CAMBRIDGE BANCORP - Annual Report: 2017 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2017

OR

FOR THE TRANSITION PERIOD FROM                      TO

Commission File Number 001-38184

CAMBRIDGE BANCORP

(Exact name of Registrant as specified in its Charter)

Registrant’s telephone number, including area code: (617) 876-5500

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of class)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☐ NO ☒

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    YES  ☐    NO  ☒

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ☒    NO  ☐

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    YES  ☒    NO  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) 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.  ☐  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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.   ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES ☐    NO ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on The NASDAQ Stock Market on June 30, 2017, was $265,376,368. The number of shares of Registrant’s Common Stock outstanding as of March 15, 2018 was 4,101,581.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement relating to the Annual Meeting of Shareholders, scheduled to be held on May 14, 2018, are incorporated by reference into Part III of this Report.

Table of Contents

i

PART I

Unless the context requires otherwise, all references to the “Company,” “we,” “us,” and “our,” refer to Cambridge Bancorp.

Forward-Looking Statements

This report contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.  Such forward-looking statements about the Company and its industry involve substantial risks and uncertainties. Statements other than statements of current or historical fact, including statements regarding the Company’s future financial condition, results of operations, business plans, liquidity, cash flows, projected costs, and the impact of any laws or regulations applicable to the Company, are forward-looking statements. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “plans,” “projects,” “may,” “will,” “should,” and other similar expressions are intended to identify these forward-looking statements. Such statements are subject to factors that could cause actual results to differ materially from anticipated results. Such factors include, but are not limited to, the following:

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The Company does not undertake, and specifically disclaims any obligation to, publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. You are cautioned not to place undue reliance on these forward-looking statements.

Item 1. Business.

The Company

Cambridge Bancorp (together with its bank subsidiary, unless the context otherwise requires, the “Company”) is a Massachusetts state-chartered, federally registered bank holding company headquartered in Cambridge, Massachusetts. The Company, is a Massachusetts corporation formed in 1983 and has one bank subsidiary (the “Bank”): Cambridge Trust Company formed in 1890. On October 17, 2017, the U.S. Securities and Exchange Commission (“SEC”) declared the Company’s Registration Statement on Form 10, as amended, effective. On October 18, 2017, shares of the Company’s common stock commenced trading on the Nasdaq stock market under symbol CATC.  As of December 31, 2017, the Company had total assets of approximately $1.9 billion. Currently, the Bank operates 10 full-service banking offices in six cities and towns in Eastern Massachusetts. As a Private Bank, we focus on four core services that center around client needs. Our core services include Wealth Management, Commercial Banking, Residential Lending and Personal Banking. The Bank’s customers consist primarily of consumers and small- and medium-sized businesses in these communities and surrounding areas throughout Massachusetts and New Hampshire. The Company’s Wealth Management Group has four offices, one in Boston, Massachusetts and three in New Hampshire in Concord, Manchester, and Portsmouth. As of December 31, 2017, the Company had Assets under Management and Administration of approximately $3.1 billion. The Wealth Management Group offers comprehensive investment management, as well as trust administration, estate settlement, and financial planning services. Our wealth management clients value personal service and depend on the commitment and expertise of our experienced banking, investment, and fiduciary professionals.  

The Wealth Management Group customizes its investment portfolios to help its clients meet their long-term financial goals while moderating short-term stock market volatility. Through careful monitoring of asset allocation and disciplined security selection, Cambridge Trust’s in-house investment team provides clients with long-term capital growth while minimizing risk. Our internally developed, research-driven process is managed by our team of portfolio managers and analysts. We build discretionary portfolios consisting of our best investment ideas, focusing on individual global equities, fixed income securities, exchange-traded funds, and mutual funds. Our team-oriented approach fosters spirited discussion and rigorous evaluation of investments.

The Company offers a wide range of services to commercial enterprises, non-profit organizations, and individuals.  The Company emphasizes service to consumers and small- and medium-sized businesses in its market area. The Company makes commercial loans, commercial real estate loans, construction loans, consumer loans, and real estate loans (including one-to-four family and home equity lines of credit), and accepts savings, time, and demand deposits. In addition, the Company offers a wide range of commercial and personal banking services which include cash management, online banking, mobile banking, and global payments.  The Company has one trademark, “Thought Series.”

The Company’s results of operations are largely dependent on net interest income, which is the difference between the interest earned on loans and securities and interest paid on deposits and borrowings, and non-interest income largely from its wealth management services. The results of operations are affected by the level of income and fees from loans, deposits, as well as operating expenses, the provision for loan losses, the impact of federal and state income taxes, the relative levels of interest rates, and local and national economic activity.

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Through Cambridge Trust, its bank subsidiary, the Company focuses on wealth management, the commercial banking business and private banking for clients including residential lending and personal banking. Within the commercial loan portfolio, the Company has traditionally been a commercial real estate lender and in recent years has diversified commercial operations within the areas of commercial and industrial lending to include Innovation Banking, which specializes in working with New England-based entrepreneurs, and asset based lending that helps companies throughout New England and New York grow by borrowing against existing assets. The Innovation Banking group has a narrow client focus for lending and provides a local banking option for technology and entrepreneurial companies within our market area that are primarily serviced by out-of-market institutions. Personal banking focuses on providing exceptional service to clients and in deepening relationships.

Cambridge Trust Company

The Bank offers a full range of commercial and consumer banking services through its network of 10 full-service banking offices in Eastern Massachusetts. The Bank is engaged principally in the business of attracting deposits from the public and investing those deposits. The Bank invests those funds in various types of loans, including residential and commercial real estate, and a variety of commercial and consumer loans. The Bank also invests its deposits and borrowed funds in investment securities and has two wholly-owned Massachusetts security corporations, CTC Security Corporation and CTC Security Corporation III, for this purpose. Deposits at the Bank are insured by the Federal Deposit Insurance Corporation (the “FDIC”) for the maximum amount permitted by FDIC Regulations.

Investment management and trust services are offered through our wealth management office located in Boston and three wealth management offices located in New Hampshire. The Bank also utilizes its subsidiary and non-depository trust company, Cambridge Trust Company of New Hampshire, Inc., to provide wealth management services in New Hampshire. The assets held for wealth management customers are not assets of the Bank and, accordingly, are not reflected in the Company’s consolidated balance sheets.

Cambridge Trust Company is active in the communities we serve. The Bank makes contributions to various non-profits and local organizations, investments in community development lending, and investments in low-income housing all of which strive to improve the communities that our employees and customers call home.

Market Area

The Company operates in Eastern Massachusetts and Southern New Hampshire. Our primary lending market includes Middlesex and Suffolk Counties in Massachusetts. We benefit from the presence of numerous institutions of higher learning, medical care and research centers, a vibrant innovation economy in life sciences and technology, and the corporate headquarters of several significant financial service companies within the Boston area. Eastern Massachusetts also has many high technology companies employing personnel with specialized skills. These factors affect the demand for wealth management services, residential homes, multi-family apartments, office buildings, shopping centers, industrial warehouses, and other commercial properties.

Our lending area is primarily an urban market area with a substantial number of one-to-four unit residential properties, some of which are non-owner occupied, as well as apartment buildings, condominiums, office buildings, and retail space. As a result, our loan portfolio contains a significantly greater number of multi-family and commercial real estate loans compared to institutions that operate in non-urban markets.

Our market area is located largely in the Boston-Cambridge-Quincy, Massachusetts/New Hampshire Metropolitan Statistical Area (“MSA”). The United States Census Bureau estimates that as of July 1, 2016, the Boston metropolitan area is the 10th largest metropolitan area in the United States. Located adjacent to major transportation corridors, the Boston metropolitan area provides a highly diversified economic base, with major employment sectors ranging from services, education, manufacturing, and wholesale/retail trade, to finance, technology, and medical care. According to the United States Department of Labor, in November 2017, the Boston-Cambridge-Quincy, Massachusetts/New Hampshire MSA had an unemployment rate of 3.0% compared to the national unemployment rate of 4.1%.

Competition

The financial services industry is highly competitive. The Company experiences substantial competition with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other non-bank financial service providers in attracting deposits, making loans, and attracting wealth management customers. The competing major commercial banks have greater resources that may provide them a competitive advantage by enabling them to maintain numerous branch offices and mount extensive advertising campaigns. The increasingly competitive environment is the result of changes in regulation, changes in technology and product delivery systems, additional financial service providers, and the accelerating pace of consolidation among financial services providers.  

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The financial services industry has become even more competitive as a result of legislative, regulatory, and technological changes and continued consolidation. Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems.

Some of the Company’s non-banking competitors have fewer regulatory constraints and may have lower cost structures.  In addition, some of the Company’s competitors have assets, capital and lending limits greater than that of the Company, greater access to capital markets and offer a broader range of products and services than the Company.  These institutions may have the ability to finance wide-ranging advertising campaigns and may also be able to offer lower rates on loans and higher rates on deposits than the Company can offer.  Some of these institutions offer services, such as international banking, which the Company does not directly offer.

Various in-state market competitors and out-of-state banks continue to enter or have announced plans to enter or expand their presence in the market areas in which the Company currently operates.  With the addition of new banking presences within our market, the Company expects increased competition for loans, deposits, and other financial products and services.

The Company is a Private Bank, stressing the holistic client relationship, and relies upon local promotional activities, personal relationships established by officers, directors, and employees with their customers, and specialized services tailored to meet the needs of the communities served. While the Company’s position varies by market, the Company’s management believes that it can compete effectively as a result of local market knowledge, local decision making, and awareness of customer needs.

Supervision and Regulation

General

Banking is a complex, highly regulated industry. Consequently, the performance of the Company and the Bank can be affected not only by management decisions and general and local economic conditions, but also by the statutes enacted by the U.S. Congress and state legislatures, and the regulations and policies of, various governmental regulatory authorities. These authorities include, but are not limited to, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Massachusetts Division of Banks (the “MDB”), the State of New Hampshire Banking Department, and the FDIC. The effect of these statutes, regulations, and policies and any changes to any of them can be significant and cannot be predicted.

The primary goals of bank regulation are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, the U.S. Congress and the Commonwealth of Massachusetts have created largely autonomous regulatory agencies that oversee and have enacted numerous laws that govern banks, bank holding companies, and the banking industry. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for the entities’ respective operations and is intended primarily for the protection of the Bank’s depositors and the public, rather than the shareholders and creditors. The following summarizes the significant laws, rules, and regulations governing banks and bank holding companies, including the Company and the Bank, but does not purport to be a complete summary of all applicable laws, rules and regulations governing bank holding companies and banks, or the Company or the Bank. The descriptions are qualified in their entirety by reference to the specific statutes, regulations, and policies discussed. Any change in applicable laws, regulations or regulatory policies may have a material effect on our businesses, operations and prospects. The Company is unable to predict the nature or extent of the effects that economic controls or new federal or state legislation may have on our business and earnings in the future.

Regulatory Agencies 

Cambridge Bancorp is a legal entity separate and distinct from its first tier bank subsidiary, Cambridge Trust Company, and its second tier subsidiaries, Cambridge Trust Company of New Hampshire, Inc., a New Hampshire state-chartered non-depository trust company, CTC Security Corporation and CTC Security Corporation III, which are used to invest the Bank’s deposits and borrowed funds in investment securities. As a bank holding company, the Company is regulated under the Bank Holding Company Act of 1956, as amended (“BHC Act”) and is subject to inspection, examination, and supervision by the Federal Reserve Board.

As a Massachusetts state-chartered insured depository institution, Cambridge Trust Company is subject to supervision, periodic examination, and regulation by the MDB as its chartering authority, by the FDIC as its primary federal regulator and the State of New Hampshire Banking Department. The prior approval of the MDB and the FDIC is required, among other things, for the Bank to establish or relocate any additional branch offices, assume deposits, or engage in any merger, consolidation, purchase, or sale of all or substantially all of the assets of any insured depository institution.

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Bank Holding Company Regulations Applicable to the Company

The BHC Act and other federal laws and regulations subject bank holding companies to particular restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations. As a Massachusetts corporation, the Company is subject to certain limitations and restrictions under applicable Massachusetts corporate law.

Mergers & Acquisitions.   The BHC Act, the Bank Merger Act, the laws of the Commonwealth of Massachusetts applicable to financial institutions and other federal and state statutes regulate acquisitions of banks and their holding companies. The BHC Act generally limits acquisitions by bank holding companies to banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring more than 5% of the voting stock of any bank or other bank holding company, (ii) acquiring all or substantially all of the assets of any bank or bank holding company, or (iii) merging or consolidating with any other bank holding company.

In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities generally consider, among other things, the competitive effect and public benefits of the transactions, the financial and managerial resources and future prospects of the combined organization (including the capital position of the combined organization), the applicant’s performance record under the Community Reinvestment Act (see —Community Reinvestment Act), fair housing laws, and the effectiveness of the subject organizations in combating money laundering activities.

Non-bank Activities.  Generally, bank holding companies are prohibited, under the BHC Act, from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in any activity other than (i) banking or managing or controlling banks or (ii) an activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking. The Federal Reserve has the authority to require a bank holding company to terminate an activity or terminate control of, or liquidate or divest, certain subsidiaries or affiliates when the Federal Reserve believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness, or stability of any of its bank subsidiaries.

A bank holding company that qualifies and elects to become a financial holding company is permitted to engage in additional activities that are financial in nature or incidental or complementary to financial activity. The Company currently has no plans to make a financial holding company election.

Bank holding companies and their non-banking subsidiaries are prohibited from engaging in activities that represent unsafe and unsound banking practices. For example, under certain circumstances the Federal Reserve’s Regulation Y requires a holding company to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate a regulation. As another example, a holding company is prohibited from impairing its subsidiary bank’s soundness by causing the bank to make funds available to non-bank subsidiaries or their customers if the Federal Reserve Board believes it is not prudent to do so. The Federal Reserve has the power to assess civil money penalties for knowing or reckless violations, if the activities leading to a violation caused a substantial loss to a depository institution. Potential penalties are as high as $2.0 million for each day such activity continues.

Source of Strength.  In accordance with Federal Reserve policy, the Company is expected to act as a source of financial and managerial strength to the Bank. Section 616 of the Dodd-Frank Act codifies the requirement that bank holding companies serve as a source of financial strength to their subsidiary depository institutions.   Under this policy, the holding company is expected to commit resources to support its bank subsidiary, including at times when the holding company may not be in a financial position to provide it. As discussed below, the Company could be required to guarantee the capital plan of the Bank if it becomes undercapitalized for purposes of banking regulations. Any capital loans by a bank holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. The BHC Act provides that, in the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy trustee and entitled to priority of payment. 

Regulatory agencies have promulgated regulations to increase the capital requirements for bank holding companies to a level that matches those of banking institutions. See —Capital Adequacy and Prompt Corrective Action and Safety and Soundness.

Annual Reporting & Examinations.   The Company is required to file annual and periodic reports with the Federal Reserve, and such additional information as the Federal Reserve may require. The Federal Reserve may examine a bank holding company and any of its subsidiaries, and charge the Company for the cost of such an examination.

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Imposition of Liability for Undercapitalized Subsidiaries.   Pursuant to Section 38 of the Federal Deposit Insurance Act (the “FDIA”) federal banking agencies are required to take “prompt corrective action” should an insured depository institution fail to meet certain capital adequacy standards. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company “having control of” the undercapitalized institution “guarantees” the subsidiary’s compliance with the capital restoration plan until it becomes “adequately capitalized.” For purposes of this statute, the Company has control of the Bank. Under the FDIA, the aggregate liability of all companies controlling a particular institution is limited to the lesser of 5% of the depository institution’s total assets at the time it became undercapitalized or the amount necessary to bring the institution into compliance with applicable capital standards. FDIA grants greater powers to the federal banking agencies in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve approval of proposed distributions or might be required to consent to a merger or to divest the troubled institution or other affiliates. See — Capital Adequacy and Prompt Corrective Action and Safety and Soundness.

Dividends  

Dividends from the Bank are the Company’s principal source of cash revenues. The Company’s earnings and activities are affected by legislation, regulations, and local legislative and administrative bodies and decisions of courts in the jurisdictions in which we conduct business. These include limitations on the ability of the Bank to pay dividends to the Company and our ability to pay dividends to our shareholders. It is the policy of the Federal Reserve that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its bank subsidiary. Consistent with such policy, a banking organization should have comprehensive policies on dividend payments that clearly articulate the organization’s objectives and approaches for maintaining a strong capital position and achieving the objectives of the policy statement. The Company has a comprehensive dividend policy in place.

The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Under Massachusetts General Laws chapter 172, section 28, the MDB Commissioner’s approval is required in order to authorize the payment of a dividend, if the total dividends declared in a calendar year exceed that year’s net profits combined with retained net profits for the preceding two years, less any required transfer to surplus or a fund for the retirement of any preferred stock.

Federal Reserve System

Federal Reserve regulations require depository institutions to maintain reserves against transaction accounts, primarily interest-bearing and regular checking accounts. The Bank’s required reserves can be in the form of vault cash.  If vault cash does not fully satisfy the required reserves, the reserves can be in the form of a balance maintained with the Federal Reserve Bank of Boston. Federal Reserve regulations required for 2018 that reserves be maintained against aggregate transaction accounts except for transaction accounts which are exempt up to and including $16 million. Transaction accounts greater than $16 million up to and including $122.3 million have a reserve requirement of 3%. A 10% reserve ratio will be assessed on transaction accounts in excess of $122.3 million. The Federal Reserve generally makes annual adjustments to the tiered reserves. The Bank is in compliance with these reserve requirements.

Under the Federal Deposit Insurance Corporation Improvement Act, banks may be restricted in their ability to accept brokered deposits, depending on their classification. “Well-capitalized” institutions are permitted to accept brokered deposits, but banks that are not well-capitalized are generally restricted from accepting such deposits.  The Bank is currently well-capitalized and not restricted from accepting brokered deposits.

Transactions with Affiliates 

The Company and the Bank are considered “affiliates” under the Federal Reserve Act (the “FRA”), and transactions between a bank and its affiliates are subject to certain restrictions, under Sections 23A and 23B of the FRA and the Federal Reserve’s implementing Regulation W. Generally, Sections 23A and 23B: (1) limit the extent to which an insured depository or its subsidiaries may engage in covered transactions (a) with an affiliate (as defined in such sections) to an amount equal to 10% of such institution’s capital and surplus, and (b) with all affiliates, in the aggregate, to an amount equal to 20% of such capital and surplus; and (2) require all transactions with an affiliate, whether or not covered transactions, to be on terms substantially the same, or at least as favorable to the institution or subsidiary, as the terms provided or that would be provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee, and other similar types of transactions.

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Capital Adequacy

In July 2013, the Federal Reserve, the Office of the Comptroller of the Currency (“OCC”), and the FDIC approved final rules (the “Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The Capital Rules generally implement the Basel Committee on Banking Supervision’s (the “Basel Committee”) December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards. The Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The Capital Rules also address asset risk weights and other matters affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing general risk-weighting approach with a more risk-sensitive approach.

The Capital Rules: (i) include “Common Equity Tier 1” (“CET1”) and related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandate that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. Under the Capital Rules, for most banking organizations, including the Company, the most common form of Additional Tier 1 capital is non-cumulative perpetual preferred stock, and the most common forms of Tier 2 capital are subordinated notes and a portion of the allocation for loan and lease losses, in each case, subject to the Capital Rules’ specific requirements.

Pursuant to the Capital Rules, effective January 1, 2015, the minimum capital ratios are as follows:

The Capital Rules also include a “capital conservation buffer,” composed entirely of CET1, in addition to these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity, and other capital instrument repurchases and compensation based on the amount of the shortfall. Thus, when fully phased-in on January 1, 2019, the capital standards applicable to the Company will include an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios inclusive of the capital conservation buffer of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) total capital to risk-weighted assets of at least 10.5%.

The Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing assets, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks, and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.  Since January 1, 2015, and continuing until January 1, 2019, the deductions and adjustments are being incrementally phased in.  

In addition, under the current general risk-based capital rules, the effects of accumulated other comprehensive income or loss items included in shareholders’ equity (for example, mark-to-market of securities held in the available for sale portfolio) under U.S. generally accepted accounting principles (“GAAP”) are reversed for the purposes of determining regulatory capital ratios. Pursuant to the Capital Rules, the effects of certain of the above items are not excluded. However, banking organizations, including the Company, that are not subject to the advanced approaches rule, could make a one-time permanent election to exclude these items. The Company made the one-time permanent election to exclude these items.

The Capital Rules also preclude certain hybrid securities, such as trust preferred securities, issued on or after May 19, 2010 from inclusion in bank holding companies’ Tier 1 capital.

As noted, implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and are being phased in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and increases by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019. The risk-weighting categories in the Capital Rules are standardized and include a risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 1,250% for certain credit exposures, and resulting in higher risk weights for a variety of asset classes.

Management believes the Company is in compliance, and will continue to be in compliance, with the targeted capital ratios as such requirements are phased in.

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Prompt Corrective Action and Safety and Soundness

Pursuant to Section 38 of the FDIA, federal banking agencies are required to take “prompt corrective action” should a depository institution fail to meet certain capital adequacy standards.  At each successive lower capital category, an insured depository institution is subject to more restrictions and prohibitions, including restrictions on growth, restrictions on interest rates paid on deposits, restrictions or prohibitions on payment of dividends, and restrictions on the acceptance of brokered deposits. Furthermore, if an insured depository institution is classified in one of the undercapitalized categories, it is required to submit a capital restoration plan to the appropriate federal banking agency, and the holding company must guarantee the performance of that plan. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment.

For purposes of prompt corrective action, to be: (i) well-capitalized, a bank must have a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 8%, a CET1 risk-based capital ratio of at least 6.5%, and a Tier 1 leverage ratio of at least 5%; (ii) adequately capitalized, a bank must have a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 6%, a CET1 risk-based capital ratio of at least 4.5%, and a Tier 1 leverage ratio of at least 4%; (iii)  undercapitalized, a bank would have a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 6%, a CET1 risk-based capital ratio of less than 4.5%, and a Tier 1 leverage ratio of less than 4%; (iv) significantly undercapitalized, a bank would have a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 4%, a CET1 risk-based capital ratio of less than 3%, and a Tier 1 leverage ratio of less than 3%; and (v) critically undercapitalized, a bank would have a ratio of tangible equity to total assets that is less than or equal to 2%.

Bank holding companies and insured banks also may be subject to potential enforcement actions of varying levels of severity by the federal banking agencies for unsafe or unsound practices in conducting their business, or for violation of any law, rule, regulation, condition imposed in writing by the agency or term of a written agreement with the agency. In more serious cases, enforcement actions may include: issuances of directives to increase capital; issuances of formal and informal agreements; impositions of civil monetary penalties; issuances of a cease and desist order that can be judicially enforced; issuances of removal and prohibition orders against officers, directors, and other institution−affiliated parties; terminations of the bank’s deposit insurance; appointment of a conservator or receiver for the bank; and enforcements of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.

The Volcker Rule

Section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule, restricts the ability of banking entities, such as the Company and the Bank, from: (i) engaging in “proprietary trading” and (ii) investing in or sponsoring certain types of funds (“Covered Funds”), subject to certain limited exceptions. Under the Volcker Rule, a Covered Fund is any issuer that would be an investment company under the Investment Company Act (the “ICA”) but for the exemptions in section 3(c)(1) and 3(c)(7) of the ICA, which includes collateralized loan obligation (“CLO”) and collateralized debt obligation securities. The regulation also provides, among other exemptions, an exemption for CLOs meeting certain requirements. The Company is in compliance with the Volcker Rule.

Deposit Insurance

The Bank’s deposit accounts are fully insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to the deposit insurance limit of $250,000 per depositor, per insured institution, in accordance with applicable laws and regulations.

The FDIC uses a risk-based assessment system that imposes insurance premiums based upon a risk matrix that accounts for a bank’s capital level and supervisory rating (CAMELS rating). The risk matrix uses different risk categories distinguished by capital levels and supervisory ratings. The base for deposit insurance assessments is consolidated average assets less average tangible equity.  Assessment rates are calculated using formulas that take into account the risk of the institution being assessed.  The FDIC may increase or decrease the assessment rate schedule in order to manage the DIF to prescribed statutory target levels. An increase in the risk category for the Bank or in the assessment rates could have an adverse effect on the Bank’s and consequently the Company’s earnings. The FDIC may terminate deposit insurance if it determines the institution involved has engaged in or is engaging in unsafe or unsound banking practices, is in an unsafe or unsound condition, or has violated applicable laws, regulations, or orders.  The Bank is not aware of any practice, condition, or violation that might lead to the termination of its deposit insurance.

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In addition to deposit insurance assessments, the FDIA provides for additional assessments to be imposed on insured depository institutions to pay for the cost of Financing Corporation (“FICO”) funding. FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987, whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation. FICO assessments are adjusted quarterly to reflect changes in the assessment base of the DIF and do not vary depending upon a depository institution’s capitalization or supervisory evaluation. The current annualized assessment rate is approximately three basis points and the rate is adjusted quarterly. These assessments will continue until FICO bonds mature in 2019.  

Depositor Preference

The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

Consumer Financial Protection

The Company and Bank are subject to a number of federal and state consumer protection laws that govern its relationship with its customers. These laws include the Consumer Financial Protection Act of 2010, Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act, the Service Members Civil Relief Act, and these laws’ respective state-law counterparts, as well as state usury laws and laws regarding unfair and deceptive acts and practices. These and other federal laws, among other things, require disclosures of the cost of credit and terms of deposit accounts, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, prohibit unfair, deceptive and abusive practices, restrict the Bank’s ability to raise interest rates, and subject the Bank to substantial regulatory oversight. Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution, and attorneys’ fees.

Further, the Consumer Financial Protection Bureau (“CFPB”) has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. While there are no statutory definitions for those terms, the CFPB has found an act or practice to be “unfair” when: “(i) it causes or is likely to cause substantial injury to consumers; (ii) the injury is not reasonably avoidable by consumers; and (iii) the injury is not outweighed by countervailing benefits to consumers or to competition.” “Deceptive acts or practices” occur when “(i) the act or practice misleads or is likely to mislead the consumer; (ii) the consumer’s interpretation is reasonable under the circumstances; and (iii) the misleading act or practice is material.”  Finally, an act or practice is “abusive” when it: “(i) materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or services; or (ii) takes unreasonable advantage of (a) a consumer’s lack of understanding of the material risks, costs, or conditions of the product or services; (b) a consumer’s inability to protect his or her interests in selecting or using a consumer financial product or service; or (c) a consumer’s reasonable reliance on a covered person to act in his or her interests.”

Neither the Dodd-Frank Act, nor the individual consumer financial protection laws prevent states from adopting stricter consumer protection standards.

Community Reinvestment Act 

The Community Reinvestment Act of 1977 (the “CRA”), requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low and moderate income individuals and communities. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. The applicable federal banking agencies regularly conduct CRA examinations to assess the performance of financial institutions and assign one of four ratings to the institution’s records of meeting the credit needs of its community. The Bank received a “Satisfactory” rating during its last examination in August 2017.

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Insider Credit Transactions

Section 22(h) of the FRA and its implementing Regulation O restricts loans to directors, executive officers, and principal shareholders (“insiders”). Under Section 22(h), loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the board of directors. Further, under Section 22(h) of the FRA, loans to directors, executive officers, and principal shareholders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to the bank’s employees and does not give preference to the insider over the employees. Section 22(g) of the FRA places additional limitations on loans to executive officers.  A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the affected bank or any officer, director, employee, agent, or other person participating in the conduct of the affairs of that bank, the imposition of a cease and desist order, and other regulatory sanctions.

Financial Privacy

The Company is subject to federal laws, including the Gramm-Leach-Bliley Act (the “GLBA”), and certain state laws containing consumer privacy protection provisions. These provisions limit the ability of banks and other financial institutions to disclose nonpublic information about consumers to affiliated and non-affiliated third parties and limit the reuse of certain consumer information received from non-affiliated financial institutions. These provisions require notice of privacy policies to customers and, in some circumstances, allow consumers to prevent disclosure of certain nonpublic personal information to affiliates or non-affiliated third parties by means of “opt out” or “opt in” authorizations.

Financial Data Security

The GLBA requires that financial institutions implement comprehensive written information security programs that include administrative, technical, and physical safeguards to protect consumer information. Further, pursuant to interpretive guidance issued under the GLBA and certain state laws, financial institutions are required to notify customers and regulators of security breaches that result in unauthorized access to their nonpublic personal information.

Incentive Compensation

The Dodd-Frank Act requires the federal banking agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities, including the Company and the Bank, with at least $1 billion in total consolidated assets that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits that could lead to material financial loss to the entity. The federal banking agencies and the SEC most recently proposed such regulations in 2016, but the regulations have not yet been finalized. If the regulations are adopted in the form initially proposed, they will restrict the manner in which executive compensation is structured.

The Dodd-Frank Act also requires publicly traded companies to give shareholders a non-binding vote on executive compensation and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions.

Anti-Money Laundering Initiatives and the USA PATRIOT Act

Under Title III of the USA PATRIOT Act, all financial institutions are required to take certain measures to identify their customers, prevent money laundering, monitor customer transactions, and report suspicious activity to U.S. law enforcement agencies. Financial institutions also are required to respond to requests for information from federal banking agencies and law enforcement agencies. Information sharing among financial institutions for the above purposes is encouraged by an exemption granted to complying financial institutions from the privacy provisions of the GLBA and other privacy laws. Financial institutions that hold correspondent accounts for foreign banks or provide private banking services to foreign individuals are required to take measures to avoid dealing with certain foreign individuals or entities, including foreign banks with profiles that raise money laundering concerns, and are prohibited from dealing with foreign “shell banks” and persons from jurisdictions of particular concern. The primary federal banking agencies and the Secretary of the U.S. Department of the Treasury have adopted regulations to implement several of these provisions. All financial institutions also are required to establish internal anti-money laundering programs. The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act. The Company has a Bank Secrecy Act and USA PATRIOT Act compliance program commensurate with its risk profile.

The Fair Credit Reporting Act’s Red Flags Rule requires financial institutions with covered accounts (e.g., consumer bank accounts and loans) to develop, implement, and administer an identity theft prevention program. This program must include reasonable policies and procedures to detect suspicious patterns or practices that indicate the possibility of identity theft, such as inconsistencies in personal information or changes in account activity.

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Office of Foreign Assets Control (“OFAC”) Regulation

The Office of Foreign Assets Control (OFAC) of the US Department of the Treasury administers and enforces economic and trade sanctions based on US foreign policy and national security goals against targeted foreign countries and regimes, terrorists, international narcotics traffickers, those engaged in activities related to the proliferation of weapons of mass destruction, and other threats to the national security, foreign policy or economy of the United States. OFAC publishes lists of individuals and companies owned or controlled by, or acting for or on behalf of, targeted countries. It also lists individuals, groups, and entities, such as terrorists and narcotics traffickers designated under programs that are not country-specific. These are typically known as the OFAC rules based on their administration by the OFAC. The OFAC-administered sanctions targeting countries take many different forms. Generally, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (property and bank deposits) cannot be paid out, withdrawn, set off, or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.

Employees

As of February 28, 2018, the Company had 238 full-time and nine part-time employees. The Company’s employees are not represented by any collective bargaining unit. The Company believes that its employee relations are good.

Item 1A. Risk Factors.

Deterioration in local economic conditions may negatively impact our financial performance.

The Company’s success depends primarily on the general economic conditions in Eastern Massachusetts and the specific local markets in which the Company operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in Massachusetts and New Hampshire. The local economic conditions in these areas have a significant impact on the demand for the Company’s products and services as well as the ability of the Company’s customers to repay loans, the value of the collateral securing loans, and the stability of the Company’s deposit funding sources.

A downturn in our local economy may limit funds available for deposit and may negatively affect our borrowers’ ability to repay their loans on a timely basis, both of which could have an impact on our profitability.

Variations in interest rates may negatively affect our financial performance.

The Company’s earnings and financial condition are largely dependent upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads could adversely affect the Company’s earnings and financial condition. The Company cannot predict with certainty, or control, changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve, affect interest income and interest expense. High interest rates could also affect the amount of loans that the Company can originate because higher rates could cause customers to apply for fewer mortgages or cause depositors to shift funds from accounts that have a comparatively lower cost to accounts with a higher cost.  The Company may also experience customer attrition due to competitor pricing.  If the cost of interest-bearing deposits increases at a rate greater than the yields on interest-earning assets increase, then net interest income will be negatively affected. Changes in the asset and liability mix may also affect net interest income. Similarly, lower interest rates cause higher yielding assets to prepay and floating or adjustable rate assets to reset to lower rates. If the Company is not able to reduce its funding costs sufficiently, due to either competitive factors or the maturity schedule of existing liabilities, then the Company’s net interest margin will decline.

Although management believes it has implemented effective asset and liability management strategies to mitigate the potential adverse effects of changes in interest rates on the Company’s results of operations, any substantial or unexpected change in, or prolonged change in market interest rates could have a material adverse effect on the Company’s financial condition and results of operations.

Changes in the economy or the financial markets could materially affect our financial performance.

Downturns in the United States or global economies or financial markets could adversely affect the demand for and income received from the Company's fee-based services. Revenues from the Wealth Management Group depend in large part on the level of assets under management and administration.  Market volatility that leads customers to liquidate investments, as well as lower asset values, can reduce our level of assets under management and administration and thereby decrease our investment management and administration revenues.

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Our loan portfolio includes loans with a higher risk of loss.

The Bank originates commercial and industrial loans, commercial real estate loans, consumer loans, and residential mortgage loans primarily within our market area. Our lending strategy focuses on residential real estate lending as well as servicing commercial customers, including increased emphasis on commercial and industrial lending, and commercial deposit relationships. Commercial and industrial loans, commercial real estate loans, and consumer loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. In addition, commercial real estate and commercial and industrial loans may also involve relatively large loan balances to individual borrowers or groups of borrowers. These loans also have greater credit risk than residential real estate for the following reasons:

Any downturn in the real estate market or local economy could adversely affect the value of the properties securing the loans or revenues from the borrowers’ businesses thereby increasing the risk of non-performing loans.

If our allowance for loan losses is not sufficient to cover actual loan losses, then our earnings will decrease.

The Bank’s loan customers may not repay their loans according to their terms and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. The Bank therefore may experience significant loan losses, which could have a material adverse effect on our operating results. Material additions to our allowance for loan losses also would materially decrease our net income, and the charge-off of loans may cause us to increase the allowance. The Bank makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We rely on our loan quality reviews, our experience, and our evaluation of economic conditions, among other factors, in determining the amount of the allowance for loan losses. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance.

Strong competition within our industry and market area could hurt our performance and slow our growth.

The Company operates in a competitive market for both attracting deposits, which is our primary source of funds, and originating loans. Historically, our most direct competition for deposits has come from savings and commercial banks. Our competition for loans comes principally from commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies, and investment banking firms. We also face additional competition from internet-based institutions and brokerage firms. Competition for loan originations and deposits may limit our future growth and earnings prospects.

The Company’s ability to compete successfully depends on a number of factors, including, among other things:

Failure to perform in any of these areas could significantly weaken the Company’s competitive position, which could adversely affect the Company’s growth and profitability, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.

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The Company is subject to extensive government regulation and supervision, which may interfere with our ability to conduct our business and may negatively impact our financial results.

The Company, primarily through the Bank and certain non-bank subsidiaries, are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, the Depositors Insurance Fund (“DIF”) and the safety and soundness of the banking system as a whole, not shareholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy, and growth, among other things. Congress and federal banking agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer, and/or limit the pricing the Company may charge on certain banking services, among other things. Compliance personnel and resources may increase our costs of operations and adversely impact our earnings.

Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputation damage, which could have a material adverse effect on our business, financial condition, and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

State and federal banking agencies periodically conduct examinations of our business, including for compliance with laws and regulations, and our failure to comply with any supervisory actions to which we are or become subject as a result of such examinations may adversely affect our business.

Federal and state regulatory agencies periodically conduct examinations of our business, including our compliance with laws and regulations. If, as a result of an examination, an agency were to determine that the financial, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of any of our operations had become unsatisfactory or violates any law or regulation, such agency may take certain remedial or enforcement actions it deems appropriate to correct any deficiency. Remedial or enforcement actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced against a bank, to direct an increase in the bank’s capital, to restrict the bank’s growth, to assess civil monetary penalties against a bank’s officers or directors, and to remove officers and directors. In the event that the FDIC concludes that, among other things, our financial conditions cannot be corrected or that there is an imminent risk of loss to our depositors, it may terminate our deposit insurance. The CFPB also has authority to take enforcement actions, including cease-and desist orders or civil monetary penalties, if it finds that we offer consumer financial products and services in violation of federal consumer financial protection laws.

If we are unable to comply with future regulatory directives, or with the terms of any future supervisory requirements to which we may become subject, then we could become subject to a variety of supervisory actions and orders, including cease and desist orders, prompt corrective actions, Memorandum of Understanding, and other regulatory enforcement actions. Such supervisory actions could, among other things, impose greater restrictions on our business, as well as our ability to develop any new business. The Company could also be required to raise additional capital, or dispose of certain assets and liabilities within a prescribed time period, or both. Failure to implement remedial measures as required by financial regulatory agencies could result in additional orders or penalties from federal and state regulators, which could trigger one or more of the remedial actions described above. The terms of any supervisory action and associated consequences with any failure to comply with any supervisory action could have a material negative effect on our business, operating flexibility, and overall financial condition.

The Company is subject to liquidity risk, which could adversely affect net interest income and earnings.

The purpose of the Company’s liquidity management is to meet the cash flow obligations of its customers for both deposits and loans.  The primary liquidity measurement the Company utilizes is called basic surplus, which captures the adequacy of the Company’s access to reliable sources of cash relative to the stability of its funding mix of average liabilities.  This approach recognizes the importance of balancing levels of cash flow liquidity from short- and long-term securities with the availability of dependable borrowing sources which can be accessed when necessary.  However, competitive pressure on deposit pricing could result in a decrease in the Company’s deposit base or an increase in funding costs.  In addition, liquidity will come under additional pressure if loan growth exceeds deposit growth.  These scenarios could lead to a decrease in the Company’s basic surplus measure below the minimum policy level of 5%.  To manage this risk, the Company has the ability to purchase brokered certificates of deposit, borrow against established borrowing facilities with other banks (Federal funds), and enter into repurchase agreements with investment companies.  Depending on the level of interest rates, the Company’s net interest income, and therefore earnings, could be adversely affected.

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Our ability to service our debt, pay dividends, and otherwise pay our obligations as they come due is substantially dependent on capital distributions from our subsidiary.

The holding company is a separate and distinct legal entity from its subsidiary. It receives substantially all of its revenue from dividends from its subsidiary, Cambridge Trust Company. These dividends are the principal source of funds to pay dividends on the Company’s common stock.  Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Company. Also, the Company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service debt, pay obligations, or pay dividends on the Company’s common stock. The inability to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition, and results of operations.

A breach of information security, including cyber-attacks, could disrupt our business and impact our earnings.

The Company depends upon data processing, communication, and information exchange on a variety of computing platforms and networks and over the internet.  In addition, we rely on the services of a variety of vendors to meet our data processing and communication needs.  Despite existing safeguards, we cannot be certain that all of our systems are free from vulnerability to attack or other technological difficulties or failures.  If information security is breached or difficulties or failures occur, despite the controls we and our third party vendors have instituted, information can be lost or misappropriated, resulting in financial loss or costs to us, reputational harm, or damages to others. Such costs or losses could exceed the amount of insurance coverage, if any, which would adversely affect our earnings.

The Company may be adversely affected by fraud.

The Company is inherently exposed to operational risk in the form of theft and other fraudulent activity by employees, customers, and other third parties targeting the Company and/or the Company’s customers or data. Such activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering, and other dishonest acts.

Although the Company devotes substantial resources to maintaining effective policies and internal controls to identify and prevent such incidents, given the increasing sophistication of possible perpetrators, the Company may experience financial losses or reputational harm as a result of fraud.

The Company continually encounters technological change and the failure to understand and adapt to these changes could hurt our business.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological changes affecting the financial services industry could have a material adverse impact on the Company’s business and, in turn, the Company’s financial condition and results of operations.

The Company relies on third parties to provide key components of its business infrastructure.

The Company relies on third parties to provide key components for its business operations, such as data processing and storage, recording and monitoring transactions, online banking interfaces and services, internet connections, and network access. While the Company selects these third-party vendors carefully, it does not control their actions. Any problems caused by these third parties, including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher volumes, cyber-attacks and security breaches at a vendor, failure of a vendor to provide services for any reason, or poor performance of services by a vendor, could adversely affect the Company’s ability to deliver products and services to its customers and otherwise conduct its business. Financial or operational difficulties of a third-party vendor could also hurt the Company’s operations if those difficulties interfere with the vendor's ability to serve the Company. Replacing these third party vendors could create significant delays and expense that adversely affect the Company’s business and performance.

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The possibility of the economy’s return to recessionary conditions and the possibility of further turmoil or volatility in the financial markets would likely have an adverse effect on our business, financial position, and results of operations.

The economy in the United States and globally has experienced volatility in recent years and may continue to do so for the foreseeable future. There can be no assurance that economic conditions will not worsen.  Unfavorable or uncertain economic conditions can be caused by declines in economic growth, business activity, or investor or business confidence, limitations on the availability or increases in the cost of credit and capital, increases in inflation or interest rates, the timing and impact of changing governmental policies, natural disasters, terrorist attacks, acts of war, or a combination of these or other factors. A worsening of business and economic conditions could have adverse effects on our business, including the following:

The Company is subject to other-than-temporary impairment risk, which could negatively impact our financial performance.

The Company recognizes an impairment charge when the decline in the fair value of equity, debt securities, and cost-method investments below their cost basis are judged to be other-than-temporary. Significant judgment is used to identify events or circumstances that would likely have a significant adverse effect on the future use of the investment. The Company considers various factors in determining whether an impairment is other-than-temporary, including the severity and duration of the impairment, forecasted recovery, the financial condition and near-term prospects of the investee, whether the Company has the intent to sell and whether it is more likely than not it will be forced to sell the security in question. Information about unrealized gains and losses is subject to changing conditions. The values of securities with unrealized gains and losses will fluctuate, as will the values of securities that we identify as potentially distressed. Our current evaluation of other-than-temporary impairments reflects our intent to hold securities for a reasonable period of time sufficient for a forecasted recovery of fair value. However, our intent to hold certain of these securities may change in future periods as a result of facts and circumstances impacting a specific security. If our intent to hold a security with an unrealized loss changes and we do not expect the security to fully recover prior to the expected time of disposition, we will write down the security to its fair value in the period that our intent to hold the security changes.

The risks presented by acquisitions could adversely affect our financial condition and results of operations.

The business strategy of the Company may include growth through acquisition.  Any future acquisitions will be accompanied by the risks commonly encountered in acquisitions.  These risks may include, among other things:

The Company cannot provide any assurance that we will be successful in overcoming these risks or any other problems encountered in connection with acquisitions. Our inability to overcome these risks could have an adverse effect on the achievement of our business strategy and results of operations.

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There are substantial risks and uncertainties associated with the introduction or expansion of lines of business or new products and services within existing lines of business.

From time to time, the Company may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, the Company may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove attainable.  External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Company’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Company’s business, results of operations, and financial condition.

Our controls and procedures may fail or be circumvented, which may result in a material adverse effect on our business.

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to could have a material adverse effect on our business, results of operations and financial condition.

The Company is exposed to risk of environmental liabilities with respect to properties to which we obtain title.

A significant portion of our loan portfolio is secured by real estate. In the course of our business, we may foreclose and take title to real estate and could be subject to environmental liabilities with respect to these properties. The Company may be held liable to a government entity or to third parties for property damage, personal injury, investigation, and clean-up costs incurred by these parties in connection with environmental contamination or may be required to clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation and remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect our business, results of operations, and prospects.

The Company may be adversely affected by the soundness of other financial institutions, including the FHLB of Boston.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. The Company has exposure to different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated if the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our business, financial condition, or results of operations.

The Company owns common stock of FHLB of Boston in order to qualify for membership in the FHLB system, which enables it to borrow funds under the FHLB of Boston’s advance program. The carrying value and fair market value of our FHLB of Boston common stock was $4.2 million as of December 31, 2017. There are 11 branches of the FHLB, including Boston, which are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB branch cannot meet its obligations to pay its share of the system’s debt, other FHLB branches can be called upon to make the payment.  Any adverse effects on the FHLB of Boston could adversely affect the value of our investment in its common stock and negatively impact our results of operations.

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The Company’s common stock price may fluctuate significantly.

The market price of the Company’s common stock may fluctuate significantly in response to a number of factors including, but not limited to:

There may be future sales or other dilution of the Company’s equity, which may adversely affect the market price of the Company’s stock.

The Company is not restricted from issuing additional common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock.  The Company also grants shares of common stock to employees and directors under the Company’s incentive plan each year.  The issuance of any additional shares of the Company’s common stock or securities convertible into, exchangeable for or that represent the right to receive common stock, or the exercise of such securities could be substantially dilutive to shareholders of the Company’s common stock.  Holders of the Company’s common stock have no preemptive rights that entitle such holders to purchase their pro rata share of any offering of shares or any class or series.  Because the Company’s decision to issue securities in any future offering will depend on market conditions, its acquisition activity and other factors, the Company cannot predict or estimate the amount, timing, or nature of its future offerings.  Thus, the Company’s shareholders bear the risk of the Company’s future offerings reducing the market price of the Company’s common stock and diluting their stock holdings in the Company.

The Company depends on our executive officers and key personnel to continue the implementation of our long-term business strategy and could be harmed by the loss of their services.

The Company believes that our continued growth and future success will depend in large part upon the skills of our management team. The competition for qualified personnel in the financial services industry is intense, and the loss of our key personnel, or an inability to continue to attract or retain and motivate key personnel could adversely affect our business. We cannot assure that we will be able to retain our existing key personnel, attract additional qualified personnel, or effectively manage the succession of key personnel. We have change of control agreements with our actively employed named executive officers, and the loss of the services of one or more of our executive officers and key personnel could impair our ability to continue to develop our business strategy.

The Company may be subject to more stringent capital requirements.

The Bank and the Company are each subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital which each of the Bank and the Company must maintain. From time to time, the regulators implement changes to these regulatory capital adequacy guidelines. If we fail to meet these minimum capital guidelines and other regulatory requirements, then our financial condition would be materially and adversely affected. In light of proposed changes to regulatory capital requirements contained in the Dodd-Frank Act and the regulatory accords on international banking institutions formulated by the Basel Committee and implemented by the Federal Reserve and the Office of the Comptroller of the Currency (“OCC”), we may be required to satisfy additional, more stringent, capital adequacy standards. The ultimate impact of the revised capital and liquidity standards on us cannot be determined at this time and will depend on a number of factors, including the treatment and implementation by the federal banking regulators. These requirements, however, and any other new regulations, could adversely affect our ability to pay dividends, or could require us to reduce business levels or to raise capital, including in ways that may adversely affect our financial condition or results of operations.

17

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

The Company conducts its business through 11 full-service banking offices, including its main banking office and headquarters in Cambridge, Massachusetts, its operations center in Burlington, Massachusetts, four wealth management offices and one off-site ATM.  The following table sets forth certain information regarding our properties as of December 31, 2017:

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Item 3. Legal Proceedings.

From time to time, the Company and its subsidiaries may be parties to various claims and lawsuits arising in the ordinary course of their normal business activities. Although the ultimate outcome of these suits, if any, cannot be ascertained at this time, it is the opinion of management that none of these matters, even if it resolved adversely to the Company, will have a material adverse effect on the Company’s consolidated financial position. The Company is not currently party to any pending legal proceedings.  

Item 4. Mine Safety Disclosures.

None.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

On October 17, 2017, the SEC declared the Company’s Registration Statement on Form 10, as amended, effective. On October 18, 2017, shares of the Company’s common stock commenced trading on the Nasdaq stock market under the symbol CATC. Prior to this date the Company’s shares traded on the over the counter market. The following table summarizes quarterly high and low stock price ranges, the end of quarter closing price and dividends paid per share for the years ended December 31, 2017 and 2016:

At February 28, 2018, there were 341 holders of record of the Company’s common stock.

The continued payment of dividends depends upon our profitability, debt and equity structure, earnings, financial condition, need for capital and other factors, including economic conditions, regulatory restrictions and tax considerations. We cannot guarantee the payment of dividends or that, if paid, that dividends will not be reduced or eliminated in the future.

The only funds available for the payment of dividends on our capital stock will be cash and cash equivalents held by us, dividends paid to us by the Bank, and borrowings. The Bank will be prohibited from paying cash dividends to us to the extent that any such payment would reduce the Bank’s capital below required capital levels.

The Company’s primary source of funds for dividends paid to shareholders is the receipt of dividends from the Bank. A discussion of the restrictions on the advance of funds or payments of dividends by the Bank to the Company is included in “Supervision and Regulation – Dividends.”

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Stock Performance Graph

The following compares the cumulative total shareholder return on the Company’s common stock against the cumulative total return of the NASDAQ Composite Index and the SNL Bank NASDAQ Index from December 31, 2012 to December 31, 2017. The results presented assume that the value of the Company’s common stock and each index was $100.00 on December 31, 2012.  The total return assumes reinvestment of dividends.

Source:  S&P Global Market Intelligence © 2017

The stock price performance shown on the stock performance graph and associated table below is not necessarily indicative of future price performance. Information used in the graph and table was obtained from a third party provider, a source believed to be reliable, but the Company is not responsible for any errors or omissions in such information.

Issuer Purchase of Equity Securities

Except as previously reported in our quarterly report on Form 10-Q and Registration Statement on Form 10 filed with the Securities and Exchange Commission during 2017, the Company did not repurchase any additional shares during the year ended December 31, 2017.

Recent Sales of Unregistered Securities

Except as previously reported in our quarterly report on Form 10-Q and Registration Statement on Form 10 filed with the Securities and Exchange Commission during 2017, there were no additional unregistered sales of equity securities during the year ended December 31, 2017.

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Item 6. Selected Financial Data.

The selected consolidated financial data set forth below does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information including the Consolidated Financial Statements and related Notes, and the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

Cambridge Bancorp (together with its bank subsidiary, unless the context otherwise requires, the “Company”) is a Massachusetts state-chartered, federally registered bank holding company headquartered in Cambridge, Massachusetts. The Company is a Massachusetts corporation formed in 1983 and has one banking subsidiary (the “Bank”): Cambridge Trust Company, formed in 1890.  At December 31, 2017, the Company had total assets of approximately $1.9 billion. Currently, the Bank operates 10 full-service banking offices in six cities and towns in Eastern Massachusetts. The Company’s Wealth Management Group has four offices, one in Boston, Massachusetts and three in New Hampshire in Concord, Manchester, and Portsmouth. The Company’s Assets under Management and Administration as of December 31, 2017 were approximately $3.1 billion.  The Bank’s clients consist primarily of small- and medium-sized businesses and retail customers in these communities and surrounding areas throughout Massachusetts and New Hampshire.

The Company’s results of operations are largely dependent on net interest income, which is the difference between the interest earned on loans and securities and interest paid on deposits and borrowings. The results of operations are also affected by the level of income and fees from wealth management services, loans, deposits, as well as operating expenses, the provision for loan losses, the impact of federal and state income taxes, and the relative levels of interest rates and economic activity.

Critical Accounting Policies

Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on the carrying value of certain assets and impact income, are considered critical accounting policies.

The Company considers allowance for loan losses and income taxes to be its critical accounting policies.

Allowance for loan losses

Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. Management maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on assessments of the probable estimated losses inherent in the loan portfolio. Management’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include the specific allowances, if appropriate, for identified problem loans, formula allowance, and possibly an unallocated allowance.

The provision for loan losses and the level of the allowance for loan losses reflects management’s estimate of probable loan losses inherent in the loan portfolio at the balance sheet date. Management uses a systematic process and methodology to establish the allowance for loan losses each quarter. To determine the total allowance for loan losses, management estimates the allowance needed for each of the following segments of the loan portfolio: (1) residential mortgage loans, (2) commercial mortgage loans, including multi-family loans and construction loans, (3) home equity loans and lines of credit, (4) commercial & industrial loans, and (5) consumer loans.

The establishment of the allowance for each portfolio segment is based on a process that evaluates the risk characteristics relevant to each portfolio segment and takes into consideration multiple internal and external factors.

Internal factors include, but are not limited to:

(a) the loss emergence period,

(b) historic levels and trends in the number and amount of loans on non-accrual and past due, charge-offs, delinquencies, risk ratings, and foreclosures,

(c) level and changes in industry, geographic, and credit concentrations,

(d) underwriting policies and adherence to such policies,

(e) the growth and vintage of the portfolios, and

(f) the experience of, and any changes in, lending and credit personnel.

External factors include, but are not limited to:

(a) conditions and trends in the local and national economy and

(b) levels and trends in national delinquent and non-performing loans.

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The Bank evaluates certain loans individually for specific impairment. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Loans are selected for evaluation based upon internal risk rating, delinquency status, or non-accrual status. A specific allowance amount is allocated to an individual loan when such loan has been deemed impaired and when the amount of the probable loss is able to be estimated. Estimates of loss may be determined by the present value of anticipated future cash flows, the loan’s observable fair market value, or the fair value of the collateral, if the loan is collateral dependent.

Income Taxes

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, the Commonwealth of Massachusetts, the State of New Hampshire, and other states as required. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred tax assets are reviewed quarterly and reduced by a valuation allowance if, based upon the information available, it is more likely than not that some or all of the deferred tax assets will not be realized. Interest and penalties related to unrecognized tax benefits, if incurred, are recognized as a component of income tax expense.

In accordance with the Tax Cuts and Jobs Act of 2017 (the “Tax Act”), the Company re-measured its net deferred tax assets which resulted in a one-time non-cash write-down of its net deferred tax assets and recognized an additional income tax expense of $3.9 million for the year ended December 31, 2017.  Effective in 2018, the change in tax law will reduce the Company’s statutory federal tax rate from 35% to 21%.

Recent Accounting Developments

See Note 3 to the Audited Consolidated Financial Statements for details of recently issued and adopted accounting pronouncements and their expected impact on the Corporation’s financial statements.

Results of Operations

Results of Operations for the years ended December 31, 2017 and 2016

General. Net income decreased by $2.1 million, or 12.3%, to $14.8 million for the year ended December 31, 2017, from $16.9 million for the year ended December 31, 2016. The decrease was primarily due to a $4.8 million increase in income tax expense and a $2.5 million increase in noninterest expense, partially offset by a $3.7 million increase in net interest and dividend income after the provision for loan losses, and a $1.6 million increase in noninterest income. The increase in income tax expense was mainly due to the enactment of the Tax Act.  The change in tax law will reduce the statutory federal tax rate from 35% to 21% effective in 2018 and required the Company to take a one-time non-cash write-down of its net deferred tax assets of $3.9 million, as these deferred tax assets were required to be re-measured using the new lower tax rate in 2017.

Net Interest and Dividend Income. Net interest and dividend income after provision for loan losses increased by $3.7 million, or 6.9% to $57.2 million for the year ended December 31, 2017, from $53.5 million for the year ended December 31, 2016. The increase in net interest and dividend income after provision for loan losses was primarily due to higher average loan balances.  Interest on loans increased by $3.0 million, or 6.1% for the year ended December 31, 2017, as compared to the year ended December 31, 2016.  Total average interest-earning assets increased $97.9 million, or 5.7%, to $1.8 billion for the year ended December 31, 2017 from $1.7 billion in 2016. The Company’s net interest margin, on a fully tax equivalent basis, increased four basis points to 3.25% for the year ended December 31, 2017, as compared to 3.21% in 2016, and the net interest rate spread increased four basis points to 3.16% for the year ended December 31, 2017, compared to 3.12% in 2016.

Interest and Dividend Income. Total interest and dividend income increased by $4.2 million, or 7.3%, to $61.2 million for the year ended December 31, 2017, from $57.0 million in 2016. The increase in interest and dividend income was primarily due to a $3.0 million increase in interest income on loans and a $1.0 million increase in interest income on investment securities. Total average interest-earning assets increased $97.9 million, or 5.7%, to $1.8 billion for the year ended December 31, 2017 from $1.7 billion in 2016.

Interest Expense. Interest expense increased by $232,000, or 6.9%, to $3.6 million for the year ended December 31, 2017, from $3.4 million in 2016. The increase was primarily the result of a $69.5 million increase in the average balance of interest-bearing liabilities.  The average cost of interest bearing liabilities remained unchanged from 2016 and stood at 0.29%.

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Provision for Loan Losses. The Company recorded a provision for loan losses of $362,000 for the year ended December 31, 2017, compared to a provision for loan losses of $132,000 in 2016. We recorded net charge-offs of $303,000 for the year ended December 31, 2017, compared to net charge-offs of $62,000 during 2016. The allowance for loan losses was $15.3 million, or 1.13% of total loans outstanding at December 31, 2017, as compared to $15.3 million, or 1.16% of total loans outstanding at year end 2016.

Noninterest Income.  Noninterest income increased by $1.6 million, or 5.5%, to $30.2 million for the year ended December 31, 2017, as compared to $28.7 million for the year ended December 31, 2016, primarily as a result of higher wealth management revenue. The Company’s wealth management revenue is the largest component of noninterest income and increased by $2.6 million, or 12.9%, to $23.0 million for the year ended 2017, as compared to $20.4 million in 2016 due to a combination of market appreciation and net new business. Assets under Management combined with Assets under Administration were $3.1 billion at December 31, 2017 compared to $2.7 billion at December 31, 2016.

The categories of wealth management revenues are shown in the following table:

The following table presents the changes in wealth management assets under management:

There were no significant changes to the average fee rates and fee structure for the year ended December 31, 2017 and 2016.

Noninterest Expense. Noninterest expense increased by $2.5 million, or 4.5%, to $59.3 million for the year ended December 31, 2017, as compared to $56.8 million in 2016, primarily driven by higher salaries and benefits expense and professional services. The increase in salaries and benefits expense of $2.2 million is primarily due to annual merit increases, increased staffing to support business initiatives, and higher employee benefit costs. The increase in professional services of $980,000 is a result of increased recruitment fees, legal costs, audits and exams, compensation consulting, marketing consulting, training and development, and costs associated with the registration of our securities with the SEC.

Noninterest expense increases were partially offset by decreases in occupancy and equipment expense of $217,000 and lower FDIC insurance expense of $205,000 for the year ended December 31, 2017, as compared to 2016.

Income Tax Expense. In accordance with the Tax Act, the Company re-measured its net deferred tax assets which resulted in a one-time non-cash write-down of its net deferred tax assets and recognized an additional income tax expense of $3.9 million for the year ended December 31, 2017. The Company recorded a provision for income taxes of $13.4 million for the year ended December 31, 2017, compared to a provision for income taxes of $8.6 million for 2016, reflecting effective tax rates of 47.41%, and 33.62%, respectively. The Company also recognized $221,000 of tax benefit resulting from the adoption of new accounting guidance for share-based payments during 2017.

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Results of Operations for the years ended December 31, 2016 and 2015

General. Net income increased $1.2 million, or 7.7%, to $16.9 million for the year ended December 31, 2016, from $15.7 million for the year ended December 31, 2015. The increase was primarily due to a $3.0 million increase in net interest and dividend income after the provision for loan losses, a $2.8 million increase in noninterest income, partially offset by a $3.6 million increase in noninterest expense, and a $1.0 million increase in income tax expense.

Net Interest and Dividend Income. Net interest and dividend income after provision for loan losses increased by $3.0 million to $53.5 million for the year ended December 31, 2016, from $50.6 million for the year ended December 31, 2015. The increase in net interest and dividend income after provision for loan losses was primarily due to strong loan growth in both 2016 and 2015.  Interest income on loans increased by $3.4 million, or 7.5%.  Total average interest-earning assets increased to $1.7 billion for the year ended December 31, 2016, from $1.6 billion for the year ended December 31, 2015. The Company’s net interest margin, on a fully taxable basis, decreased 11 basis points to 3.21% for the year ended December 31, 2016, compared to 3.32% for the year ended December 31, 2015, and our net interest rate spread decreased 12 basis point to 3.12% for the year ended December 31, 2016, compared to 3.24% for the year ended December 31, 2015.

Interest and Dividend Income. Total interest and dividend income increased $2.7 million, or 4.9%, to $57.0 million for the year ended December 31, 2016, from $54.3 million for the year ended December 31, 2015. The increase in interest and dividend income was primarily due to a $3.4 million increase in interest income on loans, partially offset by a $720,000 decrease in interest income on investment securities. The increase in interest income on loans resulted primarily from a $119.2 million increase in the average balance of loans.

Interest Expense. Interest expense increased $661,000, or 24.5%, to $3.4 million for the year ended December 31, 2016, from $2.7 million for the year ended December 31, 2015. The increase was driven by a $76.8 million increase in the average balance of interest-bearing liabilities as well an increase in the average cost of interest bearing liabilities of four basis points to 0.29% from 0.25%.

Interest expense on interest-bearing deposits increased by $801,000 to $3.3 million for the year ended December 31, 2016, from $2.5 million for the year ended December 31, 2015. This increase was primarily due to an increase of $151.9 million in the average balance of interest-bearing deposits to $1.2 billion at December 31, 2016, from $1.0 billion at December 31, 2015. The average cost of interest-bearing deposits remained low at 0.28% for the year ended December 31, 2016, compared to 0.24% for the year ended December 31, 2015. The average cost of certificates of deposits increased slightly during the year ended December 31, 2016 as compared to the year ended December 31, 2015, and we experienced an increase in the average cost of savings accounts for the year ended December 31, 2016, as compared to the year ended December 31, 2015 as the Bank has been able to grow these products and attract new relationships.

Provision for Loan Losses. The Company recorded a provision for loan losses of $132,000 for the year ended December 31, 2016, compared to a provision for loan losses of $1.1 million for the year ended December 31, 2015. The decrease in provision expense is primarily due to the change in the allowance methodology that occurred during 2016. We recorded net charge-offs of $62,000 for the year ended December 31, 2016, compared to net charge-offs of $153,000 during the year ended December 31, 2015. The allowance for loan losses was $15.3 million, or 1.16% of total loans, at December 31, 2016, compared to $15.2 million, or 1.27% of total loans, at December 31, 2015.

Noninterest Income.  Noninterest income increased $2.8 million to $28.7 million in 2016, compared to $25.9 million in 2015. The Company’s wealth management revenue is the largest component of noninterest income and increased by $1.1 million, or 6.0%, to $20.4 million compared, to $19.2 million for 2015. Assets under Management combined with Assets under Administration were $2.7 billion at year-end 2016, compared to $2.4 billion at year-end 2015.

The categories of wealth management revenues are shown in the following table:

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The following table presents the changes in wealth management assets under management:

There were no significant changes to the average fee rates and fee structure for the year ended December 31, 2016 and 2015.

Noninterest Expense. Noninterest expense increased $3.6 million to $56.8 million for the year ended December 31, 2016, from $53.2 million for the year ended December 31, 2015. This increase was primarily the result of strategic new hires to support business growth, coupled with higher expenses related to long-term equity compensation and health care benefits.  The increase of $307,000 in occupancy and equipment for the year is the result of increased cost of facilities and amortization of leasehold improvements. The increase of $217,000 in data processing expense is attributable to increased transaction volumes and new products. The increase of $134,000 in professional services is primarily the result of higher consulting fees. The increases in noninterest expense categories were partially offset by lower marketing expenses of $674,000 for 2016.

Income Tax Expense. The Company recorded a provision for income taxes of $8.6 million for the year ended December 31, 2016, compared to a provision for income taxes of $7.6 million for the year ended December 31, 2015, reflecting effective tax rates of 33.62% and 32.49%, respectively. The effective tax rate was reduced from the statutory federal income tax rate of 35% largely as a result of the benefits of tax-exempt income, partially offset by state income tax expense. The effective tax rate for the year ended December 31, 2016, as compared to the effective tax rate for the year ended December 31, 2015, increased primarily as a result of higher state income tax expense.

Results of Operations for the years ended December 31, 2015 and 2014

General. Net income increased $750,000, or 5.0%, to $15.7 million for the year ended December 31, 2015, from $14.9 million for the year ended December 31, 2014. The increase was primarily due to a $3.8 million increase in net interest and dividend income after the provision for loan losses, a $1.4 million increase in noninterest income, partially offset by a $4.2 million increase in noninterest expense, and a $315,000 increase in income tax expense.

Net Interest and Dividend Income. Net interest and dividend income after provision for loan losses increased by $3.8 million to $50.6 million for the year ended December 31, 2015, from $46.7 million for the year ended December 31, 2014. The increase in net interest and dividend income after provision for loan losses was primarily due to strong loan growth in both 2015 and 2014.  Interest income on loans increased by $4.9 million, or 12.0%.  Total average interest-earning assets increased to $1.7 billion for the year ended December 31, 2015, from $1.5 billion for the year ended December 31, 2014. The Company’s net interest margin, on a fully taxable basis, decreased five basis points to 3.32% for the year ended December 31, 2015, compared to 3.37% for the year ended December 31, 2014, and the net interest rate spread decreased seven basis point to 3.24% for the year ended December 31, 2015, compared to 3.31% for the year ended December 31, 2014.

Interest and Dividend Income. Total interest and dividend income increased $4.0 million, or 7.9%, to $54.3 million for the year ended December 31, 2015, from $50.4 million for the year ended December 31, 2014. The increase in interest and dividend income was primarily due to a $4.9 million increase in interest income on loans partially offset by a $1.1 million decrease in interest income on investment securities. The increase in interest income on loans resulted primarily from a $152.6 million increase in the average balance of loans.

Interest Expense. Interest expense increased $596,000, or 28.4%, to $2.7 million for the year ended December 31, 2015, from $2.1 million for the year ended December 31, 2014. The increase was driven by an $84.0 million increase in the average balance of interest-bearing liabilities as well an increase in the average cost of interest bearing liabilities of four basis points to 0.25% from 0.21%.

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Interest expense on interest-bearing deposits increased by $509,000 to $2.5 million for the year ended December 31, 2015, from $2.0 million for the year ended December 31, 2014. This increase was primarily due to an increase of $71.4 million in the average balance of interest-bearing deposits to $1.0 billion at December 31, 2015, from $937.0 million at December 31, 2014. The average cost of interest-bearing deposits remained low at 0.24% for the year ended December 31, 2015, compared to 0.21% for the year ended December 31, 2015. The average cost of certificates of deposits increased slightly during the year ended December 31, 2015, as compared to the year ended December 31, 2014, and we experienced an increase in the average cost of savings accounts for the year ended December 31, 2015, as compared to the year ended December 31, 2014 as the Bank was able to grow these products and attract new relationships.

Provision for Loan Losses. The Company recorded a provision for loan losses of $1.1 million for the year ended December 31, 2015, compared to a provision for loan losses of $1.6 million for the year ended December 31, 2014. We recorded net charge-offs of $153,000 for the year ended December 31, 2015, compared to net recoveries of $11,000 during the year ended December 31, 2014. The allowance for loan losses was $15.2 million, or 1.27% of total loans, at December 31, 2015, compared to $14.3 million, or 1.32% of total loans, at December 31, 2014.

Noninterest Income.  Noninterest income increased $1.4 million to $25.9 million in 2015, compared to $24.5 million in 2014. The Company’s wealth management revenue is the largest component of noninterest income and increased by $1.3 million, or 7.2%, to $19.2 million, compared to $17.9 million for 2014. Assets under Management combined with Assets under Administration were $2.4 billion at year-end 2015 compared to $2.4 billion at year-end 2014.

The categories of wealth management revenues are shown in the following table:

The following table presents the changes in wealth management assets under management:

There were no significant changes to the average fee rates and fee structure for the year ended December 31, 2015 and 2014.

Noninterest Expense. Noninterest expense increased $4.2 million to $53.2 million for the year ended December 31, 2015, from $49.0 million for the year ended December 31, 2014. The increase in salary and benefits of $3.0 million is primarily due to higher retirement plan expenses, annual merit increases, and higher health care costs.  The increase of $514,000 in occupancy and equipment for the year is the result of increased cost of facilities and amortization of leasehold improvements and higher software maintenance costs. The increase of $263,000 in marketing expense is primarily the result of additional marketing initiatives in 2015. The increase of $252,000 in professional services is primarily the result of higher consulting fees. The increase of $240,000 in data processing expense is largely attributable to increased transaction volumes and new products.

Income Tax Expense. The Company recorded a provision for income taxes of $7.6 million for the year ended December 31, 2015, compared to a provision for income taxes of $7.2 million for the year ended December 31, 2014, reflecting effective tax rates of 32.49% and 32.63%, respectively. The effective tax rate was reduced from the statutory federal income tax rate of 35% largely as a result of the benefits of tax-exempt income, partially offset by state income tax expense.

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Changes in Financial Condition

Total Assets. Total assets increased $100.9 million, or 5.5%, to $1.9 billion at December 31, 2017, from $1.8 billion at December 31, 2016. The increase was primarily the result of a $49.5 million, or 91.7% increase in cash and cash equivalents and a $30.7 million, or 2.4% increase in net loans.

Cash and Cash Equivalents. Cash and cash equivalents increased by $49.5 million to $103.6 million at December 31, 2017, from $54.1 million at December 31, 2016.

Investment Securities. The carrying value of total investment securities increased by $29.1 million to $437.2 million at December 31, 2017, from $408.1 million at December 31, 2016. The increase in investment securities was driven by an increase of $149.7 million, in held to maturity investment securities, partially offset by a decrease of $120.6 million in available for sale investment securities.

Loans Held for Sale. Loans held for sale decreased to $0 at December 31, 2017 from $6.5 million at December 31, 2016. The balance of loans held for sale usually relates to the timing and volume of residential loans originated for sale and the ultimate sale transaction which is typically executed within a short-time following the loan origination.

Loans. Net loans increased by $30.7 million, or 2.4%, to $1.3 billion at December 31, 2017, from $1.3 billion at December 31, 2016. The growth in total loans was primarily due to increases of $17.5 million, or 2.8%, in commercial mortgages, $5.6 million, or 9.4% increase in commercial and industrial loans, a $4.5 million, or 0.8% increase in residential mortgages, and a $3.7 million, or 10.7% increase in consumer loans.

Bank-Owned Life Insurance. The Company invests in bank-owned life insurance to help offset the costs of our employee benefit plan obligations. Bank-owned life insurance also generally provides noninterest income that is nontaxable. At December 31, 2017, our investment in bank-owned life insurance was $31.1 million, an increase of $584,000 from $30.5 million at December 31, 2016, primarily due to increases in the cash surrender value of the policies.

Deposits. Deposits increased $89.4 million, or 5.3%, to $1.8 billion at December 31, 2017, from $1.7 billion at December 31, 2016. The increase was primarily due to a $50.6 million increase in savings accounts, a $32.3 million increase in interest bearing checking accounts, a $20.7 million increase in demand deposit accounts partially offset by an $11.3 million decrease in certificates of deposits.  Starting in the second quarter of 2017, the Bank initiated promotional saving campaigns to attract and deepen client relationships.

Borrowings. At December 31, 2017, borrowings consisted of advances from the FHLB of Boston. Total borrowings decreased $167,000 to $3.6 million at December 31, 2017, from $3.7 million at December 31, 2016.

Shareholders’ Equity. Total shareholders’ equity increased $13.3 million, or 9.9%, to $148.0 million at December 31, 2017, from $134.7 million at December 31, 2016. The increase is the result of net income of $14.8 million, an additional $4.0 million in other comprehensive income associated with the Company’s defined benefit pension plan, an increase of $2.4 million in additional paid-in capital related to stock-based compensation, partially offset by regular dividend payments of $7.6 million for the year.  

Investment Securities

The Company’s securities portfolio consists of securities available for sale (“AFS”) and securities held to maturity (“HTM”). The largest component of the securities portfolio is mortgage-backed securities, all of which are issued by U.S. government agencies or U.S. government-sponsored enterprises.

Securities available for sale consist of certain U.S. Government Sponsored Enterprises (“GSE”) and U.S. GSE mortgage-backed securities, corporate debt securities, and mutual funds. These securities are carried at fair value, and unrealized gains and losses net of applicable income taxes, are recognized as a separate component of shareholders’ equity. The fair value of securities available for sale totaled $205.0 million and included gross unrealized gains of $260,000 and gross unrealized losses of $4.2 million at December 31, 2017.  At December, 31, 2016, the fair value of securities available for sale totaled $325.6 million and included gross unrealized gains of $515,000 and gross unrealized losses of $4.6 million.

Securities classified as held to maturity consist of certain U.S. GSE and U.S. GSE mortgage-backed securities, corporate debt securities, and state, county, and municipal securities. Securities held to maturity as of December 31, 2017 are carried at their amortized cost of $232.2 million. At December, 31, 2016, securities held to maturity totaled $82.5 million.

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The following table sets forth the fair value of available for sale investment securities, the amortized costs of held to maturity and the percentage distribution at the dates indicated:

The following tables set forth the composition and maturities of investment securities. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.