Filed with the SEC from June 28 to July 4:
Chicopee Bancorp (CBNK)
Clover Partners increased its holdings to 486,006 shares (8.7%) after it bought 267,948 shares from May 1 through June 15 at prices in a range of $14.18 to $14.75. Clover said it expects to engage in discussions with the management of the western Massachusetts bank-holding company, but did not disclose plans or proposals.
Chicopee Bancorp, Inc. (the â€śCompanyâ€ť or â€śChicopee Bancorpâ€ť), a Massachusetts corporation, was formed on March 14, 2006 by Chicopee Savings Bank (the â€śBankâ€ť or â€śChicopee Savings Bankâ€ť) to become the holding company for the Bank upon completion of the Bankâ€™s conversion from a mutual savings bank to a stock savings bank. The conversion and the offering were completed on July 19, 2006.
The Bank, a Massachusetts stock savings bank, was organized in 1845 under the name Cabot Savings Bank and adopted its present name in 1854. The Bank is a full-service, community oriented financial institution offering products and services to individuals and businesses through nine offices located in Western Massachusetts. The Bankâ€™s deposits are insured by the Federal Deposit Insurance Corporation (â€śFDICâ€ť) and Depositorâ€™s Insurance Fund (â€śDIFâ€ť) of Massachusetts. The Bank is also a member of the Federal Home Loan Bank of Boston (â€śFHLBâ€ť) and is regulated by the FDIC and the Massachusetts Division of Banks. Chicopee Savings Bankâ€™s business consists primarily of making loans to its customers, including residential mortgages, commercial real estate loans, commercial loans and consumer loans, including home equity loans, and investing in a variety of investments. The Bank funds these lending and investment activities with deposits from the general public, funds generated from operations and borrowings. The Bank also sells residential one-to-four family real estate loans to the secondary market to reduce interest rate risk. The Bankâ€™s revenues are derived from the generation of interest and fees on loans, interest and dividends on investment securities, fees from its retail banking operation, and investment management. The Bankâ€™s primary sources of funds are deposits, principal and interest payments on loans and investments, advances from the FHLB and proceeds from loan sales. The Bank also provides access to insurance and investment products through its Financial Services Division.
The Companyâ€™s website is www.chicopeesavings.com . The Company makes available free of charge, on or through its website, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. Information on the Companyâ€™s website shall not be considered part of this Form 10-K.
Chicopee Savings Bank is headquartered in Chicopee, Massachusetts. The Bankâ€™s primary lending and deposit market areas include Hampden and Hampshire Counties in Western Massachusetts. Chicopee is located at the â€śCrossroads of New Englandâ€ť, the intersection of Interstate 91 and the Massachusetts Turnpike. Interstate 91 is the major north-south highway and Interstate 90 is the major east-west highway that crosses Massachusetts. The city is also bisected by several secondary highways, which include Routes 391, 116, 33 and 141. These roadways provide good access to major highways and centers of employment. Chicopee is located approximately 90 miles west of Boston, Massachusetts, 80 miles southeast of Albany, New York and 30 miles north of Hartford, Connecticut.
Chicopee is an urban community, which serves as the home of the Westover Air Force Base, which is the nationâ€™s largest Air Force Reserve Base and is a key part of the local economy. More than 2,700 military and civilian workers are assigned to Westoverâ€™s 439 th Military Airlift Wing. A diversified mix of industry groups also operate within Hampden and Hampshire County, including manufacturing, health care, higher education, whole sale retail trade and service. The economy of our primary market area has benefited from the presence of large employers such as Baystate Health, Big Y Supermarkets, University of Massachusetts, Mass Mutual Financial Group, Hasbro Games, Peter Pan Bus Lines, Friendlyâ€™s Ice Cream Corporation, Sisters of Providence Health Systems, Westover Air Force Base, Smith and Wesson, Yankee Candle and Verizon. Other employment and economic activity is provided by financial institutions, nine other colleges and universities, eight other hospitals, and a variety of wholesale and retail trade business. Our market also enjoys a strong tourism business with attractions such as the Eastern States Exposition called the Big E, the largest fair in the northeast, the Basketball Hall of Fame and Six Flags New England.
We face significant competition in attracting deposits and loans. Our most direct competition for deposits has historically come from the several financial institutions and credit unions operating in our market area and, to a lesser extent, from other financial service companies such as brokerage firms and insurance companies. We also face competition for depositorsâ€™ funds from money market funds, mutual funds and other corporate and government securities. At June 30, 2011, which is the most recent date for which data is available from the FDIC, we held approximately 4.86% of the deposits in Hampden County, which was the 8 th largest market share out of the 20 banks and thrifts with offices in Hampden County. This data does not include deposits held by one of our primary competitors, credit unions, which, as tax-exempt organizations, are able to offer higher rates on deposits than banks. There are also 18 credit unions headquartered in Hampden County, some of the larger of which are headquartered in Chicopee, Massachusetts. In addition, banks owned by large super-regional bank holding companies such as Bank of America Corporation, Sovereign Bancorp, Inc., Citizens Financial Group, First Niagara Financial Group, Inc., and TD Bank, Inc. also operate in our market area. These institutions are significantly larger than us and, therefore, have greater resources.
Our competition for loans comes primarily from financial institutions in our market areas, 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.
We expect 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 the barriers to market entry, allowed banks and other lenders 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 laws 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 our future growth.
General. The Companyâ€™s loan portfolio totaled $447.1 million at December 31, 2011 compared to $433.8 million at December 31, 2010, representing 72.6% and 75.6% of total assets, respectively. In its lending activity, the Company originates one-to-four family real estate loans, commercial real estate loans, residential and commercial construction loans, commercial and industrial loans, home equity lines-of-credit, fixed rate home equity loans and other consumer loans. The Company does not originate loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios. While the Company makes loans throughout Massachusetts, most of its lending activities are concentrated in Hampden and Hampshire counties. Loans originated totaled $143.4 million in fiscal year 2011 and $156.4 million in 2010, including residential mortgage loans sold to the secondary market of $18.0 million and $18.2 million, respectively. Servicing rights are retained on all loans originated and sold into the secondary market.
Residential Real Estate Loans. At December 31, 2011 and 2010, the residential real estate loan portfolio totaled $123.3 million and $132.7 million, or 27.6% and 30.6% of the total loan portfolio, with an average yield of 5.08% and 5.28%, respectively. This yield calculation includes residential construction loan balances and interest income. Residential real estate loans originated totaled $37.9 million and $40.3 million in 2011 and 2010, respectively, including loans sold to the secondary market. Of the residential real estate loans outstanding at December 31, 2011, $103.9 million, or 84.3%, of the total residential real estate loan portfolio, were adjustable rate loans. Total loans serviced for others as of December 31, 2011 and 2010 were $80.7 million and $75.8 million, respectively. Residential real estate loans enable borrowers to purchase or refinance existing homes, most of which serve as the primary residence of the owner. We offer fixed-rate and adjustable-rate loans with terms up to 30 years. Borrower demand for adjustable-rate loans versus fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and 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. The loan fees, interest rates and other provisions of mortgage loans are determined by the demand for each in a competitive environment.
We offer fixed-rate residential real estate loans secured by one-to-four family residences with terms between 10 and 30 years. Management establishes the loan interest rates based on market conditions. Interest rates and payments on our adjustable-rate mortgage loans generally adjust annually after an initial fixed period that ranges from one to 10 years. Interest rates and payments on our adjustable-rate loans generally are adjusted to a rate typically equal to 3.50 percentage points above the one-year constant maturity Treasury index. The maximum amount by which the interest rate on our adjustable-rate mortgage loans may be increased or decreased is generally 2 percentage points per adjustment period and the lifetime interest rate cap is generally 6 percentage points over the initial interest rate of the loan. We also offer adjustable-rate mortgage loans that adjust every three years after an initial three-year fixed period and adjustable-rate mortgage loans that adjust every five years after an initial six-year fixed period. Interest rates and payments on these adjustable-rate loans generally are adjusted to a rate typically equal to 3.50 percentage points above the three- and five-year constant maturity Treasury index.
The largest owner-occupied residential real estate loan was $1.8 million and was performing according to its original terms as of December 31, 2011.
All adjustable-rate mortgage loans are underwritten taking the indexed rate into consideration at each adjustment period until the full cap is reached. A Mass Attorney General Important Disclosure (MA Chapter 93A-Determining Affordability of ARM Loans) is completed for each adjustable rate mortgage request, which calculates the overall debt to income based on the initial principal and interest payment along with real estate taxes, insurance, and other monthly payments due from the borrower and also includes the repricing of these payments at each adjustment up to the maximum caps allowed under the note. This process minimizes the risk of qualification at the time the loan reaches the maximum rate for that product.
Adjustable rate mortgage loans help decrease the risk associated with changes in market interest rates by periodically repricing. However, upward adjustment of interest rates is limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan documents. In addition, adjustable rate mortgage loans may increase credit risk because, as interest rates increase, interest payments on adjustable rate loans increase, which increases the potential for defaults by our borrowers. See â€śLoan Underwriting Risksâ€ť below.
While one-to-four-family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon 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 and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.
We generally do not make conventional loans with loan-to-value ratios exceeding 95% at the time the loan is originated. Conventional loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance or additional collateral. We require all properties securing mortgage loans to be appraised by a board-approved independent appraiser. We generally require 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 first-time home buyers, we offer 30-year fixed-rate residential mortgage loans and 10/1 adjustable rate mortgage loans with loan-to-value ratios up to 97%. We offer mortgage loans through this program to qualified individuals and originate the loans using underwriting guidelines as set forth by the Company.
Commercial Real Estate Loans. At December 31, 2011 and 2010, commercial real estate loans totaled $174.8 million and $162.1 million, or 39.1% and 37.4% of the total loan portfolio, with an average yield of 5.77% and 5.99%, respectively. This yield calculation includes commercial construction and residential investment loan balances and interest income. Our commercial real estate and residential investment loans are generally secured by apartment buildings and properties used for business purposes such as office buildings, industrial facilities and retail facilities. In addition to originating these loans, we also participate in loans with other financial institutions located primarily in Massachusetts.
We originate a variety of fixed- and adjustable-rate commercial real estate and residential investment loans for terms up to 20 years. Interest rates and payments on our adjustable-rate loans adjust every one to ten years and generally are adjusted to a rate equal to 2.0% to 3.0% above the corresponding U.S. Treasury rate or FHLB rate. Most of our adjustable-rate commercial real estate and residential investment loans adjust every five years. There are no adjustment period or lifetime interest rate caps. Loan amounts generally do not exceed 80% of the propertyâ€™s appraised value at the time the loan is originated.
At December 31, 2011, our largest commercial real estate loan was $4.8 million and was secured by an industrial building in Chicopee, Massachusetts. This loan was performing according to the original terms at December 31, 2011.
At December 31, 2011, our exposure to commercial real estate and commercial business loan participations purchased and sold totaled $16.0 million and $13.0 million, respectively. The properties securing these loans are located primarily in Massachusetts.
We also originate land loans primarily to local contractors and developers for making improvements on approved building lots. Such loans are generally written with a maximum 75% loan-to-value ratio based upon the appraised value or purchase price, whichever is less, for a term of up to three years. Interest rates on our land loans are fixed for three years. At December 31, 2011, we had eight land loans totaling $470,000.
Construction Loans. At December 31, 2011 and 2010, the Company had $37.3 million and $33.1 million of construction loans outstanding, representing 8.3% and 7.6% of the total loan portfolio, respectively. We originate fixed-rate and adjustable-rate loans to individuals and builders to finance the construction of residential dwellings. We also make construction loans for commercial development projects, including apartment buildings, condominiums, small industrial buildings and retail and office buildings. Our construction loans generally provide for the payment of interest only during the construction phase, which is usually 12 to 36 months. At the end of the construction phase, the loan generally converts to a permanent mortgage loan. Loans generally can be made with a maximum loan to value ratio of 80% at the time the loan is originated. Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also will require an inspection of the property before disbursement of funds during the term of the construction loan.
At December 31, 2011, our largest outstanding residential construction loan was $500,000, of which $480,000 was outstanding. At December 31, 2011, our largest outstanding commercial construction loan was $6.3 million, of which $305,000 was outstanding for the development of an office building. These loans were performing in accordance with their original terms at December 31, 2011.
Commercial and Industrial Loans. The Company originated $39.0 million and $54.0 million in commercial loans in 2011 and 2010, respectively. As of December 31, 2011 and 2010, the Company had $79.4 million and $72.8 million in commercial loans, representing 17.8% and 16.8% of the total loan portfolio, with an average yield of 4.39% and 4.59%, respectively. We make commercial business loans primarily in our market area to a variety of professionals, sole proprietorships and small businesses. Commercial lending products include term loans, revolving lines of credit and letters of credit loans. Commercial loans and lines of credit are made with either variable or fixed rates of interest. Variable rates are based on the prime rate as published in The Wall Street Journal , plus a margin. Fixed-rate business loans are generally indexed to a corresponding U.S. Treasury rate, plus margin, or FHLB, plus margin. The Company generally does not make unsecured commercial loans.
When making commercial loans, we consider the financial statements of the borrower, our lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral, primarily accounts receivable, inventory and equipment, and are supported by personal guarantees. Depending on the collateral used to secure the loans, commercial loans are made in amounts of up to 80% of the value of the collateral securing the loan. The collateral securing commercial loans may depreciate over time, may be difficult to appraise and may fluctuate in value. See â€śLoan Underwriting Risksâ€ť below.
At December 31, 2011, our largest commercial term loan was a $2.6 million loan secured by real estate located in East Longmeadow, Massachusetts, including all assets of the borrower. The loan was performing according to its original terms at December 31, 2011. Our largest lending exposure was a $13.3 million commercial lending relationship, of which $10.0 million was outstanding at December 31, 2011. The loans that comprised this relationship are secured by the assets of the borrower, including commercial real estate. The loans were performing in accordance with their original terms at December 31, 2011.
Consumer Loans. The Company originated $9.3 million and $10.3 million of consumer loans in 2011 and 2010, respectively. At December 31, 2011 and 2010, consumer loans outstanding totaled $32.4 million and $33.1 million, or 7.3% and 7.6%, of the total loan portfolio, with an average yield of 4.52% and 4.85%, respectively. We offer a variety of consumer loans, primarily home equity loans and lines of credit, and, to a much lesser extent, loans secured by automobiles and recreational vehicles and pools and spas and home improvement loans.
The procedures for underwriting consumer loans include an assessment of the applicantâ€™s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicantâ€™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.
We generally offer home equity loans with a maximum combined loan to value ratio of 80% and home equity lines of credit with a maximum combined loan to value ratio of 80%. Home equity lines of credit have adjustable rates of interest that are indexed to the prime rate as reported in The Wall Street Journal. Home equity loans have fixed interest rates and terms that range from five to 20 years.
We offer automobile and recreational vehicle loans secured by new and used vehicles. These loans have fixed interest rates and generally have terms up to six years for new automobiles, five years for used automobiles and four years for recreational vehicles. We also offer fixed-rate pool and spa loans up to $10,000 for terms up to five years.
Loan Underwriting Risks
Adjustable-Rate Loans. While we anticipate adjustable-rate loans will better offset the potential 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 of the underlying property also may be adversely affected in a high interest rate environment. In addition, although adjustable-rate mortgage loans help make our loan portfolio more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.
Commercial Real Estate. Loans secured by commercial real estate and residential investment real estate generally have larger balances and involve a greater degree of risk than one-to four-family residential mortgage loans. Of primary concern in commercial real estate and residential investment lending is the borrowerâ€™s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on 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 properties, we generally require borrowers and loan guarantors, if any, to provide annual financial statements and/or tax returns on commercial real estate and residential investment loans. In reaching a decision on whether to make a commercial real estate and residential investment loan, we consider the net operating income of the property, the borrowerâ€™s expertise, credit history and profitability and the value of the underlying property. We have generally required 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 1.20x; however, this ratio can be lower depending on the amount and type of collateral. Environmental surveys and inspections are obtained when circumstances suggest the possibility of the presence of hazardous materials.
We underwrite all loan participations to our own underwriting standards. In addition, we also consider the financial strength and reputation of the lead lender. To monitor cash flows on loan participations, we require the lead lender to provide annual financial statements for the borrower. Generally, we also conduct an annual internal loan review for loan participations.
Construction Loans. 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 propertyâ€™s value at completion of construction and the estimated cost (including interest) of construction. 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, we 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, we may be confronted, at or before the maturity of the loan, with a building having a value which is insufficient to assure full repayment. If we are forced to foreclose on a building before or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
Commercial Loans. Unlike residential mortgage loans, which generally are made on the basis of the borrowerâ€™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 loans are of higher risk and typically are made on the basis of the borrowerâ€™s ability to make repayment from the cash flow of the borrowerâ€™s business. As a result, the availability of funds for the repayment of commercial 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. Consumer loans may entail greater risk than do 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 further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrowerâ€™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 that can be recovered on such loans.
Loan Originations, Purchases, and Sales. Loan originations come from a number of sources. The primary sources of loan originations are existing customers, walk-in traffic, advertising and referrals from customers. We advertise on television, on the radio and in newspapers that are widely circulated in Hampden and Hampshire Counties, both in Massachusetts. Accordingly, because our rates are competitive, we attract loans from throughout Hampden and Hampshire Counties. We occasionally purchase participation interests in loans to supplement our origination efforts.
We generally originate loans for our portfolio; however, we generally sell, prior to funding, to the secondary market all newly originated conforming fixed-rate, 10- to 30-year one-to-four-family residential real estate loans. Our decision to sell loans is based on prevailing market interest rate conditions and interest rate risk management. Generally, loans are sold to Freddie Mac with loan servicing retained. In addition, we sell participation interests in commercial real estate loans to local financial institutions, primarily on the portion of loans that exceed our borrowing limits.
Loan Approval Procedures and Authority. Our lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by our board of directors and management. Our Board of Directors has granted loan approval authority to certain officers up to prescribed limits, depending on the officerâ€™s experience, the type of loan and whether the loan is secured or unsecured. Loans in excess of the Senior Lending Officer limits ($500,000 for real estate loans, secured consumer loans, and secured and unsecured commercial loans; and $100,000 for unsecured consumer loans.) must be authorized by the President and the Executive Vice President of Lending up to 1.5 times the Senior Lending Officer lending limits. All other extensions of credit exceeding such limitations require the approval of the executive committee, a committee of the Board of Directors of the Bank.
Thomas J. Bardon is the Treasurer of Chicopee Provision Co., Inc., a meat manufacturing company and home of the Blue Seal brand operating in Chicopee since 1920. Mr. Bardon serves on the Companyâ€™s Executive Committee and serves as Chairman on the Nominating and Corporate Governance Committee. Mr. Bardon was the owner and operator of Custom Electronics, formerly operating in Chicopee . Mr. Bardon brings to the Board tremendous experience of operating two very successful local businesses. Age 71. Director since 1981.
James H. Bugbee is the Vice President and Treasurer of Granfield, Bugbee & Masse Insurance Agency. Mr. Bugbee serves on the Executive Committee and the Bankâ€™s Compliance and CRA Committee. Mr. Bugbee holds a Bachelor of Science degree in Business Administration from Western New England University. He served as the past President/Chairman of several local non-profit organizations, including the Chicopee Boys & Girls Club. His expertise in the insurance industry, knowledge of the community, and business contacts are a value to the Company. Age 49. Director since 1996.
Douglas K. Engebretson is the Vice President and a Director of Tessier Associates, Inc., an architecture and interior design firm providing services for Western New England since 1923. Mr. Engebretson currently serves on the Executive and Compensation Committees. Mr. Engebretson received his Bachelor of Architecture degree from the University of Arizona. Among his professional affiliations, he is on the board of the National Architectural Accrediting Board. He recently served on the board of directors of the National Council of Architectural Registration Board, as their President. He is also a member of the Massachusetts Board of Registration of Architects. Mr. Engebretson is a recipient of the Fellowship, Group Study Exchange Award to Norway, by Rotary International. Mr. Engebretson brings to the Board a unique perspective of the market from a developers perspective along with local business and community contacts. Age 65. Director since 2000.
Gary G. Fitzgerald is a Certified Public Accountant and a Principal and Treasurer of Downey, Sweeney, Fitzgerald & Co., P.C. a Certified Public Accounting Firm. Mr. Fitzgerald served on the Board of Corporators of the Bank from 1993 until its dissolution in 2006. He holds a Masters of Science in Taxation degree. His extensive accounting background makes him a valuable asset to the Audit Committee, and he has been designated by the Board as the Companyâ€™s Financial Expert. Age 45. Director since 2009.
Paul C. Picknelly is a hotel owner and operator, as well as a commercial real estate developer. Mr. Picknelly currently serves as President of the Sheraton Springfield, the Hilton Garden Inn in Springfield and Worcester and the Country Inn & Suites in Holyoke. Mr. Picknelly also serves as President of the Monarch Place Office Complex. Mr. Picknelly currently serves on the Audit Committee and brings to the Board his unique and extensive knowledge of the local economy from a hotel management and real estate developer perspective as well having many community and political contacts. Age 51. Director since 2000.
MANAGEMENT DISCUSSION FROM LATEST 10K
Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and securities, and interest expense, which is the interest that we pay on our deposits and borrowings. Other significant sources of pre-tax income are service charges fees and commissions, which include service charges on deposit accounts, brokerage fee income and other loan fees (including loan brokerage fees and late charges), income from bank-owned life insurance and income from loan sales and servicing. In addition, we recognize income or losses from the sale of securities available for sale in years that we have such sales.
Allowance for Loan Losses . The allowance for loan losses is a valuation allowance to cover the inherent probable losses in the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, information about specific borrower situations, estimated collateral values, economic conditions, and other factors. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in managementâ€™s judgment, should be charged off.
Expenses. The non-interest expenses we incur in operating our business consist of salaries and employee benefits expenses, occupancy expenses, furniture and equipment expenses, data processing expenses and various other miscellaneous expenses.
Critical Accounting Policies
We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the following to be our critical accounting policies:
Allowance for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Management believes the allowance for loan losses requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on managementâ€™s evaluation of the level of the allowance required in relation to the probable loss exposure in the loan portfolio. The allowance for loan losses is evaluated on a regular basis by management. Qualitative factors, or risks considered in evaluating the adequacy of the allowance for loan losses for all loan classes include historical loss experience; levels and trends in delinquencies, nonaccrual loans, impaired loans and net charge-offs; the character and size of the loan portfolio; effects of any changes in underwriting policies; experience of management and staff; current economic conditions and their effect on borrowers; effects of changes in credit concentrations, and managementâ€™s estimation of probable losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect managementâ€™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 specific and general losses in the portfolio.
Loans considered for impairment include all loan classes of commercial and residential, as well as home equity loans. The classes are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrowerâ€™s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loanâ€™s effective interest rate, the loanâ€™s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment evaluation, except for home equity loans.
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, our banking regulators, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.
Deferred Income Taxes. We use the asset and liability method of accounting for income taxes as prescribed in â€śAccounting for Income Taxesâ€ť. Under this method, deferred tax assets and liabilities 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. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. 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. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. A valuation allowance would result in additional income tax expense in the period, which would negatively affect earnings.
Mortgage Servicing Rights. Mortgage servicing rights associated with loans originated and sold, where servicing is retained, are capitalized and included in other assets in the consolidated balance sheet. Mortgage servicing rights are amortized into non-interest income in proportion to, and over the period of, estimated future net servicing income of the underlying financial assets. Mortgage servicing rights are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for mortgage servicing rights relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of mortgage servicing rights requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the mortgage servicing rights is periodically reviewed for impairment based on a determination of fair value. Impairment, if any, is recognized through a valuation allowance and is recorded as a component of non-interest expense.
Other-Than-Temporary Impairment. â€śAccounting for Certain Investments in Debt and Equity Securities,â€ť â€śThe Meaning of Other-Than-Temporary Impairment and Its Application to Certain Benefits,â€ť and â€śNoncurrent Marketable Equity Securities,â€ť require companies to perform periodic reviews of individual securities in their investment portfolios to determine whether decline in the value of a security is other than temporary. A review of other-than-temporary impairment requires companies to make certain judgments regarding the materiality of the decline, its effect on the financial statements and the probability, extent and timing of a valuation recovery and the companyâ€™s intent and ability to hold the security. Pursuant to these requirements, we assess valuation declines to determine the extent to which such changes are attributable to (1) fundamental factors specific to the issuer, such as financial condition, business prospects or other factors or (2) market-related factors, such as interest rates or equity market declines. Declines in the fair value of securities below their costs that are deemed to be other than temporary are recorded in earnings as realized losses. For declines in the fair value of individual debt securities available-for-sale below their cost that are deemed to be other-than-temporary, where the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before recovery of its amortized cost basis, the other-than-temporary decline in the fair value of the debt security related to 1) credit loss is recognized in earnings and 2) other factors is recognized in other comprehensive income or loss. Credit loss is determined to exist if the present value of expected future cash flows using the effective rate at acquisition is less than the amortized cost basis of the debt security. For individual debt securities where the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost, the other-than-temporary impairment is recognized in earnings equal to the difference between the securityâ€™s cost basis and its fair value at the balance sheet date. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Continuing to increase our commercial relationships in our expanding market area. We have diversified our loan portfolio beyond residential loans by increasing our commercial relationships. Our commercial real estate, commercial construction and commercial and industrial loan portfolio has increased $90.2 million, or 46.1%, from $195.7 million, or 51.2% of the total loan portfolio, at December 31, 2007 to $285.9 million, or 64.0% of the total loan portfolio, at December 31, 2011. Business deposit accounts have increased $29.9 million, or 128.3%, from $23.3 million at December 31, 2007 to $53.2 million at December 31, 2011. In order to support the growth in the commercial loan portfolio, we have also increased the number of commercial lenders and commercial lending administrative staff.
Increasing our deposit market share in our expanding market area. Retail deposits are our primary source of funds for investing and lending. By offering a variety of deposit products, special and tiered pricing, and superior customer service, we will seek to retain and expand existing customer relationships as well as attract new deposit customers. Personalized service and flexibility with regard to customer needs will continue to be augmented with a full array of delivery channels to maximize customer convenience. These include drive-up banking, ATMs, internet banking, automated bill payment, remote capture, and telephone banking. Through our continued focus on these deposit-gathering efforts in existing branch locations, couple with our plans for geographic expansion, we expect to increase the overall level of deposits and our market share in the markets we serve.
In addition, historically, one of our primary competitors for retail deposits in the Chicopee market area has been credit unions. Credit unions are formidable competitors since, as tax-exempt organizations, they are able to offer higher rates on retail deposits than banks. By expanding our market area beyond the immediate Chicopee market area, and beyond the market areas of our larger credit union competitors, we intend to increase our overall deposit market share of Hampden County.
Increasing our sale of non-deposit investment products. Our profits rely heavily on the spread between the interest earned on loans and securities and interest paid on deposits and borrowings. In order to decrease our reliance on interest rate spread income we have pursued initiatives to increase non-interest income. We offer non-deposit investment products, including mutual funds, annuities, pension plans, life insurance, long-term care and 529 college savings plans through a third party registered broker-dealer, Linsco/Private Ledger. This initiative generated $232,000, $183,000 and $142,000 of non-interest income during the years ended December 31, 2011, 2010, and 2009, respectively. In connection with our expanding branch network, we intend to continue to increase our sale of non-deposit investment products by engaging one additional retail investment employee to serve customers of our anticipated branch expansion.
Improving operating efficiency and cost control. Non-interest expense increased $725,000, or 4.0%, from $18.0 million, or 3.24% of average total assets, at December 31, 2010 to $18.7 million, or 3.21% of average total assets, at December 31, 2011. The increase in expenses was largely due to the increase in salaries and benefits of $488,000, or 4.7%, and an increase in FDIC insurance premium fees of $115,000, or 27.3%. In 2011, despite the 4.0% increase in non-interest expense, we were able to decrease the non-interest expense ratio as a percentage of average assets from 3.24% at December 31, 2010 to 3.21% at December 31, 2011 due to the increase in average assets. We recognize that our growth strategies have required greater investments in personnel, marketing, premises and equipment which have had a negative impact on our expense ratio over the short term. Our non-interest expenses are also impacted as a result of the financial, accounting, legal and compliance and other additional expenses usually associated with operating as a public company. We will also recognize additional annual employee compensation and benefit expenses stemming from our employee stock ownership plan and options and restricted stock granted to employees and executives. These additional expenses adversely affect our profitability. We recognize expenses for our employee stock ownership plan when shares are committed to be released to participantsâ€™ accounts and recognize expenses for restricted stock awards and stock options over the vesting period of awards made to recipients pursuant to our 2007 Equity Incentive Plan.
Applying disciplined underwriting practices to maintain the high quality of our loan portfolio. We believe that high asset quality is a key to long-term financial success. We have sought to grow and diversify the loan portfolio, while maintaining a high level of asset quality and moderate credit risk, using underwriting standards that we believe are conservative and diligent monitoring and collection efforts. At December 31, 2011, our ratio of nonperforming loans (loans which are 90 or more days delinquent) to total loans was 1.05% of our total loan portfolio. Although we intend to continue our efforts to originate commercial real estate, commercial business and construction loans, we intend to continue our philosophy of managing large loan exposures through our conservative approach to lending.
Comparison of Financial Condition at December 31, 2011 and December 31, 2010
Total Assets. Total assets increased $42.6 million, or 7.4%, from $573.7 million at December 31, 2010 to $616.3 million at December 31, 2011. The increase was primarily due to a $25.3 million, or 70.4%, increase in cash and cash equivalents, an increase in net loans of $13.2 million, or 3.1%, and an increase in investments of $4.4 million, or 6.3%.
Cash and Cash Equivalents. Cash, including correspondent bank balances and federal funds sold, increased $25.3 million, or 70.4%, from $35.9 million at December 31, 2010 to $61.1 million at December 31, 2011.
Investments. The investment securities portfolio, including held-to-maturity and available-for-sale securities, increased $4.4 million, or 6.3%, from $70.1 million at December 31, 2010 to $74.5 million at December 31, 2011. The increase in investments was primarily due an increase of $8.2 million, or 35.2%, in tax-exempt industrial revenue bonds, a $1.5 million, or 12.6%, and increase in certificates of deposit held for investment. These increases were partially offset by a decrease in U.S. Treasury securities of $3.8 million, or 12.4%, and a decrease of $1.8 million, or 45.9%, in collateralized mortgage obligations.
Net Loans. Net loans increased $13.2 million, or 3.1%, from $430.3 million at December 31, 2010 to $443.5 million at December 31, 2011. Commercial real estate loans increased $12.7 million, or 7.8%, commercial and industrial loans increased $6.6 million, or 9.0%, and commercial construction loans increased $5.1 million, or 19.0%. These increases were partially offset by a decrease in one-to four-family residential loans of $9.4 million, or 7.1%, a decrease in residential construction loans of $831,000, or 12.9%, a decrease of $599,000, or 18.9%, in consumer loans and a decrease of $143,000, or 0.5%, in home equity loans. The decrease in residential real estate loans was primarily due to prepayments and refinancing activity attributed to the decline in interest rates to historically low levels. The residential construction portfolio decreased as borrowers completed construction projects and the demand for construction loans decreased due to the economy. In accordance with the Companyâ€™s asset/liability management strategy and in an effort to reduce interest rate risk, the Company sold $18.0 million fixed rate, low coupon residential real estate loans originated in 2011 to the secondary market. The Company currently services $80.7 million in loans sold to the secondary market. Servicing rights will continue to be retained on all loans originated and sold in the secondary market.
Deposits and Borrowed Funds. Total deposits increased $61.4 million, or 15.7%, from $391.9 million at December 31, 2010 to $453.4 million at December 31, 2011. NOW accounts increased $12.2 million, or 83.6%, to $26.8 million, money market accounts increased $31.4 million, or 47.4%, to $97.6 million, demand accounts increased $20.5 million, or 42.4%, to $68.8 million and regular savings accounts increased $2.9 million, or 6.6%, to $47.1 million. These increases were offset by a decrease in certificate of deposits of $5.5 million, or 2.5%, to $213.1 million. The decrease in certificates of deposits was mainly attributed to the strategic run-off of high cost accounts as a result of managementâ€™s focus to lower the cost of deposits and allow higher cost, short-term time deposits to mature without renewals. The $5.5 million, or 2.5%, decrease in certificates of deposit was offset by the $67.0 million, or 38.6%, increase in low cost relationship focused transaction and savings accounts.
Total borrowings, including securities sold under agreement to repurchase of $12.3 million and Federal Home Loan Bank (â€śFHLBâ€ť) advances of $59.3 million, decreased $18.0 million, or 20.1%, to $71.6 million at December 31, 2011. FHLB advances decreased $12.4 million, or 17.3%. On August 11, 2011, the Bank restructured $6.6 million of FHLB advances. Prior to this restructuring, these advances had a weighted average cost of 3.56% and a weighted average maturity term of 32.8 months. After this restructuring, the weighted average cost was reduced by 1.16% to 2.40% and the weighted average maturity term was reduced to 26.7 months. In an effort to decrease the Bankâ€™s interest rate risk from rising interest rates, the Bank took advantage of the Federal Home Loan Bank of Bostonâ€™s program to restructure outstanding advances. Repurchase agreements decreased $5.6 million, or 31.3%, from $18.0 million at December 31, 2010 to $12.4 million at December 31, 2011.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Chicopee Savings Bank is a community-oriented financial institution dedicated to serving the financial services needs of consumers and businesses within its market area. We attract deposits from the general public and use such funds to originate primarily one- to four-family residential real estate loans, commercial real estate loans, commercial loans, multi-family loans, construction loans and consumer loans. At March 31, 2012, we operated out of our main office, lending and operations center, and eight branch offices located in Chicopee, Ludlow, South Hadley, Ware, and West Springfield. All of our offices are located in western Massachusetts.
CRITICAL ACCOUNTING POLICIES
Managementâ€™s discussion and analysis of the Companyâ€™s financial condition is based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such financial statements requires Management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, Management evaluates its estimates, including those related to the allowance for loan losses, other-than-temporary impairment of securities, the valuation of mortgage servicing rights, and the valuation of other real estate owned. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from Managementâ€™s estimates and assumptions under different assumptions or conditions. Additional accounting policies are more fully described in Note 1 in the â€śNotes to Consolidated Financial Statementsâ€ť presented in our 2011 Annual Report on Form 10-K. A brief description of our current accounting policies involving significant management judgment follows.
Allowance for Loan Losses. Management believes the allowance for loan losses requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on Managementâ€™s evaluation of the level of the allowance required in relation to the probable losses inherent in the loan portfolio. Management believes the allowance for loan losses is a significant estimate and therefore regularly evaluates it for adequacy by taking into consideration factors such as: levels and historical trends in delinquencies, impaired loans, non-accruing loans, charge-offs and recoveries, and classified assets; trends in the volume and terms of the loans; effects of any change in underwriting policies, procedures, and practices; experience, ability, and depth of management staff; national and local economic trends and conditions; trends and conditions in the industries in which borrowers operate; and effects of changes in credit concentrations. The use of different estimates or assumptions could produce different a provision for loan losses.
Other-Than-Temporary Impairment of Securities. One of the significant estimates related to investment securities is the evaluation of other-than-temporary impairments. The evaluation of securities for other-than- temporary impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuerâ€™s financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period of unrealized losses. Securities that are in an unrealized loss position are reviewed at least quarterly to determine if other-than-temporary impairment is present based on certain quantitative and qualitative factors and measures. The primary factors considered in evaluating whether a decline in value of securities is other-than-temporary include: (a) the length of time and extent to which the fair value has been less than cost or amortized cost and the expected recovery period of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments, (d) the volatility of the securities market price, (e) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery, which may be at maturity and (f) any other information and observable data considered relevant in determining whether other-than-temporary impairment has occurred, including the expectation of receipt of all principal and interest due.
Mortgage Servicing Rights. The valuation of mortgage servicing rights is a critical accounting policy which requires significant estimates and assumptions. The Company often sells mortgage loans it originates and retains the ongoing servicing of such loans, receiving a fee for these services, generally 1% of the outstanding balance of the loan per annum. Mortgage servicing rights are recognized when they are acquired through the sale of loans, and are reported in other assets. They are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Management uses an independent firm which specializes in the valuation of mortgage servicing rights to determine the fair value. The Company uses the amortization method for financial reporting. The most important assumption is the anticipated loan prepayment rate, and increases in prepayment speeds result in lower valuations of mortgage servicing rights. Management evaluates for impairment based upon the fair value of the rights, which can vary depending upon current interest rates and prepayment expectations, as compared to amortized cost. The use of different assumptions could produce a different valuation. All of the assumptions are based on standards the Company believes would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources.
Valuation of Other Real Estate Owned (â€śOREOâ€ť). Periodically, we acquire property through foreclosure or acceptance of a deed in lieu-of-foreclosure as OREO. OREO is recorded at fair value less costs to sell. The valuation of this property is accounted for individually based on its net realizable value on the date of acquisition. At the acquisition date, if the net realizable value of the property is less than the book value of the loan, a charge or reduction in the allowance for loan losses is recorded. If the value of the property becomes subsequently impaired, as determined by an appraisal or an evaluation in accordance with our appraisal policy, we will record the decline by a charge against current earnings. Upon acquisition of a property, a current appraisal or brokerâ€™s opinion must substantiate market value for the property.
Comparison of Financial Condition at March 31, 2012 and December 31, 2011
Total assets decreased $11.2 million, or 1.8%, from $616.3 million at December 31, 2011 to $605.1 million at March 31, 2012. The decrease in total assets was primarily due to a decrease in investments of $11.5 million, or 15.4%, and a decrease in cash and cash equivalents of $5.5 million, or 9.1%, partially offset by the increase in net loans of $6.1 million, or 1.4%, from $443.5 million at December 31, 2011 to $450.0 million at March 31, 2012.
The Companyâ€™s net loan portfolio increased $6.1 million, or 1.4%, during the first quarter of 2012. The significant components of the increase in net loans was an increase of $4.3 million, or 13.4%, in commercial construction loans, and an increase of $3.1 million, or 1.7%, in commercial real estate loans. These increases were partially offset by a decrease of $850,000, or 1.1%, in commercial and industrial loans and a decrease of $885,000, or 0.7%, in residential real estate loans. The $4.3 million, or 13.4%, increase in commercial construction loans was to existing commercial relationships for the expansion of their facilities. Upon completion, the loans will be transferred to the commercial real estate portfolio. The decrease in residential real estate loans was primarily due to prepayments and refinancing activity attributed to the historically low interest rates. In accordance with the Companyâ€™s asset/liability management strategy and in an effort to reduce interest rate risk, the Company continues to sell fixed rate, low coupon residential real estate loans to the secondary market. In the first quarter of 2012, the Company sold $6.7 million in low coupon residential real estate loans and currently services $83.0 million in loans sold to the secondary market. In order to service our customers, the servicing rights will continue to be retained on all loans written and sold in the secondary market.
The investment securities portfolio, including held-to-maturity and available-for-sale securities, decreased $11.5 million, or 15.4%, to $63.0 million at March 31, 2012 from $74.5 million at December 31, 2011 The decrease in investments was primarily due to $11.0 million, or 40.7%, in U.S. Treasury securities maturities.
Total deposits decreased $4.8 million, or 1.1%, from $453.4 million at December 31, 2011 to $448.6 million at March 31, 2012. Core deposits increased $4.0 million, or 1.7%, from $240.3 million at December 31, 2011 to $244.3 million at March 31, 2012. Demand deposits decreased $5.4 million, or 7.9%, money market accounts decreased $4.9 million, or 5.1%, to $102.5 million, NOW accounts increased $3.0 million, or 11.1%, and savings accounts increased $1.6 million, or 3.3%. The $4.0 million, or 1.7%, increase in core deposits was partially offset by the $8.8 million, or 4.1%, decrease in certificates of deposit to $204.3 million, at March 31, 2012 compared to $213.1 million, at December 31, 2011. The decrease in certificates of deposit was mainly attributed to the strategic run-off of high cost deposits as a result of managementâ€™s focus to lower the cost of deposits and allow higher cost, short-term time deposits to mature without renewals.
Specific allowance required for identified problem loans . We establish an allowance on certain identified problem loans based on such factors as: (1) the strength of the customerâ€™s personal or business cash flows; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of our collateral position; (6) the estimated cost to sell the collateral; and (7) the borrowerâ€™s effort to cure the delinquency.
General valuation allowance on the remainder of the loan portfolio . We establish a general allowance for loans that are not delinquent to recognize the probable losses associated with lending activities. This general valuation allowance is determined by segregating the loans by loan category and assigning percentages to each category. The percentages are adjusted for significant factors that, in managementâ€™s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors include: levels and historical trends in delinquencies, impaired loans, nonaccrual loans, charge-offs, recoveries, and classified assets; trends in the volume and terms of loans; effects of any change in underwriting, policies, procedures, and practices; experience, ability, and depth of management and staff; national and local economic trends and conditions; trends and conditions in the industries in which borrowers operate; effects of changes in credit concentrations. The applied loss factors are reevaluated quarterly to ensure their relevance in the current economic environment.
We identify loans that may need to be charged off as a loss by reviewing all delinquent loans, classified loans and other loans for which management may have concerns about collectability. For individually reviewed loans, the borrowerâ€™s inability to make payments under the terms of the loan or a shortfall in the fair value of the collateral if the loan is collateral dependent would result in our allocating a portion of the allowance to the loan that was impaired.
The allowance for loan losses is based on managementâ€™s estimate of the amount required to reflect the potential inherent losses in the loan portfolio, based on circumstances and conditions known or anticipated at each reporting date. There are inherent uncertainties with respect to the collectability of the Companyâ€™s loans and it is reasonably possible that actual loss experience in the near term may differ from the amounts reflected in this report.
At March 31, 2012, the allowance for loan losses represented 0.98% of total loans and 118.9% of nonperforming loans. The allowance for loan losses decreased $128,000 , or 2.8%, from $4.6 million at December 31, 2011 to $4. 4 million at March 31, 2012, due to a provision for loan losses of $7,000 offset by net charge-offs of $135,000. The provision for loan losses was $7,000 for the three months ended March 31, 2012 compared to $233,000 for the three months ended March 31, 2011, a decrease of $226,000, or 97.0%. Non-performing loans decreased $1.6 million, or 29.6% from $5.3 million, or 1.19% of total loans at March 31, 2011, to $3.7 million, or 0.83% of total loans at March 31, 2012. Total non-performing assets decreased $1.1 million, or 19.3%, from $5.8 million, or 0.99% of total assets, at March 31, 2011 to $4.6 million, or 0.77% of total assets at March 31, 2012. The allowance for loan losses as a percentage of total loans decreased from 1.0% at March 31, 2011 to 0.98% at March 31, 2012 and the allowance for loan losses as a percentage of non-performing loans increased from 83.6% at March 31, 2011 to 118.9% at March 31, 2012.
Provision for Loan Losses
The provision for loan losses was $7,000 for the three months ended March 31, 2012 compared to $233,000 for the three months ended March 31, 2011, a decrease of $226,000, or 97.0%. Non-performing loans decreased $1.6 million, or 30.2% from $5.3 million, or 1.19% of total loans at March 31, 2011, to $3.7 million, or 0.83% of total loans at March 31, 2012. Total non-performing assets decreased $1.2 million, or 19.3%, from $5.8 million, or 0.99% of total assets, at March 31, 2011 to $4.6 million, or 0.77% of total assets at March 31, 2012. The allowance for loan losses as a percentage of total loans decreased from 1.0% at March 31, 2011 to 0.98% at March 31, 2012 and the allowance for loan losses as a percentage of non-performing loans increased from 83.6% at March 31, 2011 to 118.9% at March 31, 2012.
Non-interest income for the three months ended March 31, 2012, increased $20,000, or 3.0%, from $661,000 at March 31, 2011 to $681,000 at March 31, 2012. Income from customer service fees and commissions increased $74,000, or 15.9%, partially offset by a $45,000, or 71.4%, increase in net losses on OREO.
Non-interest expense increased $84,000, or 1.8%, for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This increase was primarily due to the increase in furniture and equipment of $29,000, or 11.6%, increase in data processing of $21,000, or 7.2%, increase in professional fees of $23,000, or 16.2%, increase in advertising expense of $23,000, or 18.3%, increase in stationery, supplies and postage of $25,000, or 30.1%, and an increase of $91,000, or 19.6%, in other non-interest expense. These increases were partially offset by a decrease of $68,000, or 2.4%, in salaries and benefits, a decrease of $52,000, or 11.6%, in occupancy expense and an $8,000, or 7.8%, decrease in FDIC insurance expense. The $68,000, or 2.4%, decrease in salaries and benefits from the previous year was due to the retirement of one of our senior officers on March 31, 2011.
Explanation of Use of Non-GAAP Financial Measurements
We believe that it is common practice in the banking industry to present interest income and related yield information on tax exempt securities on a tax-equivalent basis and that such information is useful to investors because it facilitates comparisons among financial institutions. However, the adjustment of interest income and yields on tax exempt securities to a tax equivalent amount may be considered to include financial information that is not in compliance with U.S. generally accepted accounting principles (â€śGAAPâ€ť). A reconciliation from GAAP to non-GAAP is provided below.
Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities, borrowings from the FHLB and securities sold under agreements to repurchase. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Prepayment rates can have a significant impact on interest income. Because of the large percentage of loans we hold, rising or falling interest rates have a significant impact on the prepayment speeds of our earning assets that, in turn, affect the rate sensitivity position. When interest rates rise, prepayments tend to slow. When interest rates fall, prepayments tend to rise. Our asset sensitivity would be reduced if prepayments slow and vice versa. While we believe these assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual loan repayment activity. Our short-term securities are primarily consisted of U.S. Treasury and government agencies, which we use primarily for the collateral purposes for sweep accounts maintained by commercial customers. The balances of these securities fluctuate as the aggregate balance of our sweep accounts fluctuate.
We regularly adjust our investments in liquid assets based upon our assessment of: (1) expected loan demands; (2) expected deposit flows; (3) yields available on interest-earning deposits and securities; and (4) the objectives of our asset/liability management policy.
Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At March 31, 2012, total cash and cash equivalents totaled $55.6 million, net of reserve requirements. Securities classified as available-for-sale whose market value exceeds our cost, which provides additional sources of liquidity, totaled $372,000 at March 31, 2012. Other liquid assets as of March 31, 2012 included: U.S. Treasury securities and collateralized mortgage, net of pledged securities, totaling $2.8 million, and certificates of deposit of $13.2 million. At March 31, 2012, the Company had an over collateralized securities pledging position of $5.0 million.
In addition, at March 31, 2012, we had the ability to borrow a total of approximately $85.1 million from the FHLB. On March 31, 2012, we had $56.4 million of borrowings outstanding. We have the ability to increase our borrowing capacity with the FHLB by pledging additional loans. We have received approval from the Federal Reserve Bank to access itâ€™s discount window. The Companyâ€™s unused borrowing capacity with the Federal Reserve Bank was approximately $47.7 million at March 31, 2012. In addition, we had the following available lines of credit to use as contingency funding sources: $3.0 million with Bankers Bank, N.E. and available Fed Funds to purchase of $3.0 million.
Certificates of deposit due within one year of March 31, 2012 totaled $97.3 million, or 47.6%, of our certificates of deposit. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before March 31, 2013. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
We are subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At March 31, 2012, the Company exceeded all of its regulatory capital requirements. The Company is considered â€śwell capitalizedâ€ť under regulatory guidelines. The Company is subject to the Federal Reserve Boardâ€™s capital adequacy guidelines for bank holding companies (on a consolidated basis) substantially similar to those of the FDIC. The Company exceeded these requirements at March 31, 2012.