loans outstanding during the year | 0.06 |
| | 0.01 |
| | 0.02 |
| | 0.04 |
| | 0.06 |
|
The allowance as a percentage of total loans increased to 1.11% at December 31, 2018 compared to 0.99% at December 31, 2017. The higher provision for loan losses for 2018 was primarily due to increases in nonperforming loans, charge-offs, reserves for impaired loans and an increase in commercial loans, which carry a higher degree of risk than other loans held in the loan portfolio. At December 31, 2018, nonperforming loans totaled $9.8 million compared to $6.4 million at December 31, 2017. An increase of $1.6 million in nonperforming multi-family and commercial real estate loans and an increase of $1.3 million in nonperforming residential real estate loans , contributed to the higher balance of nonperforming loans at December 31, 2018. Specific loan loss allowances relating to impaired loans increased to $1.9 million at December 31, 2018 compared to $482,000 at December 31, 2017.
Investment Activities
The Company has legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, government-sponsored enterprises, state and municipal governments, mortgage-backed securities and certificates of deposit of federally-insured institutions. Within certain regulatory limits, the Company also may invest a portion of its assets in corporate securities and mutual funds. The Company is also required to maintain an investment in FHLB stock and Federal Reserve Bank ("FRB") stock. While the Company has the authority under applicable law and its investment policies to invest in derivative securities, the Company had no such investments at December 31, 2018.
The Company’s primary source of income continues to be derived from its loan portfolio. The investment portfolio is mainly used to meet the cash flow needs of the Company, provide adequate liquidity for the protection of customer deposits and yield a favorable return on excess funds. The type of securities and the maturity periods are dependent on the composition of the loan portfolio, interest rate risk, liquidity position and tax strategies of the Company. The Company’s investment objectives are to provide and maintain liquidity, to maintain a balance of high quality, diversified investments to minimize risk, to provide collateral for pledging requirements, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak, to generate a favorable return and to assist in the financing needs of various local public entities, subject to credit quality review and liquidity concerns.
The Company’s Board of Directors has the overall responsibility for the investment portfolio, including approval of the Company’s Investment Policy and appointment of the Investment Committee. The Investment Committee is responsible for the approval of investment strategies and monitoring investment performance. The execution of specific investment initiatives and the day-to-day oversight of the Company’s investment portfolio is the responsibility of the Chief Executive Officer and the Chief Financial Officer. These officers, and others designated by the Board, are authorized to execute investment transactions up to specified limits based on the type of security without prior approval of the Investment Committee. Transactions exceeding these limitations require the approval of two of these officers designated by the Board, one of whom must be either the Chief Executive Officer or the Chief Financial Officer. Individual investment transactions are reviewed by the Board of Directors on a monthly basis, while portfolio composition and performance are reviewed at least quarterly by the Investment Committee. Management determines the appropriate classification of securities at the date individual securities are acquired, and the appropriateness of such classification is reassessed at each balance sheet date.
Debt securities management has the intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities purchased and held principally for trading in the near term are classified as “trading securities.” These securities are carried at fair value, with unrealized gains and losses recognized in earnings. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss), net of taxes.
At December 31, 2018, the Company’s investment portfolio consisted solely of available for sale securities, totaling $143.8 million, representing 8.7% of assets. The Company’s available for sale securities consisted primarily of “agency” mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae with stated final maturities of 30 years or less, U.S. government and agency obligations, government-sponsored enterprise securities with maturities of 20 years or less, and, to a lesser extent, tax-exempt securities, collateralized debt obligations and obligations of state and political subdivisions with maturities of 30 years or less.
The following table sets forth the amortized costs and fair values of the Company’s securities portfolio at the dates indicated.
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| | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, |
| | 2018 | | 2017 | | 2016 |
| | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
| | | | | | |
| | (In Thousands) |
U.S. Government and agency obligations | $ | 58,296 |
| | $ | 57,038 |
| | $ | 62,749 |
| | $ | 61,768 |
| | $ | 64,894 |
| | $ | 64,296 |
|
Government-sponsored enterprises | 9,969 |
| | 9,945 |
| | 9,212 |
| | 9,217 |
| | 11,267 |
| | 11,364 |
|
Mortgage-backed securities: (1) | |
| | | | |
| | |
| | |
| | |
|
Agency - residential | 74,412 |
| | 72,939 |
| | 79,134 |
| | 78,230 |
| | 78,843 |
| | 78,302 |
|
Non-agency - residential | 51 |
| | 47 |
| | 70 |
| | 65 |
| | 93 |
| | 87 |
|
Collateralized debt obligations | 786 |
| | 826 |
| | 1,090 |
| | 1,124 |
| | 1,157 |
| | 1,157 |
|
Obligations of state and political subdivisions | 500 |
| | 500 |
|